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HILLTOP HOLDINGS INC. – 10-K – 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 toHilltop Holdings Inc. and its direct and indirect wholly owned subsidiaries, references to "Hilltop" refer solely toHilltop Holdings Inc. , references to "PCC" refer toPlainsCapital Corporation (a wholly owned subsidiary of Hilltop), references to "Securities Holdings " refer toHilltop Securities Holdings LLC (a wholly owned subsidiary of Hilltop), references to "Hilltop Securities " refer toHilltop Securities Inc. (a wholly owned subsidiary ofSecurities Holdings ), references to "Momentum Independent Network" refer toMomentum Independent Network Inc. (a wholly owned subsidiary ofSecurities Holdings ),Hilltop Securities and Momentum Independent Network are collectively referred to as the "Hilltop Broker-Dealers," references to the "Bank" refer toPlainsCapital Bank (a wholly owned subsidiary of PCC), references to "FNB" refer toFirst National Bank , references to "SWS" refer to the former SWS Group, Inc., references to "PrimeLending" refer to PrimeLending, aPlainsCapital Company (a wholly owned subsidiary of the Bank) and its subsidiaries as a whole, references to "NLC" refer toNational Lloyds Corporation (formerly a wholly owned subsidiary of Hilltop) and its wholly owned subsidiaries. 50 Table of Contents 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 throughoutTexas through the Bank. We also provide an array of financial products and services through our broker-dealer and mortgage origination segments. The following includes additional details regarding the financial products and services provided by each of our primary business units.
PCC. PCC is a financial holding company that provides, through its subsidiaries,
traditional banking and wealth, investment and treasury management services
primarily in
Securities Holdings .Securities Holdings is a holding company that provides, through its subsidiaries, investment banking and other related financial services, including municipal advisory, sales, trading and underwriting of taxable and tax-exempt fixed income securities, clearing, securities lending, structured finance and retail brokerage services throughoutthe United States . The following historical consolidated data for the periods indicated has been derived from our historical consolidated financial statements included elsewhere in this Annual Report (dollars in thousands, except per share data and weighted average shares outstanding). 2021 2020 2019 Statement of Operations Data: Net interest income$ 422,982 $ 424,166 $ 438,979 Provision for (reversal of) credit losses (58,213) 96,491 7,206 Total noninterest income 1,410,275 1,690,480 1,062,817 Total noninterest expense 1,387,398 1,453,803 1,211,889 Income from continuing operations before income taxes 504,072 564,352 282,701 Income tax expense 117,976 133,071 63,714 Income from continuing operations before income taxes 386,096 431,281 218,987 Income from discontinued operations, net of income taxes - 38,396 13,990 Net income 386,096 469,677 232,977 Less: Net income attributable to noncontrolling interest 11,601 21,841 7,686 Income attributable to Hilltop $
374,495
Per Share Data: Diluted earnings per common share from continuing operations$ 4.61 $ 4.58 $ 2.29 Diluted weighted average shares outstanding$ 81,173 $ 89,304 $ 92,394 Book value per common share$ 31.95 $ 28.28 $ 23.20 Tangible book value per common share (1)$ 28.37 $ 24.77 $ 19.65 Cash dividends declared per common share$ 0.48 $ 0.36 $ 0.32 Dividend payout ratio (2) 10.34 % 7.18 % 13.12 % Balance Sheet Data: Total assets of continuing operations$ 18,689,080 $ 16,944,264 $ 14,924,019 Cash and due from banks 2,823,138 1,062,560 433,626 Securities 3,046,500 2,468,544 1,987,561 Loans held for sale 1,878,190 2,788,386 2,106,361 Loans held for investment, net of unearned income 7,879,904 7,693,141 7,381,400 Allowance for credit losses (91,352) (149,044) (61,136) Total deposits 12,818,077 11,242,319 9,032,214 Notes payable 387,904 381,987 256,269 Total stockholders' equity 2,549,203 2,350,647 2,128,796 Capital Ratios (3): Common equity to assets ratio 13.50 % 13.72 % 13.86 % Tangible common equity to tangible assets (1)
12.17 % 12.22 % 12.00 %
(1) For a reconciliation to the nearest GAAP measure, see "-Reconciliation and
Management's Explanation of Non-GAAP Financial Measures."
(2) Dividend payout ratio is defined as cash dividends declared per common share
divided by basic earnings per common share.
Ratios and financial data presented on a consolidated basis and includes
(3) discontinued operations for 2020 and 2019 periods and those assets and
liabilities classified as discontinued as ofDecember 31, 2019 . 51 Table of Contents
Income from continuing operations before income taxes during 2021 included the
following contributions from our reportable business segments.
? The banking segment contributed
during 2021;
? The broker-dealer segment contributed
taxes during 2021; and
? The mortgage origination segment contributed
income taxes during 2021.
During 2021, we paid an aggregate of
common stock, and declared and paid total common dividends of
On
of
stockholders of record as of the close of business on
Reconciliation and Management's Explanation of Non-GAAP Financial Measures
We present certain measures in our selected financial data that are not measures
of financial performance recognized by GAAP. "Tangible book value per common
share" is defined as our total stockholders' equity reduced by goodwill and
other intangible assets, divided by total common shares outstanding. "Tangible
common equity to tangible assets" is defined as our total stockholders' equity
reduced by goodwill and other intangible assets, divided by total assets reduced
by goodwill and other intangible assets. These measures are important to
investors interested in changes from period to period in tangible common equity
per share exclusive of changes in intangible assets. For companies such as ours
that have engaged in business combinations, purchase accounting can result in
the recording of significant amounts of goodwill and other intangible assets
related to those transactions.
You should not view this disclosure as a substitute for results determined in
accordance with GAAP, and our disclosure is not necessarily comparable to that
of other companies that use non-GAAP measures.
The following table reconciles these non-GAAP financial measures to the most
comparable GAAP financial measures, "book value per common share" and "equity to
total assets" (dollars in thousands, except per share data).
December 31,
2021 2020 2019
Book value per common share $ 31.95 $ 28.28 $ 23.20
Effect of goodwill and intangible assets
per share (3.58) (3.51)
(3.55)
Tangible book value per common share
Hilltop stockholders' equity$ 2,522,668 $ 2,323,939 $ 2,103,039 Less: goodwill and intangible assets, net 282,731 287,811 321,590 Tangible common equity$ 2,239,937 $ 2,036,128 $ 1,781,449 Total assets$ 18,689,080 $ 16,944,264 $ 15,172,448 Less: goodwill and intangible assets, net 282,731 287,811 321,590 Tangible assets$ 18,406,349 $ 16,656,453 $ 14,850,858 Equity to assets 13.50 % 13.72 % 13.86 % Tangible common equity to tangible assets 12.17 % 12.22 % 12.00 % 52 Table of Contents Recent Developments COVID-19 The COVID-19 pandemic and related governmental control measures severely disrupted financial markets and overall economic conditions throughout 2020. While the impact of the pandemic and the uncertainties have remained into 2022, significant progress associated with COVID-19 vaccination levels inthe United States has resulted in easing of restrictive measures inthe United States even as additional variants have emerged. Further, theU.S. federal government enacted policies to provide fiscal stimulus to the economy and relief to those affected by the pandemic, with the stimulus intended to bolster household finances as well as those of small businesses, states and municipalities. Throughout the pandemic, we have taken a number of precautionary steps to safeguard our business and our employees from COVID-19, including, but not limited to, banking by appointment, implementing employee travel restrictions and telecommuting arrangements, while maintaining business continuity so that we can continue to deliver service to and meet the demands of our clients. In 2021, we returned a majority of our employees to their respective office locations beginning in the second quarter of 2021 based initially on a rotational team schedule to better ensure that appropriate social distancing measures were followed, and with limited exceptions due to the emergence of new variants of the virus, have generally returned to pre-pandemic work arrangements with available hybrid options for designated roles. We are continuing to monitor and assess the impact of the COVID-19 pandemic on a regular basis. In light of the extreme volatility and disruptions in the capital and credit markets beginning inMarch 2020 resulting from the COVID-19 crisis and its negative impact on the economy, we took a number of precautionary actions beginning inMarch 2020 to enhance our financial flexibility, protect capital, minimize losses and ensure target liquidity levels. As a result of the short-term rate adjustments by the Federal Open Markets Committee ("FOMC") and the stressed economic outlook duringMarch 2020 , mortgage rates fell to historically low levels. Given our exposure to the mortgage market, this precipitous decline in rates resulted in significant growth in mortgage originations at bothPrimeLending and Hilltop Securities through its partnerships with certain housing finance authorities. To improve our already strong liquidity position, we raised brokered and other wholesale funding to support the enhanced mortgage activity. To meet increased liquidity demands, we raised brokered deposits during 2020 that have a remaining balance of approximately$228 million atDecember 31, 2021 , down from approximately$731 million atDecember 31, 2020 . Further, beginning inMarch 2020 , additional deposits were swept fromHilltop Securities into the Bank. SinceJune 30, 2020 , given the continued strong cash and liquidity levels at the Bank, the total funds swept fromHilltop Securities into the Bank was reduced, and was approximately$800 million as ofDecember 31, 2021 . Asset Valuation At each reporting date between annual impairment tests, we consider potential indicators of impairment. Given the current economic uncertainties surrounding COVID-19, we considered whether the events and circumstances resulted in it being more likely than not that the fair value of any reporting unit and other intangible assets were less than their respective carrying value. Impairment indicators considered comprised the condition of the economy and financial services industry; government intervention and regulatory updates; the impact of recent events to financial performance and cost factors of the reporting unit; performance of our stock and other relevant events. Given the potential impacts as a result of economic uncertainties associated with the pandemic, actual results may differ materially from our current estimates as the scope of such impacts evolves or if the duration of business disruptions is longer than currently anticipated. The Company further considered the amount by which fair value exceeded book value in the most recent quantitative analysis and sensitivities performed. At the conclusion of the annual assessment, the Company determined that as ofOctober 1, 2021 it was more likely than not that the fair value of goodwill and other intangible assets exceeded their respective carrying values. We continue to monitor developments regarding the COVID-19 pandemic and measures implemented in response to the pandemic, market capitalization, overall economic conditions and any other triggering events or circumstances that may indicate an impairment in the future. To the extent a sustained decline in our stock price or the occurrence of what management would deem to be a triggering event that could, under certain circumstances, cause us to perform impairment tests on our goodwill and other intangible assets, and result in an impairment charge being recorded for that period. In the event that we conclude that all or a portion of our goodwill and other intangible assets are impaired, a non-cash charge for the respective amount of such impairment would be recorded to earnings. Such a charge would have no impact on tangible capital or regulatory capital. 53 Table of Contents Loan Portfolio In response to the COVID-19 pandemic, the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") and the Paycheck Protection Program and Health Care Enhancement Act (the "PPP/HCE Act") were passed inMarch 2020 , which were intended to provide emergency relief to several groups and individuals impacted by the COVID-19 pandemic. Among the numerous provisions contained in the CARES Act was the creation of a$349 billion Paycheck Protection Program ("PPP"), which was later expanded by an additional$310 billion , that provides federal government loan forgiveness forSmall Business Administration ("SBA") Section 7(a) loans for small businesses, which may include our customers, to pay up to eight weeks of employee compensation and other basic expenses such as electric and telephone bills. PPP loans have: (a) an interest rate of 1.0%; (b) a two-year loan term to maturity; and (c) principal and interest payments deferred for six months from the date of disbursement. Further, the CARES Act and subsequent legislation allowed the Bank to suspend the troubled debt restructuring ("TDR") requirements for certain loan modifications to be categorized as a TDR throughJanuary 1, 2022 . Starting inMarch 2020 , the Bank implemented several actions to better support our impacted banking clients and allow for loan modifications such as principal and/or interest payment deferrals, participation in the PPP as an SBA preferred lender and personal banking assistance including waived fees, increased daily spending limits and suspension of residential foreclosure activities. The COVID-19 payment deferment programs allow for a deferral of principal and/or interest payments with such deferred principal payments due and payable on the maturity date of the existing loan. The Bank's actions during 2020 included approval of approximately$1.0 billion in COVID-19 related loan modifications as ofDecember 31, 2020 .
During 2021, the Bank has continued to support its impacted banking clients through the approval of COVID-19 related loan modifications, which resulted in an additional$16 million of new COVID-19 related loan modifications during 2021. The portfolio of active deferrals that have not reached the end of their deferral period was approximately$4 million as ofDecember 31, 2021 . While the majority of the portfolio of COVID-19 related loan modifications no longer require deferral, such loans represent elevated risk, and therefore management continues to monitor these loans.
While all industries could experience adverse impacts due to the COVID-19
pandemic, certain of our loan portfolio industry sectors and subsectors,
including real estate collateralized by office buildings, have an increased
level of risk. The following table provides information on those loans held for
investment balances, by portfolio industry sector, including collectively
evaluated allowance for credit losses, that include active COVID-19 payment
deferrals (dollars in thousands).
Allowance for Allowance for
Active Credit Losses Credit Losses
Active 90 Day Classified Allowance as a % of as a % of
90 Day Interest and Total and for Total Classified
Principal Principal Active Modifications Criticized Credit Active and Criticized
December 31, 2021 Deferrals Deferrals ($) (#) Loans Losses Modifications Loans
Hotel $ - $ - $ - - $ - $ - - % - %
Restaurants - - - - - - - % - %
Transportation &
Warehousing - - - - - - - % - %
1-4 Family
Residential - 3,573 3,573 30 3,080 54 1.5 % 1.8 %
Retail - - - - - - - % - %
Real Estate & Rental
& Leasing - - - - - - - % - %
Healthcare and Social
Assistance - - - - - - - % - %
All Other - - - - - - - % - %
$ - $ 3,573 $ 3,573 30 $ 3,080 $ 54 1.5 % 1.8 %
In addition, the Bank's loan portfolio includes collateralized loans extended to
businesses that depend on the energy industry, including those within the
exploration and production, field services, pipeline construction and
transportation sectors. Crude oil prices have increased since historical lows
observed in 2020, but uncertainty remains as economies continue to recover from
the COVID-19 pandemic, vaccination programs evolve, and future supply and demand
for oil are influenced by a return to business travel, new energy policies and
government regulation, and the pace of transition towards renewable energy
resources. At December 31, 2021 , the Bank's energy loan exposure was
approximately $75 million of loans held for investment with unfunded commitment
balances of approximately $39 million . The allowance for credit losses on the
Bank's energy portfolio was $0.3 million , or 0.4% of loans held for investment
at December 31, 2021 .
As noted above, the Bank's actions during the second quarter of 2020 and again
during the first and second quarters of 2021 included supporting our impacted
banking clients through the PPP effort. These efforts included approval and
funding of over 4,100 PPP loans, with approximately $78 million outstanding at
December 31, 2021 . The PPP loans made by the Bank are guaranteed by the SBA and,
if used by the borrower for authorized purposes, may be fully forgiven. On
October 2, 2020 , the SBA began approving PPP forgiveness applications and
remitting forgiveness payments to PPP lenders for PPP borrowers. Through
February 11, 2022 , the SBA had approved approximately 3,700 initial and second
round PPP forgiveness
54
Table of Contents
applications from the Bank totaling approximately
of approximately
Refer to the discussion in the "Financial Condition - Allowance for Credit
Losses on Loans" section that follows for more details regarding the significant
assumptions and estimates involved in estimating credit losses given the
economic uncertainties associated with COVID-19.
Outlook
The COVID-19 pandemic has adversely impacted financial markets and overall economic conditions, and is expected to continue to have implications on our business and operations. The extent of the impact of the pandemic on our operational and financial performance for 2022 is currently uncertain and will depend on certain developments outside of our control, including, among others, the ongoing distribution and effectiveness of vaccines, the emergence of new variants of the virus, government stimulus, the ultimate impact of the pandemic on our customers and clients, and additional, or extended, federal, state and local government orders and regulations that might be imposed in response to the pandemic. Additionally, our balance sheet, operating results and certain metrics during 2021 reflected strong credit quality, significant reversals of credit losses, heightened capital and liquidity levels, and low mortgage interest rates. The extent of the impact on 2022 of expected headwinds including tight housing inventories on mortgage volumes, a return to normalized credit loss exposures, declining deposit balances, the timing and magnitude of interest rate changes, and inflationary pressures associated with compensation, occupancy and software costs within our business segments is currently uncertain.
See "Item 1A. Risk Factors" for additional discussion of the potential adverse
impact of COVID-19 on our business, results of operations and financial
condition.
Factors Affecting Results of Operations
As a financial institution providing products and services through our banking, broker-dealer and mortgage origination segments, we are directly affected by general economic and market conditions, many of which are beyond our control and unpredictable. A key factor impacting our results of operations includes changes in the level of interest rates in addition to twists in the shape of the yield curve with the magnitude and direction of the impact varying across the different lines of business. Other factors impacting our results of operations include, but are not limited to, fluctuations in volume and price levels of securities, inflation, political events, investor confidence, investor participation levels, legal, regulatory, and compliance requirements and competition. All of these factors have the potential to impact our financial position, operating results and liquidity. In addition, the recent economic and political environment has led to legislative and regulatory initiatives, both enacted and proposed, that could substantially change the regulation of the financial services industry and may significantly impact us.
Factors Affecting Comparability of Results of Operations
NLC Sale OnJune 30, 2020 , we completed the sale of all of the outstanding capital stock of NLC, which comprised the operations of our former insurance segment, for cash proceeds of$154.1 million . During 2020, Hilltop recognized an aggregate gain associated with this transaction of$36.8 million , net of$5.1 million in transaction costs and was subject to post-closing adjustments. The resulting book gain from this sale transaction was not recognized for tax purposes due to the excess tax basis over book basis being greater than the recorded book gain. Any tax loss related to this transaction is deemed disallowed pursuant to the rules under the Internal Revenue Code. We also entered into an agreement at closing to refrain for a specified period from certain activities that compete with the business of NLC. As a result, NLC's results and its assets and liabilities have been presented as discontinued operations in the consolidated financial statements, and we no longer have an insurance segment. Unless otherwise noted, for purposes of this Management's Discussion and Analysis of Financial Condition and Results of Operations, "consolidated" refers to our consolidated financial position and consolidated results of operations, including discontinued operations and assets and liabilities of the discontinued operations. 55 Table of Contents
Subordinated Notes due 2030 and 2035
OnMay 7, 2020 , we completed a public offering of$50 million aggregate principal amount of 5.75% fixed-to-floating rate subordinated notes dueMay 15, 2030 (the "2030 Subordinated Notes") and$150 million aggregate principal amount of 6.125% fixed-to-floating rate subordinated notes dueMay 15, 2035 (the "2035 Subordinated Notes"). We collectively refer to the 2030 Subordinated Notes and the 2035 Subordinated Notes as the "Subordinated Notes". The price for the Subordinated Notes was 100% of the principal amount of the Subordinated Notes. The net proceeds from the offering, after deducting underwriting discounts and fees and expenses of$3.4 million , were$196.6 million . We intend to use the net proceeds of the offerings for general corporate purposes. The 2030 Subordinated Notes and the 2035 Subordinated Notes will mature onMay 15, 2030 andMay 15, 2035 , respectively. We may redeem the Subordinated Notes, in whole or in part, from time to time, subject to obtainingFederal Reserve approval, beginning with the interest payment date ofMay 15, 2025 for the 2030 Subordinated Notes and beginning with the interest payment date ofMay 15, 2030 for the 2035 Subordinated Notes, at a redemption price equal to 100% of the principal amount of the Subordinated Notes being redeemed plus accrued and unpaid interest to but excluding the date of redemption. The 2030 Subordinated Notes bear interest at a rate of 5.75% per year, payable semi-annually in arrears commencing onNovember 15, 2020 . The interest rate for the 2030 Subordinated Notes will reset quarterly beginningMay 15, 2025 to an interest rate, per year, equal to the then-current benchmark rate, which is expected to be three-month term Secured Overnight Financing Rate ("SOFR") rate, plus 5.68%, payable quarterly in arrears. The 2035 Subordinated Notes bear interest at a rate of 6.125% per year, payable semi-annually in arrears commencing onNovember 15, 2020 . The interest rate for the 2035 Subordinated Notes will reset quarterly beginningMay 15, 2030 to an interest rate, per year, equal to the then-current benchmark rate, which is expected to be three-month term SOFR rate, plus 5.80%, payable quarterly in arrears. LIBOR InJuly 2017 , theFinancial Conduct Authority ("FCA") announced that it intends to cease compelling banks to submit rates for the calculation of LIBOR after 2021. Most recently inMarch 2021 , theFCA and the Intercontinental Exchange ("ICE")Benchmark Administration concurrently confirmed their original intention to stop requesting banks to submit the rates required to calculate LIBOR after the 2021 calendar year and additionally announced firm target dates for the phase out of various LIBOR tenors. Pursuant to the announcement, one week and two-month LIBOR ceased to be published onDecember 31, 2021 , and all remaining USD LIBOR tenors will cease to be published or lose representativeness immediately afterJune 30, 2023 . Working groups comprised of various regulators and other industry groups have been formed inthe United States and other countries in order to provide guidance on this topic. In particular, the Alternative Reference Rates Committee ("ARRC") has proposed that the Secured Overnight Financing Rate ("SOFR") is the rate that represents best practice as the alternative to LIBOR for use in derivatives and other financial contracts that are currently indexed to LIBOR. The ARRC has also published recommended fallback language for LIBOR-linked financial instruments, among numerous other areas of guidance. TheFinancial Accounting Standards Board ("FASB") issued guidance inMarch 2020 intended to provide temporary optional expedients and exceptions to the GAAP guidance on contract modifications and hedge accounting to ease the financial reporting burdens related to the expected market transition from LIBOR and other interbank offered rates to alternative reference rates. Additionally, the FASB issued specific accounting guidance that permits the use of the Overnight Index Swap rate based on the SOFR to be designated as a benchmark interest rate for hedge accounting purposes. Certain loans we originated bear interest at a floating rate based on LIBOR. We also pay interest on certain borrowings and are counterparty to derivative agreements that are based on LIBOR and have existing contracts with payment calculations that use LIBOR as the reference rate. The cessation of publication of LIBOR will create various risks surrounding the financial, operational, compliance and legal aspects associated with changing certain elements of existing contracts. ARRC has proposed a paced market transition plan to SOFR from LIBOR, and organizations are currently working on industry-wide and company-specific transition plans as it relates to derivatives and cash markets exposed to LIBOR. The ARRC has formally recommended SOFR as its preferred alternative rate for LIBOR. However, at this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR and it is impossible to predict the effect of any such alternatives on the value of LIBOR-based securities and variable rate loans, or other securities or financial arrangements, given LIBOR's role in determining market interest rates globally. 56 Table of Contents We have completed our targeted assessment of exposures across the organization associated with the migration away from LIBOR and have transitioned to the impact assessment and implementation stages. In light of the above described recent changes to the LIBOR phase out dates being pushed out to 2023, we have begun taking necessary actions, including negotiating certain of our agreements based on alternative benchmark rates that have been established. Since the third quarter of 2020, PrimeLending has been originating conventional adjustable-rate mortgage, or ARM, loan products utilizing a SOFR rate with terms consistent with government-sponsored enterprise, or GSE, guidelines. In addition, the Bank's management team continues to work with its commercial relationships that have LIBOR-based contracts maturing after 2021 to amend terms and establish an alternative benchmark rate. We also continue to evaluate the impacts of the LIBOR phase-out and transition requirements as it pertains to contracts, models and systems. To date, an immaterial amount of expenses have been incurred as a result of our efforts; however, in the future we may incur additional expenses as we finalize the transition of our systems and processes away from LIBOR.
