Hilltop (HTH) 10-Q 2019 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2019

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

Commission File Number: 1-31987

Hilltop Holdings Inc.

(Exact name of registrant as specified in its charter)

Maryland	84-1477939
(State or other jurisdiction of incorporation or	(I.R.S. Employer Identification No.)
organization)
2323 Victory Avenue, Suite 1400
Dallas, TX	75219
(Address of principal executive offices)	(Zip Code)

(214) 855-2177

(Registrant’s telephone number, including area code)

Securities registered pursuant to section 12(b) of the Act:

Title of each class	Trading symbol	Name of each exchange on which registered
Common Stock, par value $0.01 per share	HTH	New York Stock Exchange

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

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒   No ◻

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

Large accelerated filer ⌧	Accelerated filer ◻
Non-accelerated filer ◻ ​	Smaller reporting company ☐
	Emerging growth company ☐

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

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

The number of shares of the registrant's common stock outstanding at July 25, 2019 was 92,775,411.

HILLTOP HOLDINGS INC.

FORM 10-Q

FOR THE QUARTER ENDED JUNE 30, 2019

TABLE OF CONTENTS

PART I — FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Balance Sheets	3
	Consolidated Statements of Operations	4
	Consolidated Statements of Comprehensive Income	5
	Consolidated Statements of Stockholders’ Equity	7
	Consolidated Statements of Cash Flows	8
	Notes to Consolidated Financial Statements	9
	Schedule I - Insurance Incurred and Cumulative Paid Losses and Allocated Loss and Loss Adjustment Expenses, Net of Reinsurance	51
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	52
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	86
Item 4.	Controls and Procedures	89
PART II — OTHER INFORMATION
Item 1.	Legal Proceedings	90
Item 1A.	Risk Factors	90
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	90
Item 5.	Other Information	90
Item 6.	Exhibits	91

2

HILLTOP HOLDINGS INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share data)

(Unaudited)

	June 30,		December 31,
	2019		2018
Assets
Cash and due from banks	$	342,001	$	644,073
Federal funds sold		521		400
Assets segregated for regulatory purposes		151,271		133,993
Securities purchased under agreements to resell		50,660		61,611
Securities:
Trading, at fair value		601,524		745,466
Available for sale, at fair value (amortized cost of $999,798 and $886,799, respectively)		1,009,924		875,658
Held to maturity, at amortized cost (fair value of $368,546 and $341,124, respectively)		365,905		351,012
Equity, at fair value		19,592		19,679
		1,996,945		1,991,815
Loans held for sale		1,609,477		1,393,246
Loans held for investment, net of unearned income		7,202,604		6,930,458
Allowance for loan losses		(55,177)		(59,486)
Loans held for investment, net		7,147,427		6,870,972
Broker-dealer and clearing organization receivables		1,707,249		1,440,287
Premises and equipment, net		208,975		237,373
Operating lease right-of-use assets		123,832		—
Other assets		602,143		580,362
Goodwill		291,435		291,435
Other intangible assets, net		33,934		38,005
Total assets	$	14,265,870	$	13,683,572
Liabilities and Stockholders' Equity
Deposits:
Noninterest-bearing	$	2,598,253	$	2,560,750
Interest-bearing		5,864,826		5,975,406
Total deposits		8,463,079		8,536,156
Broker-dealer and clearing organization payables		1,531,891		1,294,925
Short-term borrowings		1,338,893		1,065,807
Securities sold, not yet purchased, at fair value		45,447		81,667
Notes payable		231,923		228,872
Operating lease liabilities		132,750		—
Junior subordinated debentures		67,012		67,012
Other liabilities		403,070		435,240
Total liabilities		12,214,065		11,709,679
Commitments and contingencies (see Notes 13 and 14)
Stockholders' equity:
Hilltop stockholders' equity:
Common stock, $0.01 par value, 125,000,000 shares authorized; 92,775,411 and 93,610,217 shares issued and outstanding at June 30, 2019 and December 31, 2018, respectively		928		936
Additional paid-in capital		1,473,599		1,489,816
Accumulated other comprehensive income (loss)		7,862		(8,627)
Retained earnings		544,275		466,737
Deferred compensation employee stock trust, net		788		825
Employee stock trust (8,579 and 11,672 shares, at cost, at June 30, 2019 and December 31, 2018, respectively)		(171)		(217)
Total Hilltop stockholders' equity		2,027,281		1,949,470
Noncontrolling interests		24,524		24,423
Total stockholders' equity		2,051,805		1,973,893
Total liabilities and stockholders' equity	$	14,265,870	$	13,683,572

See accompanying notes.

3

HILLTOP HOLDINGS INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(Unaudited)

	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
Interest income:
Loans, including fees	$	114,325	$	103,924	$	225,195	$	203,868
Securities borrowed		15,517		17,486		32,376		33,786
Securities:
Taxable		14,684		12,516		30,300		23,469
Tax-exempt		1,513		1,697		3,011		3,469
Other		4,017		4,417		9,214		8,808
Total interest income		150,056		140,040		300,096		273,400
Interest expense:
Deposits		18,036		10,136		35,142		18,811
Securities loaned		13,470		15,075		28,208		28,814
Short-term borrowings		6,897		6,466		12,368		10,509
Notes payable		2,629		2,437		5,270		4,934
Junior subordinated debentures		986		918		1,987		1,740
Other		162		160		314		324
Total interest expense		42,180		35,192		83,289		65,132
Net interest income		107,876		104,848		216,807		208,268
Provision (recovery) for loan losses		(672)		340		279		(1,467)
Net interest income after provision (recovery) for loan losses		108,548		104,508		216,528		209,735
Noninterest income:
Net gains from sale of loans and other mortgage production income		131,173		132,478		227,312		238,245
Mortgage loan origination fees		33,409		29,318		55,282		49,944
Securities commissions and fees		34,142		38,320		70,111		77,037
Investment and securities advisory fees and commissions		22,859		21,965		43,019		40,319
Net insurance premiums earned		33,466		34,105		66,669		68,420
Other		57,822		23,248		102,946		40,612
Total noninterest income		312,871		279,434		565,339		514,577
Noninterest expense:
Employees' compensation and benefits		215,743		200,632		405,641		383,232
Occupancy and equipment, net		28,219		27,893		56,242		55,723
Professional services		23,753		26,020		46,695		50,724
Loss and loss adjustment expenses		24,981		24,409		39,907		39,941
Other		50,981		59,563		104,277		117,099
Total noninterest expense		343,677		338,517		652,762		646,719
Income before income taxes		77,742		45,425		129,105		77,593
Income tax expense		17,951		11,034		29,537		18,522
Net income		59,791		34,391		99,568		59,071
Less: Net income attributable to noncontrolling interest		1,980		1,311		2,971		1,550
Income attributable to Hilltop	$	57,811	$	33,080	$	96,597	$	57,521
Earnings per common share:
Basic	$	0.62	$	0.35	$	1.03	$	0.60
Diluted	$	0.62	$	0.35	$	1.03	$	0.60
Weighted average share information:
Basic		93,399		95,270		93,533		95,625
Diluted		93,418		95,358		93,534		95,727

See accompanying notes.

4

HILLTOP HOLDINGS INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)

(Unaudited)

	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
Net income	$	59,791	$	34,391	$	99,568	$	59,071
Other comprehensive income:
Net unrealized gains (losses) on securities available for sale, net of tax of $2,574, $(602), $4,782 and $(2,495), respectively		8,924		(2,148)		16,473		(8,851)
Reclassification adjustment for gains included in net income, net of tax of $0, $0, $5 and $0, respectively		—		—		16		—
Comprehensive income		68,715		32,243		116,057		50,220
Less: comprehensive income attributable to noncontrolling interest		1,980		1,311		2,971		1,550
Comprehensive income applicable to Hilltop	$	66,735	$	30,932	$	113,086	$	48,670

See accompanying notes.

5

HILLTOP HOLDINGS INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands)

(Unaudited)

						Accumulated				Deferred					Total
				Additional		Other				Compensation		Employee			Hilltop				Total
	Common Stock			Paid-in		Comprehensive		Retained		Employee Stock		Stock Trust			Stockholders’		Noncontrolling		Stockholders’
	Shares	Amount		Capital		Income (Loss)		Earnings		Trust, Net		Shares	Amount		Equity		Interest		Equity
Balance, March 31, 2018	96,048	$	960	$	1,526,867	$	(9,698)	$	404,260	$	857	11	$	(254)	$	1,922,992	$	2,464	$	1,925,456
Net income	—		—		—		—		33,080		—	—		—		33,080		1,311		34,391
Other comprehensive loss	—		—		—		(2,148)		—		—	—		—		(2,148)		—		(2,148)
Stock-based compensation expense	—		—		2,385		—		—		—	—		—		2,385		—		2,385
Common stock issued to board members	5		—		124		—		—		—	—		—		124		—		124
Issuance of common stock related to share-based awards, net	152		2		(1,039)		—		—		—	—		—		(1,037)		—		(1,037)
Repurchases of common stock	(1,634)		(16)		(26,232)		—		(10,923)		—	—		—		(37,171)		—		(37,171)
Dividends on common stock ($0.07 per share)	—		—		—		—		(6,734)		—	—		—		(6,734)		—		(6,734)
Deferred compensation plan	—		—		—		—		—		—	—		2		2		—		2
Net cash distributed from noncontrolling interest	—		—		—		—		—		—	—		—		—		1,145		1,145
Balance, June 30, 2018	94,571	$	946	$	1,502,105	$	(11,846)	$	419,683	$	857	11	$	(252)	$	1,911,493	$	4,920	$	1,916,413
Balance, March 31, 2019	93,821	$	938	$	1,491,585	$	(1,062)	$	499,452	$	827	11	$	(213)	$	1,991,527	$	23,604	$	2,015,131
Net income	—		—		—		—		57,811		—	—		—		57,811		1,980		59,791
Other comprehensive income	—		—		—		8,924		—		—	—		—		8,924		—		8,924
Stock-based compensation expense	—		—		2,385		—		—		—	—		—		2,385		—		2,385
Common stock issued to board members	7		—		141		—		—		—	—		—		141		—		141
Issuance of common stock related to share-based awards, net	162		2		(1,013)		—		—		—	—		—		(1,011)		—		(1,011)
Repurchases of common stock	(1,215)		(12)		(19,499)		—		(5,469)		—	—		—		(24,980)		—		(24,980)
Dividends on common stock ($0.08 per share)	—		—		—		—		(7,519)		—	—		—		(7,519)		—		(7,519)
Deferred compensation plan	—		—		—		—		—		(39)	(2)		42		3		—		3
Net cash distributed to noncontrolling interest	—		—		—		—		—		—	—		—		—		(1,060)		(1,060)
Balance, June 30, 2019	92,775	$	928	$	1,473,599	$	7,862	$	544,275	$	788	9	$	(171)	$	2,027,281	$	24,524	$	2,051,805

See accompanying notes.

6

HILLTOP HOLDINGS INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (continued)

(in thousands)

(Unaudited)

						Accumulated				Deferred					Total
				Additional		Other				Compensation		Employee			Hilltop				Total
	Common Stock			Paid-in		Comprehensive		Retained		Employee Stock		Stock Trust			Stockholders’		Noncontrolling		Stockholders’
	Shares	Amount		Capital		Income (Loss)		Earnings		Trust, Net		Shares	Amount		Equity		Interest		Equity
Balance, December 31, 2017	95,982	$	960	$	1,526,369	$	(394)	$	384,545	$	848	12	$	(247)	$	1,912,081	$	2,726	$	1,914,807
Net income	—		—		—		—		57,521		—	—		—		57,521		1,550		59,071
Other comprehensive loss	—		—		—		(8,851)		—		—	—		—		(8,851)		—		(8,851)
Stock-based compensation expense	—		—		4,549		—		—		—	—		—		4,549		—		4,549
Common stock issued to board members	10		—		248		—		—		—	—		—		248		—		248
Issuance of common stock related to share-based awards, net	281		3		(1,732)		—		—		—	—		—		(1,729)		—		(1,729)
Repurchases of common stock	(1,702)		(17)		(27,329)		—		(11,531)		—	—		—		(38,877)		—		(38,877)
Dividends on common stock ($0.14 per share)	—		—		—		—		(13,453)		—	—		—		(13,453)		—		(13,453)
Deferred compensation plan	—		—		—		—		—		9	(1)		(5)		4		—		4
Adoption of accounting standards	—		—		—		(2,601)		2,601		—	—		—		—		—		—
Net cash distributed from noncontrolling interest	—		—		—		—		—		—	—		—		—		644		644
Balance, June 30, 2018	94,571	$	946	$	1,502,105	$	(11,846)	$	419,683	$	857	11	$	(252)	$	1,911,493	$	4,920	$	1,916,413
Balance, December 31, 2018	93,610	$	936	$	1,489,816	$	(8,627)	$	466,737	$	825	11	$	(217)	$	1,949,470	$	24,423	$	1,973,893
Net income	—		—		—		—		96,597		—	—		—		96,597		2,971		99,568
Other comprehensive income	—		—		—		16,489		—		—	—		—		16,489		—		16,489
Stock-based compensation expense	—		—		4,739		—		—		—	—		—		4,739		—		4,739
Common stock issued to board members	15		—		281		—		—		—	—		—		281		—		281
Issuance of common stock related to share-based awards, net	365		4		(1,738)		—		—		—	—		—		(1,734)		—		(1,734)
Repurchases of common stock	(1,215)		(12)		(19,499)		—		(5,469)		—	—		—		(24,980)		—		(24,980)
Dividends on common stock ($0.16 per share)	—		—		—		—		(14,983)		—	—		—		(14,983)		—		(14,983)
Deferred compensation plan	—		—		—		—		—		(37)	(2)		46		9		—		9
Adoption of accounting standards (Note 2)	—		—		—		—		1,393		—	—		—		1,393		—		1,393
Net cash distributed to noncontrolling interest	—		—		—		—		—		—	—		—		—		(2,870)		(2,870)
Balance, June 30, 2019	92,775	$	928	$	1,473,599	$	7,862	$	544,275	$	788	9	$	(171)	$	2,027,281	$	24,524	$	2,051,805

See accompanying notes.