Brokered Deposits InDecember 2020 , theFederal Deposit Insurance Corporation ("FDIC") finalized revisions to its rules and prior guidance regarding brokered deposits (the "Revisions"). The Revisions are intended to modernize theFDIC's framework for regulating brokered deposits and ensure that the classification of a deposit as brokered appropriately reflects changes in the banking landscape. In addition, the Revisions are intended to modify the interest rate restrictions applicable to certain depository institutions and clarify the application of the brokered deposit requirements to non-maturity deposits. The Revisions became effective onApril 1, 2021 , but full compliance is not required during a transitionary period endingJanuary 1, 2022 . We have evaluated the Revisions and publishedFDIC guidance and, after consulting with theFDIC , expect that, effectiveJanuary 1, 2022 , we will continue to treat deposits swept to the banking segment from the broker-dealer segment as non-brokered. At that time, the cost of these sweep deposits will be based on a current market rate of interest rather than a per account fee. Company Background
FromJanuary 2007 untilNovember 2012 , our primary operations were limited to providing fire and homeowners insurance to low value dwellings and manufactured homes primarily inTexas and other areas of the southernUnited States through NLC's wholly owned insurance subsidiaries. As previously discussed, onJune 30, 2020 , we completed the sale of all of the outstanding capital stock of NLC. OnNovember 30, 2012 , we acquiredPlainsCapital Corporation pursuant to a plan of merger wherebyPlainsCapital 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. OnSeptember 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 ofEdinburg, Texas -based FNB from theFDIC , as receiver, and reopened former branches of FNB acquired from theFDIC under the "PlainsCapital Bank " name (the "FNB Transaction"). OnJanuary 1, 2015 , we acquired SWS in a stock and cash transaction (the "SWS Merger"), whereby SWS's broker-dealer subsidiaries became subsidiaries ofSecurities Holdings and SWS's banking subsidiary, Southwest Securities, FSB, was merged into the Bank. OnOctober 5, 2015 ,Southwest Securities, Inc. was renamed "Hilltop Securities Inc. " OnAugust 1, 2018 , we acquired privately-held,Houston -based BORO in an all-cash transaction ("BORO Acquisition"). In connection with the BORO Acquisition, we merged BORO into the Bank, and all customer accounts were converted to the
PlainsCapital Bank platform. Segment Information
As previously discussed, onJune 30, 2020 , we completed the sale of all of the outstanding capital stock of NLC, which comprised the operations of the former insurance segment. As a result, insurance segment results and its assets and liabilities have been presented as discontinued operations in the consolidated financial statements, and we no longer have an insurance segment. Additional details are presented in Note 3, Discontinued Operations, in the notes to our consolidated financial statements. 57 Table of Contents Following the above-noted sale of NLC, we have two primary business units within continuing operations, PCC (banking and mortgage origination) andSecurities Holdings (broker-dealer). Under accounting principles generally accepted inthe United States ("GAAP"), our continuing operations business units are comprised of three reportable business segments organized primarily by the core products offered to the segments' respective customers: banking, broker-dealer and mortgage origination. Consistent with our historical segment operating results, we anticipate that future revenues will be driven primarily from the banking segment, with the remainder being generated by our broker-dealer and mortgage origination segments. Operating results for the mortgage origination segment have historically been more volatile than operating results for the banking
and broker-dealer segments. The banking segment includes the operations of the Bank. The banking segment primarily provides business and consumer banking services from offices located throughoutTexas and generates revenue from its portfolio of earning assets. The Bank's results of operations are primarily dependent on net interest income. The Bank also derives revenue from other sources, including service charges on customer deposit accounts and trust fees. The broker-dealer segment includes the operations ofSecurities Holdings , which operates through its wholly owned subsidiariesHilltop Securities ,Momentum Independent Network and Hilltop Securities Asset Management, LLC . The broker-dealer segment generates a majority of its revenues from fees and commissions earned from investment advisory and securities brokerage services.Hilltop Securities is a broker-dealer registered with theSEC and theFinancial Industry Regulatory Authority ("FINRA") and a member of theNew York Stock Exchange ("NYSE"). Momentum Independent Network is an introducing broker-dealer that is also registered with theSEC andFINRA .Hilltop Securities ,Momentum Independent Network and Hilltop Securities Asset Management, LLC are registered investment advisers under the Investment Advisers Act of 1940. The mortgage origination segment includes the operations of PrimeLending, which offers a variety of loan products and generates revenue predominantly from fees charged on the origination and servicing of loans and from selling these loans in the secondary market.
Corporate includes certain activities not allocated to specific business
segments. These activities include holding company financing and investing
activities, merchant banking investment opportunities, and management and
administrative services to support the overall operations of the Company.
The eliminations of intercompany transactions are included in "All Other and
Eliminations." Additional information concerning our reportable segments is
presented in Note 29, Segment and Related Information, in the notes to our
consolidated financial statements.
58
Table of Contents
The following table presents certain information about the continuing operating
results of our reportable segments (in thousands). This table serves as a basis
for the discussion and analysis in the segment operating results sections that
follow.
Year Ended December 31, Variance 2021 vs 2020 Variance 2020 vs 2019
2021 2020 2019 Amount Percent Amount Percent
Net interest
income (expense):
Banking $ 406,524 $ 390,871 $ 379,258 $ 15,653 4 $ 11,613 3
Broker-Dealer 43,296 39,912 51,308 3,384 8 (11,396) (22)
Mortgage
Origination (20,400) (10,489) (6,273) (9,911) (94) (4,216) (67)
Corporate (17,239) (14,192) (5,541) (3,047) (21) (8,651) (156)
All Other and
Eliminations 10,801 18,064 20,227 (7,263) (40) (2,163) (11)
Hilltop Continuing
Operations $ 422,982 $ 424,166 $ 438,979 $ (1,184) (0) $ (14,813) (3)
Provision for
(reversal of)
credit losses:
Banking $ (58,175) $ 96,326 $ 7,280 $ (154,501) NM $ 89,046 NM
Broker-Dealer (38) 165 (74) (203) NM 239 NM
Mortgage
Origination - - - - - - -
Corporate - - - - - - -
All Other and
Eliminations - - - - - - -
Hilltop Continuing
Operations $ (58,213) $ 96,491 $ 7,206 $ (154,704) NM $ 89,285 NM
Noninterest
income:
Banking $ 45,113 $ 41,376 $ 41,753 $ 3,737 9 $ (377) (1)
Broker-Dealer 381,125 491,355 404,411 (110,230) (22) 86,944 21
Mortgage
Origination 986,990 1,172,450 634,992 (185,460) (16) 537,458 85
Corporate 9,133 3,945 2,104 5,188 132 1,841 88
All Other and
Eliminations (12,086) (18,646) (20,443) 6,560 35 1,797 9
Hilltop Continuing
Operations $ 1,410,275 $ 1,690,480 $ 1,062,817 $ (280,205) (17) $ 627,663 59
Noninterest
expense:
Banking $ 226,915 $ 232,447 $ 231,524 $ (5,532) (2) $ 923 0
Broker-Dealer 380,798 415,463 366,031 (34,665) (8) 49,432 14
Mortgage
Origination 731,056 753,917 563,998 (22,861) (3) 189,919 34
Corporate 50,507 53,040 50,968 (2,533) (5) 2,072 4
All Other and
Eliminations (1,878) (1,064) (632) (814) (77) (432) (68)
Hilltop Continuing
Operations $ 1,387,398 $ 1,453,803 $ 1,211,889 $ (66,405) (5) $ 241,914 20
Income (loss) from
continuing
operations before
taxes:
Banking $ 282,897 $ 103,474 $ 182,207 $ 179,423 173 $ (78,733) (43)
Broker-Dealer 43,661 115,639 89,762 (71,978) (62) 25,877 29
Mortgage
Origination 235,534 408,044 64,721 (172,510) (42) 343,323 530
Corporate (58,613) (63,287) (54,405) 4,674 7 (8,882) (16)
All Other and
Eliminations 593 482 416 111 23 66 16
Hilltop Continuing
Operations $ 504,072 $ 564,352 $ 282,701 $ (60,280) (11) $ 281,651 100
NMNot meaningful
Key Performance Indicators
We utilize several key indicators of financial condition and operating
performance to evaluate the various aspects of our business. In addition to
traditional financial metrics, such as revenue and growth trends, we monitor
several other financial measures and non-financial operating metrics to help us
evaluate growth trends, measure the adequacy of our capital based on regulatory
reporting requirements, measure the effectiveness of our operations and assess
operational efficiencies. These indicators change from time to time as the
opportunities and challenges in our businesses change.
Specifically, performance ratios and asset quality ratios are typically used for
measuring the performance of banking and financial institutions. We consider
return on average stockholders' equity, return on average assets and net
interest margin to be important supplemental measures of operating performance
that are commonly used by securities analysts, investors and other parties
interested in the banking and financial industry. The net recoveries
(charge-offs) to average loans outstanding ratio is also considered a key
measure for our banking segment as it indicates the performance of our loan
portfolio.
In addition, we consider regulatory capital ratios to be key measures that are
used by us, as well as banking regulators, investors and analysts, to assess our
regulatory capital position and to compare our regulatory capital to that of
other financial services companies. We monitor our capital strength in terms of
both leverage ratio and risk-based capital ratios based on capital requirements
administered by the federal banking agencies. The risk-based capital ratios are
minimum supervisory ratios generally applicable to banking organizations, but
banking organizations are widely expected to operate with capital positions well
above the minimum ratios. Failure to meet minimum capital requirements can
initiate certain mandatory actions by regulators that, if undertaken, could have
a material effect on our financial condition or results of operations.
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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 $423.0 million in net interest income
during 2021, compared with net interest income of $424.2 million and $439.0
million during 2020 and 2019, respectively. Changes in net interest income
during 2021, compared with 2020, primarily due to an increase within our banking
segment, significantly offset by a decrease within our mortgage origination
segment.
The other component of our revenue is noninterest income, which is primarily
comprised of the following:
Income from broker-dealer operations. Through
investment banking and other related financial services that generated
million,
(i) and investment and securities advisory fees and commissions, and
million,
trading portfolio activities (included within other noninterest income)
during 2021, 2020 and 2019, respectively.
Income from mortgage operations. Through PrimeLending, we generate
noninterest income by originating and selling mortgage loans. During 2021,
(ii) 2020 and 2019, we generated
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.
In the aggregate, we generated$1.4 billion ,$1.7 billion and$1.1 billion in noninterest income during 2021, 2020 and 2019, respectively. The decrease in noninterest income from continuing operations during 2021, compared with 2020, was predominantly attributable to a decrease of$186.9 million in net gains from sale of loans, other mortgage production income and mortgage loan origination fees within our mortgage origination segment and a decrease of$127.9 million in gains from derivative and trading portfolio activities within our broker-dealer segment.
We also incur noninterest expenses in the operation of our businesses. Our
businesses engage in labor intensive activities and, consequently, employees'
compensation and benefits represent the majority of our noninterest expenses.
Consolidated Operating Results
Income from continuing operations applicable to common stockholders during 2021 was$374.5 million , or$4.61 per diluted share, compared with$409.4 million , or$4.58 per diluted share, during 2020, and$211.3 million , or$2.29 per diluted share, during 2019. Hilltop's financial results from continuing operations during 2021 reflect a significant decrease in year-over-year mortgage origination segment net gains from sales of loans and other mortgage production income as well as declines in net revenues within the broker-dealer segment's structured finance business and fixed income services lines, while the banking segment reflected positive changes in macroeconomic and loan expected loss rates during 2021 as opposed to a significant build in the allowance for credit losses given the market disruption and economic uncertainties caused by COVID-19 during 2020.
Including income from discontinued operations, net of income taxes, income
applicable to common stockholders was
share, during 2020, and
Certain items included in net income during 2021, 2020 and 2019 resulted from purchase accounting associated with the PlainsCapital Merger, the FNB Transaction, the SWS Merger and the BORO Acquisition (collectively, the "Bank Transactions"). Income before income taxes during 2021, 2020 and 2019 included net accretion on earning assets and liabilities of$19.2 million ,$18.9 million and$28.5 million , respectively, and amortization of identifiable intangibles of$5.2 million ,$6.3 million and$7.6 million , respectively, related to the Bank Transactions. 60 Table of Contents
The information shown in the table below includes certain key performance
indicators on a consolidated basis.
Year Ended December 31,
2021 2020 2019
Return on average stockholders' equity (1) 15.38 % 20.03 %
11.18 % Return on average assets (2) 2.17 % 2.88 % 1.66 % Net interest margin (3) (4) 2.57 % 2.85 % 3.48 %
Leverage ratio (5) (end of year) 12.58 % 12.64 % 12.71 % Common equity Tier 1 risk-based capital ratio (6) (end of year) 21.22 % 18.97 %
16.70 %
Return on average stockholders' equity is defined as consolidated income
(1) attributable to Hilltop divided by average total Hilltop stockholders'
equity.
(2) Return on average assets is defined as consolidated net income divided by
average assets.
Net interest margin is defined as net interest income divided by average
(3) interest-earning assets. We consider net interest margin as a key indicator
of profitability as it represents interest earned on our interest-earning
assets compared to interest incurred.
The securities financing operations within our broker-dealer segment had the
(4) effect of lowering both net interest margin and taxable equivalent net
interest margin by 16 basis points, 25 basis points and 40 basis points
during 2021, 2020 and 2019, respectively.
(5) The leverage ratio is a regulatory capital ratio and is defined as Tier 1
risk-based capital divided by average consolidated assets.
The common equity Tier 1 risk-based capital ratio is a regulatory capital
ratio and is defined as common equity Tier 1 risk-based capital divided by
risk weighted assets. Common equity includes common equity Tier 1 capital
(6) (common stockholders' equity and certain minority interests in the equity
capital accounts of consolidated subsidiaries, but excluding goodwill and
various intangible assets) and additional Tier 1 capital (certain qualifying
minority interests not included in common equity Tier 1 capital, certain
preferred stock and related surplus, and certain subordinated debt). We present net interest margin and net interest income below on a taxable-equivalent basis. Net interest margin (taxable equivalent), a non-GAAP measure, is defined as taxable equivalent net interest income divided by average interest earning assets. Taxable equivalent adjustments are based on the applicable corporate federal income tax rate of 21% for all periods presented. The interest income earned on certain earning assets is completely or partially exempt from federal income tax. As such, these tax-exempt instruments typically yield lower returns than taxable investments. To provide more meaningful comparisons of net interest margins for all earning assets, we use net interest income on a taxable-equivalent basis in calculating net interest margin by increasing the interest income earned on tax-exempt assets to make it fully equivalent to interest income earned on taxable investments. During 2021, 2020 and 2019, purchase accounting contributed 12, 14 and 25 basis points, respectively, to our consolidated taxable equivalent net interest margin of 2.58%, 2.85% and 3.48%, respectively. The purchase accounting activity is primarily related to the accretion of discount of loans which totaled$18.8 million ,$18.8 million and$28.7 million during 2021, 2020 and 2019, respectively, associated with the Bank Transactions. 61 Table of Contents
The table below provides additional details regarding our consolidated net
interest income (dollars in thousands).
Year Ended December 31,
2021 2020 2019
Average Interest Annualized Average Interest Annualized Average Interest Annualized
Outstanding Earned Yield or Outstanding Earned Yield or Outstanding Earned Yield or
Balance or Paid Rate Balance or Paid Rate Balance or Paid Rate
Assets
Interest-earning assets
Loans held for sale $ 2,293,543 $ 64,767 2.82 % $ 2,306,203 $ 74,467 3.23 % $ 1,501,154 $ 64,830 4.32 %
Loans held for investment,
gross (1) 7,645,292 339,548 4.44 % 7,618,723 358,844 4.71 % 7,088,208 395,641 5.58 %
Investment securities -
taxable 2,493,848 47,582 1.91 % 1,897,859 49,936 2.63 % 1,803,622 61,983 3.44 %
Investment securities -
non-taxable (2) 313,703 11,448 3.65 % 231,824 7,918 3.42 % 233,713 6,803 2.91 %
Federal funds sold and
securities purchased under
agreements to resell 152,273 372 0.24 % 90,961 138 0.15 % 63,598 1,236 1.94 %
Interest-bearing deposits
in other financial
institutions 2,078,666 2,942 0.14 % 1,257,902 3,165 0.25 % 371,312 8,469 2.28 %
Securities borrowed 1,445,464 61,667 4.21 % 1,435,572 51,360 3.58 % 1,550,322 69,582 4.49 %
Other 50,929 3,332 6.54 % 59,412 3,687 6.21 % 75,298 6,869 9.12 %
Interest-earning assets,
gross (2) 16,473,718 531,658 3.23 % 14,898,456 549,515 3.69 % 12,687,227 615,413 4.85 %
Allowance for credit
losses (129,689) (122,148) (57,690)
Interest-earning assets,
net 16,344,029 14,776,308 12,629,537
Noninterest-earning assets 1,451,928
1,537,269 1,397,420 Total assets$ 17,795,957 $ 16,313,577 $ 14,026,957 Liabilities and Stockholders' Equity Interest-bearing liabilities
Interest-bearing deposits$ 7,722,584 $ 23,624 0.31 % $
7,397,121$ 47,040 0.64 %$ 5,916,491 $ 71,509 1.21 % Securities loaned 1,374,142 50,974 3.71 % 1,336,873 42,817 3.20 % 1,423,847 60,086 4.22 % Notes payable and other borrowings 1,216,381 32,393 2.66 % 1,222,044 33,249 2.72 % 1,398,559 41,928 3.00 % Total interest-bearing liabilities 10,313,107 106,991 1.04 % 9,956,038 123,106 1.24 % 8,738,897 173,523 1.99 % Noninterest-bearing liabilities Noninterest-bearing deposits 4,157,962 3,304,475 2,635,924 Other liabilities 863,976 791,002 614,164 Total liabilities 15,335,045 14,051,515 11,988,985 Stockholders' equity 2,435,185 2,235,690 2,014,535 Noncontrolling interest 25,727 26,372 23,437 Total liabilities and stockholders' equity$ 17,795,957 $ 16,313,577 $ 14,026,957 Net interest income (2)$ 424,667 $ 426,409 $ 441,890 Net interest spread (2) 2.19 % 2.45 % 2.86 % Net interest margin (2) 2.58 % 2.85 % 3.48 %
(1) Average balance includes non-accrual loans.
Presented on a taxable equivalent basis with taxable equivalent adjustments
(2) based on the applicable corporate federal income tax rate of 21% for the
periods presented. The adjustment to interest income was
million and$0.6 million during 2021, 2020 and 2019, respectively. The banking segment's net interest margin exceeds our consolidated net interest margin shown above. Our consolidated net interest margin includes certain items that are not reflected in the calculation of our net interest margin within our banking segment and reduce our consolidated net interest margin, such as the borrowing costs of Hilltop and the yields and costs associated with certain items within interest-earning assets and interest-bearing liabilities in the broker-dealer segment, including items related to securities financing operations that particularly decrease net interest margin. In addition, yields and costs on certain interest-earning assets, such as warehouse lines of credit extended to subsidiaries (operating segments) by the banking segment, are eliminated from the consolidated financial statements. Our consolidated net interest margins during 2020 and, to a lesser extent, 2021 were also negatively impacted by certain actions taken by management during 2020 to strengthen our available liquidity position. Such actions, including increasing overall cash balances by raising brokered money market and brokered time deposits and raising capital through the issuance of subordinated debt, were taken out of an abundance of caution in light of extreme volatility and disruptions in the capital and credit markets beginning inMarch 2020 resulting from the COVID-19 crisis and its negative impact on the economy. On a consolidated basis, net interest income from continuing operations decreased during 2021, compared with 2020, primarily due to the effects of decreased net yields on loans held for investment and mortgage loans held for sale, year-over-year increase in interest incurred related to the Subordinated Notes at corporate beginning inMay 2020 , and the decrease in market interest rates on deposits within the banking segment. Net interest income from continuing operations decreased during 62
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2020, compared with 2019, primarily due to decreases in interest earned on loans held for investment, interest incurred beginning inMay 2020 related to the Subordinated Notes at corporate and decreases in net interest income from our stock lending business, customer margin loans and other customer activities within the broker-dealer segment. Refer to the discussion in the "Banking Segment" section that follows for more details on the changes in net interest income, including the component changes in the volume of average interest-earning assets and interest-bearing liabilities and changes in the rates earned or paid on those items. The provision for (reversal of) credit losses is determined by management as the amount necessary to maintain the allowance for credit losses at the amount of expected credit losses inherent within the loans held for investment portfolio. The amount of expense and the corresponding level of allowance for credit losses for loans are based on our evaluation of the collectability of the loan portfolio based on historical loss experience, reasonable and supportable forecasts, and other significant qualitative and quantitative factors. Substantially all of our consolidated provision for (reversal of) credit losses is related to the banking segment. During 2021, the reversal of credit losses was primarily impacted by the banking segment's reduction in reserves associated with collectively evaluated loans within the portfolio attributable to improvements in both macroeconomic forecast assumptions and credit quality metrics on COVID-19 impacted industry sector exposures. During 2020, the provision for credit losses was significantly impacted by the banking segment's build in reserves associated with the increase in the expected lifetime credit losses under the Current Expected Credit Losses ("CECL") methodology attributable to the market disruption and related economic uncertainties caused by COVID-19. Refer to the discussion in the "Financial Condition - Allowance for Credit Losses on Loans" section that follows for more details regarding the significant assumptions and estimates involved in estimating credit losses. Noninterest income from continuing operations decreased during 2021, compared with 2020, primarily due to changes in net fair value and related derivative activity and a decrease in average loan sales margin, partially offset by a slight increase in total mortgage loan sales volume within our mortgage origination segment, as well as decreases in structured finance and fixed income services net revenues within our broker-dealer segment. The increase in noninterest income from continuing operations during 2020, compared with 2019, was primarily due to increases in total mortgage loan sales volume and changes in net fair value and related derivative activity within our mortgage origination segment, as well as increases in fixed income services, public finance services and structured finance net revenues within our broker-dealer segment. Noninterest expense from continuing operations decreased during 2021, compared with 2020, primarily due to decreases in both variable and non-variable compensation within our mortgage origination segment associated with the decreased mortgage loan originations, and a decline in variable compensation within our broker-dealer segment. We expect inflationary headwinds related to certain noninterest expenses, including compensation, occupancy, and software costs, to result in higher fixed costs during 2022. The increase in noninterest expense from continuing operations during 2020, compared with 2019, was primarily due to increases in variable compensation and segment operating costs associated with the increased mortgage loan originations within our mortgage origination segment and increases in variable compensation within our broker-dealer segment.
Effective income tax rates from continuing operations were 23.4%, 23.6% and
22.5% for 2021, 2020 and 2019, respectively, and approximated applicable
statutory rates for such periods.
Segment Results from Continuing Operations
Banking Segment
The following table presents certain information about the operating results of
our banking segment (in thousands).
Year Ended December 31, Variance
2021 2020 2019 2021 vs 2020 2020 vs 2019
Net interest income$ 406,524 $ 390,871 $ 379,258 $ 15,653 $ 11,613 Provision for (reversal of) credit losses (58,175) 96,326 7,280 (154,501) 89,046 Noninterest income 45,113 41,376 41,753 3,737 (377) Noninterest expense 226,915 232,447 231,524 (5,532) 923 Income before income taxes$ 282,897 $ 103,474 $ 182,207 $ 179,423 $ (78,733) 63 Table of Contents
The increase in income before income taxes during 2021, compared with 2020, was primarily due to the impact of reversals of credit losses throughout 2021, which reflected improvement in both realized economic results and the macroeconomic outlook, as opposed to significant increases in the provision for credit losses during the first half 2020 associated with the adoption of the CECL model and the significant market disruption caused by COVID-19. Changes to net interest income related to the component changes in the volume of average interest-earning assets and interest-bearing liabilities and changes in the rates earned or paid on those items are discussed in more detail below.
The information shown in the table below includes certain key indicators of the
performance and asset quality of our banking segment.
Year Ended December 31,
2021 2020 2019
Efficiency ratio (1) 50.25 % 53.78 % 54.99 %
Return on average assets (2) 1.55 % 0.63 % 1.36 % Net interest margin (3) 3.07 % 3.31 % 4.00 % Net recoveries (charge-offs) to average loans outstanding (4) 0.01 % (0.30) %
(0.08) %
Efficiency ratio is defined as noninterest expenses divided by the sum of
(1) total noninterest income and net interest income for the period. We consider
the efficiency ratio to be a measure of the banking segment's profitability.
(2) Return on average assets is defined as net income divided by average assets.
Net interest margin is defined as net interest income divided by average
(3) interest-earning assets. We consider net interest margin as a key indicator
of profitability, as it represents interest earned on interest-earning assets
compared to interest incurred.
Net recoveries (charge-offs) to average loans outstanding is defined as the
(4) greater of recoveries or charge-offs during the reported period minus
charge-offs or recoveries divided by average loans outstanding. We use the
ratio to measure the credit performance of our loan portfolio.
The banking segment presents net interest margin and net interest income in the
following discussion and table below, on a taxable equivalent basis. Net
interest margin (taxable equivalent), a non-GAAP measure, is defined as taxable
equivalent net interest income divided by average interest-earning assets.
Taxable equivalent adjustments are based on the applicable corporate federal
income tax rates of 21% for all periods presented. The interest income earned on
certain earning assets is completely or partially exempt from federal income
tax. As such, these tax-exempt instruments typically yield lower returns than
taxable investments. To provide more meaningful comparisons of net interest
margins for all earning assets, we use net interest income on a taxable
equivalent basis in calculating net interest margin by increasing the interest
income earned on tax-exempt assets to make it fully equivalent to interest
income earned on taxable investments.
During 2021, 2020 and 2019, purchase accounting contributed 16, 18 and 33 basis
points, respectively, to the banking segment's taxable equivalent net interest
margin of 3.08%, 3.31% and 4.01%, respectively. These purchase accounting items
are primarily related to accretion of discount of loans associated with the Bank
Transactions as discussed in the Consolidated Operating Results section.
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The table below provides additional details regarding our banking segment's net
interest income (dollars in thousands).
Year Ended December 31,
2021 2020 2019
Average Interest Annualized Average Interest Annualized Average Interest Annualized
Outstanding Earned Yield or Outstanding Earned Yield or Outstanding Earned Yield or
Balance or Paid Rate Balance or Paid Rate Balance or Paid Rate
Assets
Interest-earning assets
Loans held for investment,
gross (1) $ 7,069,485 $ 323,136 4.57 % $ 7,152,783 $ 341,383 4.77 % $ 6,564,748 $ 367,903 5.60 %
Subsidiary warehouse lines
of credit 2,124,700 80,761 3.75 % 2,073,087 79,488 3.83 % 1,374,051 61,812 4.50 %
Investment securities -
taxable 2,026,189 29,215 1.44 % 1,377,578 27,651 2.01 % 1,181,198 29,879 2.53 %
Investment securities -
non- taxable (2) 114,118 3,905 3.42 % 111,471 3,789 3.40 % 96,186 3,267 3.40 %
Federal funds sold and
securities purchased under
agreements to resell 30,395 89 0.30 % 460 1 0.18 % 447 1 0.17 %
Interest-bearing deposits
in other financial
institutions 1,837,196 2,459 0.13 % 1,038,647 1,888 0.18 % 202,478 4,525 2.23 %
Other 36,813 460 1.25 % 42,977 377 0.88 % 55,403 2,534 4.57 %
Interest-earning assets,
gross (2) 13,238,896 440,025 3.32 %
11,797,003 454,577 3.85 % 9,474,511 469,921 4.96 %
Allowance for credit losses (129,303)
(121,770) (57,546) Interest-earning assets, net 13,109,593 11,675,233 9,416,965 Noninterest-earning assets 966,296
967,690 938,663 Total assets$ 14,075,889 $ 12,642,923 $ 10,355,628 Liabilities and Stockholders' Equity Interest-bearing liabilities
Interest-bearing deposits$ 7,578,963 $ 30,988 0.41 % $
7,306,143$ 60,297 0.83 %$ 5,654,663 $ 79,805 1.41 % Notes payable and other borrowings 142,705 1,586 1.11 % 205,448 2,642 1.29 % 481,924 10,233 2.12 % Total interest-bearing liabilities 7,721,668 32,574 0.42 % 7,511,591 62,939 0.84 % 6,136,587 90,038 1.47 % Noninterest-bearing liabilities Noninterest-bearing deposits 4,512,227 3,412,212 2,622,229 Other liabilities 155,979 128,795 93,861 Total liabilities 12,389,874 11,052,598 8,852,677 Stockholders' equity 1,686,015 1,590,325 1,502,951 Total liabilities and stockholders' equity$ 14,075,889 $ 12,642,923 $ 10,355,628 Net interest income (2)$ 407,451 $ 391,638 $ 379,883 Net interest spread (2) 2.90 % 3.01 % 3.49 % Net interest margin (2) 3.08 % 3.31 % 4.01 %
(1) Average balance includes non-accrual loans.
Presented on a taxable equivalent basis with taxable equivalent adjustments
(2) based on the applicable corporate federal income tax rates of 21% for all
periods presented. The adjustment to interest income was
million and$0.6 million during 2021, 2020 and 2019, respectively. The banking segment's net interest margin exceeds our consolidated net interest margin. Our consolidated net interest margin includes certain items that are not reflected in the calculation of our net interest margin within our banking segment and reduce our consolidated net interest margin, such as the borrowing costs of Hilltop and the yields and costs associated with certain items within interest-earning assets and interest-bearing liabilities in the broker-dealer segment, including items related to securities financing operations that particularly decrease net interest margin. In addition, the banking segment's interest-earning assets include warehouse lines of credit extended to other subsidiaries, which are eliminated from the consolidated financial statements. The banking segment's net interest margins during 2021 and 2020 were negatively impacted by certain actions taken by management during 2020 to strengthen the Bank's available liquidity position. Such actions, including increasing overall cash balances by raising brokered money market and brokered time deposits were taken out of an abundance of caution in light of the extreme volatility and disruptions in the capital and credit markets beginning inMarch 2020 resulting from the COVID-19 crisis and its negative impact on the economy. 65 Table of Contents The following table summarizes the changes in the banking segment's net interest income for the periods indicated below, including the component changes in the volume of average interest-earning assets and interest-bearing liabilities and changes in the rates earned or paid on those items (in thousands). Year Ended December 31, 2021 vs. 2020 2020 vs. 2019 Change Due To (1) Change Due To (1) Volume Yield/Rate Change Volume Yield/Rate Change Interest income
Loans held for investment, gross$ (3,973) $ (14,274) $ (18,247) $ 32,930 $ (59,450) $ (26,520) Subsidiary warehouse lines of credit 1,979 (706) 1,273 31,446 (13,770) 17,676 Investment securities - taxable 13,019 (11,455) 1,564
4,968 (7,196) (2,228) Investment securities - non-taxable (2) 90 26 116 519 3 522 Federal funds sold and securities purchased under agreements to resell 55 33 88 - - - Interest-bearing deposits in other financial institutions 1,451 (880) 571 18,685 (21,322) (2,637) Other (54) 137 83 (568) (1,589) (2,157) Total interest income (2) 12,567 (27,119) (14,552) 87,980 (103,324) (15,344) Interest expense Deposits$ 2,252 $ (31,561) $ (29,309) $ 23,308 $ (42,816) $ (19,508) Notes payable and other borrowings (807) (249) (1,056) (5,871) (1,720) (7,591) Total interest expense 1,445 (31,810) (30,365) 17,437 (44,536) (27,099) Net interest income (2)$ 11,122 $ 4,691 $ 15,813 $ 70,543 $ (58,788) $ 11,755
(1) Changes attributable to both volume and yield/rate are included in yield/rate
column.
(2) Taxable equivalent.
Changes in the yields earned on interest-earning assets decreased taxable
equivalent net interest income during 2021, compared with 2020, primarily as a
result of lower reinvestment yield on the securities portfolio and a reduction
in yields on loans held for investment and the slight decrease in accretion of
discount on loans. Accretion of discount on loans is expected to decrease in
future periods as loans acquired in the Bank Transactions are repaid, refinanced
or renewed. Changes in the volume of interest-earning assets increased taxable
equivalent net interest income during 2021, compared with 2020, primarily due to
increases in investment securities portfolio balances. Changes in rates paid on
interest-bearing liabilities increased taxable equivalent net interest income
during 2021, compared with 2020, as deposit costs declined more than interest
income declined. Our portfolio includes loans that periodically reprice or
mature prior to the end of an amortized term. Approximately 68% of our
variable-rate loans remained at applicable rate floors at December 31, 2021 ,
which may delay and/or limit changes in net interest income during a period of
changing rates. If interest rates were to rise, yields on the portion of our
loan portfolio that remain at applicable rate floors would rise more slowly than
increases in market interest rates. If interest rates were to fall further, the
impact on our net interest income for certain variable-rate loans would be
limited by these rate floors. In addition, declining interest rates may reduce
our cost of funds on deposits. The extent of this impact will ultimately be
driven by the timing, magnitude and frequency of interest rate and yield curve
movements, as well as changes in market conditions and timing of management
strategies. Any changes in interest rates across the term structure will
continue to impact net interest income and net interest margin. The impact of
rate movements will change with the shape of the yield curve, including any
changes in steepness or flatness and inversions at any points on the yield
curve.
Changes in the yields earned on interest-earning assets decreased taxable
equivalent net interest income during 2020, compared with 2019, primarily as a
result of lower loan yields due to decreased market rates, the addition of 1%
note rate PPP loans, and the decrease in accretion of discount on loans of $9.9
million . Changes in the volume of interest-earning assets, primarily due to the
significant increase in mortgage warehouse lending volume and new PPP loan
originations, increased taxable equivalent net interest income during 2020,
compared with 2019. Changes in rates paid on interest-bearing liabilities
increased taxable equivalent net interest income during 2020, compared with
2019, due to decreases in market interest rates.
Starting in March 2020 , the Bank implemented several actions to better support
our impacted banking clients and allow for loan modifications such as principal
and/or interest payment deferrals, participation in the PPP as an SBA preferred
lender and personal banking assistance including waived fees, increased daily
spending limits and suspension of residential foreclosure activities. The Bank's
actions during 2020 and 2021 included approval of approximately $1.0 billion in
COVID-19 related
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loan modifications. While the majority of the portfolio of COVID-19 related loan modifications no longer require deferral, such loans represent elevated risk, and therefore management continues to monitor these loans. The adverse economic conditions caused by the COVID-19 pandemic negatively impacted the banking segment's business and results of operations, including significantly reduced demand for loan products and services from customers, recognition of credit losses and increases in allowance for credit losses. We will continue to monitor developments regarding the COVID-19 pandemic and measures implemented in response to the pandemic, market capitalization, overall economic conditions, effectiveness of vaccinations, the emergence of new variants, government stimulus, payment deferral programs and any other triggering events or circumstances that may indicate an impairment of goodwill or core deposit intangible assets in the future. See further discussion in the "Recent Developments" section above. During 2021, 2020 and 2019, the banking segment retained approximately$778 million ,$193 million and$149 million , respectively, in mortgage loans originated by the mortgage origination segment. These loans are purchased by the banking segment at par. For origination services provided, the banking segment reimburses the mortgage origination segment for direct origination costs associated with these mortgage loans, in addition to payment of a correspondent fee. The correspondent fees are eliminated in consolidation. InMarch 2020 , the Bank made a decision to sell the previously purchased mortgage loans to the mortgage origination segment, instead of holding them for investment. InOctober 2020 , the Bank resumed purchasing and retaining mortgage loans originated by the mortgage origination segment. We expect loans originated by the mortgage origination segment on behalf of and retained by the banking segment to increase based on approved authority for up to 5% of the mortgage origination segment's total origination volume during 2022. The determination of mortgage loan retention levels by the banking segment will be impacted by, among other things, an ongoing review of the prevailing mortgage rates, balance sheet positioning at Hilltop and the banking segment's outlook for commercial loan growth. The banking segment's provision for (reversal of) credit losses has been subject to significant year-over-year and quarterly changes primarily attributable to the effects of the deteriorating economic outlook associated with the impact of the market disruption caused by the COVID-19 pandemic beginning inMarch 2020 , and then the reduction in reserves associated with improvements in macroeconomic forecast assumptions beginning in the second half of 2020 and throughout 2021. Specifically, during 2021, the banking segment had net reversals of credit losses on expected losses of collectively evaluated loans of$58.3 million , primarily due to improvements in both macroeconomic forecast assumptions and credit quality metrics on COVID-19 impacted industry sector exposures. The net impact to the allowance of changes associated with individually evaluated loans during 2021 included a provision of credit losses of$0.1 million . The change in the allowance during 2021 was also impacted by net recoveries of$0.5 million . During 2020, the significant build in the allowance included provision for credit losses on individually evaluated loans of$20.1 million , while the provision for credit losses on expected losses of collectively evaluated loans accounted for$76.1 million of the total provision primarily due to the increase in the expected lifetime credit losses under CECL attributable to the deteriorating economic outlook associated with the impact of the market disruption caused by the COVID-19 pandemic. The change in the allowance during 2020 was also impacted by net charge-offs of$21.1 million , primarily associated with loans specifically reserved for during the first quarter of 2020. The changes in the allowance for credit losses during the noted periods also reflected other factors including, but not limited to, loan growth, loan mix, and changes in risk grades. Refer to the discussion in the "Financial Condition - Allowance for Credit Losses on Loans" section that follows for more details regarding the significant assumptions and estimates involved in estimating credit losses.
The banking segment's noninterest income increased during 2021, compared to
2020, primarily due to increased service charges on depositor accounts and trust
fees.
The banking segment's noninterest expenses decreased during 2021, compared to
2020, primarily due to the decrease in the reserve for unfunded commitments
attributable to year-over-year improvements in loan expected loss rates
as well as reductions in legal and other real estate owned ("OREO") expenses,
partially offset by increases in FDIC assessment and software related expenses.
The noninterest expenses were relatively flat during 2020, compared to 2019, and
included an increase in the reserve for unfunded commitments attributable to
macroeconomic uncertainties associated with the impact of market disruption
caused by COVID-19 conditions, significantly offset by a reduction in legal,
business development and other operating expenses.
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Broker-Dealer Segment
The following table provides additional details regarding our broker-dealer
segment operating results (in thousands).
Year Ended December 31, Variance
2021 2020 2019 2021 vs 2020 2020 vs 2019
Net interest income: Wealth management: Securities lending$ 10,693 $ 8,544 $ 9,496 $ 2,149 $ (952) Clearing services 7,314 6,916 11,530 398 (4,614) Structured finance (5) 2,857 5,430 8,337 (2,573) (2,907) Fixed income services 19,249 12,173 6,180 7,076 5,993 Other (5) 3,183 6,849 15,765 (3,666) (8,916) Total net interest income 43,296 39,912 51,308 3,384 (11,396) Noninterest income: Securities commissions and fees by business line (1): Fixed income services 47,844 49,573 36,997 (1,729) 12,576 Wealth management: Retail 73,149 69,718 71,934 3,431 (2,216) Clearing services 22,478 30,018 33,787 (7,540) (3,769) Structured finance (5) 3,275 1,824 1,793 1,451 31 Other (5) 4,016 4,761 4,664 (745) 97 150,762 155,894 149,175 (5,132) 6,719 Investment and securities advisory fees and commissions by business line: Public finance services (5) 108,372 96,186 76,679 12,186 19,507 Fixed income services 8,442 6,395 2,936 2,047 3,459 Wealth management: Retail 31,453 24,023 20,820 7,430 3,203 Clearing services 1,945 1,649 1,264 296 385 Structured finance (5) 1,850 2,732 1,903 (882) 829 Other 381 342 185 39 157 152,443 131,327 103,787 21,116 27,540 Other: Structured finance (5) 77,424 157,465 114,192 (80,041) 43,273 Fixed income services (2,197) 45,365 35,859 (47,562) 9,506 Other (5) 2,693 1,304 1,398 1,389 (94) 77,920 204,134 151,449 (126,214) 52,685 Total noninterest income 381,125 491,355 404,411 (110,230) 86,944 Net revenue (2) 424,421 531,267 455,719 (106,846) 75,548 Noninterest expense: Variable compensation (3) 161,264 205,464 163,840 (44,200) 41,624 Non-variable compensation and benefits (5) 114,912 106,932 104,909 7,980 2,023 Segment operating costs (4)(5) 104,584 103,232 97,208
1,352 6,024 Total noninterest expense 380,760 415,628 365,957 (34,868) 49,671 Income before income taxes$ 43,661 $ 115,639 $ 89,762 $ (71,978) $ 25,877
Securities commissions and fees includes income of
(1) million, and
eliminated in consolidation.
Net revenue is defined as the sum of total net interest income and total
(2) noninterest income. We consider net revenue to be a key performance measure
in the
evaluation of the broker-dealer segment's financial position and operating performance as we believe it is a primary revenue performance measure used by investors and analysts. Net revenue provides for some level of comparability of trends across the financial services industry as it reflects both noninterest income, including
investment and securities advisory fees and commissions, as well as net interest
income. Internally, we assess the broker-dealer segment's performance on a
revenue
basis for comparability with our banking segment.
(3) Variable compensation represents performance-based commissions and
incentives.
(4) Segment operating costs include provision for credit losses associated with
the broker-dealer segment within other noninterest expenses.
(5) Noted balances during all prior periods include certain reclassifications to
conform to current period presentation. During 2021, the broker-dealer segment's structured finance and fixed income business lines both experienced a decline in net revenues. Structured finance net revenues declined compared to 2020 due to lower production volumes and less favorable market conditions given the expectation of higher interest rates in the near term. Fixed income services business line net revenues also decreased, compared to 2020, primarily due to a decrease in net gains from trading activities. Both the fixed income services and structured finance business lines experienced a reduction in activity and overall demand from the buyside, given the expectation of higher interest rates in the near term. The increase in net revenues in the broker-dealer segment's public finance services and wealth management business lines partially offset these declines. The improvement in the public finance business line net revenue can primarily be attributed to improved underwriting revenues. Wealth management business line net revenues were higher during 2021, compared to 2020, from improved production and advisory fee income, despite lower money market andFDIC sweep revenues due to the low interest rate environment. Additional information related to the impact of COVID-19 is included within the "Recent Developments" section above. 68 Table of Contents
The decrease in the broker-dealer segment's income before income taxes during
2021, compared with 2020, was primarily as a result of the following:
decrease in the broker-dealer segment's structured finance net revenues as a
result of lower volumes and a less robust market environment resulting in
decreases in the business line's other noninterest income compared with 2020.
? Specifically, the decrease was due to lower mortgage originations, with loan
lock volumes totaling
2020. The structured finance business line also saw weaker demand from the
buyside for call-protected collateral in the fourth quarter of 2021 given the
expectation of rising interest rates.
decrease in the broker-dealer segment's fixed income services net revenues
primarily from declines in noninterest income compared with 2020. During 2021,
the broker-dealer segment experienced net revenue declines in each trading
division as a result of less robust customer demand and a less favorable
? trading environment. Additionally, the decline also included a
decrease in net revenues due to the wind-down of the equity capital market
division. Specifically, the broad decline was experienced across all product
areas as customer demand has been less robust when compared to 2020 given the
expectation of higher interest rates resulting in weaker customer volumes.
decrease in compensation expense, of which
? the decrease in variable compensation associated with revenue declines in our
structured finance and fixed income services business lines.