7

HILLTOP HOLDINGS INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

	Six Months Ended June 30,
	2019		2018
Operating Activities
Net income	$	99,568	$	59,071
Adjustments to reconcile net income to net cash used in operating activities:
Provision (recovery) for loan losses		279		(1,467)
Depreciation, amortization and accretion, net		(256)		3,412
Net change in fair value of equity securities		(1,466)		512
Deferred income taxes		1,528		734
Other, net		5,228		4,926
Net change in securities purchased under agreements to resell		10,951		(42,635)
Net change in trading securities		143,942		96,488
Net change in broker-dealer and clearing organization receivables		(258,976)		(172,846)
Net change in other assets		(17,446)		2,897
Net change in broker-dealer and clearing organization payables		138,310		52,574
Net change in other liabilities		4,064		(90,078)
Net change in securities sold, not yet purchased		(36,220)		18,760
Proceeds from sale of mortgage servicing rights asset		—		9,303
Net gains from sales of loans		(227,312)		(238,245)
Loans originated for sale		(6,783,246)		(7,308,972)
Proceeds from loans sold		6,790,418		7,286,188
Net cash used in operating activities		(130,634)		(319,378)
Investing Activities
Proceeds from maturities and principal reductions of securities held to maturity		25,726		24,047
Proceeds from sales, maturities and principal reductions of securities available for sale		77,146		90,950
Proceeds from sales, maturities and principal reductions of equity securities		1,860		3
Purchases of securities held to maturity		(40,789)		(21,634)
Purchases of securities available for sale		(191,108)		(170,328)
Purchases of equity securities		(307)		(492)
Net change in loans held for investment		(267,006)		(49,003)
Purchases of premises and equipment and other assets		(14,935)		(12,252)
Proceeds from sales of premises and equipment and other real estate owned		9,777		8,172
Net cash paid for Federal Home Loan Bank and Federal Reserve Bank stock		(11,301)		(16,626)
Net cash used in investing activities		(410,937)		(147,163)
Financing Activities
Net change in deposits		25,579		(94,730)
Net change in short-term borrowings		273,086		404,311
Proceeds from notes payable		365,270		267,194
Payments on notes payable		(362,255)		(248,167)
Payments to repurchase common stock		(24,980)		(38,877)
Dividends paid on common stock		(14,983)		(13,453)
Net cash received from (distributed to) noncontrolling interest		(2,870)		644
Taxes paid on employee stock awards netting activity		(1,734)		(1,726)
Other, net		(215)		(363)
Net cash provided by financing activities		256,898		274,833
Net change in cash and cash equivalents		(284,673)		(191,708)
Cash, cash equivalents and restricted cash, beginning of period		778,466		673,960
Cash, cash equivalents and restricted cash, end of period	$	493,793	$	482,252
Reconciliation of Cash, Cash Equivalents and Restricted Cash to Consolidated Balance Sheets
Cash and due from banks	$	342,001	$	353,432
Federal funds sold		521		403
Assets segregated for regulatory purposes		151,271		128,417
Total cash, cash equivalents and restricted cash	$	493,793	$	482,252
Supplemental Disclosures of Cash Flow Information
Cash paid for interest	$	80,880	$	65,349
Cash paid for income taxes, net of refunds	$	12,504	$	966
Supplemental Schedule of Non-Cash Activities
Derecognition of construction in progress related to build-to-suit lease obligations	$	29,195	$	—
Conversion of loans to other real estate owned	$	2,931	$	4,846
Additions to mortgage servicing rights	$	4,408	$	9,729

See accompanying notes.

8

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

1. Summary of Significant Accounting and Reporting Policies

Nature of Operations

Hilltop Holdings Inc. (“Hilltop” and, collectively with its subsidiaries, the “Company”) is a financial holding company registered under the Bank Holding Company Act of 1956. The Company’s primary line of business is to provide business and consumer banking services from offices located throughout Texas through PlainsCapital Bank (the “Bank”). In addition, the Company provides an array of financial products and services through its broker-dealer, mortgage origination and insurance subsidiaries.

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

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States (“GAAP”), and in conformity with the rules and regulations of the Securities and Exchange Commission (the “SEC”). In the opinion of management, these financial statements contain all adjustments necessary for a fair statement of the results of the interim periods presented. Accordingly, the financial statements do not include all of the information and footnotes required by GAAP for complete financial statements and should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018 (“2018 Form 10-K”). Results for interim periods are not necessarily indicative of results to be expected for a full year or any future period.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Estimates regarding the allowance for loan losses, the fair values of financial instruments, reserves for losses and loss adjustment expenses (“LAE”), the mortgage loan indemnification liability, and the potential impairment of assets are particularly subject to change. The Company has applied its critical accounting policies and estimation methods consistently in all periods presented in these consolidated financial statements.

Hilltop owns 100% of the outstanding stock of PCC. PCC owns 100% of the outstanding stock of the Bank and 100% of the membership interest in Hilltop Opportunity Partners LLC, a merchant bank utilized to facilitate investments in companies engaged in non-financial activities. The Bank owns 100% of the outstanding stock of PrimeLending, a PlainsCapital Company (“PrimeLending”).

PrimeLending owns a 100% membership interest in PrimeLending Ventures Management, LLC (“Ventures Management”), which holds an ownership interest in and is the managing member of certain affiliated business arrangements (“ABAs”).

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

9

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

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

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

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

In addition, Hilltop owns 100% of the membership interest in each of HTH Hillcrest Project LLC (“HTH Project LLC”) and Hilltop Investments I, LLC. Hilltop Investments I, LLC owns 50% of the membership interest in HTH Diamond Hillcrest Land LLC (“Hillcrest Land LLC”) which is consolidated under the aforementioned VIE Subsections of the ASC. These entities are related to the Hilltop Plaza investment discussed in detail in Note 13 to the consolidated financial statements and are collectively referred to as the “Hilltop Plaza Entities.”

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

Certain reclassifications have been made to the prior period consolidated financial statements to conform with the current period presentation, including reclassifications due to the adoption of new accounting pronouncements. As previously disclosed, the quarterly report on Form 10-Q for the period ended June 30, 2018, filed with the SEC on July 26, 2018, incorrectly included the change in assets segregated for regulatory purposes in the operating section of the statements of cash flows. Previously disclosed net changes in assets segregated for regulatory purposes of $58.2 million for the six months ended June 30, 2018, should have been excluded from the cash flows from operating activities and the beginning-of-period and end-of-period balances of assets segregated for regulatory purposes are included in total cash, cash equivalents and restricted cash in accordance with Accounting Standards Update (“ASU”) 2016-18. Accordingly, net cash used in operating activities for the six months ended June 30, 2018, originally reported as $(261.2) million, is $(319.4) million. In preparing these consolidated financial statements, subsequent events were evaluated through the time the financial statements were issued. Financial statements are considered issued when they are widely distributed to all stockholders and other financial statement users, or filed with the SEC.

Significant accounting policies are detailed in Note 1 to the consolidated financial statements included in the Company’s 2018 Form 10-K. As a result of the adoption of ASU 2016-02 and related amendments and technical corrections (collectively, the “Leasing Standard”), the Company has included a new significant accounting policy related to lease accounting as summarized below.

Leases

The Company determines if an arrangement is a lease at inception. Operating leases with a term of greater than one year are included in operating lease right-of-use (“ROU”) assets and operating lease liabilities on the Company’s consolidated balance sheets. Finance leases are included in premises and equipment and other liabilities on the Company’s consolidated balance sheets. The Company has lease agreements with lease and nonlease components, which are generally accounted for as a single lease component. Leases of low-value assets are assessed on a lease-by-lease basis to determine the need for balance sheet capitalization.

10

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

ROU assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent its obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized on the lease commencement date based on the present value of lease payments over the lease term. As most of the Company’s leases do not provide an implicit rate, the Company uses the incremental borrowing rate commensurate with the lease term based on the information available at the lease commencement date in determining the present value of lease payments. No significant judgments or assumptions were involved in developing the estimated operating lease liabilities as the Company’s operating lease liabilities largely represent the future rental expenses associated with operating leases, and the incremental borrowing rates are based on publicly available interest rates. The operating lease ROU asset also includes any lease payments made and excludes lease incentives. The Company’s lease terms may include options to extend or terminate the lease. These options to extend or terminate are assessed on a lease-by-lease basis, and the ROU assets and lease liabilities are adjusted when it is reasonably certain that an option will be exercised. Rental expense for lease payments is recognized on a straight-line basis over the lease term and is included in occupancy and equipment, net within our consolidated statements of operations.

2. Recently Issued Accounting Standards

Accounting Standards Adopted During 2019

In July 2018, the FASB issued ASU 2018-09 which clarifies, corrects and makes minor improvements to a wide variety of topics in the ASC. The amendments make the ASC easier to understand and apply by eliminating inconsistencies and providing clarifications. The transition and effective dates are based on the facts and circumstances of each amendment, with some amendments becoming effective upon issuance of the ASU, and others becoming effective for annual periods beginning after December 15, 2018. The Company adopted the amendments as of January 1, 2019, which did not have a material effect on the Company’s consolidated financial statements.

In August 2017, the FASB issued ASU 2017-12 which provides targeted improvements to accounting for hedging activities. The FASB has issued various updates, improvements and technical corrections since the issuance of ASU 2017-12. The purpose of the amendment is to better align a company’s risk management activities with its financial reporting for hedging relationships, to simplify the hedge accounting requirements and to improve the disclosures of hedging arrangements. The amendment is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2018. The Company adopted the standard on January 1, 2019. The Company has not historically applied hedge accounting to its derivative transactions, so the provisions of the amendment did not have a material effect on the Company’s consolidated financial statements.

In February 2016, the FASB issued the Leasing Standard, which is codified in ASC 842, Leases, and is intended to increase transparency and comparability among organizations and require lessees to record an ROU asset and a liability representing the obligation to make lease payments for long-term leases. Accounting by lessors remains largely unchanged. The Company adopted the standard on January 1, 2019, using the modified retrospective transition under the option to apply the Leasing Standard at its effective date without adjusting the prior period comparative financial statements. The Company elected the package of practical expedients to not reassess: (i) whether any existing contracts are or contain a lease, (ii) the lease classification of any existing leases and (iii) initial direct costs related to existing leases. The Company also elected to apply an additional practical expedient to include both the lease and nonlease components of all leases as a single component and account for it as a lease. The Company implemented internal controls and key system functionality to enable the preparation of financial information upon adoption. The implementation of the Leasing Standard had a material impact on our consolidated balance sheets but did not have a material impact on our consolidated statements of operations. On January 1, 2019, the Company recorded operating lease liabilities of $121.8 million and ROU assets of $111.9 million upon adoption of the Leasing Standard. The lease liabilities (at their present value) represent predominantly all of the future minimum lease payments required under operating leases. The balance sheet effects of the new lease accounting standard also impacted regulatory capital ratios, performance ratios and other measures which are dependent upon asset or liability balances. In addition, the Company reassessed its accounting ownership of the Hilltop Plaza assets under construction as of January 1, 2019, under the build-to-suit provisions of ASC 842 and concluded it is not the accounting owner. As such, the assets and liabilities of the project were derecognized during the first quarter of 2019, with the $1.4 million offset representing deferred expenses

11

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

recognized on the project to date through January 1, 2019, recorded as an increase to retained earnings. Refer to Note 13 for more details regarding the Hilltop Plaza transaction.

Accounting Standards Issued But Not Yet Adopted

In August 2018, the FASB issued ASU 2018-15 which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software licenses). The accounting for the service element of a hosting arrangement that is a service contract is not affected by the amendments in this update. The amendment also includes presentation and disclosure provisions regarding capitalized implementation costs. The amendment is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2019. Early adoption is permitted. The Company is currently evaluating the provisions of the amendment and the impact on its future consolidated financial statements.

In August 2018, the FASB issued ASU 2018-13 which includes various removals, modifications and additions to existing guidance regarding fair value disclosures. The amendments are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2019. Early adoption is permitted. The Company is currently evaluating the provisions of the amendments but does not expect the amendments to have a material impact on its future consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13 which sets forth a “current expected credit loss” (CECL) model which requires entities to measure all credit losses expected over the life of an exposure (or pool of exposures) for financial instruments held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts. The FASB has issued various updates, improvements and technical corrections to the standard since the issuance of ASU 2016-13. The new standard, which is codified in ASC 326, Financial Instruments – Credit Losses, replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost and applies to some off-balance sheet credit exposures. The new standard also requires enhanced disclosures to help financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an entity’s portfolio. The new standard is effective for annual periods, and interim reporting periods within those annual periods, beginning after December 15, 2019 with a cumulative-effect adjustment to retained earnings as of the beginning of the reporting period of adoption. The Company does not intend to adopt the provisions of the new standard early. The Company’s cross-functional team is continuing to implement and test new credit forecasting models and a credit scoring system that will be utilized to estimate the likelihood of default and loss severity as a part of its credit loss estimation methodology in accordance with the new standard. The Company is working to produce parallel credit loss calculations during the remainder of 2019, with a focus on calculating a potential range of financial impact. In addition, the Company continues to identify and assess key interpretive policy issues, as well as design and build new and modified policies and procedures that will be used to calculate its credit loss reserves. New and revised internal controls and processes are also being designed. The Company expects that the CECL model will require a material increase in the allowance for credit losses upon adoption on January 1, 2020. However, the magnitude of the increase in allowance for credit losses upon adoption will depend on, among other things, the portfolio composition and quality at the adoption date, as well as economic conditions and forecasts at that time.