The broker-dealer segment is subject to interest rate risk as a consequence of maintaining inventory positions, trading in interest rate sensitive financial instruments and maintaining a matched stock loan book. Changes in interest rates are likely to have a meaningful impact on our overall financial performance. Our broker-dealer segment has historically earned a significant portion of its revenues from advisory fees upon the successful completion of client transactions, which could be adversely impacted by interest rate volatility. Rapid or significant changes in interest rates could adversely affect the broker-dealer segment's bond trading, sales, underwriting activities and other interest spread-sensitive activities described below. The broker-dealer segment also receives administrative fees for providing money market andFDIC investment alternatives to clients, which tend to be sensitive to short term interest rates. In addition, the profitability of the broker-dealer segment depends, to an extent, on the spread between revenues earned on customer loans and excess customer cash balances, and the interest expense paid on customer cash balances, as well as the interest revenue earned on trading securities, net of financing costs. In the broker-dealer segment, interest is earned from securities lending activities, interest charged on customer margin loan balances and interest earned on investment securities used to support sales, underwriting and other customer activities. The increase in net interest income during 2021, compared with 2020, was primarily due to increases in net interest income from our fixed income business line and securities lending division of our wealth management business line partially offset by intercompany interest expense. With the 30 basis point decrease in the weighted average Federal Funds interest rate from 2020 to 2021, the amount of interest earned on customer investment activities decreased as well. The decrease in net interest income during 2020, compared with 2019, was primarily due to decreases in net interest income from our stock lending business, customer margin loans and other customer activities, partially offset by an increase in net interest earnings from the broker-dealers' taxable securities.
Noninterest income decreased during 2021 compared to 2020 primarily due to
decreases in other noninterest income and securities commissions and fees,
partially offset by the increases in investment banking and advisory fees.
Noninterest income increased during 2020 compared to 2019 primarily due to
increases in securities commissions and fees, investment and securities advisory
fees and commissions, and other noninterest income.
Securities commissions and fees decreased during 2021 compared to 2020 primarily due to a decrease in commissions earned in our wealth management line of business given a$10.6 million decline in our money market andFDIC sweep revenues as a result of the lower interest rate environment and decreases in commissions earned from our wind-down of the equity capital markets division. These decreases were partially offset by increases in commissions earned on mutual fund, insurance product and commodities contract sales transactions. Securities commissions and fees increased during 2020 compared to 2019 primarily due to the increases in commissions earned in our fixed income service line of business offset by the decreases in commissions earned through the wind-down of our equity capital markets business line, which resulted in a decrease of$5.5 million . Additionally, the overall increase in securities commissions and fees was offset by the decreases in commissions and fees earned by our wealth management business line from declines in our money market andFDIC sweep revenues.
Investment and securities advisory fees and commissions increased during 2021
compared to 2020, primarily due to increases in fees earned from our public
finance municipal transactions and from improved wealth management advisory
services fees.
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Investment and securities advisory fees and commissions increased during 2020,
compared with 2019, primarily due to increases in municipal advisory and
underwriting transactions.
Other noninterest income decreased during 2021, compared to 2020, primarily due to decreases in trading gains earned from our structured finance business line's derivative activities resulting from decreased volumes and interest rate volatility. The year-over-year decrease in other noninterest income was heightened by decreases within our fixed income services business line within our taxable and municipal securities trading portfolios. Other noninterest income increased during 2020, compared to 2019, primarily due to an increase in trading gains earned from our structured finance business line's derivative activities due to strong year-over-year volumes and robust customer demand despite heightened market volatility in the first quarter of 2020. Additionally, other noninterest income within our fixed income services business line increased during 2020, compared to 2019, with increases in both our taxable and municipal securities trading portfolio activities, partially offset by a decrease in our securitized mortgage backed securities portfolio. Noninterest expenses decreased during 2021 compared to 2020, primarily due to decreases in variable compensation, partially offset by increased non-variable compensation and benefits and expenses associated with the deployment of the new back-office and accounting systems. Noninterest expenses increased during 2020, compared to 2019, primarily due to increases in variable compensation and the deployment of a new back-office system inJune 2020 , partially offset by$2.9 million in pre-tax costs associated with leadership changes and efficiency initiative-related charges in 2019.
Selected information concerning the broker-dealer segment, including key
performance indicators, follows (dollars in thousands).
Year Ended December 31,
2021 2020 2019
Total compensation as a % of net revenue
(1) 65.1 % 58.8 % 59.0 %
Pre-tax margin (2) 10.3 % 21.8 % 19.7 %
FDIC insured program balances at the Bank
(end of year) $ 803,941 $ 700,006 $ 1,304,333
Other FDIC insured program balances (end
of year) $ 1,503,277 $ 1,892,974 $ 666,418
Customer funds on deposit, including short
credits (end of year) $ 499,476 $ 480,200 $ 329,743
Public finance services:
Number of issues 1,149 1,252 1,179
Aggregate amount of offerings$ 60,243,826 $ 57,107,263
$ 54,395,943 Structured finance: Lock production/TBA volume$ 7,007,564 $ 9,075,232 $ 5,876,466 Fixed income services: Total volumes$ 244,643,358 $ 169,559,201 $ 83,571,542 Net inventory (end of year)$ 551,289 $ 613,413 $ 643,371 Wealth management (Retail and Clearing services groups): Retail employee representatives (end of year) 98 117 122 Independent registered representatives (end of year) 177 189 195 Correspondents (end of year) 122 129 145 Correspondent receivables (end of year)$ 306,064 $ 180,173 $ 264,201 Customer margin balances (end of year)$ 426,584 $ 256,682
Wealth management (Securities lending group): Interest-earning assets - stock borrowed (end of year)$ 1,518,372 $ 1,338,855 $ 1,634,782 Interest-bearing liabilities - stock loaned (end of year)$ 1,432,196 $ 1,245,066
Total compensation includes the sum of non-variable compensation and benefits
(1) and variable compensation. We consider total compensation as a percentage of
net revenue to be a key performance measure and indicator of segment
profitability.
Pre-tax margin is defined as income before income taxes divided by net
(2) revenue. We consider pre-tax margin to be a key performance measure given its
use as a profitability metric representing the percentage of net revenue
earned that results in a profit.
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Mortgage Origination Segment
The following table presents certain information regarding the operating results
of our mortgage origination segment (in thousands).
Year Ended December 31, Variance
2021 2020 2019 2021 vs 2020 2020 vs 2019
Net interest income (expense) $ (20,400) $ (10,489) $ (6,273) $
(9,911)$ (4,216) Noninterest income 986,990 1,172,450 634,992 (185,460) 537,458 Noninterest expense 731,056 753,917 563,998 (22,861) 189,919 Income before income taxes$ 235,534 $ 408,044 $ 64,721 $ (172,510) $ 343,323
The mortgage lending business is subject to variables that can impact loan
origination volume, including seasonal transaction volumes and interest rate
fluctuations. Historically, the mortgage origination segment has experienced
increased loan origination volume from purchases of homes during the spring and
summer months, when more people tend to move and buy or sell homes. An increase
in mortgage interest rates tends to result in decreased loan origination volume
from refinancings, while a decrease in mortgage interest rates tends to result
in increased loan origination volume from refinancings. Changes in mortgage
interest rates have historically had a lesser impact on home purchases volume
than on refinancing volume. See details regarding loan origination volume in the
table below.
Recent trends, as well as typical historical patterns in loan origination volume
from purchases of homes or from refinancings as a result of movements in
mortgage interest rates, may not be indicative of future loan origination
volumes given continued economic uncertainties stemming from the COVID-19
pandemic. The mortgage origination segment's business is dependent upon the
willingness and ability of its employees and customers to conduct mortgage
transactions. Current home inventory levels, affordability challenges, and
supply chain problems related to new home construction have impacted customers'
abilities to purchase homes. Home inventory shortages and affordability
challenges present prior to 2020 were amplified by the economic impact of
COVID-19, while supply chain problems can be more directly tied to COVID-19. The
continuing impact of the COVID-19 pandemic on customers could have a material
adverse effect on the operations of the mortgage origination segment. In
addition, a further increase in mortgage interest rates and/or continuing home
inventory shortages and supply chain issues related to new home construction
could adversely affect loan origination volume and/or alter the percentage mix
of refinancing and purchase volumes relative to total loan origination volume in
2022.
Income before income taxes decreased in 2021, compared with 2020. This decrease
was primarily the result of a decrease in interest rate lock commitments
("IRLCs") related to a decrease in mortgage loan applications, in addition to a
decrease in the average value of individual IRLCs.
The CARES Act has provided borrowers the ability to request forbearance of
residential mortgage loan payments, placing a significant strain on mortgage
servicers as they may be required to fund missed or deferred payments related to
loans in forbearance. A significant increase in nationwide forbearance requests
that began in March 2020 resulted in the reduction of third-party mortgage
servicers willing to purchase mortgage servicing rights. As a result of this
market dynamic, beginning in the second quarter 2020, we increased the amount of
retained servicing on mortgage loan sales. Beginning in the fourth quarter of
2020 and continuing into 2021, PrimeLending has reduced the amount of retained
servicing. However, amounts retained during the fourth quarter of 2021 continued
to exceed amounts retained prior to the second quarter of 2020. PrimeLending
utilizes a third-party to manage its servicing portfolio, and we therefore do
not expect significant fluctuations in infrastructure costs to manage changes in
PrimeLending's servicing portfolio. However, PrimeLending may be at risk of
third-party servicers increasing their pricing to address increased regulatory
requirements surrounding servicers. PrimeLending's liquidity has not been, and
we do not expect that it will be, significantly impacted by forbearance requests
resulting from the CARES Act. Government National Mortgage Association ("GNMA"),
Federal National Mortgage Association ("FNMA") and Federal Home Loan Mortgage
Corporation ("FHLMC") may impose restrictions on loans the agencies will accept,
including loans under a forbearance agreement, which could result in
PrimeLending seeking non-agency investors or choosing to retain these loans.
In response to the COVID-19 pandemic, the U.S. 10-Year Treasury Rate and
mortgage interest rates declined during 2020, which was followed in 2021 by an
increase in mortgage interest rates that remained lower on average during 2021,
compared to 2020. As average mortgage interest rates increased during 2021,
compared to a decrease in rates during 2020, refinancing volume as a percentage
of total origination volume decreased to 36.3% during 2021, as compared to
41.6%
in 2020. If current
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mortgage interest rates remain relatively unchanged during 2022, we anticipate a
lower percentage of refinancing volume relative to total loan origination volume
during 2022, as compared to 2021. However, a higher refinance percentage could
be driven by a slowing of purchase volume due to the negative impact on new and
existing home sales resulting from existing home inventory shortages,
affordability challenges, and supply chain problems related to new home
construction. Refinancing volume as a percentage of total origination volume
increased from 24.8% during 2019 to 41.6% during 2020, primarily as a result of
average mortgage interest rates decreasing between periods.
The mortgage origination segment primarily originates its mortgage loans through
a retail channel, with limited lending through its affiliated business
arrangements ("ABAs"). For 2021, funded volume through ABAs was approximately 5%
of the mortgage origination segment's total loan volume. PrimeLending held an
interest in three ABAs throughout 2021. In December 2021 , interest in a fourth
ABA was added. PrimeLending owns a greater than 50% interest in all four ABAs.
We expect total production within the ABA channel to increase slightly to
approximately 7% loan volume of the mortgage origination segment during 2022.
The following table provides further details regarding our mortgage loan
originations and sales for the periods indicated below (dollars in thousands).
Year Ended December 31,
2021 2020 2019
% of % of % of Variance
Amount Total Amount Total Amount Total 2021 vs 2020 2020 vs 2019
Mortgage Loan Originations
- units 77,263 84,209 61,045 (6,946) 23,164
Mortgage Loan Originations
- volume:
Conventional $ 15,787,942 69.65 % $ 16,519,498 71.92 % $ 9,503,044 61.00 % $ (731,556) $ 7,016,454
Government 3,387,270 14.94 % 4,473,763 19.48 % 3,860,802 24.78 % (1,086,493) 612,961
Jumbo 2,511,442 11.08 % 1,219,492 5.31 % 1,309,317 8.40 % 1,291,950 (89,825)
Other 981,629 4.33 % 757,441 3.29 % 906,274 5.82 % 224,188 (148,833)
$ 22,668,283 100.00 % $ 22,970,194 100.00 % $ 15,579,437 100.00 % $ (301,911) $ 7,390,757
Home purchases $ 14,429,190 63.65 % $ 13,413,545 58.40 % $ 11,718,772 75.22 % $ 1,015,645 $ 1,694,773
Refinancings 8,239,093 36.35 % 9,556,649 41.60 % 3,860,665 24.78 % (1,317,556) 5,695,984
$ 22,668,283 100.00 % $ 22,970,194 100.00 % $ 15,579,437 100.00 % $ (301,911) $ 7,390,757
Texas $ 4,224,691 18.64 % $ 4,280,831 18.64 % $ 2,999,633 19.25 % $ (56,140) $ 1,281,198
California 2,692,198 11.88 % 2,497,066 10.87 % 1,561,926 10.03 % 195,132 935,140
Arizona 1,045,218 4.61 % 1,045,298 4.55 % 681,486 4.37 % (80) 363,812
Florida 1,013,206 4.47 % 1,403,196 6.11 % 1,113,827 7.15 % (389,990) 289,369
South Carolina 950,028 4.19 % 929,710 4.05 % 604,546 3.88 % 20,318 325,164
Ohio 868,378 3.83 % 869,393 3.78 % 642,130 4.12 % (1,015) 227,263
Missouri 742,220 3.27 % 777,389 3.38 % 510,025 3.27 % (35,169) 267,364
North Carolina 740,169 3.27 % 719,936 3.13 % 485,682 3.12 % 20,233 234,254
New York 705,601 3.11 % 641,387 2.79 % 456,681 2.93 % 64,214 184,706
Washington 703,239 3.10 % 736,135 3.20 % 631,549 4.05 % (32,896) 104,586
All other states 8,983,335 39.63 % 9,069,853 39.50 % 5,891,952 37.83 % (86,518) 3,177,901
$ 22,668,283 100.00 % $ 22,970,194 100.00 % $ 15,579,437 100.00 % $ (301,911) $ 7,390,757
Mortgage Loan Sales -
volume:
Third parties $ 22,280,872 96.62 % $ 22,321,599 99.14 % $ 14,442,929 98.98 % $ (40,727) $ 7,878,670
Banking segment 778,288 3.38 % 192,571 0.86 % 148,798 1.02 % 585,717 43,773
$ 23,059,160 100.00 % $ 22,514,170 100.00 % $ 14,591,727 100.00 % $ 544,990 $ 7,922,443
We consider the mortgage origination segment's total loan origination volume to
be a key performance measure. Loan origination volume is central to the
segment's ability to generate income by originating and selling mortgage loans,
resulting in net gains from the sale of loans, other mortgage production income
and other mortgage loan origination fees. Total loan origination volume is a
measure utilized by management, our investors, and analysts in assessing market
share and growth of the mortgage origination segment.
The mortgage origination segment's total loan origination volume during 2021
decreased 1.3%, compared with 2020, while income before income taxes during 2021
decreased 42.3%, compared with 2020. The decrease in income before income taxes
during 2021 was primarily the result of a decrease of IRLCs related to a
decrease in mortgage loan applications, and a decrease in the average value of
individual IRLCs.
The mortgage origination segment's total loan origination volume during 2020
increased 47.4% compared with 2019, while income before income taxes during 2020
increased 530.5%, compared with 2019. The increase in income before income taxes
during 2020 was primarily due to an increase of IRLCs related to an increase in
mortgage loan applications, and an increase in
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the average value of individual IRLCs. These changes were partially offset by increases in variable compensation that varies with the volume of mortgage loan originations, in non-variable compensation, and segment operating costs.
The information shown in the table below includes certain key performance
indicators for the mortgage origination segment.
Year Ended December 31,
2021
2020 2019
Net gains from mortgage loan sales (basis points):
Loans sold to third parties
375 409 327 Impact of loans retained by banking segment (13) (3) (3) As reported 362 406 324 Variable compensation as a percentage of total compensation 65.8 %
69.0 % 60.4 %
Mortgage servicing rights asset (
Reported on a consolidated basis and therefore does not include mortgage
(1) servicing rights assets related to loans serviced for the banking segment,
which are eliminated in consolidation.
Net interest expense was comprised of interest income earned on loans held for
sale offset by interest incurred on warehouse lines of credit primarily held
with the Bank, and related intercompany financing costs. The changes in net
interest expense during 2021, compared with 2020, and during 2020, compared with
2019, included the effects of decreased net yields on mortgage loans held for
sale between the two periods.
Noninterest income was comprised of the items set forth in the table below (in
thousands).
Year Ended December 31, Variance
2021 2020 2019 2021 vs 2020 2020 vs 2019
Net gains from sale of
loans $ 834,580 $ 913,474 $ 473,380 $ (78,894) $ 440,094
Mortgage loan origination
fees and other related
income 160,011 172,096 130,208 (12,085) 41,888
Other mortgage production
income:
Change in net fair value
and related derivative
activity:
IRLCs and loans held for
sale (67,714) 81,560 21,253 (149,274) 60,307
Mortgage servicing rights
asset 2,446 (30,119) (15,166) 32,565 (14,953)
Servicing fees 57,667 35,439 25,317 22,228 10,122
Total noninterest income
(185,460)$ 537,458 The decrease in net gains from sale of loans during 2021, compared with 2020, was primarily the result of a decrease in average loan sales margin, partially offset by a slight increase in loan sales volume. Since PrimeLending sells substantially all mortgage loans it originates to various investors in the secondary market, the slight increase in loan sales volume during 2021 is consistent with the relatively flat loan origination volume during the period. The decrease in average loan sales margin was primarily attributable to competitive pricing pressure resulting from home inventory shortages and a reduction in national refinancing volume. While average loan sales margins increased between the second and fourth quarters of 2020, margins steadily declined during 2021, approaching margins recognized at the beginning of the COVID-19 pandemic. The slight decrease in mortgage loan origination fees during 2021, compared with 2020, was primarily the result of the decrease in average mortgage loan origination fees, in addition to the slight decrease in loan origination volume during 2021, compared to 2020. During 2020, compared with 2019, the increase in net gains from sale of loans was primarily a result of an increase in total loan sales volume, in addition to an increase in average
loan sales margin.