3. Acquisition

BORO Acquisition

On August 1, 2018, to expand its Houston-area banking operations, the Company acquired privately-held The Bank of River Oaks (“BORO”) in an all-cash transaction (the “BORO Acquisition”). Pursuant to the terms of the definitive agreement, the Company paid cash in the aggregate amount of $85 million to the shareholders and option holders of BORO. The operations of BORO are included in the Bank’s operating results beginning August 1, 2018. BORO’s results of operations prior to the acquisition date are not included in the Company’s consolidated operating results.

12

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

The BORO Acquisition was accounted for using the acquisition method of accounting, and accordingly, purchased assets, including identifiable intangible assets, and assumed liabilities were recorded at their respective acquisition date fair values. The resulting fair values of the identifiable assets acquired and liabilities assumed from BORO at August 1, 2018 are summarized in the following table (in thousands).

Cash and due from banks	$	21,756
Securities		60,477
Loans held for investment		326,618
Other assets		25,912
Total identifiable assets acquired		434,763
Deposits		376,393
Short-term borrowings		10,000
Other liabilities		2,996
Total liabilities assumed		389,389
Net identifiable assets acquired		45,374
Goodwill resulting from the acquisition		39,627
Net assets acquired	$	85,001

The goodwill of $39.6 million resulting from the BORO Acquisition represents the inherent long-term value expected from the business opportunities created from combining BORO with the Company. The Company used significant estimates and assumptions to value the identifiable assets acquired and liabilities assumed. The amount of goodwill recorded in connection with the Company’s acquisition of BORO is not deductible for tax purposes.

Included within the fair value of other assets in the table above are $10.0 million of identifiable core deposits intangible assets recorded in connection with the BORO Acquisition which are being amortized on an accelerated basis over an estimated useful life of six years. The fair value of the core deposit intangible assets was estimated using the net cost savings method, a variation of the income approach. This involved the use of the following significant assumptions: cost of deposits, customer attrition rate, and discount rate.

In connection with the BORO Acquisition, the Company acquired loans both with and without evidence of credit quality deterioration since origination. The acquired loans were initially recorded at fair value with no carryover of any allowance for loan losses. Acquired loans were segregated between those considered to be purchased credit impaired (“PCI”) loans and those without credit impairment at acquisition.

The following table presents details on acquired loans at the acquisition date (in thousands).

	Loans, excluding		PCI		Total Loans Held
	PCI Loans		Loans		for Investment
Commercial real estate	$	119,188	$	5,350	$	124,538
1 - 4 family residential		55,487		39		55,526
Construction and land development		37,134		—		37,134
Commercial and industrial		98,259		2,127		100,386
Consumer		9,021		13		9,034
Total	$	319,089	$	7,529	$	326,618

The following table presents information about the PCI loans at acquisition (in thousands).

Contractually required principal and interest payments	$	10,730
Nonaccretable difference		2,859
Cash flows expected to be collected		7,871
Accretable difference		342
Fair value of loans acquired with a deterioration of credit quality	$	7,529

13

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

The following table presents information about the acquired loans without credit impairment at acquisition (in thousands).

Contractually required principal and interest payments	$	381,551
Contractual cash flows not expected to be collected		15,286
Fair value at acquisition		319,089

4. Fair Value Measurements

Fair Value Measurements and Disclosures

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

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

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

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

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

Fair Value Option

The Company has elected to measure substantially all of PrimeLending’s mortgage loans held for sale and retained mortgage servicing rights (“MSR”) asset at fair value, under the provisions of the Fair Value Option. The Company elected to apply the provisions of the Fair Value Option to these items so that it would have the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. At June 30, 2019 and December 31, 2018, the aggregate fair value of PrimeLending’s mortgage loans held for sale accounted for under the Fair Value Option was $1.48 billion and $1.26 billion, respectively, and the unpaid principal balance of those loans was $1.43 billion and $1.21 billion, respectively. The interest component of fair value is reported as interest income on loans in the accompanying consolidated statements of operations.

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

14

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

dealers and data from independent pricing services. The fair value of loans held for sale is determined using an exit price method.

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

	Level 1		Level 2		Level 3		Total
June 30, 2019	Inputs		Inputs		Inputs		Fair Value
Trading securities	$	5,204	$	596,320	$	—	$	601,524
Available for sale securities		—		1,009,924		—		1,009,924
Equity securities		19,592		—		—		19,592
Loans held for sale		—		1,418,277		56,799		1,475,076
Derivative assets		—		72,783		—		72,783
MSR asset		—		—		53,695		53,695
Securities sold, not yet purchased		14,897		30,550		—		45,447
Derivative liabilities		—		38,939		—		38,939

	Level 1		Level 2		Level 3			Total
December 31, 2018	Inputs		Inputs		Inputs			Fair Value
Trading securities	$	7,947	$	737,519	$	—	$	745,466
Available for sale securities		—		875,658		—		875,658
Equity securities		19,679		—		—		19,679
Loans held for sale		—		1,207,311		50,464		1,257,775
Derivative assets		—		35,010		—		35,010
MSR asset		—		—		66,102		66,102
Securities sold, not yet purchased		33,000		48,667		—		81,667
Derivative liabilities		—		26,355		—		26,355

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

									Total Gains or Losses
									(Realized or Unrealized)
	Balance at										Included in Other
	Beginning of		Purchases/		Sales/		Transfers to		Included in		Comprehensive		Balance at
	Period		Additions		Reductions		(from) Level 3		Net Income		Income (Loss)		End of Period
Three months ended June 30, 2019
Loans held for sale	$	57,844	$	14,053	$	(11,108)	$	(612)	$	(3,378)	$	—	$	56,799
MSR asset		62,049		2,547		—		—		(10,901)		—		53,695
Total	$	119,893	$	16,600	$	(11,108)	$	(612)	$	(14,279)	$	—	$	110,494
Six months ended June 30, 2019
Loans held for sale	$	50,464	$	29,480	$	(18,084)	$	425	$	(5,486)	$	—	$	56,799
MSR asset		66,102		4,408		—		—		(16,815)		—		53,695
Total	$	116,566	$	33,888	$	(18,084)	$	425	$	(22,301)	$	—	$	110,494
Three months ended June 30, 2018
Loans held for sale	$	43,483	$	8,071	$	(8,538)		—	$	(2,235)	$	—	$	40,781
MSR asset		63,957		3,068		(9,303)		—		(349)		—		57,373
Total	$	107,440	$	11,139	$	(17,841)	$	—	$	(2,584)	$	—	$	98,154
Six months ended June 30, 2018
Loans held for sale	$	36,972	$	20,550	$	(12,513)		—	$	(4,228)	$	—	$	40,781
MSR asset		54,714		9,729		(9,303)		—		2,233		—		57,373
Total	$	91,686	$	30,279	$	(21,816)	$	—	$	(1,995)	$	—	$	98,154

All net realized and unrealized gains (losses) in the tables above are reflected in the accompanying consolidated financial statements. The unrealized gains (losses) relate to financial instruments still held at June 30, 2019.

15

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

For Level 3 financial instruments measured at fair value on a recurring basis at June 30, 2019 and December 31, 2018, the significant unobservable inputs used in the fair value measurements were as follows.

			Range (Weighted-Average)
			June 30,							December 31,
Financial instrument	Valuation Technique	Unobservable Inputs	2019							2018
Loans held for sale	Discounted cash flows / Market comparable	Projected price	89	-	96	%	(	95	%)	95	-	96	%	(	95	%)
MSR asset	Discounted cash flows	Constant prepayment rate			13.67		%					10.51		%
		Discount rate			11.12		%					11.11		%

The fair value of certain loans held for sale that cannot be sold through normal sale channels or are non-performing is measured using Level 3 inputs. The fair value of such loans is generally based upon estimates of expected cash flows using unobservable inputs, including listing prices of comparable assets, uncorroborated expert opinions, and/or management’s knowledge of underlying collateral.

The MSR asset, which is included in other assets within the Company’s consolidated balance sheets, is reported at fair value using Level 3 inputs. The MSR asset is valued by projecting net servicing cash flows, which are then discounted to estimate the fair value. The fair value of the MSR asset is impacted by a variety of factors. Prepayment rates and discount rates, the most significant unobservable inputs, are discussed further in Note 7 to the consolidated financial statements.

The Company had no transfers between Levels 1 and 2 during the periods presented. Any transfers are based on changes in the observability and/or significance of the valuation inputs and are assumed to occur at the beginning of the quarterly reporting period in which they occur.

The following table presents those changes in fair value of instruments recognized in the consolidated statements of operations that are accounted for under the Fair Value Option (in thousands).

	Three Months Ended June 30, 2019						Three Months Ended June 30, 2018
			Other		Total				Other		Total
	Net		Noninterest		Changes in		Net		Noninterest		Changes in
	Gains (Losses)		Income		Fair Value		Gains (Losses)		Income		Fair Value
Loans held for sale	$	17,179	$	—	$	17,179	$	22,604	$	—	$	22,604
MSR asset		(10,901)		—		(10,901)		(349)		—		(349)

	Six Months Ended June 30, 2019						Six Months Ended June 30, 2018
			Other		Total				Other		Total
	Net		Noninterest		Changes in		Net		Noninterest		Changes in
	Gains (Losses)		Income		Fair Value		Gains (Losses)		Income		Fair Value
Loans held for sale	$	3,855	$	—	$	3,855	$	7,724	$	—	$	7,724
MSR asset		(16,815)		—		(16,815)		2,233		—		2,233

The Company also determines the fair value of certain assets and liabilities on a non-recurring basis. In particular, the fair value of all assets acquired and liabilities assumed in an acquisition of a business are determined at their respective acquisition date fair values. In addition, facts and circumstances may dictate a fair value measurement when there is evidence of impairment. Assets and liabilities measured on a non-recurring basis include the items discussed below.

Impaired Loans — The Company reports individually impaired loans based on the underlying fair value of the collateral through specific allowances within the allowance for loan losses. PCI loans were acquired by the Company upon completion of the merger with PCC (the “PlainsCapital Merger”), the FDIC-assisted transaction whereby the Bank acquired certain assets and assumed certain liabilities of Edinburg, Texas-based First National Bank (“FNB”) on September 13, 2013 (the “FNB Transaction”), the acquisition of SWS Group, Inc. (“SWS”) in a stock and cash transaction (the "SWS Merger"), whereby SWS’s banking subsidiary, Southwest Securities, FSB, was merged into the Bank, and the BORO Acquisition (collectively, the “Bank Transactions”). The fair value of PCI loans was determined using Level 3 inputs, including estimates of expected cash flows that incorporated significant unobservable inputs

16

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

regarding default rates, loss severity rates assuming default, prepayment speeds on acquired loans accounted for in pools (“Pooled Loans”), and estimated collateral values.

Estimates for these significant unobservable inputs and the resulting weighted average expected loss on PCI loans were as follows.

	PCI Loans
	PlainsCapital		FNB		SWS		BORO
June 30, 2019	Merger		Transaction		Merger		Acquisition
Weighted average default rate	84	%	30	%	71	%	59	%
Weighted average loss severity rate	59	%	12	%	28	%	43	%
Weighted average prepayment speed	0	%	6	%	0	%	0	%
Resulting weighted average expected loss on PCI loans	49	%	4	%	20	%	25	%
	PCI Loans
	PlainsCapital		FNB		SWS		BORO
December 31, 2018	Merger		Transaction		Merger		Acquisition
Weighted average default rate	81	%	34	%	71	%	63	%
Weighted average loss severity rate	59	%	12	%	28	%	42	%
Weighted average prepayment speed	0	%	6	%	0	%	0	%
Resulting weighted average expected loss on PCI loans	48	%	4	%	20	%	26	%

The Company obtains updated appraisals of the fair value of collateral securing impaired collateral dependent loans at least annually, in accordance with regulatory guidelines. The Company also reviews the fair value of such collateral on a quarterly basis. If the quarterly review indicates that the fair value of the collateral may have deteriorated, the Company orders an updated appraisal of the fair value of the collateral. Because the Company obtains updated appraisals when evidence of a decline in the fair value of collateral exists, it typically does not adjust appraised values.

Other Real Estate Owned — The Company determines fair value primarily using independent appraisals of other real estate owned (“OREO”) properties. The resulting fair value measurements are classified as Level 2 inputs. At June 30, 2019 and December 31, 2018, the estimated fair value of OREO was $20.8 million and $27.6 million, respectively, and the underlying fair value measurements utilized Level 2 inputs. The amounts are included in other assets within the consolidated balance sheets. During the reported periods, all fair value measurements for OREO subsequent to initial recognition utilized Level 2 inputs.

The following table presents information regarding certain assets and liabilities measured at fair value on a non-recurring basis for which a change in fair value has been recorded during reporting periods subsequent to initial recognition (in thousands).

									Total Gains (Losses) for the				Total Gains (Losses) for the
	Level 1		Level 2		Level 3		Total		Three Months Ended June 30,				Six Months Ended June 30,
June 30, 2019	Inputs		Inputs		Inputs		Fair Value		2019		2018		2019		2018
Impaired loans held for investment	$	—	$	—	$	65,660	$	65,660	$	(1,295)	$	(602)	$	(1,195)	$	(725)
Other real estate owned		—		12,885		—		12,885		(119)		(694)		(613)		(1,800)

The Fair Value of Financial Instruments Subsection of the ASC requires disclosure of the fair value of financial assets and liabilities, including the financial assets and liabilities previously discussed. There have been changes to the methods for determining estimated fair value for financial assets and liabilities as described in detail in Note 3 to the consolidated financial statements included in the Company’s 2018 Form 10-K.

17

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

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

			Estimated Fair Value
	Carrying		Level 1		Level 2		Level 3
June 30, 2019	Amount		Inputs		Inputs		Inputs		Total
Financial assets:
Cash and cash equivalents	$	342,522	$	342,522	$	—	$	—	$	342,522
Assets segregated for regulatory purposes		151,271		151,271		—		—		151,271
Securities purchased under agreements to resell		50,660		—		50,660		—		50,660
Held to maturity securities		365,905		—		368,546		—		368,546
Loans held for sale		134,401		—		134,401		—		134,401
Loans held for investment, net		7,147,427		—		570,377		6,818,592		7,388,969
Broker-dealer and clearing organization receivables		1,707,249		—		1,707,249		—		1,707,249
Other assets		71,833		—		70,724		1,109		71,833
Financial liabilities:
Deposits		8,463,079		—		8,464,697		—		8,464,697
Broker-dealer and clearing organization payables		1,531,891		—		1,531,891		—		1,531,891
Short-term borrowings		1,338,893		—		1,338,893		—		1,338,893
Debt		298,935		—		296,724		—		296,724
Other liabilities		5,640		—		5,640		—		5,640

			Estimated Fair Value
	Carrying		Level 1		Level 2		Level 3
December 31, 2018	Amount		Inputs		Inputs		Inputs		Total
Financial assets:
Cash and cash equivalents	$	644,473	$	644,473	$	—	$	—	$	644,473
Assets segregated for regulatory purposes		133,993		133,993		—		—		133,993
Securities purchased under agreements to resell		61,611		—		61,611		—		61,611
Held to maturity securities		351,012		—		341,124		—		341,124
Loans held for sale		135,471		—		135,471		—		135,471
Loans held for investment, net		6,870,972		—		578,363		6,445,810		7,024,173
Broker-dealer and clearing organization receivables		1,440,287		—		1,440,287		—		1,440,287
Other assets		69,720		—		68,573		1,147		69,720
Financial liabilities:
Deposits		8,536,156		—		8,528,947		—		8,528,947
Broker-dealer and clearing organization payables		1,294,925		—		1,294,925		—		1,294,925
Short-term borrowings		1,065,807		—		1,065,807		—		1,065,807
Debt		295,884		—		293,685		—		293,685
Other liabilities		3,482		—		3,482		—		3,482

18

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

The Company held equity investments other than securities of $36.3 million and $35.8 million at June 30, 2019 and December 31, 2018, respectively, which are included within other assets in the consolidated balance sheets. Of the $36.3 million of such equity investments held at June 30, 2019, $19.9 million do not have readily determinable fair values and each is measured at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. The following table presents the adjustments to the carrying value of these investments during the periods presented (in thousands).

	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
Balance, beginning of period	$	20,477	$	21,906	$	20,376	$	22,946
Additional investments		—		1,411		—		1,411
Upward adjustments		101		2,836		202		3,108
Impairments and downward adjustments		(672)		(2)		(672)		(1,314)
Dispositions		—		—		—		—
Balance, end of period	$	19,906	$	26,151	$	19,906	$	26,151

5. Securities

The fair value of trading securities is summarized as follows (in thousands).

	June 30,		December 31,
	2019		2018
U.S. Treasury securities	$	5,203	$	7,945
U.S. government agencies:
Bonds		6,194		1,494
Residential mortgage-backed securities		246,943		309,455
Commercial mortgage-backed securities		2,204		4,239
Collateralized mortgage obligations		149,449		206,813
Corporate debt securities		54,729		59,293
States and political subdivisions		116,202		126,748
Unit investment trusts		15,919		19,913
Private-label securitized product		1,267		5,680
Other		3,414		3,886
Totals	$	601,524	$	745,466

The Hilltop Broker-Dealers enter into transactions that represent commitments to purchase and deliver securities at prevailing future market prices to facilitate customer transactions and satisfy such commitments. Accordingly, the Hilltop Broker-Dealers’ ultimate obligations may exceed the amount recognized in the financial statements. These securities, which are carried at fair value and reported as securities sold, not yet purchased in the consolidated balance sheets, had a value of $45.4 million and $81.7 million at June 30, 2019 and December 31, 2018, respectively.

19

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

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

	Available for Sale
	Amortized		Unrealized		Unrealized
June 30, 2019	Cost		Gains		Losses		Fair Value
U.S. Treasury securities	$	10,559	$	197	$	(11)	$	10,745
U.S. government agencies:
Bonds		85,311		1,210		(14)		86,507
Residential mortgage-backed securities		467,661		5,925		(1,453)		472,133
Commercial mortgage-backed securities		11,595		540		—		12,135
Collateralized mortgage obligations		333,415		3,061		(2,206)		334,270
Corporate debt securities		47,824		1,710		—		49,534
States and political subdivisions		43,433		1,170		(3)		44,600
Totals	$	999,798	$	13,813	$	(3,687)	$	1,009,924

	Available for Sale
	Amortized		Unrealized		Unrealized
December 31, 2018	Cost		Gains		Losses		Fair Value
U.S. Treasury securities	$	11,552	$	30	$	(44)	$	11,538
U.S. government agencies:
Bonds		85,492		552		(433)		85,611
Residential mortgage-backed securities		391,428		608		(6,962)		385,074
Commercial mortgage-backed securities		11,703		189		(120)		11,772
Collateralized mortgage obligations		281,450		385		(5,436)		276,399
Corporate debt securities		53,614		268		(580)		53,302
States and political subdivisions		51,560		608		(206)		51,962
Totals	$	886,799	$	2,640	$	(13,781)	$	875,658

	Held to Maturity
	Amortized		Unrealized		Unrealized
June 30, 2019	Cost		Gains		Losses		Fair Value
U.S. Treasury securities	$	9,961	$	19	$	—	$	9,980
U.S. government agencies:
Bonds		39,019		—		(71)		38,948
Residential mortgage-backed securities		20,031		203		—		20,234
Commercial mortgage-backed securities		113,570		3,170		(98)		116,642
Collateralized mortgage obligations		130,326		300		(1,271)		129,355
States and political subdivisions		52,998		650		(261)		53,387
Totals	$	365,905	$	4,342	$	(1,701)	$	368,546

	Held to Maturity
	Amortized		Unrealized		Unrealized
December 31, 2018	Cost		Gains		Losses		Fair Value
U.S. Treasury securities	$	9,903	$	3	$	—	$	9,906
U.S. government agencies:
Bonds		39,018		—		(1,479)		37,539
Residential mortgage-backed securities		21,903		—		(263)		21,640
Commercial mortgage-backed securities		87,065		271		(1,462)		85,874
Collateralized mortgage obligations		142,474		—		(5,000)		137,474
States and political subdivisions		50,649		91		(2,049)		48,691
Totals	$	351,012	$	365	$	(10,253)	$	341,124

Additionally, the Company had unrealized net gains of $0.7 million and unrealized net losses of $0.9 million from equity securities with fair values of $19.6 million and $19.7 million held at June 30, 2019 and December 31, 2018, respectively.

20

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

The Company recognized net gains of $0.2 million and $0.1 million during the three months ended June 30, 2019 and 2018, respectively, and net gains of $1.5 million and net losses of $0.5 million during the six months ended June 30, 2019 and 2018, respectively, due to changes in the fair value of equity securities still held at the balance sheet date. During the three and six months ended June 30, 2019 and 2018, net gains recognized from equity securities sold were nominal.

Information regarding available for sale, held to maturity and equity securities that were in an unrealized loss position is shown in the following tables (dollars in thousands).

	June 30, 2019					December 31, 2018
	Number of			Unrealized		Number of			Unrealized
	Securities	Fair Value		Losses		Securities	Fair Value		Losses
Available for Sale
U.S. treasury securities:
Unrealized loss for less than twelve months	2	$	2,586	$	11	1	$	981	$	6
Unrealized loss for twelve months or longer	—		—		—	3		3,556		39
	2		2,586		11	4		4,537		45
U.S. government agencies:
Bonds:
Unrealized loss for less than twelve months	—		—		—	3		24,772		5
Unrealized loss for twelve months or longer	1		9,986		14	3		30,472		428
	1		9,986		14	6		55,244		433
Residential mortgage-backed securities:
Unrealized loss for less than twelve months	2		8,355		7	8		66,791		432
Unrealized loss for twelve months or longer	16		106,815		1,445	27		194,228		6,530
	18		115,170		1,452	35		261,019		6,962
Commercial mortgage-backed securities:
Unrealized loss for less than twelve months	—		—		—	—		—		—
Unrealized loss for twelve months or longer	—		—		—	1		4,953		120
	—		—		—	1		4,953		120
Collateralized mortgage obligations:
Unrealized loss for less than twelve months	9		55,481		153	11		44,394		498
Unrealized loss for twelve months or longer	24		106,528		2,054	28		140,483		4,938
	33		162,009		2,207	39		184,877		5,436
Corporate debt securities:
Unrealized loss for less than twelve months	—		3,009		—	8		16,256		282
Unrealized loss for twelve months or longer	—		2,407		—	8		15,665		297
	—		5,416		—	16		31,921		579
States and political subdivisions:
Unrealized loss for less than twelve months	1		822		—	29		8,590		27
Unrealized loss for twelve months or longer	3		1,223		3	18		9,029		179
	4		2,045		3	47		17,619		206
Total available for sale:
Unrealized loss for less than twelve months	14		70,253		171	60		161,784		1,250
Unrealized loss for twelve months or longer	44		226,959		3,516	88		398,386		12,531
	58	$	297,212	$	3,687	148	$	560,170	$	13,781

21

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

	June 30, 2019					December 31, 2018
	Number of			Unrealized		Number of			Unrealized
	Securities	Fair Value		Losses		Securities	Fair Value		Losses
Held to Maturity
U.S. government agencies:
Bonds:
Unrealized loss for less than twelve months	—	$	—	$	—	—	$	—	$	—
Unrealized loss for twelve months or longer	2		29,248		71	4		37,539		1,479
	2		29,248		71	4		37,539		1,479
Residential mortgage-backed securities:
Unrealized loss for less than twelve months	—		—		—	1		8,411		89
Unrealized loss for twelve months or longer	—		—		—	3		13,229		174
	—		—		—	4		21,640		263
Commercial mortgage-backed securities:
Unrealized loss for less than twelve months	1		1,601		17	1		4,973		27
Unrealized loss for twelve months or longer	2		12,551		81	13		59,670		1,435
	3		14,152		98	14		64,643		1,462
Collateralized mortgage obligations:
Unrealized loss for less than twelve months	—		—		—	1		2,051		26
Unrealized loss for twelve months or longer	15		95,659		1,271	24		135,423		4,974
	15		95,659		1,271	25		137,474		5,000
States and political subdivisions:
Unrealized loss for less than twelve months	—		—		—	9		6,431		56
Unrealized loss for twelve months or longer	41		19,683		261	86		32,909		1,993
	41		19,683		261	95		39,340		2,049
Total held to maturity:
Unrealized loss for less than twelve months	1		1,601		17	12		21,866		198
Unrealized loss for twelve months or longer	60		157,141		1,684	130		278,770		10,055
	61	$	158,742	$	1,701	142	$	300,636	$	10,253

During the three and six months ended June 30, 2019 and 2018, the Company did not record any other-than-temporary impairment (“OTTI”). While some of the securities held in the Company’s investment portfolio have decreased in value since the date of acquisition, the severity of loss and the duration of the loss position are not significant enough to warrant OTTI of the securities. Factors considered in the Company’s analysis include the reasons for the unrealized loss position, the severity and duration of the unrealized loss position, credit worthiness, and forecasted performance of the investee. The Company does not intend to sell, nor does the Company believe that it is likely that the Company will be required to sell, these securities before the recovery of the cost basis.

Expected maturities may differ from contractual maturities because certain borrowers may have the right to call or prepay obligations with or without penalties. The amortized cost and fair value of securities, excluding trading and equity securities, at June 30, 2019 are shown by contractual maturity below (in thousands).

	Available for Sale				Held to Maturity
	Amortized				Amortized
	Cost		Fair Value		Cost		Fair Value
Due in one year or less	$	39,783	$	39,797	$	11,356	$	11,376
Due after one year through five years		88,357		90,942		26,042		26,055
Due after five years through ten years		39,142		40,024		5,392		5,414
Due after ten years		19,845		20,623		59,188		59,470
		187,127		191,386		101,978		102,315
Residential mortgage-backed securities		467,661		472,133		20,031		20,234
Collateralized mortgage obligations		333,415		334,270		130,326		129,355
Commercial mortgage-backed securities		11,595		12,135		113,570		116,642
	$	999,798	$	1,009,924	$	365,905	$	368,546

The Company recognized net gains of $2.5 million and net losses of $6.8 million from its trading portfolio during the three months ended June 30, 2019 and 2018, respectively, and $10.7 million and $1.9 million during the six months ended June 30, 2019 and 2018, respectively. In addition, the Hilltop Broker-Dealers realized net gains from structured product trading activities of $30.4 million and $0.4 million during the three months ended June 30, 2019 and 2018,

22

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

respectively, and $55.7 million and $17.4 million during the six months ended June 30, 2019 and 2018, respectively. All such realized net gains and losses are recorded as a component of other noninterest income within the consolidated statements of operations.

Securities with a carrying amount of $612.3 million and $612.3 million (with a fair value of $615.6 million and $600.0 million, respectively) at June 30, 2019 and December 31, 2018, respectively, were pledged by the Bank to secure public and trust deposits, federal funds purchased and securities sold under agreements to repurchase, and for other purposes as required or permitted by law. Substantially all of these pledged securities were included in our available for sale and held to maturity securities portfolios at June 30, 2019 and December 31, 2018.