We consider the mortgage origination segment's net gains from sale of loans margin, in basis points, to be a key performance measure. Net gains from sale of loans margin is defined as net gains from sale of loans divided by loan sales volume. The net gains from sale of loans is central to the segment's generation of income, and may include loans sold to third parties and loans sold to and retained by the banking segment. For origination services provided, the mortgage origination segment was reimbursed direct origination costs associated with loans retained by the banking segment, in addition to payment of a correspondent fee. The reimbursed origination costs and correspondent fee are included in the mortgage origination segment operating results, and the correspondent fees are eliminated in consolidation. Loan volumes to be originated on behalf of and retained by the banking segment are evaluated each quarter. While we anticipate a leveling off in the quarterly rate of loans sold to and retained by the banking segment during 2022 compared to the fourth quarter of 2021, we do not expect these sales to exceed 5% of its total origination volume during this time. InMarch 2020 , the mortgage origination segment executed a letter of intent with the banking segment to purchase mortgage loans previously sold to the banking segment with an unpaid principal balance of approximately$210 million . Such original sales of approximately$121 million and$91 million are reflected in the previous mortgage loan details table within the mortgage loan sales volume to the banking segment in 2020 and 2019, 73
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respectively. When these loans were sold at par by the mortgage origination segment, the banking segment's intent was to hold these loans for investment. The mortgage origination segment completed the repurchase of these loans from the banking segment and in turn sold the loans to investors in the secondary market during the second quarter of 2020. Noninterest income included changes in the net fair value of the mortgage origination segment's IRLCs and loans held for sale and the related activity associated with forward commitments used by the mortgage origination segment to mitigate interest rate risk associated with its IRLCs and loans held for sale. The decrease in fair value of IRLCs and loans held for sale during 2021, compared to 2020, was the result of decreases in the total volume of individual IRLCs and loans held for sale and the average value of individual IRLCs and loans held for sale. The increase in noninterest income during 2020, compared to 2019, was the result of an increase in the total volume of individual IRLCs and loans held for sale, as well as an increase in the average value of individual IRLCs and loans held for sale. The mortgage origination segment sells substantially all mortgage loans it originates to various investors in the secondary market, historically with the majority servicing released. In addition, the mortgage origination segment originates loans on behalf of the Bank. The mortgage origination segment's determination of whether to retain or release servicing on mortgage loans it sells is impacted by, among other things, changes in mortgage interest rates, and refinancing and market activity. During 2021, 2020 and 2019, the mortgage origination segment retained servicing on approximately 29%, 67% and 6% of loans sold, respectively. During both the second and third quarters of 2020, PrimeLending retained servicing on 89% of total mortgage loans sold. The increased rate of retained servicing during this time was due to the reduction in third-party servicing outlets during the second quarter of 2020, resulting from the impact of the CARES Act. The CARES Act permits borrowers of federally-backed mortgage loans to forbear payments, which could negatively impact servicers' liquidity and their ability to purchase servicing. As forbearance requests leveled off during the latter part of 2020, the third-party market for mortgage servicing rights improved, increasing demand, which allowed PrimeLending to reduce retained servicing to 57% of total mortgage loans sold during the fourth quarter of 2020, and ultimately to 11% of total mortgage loans sold during the fourth quarter of 2021. If the third-party market for mortgage servicing rights continue to improve in 2022, we expect that PrimeLending will continue to reduce retained servicing on mortgage loans sold during that time to levels experienced in 2019. The mortgage origination segment may, from time to time, manage its MSR asset through different strategies, including varying the percentage of mortgage loans sold servicing released and opportunistically selling MSR assets. The mortgage origination segment has also retained servicing on certain loans sold to and retained by the banking segment. Gains and losses associated with such sales to the banking segment and the related MSR asset are eliminated in consolidation. The mortgage origination segment uses derivative financial instruments, includingU.S. Treasury bond futures and options, as a means to mitigate interest rate risk associated with its MSR asset. Changes in the net fair value of the MSR asset and the related derivatives associated with normal customer payments, changes in discount rates, prepayment speed assumptions and customer payoffs resulted in net gains (losses) as noted in the table above. Included in the net gains and losses for 2021, are MSR asset fair value adjustment gains totaling$22.8 million , which reflect the difference between the MSR asset carrying values and the sale prices reflected in the letters of intent to sell the applicable MSR assets. During 2021, the mortgage origination segment sold MSR assets of$142.6 million , which represented$12.4 billion of its serviced loan volume at the time of sale. During 2020, the mortgage origination segment sold MSR assets of$36.8 million , which represented$3.8 billion of its serviced loan volume at the time of sale, while there were no sales of MSR assets during 2019. As ofDecember 31, 2021 , the mortgage origination segment had executed a letter of intent for a pending sale of MSR assets with a serviced loan volume totaling$156.5 million . The sale of these MSR assets is expected to be completed during the first quarter of 2022 at a total price of approximately$2.0 million . The value assigned these MSR assets as ofDecember 31, 2021 , reflects the price included in this letter of intent. Noninterest expenses were comprised of the items set forth in the table below (in thousands). Year Ended December 31, Variance 2021 2020 2019 2021 vs 2020 2020 vs 2019
Variable compensation$ 373,929 $ 405,116 $ 252,956 $ (31,187) $ 152,160 Non-variable compensation and benefits 194,292 181,597 166,179 12,695 15,418 Segment operating costs 113,020 125,104 112,128 (12,084) 12,976 Lender paid closing costs 20,458 21,696 19,698 (1,238) 1,998 Servicing expense 29,357 20,404 13,037 8,953 7,367 Total noninterest expense$ 731,056 $ 753,917 $ 563,998 $ (22,861) $ 189,919 Total employees' compensation and benefits accounted for the majority of the noninterest expenses incurred during all periods presented. Specifically, variable compensation comprised the majority of total employees' compensation and benefits expenses during 2021, 2020 and 2019. The changes in the percentage concentration of variable compensation and benefits for all periods were primarily due to changes in the average incentive rate paid and the impact of incentive plans driven by non-mortgage production criteria. Variable compensation, which is primarily driven by loan origination volume, tends to fluctuate to a greater 74 Table of Contents degree than loan origination volume because mortgage loan originator and fulfillment staff incentive compensation plans are structured to pay at increasing rates as higher monthly volume tiers are achieved. However, certain other incentive compensation plans driven by non-mortgage production criteria may alter this trend. While total loan origination volumes decreased 1.3% during 2021, compared with 2020, the aggregate non-variable compensation and benefits of the mortgage origination segment increased by 7.0%. This increase during 2021, compared with 2020, was primarily due to an increase in salaries mainly resulting from increased underwriting and loan fulfillment staff to support the increase in loan origination volume starting in the second quarter of 2020. These additional staff continued to be needed to support loan origination volumes during the remainder of 2020 and throughout 2021. Segment operating costs decreased in 2021, compared to 2020, primarily due to decreases in loan related costs, software amortization expense and software license and maintenance costs. The mortgage origination segment's operating costs increased 11.6% during 2020, compared with 2019, while total loan origination volumes increased 47.4%. The increase during 2020, compared with 2019, was primarily due to an increase in overtime expense incurred due to increased loan volume and an increase in salaries resulting from increased underwriting and loan fulfillment staff, to support the increase in loan origination volume beginning in the second quarter of 2020. In exchange for a higher interest rate, customers may opt to have PrimeLending pay certain costs associated with the origination of their mortgage loan ("lender paid closing costs"). Fluctuations in lender paid closing costs are not always aligned with fluctuations in loan origination volume. Other loan pricing conditions, including the mortgage loan interest rate, loan origination fees paid by the customer, and a customer's willingness to pay closing costs, may influence fluctuations in lender paid closing costs. BetweenJanuary 1, 2012 andDecember 31, 2021 , the mortgage origination segment sold mortgage loans totaling$151.9 billion . These loans were sold under sales contracts that generally include provisions that hold the mortgage origination segment responsible for errors or omissions relating to its representations and warranties that loans sold meet certain requirements, including representations as to underwriting standards and the validity of certain borrower representations in connection with the loan. In addition, the sales contracts typically require the refund of purchased servicing rights plus certain investor servicing costs if a loan experiences an early payment default. While the mortgage origination segment sold loans prior to 2012, it does not anticipate experiencing significant losses in the future on loans originated prior to 2012 because of investor claims under these provisions of its sales contracts. When a claim for indemnification of a loan sold is made by an agency, investor, or other party, the mortgage origination segment evaluates the claim and determines if the claim can be satisfied through additional documentation or other deliverables. If the claim is valid and cannot be satisfied in that manner, the mortgage origination segment negotiates with the claimant to reach a settlement of the claim. Settlements typically result in either the repurchase of a loan or reimbursement to the claimant for losses incurred on the loan. Following is a summary of the mortgage origination segment's claims resolution activity relating to loans sold betweenJanuary 1, 2012 andDecember 31, 2021 (dollars in thousands). Original Loan Balance Loss Recognized % of % of Amount Loans Sold Amount Loans Sold
Claims resolved with no payment$ 215,848 0.14 % $ - - % Claims resolved because of a loan repurchase or payment to an investor for losses incurred (1) 235,968 0.16 %
9,452 0.01 %
$ 451,816 0.30 % $ 9,452 0.01 %
(1) Losses incurred include refunded purchased servicing rights.
For each loan the mortgage origination segment concludes its obligation to a claimant is both probable and reasonably estimable, the mortgage origination segment has established a specific claims indemnification liability reserve. An additional indemnification liability reserve has been established for probable agency, investor or other party losses that may have been incurred, but not yet reported to the mortgage origination segment based upon a reasonable estimate of such losses. In addition to other factors, the mortgage origination segment has considered that GNMA,FNMA and FHLMC have imposed certain restrictions on loans the agencies will accept under a forbearance agreement resulting from the COVID-19 pandemic, which could increase the magnitude of indemnification losses on these loans. 75 Table of Contents
At
indemnification liability reserve totaled
respectively. The related provision for indemnification losses was
million
respectively.
Corporate
The following table presents certain financial information regarding the
operating results of corporate (in thousands).
Year Ended December 31, Variance
2021 2020 2019 2021 vs 2020 2020 vs 2019
Net interest income (expense) $ (17,239) $ (14,192) $ (5,541) $
(3,047)$ (8,651) Noninterest income 9,133 3,945 2,104 5,188 1,841 Noninterest expense 50,507 53,040 50,968 (2,533) 2,072 Income (loss) from continuing operations before income taxes$ (58,613) $ (63,287) $ (54,405) $
4,674$ (8,882)
Corporate includes certain activities not allocated to specific business
segments. These activities include holding company financing and investing
activities, merchant banking investment opportunities and management and
administrative services to support the overall operations of the Company.
Hilltop's merchant banking investment activities include the identification of
attractive opportunities for capital deployment in companies engaged in
non-financial activities through its merchant bank subsidiary,
Opportunity Partners LLC
As a holding company, Hilltop's primary investment objectives are to support capital deployment for organic growth and to preserve capital to be deployed through acquisitions, dividend payments and potential stock repurchases. Investment and interest income earned during 2021 was primarily comprised of dividend income from merchant banking investment activities, in addition to interest income earned on intercompany notes. Interest expense from continuing operations during 2021, 2020 and 2019 included recurring annual interest expense of$7.7 million incurred on our$150.0 million aggregate principal amount of 5% senior notes due 2025 ("Senior Notes"). During 2021 and 2020, we incurred interest expense of$12.3 million and$7.9 million on our$200 million aggregate principal amount of Subordinated Notes, which were issued inMay 2020 . Additionally, we incurred interest expense of$1.6 million ,$2.8 million and$3.9 million during 2021, 2020 and 2019, respectively, on junior subordinated debentures of$67.0 million issued by PCC (the "Debentures"). As discussed in more detail within the section titled "Liquidity and Capital Resources - Junior Subordinated Debentures" below, during the third quarter of 2021, PCC fully redeemed all outstanding Debentures.
Noninterest income from continuing operations during each period included
activity related to our investment in a real estate development in
University Park
Hilltop and the Bank, and net noninterest income associated with activity within
our merchant bank subsidiary. During 2021, noninterest income included an
aggregate of
transactions related to two merchant bank equity investments.
Noninterest expenses from continuing operations were primarily comprised of employees' compensation and benefits, occupancy expenses and professional fees, including corporate governance, legal and transaction costs. During 2021, compared with 2020, the decrease in noninterest expenses was primarily due to decreases in expenses associated with employees' incentive compensation and professional fees. During 2020, compared with 2019, the increase in noninterest expenses was primarily due to increased employees' compensation and benefits costs associated with the consolidation of certain common back office functions into corporate and improved operating results, and professional fees, partially offset by a decrease of$6.8 million of aggregate pre-tax costs associated with the leadership changes and efficiency initiative-related charges. 76 Table of Contents
Results from Discontinued Operations
Insurance Segment As previously discussed, onJune 30, 2020 , we completed the sale of NLC. Accordingly, insurance segment results for 2020 and 2019 have been presented as discontinued operations in the consolidated financial statements. Additional details are presented in Note 3, Discontinued Operations, in the notes to our consolidated financial statements. All activity associated with the insurance segment was recognized in 2020, therefore, there was no income from discontinued operations before taxes during 2021, while income from discontinued operations before income taxes was$2.1 million and$17.6 million during 2020 and 2019, respectively. Corporate As a result of the previously noted sale of NLC onJune 30, 2020 for cash proceeds of$154.1 million , during 2020, Hilltop recognized an aggregate pre-tax gain on sale within discontinued operations of corporate of$36.8 million , net of customary transaction costs of$5.1 million . The resulting book gain from this sale transaction was not recognized for tax purposes pursuant to the rules under the Internal Revenue Code. Financial Condition
The following discussion contains a more detailed analysis of our financial
condition at
2019
Securities Portfolio AtDecember 31, 2021 , investment securities consisted of securities of theU.S. Treasury ,U.S. government and its agencies, obligations of municipalities and other political subdivisions, primarily in theState of Texas , as well as mortgage-backed, corporate debt, and equity securities. We may categorize investments as trading, available for sale, held to maturity and equity securities. Trading securities are bought and held principally for the purpose of selling them in the near term and are carried at fair value, marked to market through operations and held at the Bank and the Hilltop Broker-Dealers. Securities classified as available for sale may, from time to time, be bought and sold in response to changes in market interest rates, changes in securities' prepayment risk, increases in loan demand, general liquidity needs and to take advantage of market conditions that create more economically attractive returns. Such securities are carried at estimated fair value, with unrealized gains and losses recorded in accumulated other comprehensive income (loss). Equity investments are carried at fair value, with all changes in fair value recognized in net income. Securities are classified as held to maturity based on the intent and ability of our management, at the time of purchase, to hold such securities to maturity. These securities are carried at amortized cost. 77
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The table below summarizes our securities portfolio from continuing operations
(in thousands).
December 31,
2021 2020 2019
Trading securities, at fair value
U.S. Treasury securities $ 3,728 $ 40,491 $ -
U.S. government agencies:
Bonds 3,410 40 24,680
Residential mortgage-backed securities 152,093 336,081
331,601
Commercial mortgage-backed securities 126,389 876
2,145
Collateralized mortgage obligations - 69,172
191,154
Corporate debt securities 60,671 62,481
36,973
States and political subdivisions 285,376 171,573
93,117
Unit investment trusts - -
3,468
Private-label securitized product 11,377 8,571
2,992
Other 4,954 4,970 3,446
647,998 694,255 689,576
Securities available for sale, at fair value
U.S. Treasury securities 14,862 - -
U.S. government agencies:
Bonds 44,133 82,806 85,575
Residential mortgage-backed securities 898,446 641,611
437,029
Commercial mortgage-backed securities 210,699 124,538
12,031
Collateralized mortgage obligations 916,866 565,908
335,616
States and political subdivisions 45,562 47,342
41,242
2,130,568 1,462,205
911,493
Securities held to maturity, at amortized costU.S. government agencies: Bonds - -
24,020
Residential mortgage-backed securities 9,892 13,547
17,776
Commercial mortgage-backed securities 145,742 152,820
161,624
Collateralized mortgage obligations 43,990 74,932
113,894
States and political subdivisions 68,060 70,645
69,012
267,684 311,944
386,326
Equity securities, at fair value 250 140
166 Total securities portfolio$ 3,046,500 $ 2,468,544 $ 1,987,561 We had net unrealized losses of$18.1 million atDecember 31, 2021 , compared with net unrealized gains of$26.3 million and$11.7 million atDecember 31, 2020 and 2019, respectively, related to the available for sale investment portfolio and net unrealized gains of$8.6 million ,$14.7 million and$2.6 million atDecember 31, 2021 , 2020 and 2019, respectively, associated with the securities held to maturity portfolio. Equity securities included net unrealized gains of$0.2 million ,$0.1 million and$0.1 million atDecember 31, 2021 , 2020 and 2019, respectively. The noted significant change in net unrealized gains (losses) within our available for sale investment portfolio fromDecember 31, 2020 toDecember 31, 2021 was related to increases in market interest rates since purchase and the resulting decline in associated estimated fair values of such portfolio investments. In future periods, changes in prevailing market interest rates, coupled with changes in the aggregate size of the investment portfolio, will be significant drivers to changes in the unrealized losses
or gains in these portfolios. Banking Segment The banking segment's securities portfolio plays a role in the management of our interest rate sensitivity and generates additional interest income. In addition, the securities portfolio is used to meet collateral requirements for public and trust deposits, securities sold under agreements to repurchase and other purposes. The available for sale and equity securities portfolios serve as a source of liquidity. Historically, the Bank's policy has been to invest primarily in securities of theU.S. government and its agencies, obligations of municipalities in theState of Texas and other high grade fixed income securities to minimize credit risk. AtDecember 31, 2021 , the banking segment's securities portfolio of$2.4 billion was comprised of trading securities of$0.1 million , available for sale securities of$2.1 billion , held to maturity securities of$267.7 million and equity securities of$0.2 million , in addition to$14.4 million of other investments included in other assets within the consolidated balance sheets. 78 Table of Contents Broker-Dealer Segment The broker-dealer segment holds securities to support sales, underwriting and other customer activities. The interest rate risk inherent in holding these securities is managed by setting and monitoring limits on the size and duration of positions and on the length of time the securities can be held. The Hilltop Broker-Dealers are required to carry their securities at fair value and record changes in the fair value of the portfolio in operations. Accordingly, the securities portfolio of the Hilltop Broker-Dealers included trading securities of$647.9 million atDecember 31, 2021 . In addition, the Hilltop Broker-Dealers enter into transactions that represent commitments to purchase and deliver securities at prevailing future market prices to facilitate customer transactions and satisfy such commitments. Accordingly, the Hilltop Broker-Dealers' ultimate obligation may exceed the amount recognized in the financial statements. These securities, which are carried at fair value and reported as securities sold, not yet purchased in the consolidated balance sheets, had a value of$96.6 million atDecember 31, 2021 . Corporate
At
including those associated with merchant banking, of
assets within the consolidated balance sheets.
Allowance for Credit Losses for Available for
We have evaluated available for sale debt securities that are in an unrealized loss position and have determined that any declines in value are unrelated to credit loss and related to changes in market interest rates since purchase. None of the available for sale debt securities held were past due atDecember 31, 2021 . In addition, as ofDecember 31, 2021 , we had evaluated our held to maturity debt securities, considering the current credit ratings and recognized losses, and determined the potential credit loss to be minimal. With respect to these securities, we considered the risk of credit loss to be negligible, and therefore, no allowance was recognized on the debt securities portfolio atDecember 31, 2021 . The following table sets forth the estimated maturities of our debt securities, excluding trading securities, atDecember 31, 2021 . Contractual maturities may be different (dollars in thousands, yields are tax-equivalent). One Year One Year to Five Years to Greater Than Or Less Five Years Ten Years Ten Years TotalU.S. Treasury securities: Amortized cost$ 9,964 $ 4,973 - -$ 14,937 Fair value$ 9,962 $ 4,900 - -$ 14,862 Weighted average yield (1) 0.36 % 0.87 % - - 0.53 %U.S. government agencies: Bonds: Amortized cost -$ 22,811 $ 4,536 $ 16,101 $ 43,448 Fair value -$ 23,264 $ 4,623 $ 16,246 $ 44,133 Weighted average yield (1) - 2.14 % 0.80 % 1.14 % 1.63 % Residential mortgage-backed securities: Amortized cost$ 3 $ 3,835 $ 97,037 $ 809,101 $ 909,976 Fair value$ 3 $ 3,989 $ 99,674 $ 805,072 $ 908,738 Weighted average yield (1) 2.44 % 3.31 % 1.99 % 1.51 % 1.57 % Commercial mortgage-backed securities: Amortized cost -$ 96,821 $ 173,172 $ 95,209 $ 365,202 Fair value -$ 100,109 $ 171,136 $ 90,507 $ 361,752 Weighted average yield (1) - 2.84 % 1.78 % 1.37 % 1.95 % Collateralized mortgage obligations: Amortized cost -$ 2,502 $ 120,004 $ 848,267 $ 970,773 Fair value -$ 2,538 $ 119,854 $ 838,940 $ 961,332 Weighted average yield (1) - 1.86 % 0.97 % 1.24 % 1.21 % States and political subdivisions: Amortized cost$ 870 $ 8,432 $ 24,346 $ 78,335 $ 111,983 Fair value$ 877 $ 8,742 $ 25,392 $ 81,036 $ 116,047 Weighted average yield (1) 4.17 % 3.32 % 3.59 % 3.40 % 3.44 % Total securities portfolio: Amortized cost$ 10,837 $ 139,374 $ 419,095 $ 1,847,013 $ 2,416,319 Fair value$ 10,842 $ 143,542 $ 420,679 $ 1,831,801 $ 2,406,864 Weighted average yield (1) 0.67 % 2.68 % 1.69 % 1.46 % 1.56 %
(1) Weighted average yield is defined as interest earned by average
interest-earning assets.
79
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Loan Portfolio
Consolidated loans held for investment are detailed in the tables below,
classified by portfolio segment (in thousands).
December 31,
Loan Held for Investment 2021 2020 2019
Commercial real estate $ 3,042,729 $ 3,133,903 $ 3,000,523
Commercial and industrial 1,875,420 2,627,774 2,025,720
Construction and land development 892,783 828,852
940,564 1-4 family residential 1,303,430 629,938 791,020 Consumer 32,349 35,667 47,046 Broker-dealer 733,193 437,007 576,527
Loans held for investment, gross 7,879,904 7,693,141
7,381,400
Allowance for credit losses (91,352) (149,044)
(61,136)
Loans held for investment, net of allowance
Banking Segment The loan portfolio constitutes the primary earning asset of the banking segment and typically offers the best alternative for obtaining the maximum interest spread above the banking segment's cost of funds. The overall economic strength of the banking segment generally parallels the quality and yield of its loan portfolio.
The banking segment's total loans held for investment, net of the allowance for credit losses, were$8.8 billion ,$9.6 billion and$8.6 billion atDecember 31, 2021 , 2020 and 2019, respectively. The banking segment's loan portfolio included warehouse lines of credit extended to PrimeLending of$3.3 billion , of which$1.7 billion ,$2.5 billion and$1.8 billion was drawn atDecember 31, 2021 , 2020 and 2019, respectively. EffectiveJanuary 1, 2022 , these warehouse lines of credit were decreased to$2.8 billion to address expected declines in loan origination volumes. Amounts advanced against the warehouse lines of credit are eliminated from net loans held for investment on our consolidated balance sheets. The banking segment does not generally participate in syndicated loan transactions and has no foreign loans in its portfolio. The banking segment's loan portfolio included approximately$78 million related to both initial and second round PPP loans atDecember 31, 2021 . While these loans have terms of up to 60 months, borrowers can apply for forgiveness of these loans with the SBA. ThroughFebruary 11, 2022 , the SBA had approved approximately 3,700 initial and second round PPP forgiveness applications from the Bank totaling approximately$840 million , with PPP loans of approximately$4 million currently pending SBA review and approval. We anticipate a significant amount of these remaining PPP loans pending approval being forgiven over the next two quarters. The forgiveness/payoff of the PPP loans would generate an increase in interest income as we would recognize the remaining unamortized origination fee at the time of payoff. AtDecember 31, 2021 , the banking segment had loan concentrations (loans to borrowers engaged in similar activities) that exceeded 10% of total loans in its real estate portfolio. The areas of concentration within our real estate portfolio were non-construction commercial real estate loans, non-construction residential real estate loans, and construction and land development loans, which represented 42.6%, 18.2% and 12.5%, respectively, of the banking segment's total loans held for investment atDecember 31, 2021 . The banking segment's loan concentrations were within regulatory guidelines atDecember 31, 2021 . 80 Table of Contents The following table provides information regarding the maturities of the banking segment's gross loans held for investment, net of unearned income (in thousands). December 31, 2021 Due Within Due From One Due from Five Due After One Year To Five Years To Fifteen Years Fifteen Years Total
Commercial real estate$ 419,330 $ 1,511,778 $ 964,373$ 147,248 $ 3,042,729 Commercial and industrial 2,936,441 495,633 156,880 - 3,588,954 Construction and land development 372,915 384,809
129,594 5,465 892,783 1-4 family residential 118,683 215,418 242,050 727,279 1,303,430 Consumer 20,738 11,367 223 21 32,349 Total$ 3,868,107 $ 2,619,005 $ 1,493,120 $ 880,013 $ 8,860,245 Fixed rate loans$ 3,623,736 $ 2,357,533 $ 1,423,894 $ 880,013 $ 8,285,176 Floating rate loans 244,371 261,472 69,226 - 575,069 Total$ 3,868,107 $ 2,619,005 $ 1,493,120 $ 880,013 $ 8,860,245 In the table above, commercial and industrial includes amounts advanced against the warehouse lines of credit extended to PrimeLending. Floating rate loans that have reached their applicable rate floor or ceiling are classified as fixed rate loans rather than floating rate loans. As ofDecember 31, 2021 , floating rate loans totaling$1.3 billion had reached their applicable rate floor. The majority of floating rate loans carry an interest rate tied toThe Wall Street Journal Prime Rate, as published inThe Wall Street Journal . Broker-Dealer Segment The loan portfolio of the broker-dealer segment consists primarily of margin loans to customers and correspondents that are due within one year. The interest rate on margin accounts is computed on the settled margin balance at a fixed rate established by management. These loans are collateralized by the securities purchased or by other securities owned by the clients and, because of collateral coverage ratios, are believed to present minimal collectability exposure. Additionally, these loans are subject to a number of regulatory requirements as well as the Hilltop Broker-Dealers' internal policies. The broker-dealer segment's total loans held for investment, net of the allowance for credit losses, were$733.0 million ,$436.8 million and$576.5 million atDecember 31, 2021 , 2020 and 2019, respectively. The increase fromDecember 31, 2020 toDecember 31, 2021 , was primarily attributable to an increase of$169.9 million , or 66.2%, in customer margin accounts and an increase of$125.9 million , or 69.9%, in receivables from correspondents. The decrease fromDecember 31, 2019 toDecember 31, 2020 was primarily attributable to a decrease of$54.1 million or 17.4%, in customer margin accounts and a decrease of$84.0 million , or 31.8%, in receivables from correspondents. Mortgage Origination Segment The loan portfolio of the mortgage origination segment consists of loans held for sale, primarily single-family residential mortgages funded through PrimeLending, and IRLCs with customers pursuant to which we agree to originate a mortgage loan on a future date at an agreed-upon interest rate. The components of the mortgage origination segment's loans held for sale and IRLCs are as
follows (in thousands).