Mortgage-backed securities and collateralized mortgage obligations consist primarily of Government National Mortgage Association (“GNMA”), Federal National Mortgage Association (“FNMA”) and Federal Home Loan Mortgage Corporation (“FHLMC”) pass-through and participation certificates. GNMA securities are guaranteed by the full faith and credit of the United States, while FNMA and FHLMC securities are fully guaranteed by those respective United States government-sponsored agencies, and conditionally guaranteed by the full faith and credit of the United States.

At June 30, 2019 and December 31, 2018, NLC had investments on deposit in custody for various state insurance departments with aggregate carrying values of $9.3 million and $9.5 million, respectively.

6. Loans Held for Investment and Allowance for Loan Losses

The loans acquired in the FNB Transaction were subject to loss-share agreements with the FDIC. During the fourth quarter of 2018, the Bank and the FDIC entered into a Termination Agreement pursuant to which all rights and obligations of the Bank and the FDIC under the FDIC loss-share agreements were resolved and terminated. Accordingly, loans which were previously referred to as either “covered loans” if covered by the loss-share agreements or otherwise “non-covered loans” are now collectively referred to as “loans held for investment.” Disclosures associated with loans that were previously covered by the FDIC loss-share agreements during the three and six months ended June 30, 2018 are included in the “covered” portfolio segment in the applicable tables that follow. The majority of the loans previously covered by the FDIC loss-share agreements are comprised primarily of commercial real estate and 1-4 family residential loans. Loans held for investment summarized by portfolio segment are as follows (in thousands).

	June 30,		December 31,
	2019		2018
Commercial real estate	$	2,937,243	$	2,940,120
Commercial and industrial		1,448,221		1,508,451
Construction and land development		950,628		932,909
1-4 family residential		696,535		679,263
Mortgage warehouse		555,327		243,806
Consumer		44,273		47,546
Broker-dealer (1)		570,377		578,363
		7,202,604		6,930,458
Allowance for loan losses		(55,177)		(59,486)
Total loans held for investment, net of allowance	$	7,147,427	$	6,870,972

(1) Primarily represents margin loans to customers and correspondents associated with broker-dealer segment operations.

In connection with the Bank Transactions, the Company acquired loans both with and without evidence of credit quality deterioration since origination. The following table presents the carrying values and the outstanding balances of PCI loans (in thousands).

	June 30,		December 31,
	2019		2018
Carrying amount	$	86,200	$	93,072
Outstanding balance		155,749		172,808

23

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

Changes in the accretable yield for PCI loans were as follows (in thousands).

	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
Balance, beginning of period	$	72,172	$	93,686	$	80,693	$	98,846
Reclassifications from nonaccretable difference, net (1)		4,909		3,136		5,443		10,265
Disposals of loans		(337)		—		(703)		(98)
Accretion		(7,439)		(9,514)		(16,128)		(21,514)
Transfer of loans to OREO (2)		—		(656)		—		(847)
Balance, end of period	$	69,305	$	86,652	$	69,305	$	86,652

(1) Reclassifications from nonaccretable difference are primarily due to net increases in expected cash flows in the quarterly recasts. Reclassifications to nonaccretable difference occur when accruing loans are moved to non-accrual and expected cash flows are no longer predictable and the accretable yield is eliminated.

(2) Transfer of loans to OREO is the difference between the value removed from the pool and the expected cash flows for the loan.

The remaining nonaccretable difference for PCI loans was $59.6 million and $64.2 million at June 30, 2019 and December 31, 2018, respectively.

Impaired loans exhibit a clear indication that the borrower’s cash flow may not be sufficient to meet principal and interest payments, which generally occurs when a loan is 90 days past due unless the asset is both well secured and in the process of collection. Impaired loans include non-accrual loans, troubled debt restructurings (“TDRs”), PCI loans and partially charged-off loans.

The amounts shown in the following tables include loans accounted for on an individual basis, as well as acquired Pooled Loans. For Pooled Loans, the recorded investment and the related allowance consider impairment measured at the pool level. Impaired loans, segregated between those considered to be PCI loans and those without credit impairment at acquisition, are summarized by class in the following tables (in thousands).

	Unpaid		Recorded		Recorded		Total
	Contractual		Investment with		Investment with		Recorded		Related
June 30, 2019	Principal Balance		No Allowance		Allowance		Investment		Allowance
PCI
Commercial real estate:
Non-owner occupied	$	35,163	$	5,416	$	7,332	$	12,748	$	1,331
Owner occupied		28,977		6,965		5,636		12,601		639
Commercial and industrial		25,825		4,767		1,141		5,908		29
Construction and land development		7,791		44		23		67		3
1-4 family residential		96,746		1,623		53,249		54,872		1,987
Mortgage warehouse		—		—		—		—		—
Consumer		1,895		4		—		4		—
Broker-dealer		—		—		—		—		—
		196,397		18,819		67,381		86,200		3,989
Non-PCI
Commercial real estate:
Non-owner occupied		206		199		—		199		—
Owner occupied		5,106		3,943		—		3,943		—
Commercial and industrial		26,210		9,950		2,245		12,195		838
Construction and land development		1,536		919		492		1,411		12
1-4 family residential		10,460		7,625		—		7,625		—
Mortgage warehouse		—		—		—		—		—
Consumer		144		34		—		34		—
Broker-dealer		—		—		—		—		—
		43,662		22,670		2,737		25,407		850
	$	240,059	$	41,489	$	70,118	$	111,607	$	4,839

24

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

	Unpaid		Recorded		Recorded		Total
	Contractual		Investment with		Investment with		Recorded		Related
December 31, 2018	Principal Balance		No Allowance		Allowance		Investment		Allowance
PCI
Commercial real estate:
Non-owner occupied	$	42,668	$	5,549	$	7,540	$	13,089	$	1,125
Owner occupied		36,246		11,657		2,967		14,624		304
Commercial and industrial		27,403		5,491		1,068		6,559		72
Construction and land development		10,992		74		390		464		92
1-4 family residential		106,503		646		57,681		58,327		1,299
Mortgage warehouse		—		—		—		—		—
Consumer		2,185		9		—		9		—
Broker-dealer		—		—		—		—		—
		225,997		23,426		69,646		93,072		2,892
Non-PCI
Commercial real estate:
Non-owner occupied		—		—		—		—		—
Owner occupied		5,231		4,098		—		4,098		—
Commercial and industrial		22,277		9,891		1,740		11,631		721
Construction and land development		3,430		2,711		535		3,246		31
1-4 family residential		8,695		6,922		—		6,922		—
Mortgage warehouse		—		—		—		—		—
Consumer		149		42		—		42		—
Broker-dealer		—		—		—		—		—
		39,782		23,664		2,275		25,939		752
	$	265,779	$	47,090	$	71,921	$	119,011	$	3,644

Average recorded investment in impaired loans is summarized by class in the following table (in thousands).

	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
Commercial real estate:
Non-owner occupied	$	13,097	$	30,245	$	13,018	$	31,998
Owner occupied		17,380		4,973		17,633		7,887
Commercial and industrial		17,284		24,056		18,147		24,206
Construction and land development		1,619		1,673		2,594		1,768
1-4 family residential		63,279		—		63,873		—
Mortgage warehouse		—		—		—		—
Consumer		41		54		45		116
Broker-dealer		—		—		—		—
Covered		—		83,471		—		86,763
	$	112,700	$	144,472	$	115,310	$	152,738

Non-accrual loans, excluding those classified as held for sale, are summarized by class in the following table (in thousands).

	June 30,		December 31,
	2019		2018
Commercial real estate:
Non-owner occupied	$	1,333	$	1,226
Owner occupied		3,943		4,098
Commercial and industrial		14,152		14,870
Construction and land development		1,413		3,278
1-4 family residential		7,700		7,026
Mortgage warehouse		—		—
Consumer		34		41
Broker-dealer		—		—
	$	28,575	$	30,539

25

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

At June 30, 2019 and December 31, 2018, non-accrual loans included PCI loans of $4.4 million and $4.9 million, respectively, for which discount accretion has been suspended because the extent and timing of cash flows from these PCI loans can no longer be reasonably estimated. In addition to the non-accrual loans in the table above, $3.4 million of real estate loans secured by residential properties and classified as held for sale were in non-accrual status at both June 30, 2019 and December 31, 2018.

Interest income, including recoveries and cash payments, recorded on impaired loans was $0.3 million and $0.2 million during the three months ended June 30, 2019 and 2018, respectively, and $0.7 million and $0.4 million during the six months ended June 30, 2019 and 2018, respectively. Except as noted above, PCI loans are considered to be performing due to the application of the accretion method.

The Bank classifies loan modifications as TDRs when it concludes that it has both granted a concession to a debtor and that the debtor is experiencing financial difficulties. Loan modifications are typically structured to create affordable payments for the debtor and can be achieved in a variety of ways. The Bank modifies loans by reducing interest rates and/or lengthening loan amortization schedules. The Bank may also reconfigure a single loan into two or more loans (“A/B Note”). The typical A/B Note restructure results in a “bad” loan which is charged off and a “good” loan or loans, the terms of which comply with the Bank’s customary underwriting policies. The debt charged off on the “bad” loan is not forgiven to the debtor.

Information regarding TDRs granted during the three and six months ended June 30, 2019, is shown in the following table (dollars in thousands). There were no TDRs granted during the three or six months ended June 30, 2018. At June 30, 2019 and December 31, 2018, the Bank had nominal unadvanced commitments to borrowers whose loans have been restructured in TDRs.

	Three Months Ended June 30, 2019					Six Months Ended June 30, 2019
	Number of	Balance at		Balance at		Number of	Balance at		Balance at
	Loans	Extension		End of Period		Loans	Extension		End of Period
Commercial real estate:
Non-owner occupied	—	$	—	$	—	—	$	—	$	—
Owner occupied	—		—		—	—		—		—
Commercial and industrial	3		7,993		7,973	3		7,973		7,973
Construction and land development	—		—		—	—		—		—
1-4 family residential	—		—		—	—		—		—
Mortgage warehouse	—		—		—	—		—		—
Consumer	—		—		—	—		—		—
Broker-dealer	—		—		—	—		—		—
Covered	—		—		—	—		—		—
	3	$	7,993	$	7,973	3	$	7,973	$	7,973

26

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

There were no TDRs granted during the twelve months preceding June 30, 2019 for which a payment was at least 30 days past due. The following table presents information regarding TDRs granted during the twelve months preceding June 30, 2018, for which a payment was at least 30 days past due (dollars in thousands).

	Twelve Months Preceding June 30, 2018
	Number of	Balance at		Balance at
	Loans	Extension		End of Period
Commercial real estate:
Non-owner occupied	—	$	—	$	—
Owner occupied	1		3,294		3,206
Commercial and industrial	—		—		—
Construction and land development	—		—		—
1-4 family residential	—		—		—
Mortgage warehouse	—		—		—
Consumer	—		—		—
Broker-dealer	—		—		—
Covered	—		—		—
	1	$	3,294	$	3,206

An analysis of the aging of the Company’s loan portfolio is shown in the following tables (in thousands).

															Accruing Loans (Non-PCI)
	Loans Past Due		Loans Past Due		Loans Past Due		Total		Current		PCI		Total		Past Due
June 30, 2019	30-59 Days		60-89 Days		90 Days or More		Past Due Loans		Loans		Loans		Loans		90 Days or More
Commercial real estate:
Non-owner occupied	$	811	$	130	$	199	$	1,140	$	1,653,557	$	12,748	$	1,667,445	$	—
Owner occupied		1,526		—		2,527		4,053		1,253,144		12,601		1,269,798		—
Commercial and industrial		3,604		5,257		1,055		9,916		1,432,397		5,908		1,448,221		10
Construction and land development		2,719		839		—		3,558		947,003		67		950,628		—
1-4 family residential		4,444		1,257		2,856		8,557		633,106		54,872		696,535		—
Mortgage warehouse		—		39		—		39		555,288		—		555,327		—
Consumer		188		—		—		188		44,081		4		44,273		—
Broker-dealer		—		—		—		—		570,377		—		570,377		—
	$	13,292	$	7,522	$	6,637	$	27,451	$	7,088,953	$	86,200	$	7,202,604	$	10

															Accruing Loans (Non-PCI)
	Loans Past Due		Loans Past Due		Loans Past Due		Total		Current		PCI		Total		Past Due
December 31, 2018	30-59 Days		60-89 Days		90 Days or More		Past Due Loans		Loans		Loans		Loans		90 Days or More
Commercial real estate:
Non-owner occupied	$	1,174	$	199	$	—	$	1,373	$	1,708,160	$	13,089	$	1,722,622	$	—
Owner occupied		1,364		—		4,173		5,537		1,197,337		14,624		1,217,498		75
Commercial and industrial		1,792		1,049		11,051		13,892		1,488,000		6,559		1,508,451		3
Construction and land development		3,549		—		—		3,549		928,896		464		932,909		—
1-4 family residential		5,987		2,484		1,950		10,421		610,515		58,327		679,263		—
Mortgage warehouse		—		—		—		0		243,806		—		243,806		—
Consumer		254		147		—		401		47,136		9		47,546		—
Broker-dealer		—		—		—		—		578,363		—		578,363		—
	$	14,120	$	3,879	$	17,174	$	35,173	$	6,802,213	$	93,072	$	6,930,458	$	78

In addition to the loans shown in the tables above, PrimeLending had $77.4 million and $83.1 million of loans included in loans held for sale (with an aggregate unpaid principal balance of $78.5 million and $84.0 million, respectively) that were 90 days past due and accruing interest at June 30, 2019 and December 31, 2018, respectively. These loans are guaranteed by U.S. government agencies and include loans that are subject to repurchase, or have been repurchased, by PrimeLending.