December 31,
2021 2020 2019
Loans held for sale:
Unpaid principal balance $ 1,728,255 $ 2,411,626 $ 1,878,231
Fair value adjustment 54,336 109,778 57,482
$ 1,782,591 $ 2,521,404 $ 1,935,713
IRLCs:
Unpaid principal balance $ 1,283,152 $ 2,470,013 $ 914,526
Fair value adjustment 25,489 76,048 18,222
$ 1,308,641 $ 2,546,061 $ 932,748
The mortgage origination segment uses forward commitments to mitigate interest
rate risk associated with its loans held for sale and IRLCs. The notional
amounts of these forward commitments at December 31, 2021 , 2020 and 2019 were
$2.4 billion ,
81
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values were
Allowance for Credit Losses on Loans
For additional information regarding the allowance for credit losses, refer to
the section captioned "Critical Accounting Estimates" included in this Form
10-K.
Loans Held for Investment The Bank has lending policies in place with the goal of establishing an asset portfolio that will provide a return on stockholders' equity sufficient to maintain capital to assets ratios that meet or exceed established regulations. Loans are underwritten with careful consideration of the borrower's financial condition, the specific purpose of the loan, the primary sources of repayment and any collateral pledged to secure the loan. Underwriting procedures address financial components based on the size and complexity of the credit. The financial components include, but are not limited to, current and projected cash flows, shock analysis and/or stress testing, and trends in appropriate balance sheet and statement of operations ratios. The Bank's loan policy provides specific underwriting guidelines by portfolio segment, including commercial and industrial, real estate, construction and land development, and consumer loans. The guidelines for each individual portfolio segment set forth permissible and impermissible loan types. With respect to each loan type, the guidelines within the Bank's loan policy provide minimum requirements for the underwriting factors listed above. The Bank's underwriting procedures also include an analysis of any collateral and guarantor. Collateral analysis includes a complete description of the collateral, as well as determined values, monitoring requirements, loan to value ratios, concentration risk, appraisal requirements and other information relevant to the collateral being pledged. Guarantor analysis includes liquidity and cash flow evaluation based on the significance with which the guarantors are expected to serve as secondary repayment sources. The Bank maintains a loan review department that reviews credit risk in response to both external and internal factors that potentially impact the performance of either individual loans or the overall loan portfolio. The loan review process reviews the creditworthiness of borrowers and determines compliance with the loan policy. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel. Results of these reviews are presented to management and the Bank's board of directors and the Risk Committee of the board of directors of the Company. The allowance for credit losses for loans held for investment represents management's best estimate of all expected credit losses over the expected contractual life of our existing portfolio. Determining the appropriateness of the allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. Subsequent evaluations of the then-existing loan portfolio, in light of the factors then prevailing, may result in significant changes in the allowance for credit losses in those future periods. Such future changes in the allowance for credit losses are expected to be volatile given dependence upon, among other things, the portfolio composition and quality, as well as the impact of significant drivers, including prepayment assumptions and macroeconomic conditions and forecasts. The COVID-19 pandemic disrupted financial markets and overall economic conditions that have affected borrowers across our lending portfolios. Significant judgment is required to estimate the severity and duration of the current economic uncertainties, as well as its potential impact on borrower defaults and loss severity. In particular, macroeconomic conditions and forecasts are rapidly changing and remain highly uncertain as COVID-19 cases and vaccine effectiveness, as well as government stimulus and policy measures, evolve nationally and in key geographies. It is difficult to predict exactly how borrower behavior will be impacted by these economic conditions as the effectiveness of vaccinations, government stimulus and policy measures, customer relief and enhanced unemployment benefits have helped mitigate in the short term, but the extent and duration of government stimulus remains uncertain. One of the most significant judgments involved in estimating our allowance for credit losses relates to the macroeconomic forecasts used to estimate credit losses over the reasonable and supportable forecast period. To determine the allowance for credit losses as ofDecember 31, 2021 , we utilized a single macroeconomic consensus scenario published by aMoody's Analytics inDecember 2021 .
During our previous quarterly macroeconomic assessment as of
we utilized the single macroeconomic alternative baseline, or S7, scenario
published by
December
82
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31, 2021 was based on our evaluation of the Moody's baseline economic forecast
compared to other industry surveys over the reasonable and supportable period
and our assessment of the reasonableness of impacts associated with the key
monetary and government stimulus policy assumptions. The consensus economic
scenario considered several industry surveys in the near-term forecasts and
assumes reversion to the long-term trends embedded in the baseline economic
scenario before reverting to historical data.
The following table summarizes the
growth rates and unemployment rate assumptions used in our economic forecast to
determine our best estimate of expected credit losses.
As of
December 31, September 30, June 30, March 31, December 31,
2021 2021 2021 2021 2020
GDP growth
rates:
Q4 2020 4.0%
Q1 2021 5.0% 1.6%
Q2 2021 10.8% 6.5% 4.5%
Q3 2021 5.0% 6.6% 6.7% 4.7%
Q4 2021 6.7% 7.5% 6.9% 4.8% 5.8%
Q1 2022 3.6% 4.6% 5.4% 3.2% 4.8%
Q2 2022 3.5% 2.8% 2.8% 2.5% 4.4%
Q3 2022 2.3% 1.3% 2.3% 2.1%
Q4 2022 2.7% 1.5% 1.8%
Q1 2023 3.0% 2.4%
Q2 2023 2.4%
Unemployment
rates:
Q4 2020 6.7%
Q1 2021 6.3% 6.9%
Q2 2021 5.8% 6.2% 7.1%
Q3 2021 5.2% 5.2% 5.8% 7.0%
Q4 2021 4.3% 4.5% 4.5% 5.4% 6.8%
Q1 2022 4.3% 3.9% 4.0% 5.1% 6.5%
Q2 2022 4.0% 3.5% 3.7% 4.9% 6.2%
Q3 2022 3.8% 3.4% 3.6% 4.7%
Q4 2022 3.6% 3.3% 3.5%
Q1 2023 3.7% 3.3%
Q2 2023 3.7%
As ofDecember 31, 2021 , our economic forecast improved fromSeptember 30, 2021 based on updated economic data, including November unemployment rates improving faster than the prior quarter's forecast despite tight labor market conditions and accelerated rates of theFederal Reserve's taper of monthly asset purchases. We now assume theFederal Reserve continues to support a target range of the federal funds rate near 0% through monetary policy support and assume interest rates begin to rise as early as the second quarter of 2022. Real GDP growth rates were revised lower due to persistently higher inflation data and observed supply-chain impacts on business and consumer spending due to the delta variant. Given the timing of the Moody's economic forecast release in earlyDecember 2021 , the forecast utilized also assumed that COVID-19 cases peaked inJanuary 2021 , but did not assume a third wave of COVID-19 cases due to the omicron variant into the winter months. The forecast also did not consider uncertainty related to additional fiscal support from the Build Back Better proposal, so our model results were qualitatively adjusted to consider these recent developments as ofDecember 31, 2021 .
SinceDecember 31, 2020 , our economic forecast improved year-over-year due to a third round of$1.9 trillion in government stimulus enacted inMarch 2021 through the American Rescue Plan Act. As a result of additional stimulus checks, enhanced unemployment benefits, extended lending from the PPP program, and expanded tax credits, consumer and business spending accelerated theU.S. real GDP growth rate in the second quarter of 2021 to 6.3% and in the third quarter of 2021 to 6.7%. Also, inMarch 2021 ,President Biden implemented new programs to extend COVID-19 testing and vaccine eligibility for most adults inthe United States byMay 2021 . Most states also ended their participation in federal pandemic unemployment benefit programs in early summer 2021. TheU.S. unemployment rate decreased from 6.7% inDecember 2020 to 5.9% inJune 2021 and decreased further to 4.2% byNovember 2021 . InAugust 2021 , a second wave of COVID-19 cases progressed withinthe United States andTexas due to the delta variant, which slowedU.S. economic growth and real GDP growth rates to 2.3% in the third quarter of 2021. Then, inNovember 2021 ,Congress passed a fourth round of$0.6 trillion in government stimulus 83
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through theInfrastructure Investment and Jobs Act, and duringDecember 2021 , a third wave of COVID-19 cases progressed inthe United States andTexas due
to the new omicron variant. During 2020, our baseline economic forecast changed significantly year-over-year in response to weak economic conditions caused by the COVID-19 pandemic as developments occurred rapidly in February andMarch 2020 associated with fiscal and monetary stimulus measures and the expected beneficial impacts of the CARES Act and certain regulatory interagency guidance. As ofDecember 31, 2019 , we assumed theU.S. economy was in the late stages of the economic cycle with unemployment rates near historical lows of 3.6% increasing to 3.8% in the fourth quarter of 2020 and reverting to historical data in the fourth quarter of 2022. Downside risks to the economy were concerns over international trade war between theU.S. and its trading partners and potential fallout from a Brexit in 2020. Interest rate expectations assumed one rate cut in 2020 with theFederal Reserve target range of the federal funds rate at 1.25% to 1.50% before reverting to historical data in 2023. In response to the COVID-19 pandemic, theFederal Reserve twice cut federal funds rate targets inMarch 2020 to 0% to 0.25% with interest rate expectations as ofDecember 31, 2020 unchanged until late 2023. SeveralU.S. fiscal and monetary policy changes during early 2020 were enacted to counter a severe, but shortU.S. recession during the first half of 2020 and support a strong economic recovery during the second half of 2020 withU.S. budget deficits increasing to more than$3 trillion during the year.U.S. unemployment rates reached 14.8% inApril 2020 before declining to 6.7% as ofDecember 31, 2020 , which was 3.1% higher than the unemployment rate as ofDecember 31, 2019 . Annualized real GDP growth rates declined 31.4% in the second quarter of 2020 and increased 33.4% in the third quarter of 2020. TheU.S. presidential election later in 2020 resulted in several changes, as Presidential CandidateJoe Biden won the electoral vote to replace PresidentDonald Trump in 2021 and majority control of theU.S. Congress moved from Republican to Democratic parties. As economic growth slowed during the fourth quarter of 2020, additional government stimulus of approximately$900 billion was approved. As previously discussed, we adopted the new CECL standard and recorded transition adjustment entries that resulted in an allowance for credit losses for loans held for investment of$73.7 million as ofJanuary 1, 2020 , an increase of$12.6 million . This increase reflected credit losses of$18.9 million from the expansion of the loss horizon to life of loan and also takes into account forecasts of expected future macroeconomic conditions, partially offset by the elimination of the non-credit component within the historical allowance related to previously categorized PCI loans of$6.3 million . This increase, net of tax, was largely reflected within the banking segment and included a decrease of$5.7 million to opening retained earnings at January
1, 2020. During 2021, the decreases in the allowance for credit losses reflected improvement in both realized economic results and the macroeconomic outlook and were significantly comprised of net reversals of credit losses on expected losses of collectively evaluated loans of$58.3 million . Such reversals were primarily due to improvements in both macroeconomic forecast assumptions and credit quality metrics on COVID-19 impacted industry sector exposures. The net impact to the allowance of changes associated with individually evaluated loans during 2021 included a provision for credit losses of$0.1 million . The change in the allowance for credit losses during 2021 was primarily attributable to the Bank and also reflected other factors including, but not limited to, loan growth, loan mix, and changes in loan balances and qualitative factors. The change in the allowance during 2021 was also impacted by net recoveries of
$0.5 million .
As discussed under the section titled "Loan Portfolio" earlier in this Item 7, the Bank's actions, beginning in the second and third quarters of 2020, included supporting our impacted banking clients experiencing an increased level of risk due to the COVID-19 pandemic through loan modifications. This deteriorating economic outlook resulted in a significant build in the allowance and included provision for credit losses through the second quarter of 2020. Beginning in the fourth quarter of 2020, improvement in both economic results and the macroeconomic outlook, coupled with government stimulus and positive risk rating grade migration within the Bank, have resulted in aggregate reversals of a significant portion of previously recorded credit losses. As a result, the allowance for credit losses as a percentage of our total loan portfolio, excluding margin loans in the broker-dealer segment and banking segment mortgage warehouse lending and PPP lending programs, was 1.37% as ofDecember 31, 2021 , down from a high of 2.63% as ofSeptember 30, 2020 . 84 Table of Contents The respective distribution of the allowance for credit losses as a percentage of our total loan portfolio and total active loan modifications, excluding margin loans in the broker-dealer segment and banking segment mortgage warehouse lending and PPP lending programs, are presented in the following table (dollars in thousands). Allowance For Allowance Allowance For Credit Losses For Credit Credit Losses Total as a % of Losses on as a % of Total Allowance Total Loans Active Active Active Loans Held for Credit Held For Loan Loan Loan December 31, 2021 For Investment Losses Investment Modifications Modifications Modifications Commercial real estate$ 3,042,729 $ 59,354 1.95 % $ - $ - - % Commercial and industrial (1) 1,385,701 21,768 1.57 % - - - % Construction and land development 892,783 4,674 0.52 % - - - % 1-4 family residential 1,303,430 4,589 0.35 % 3,573 54 1.51 % Consumer 32,349 578 1.79 % - - - % 6,656,992 90,963 1.37 % 3,573 54 1.51 % Broker-dealer 733,193 175 0.02 % - - - % Mortgage warehouse lending 411,973 214 0.05 % - - - % Paycheck Protection Program 77,746 - - % - - - %$ 7,879,904 $ 91,352 1.16 % $ 3,573 $ 54 1.51 %
(1) Commercial and industrial portfolio amounts reflect balances excluding
banking segment mortgage warehouse lending and PPP loans. Allowance Model Sensitivity Our allowance model was designed to capture the historical relationship between economic and portfolio changes. As such, evaluating shifts in individual portfolio attributes or macroeconomic variables in isolation may not be indicative of past or future performance. It is difficult to estimate how potential changes in any one factor or input might affect the overall allowance for credit losses because we consider a wide variety of factors and inputs in the allowance for credit losses estimate. Changes in the factors and inputs considered may not occur at the same rate and may not be consistent across all geographies or product types, and changes in factors and input may be directionally inconsistent, such that improvement in one factor may offset deterioration in others. However, to consider the sensitivity of credit loss estimates to alternative macroeconomic forecasts, we compared the Company's allowance for credit loss estimates as ofDecember 31, 2021 , excluding margin loans in the broker-dealer segment, the banking segment mortgage warehouse and PPP lending programs, with modeled results using both upside ("S1") and downside ("S3") economic scenario forecasts published byMoody's Analytics . Compared to our economic forecast, the upside scenario assumes consumer and business confidence increases as new cases, hospitalizations and deaths from COVID-19 recede faster than expected, while availability and acceptance of vaccines and consumer spending accelerate more than expected. Real GDP is expected to grow 9.3% in the first quarter of 2022, 6.6% in the second quarter of 2022, 4.2% in the third quarter of 2022, and 4.4% in the fourth quarter of 2022. Average unemployment rates decline to 3.7% by the first quarter of 2022 and 3.0% by the end of 2022. Monetary and fiscal policy assumptions include theFederal Reserve maintaining a near 0% target for the federal funds rate until the third quarter of 2022 and additional government infrastructure and social program spending approved in the fourth quarter of 2021 of$2.3 trillion with supply-chain issues resolving more quickly than anticipated. Compared to our economic forecast, the downside scenario assumes consumer and business confidence declines as new cases, hospitalizations and deaths from COVID-19 diminish more slowly than expected, resulting in fewer people than expected getting vaccinated and increased worries about resistant strains. As a result, consumer confidence and spending erode causing the economy to fall back into recession. Real GDP is expected to decrease 4.0% in the first quarter of 2022, 3.2% in the second quarter of 2022, 1.9% in the third quarter of 2022, and increase 0.3% in the fourth quarter of 2022. Average unemployment rates increase to 6.4% by the first quarter of 2022 and 9.0% by the first quarter of 2023. Average unemployment is expected to remain elevated but improve to 7.1% by the fourth quarter of 2023 and reverts to historical average rates over time. Monetary and fiscal policy assumptions include theFederal Reserve maintaining a near 0% target for the federal funds rate through early 2026, while disagreements inCongress prevent any additional stimulus from being enacted beyond the American Rescue Plan Act passed inMarch 2021 and theInfrastructure Investment and Jobs Act passed inNovember 2021 . Supply chain issues are worse than expected and continue much longer than anticipated, weakening manufacturing. The impact of applying all of the assumptions of the upside economic scenario during the reasonable and supportable forecast period would have resulted in a decrease in the allowance for credit losses of approximately$7 million or
a
weighted average
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expected loss rate of 1.1% as a percentage of our total loan portfolio,
excluding margin loans in the broker-dealer segment and the banking segment
mortgage warehouse lending and PPP lending programs.
The impact of applying all of the assumptions of the downside economic scenario during the reasonable and supportable forecast period would have resulted in an increase in the allowance for credit losses of approximately$45 million or a weighted average expected loss rate of 1.9% as a percentage of our total loan portfolio, excluding margin loans in the broker-dealer segment and the banking segment mortgage warehouse lending and PPP lending programs. This analysis relates only to the modeled credit loss estimates and is not intended to estimate changes in the overall allowance for credit losses as they do not reflect any potential changes in the adjustment to the quantitative calculation, which would also be influenced by the judgment management applies to the modeled lifetime loss estimates to reflect the uncertainty and imprecision of these modeled lifetime loss estimates based on then-current circumstances and conditions. It also did not consider impacts from recent Bank deferral and customer accommodation efforts or government fiscal and monetary stimulus measures. Our allowance for credit losses reflects our best estimate of current expected credit losses, which is highly dependent on the path of the virus. We continue to monitor the impact of the COVID-19 pandemic and related policy measures on the economy and if pace and vigor of the expected recovery is worse than expected, further meaningful provisions could be required. Future allowance for credit losses may vary considerably for these reasons. Allowance Activity The following table presents the activity in our allowance for credit losses within our loan portfolio for the periods presented (in thousands). Substantially all of the activity shown below occurred within the banking segment. Year Ended December 31, Loans Held for Investment 2021 2020 2019 Balance, beginning of year$ 149,044 $ 61,136 $ 59,486 Transition adjustment for adoption of CECL accounting standard - 12,562 - Provision for (reversal of) credit losses (58,213) 96,491
7,206
Recoveries of loans previously charged off: Commercial real estate 266 613 6 Commercial and industrial 2,656 1,834
2,829
Construction and land development - 2
- 1-4 family residential 546 54 61 Consumer 281 392 37 Broker-dealer - - - Total recoveries 3,749 2,895 2,933 Loans charged off: Commercial real estate 310 4,517 1,160 Commercial and industrial 2,249 18,158 5,924
Construction and land development - 2
- 1-4 family residential 312 748 907 Consumer 357 615 498 Broker-dealer - - - Total charge-offs 3,228 24,040 8,489 Net recoveries (charge-offs) 521 (21,145) (5,556) Balance, end of year$ 91,352 $ 149,044 $ 61,136
Average total loans for the year$ 7,645,292 $ 7,618,723 $ 7,088,208 Total loans held for investment, end of year$ 7,879,904 $ 7,693,141 $ 7,381,400 Ratios: Net recoveries (charge-offs) to average total loans held for investment (1) 0.01 % (0.28) % (0.08) % Non-accrual loans to total loans held for investment 0.64 % 1.01 % 0.49 % Allowance for credit losses on loans held for investment to: Total loans held for investment 1.16 % 1.94 % 0.83 % Non-accrual loans held for investment 181.88 % 191.13
% 169.28 %
Net recoveries (charge-offs) to average total loans held for investment ratio
(1) presented on a consolidated basis for all periods given relative
immateriality of resulting measure by loan portfolio segment.
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Total non-accrual loans decreased by $27.8 million from December 31, 2020 to
December 31, 2021 , compared to an increase of $41.9 million from December 31,
2019 to December 31, 2020 . These changes in non-accrual loans were impacted by
loans secured by residential real estate within our mortgage origination
segment, which were classified as loans held for sale, of $2.9 million , $10.9
million and $4.8 million at December 31, 2021 , 2020 and 2019, respectively.
In addition to changes in non-accrual loans classified as loans held for sale,
the decrease in non-accrual loans during 2021 was primarily due to principal
paydowns associated with several commercial and industrial and commercial real
estate owner occupied loan relationships, while the increase in non-accrual
loans during 2020 was primarily due to the reclassification of a number of loans
reclassified to non-accrual as a part of the CECL transition and the addition of
several relationships within the commercial and industrial, commercial real
estate owner occupied and 1-4 family residential loan portfolios to non-accrual
status.
As previously discussed in detail within this section, the allowance for credit
losses fluctuated significantly during 2020 and 2021, which impacted the
resulting ratios noted in the table above. During 2020, the significant build in
the allowance was primarily due to the adoption of the new CECL standard and
recorded transition adjustment entries as well as the deteriorating economic
outlook due to the COVID-19 pandemic, while during 2021 the significant decline
in the allowance for credit losses reflected improvement in both realized
economic results and the macroeconomic outlook due to improvements in both
macroeconomic forecast assumptions and credit quality metrics on COVID-19
impacted industry sector exposures.
The distribution of the allowance for credit losses among loan types and the
percentage of the loans for that type to gross loans, excluding unearned income,
within our loan portfolio is presented in the table below (dollars in
thousands).
December 31,
2021 2020 2019
% of % of % of
Gross Gross Gross
Allocation of the Allowance
for Credit Losses Reserve Loans Reserve Loans Reserve Loans
Commercial real estate $ 59,354 38.61 % $ 109,629 40.74 % $ 31,595 40.65 %
Commercial and industrial 21,982 23.80 % 27,703 34.16 % 17,964 27.44 %
Construction and land
development 4,674 11.33 % 6,677 10.77 % 4,878 12.74 %
1-4 family residential 4,589 16.54 % 3,946 8.19 % 6,386 10.72 %
Consumer 578 0.41 % 876 0.46 % 265 0.64 %
Broker-dealer 175 9.31 % 213 5.68 % 48 7.81 %
Total $ 91,352 100.00 % $ 149,044 100.00 % $ 61,136 100.00 %
The following table summarizes historical levels of the allowance for credit
losses on loans held for investment, distributed by portfolio segment (in
thousands).
December 31, September 30, June 30, March 31, December 31,
2021 2021 2021 2021 2020
Commercial real estate $ 59,354 $ 68,535 $ 77,633 $ 104,126 $ 109,629
Commercial and industrial 21,982 30,545 27,866 28,513 27,703
Construction and land development 4,674 5,100
5,185 7,249 6,677
1-4 family residential 4,589 4,538 3,659 3,388 3,946
Consumer 578 504 592 944 876
Broker-dealer 175 290 334 279 213
$ 91,352 $ 109,512 $ 115,269 $ 144,499 $ 149,044
Unfunded Loan Commitments
In order to estimate the allowance for credit losses on unfunded loan
commitments, the Bank uses a process similar to that used in estimating the
allowance for credit losses on the funded portion. The allowance is based on the
estimated exposure at default, multiplied by the lifetime probability of default
grade and loss given default grade for that particular loan segment. The Bank
estimates expected losses by calculating a commitment usage factor based on
industry usage factors. The commitment usage factor is applied over the relevant
contractual period. Loss factors from the underlying loans to which commitments
are related are applied to the results of the usage calculation to estimate any
liability for credit losses related for each loan type. The expected losses on
unfunded commitments align with statistically calculated parameters used to
calculate the allowance for credit losses on the funded portion. Letters of
credit are not currently reserved because they are issued primarily as credit
enhancements and the likelihood of funding is low.
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Changes in the allowance for credit losses for loans with off-balance sheet
credit exposures are shown below (in thousands).
Year Ended December 31,
2021 2020 2019
Balance, beginning of year $ 8,388 $ 2,075 $ 2,366
Transition adjustment CECL accounting standard - 3,837
- Other noninterest expense (2,508) 2,476 (291) Balance, end of year$ 5,880 $ 8,388 $ 2,075 As previously discussed, we adopted the new CECL standard and recorded a transition adjustment entry that resulted in an allowance for credit losses of$5.9 million as ofJanuary 1, 2020 . During 2021, the decrease in the reserve for unfunded commitments was primarily due to improvements in loan expected loss rates. Potential Problem Loans
Potential problem loans consist of loans that are performing in accordance with
contractual terms but for which management has concerns about the ability of an
obligor to continue to comply with repayment terms because of the obligor's
potential operating or financial difficulties. Management monitors these loans
and reviews their performance on a regular basis. Potential problem loans
contain potential weaknesses that could improve, persist or further deteriorate.
If such potential weaknesses persist without improving, the loan is subject to
downgrade, typically to substandard, in three to six months. Potential problem
loans are assigned a grade of special mention within our risk grading matrix.
Potential problem loans do not include purchased credit deteriorated ("PCD")
loans because PCD loans exhibited evidence of more than insignificant credit
deterioration at acquisition that made it probable that all contractually
required principal payments would not be collected. Additionally, potential
problem loans do not include loans that have been modified in connection with
our COVID-19 payment deferment programs which allow for a deferral of principal
and/or interest payments. Within our loan portfolio, we had two credit
relationships totaling $3.1 million of potential problem loans at December 31,
2021 , compared with seven credit relationships totaling $11.3 million of
potential problem loans at December 31, 2020 and five credit relationships
totaling $16.8 million of potential problem loans at December 31, 2019 .
Non-Performing Assets
In response to the COVID-19 pandemic, the CARES Act was passed in March 2020 ,
which among other things, allowed the Bank to suspend the TDR requirements for
certain loan modifications to be categorized as a TDR. Subsequent legislation
extended such provisions through January 1, 2022 . Starting in March 2020 , the
Bank implemented several actions to better support our impacted banking clients
and allow for loan modifications such as principal and/or interest payment
deferrals, participation in the PPP as an SBA preferred lender and personal
banking assistance including waived fees, increased daily spending limits and
suspension of residential foreclosure activities. The COVID-19 payment deferment
programs allow for a deferral of principal and/or interest payments with such
deferred principal payments due and payable on the maturity date of the existing
loan.
Specifically, as discussed under the section titled "Loan Portfolio" earlier in
this Item 2, the Bank's actions during 2020 included approval of $1.0 billion of
COVID-19 related loan modifications. During 2021, the Bank continued to support
its impacted banking clients through the approval of COVID-19 related loan
modifications with a portfolio of active deferrals that have not reached the end
of their deferral period of approximately $4 million as of December 31, 2021 .
While the majority of the portfolio of COVID-19 related loan modifications no
longer require deferral, such loans represent elevated risk, and therefore
management continues to monitor these loans.
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The following table presents components of our non-performing assets (dollars in
thousands).
December 31, Variance
2021 2020 2019 2021 vs 2020 2020 vs 2019
Loans accounted for on a non-accrual basis: Commercial real estate$ 6,601 $ 11,133 $ 7,308 $ (4,532) $ 3,825 Commercial and industrial 22,478 34,049 15,262 (11,571) 18,787 Construction and land development 2 507 1,316 (505) (809) 1-4 family residential 21,123 32,263 12,204 (11,140) 20,059 Consumer 23 28 26 (5) 2 Broker-dealer - - - - -$ 50,227 $ 77,980 $ 36,116 $ (27,753) $ 41,864 Troubled debt restructurings included in accruing loans held for investment 922 1,954 2,173 (1,032) (219) Non-performing loans$ 51,149 $ 79,934 $
38,289
Non-performing loans as a percentage of total loans 0.52 % 0.76 % 0.40 % (0.24) % 0.36 % Other real estate owned$ 2,833 $ 21,289 $
18,202
Other repossessed assets $ -$ 101 $
-
Non-performing assets$ 53,982 $ 101,324 $
56,491
Non-performing assets as a percentage of total assets 0.29 % 0.60 % 0.37 % (0.31) % 0.23 % Loans past due 90 days or more and still accruing$ 60,775 $ 243,630 $ 102,707 $ (182,855) $ 140,923 AtDecember 31, 2021 , non-accrual loans included 45 commercial and industrial relationships with loans secured by accounts receivable, life insurance, oil and gas, livestock and equipment. Non-accrual loans atDecember 31, 2021 also included$2.9 million of loans secured by residential real estate which were classified as loans held for sale. AtDecember 31, 2020 , non-accrual loans included 60 commercial and industrial relationships with loans secured by accounts receivable, life insurance, oil and gas, livestock and equipment. Non-accrual loans atDecember 31, 2020 also included$10.9 million of loans secured by residential real estate which were classified as loans held for sale. AtDecember 31, 2019 , non-accrual loans included 23 commercial and industrial relationships with loans secured by accounts receivable, life insurance, livestock, oil and gas, and equipment. Non-accrual loans atDecember 31, 2019 also included$4.8 million of loans secured by residential real estate which were classified as loans held for sale. AtDecember 31, 2021 , TDRs were comprised of$0.9 million of loans that are considered to be performing and accruing, and$5.9 million of loans considered to be non-performing reported in non-accrual loans. AtDecember 31, 2020 , TDRs were comprised of$2.0 million of loans that are considered to be performing and accruing, and$16.0 million of loans considered to be non-performing reported in non-accrual loans. AtDecember 31, 2019 , TDRs were comprised of$2.2 million of loans that were considered to be performing and accruing, and$11.9 million of loans considered to be non-performing reported in non-accrual loans. InMarch 2020 , the CARES Act was passed, which, among other things, allowed the Bank to suspend the requirements for certain loan modifications to be categorized as a TDR. Therefore, the Bank has not reported COVID-19 related modifications as TDRs throughJanuary 1, 2022 when the provisions expired. OREO decreased fromDecember 31, 2020 toDecember 31, 2021 , primarily due to disposals and valuation adjustments totaling$22.0 million , partially offset by additions totaling$3.6 million . OREO increased fromDecember 31, 2019 toDecember 31, 2020 , primarily due to additions totaling$13.9 million , partially offset by disposals of$10.8 million . Loans past due 90 days or more and still accruing atDecember 31, 2021 , 2020 and 2019 were primarily comprised of loans held for sale and guaranteed byU.S. government agencies, including GNMA related loans subject to repurchase within our mortgage origination segment. The significant decrease in loans past due 90 days or more and still accruing atDecember 31, 2021 , compared toDecember 31, 2020 , was due to the sale of mortgage loans previously included within this non-performing assets category. As ofDecember 31, 2021 ,$20.2 million of loans subject to repurchase were under a forbearance agreement resulting from the COVID-19 pandemic. DuringMay 2020 , GNMA announced it will temporarily exclude any new GNMA lender delinquencies, occurring on or afterApril 2020 , when calculating the delinquency ratios for the purposes of enforcing compliance with its delinquency rate thresholds. This exclusion is extended automatically to GNMA lenders that were compliant with GNMA's delinquency rate thresholds as reflected by theirApril 2020 investor accounting report. The mortgage origination segment qualified for this exclusion as ofDecember 31, 2021 . As ofDecember 31, 2021 ,$20.2 million of loans subject to repurchase under a forbearance agreement had delinquencies on or afterApril 2020 . 89 Table of Contents Deposits The banking segment's major source of funds and liquidity is its deposit base. Deposits provide funding for its investments in loans and securities. Interest paid for deposits must be managed carefully to control the level of interest expense and overall net interest margin. The composition of the deposit base (time deposits versus interest-bearing demand deposits and savings), as discussed in more detail within the section titled "Liquidity and Capital Resources - Banking Segment" below, is constantly changing due to the banking segment's needs and market conditions.
The table below presents the average balance of, and rate paid on, consolidated
deposits (dollars in thousands).
Year Ended December 31,
2021 2020 2019
Average Average Average Average Average Average
Balance Rate Paid Balance Rate Paid Balance Rate Paid
Noninterest-bearing
demand deposits $ 4,157,962 0.00 % $ 3,304,475 0.00 % $ 2,635,924 0.00 %
Interest-bearing demand
deposits 6,077,660 0.19 % 5,284,582 0.31 % 4,283,642 0.98 %
Savings deposits 295,075 0.06 % 231,996 0.07 % 186,235 0.19 %
Time deposits 1,349,849 0.86 % 1,880,543 1.11 % 1,446,614 2.02 %
$ 11,880,546 0.20 % $ 10,701,596 0.35 % $ 8,552,415 0.84 %
The following table presents the scheduled maturities of uninsured deposits
greater than
Months to maturity: 3 months or less$ 112,517 3 months to 6 months 79,124 6 months to 12 months 173,787 Over 12 months 77,891$ 443,319 Borrowings
Our consolidated borrowings associated with continuing operations are shown in
the table below (dollars in thousands).
December 31,
2021 2020 2019
Average Average Average
Balance Rate Paid Balance Rate Paid Balance Rate Paid
Short-term borrowings $ 859,444 1.22 % $ 695,798 1.46 % $ 1,424,010 2.41 %
Notes payable 387,904 5.79 % 381,987 4.54 % 256,269 4.70 %
Junior subordinated debentures - 3.45 % 67,012
4.13 % 67,012 5.75 %
$ 1,247,348 1.32 % $ 1,144,797 2.51 % $ 1,747,291 2.90 %
Short-term borrowings consisted of federal funds purchased, securities sold under agreements to repurchase, borrowings at theFederal Home Loan Bank ("FHLB"), short-term bank loans and commercial paper. The increase in short-term borrowings atDecember 31, 2021 , compared withDecember 31, 2020 , primarily included increases in short-term bank loans and commercial paper used by the Hilltop Broker-Dealers to finance their activities, partially offset by a decrease in securities sold under agreements to repurchase by the Hilltop Broker-Dealers given increased utilization of internal funds. The decrease in short-term borrowings atDecember 31, 2020 compared withDecember 31, 2019 included a decrease in borrowings in our banking and broker-dealer segments primarily associated with the increased utilization of available internal funds, a decrease in FHLB borrowings and a decrease in securities sold under agreements to repurchase by the Hilltop Broker-Dealers, partially offset by an increase in commercial paper used by the Hilltop Broker-Dealers to finance their activities. Notes payable atDecember 31, 2021 of$387.9 million was comprised of$149.1 million related to Senior Notes, net of loan origination fees, Subordinated Notes, net of origination fees, of$197.1 million and mortgage origination segment borrowings of$41.7 million . Notes payable atDecember 31, 2020 of$382.0 million was comprised of$148.9 million related to Senior Notes, net of loan origination fees, Subordinated Notes, net of origination fees, of$196.8 million and mortgage origination 90
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segment borrowings of$36.2 million . Notes payable atDecember 31, 2019 of$283.8 million was comprised of$148.8 million related to Senior Notes, net of loan origination fees, FHLB borrowings with an original maturity greater than one year within our banking segment of$28.8 million , and mortgage origination segment borrowings of$78.7 million . As discussed in more detail within the section titled "Liquidity and Capital Resources - Junior Subordinated Debentures" below, during the third quarter of 2021, PCC fully redeemed all outstanding Debentures.
Liquidity and Capital Resources
Hilltop is a financial holding company whose assets primarily consist of the stock of its subsidiaries and invested assets. Hilltop's primary investment objectives, as a holding company, are to support capital deployment for organic growth and to preserve capital to be deployed through acquisitions, dividend payments and stock repurchases. AtDecember 31, 2021 , Hilltop had$367.9 million in cash and cash equivalents, a decrease of$6.9 million from$374.8 million atDecember 31, 2020 . This decrease in cash and cash equivalents was primarily due to cash outflows of$39.0 million in cash dividends declared,$123.6 million of stock repurchases, and other general corporate expenses, significantly offset by the receipt of$264.2 million of dividends from subsidiaries. Subject to regulatory restrictions, Hilltop has received, and may also continue to receive, dividends from its subsidiaries. If necessary or appropriate, we may also finance acquisitions with the proceeds from equity or debt issuances. We believe that Hilltop's liquidity is sufficient for the foreseeable future, with current short-term liquidity needs including operating expenses, interest on debt obligations, dividend payments to stockholders and potential stock repurchases. COVID-19
As previously discussed, in light of the extreme volatility and disruptions in
the capital and credit markets beginning in
COVID-19 crisis and its negative impact on the economy, we took a number of
precautionary actions beginning in
flexibility, protect capital, minimize losses and ensure target liquidity
levels.
To strengthen the Bank's available liquidity position during 2020, we raised brokered deposits, as well as swept additional deposits fromHilltop Securities into the Bank. AtDecember 31, 2021 , given the continued strong cash and liquidity levels at the Bank, brokered deposits declined to approximately$228 million and the total funds swept fromHilltop Securities into the Bank was approximately$800 million . In addition, we continue to evaluate market conditions to determine the appropriateness of capital market inventory limits atHilltop Securities . To meet demand for customer loan advances and satisfy our obligations to repay any debt maturing over the next 12 months, we believe we currently have sufficient liquidity from the available on- and off-balance sheet liquidity sources and our ability to issue debt in the capital markets. We continue to review actions that we may take to further enhance our financial flexibility in the event that market conditions deteriorate further or for an extended period.
Dividend Program and Declaration
InOctober 2016 , we announced that our board of directors authorized a dividend program under which we intend to pay quarterly dividends on our common stock, subject to quarterly declarations by our board of directors. During 2021, we declared and paid cash dividends of$0.48 per common share, or$39.0 million .
On
of
stockholders of record as of the close of business on
Future dividends on our common stock are subject to the determination by the board of directors based on an evaluation of our earnings and financial condition, liquidity and capital resources, the general economic and regulatory climate, our ability to service any equity or debt obligations senior to our common stock and other factors. Stock Repurchases InJanuary 2021 , our board of directors authorized a new stock repurchase program throughJanuary 2022 , pursuant to which we were originally authorized to repurchase, in the aggregate, up to$75.0 million of our outstanding common stock. InJuly 2021 , our board of directors authorized an increase to the aggregate amount of common stock we may repurchase under this program by$75.0 million to$150.0 million . Then, inOctober 2021 , our board of directors authorized an increase to the 91 Table of Contents aggregate amount of common stock we may repurchase under this program by$50.0 million to$200.0 million , which was inclusive of repurchases to offset dilution related to grants of stock-based compensation.
During 2021, we paid
shares of common stock at an average price of
were funded from available cash balances.
InJanuary 2022 , our board of directors authorized a new stock repurchase program throughJanuary 2023 , pursuant to which we are authorized to repurchase, in the aggregate, up to$100.0 million of our outstanding common stock, inclusive of repurchases to offset dilution related to grants of stock-based compensation. Under the stock repurchase program authorized, we may repurchase shares in the open market or through privately negotiated transactions as permitted under Rule 10b-18 promulgated under the Exchange Act. The extent to which we repurchase our shares and the timing of such repurchases depends upon market conditions and other corporate considerations, as determined by Hilltop's management team. Repurchased shares will be returned to our pool of authorized but unissued shares of common stock. Senior Notes due 2025 OnApril 9, 2015 , we completed an offering of$150.0 million aggregate principal amount of our 5% senior notes due 2025 ("Senior Unregistered Notes") in a private offering that was exempt from the registration requirements of the Securities Act. The Senior Unregistered Notes were offered withinthe United States only to qualified institutional buyers pursuant to Rule 144A under the Securities Act, and to persons outside ofthe United States under Regulation S under the Securities Act. The Senior Unregistered Notes were issued pursuant to an indenture, dated as ofApril 9, 2015 (the "indenture"), by and betweenHilltop andU.S. Bank National Association , as trustee. The net proceeds from the offering, after deducting estimated fees and expenses and the initial purchasers' discounts, were approximately$148 million . We used the net proceeds of the offering to redeem all of our outstanding Series B Preferred Stock at an aggregate liquidation value of$114.1 million , plus accrued but unpaid dividends of$0.4 million , and Hilltop utilized the remainder for general corporate purposes. In connection with the issuance of the Senior Unregistered Notes, onApril 9, 2015 , we entered into a registration rights agreement with the initial purchasers of the Senior Unregistered Notes. Under the terms of the registration rights agreement, we agreed to offer to exchange the Senior Unregistered Notes for notes registered under the Securities Act (the "Senior Registered Notes"). The terms of the Senior Registered Notes are substantially identical to the Senior Unregistered Notes for which they were exchanged (including principal amount, interest rate, maturity and redemption rights), except that the Senior Registered Notes generally are not subject to transfer restrictions. OnMay 22, 2015 , and subject to the terms and conditions set forth in the Senior Registered Notes prospectus, we commenced an offer to exchange the outstanding Senior Unregistered Notes for Senior Registered Notes. Substantially all of the Senior Unregistered Notes were tendered for exchange, and onJune 22, 2015 , we fulfilled all of the requirements of the registration rights agreement for the Senior Unregistered Notes by issuing Senior Registered Notes in exchange for the tendered Senior Unregistered Notes. We refer to the Senior Registered Notes and the Senior Unregistered Notes that remain outstanding collectively as the "Senior Notes." The Senior Notes bear interest at a rate of 5% per year, payable semi-annually in arrears in cash onApril 15 andOctober 15 of each year, commencing onOctober 15, 2015 . The Senior Notes will mature onApril 15, 2025 , unless we redeem the Senior Notes, in whole at any time or in part from time to time, on or afterJanuary 15, 2025 (three months prior to the maturity date of the Senior Notes) at our election at a redemption price equal to 100% of the principal amount of the Senior Notes to be redeemed plus accrued and unpaid interest to, but excluding, the redemption date. AtDecember 31, 2021 ,$150.0 million of our Senior Notes was outstanding. The indenture contains covenants that limit our ability to, among other things and subject to certain significant exceptions: (i) dispose of or issue voting stock of certain of our bank subsidiaries or subsidiaries that own voting stock of our bank subsidiaries, (ii) incur or permit to exist any mortgage, pledge, encumbrance or lien or charge on the capital stock of certain of our bank subsidiaries or subsidiaries that own capital stock of our bank subsidiaries and (iii) sell all or substantially all of our assets or merge or consolidate with or into other companies. The indenture also provides for certain events of default, which, if any of them occurs, would permit or require the principal amount, premium, if any, and accrued and unpaid interest on the then outstanding Senior Notes to be declared immediately due and payable. 92 Table of Contents
Subordinated Notes due 2030 and 2035
OnMay 7, 2020 , we completed a public offering of$50 million aggregate principal amount of 2030 Subordinated Notes and$150 million aggregate principal amount of 2035 Subordinated Notes. The price to the public for the Subordinated Notes was 100% of the principal amount of the Subordinated Notes. The net proceeds from the offering, after deducting underwriting discounts and fees and expenses of$3.4 million , were$196.6 million . The 2030 Subordinated Notes and the 2035 Subordinated Notes will mature onMay 15, 2030 andMay 15, 2035 , respectively. We may redeem the Subordinated Notes, in whole or in part, from time to time, subject to obtainingFederal Reserve approval, beginning with the interest payment date ofMay 15, 2025 for the 2030 Subordinated Notes and beginning with the interest payment date ofMay 15, 2030 for the 2035 Subordinated Notes at a redemption price equal to 100% of the principal amount of the Subordinated Notes being redeemed plus accrued and unpaid interest to but excluding the date of redemption. The 2030 Subordinated Notes bear interest at a rate of 5.75% per year, payable semi-annually in arrears commencing onNovember 15, 2020 . The interest rate for the 2030 Subordinated Notes will reset quarterly beginningMay 15, 2025 to an interest rate, per year, equal to the then-current benchmark rate, which is expected to be three-month term SOFR rate, plus 5.68%, payable quarterly in arrears. The 2035 Subordinated Notes bear interest at a rate of 6.125% per year, payable semi-annually in arrears commencing onNovember 15, 2020 . The interest rate for the 2035 Subordinated Notes will reset quarterly beginningMay 15, 2030 to an interest rate, per year, equal to the then-current benchmark rate, which is expected to be three-month term SOFR rate plus 5.80%, payable quarterly in arrears. AtDecember 31, 2021 ,$200.0 million of our Subordinated Notes was outstanding.