Management tracks credit quality trends on a quarterly basis related to: (i) past due levels, (ii) non-performing asset levels, (iii) classified loan levels, (iv) net charge-offs, and (v) general economic conditions in state and local markets.

27

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

The Company utilizes a risk grading matrix to assign a risk grade to each of the loans in its portfolio with the exception of broker-dealer margin loans. A risk rating is assigned based on an assessment of the borrower’s management, collateral position, financial capacity, and economic factors. The general characteristics of the various risk grades are described below.

Pass – “Pass” loans present a range of acceptable risks to the Company. Loans that would be considered virtually risk-free are rated Pass – low risk. Loans that exhibit sound standards based on the grading factors above and present a reasonable risk to the Company are rated Pass – normal risk. Loans that exhibit a minor weakness in one or more of the grading criteria but still present an acceptable risk to the Company are rated Pass – high risk.

Special Mention – “Special Mention” loans have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in a deterioration of the repayment prospects for the loans and weaken the Company’s credit position at some future date. Special Mention loans are not adversely classified and do not expose the Company to sufficient risk to require adverse classification.

Substandard – “Substandard” loans are inadequately protected by the current sound worth and paying capacity of the obligor or the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Many substandard loans are considered impaired.

PCI – “PCI” loans exhibited evidence of credit deterioration at acquisition that made it probable that all contractually required principal payments would not be collected.

The following tables present the internal risk grades of loans, as previously described, in the portfolio by class (in thousands).

June 30, 2019	Pass		Special Mention		Substandard		PCI		Total
Commercial real estate:
Non-owner occupied	$	1,599,634	$	5,935	$	49,128	$	12,748	$	1,667,445
Owner occupied		1,222,925		—		34,272		12,601		1,269,798
Commercial and industrial		1,383,938		447		57,928		5,908		1,448,221
Construction and land development		948,148		—		2,413		67		950,628
1-4 family residential		623,710		371		17,582		54,872		696,535
Mortgage warehouse		555,327		—		—		—		555,327
Consumer		44,188		—		81		4		44,273
Broker-dealer		570,377		—		—		—		570,377
	$	6,948,247	$	6,753	$	161,404	$	86,200	$	7,202,604

December 31, 2018	Pass		Special Mention		Substandard		PCI		Total
Commercial real estate:
Non-owner occupied	$	1,673,424	$	—	$	36,109	$	13,089	$	1,722,622
Owner occupied		1,175,225		2,083		25,566		14,624		1,217,498
Commercial and industrial		1,433,227		15,320		53,345		6,559		1,508,451
Construction and land development		929,130		—		3,315		464		932,909
1-4 family residential		601,264		393		19,279		58,327		679,263
Mortgage warehouse		243,806		—		—		—		243,806
Consumer		47,416		—		121		9		47,546
Broker-dealer		578,363		—		—		—		578,363
	$	6,681,855	$	17,796	$	137,735	$	93,072	$	6,930,458

28

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

Allowance for Loan Losses

The allowance for loan losses is subject to regulatory examinations and determinations as to adequacy, which may take into account such factors as the methodology used to calculate the allowance and the size of the allowance. The Company’s analysis of the level of the allowance for loan losses to ensure that it is appropriate for the estimated credit losses in the portfolio consistent with the Interagency Policy Statement on the Allowance for Loan and Lease Losses and the Receivables and Contingencies Topics of the ASC is described in detail in Note 5 to the consolidated financial statements included in the Company’s 2018 Form 10-K.

Changes in the allowance for loan losses, distributed by portfolio segment, are shown below (in thousands).

	Balance,		Provision (Recovery)		Loans		Recoveries on		Balance,
Three Months Ended June 30, 2019	Beginning of Period		for Loan Losses		Charged Off		Charged Off Loans		End of Period
Commercial real estate	$	26,845	$	(1,731)	$	—	$	—	$	25,114
Commercial and industrial		21,268		1,254		(2,430)		322		20,414
Construction and land development		5,908		(1,512)		—		—		4,396
1-4 family residential		4,331		1,447		(871)		17		4,924
Mortgage warehouse		—		—		—		—		—
Consumer		409		(128)		(10)		12		283
Broker-dealer		48		(2)		—		—		46
Total	$	58,809	$	(672)	$	(3,311)	$	351	$	55,177

	Balance,		Provision (Recovery)		Loans		Recoveries on		Balance,
Six Months Ended June 30, 2019	Beginning of Period		for Loan Losses		Charged Off		Charged Off loans		End of Period
Commercial real estate	$	27,100	$	(1,986)	$	—	$	—	$	25,114
Commercial and industrial		21,980		1,712		(4,248)		970		20,414
Construction and land development		6,061		(1,665)		—		—		4,396
1-4 family residential		3,956		1,836		(899)		31		4,924
Mortgage warehouse		—		—		—		—		—
Consumer		267		458		(464)		22		283
Broker-dealer		122		(76)		—		—		46
Total	$	59,486	$	279	$	(5,611)	$	1,023	$	55,177

	Balance,		Provision (Recovery)		Loans		Recoveries on		Balance,
Three Months Ended June 30, 2018	Beginning of Period		for Loan Losses		Charged Off		Charged Off Loans		End of Period
Commercial real estate	$	27,193	$	(1,143)	$	(18)	$	—	$	26,032
Commercial and industrial		23,269		1,815		(2,233)		666		23,517
Construction and land development		7,449		(178)		—		—		7,271
1-4 family residential		2,107		376		(6)		75		2,552
Mortgage warehouse		—		—		—		—		—
Consumer		276		(75)		(30)		36		207
Broker-dealer		77		340		—		—		417
Covered		2,823		(795)		(57)		3		1,974
Total	$	63,194	$	340	$	(2,344)	$	780	$	61,970

	Balance,		Provision (Recovery)		Loans		Recoveries on		Balance,
Six Months Ended June 30, 2018	Beginning of Period		for Loan Losses		Charged Off		Charged Off Loans		End of Period
Commercial real estate	$	26,413	$	(363)	$	(18)	$	—	$	26,032
Commercial and industrial		23,674		119		(3,416)		3,140		23,517
Construction and land development		7,844		(573)		—		—		7,271
1-4 family residential		2,362		99		(12)		103		2,552
Mortgage warehouse		—		—		—		—		—
Consumer		311		(109)		(43)		48		207
Broker-dealer		353		64		—		—		417
Covered		2,729		(704)		(57)		6		1,974
Total	$	63,686	$	(1,467)	$	(3,546)	$	3,297	$	61,970

29

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

The loan portfolio was distributed by portfolio segment and impairment methodology as shown below (in thousands).

	Loans Individually		Loans Collectively
	Evaluated for		Evaluated for		PCI
June 30, 2019	Impairment		Impairment		Loans			Total
Commercial real estate	$	3,559	$	2,908,335	$	25,349	$	2,937,243
Commercial and industrial		11,362		1,430,951		5,908		1,448,221
Construction and land development		1,317		949,244		67		950,628
1-4 family residential		608		641,055		54,872		696,535
Mortgage warehouse		—		555,327		—		555,327
Consumer		—		44,269		4		44,273
Broker-dealer		—		570,377		—		570,377
Total	$	16,846	$	7,099,558	$	86,200	$	7,202,604

	Loans Individually		Loans Collectively
	Evaluated for		Evaluated for		PCI
December 31, 2018	Impairment		Impairment		Loans			Total
Commercial real estate	$	3,909	$	2,908,498	$	27,713	$	2,940,120
Commercial and industrial		10,741		1,491,151		6,559		1,508,451
Construction and land development		3,241		929,204		464		932,909
1-4 family residential		—		620,936		58,327		679,263
Mortgage warehouse		—		243,806		—		243,806
Consumer		—		47,537		9		47,546
Broker-dealer		—		578,363		—		578,363
Total	$	17,891	$	6,819,495	$	93,072	$	6,930,458

The allowance for loan losses was distributed by portfolio segment and impairment methodology as shown below (in thousands).

	Loans Individually		Loans Collectively
	Evaluated for		Evaluated for		PCI
June 30, 2019	Impairment		Impairment		Loans			Total
Commercial real estate	$	—	$	23,144	$	1,970	$	25,114
Commercial and industrial		838		19,547		29		20,414
Construction and land development		12		4,381		3		4,396
1-4 family residential		—		2,937		1,987		4,924
Mortgage warehouse		—		—		—		—
Consumer		—		283		—		283
Broker-dealer		—		46		—		46
Total	$	850	$	50,338	$	3,989	$	55,177

	Loans Individually		Loans Collectively
	Evaluated for		Evaluated for		PCI
December 31, 2018	Impairment		Impairment		Loans			Total
Commercial real estate	$	—	$	25,671	$	1,429	$	27,100
Commercial and industrial		721		21,187		72		21,980
Construction and land development		31		5,938		92		6,061
1-4 family residential		—		2,657		1,299		3,956
Mortgage warehouse		—		—		—		—
Consumer		—		267		—		267
Broker-dealer		—		122		—		122
Total	$	752	$	55,842	$	2,892	$	59,486

30

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

7. Mortgage Servicing Rights

The following tables present the changes in fair value of the Company’s MSR asset, as included in other assets within the consolidated balance sheets, and other information related to the serviced portfolio (dollars in thousands).

	Three Months Ended June 30,						Six Months Ended June 30,
	2019			2018			2019		2018
Balance, beginning of period	$	62,049		$	63,957		$	66,102	$	54,714
Additions		2,547			3,068			4,408		9,729
Sales		—			(9,303)			—		(9,303)
Changes in fair value:
Due to changes in model inputs or assumptions (1)		(8,739)			1,032			(13,772)		4,673
Due to customer payoffs		(2,162)			(1,381)			(3,043)		(2,440)
Balance, end of period	$	53,695		$	57,373		$	53,695	$	57,373
	June 30,			December 31,				���
	2019			2018
Mortgage loans serviced for others	$	5,027,953		$	5,086,461
MSR asset as a percentage of serviced mortgage loans		1.07	%		1.30	%

(1) Primarily represents normal customer payments, changes in discount rates and prepayment speed assumptions, which are primarily affected by changes in interest rates and the refinement of other MSR model assumptions.

The key assumptions used in measuring the fair value of the Company’s MSR asset were as follows.

	June 30,		December 31,
	2019		2018
Weighted average constant prepayment rate	13.67	%	10.51	%
Weighted average discount rate	11.12	%	11.11	%
Weighted average life (in years)	5.8		7.1

A sensitivity analysis of the fair value of the Company’s MSR asset to certain key assumptions is presented in the following table (in thousands).

	June 30,		December 31,
	2019		2018
Constant prepayment rate:
Impact of 10% adverse change	$	(3,097)	$	(2,512)
Impact of 20% adverse change		(5,977)		(4,980)
Discount rate:
Impact of 10% adverse change		(1,988)		(2,677)
Impact of 20% adverse change		(3,826)		(5,139)

This sensitivity analysis presents the effect of hypothetical changes in key assumptions on the fair value of the MSR asset. The effect of such hypothetical change in assumptions generally cannot be extrapolated because the relationship of the change in one key assumption to the change in the fair value of the MSR asset is not linear. In addition, in the analysis, the impact of an adverse change in one key assumption is calculated independent of any impact on other assumptions. In reality, changes in one assumption may change another assumption.

Contractually specified servicing fees, late fees and ancillary fees earned of $6.6 million and $6.1 million during the three months ended June 30, 2019 and 2018, respectively, and $12.9 million and $11.8 million during the six months ended June 30, 2019 and 2018, respectively, were included in net gains from sale of loans and other mortgage production income within the consolidated statements of operations.

31

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

8. Deposits

Deposits are summarized as follows (in thousands).

	June 30,		December 31,
	2019		2018
Noninterest-bearing demand	$	2,598,253	$	2,560,750
Interest-bearing:
NOW accounts		1,495,785		1,358,196
Money market		2,428,191		2,725,541
Brokered - money market		5,000		5,000
Demand		325,105		393,685
Savings		180,747		184,700
Time		1,429,998		1,308,284
	$	8,463,079	$	8,536,156

9. Short-term Borrowings

Short-term borrowings are summarized as follows (in thousands).

	June 30,		December 31,
	2019		2018
Federal funds purchased	$	124,050	$	100,100
Securities sold under agreements to repurchase		508,843		576,707
Federal Home Loan Bank		475,000		200,000
Short-term bank loans		231,000		189,000
	$	1,338,893	$	1,065,807

Federal funds purchased and securities sold under agreements to repurchase generally mature daily, on demand, or on some other short-term basis. The Bank and the Hilltop Broker-Dealers execute transactions to sell securities under agreements to repurchase with both customers and other broker-dealers. Securities involved in these transactions are held by the Bank, the Hilltop Broker-Dealers or a third-party dealer.

Information concerning federal funds purchased and securities sold under agreements to repurchase is shown in the following tables (dollars in thousands).

	Six Months Ended June 30,
	2019			2018
Average balance during the period	$	621,268		$	721,167
Average interest rate during the period		2.54	%		1.63	%
	June 30,			December 31,
	2019			2018
Average interest rate at end of period		2.57	%		2.43	%
Securities underlying the agreements at end of period:
Carrying value	$	516,067		$	587,609
Estimated fair value	$	554,160		$	618,231

32

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

Federal Home Loan Bank (“FHLB”) short-term borrowings mature over terms not exceeding 365 days and are collateralized by FHLB Dallas stock, nonspecified real estate loans and certain specific commercial real estate loans. Other information regarding FHLB short-term borrowings is shown in the following tables (dollars in thousands).