Junior Subordinated Debentures
Following receipt of regulatory approval, inJune 2021 , PCC submitted to the trustee of one of the statutory trusts a notice to redeem in full outstanding Debentures in the principal amount of$18.0 million onJuly 31, 2021 (which resulted in the full redemption to the holders of the associated preferred securities and common securities). Subsequently, during July andAugust 2021 , PCC submitted to the trustees of each of the three remaining statutory trusts a notice to redeem in full outstanding Debentures in the aggregate principal amount of$49.0 million duringSeptember 2021 (which resulted in the full redemption to the holders of the associated preferred securities and common securities). The Debentures, which were held by four statutory trusts created for the sole purpose of issuing and selling preferred securities and common securities used to acquire the Debentures, had an original stated term of 30 years with original maturities ranging fromJuly 2031 toFebruary 2038 . The Debentures were callable at PCC's discretion with a minimum of a 45- to 60- day notice. AtDecember 31, 2021 , PCC had no remaining borrowings associated with the Debentures. The redemptions noted above were funded from available cash balances held at PCC.Regulatory Capital We are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements may prompt certain actions by regulators that, if undertaken, could have a direct material adverse effect on our financial condition and results of operations. Under capital adequacy and regulatory requirements, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. Our capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
In order to avoid limitations on capital distributions, including dividend
payments, stock repurchases and certain discretionary bonus payments to
executive officers, Basel III requires banking organizations to maintain a
capital conservation buffer above minimum risk-based capital requirements
measured relative to risk-weighted assets.
The following table showsPlainsCapital's and Hilltop's actual capital amounts and ratios in accordance with Basel III compared to the regulatory minimum capital requirements including conservation buffer ratio in effect atDecember 31, 2021 (dollars in thousands). Based on actual capital amounts and ratios shown in the following table,PlainsCapital's ratios place it in the "well capitalized" (as defined) capital category under regulatory requirements. Actual capital amounts and ratios as ofDecember 31, 2021 reflectPlainsCapital's and Hilltop's decision to elect the transition option as issued by the federal banking regulatory agencies inMarch 2020 that permits banking institutions to mitigate the estimated cumulative regulatory capital effects from CECL over a five-year transitionary period. 93 Table of Contents Minimum Capital Requirements Including Conservation To Be Well December 31, 2021 Buffer Capitalized Amount Ratio Ratio Ratio Tier 1 capital (to average assets): PlainsCapital$ 1,469,695 10.20 % 4.0 % 5.0 % Hilltop 2,262,356 12.58 % 4.0 % N/A Common equity Tier 1 capital (to risk-weighted assets): PlainsCapital 1,469,695 16.00 % 7.0 % 6.5 % Hilltop 2,262,356 21.22 % 7.0 % N/A Tier 1 capital (to risk-weighted assets): PlainsCapital 1,469,695 16.00 % 8.5 % 8.0 % Hilltop 2,262,356 21.22 % 8.5 % N/A Total capital (to risk-weighted assets): PlainsCapital 1,540,100 16.77 % 10.5 % 10.0 % Hilltop 2,532,008 23.75 % 10.5 % N/A
We discuss regulatory capital requirements in more detail in Note 23 to our
consolidated financial statements, as well as under the caption "Government
Supervision and Regulation - Corporate - Capital Adequacy Requirements and
III" set forth in Part I, Item I. of this Annual Report.
Banking Segment Within our banking segment, our primary uses of cash are for customer withdrawals and extensions of credit as well as our borrowing costs and other operating expenses. Our corporate treasury group is responsible for continuously monitoring our liquidity position to ensure that our assets and liabilities are managed in a manner that will meet our short-term and long-term cash requirements. Our goal is to manage our liquidity position in a manner such that we can meet our customers' short-term and long-term deposit withdrawals and anticipated and unanticipated increases in loan demand without penalizing earnings. Funds invested in short-term marketable instruments, the continuous maturing of other interest-earning assets, cash flows from self-liquidating investments such as mortgage-backed securities and collateralized mortgage obligations, the possible sale of available for sale securities, and the ability to securitize certain types of loans provide sources of liquidity from an asset perspective. The liability base provides sources of liquidity through deposits and the maturity structure of short-term borrowed funds. For short-term liquidity needs, we utilize federal fund lines of credit with correspondent banks, securities sold under agreements to repurchase, borrowings from theFederal Reserve and borrowings under lines of credit with other financial institutions. For intermediate liquidity needs, we utilize advances from the FHLB. To supply liquidity over the longer term, we have access to brokered time deposits, term loans at the FHLB and borrowings under lines of credit with
other financial institutions. As previously discussed, to meet increased liquidity demands and ensure availability of adequate cash to meet both expected and unexpected funding needs without adversely affecting our daily operations and to improve the Bank's already strong liquidity position, we raised brokered deposits during 2020 that have a remaining balance of approximately$228 million atDecember 31, 2021 , down from approximately$731 million atDecember 31, 2020 . Further, beginning inMarch 2020 , additional deposits were swept fromHilltop Securities into the Bank. SinceJune 30, 2020 , given the continued strong cash and liquidity levels at the Bank, the total funds swept fromHilltop Securities into the Bank was reduced and was approximately$800 million as ofDecember 31, 2021 . As a result, the Bank was able to further fortify its borrowing capacity through access to secured funding sources as summarized in the following table (in millions).
December 31,
2021 2020
FHLB capacity $ 4,221 $ 4,410
Investment portfolio (available) 1,478 982
Fed deposits (excess daily requirements) 2,686 875
$ 8,385 $ 6,267 As noted in the table above, the Bank's available liquidity position and borrowing capacity atDecember 31, 2021 and 2020 continued to be at a heightened level given the uncertain outlook for 2022 due to the COVID-19 pandemic. While the extent to 94 Table of Contents which COVID-19 will impact the Bank remains uncertain, the Bank is targeting available liquidity of between approximately$5 billion and$6 billion during 2022. Available liquidity does not include borrowing capacity available through the discount window at theFederal Reserve . Within our banking segment, deposit flows are affected by the level of market interest rates, the interest rates and products offered by competitors, the volatility of equity markets and other factors. While the Bank experienced an increase in non-brokered customer deposits during 2020, an economic recovery and improved commercial real estate investment outlook may result in an outflow of deposits at an accelerated pace as customers utilize such available funds for expanded operations and investment opportunities. The Bank regularly evaluates its deposit products and pricing structures relative to the market to maintain competitiveness over time.
The Bank's 15 largest depositors, excludingHilltop and Hilltop Securities , collectively accounted for 8.48% of the Bank's total deposits, and the Bank's five largest depositors, excludingHilltop and Hilltop Securities , collectively accounted for 4.16% of the Bank's total deposits atDecember 31, 2021 . The loss of one or more of our largest Bank customers, or a significant decline in our deposit balances due to ordinary course fluctuations related to these customers' businesses, could adversely affect our liquidity and might require us to raise deposit rates to attract new deposits, purchase federal funds or borrow funds on a short-term basis to replace such deposits. Broker-Dealer Segment The Hilltop Broker-Dealers rely on their equity capital, short-term bank borrowings, interest-bearing and noninterest-bearing client credit balances, correspondent deposits, securities lending arrangements, repurchase agreement financing, commercial paper issuances and other payables to finance their assets and operations, subject to their respective compliance with broker-dealer net capital and customer protection rules. AtDecember 31, 2021 ,Hilltop Securities had credit arrangements with four unaffiliated banks, with maximum aggregate commitments of up to$600.0 million . These credit arrangements are used to finance securities owned, securities held for correspondent accounts, receivables in customer margin accounts and underwriting activities. These credit arrangements are provided on an "as offered" basis and are not committed lines of credit. In addition,Hilltop Securities has committed revolving credit facilities with three unaffiliated banks, with aggregate availability of up to$250.0 million . AtDecember 31, 2021 ,Hilltop Securities had borrowed$142.0 million under its credit arrangements and had no borrowings under its credit facilities.
Hilltop Securities uses the net proceeds (after deducting related issuance expenses) from the sale of two commercial paper programs for general corporate purposes, including working capital and the funding of a portion of its securities inventories. The commercial paper notes ("CP Notes") may be issued with maturities of 14 days to 270 days from the date of issuance. The CP Notes are issued under two separate programs, Series 2019-1 CP Notes and Series 2019-2 CP Notes, in maximum aggregate amounts of$300 million and$200 million , respectively. The CP Notes are not redeemable prior to maturity or subject to voluntary prepayment and do not bear interest, but are sold at a discount to par. The discount to maturity will be based on an interest factor and the CP Notes are secured by a pledge of collateral owned byHilltop Securities . As ofDecember 31, 2021 , the weighted average maturity of the CP Notes was 141 days at a rate of 0.99%, with a weighted average remaining life of 66 days. AtDecember 31, 2021 , the aggregate amount outstanding under these secured arrangements was$354.0 million , which was collateralized by securities held for firm accounts valued at$384.7 million . Mortgage Origination Segment PrimeLending funds the mortgage loans it originates through a warehouse line of credit maintained with the Bank which had an aggregate commitment of$3.2 billion , of which$1.7 billion was drawn atDecember 31, 2021 . EffectiveJanuary 1, 2022 , this warehouse line of credit was decreased to$2.7 billion to address expected declines in loan origination volumes. PrimeLending sells substantially all mortgage loans it originates to various investors in the secondary market, historically with the majority with servicing released. As these mortgage loans are sold in the secondary market, PrimeLending pays down its warehouse line of credit with the Bank. In addition, PrimeLending has an available line of credit with an unaffiliated bank of up to$1.0 million , of which no borrowings were drawn atDecember 31, 2021 . PrimeLending owns a 100% membership interest inPrimeLending Ventures Management, LLC ("Ventures Management") which holds an ownership interest in and is the managing member of certain ABAs. AtDecember 31, 2021 , these ABAs had combined available lines of credit totaling$145.0 million ,$55.0 million of which was with a single unaffiliated bank, and the remaining$90.0 million of which was with the Bank. AtDecember 31, 2021 , Ventures Management had outstanding borrowings of$60.4 million ,$18.7 million of which was with the Bank. 95 Table of Contents
Other Material Contractual Obligations, Off-Balance Sheet Arrangements,
Commitments and Guarantees
The following table presents information regarding other material contractual obligations atDecember 31, 2021 not previously discussed (in thousands). Payments related to leases are based on actual payments specified in the underlying contracts, and the table below includes all leases that had commenced as ofDecember 31, 2021 . Payments Due by Period More than 1 3 Years or 1 year Year but Less More but Less 5 Years or Less than 3 Years than 5 Years or More Total Finance lease obligations$ 1,241 $ 2,443 $ 1,699$ 598 $ 5,981 Operating lease obligations 26,608 52,711 29,197 38,511 147,027 Total$ 27,849 $ 55,154 $ 30,896 $ 39,109 $ 153,008
Additionally, in the normal course of business, we enter into various
transactions, which, in accordance with GAAP, are not included in our
consolidated balance sheets. We enter into these transactions to meet the
financing needs of our customers. These transactions include commitments to
extend credit and standby letters of credit, which involve, to varying degrees,
elements of credit risk and interest rate risk in excess of the amounts
recognized in our consolidated balance sheets.
Banking Segment
We enter into contractual loan commitments to extend credit, normally with fixed expiration dates or termination clauses, at specified rates and for specific purposes. Substantially all of our commitments to extend credit are contingent upon customers maintaining specific credit standards until the time of loan funding. We minimize our exposure to loss under these commitments by subjecting them to credit approval and monitoring procedures. We assess the credit risk associated with certain commitments to extend credit and have recorded a liability related to such credit risk in our consolidated financial statements. Standby letters of credit are written conditional commitments issued by us to guarantee the performance of a customer to a third party. In the event the customer does not perform in accordance with the terms of the agreement with the third party, we would be required to fund the commitment. The maximum potential amount of future payments we could be required to make is represented by the contractual amount of the commitment. If the commitment is funded, we would be entitled to seek recovery from the customer. Our policies generally require that standby letter of credit arrangements contain security and debt covenants similar to those contained in loan agreements. In the aggregate, the Bank had outstanding unused commitments to extend credit of$2.2 billion atDecember 31, 2021 and outstanding financial and performance standby letters of credit of$96.3 million atDecember 31, 2021 . Broker-Dealer Segment The Hilltop Broker-Dealers execute, settle and finance various securities transactions that may expose the Hilltop Broker-Dealers to off-balance sheet risk in the event that a customer or counterparty does not fulfill its contractual obligations. Examples of such transactions include the sale of securities not yet purchased by customers or for the account of the Hilltop Broker-Dealers, use of derivatives to support certain non-profit housing organization clients, clearing agreements between the Hilltop Broker-Dealers and various clearinghouses and broker-dealers, secured financing arrangements that involve pledged securities, and when-issued underwriting and purchase commitments.
Impact of Inflation and Changing Prices
Our consolidated financial statements included herein have been prepared in accordance with GAAP, which presently require us to measure financial position and operating results primarily in terms of historic dollars. Changes in the relative value of money due to inflation or recession are generally not considered. The primary effect of inflation on our operations is reflected in increased operating costs. In management's opinion, changes in interest rates affect the financial condition of a financial institution to a far greater degree than changes in the inflation rate. While interest rates are greatly influenced by changes in the inflation rate, they do not necessarily change at the same rate or in the same magnitude as the inflation rate. Interest rates are highly sensitive to many factors that are beyond our control, including changes in the expected rate of inflation, the influence of general and local economic conditions and the monetary and fiscal policies of theU.S. government, its agencies and various other governmental regulatory authorities. 96 Table of Contents Critical Accounting Estimates
We have identified certain accounting estimates which involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on our financial condition or results of operations. Our accounting policies are more fully described in Note 1 to the consolidated financial statements. Actual amounts and values as of the balance sheet dates may be materially different than the amounts and values reported due to the inherent uncertainty in the estimation process. Also, future amounts and values could differ materially from those estimates due to changes in values and circumstances after the balance sheet date. The critical accounting estimates, as summarized below, which we believe to be the most critical in preparing our consolidated financial statements relate to allowance for credit losses, mortgage servicing rights asset, goodwill and identifiable intangible assets, mortgage loan indemnification liability and acquisition accounting. Allowance for Credit Losses
The allowance for credit losses for loans represents management's estimate of all expected credit losses over the expected contractual life of our existing loan portfolio. Determining the appropriateness of the allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. Subsequent evaluations of the then existing loan portfolio, in light of the factors then prevailing, may result in significant changes in the allowance for credit losses in those future periods. We employ a disciplined process and methodology to establish our allowance for credit losses that has two basic components: first, an asset-specific component involving individual loans that do not share risk characteristics with other loans and the measurement of expected credit losses for such individual loans; and second, a pooled component for estimated expected credit losses for pools of loans that share similar risk characteristics. The credit loss estimation process for both on and off-balance sheet exposures involves procedures to appropriately consider the unique characteristics of our loan portfolio segments, which are further disaggregated into loan classes, the level at which credit risk is monitored. When computing allowance levels, credit loss assumptions are estimated using models that analyze loans according to credit risk ratings, loss history, delinquency status and other credit trends and risk characteristics, including current conditions and reasonable and supportable forecasts about the future. Significant variables that impact the modeled losses across our loan portfolios are theU.S. Real Gross Domestic Product, or GDP, growth rates and unemployment rate assumptions. Future factors and forecasts may result in significant changes in the allowance and provision for (reversal of) credit losses in those future periods. Credit quality is assessed and monitored by evaluating various attributes, such as credit risk ratings, historic loss experience, past due status and other credit trends and risk characteristics, including current conditions and reasonable and supportable forecasts about the future. The results of these continuous credit quality evaluations help form our underwriting criteria for new loans and also factor into the process for estimation of the allowance for credit losses. The allowance level is influenced by loan volumes, loan asset quality, delinquency status, historic loss experience and other conditions influencing loss expectations, such as reasonable and supportable forecasts of economic conditions. The allowance for credit losses will primarily reflect estimated losses for pools of loans that share similar risk characteristics, but will also consider individual loans that do not share risk characteristics
with
other loans.
In estimating the component of the allowance for credit losses for loans that
share similar risk characteristics with other loans, such loans are segregated
into loan classes. Loans are designated into loan classes based on loans pooled
by product types and similar risk characteristics or areas of risk
concentration. In determining the allowance for credit losses, we derive an
estimated credit loss assumption from a model that categorizes loan pools based
on loan type and internal risk rating or delinquency bucket.
When a loan moves to a substandard non-accrual risk rating grade, it is removed
from the collective evaluation allowance methodology and is subject to
individual evaluation. A problem asset report is prepared for each loan in
excess of a predetermined threshold and the net realizable value of the loan is
determined. This value is compared to the appropriate loan basis (depending on
whether the loan is a PCD loan or a non-PCD loan) to determine the required
allowance for credit loss reserve amount.
Estimating the timing and amounts of future loss cash flows is subject to
significant management judgment as these loss cash flows rely upon estimates
such as default rates, loss severities, collateral valuations, the amounts and
timing of principal payments (including any expected prepayments) or other
factors that are reflective of current or future expected conditions.
97
Table of Contents
These estimates, in turn, depend on the duration of current overall economic conditions, industry, borrower, or portfolio specific conditions, the expected outcome of bankruptcy or insolvency proceedings, as well as, in certain circumstances, other economic factors, including the level of current and future real estate prices. All of these estimates and assumptions require significant management judgment and certain assumptions that are highly subjective. Model imprecision also exists in the allowance for credit losses estimation process due to the inherent time lag of available industry information and differences between expected and actual outcomes. The provision for (reversal of) credit losses recorded through earnings, and reduced by the charge-off of loan amounts, net of recoveries, is the amount necessary to maintain the allowance for credit losses at the amount of expected credit losses inherent within the loans held for investment portfolio. The amount of expense and the corresponding level of allowance for credit losses for loans are based on our evaluation of the collectability of the loan portfolio based on historical loss experience, reasonable and supportable forecasts, and other significant qualitative and quantitative factors. Refer to "Financial Condition - Allowance for Credit Losses on Loans" and Notes 1 and 7 to the consolidated financial statements for further discussion of the methodology used in establishing the allowance and changes during the relevant period in the provision for (reversal of) credit losses.
Mortgage Servicing Rights Asset
The Company measures its residential mortgage servicing rights asset using the fair value method. Under the fair value method, the retained MSR assets are carried in the balance sheet at fair value and the changes in fair value are reported in earnings within other noninterest income in the period in which the change occurs. Retained MSR assets are measured at fair value as of the date of sale of the related mortgage loan. Subsequent fair value measurements are determined using a discounted cash flow model. In order to determine the fair value of the MSR asset, the present value of expected future cash flows is estimated. Assumptions used include market discount rates, anticipated prepayment speeds, delinquency and foreclosure rates, and ancillary fee income. The model assumptions and the MSR asset fair value estimates are compared to observable trades of similar portfolios as well as to MSR asset broker valuations and industry surveys, as available. The expected life of the loan can vary from management's estimates due to prepayments by borrowers, especially when rates fall. Prepayments in excess of management's estimates would adversely impact the recorded value of the MSR asset. The value of the MSR asset is also dependent upon the discount rate used in the model, which is based on current market rates and is reviewed by management on an ongoing basis. An increase in the discount rate would result in a decrease in the value of the MSR asset. Refer to Notes 1, 4 and 11 to the consolidated financial statements for further discussion of the methodology used in establishing the MSR asset and changes during the relevant period thereof.
Goodwill and other identifiable intangible assets are initially recorded at their estimated fair values at the date of acquisition.Goodwill and other intangible assets having an indefinite useful life are not amortized for financial statement purposes. In the event that facts and circumstances indicate that the goodwill or other identifiable intangible assets may be impaired, an interim impairment test would be required. Intangible assets with finite lives are amortized over their useful lives. We perform required annual impairment tests of our goodwill and other intangible assets as of October 1st for our reporting units. The goodwill impairment test requires us to make judgments and assumptions. The test consists of estimating the fair value of each reporting unit based on valuation techniques, including a discounted cash flow model using revenue and profit forecasts and recent industry transaction and trading multiples of our peers, and comparing those estimated fair values with the carrying values of the assets and liabilities of each reporting unit, which includes the allocated goodwill. If the estimated fair value is less than the carrying value, we will recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value; however, any loss recognized will not exceed the total amount of goodwill allocated to that reporting unit. This evaluation includes multiple assumptions, including estimated discounted cash flows and other estimates that may change over time. If future discounted cash flows become less than those projected by us, future impairment charges may become necessary that could have a materially adverse impact on our results of operations and financial condition in the period in which the write-off occurs. 98 Table of Contents
Mortgage Loan Indemnification Liability
The mortgage origination segment may be responsible for errors or omissions relating to its representations and warranties that the mortgage loans sold meet certain requirements, including representations as to underwriting standards and the validity of certain borrower representations in connection with a mortgage loan. If determined to be at fault, the mortgage origination segment either repurchases the mortgage loans from the investors or reimburses the investors' losses (a "make-whole" payment). The mortgage origination segment has established an indemnification liability for such probable losses based upon, among other things, the level of current unresolved repurchase requests, the volume of estimated probable future repurchase requests, our ability to cure the defects identified in the repurchase requests, and the severity of an estimated loss upon repurchase. Although we consider this reserve to be appropriate, there can be no assurance that the reserve will prove to be appropriate over time to cover ultimate losses due to conditions outside of our control such as unanticipated adverse changes in the economy and historical loss patterns, discrete events adversely affecting specific borrowers or industries, or actions taken by institutions or investors. The impact of such matters will be considered in the reserving process when known. Refer to "Segment Results from Continuing Operations-Mortgage Origination Segment" and Notes 1 and 20 to the consolidated financial statements for further discussion of the methodology used in establishing the mortgage loan indemnification liability and changes during the relevant period thereof. Acquisition Accounting We account for business combinations using the acquisition method, which requires an allocation of the purchase price of an acquired entity to the assets acquired and liabilities assumed, including identifiable intangibles, based on their estimated fair values at the date of acquisition. Management applies various valuation methodologies to these acquired assets and assumed liabilities which often involve a significant degree of judgment, as liquid markets often do not exist for certain loans, deposits, identifiable intangible assets and other assets and liabilities acquired or assumed. Our valuation methodologies employ significant estimates and assumptions to value such items, including, among others, projected cash flows, prepayment and default assumptions, discount rates, and realizable collateral values. Purchase date valuations, which are permitted to be revised for up to one year after the acquisition date, determine the amount of goodwill or bargain purchase gain recognized in connection with a business combination. Changes to provisional amounts identified during this measurement period are recognized in the reporting period in which the adjustment amounts are determined. Certain assumptions and estimates must be updated regularly in connection with the ongoing accounting for purchased loans. Valuation assumptions and estimates may also have to be revisited in connection with our periodic impairment assessments of goodwill, intangible assets and certain other long-lived assets. The use of different assumptions could produce significantly different valuation results, which could have material positive or negative effects on the Company's results of operations.
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