	Six Months Ended June 30,
	2019			2018
Average balance during the period	$	159,945		$	117,956
Average interest rate during the period		2.47	%		1.91	%
		June 30,			December 31,
		2019			2018
Average interest rate at end of period		2.32	%		2.65	%

The Hilltop Broker-Dealers use short-term bank loans periodically to finance securities owned, margin loans to customers and correspondents and underwriting activities. Interest on the borrowings varies with the federal funds rate. The weighted average interest rate on the borrowings at June 30, 2019 and December 31, 2018 was 3.28% and 3.35%, respectively.

10. Notes Payable

Notes payable consisted of the following (in thousands).

	June 30,		December 31,
	2019		2018
Senior Notes due April 2025, net of discount of $1,313 and $1,393, respectively	$	148,687	$	148,607
FHLB notes, including premium of $179 and $222, respectively, with maturities ranging from September 2020 to June 2030		4,037		4,391
NLIC note payable due May 2033		10,000		10,000
NLIC note payable due September 2033		10,000		10,000
ASIC note payable due April 2034		7,500		7,500
Ventures Management lines of credit due May 2020		51,699		48,374
	$	231,923	$	228,872

11. Leases

Hilltop and its subsidiaries lease space, primarily for corporate offices, branch facilities and automated teller machines, under both operating and finance leases. Certain of the Company’s leases have options to extend, with the longest extension option being ten years, and some of the Company’s leases include options to terminate within one year. The Company’s leases contain customary restrictions and covenants. The Company has certain intercompany leases and subleases between its subsidiaries, and these transactions and balances have been eliminated in consolidation and are not reflected in the tables and information presented below.

Supplemental balance sheet information related to finance leases is as follows (in thousands).

	June 30,
	2019
Finance leases:
Premises and equipment	$	7,780
Accumulated depreciation		(3,883)
Premises and equipment, net	$	3,897

33

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

Operating lease rental cost and finance lease amortization of ROU assets is included within occupancy and equipment, net in the consolidated statements of operations. Finance lease interest expense is included within other interest expense in the consolidated statements of operations. The Company does not generally enter into leases which contain variable payments, other than due to the passage of time. The components of lease costs, including short-term lease costs, are as follows (in thousands).

	Three Months Ended		Six Months Ended
	June 30, 2019		June 30, 2019
Operating lease cost	$	10,599	$	21,130
Less operating lease and sublease income		(663)		(1,050)
Net operating lease cost	$	9,936	$	20,080
Finance lease cost:
Amortization of lease assets	$	147	$	295
Interest on lease liabilities		150		302
Total finance lease cost	$	297	$	597

Supplemental cash flow information related to leases is as follows (in thousands):

	Six Months Ended
	June 30, 2019
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases	$	19,810
Operating cash flows from finance leases		302
Financing cash flows from finance leases		290
Right-of-use assets obtained in exchange for new lease obligations:
Operating leases	$	24,188
Finance leases		—

Information regarding the lease terms and discount rates of the Company’s leases is as follows.

	June 30, 2019
	Weighted Average	Weighted Average
Lease Classification	Remaining Lease Term (Years)	Discount Rate
Operating	5.9	5.35	%
Finance	7.0	4.78	%

Future minimum lease payments under the Leasing Standard as of June 30, 2019, under lease agreements that had commenced as of or subsequent to January 1, 2019, are presented below (in thousands).

	Operating Leases		Finance Leases
2019	$	18,039	$	595
2020		32,798		1,197
2021		27,089		1,212
2022		21,209		1,241
2023		17,077		1,280
Thereafter		41,660		3,460
Total minimum lease payments	$	157,872	$	8,985
Less amount representing interest		(25,122)		(3,189)
Lease liabilities	$	132,750	$	5,796

As of June 30, 2019, the Company had additional operating leases that have not yet commenced with aggregate future minimum lease payments of approximately $0.6 million. These operating leases are expected to commence between July 2019 and September 2019 with lease terms ranging from two to five years.

34

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

A related party is the lessor in an operating lease with the Bank. The Bank’s minimum payment under the lease is $0.5 million annually through 2028, for an aggregate remaining obligation of $4.6 million at June 30, 2019.

The Company adopted the Leasing Standard on January 1, 2019, using the modified retrospective transition under the option to apply the new standard at its effective date without adjusting the prior period comparative financial statements. As such, disclosures for comparative periods under the predecessor standard, ASC 840, Leases, are required in the year of transition. Future minimum lease payments under ASC 840 as of December 31, 2018, under lease agreements that had commenced as of December 31, 2018, are presented below (in thousands).

	Operating Leases		Capital Leases
2019	$	36,171	$	1,186
2020		29,109		1,197
2021		21,058		1,212
2022		16,386		1,241
2023		12,361		1,280
Thereafter		18,264		3,460
Total minimum lease payments	$	133,349		9,576
Amount representing interest				(1,221)
Present value of minimum lease payments			$	8,355

12. Income Taxes

The Company applies an estimated annual effective rate to interim period pre-tax income to calculate the income tax provision for the quarter in accordance with the principal method prescribed by the accounting guidance established for computing income taxes in interim periods. The Company’s effective tax rates were 23.1% and 24.3% for the three months ended June 30, 2019 and 2018, respectively, and 22.9% and 23.9% for the six months ended June 30, 2019 and 2018, respectively, and approximated the applicable statutory rates for such periods.

13. Commitments and Contingencies

Legal Matters

The Company is subject to loss contingencies related to litigation, claims, investigations and legal and administrative cases and proceedings arising in the ordinary course of business. The Company evaluates these contingencies based on information currently available, including advice of counsel. The Company establishes accruals for those matters when a loss contingency is considered probable and the related amount is reasonably estimable. Any accruals are periodically reviewed and may be adjusted as circumstances change. A portion of the Company’s exposure with respect to loss contingencies may be offset by applicable insurance coverage. In determining the amounts of any accruals or estimates of possible loss contingencies, the Company does not take into account the availability of insurance coverage, other than that provided by reinsurers in the insurance segment. When it is practicable, the Company estimates loss contingencies for possible litigation and claims, whether or not there is an accrued probable loss. When the Company is able to estimate such probable losses, and when it estimates that it is reasonably possible it could incur losses in excess of amounts accrued, the Company is required to make a disclosure of the aggregate estimation. As available information changes, however, the matters for which the Company is able to estimate, as well as the estimates themselves, will be adjusted accordingly.

Assessments of litigation and claims exposures are difficult due to many factors that involve inherent unpredictability. Those factors include the following: the varying stages of the proceedings, particularly in the early stages; unspecified, unsupported, or uncertain damages; damages other than compensatory, such as punitive damages; a matter presenting meaningful legal uncertainties, including novel issues of law; multiple defendants and jurisdictions; whether discovery has begun or is complete; whether meaningful settlement discussions have commenced; and whether the claim involves a class action and if so, how the class is defined. As a result of some of these factors, the Company may be unable to

35

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

estimate reasonably possible losses with respect to some or all of the pending and threatened litigation and claims asserted against the Company.

While the final outcome of litigation and claims exposures is inherently unpredictable, management is currently of the opinion that the outcome of pending and threatened litigation will not have a material effect on the Company’s business, consolidated financial position, results of operations or cash flows as a whole. However, in the event of unexpected future developments, it is reasonably possible that an adverse outcome in any matter could be material to the Company’s business, consolidated financial position, results of operations or cash flows for any particular reporting period of occurrence.

Indemnification Liability Reserve

The mortgage origination segment may be responsible to agencies, investors, or other parties for errors or omissions relating to its representations and warranties that each loan sold meets certain requirements, including representations as to underwriting standards and the validity of certain borrower representations in connection with the loan. If determined to be at fault, the mortgage origination segment either repurchases the affected loan from or indemnifies the claimant against loss. The mortgage origination segment has established an indemnification liability reserve for such probable losses.

Generally, the mortgage origination segment first becomes aware that an agency, investor, or other party believes a loss has been incurred on a sold loan when it receives a written request from the claimant to repurchase the loan or reimburse the claimant’s losses. Upon completing its review of the claimant’s request, the mortgage origination segment establishes a specific claims reserve for the loan if it concludes its obligation to the claimant is both probable and reasonably estimable.

An additional reserve has been established for probable agency, investor or other party losses that may have been incurred, but not yet reported to the mortgage origination segment based upon a reasonable estimate of such losses. Factors considered in the calculation of this reserve include, but are not limited to, the total volume of loans sold exclusive of specific claimant requests, actual claim settlements and the severity of estimated losses resulting from future claims, and the mortgage origination segment’s history of successfully curing defects identified in claim requests. While the mortgage origination segment’s sales contracts typically include borrower early payment default repurchase provisions, these provisions have not been a primary driver of claims to date, and therefore, are not a primary factor considered in the calculation of this reserve.

At both June 30, 2019 and December 31, 2018, the mortgage origination segment’s indemnification liability reserve totaled $10.8 million and $10.7 million, respectively. The provision for indemnification losses was $0.8 million and $1.0 million during the three months ended June 30, 2019 and 2018, respectively, and $1.3 million and $1.7 million during the six months ended June 30, 2019 and 2018, respectively.

The following tables provide for a rollforward of claims activity for loans put-back to the mortgage origination segment based upon an alleged breach of a representation or warranty with respect to a loan sold and related indemnification liability reserve activity (in thousands).

	Representation and Warranty Specific Claims
	Activity - Origination Loan Balance
	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
Balance, beginning of period	$	30,112	$	32,321	$	33,784	$	33,702
Claims made		6,504		5,361		9,686		12,350
Claims resolved with no payment		(1,579)		(5,892)		(7,266)		(11,753)
Repurchases		(1,478)		(1,245)		(2,645)		(3,334)
Indemnification payments		(485)		—		(485)		(420)
Balance, end of period	$	33,074	$	30,545	$	33,074	$	30,545

36

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

	Indemnification Liability Reserve Activity (1)
	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
Balance, beginning of period	$	10,721	$	23,332	$	10,701	$	23,472
Additions for new sales		792		1,014		1,281		1,743
Repurchases		(127)		(85)		(209)		(245)
Early payment defaults		(97)		(41)		(239)		(188)
Indemnification payments		(92)		(4)		(95)		(121)
Change in reserves for loans sold in prior years		(364)		(306)		(606)		(751)
Balance, end of period	$	10,833	$	23,910	$	10,833	$	23,910
	June 30,		December 31,
	2019		2018
Reserve for Indemnification Liability:
Specific claims	$	732	$	676
Incurred but not reported claims		10,101		10,025
Total	$	10,833	$	10,701

(1) The Reserve for Indemnification Liability at June 30, 2018 reflected $10.2 million of specific claims related to an inquiry by the U.S. Department of Housing and Urban Development (“HUD”) and the U.S. Department of Justice which was resolved in the fourth quarter of 2018. The resolution of this matter is discussed in detail in Note 18 to the consolidated financial statements included in the Company’s 2018 Form 10-K.

Although management considers the total indemnification liability reserve to be appropriate, there may be changes in the reserve over time to address incurred losses due to unanticipated adverse changes in the economy and historical loss patterns, discrete events adversely affecting specific borrowers or industries, and/or actions taken by institutions or investors. The impact of such matters is considered in the reserving process when probable and estimable.

Hilltop Plaza Investment

On July 31, 2018, Hillcrest Land LLC purchased approximately 1.7 acres of land in the City of University Park, Texas for $38.5 million. Hillcrest Land LLC is owned equally between Hilltop Investments I, LLC, a wholly owned entity of Hilltop, and Diamond Ground, LLC, an affiliate of Mr. Gerald J. Ford, Chairman of the Board of Directors. Each of Hilltop Investments I, LLC and Diamond Ground, LLC contributed $19.3 million to Hillcrest Land LLC to complete the purchase. As the voting rights of Hillcrest Land LLC are shared equally between the Company and Diamond Ground, LLC, there is no primary beneficiary, and Diamond Ground, LLC’s interest in Hillcrest Land LLC has been reflected as a noncontrolling interest in the Company’s consolidated financial statements. Therefore, the Company has consolidated Hillcrest Land LLC under the VIE model according to the “most-closely associated” test. The purchased land is included within premises and equipment, net in the consolidated balance sheets. Any income (loss) associated with Hillcrest Land LLC is included within other noninterest income in the consolidated statements of operations. Trusts for which Jeremy Ford, President and Chief Executive Officer, and the wife of Corey Prestidge, Executive Vice President, General Counsel and Secretary, are a beneficiary own 10.2% and 10.1%, respectively, of Diamond Ground, LLC.

In connection with the purchase of the land, Hillcrest Land LLC entered into a 99-year ground lease of the land with three tenants-in-common: SPC Park Plaza Partners LLC (“Park Plaza LLC”), an unaffiliated entity which received an undivided 50% leasehold interest; HTH Project LLC, a wholly owned subsidiary of Hilltop, which received an undivided 25% leasehold interest; and Diamond Hillcrest, LLC (“Diamond Hillcrest”), an entity owned by Mr. Gerald J. Ford, which received an undivided 25% leasehold interest (collectively, the “Co-Owners”). The ground lease is triple net. The base rent from the Co-Owners under the ground lease commences 18 months after the ground lease was signed at $1.8 million per year and increases 1.0% per year each January 1 thereafter. The ground lease was classified as an operating lease, and the accounting commencement date was determined to be July 31, 2018, the date the land was available to the Co-Owners.

Concurrent with the ground lease, the Co-Owners entered into an agreement to purchase the improvements currently being constructed on the land, which is a mixed-use project containing a six-story building (“Hilltop Plaza”). HTH

37

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

Project LLC and Diamond Hillcrest each own an undivided 25% interest in Hilltop Plaza. Park Plaza LLC owns the remaining undivided 50% interest in Hilltop Plaza. Park Plaza LLC has agreed to serve as the Co-Owner property manager under the Co-Owners Agreement; however, certain actions require unanimous approval of all Co-Owners. Funding for Hilltop Plaza includes a $41.0 million construction loan from an unaffiliated third party bank, as well as cash contributions of $5.3 million from each of HTH Project LLC and Diamond Hillcrest. HTH Project LLC’s undivided interest in Hilltop Plaza is accounted for as an equity method investment as the tenants-in-common have joint control over decisions regarding Hilltop Plaza. The investment is included within other assets in the consolidated balance sheets and any income (loss) is included within other noninterest income in the consolidated statements of operations.

Hilltop and the Bank entered into leases for an aggregate of approximately 72,000 of the total 119,000 square feet of rentable space in Hilltop Plaza to serve as the headquarters for both companies. Affiliates of Mr. Gerald J. Ford also entered into leases for approximately 11,000 square feet of office space in the building. The two separate 129-month office and retail leases have combined total base rent of approximately $35 million with the first nine months of rent abated. The accounting commencement date of both leases was determined to be June 29, 2019, the date the building was delivered in order for tenant improvement work to commence. The combined operating lease liability, net of lease incentives, recognized during the second quarter of 2019 as a result of the commencement of these leases was $18.9 million. The office and retail leases were considered under the build-to-suit provisions of ASC 840, and the Company was determined to be the accounting owner of the project as its affiliate, HTH Project LLC, has an equity investment in the project. As such, the assets of Hilltop Plaza were recognized during the construction period through December 31, 2018, as costs were incurred to construct the asset, with a corresponding liability representing the costs paid for by the lessor (the Co-Owners). At December 31, 2018, the $27.8 million of costs incurred to date were included within premises and equipment and other liabilities, respectively, in the consolidated balance sheets. The Company reassessed its accounting ownership of the Hilltop Plaza assets under construction as of January 1, 2019, under the build-to-suit provisions of the newly adopted Leasing Standard and concluded it is not the accounting owner. As such, the assets and liabilities of the project were derecognized on January 1, 2019, with the $1.4 million offset representing deferred expenses recognized on the project to date through December 31, 2018, recorded as an increase to retained earnings.

All intercompany transactions associated with the Hilltop Plaza investment and the related transactions discussed above are eliminated in consolidation.

14. Financial Instruments with Off-Balance Sheet Risk

The Bank is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit that involve varying degrees of credit and interest rate risk in excess of the amount recognized in the consolidated financial statements. Such financial instruments are recorded in the consolidated financial statements when they are funded or related fees are incurred or received. The contract amounts of those instruments reflect the extent of involvement (and therefore the exposure to credit loss) the Bank has in particular classes of financial instruments.

Commitments to extend credit are agreements to lend to a customer provided that the terms established in the contract are met. Commitments generally have fixed expiration dates and may require payment of fees. Because some commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. These letters of credit are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan commitments to customers.

In the aggregate, the Bank had outstanding unused commitments to extend credit of $2.3 billion at June 30, 2019 and outstanding financial and performance standby letters of credit of $92.4 million at June 30, 2019.

The Bank uses the same credit policies in making commitments and standby letters of credit as it does for on-balance sheet instruments. The amount of collateral obtained, if deemed necessary, in these transactions is based on management’s credit evaluation of the borrower. Collateral held varies but may include real estate, accounts receivable, marketable securities, interest-bearing deposit accounts, inventory, and property, plant and equipment.

38

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

In the normal course of business, the Hilltop Broker-Dealers execute, settle, and finance various securities transactions that may expose the Hilltop Broker-Dealers to off-balance sheet risk in the event that a customer or counterparty does not fulfill its contractual obligations. Examples of such transactions include the sale of securities not yet purchased by customers or for the accounts of the Hilltop Broker-Dealers, use of derivatives to support certain non-profit housing organization clients and to hedge changes in the fair value of certain securities, clearing agreements between the Hilltop Broker-Dealers and various clearinghouses and broker-dealers, secured financing arrangements that involve pledged securities, and when-issued underwriting and purchase commitments.

15. Stock-Based Compensation

Pursuant to the Hilltop Holdings Inc. 2012 Equity Incentive Plan (the “2012 Plan”), the Company may grant nonqualified stock options, stock appreciation rights, restricted stock, restricted stock units (“RSUs”), performance awards, dividend equivalent rights and other awards to employees of the Company, its subsidiaries and outside directors of the Company. In the aggregate, 4,000,000 shares of common stock may be delivered pursuant to awards granted under the 2012 Plan. At June 30, 2019, 680,623 shares of common stock remained available for issuance pursuant to awards granted under the 2012 Plan, excluding shares that may be delivered pursuant to outstanding awards. Compensation expense related to the 2012 Plan was $2.5 million during both the three months ended June 30, 2019 and 2018, and $5.0 million and $4.8 million during the six months ended June 30, 2019 and 2018, respectively.

During the six months ended June 30, 2019 and 2018, Hilltop granted 14,895 and 10,024 shares of common stock, respectively, pursuant to the 2012 Plan to certain non-employee members of the Company’s board of directors for services rendered to the Company.

Restricted Stock Units

The following table summarizes information about nonvested RSU activity for the six months ended June 30, 2019 (shares in thousands).

		RSUs
			Weighted
			Average
			Grant Date
		Outstanding	Fair Value
Balance, December 31, 2018		1,270	$	22.44
	Granted	578	$	19.18
	Vested/Released	(456)	$	17.70
	Forfeited	(28)	$	25.78
Balance, June 30, 2019		1,364	$	22.58

Vested/Released RSUs include an aggregate of 90,867 shares withheld to satisfy employee statutory tax obligations during the six months ended June 30, 2019. Pursuant to certain RSU award agreements, an aggregate of 17,692 vested RSUs at June 30, 2019 require deferral of the settlement in shares and statutory tax obligations to a future date.

During the six months ended June 30, 2019, the Compensation Committee of the board of directors of the Company awarded certain executives and key employees an aggregate of 570,361 RSUs pursuant to the 2012 Plan. Of the RSUs granted during the six months ended June 30, 2019, 479,112 that were outstanding at June 30, 2019, are subject to time-based vesting conditions and generally cliff vest on the third anniversary of the grant date. Of the RSUs granted during the six months ended June 30, 2019, 91,249 that were outstanding at June 30, 2019, provide for cliff vesting based upon the achievement of certain performance goals over a three-year period.

At June 30, 2019, in the aggregate, 1,126,126 of the outstanding RSUs are subject to time-based vesting conditions and generally cliff vest on the third anniversary of the grant date, and 238,145 outstanding RSUs cliff vest based upon the achievement of certain performance goals over a three-year period. At June 30, 2019, unrecognized compensation expense related to outstanding RSUs of $17.7 million is expected to be recognized over a weighted average period of 1.87 years.  

39

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

16. Regulatory Matters

Banking and Hilltop

PlainsCapital, which includes the Bank and PrimeLending, and Hilltop are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory — and possibly additional discretionary — actions by regulators that, if undertaken, could have a direct, material effect on the consolidated financial statements. The regulations require PlainsCapital and Hilltop to meet specific capital adequacy guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Company performs reviews of the classification and calculation of risk-weighted assets to ensure accuracy and compliance with the Basel III regulatory capital requirements as implemented by the Board of Governors of the Federal Reserve System. The capital classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the companies to maintain minimum amounts and ratios (set forth in the following table) of Tier 1 capital (as defined in the regulations) to total average assets (as defined), and minimum ratios of common equity Tier 1, Tier 1 and total capital (as defined) to risk-weighted assets (as defined).

In order to avoid limitations on capital distributions, including dividend payments, stock repurchases and certain discretionary bonus payments to executive officers, Basel III requires banking organizations to maintain a capital conservation buffer above minimum risk-based capital requirements measured relative to risk-weighted assets. The phase-in of the capital conservation buffer requirements began on January 1, 2016 for PlainsCapital and Hilltop, and the requirements were fully phased in as of January 1, 2019.

The following tables show PlainsCapital’s and Hilltop’s actual capital amounts and ratios in accordance with Basel III compared to the regulatory minimum capital requirements including conservation buffer in effect at the end of the period and on a fully phased-in basis as if such requirements were currently in effect at December 31, 2018 (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.

					Minimum Capital Requirements
					Including Conservation Buffer
					In Effect at		Fully		To Be Well
	Actual				End of Period		Phased In		Capitalized
	Amount		Ratio		Ratio		Ratio		Ratio
June 30, 2019
Tier 1 capital (to average assets):
PlainsCapital	$	1,235,458	12.53	%	4.0	%	4.0	%	5.0	%
Hilltop		1,747,412	13.00	%	4.0	%	4.0	%	N/A
Common equity Tier 1 capital (to risk-weighted assets):
PlainsCapital		1,235,458	13.84	%	7.0	%	7.0	%	6.5	%
Hilltop		1,700,823	16.32	%	7.0	%	7.0	%	N/A
Tier 1 capital (to risk-weighted assets):
PlainsCapital		1,235,458	13.84	%	8.5	%	8.5	%	8.0	%
Hilltop		1,747,412	16.77	%	8.5	%	8.5	%	N/A
Total capital (to risk-weighted assets):
PlainsCapital		1,292,852	14.48	%	10.5	%	10.5	%	10.0	%
Hilltop		1,786,441	17.14	%	10.5	%	10.5	%	N/A

40

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

					Minimum Capital Requirements
					Including Conservation Buffer
					In Effect at		Fully		To Be Well
	Actual				End of Period		Phased In		Capitalized
	Amount		Ratio		Ratio		Ratio		Ratio
December 31, 2018
Tier 1 capital (to average assets):
PlainsCapital	$	1,183,447	12.47	%	4.0	%	4.0	%	5.0	%
Hilltop		1,680,364	12.53	%	4.0	%	4.0	%	N/A
Common equity Tier 1 capital (to risk-weighted assets):
PlainsCapital		1,183,447	13.90	%	6.375	%	7.0	%	6.5	%
Hilltop		1,634,978	16.58	%	6.375	%	7.0	%	N/A
Tier 1 capital (to risk-weighted assets):
PlainsCapital		1,183,447	13.90	%	7.875	%	8.5	%	8.0	%
Hilltop		1,680,364	17.04	%	7.875	%	8.5	%	N/A
Total capital (to risk-weighted assets):
PlainsCapital		1,245,177	14.63	%	9.875	%	10.5	%	10.0	%
Hilltop		1,722,602	17.47	%	9.875	%	10.5	%	N/A

Broker-Dealer

Pursuant to the net capital requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), Hilltop Securities has elected to determine its net capital requirements using the alternative method. Accordingly, Hilltop Securities is required to maintain minimum net capital, as defined in Rule 15c3-1 promulgated under the Exchange Act, equal to the greater of $250,000 and $1,000,000, respectively, or 2% of aggregate debit balances, as defined in Rule 15c3-3 promulgated under the Exchange Act. Additionally, the net capital rule of the NYSE provides that equity capital may not be withdrawn or cash dividends paid if resulting net capital would be less than 5% of the aggregate debit items. HTS Independent Network follows the primary (aggregate indebtedness) method, as defined in Rule 15c3-1 promulgated under the Exchange Act, which requires the maintenance of the larger of minimum net capital of $250,000 or 1/15 of aggregate indebtedness.

At June 30, 2019, the net capital position of each of the Hilltop Broker-Dealers was as follows (in thousands).

				HTS
	Hilltop			Independent
	Securities			Network
Net capital	$	225,288		$	3,072
Less: required net capital		9,971			250
Excess net capital	$	215,317		$	2,822
Net capital as a percentage of aggregate debit items		45.2	%
Net capital in excess of 5% aggregate debit items	$	200,359

Under certain conditions, Hilltop Securities may be required to segregate cash and securities in a special reserve account for the benefit of customers under Rule 15c3-3 promulgated under the Exchange Act. Assets segregated under the provisions of the Exchange Act are not available for general corporate purposes. At June 30, 2019 and December 31, 2018, the Hilltop Broker-Dealers held cash of $151.3 million and $134.0 million, respectively, segregated in special reserve bank accounts for the benefit of customers. The Hilltop Broker-Dealers were not required to segregate cash and securities in special reserve accounts for the benefit of proprietary accounts of introducing broker-dealers at June 30, 2019 or December 31, 2018.

41

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

Mortgage Origination

As a mortgage originator, PrimeLending and its subsidiaries are subject to minimum net worth and liquidity requirements established by HUD and GNMA, as applicable. On an annual basis, PrimeLending and its subsidiaries submit audited financial statements to HUD and GNMA, as applicable, documenting their respective compliance with minimum net worth and liquidity requirements. As of June 30, 2019, PrimeLending and its subsidiaries’ net worth and liquidity exceeded the amounts required by both HUD and GNMA, as applicable.

Insurance

The statutory financial statements of the Company's insurance subsidiaries, which are domiciled in the State of Texas, are presented on the basis of accounting practices prescribed or permitted by the Texas Department of Insurance. Texas has adopted the statutory accounting practices of the National Association of Insurance Commissioners (“NAIC”) as the basis of its statutory accounting practices with certain differences that are not significant to the insurance company subsidiaries’ statutory equity.

A summary of statutory capital and surplus and statutory net income (loss) of each insurance subsidiary is as follows (in thousands).

	June 30,		December 31,
	2019		2018
Statutory capital and surplus:
National Lloyds Insurance Company	$	58,905	$	78,637
American Summit Insurance Company		19,041		17,908

	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
Statutory net income (loss):
National Lloyds Insurance Company	$	(3,826)	$	(2,633)	$	(409)	$	1,134
American Summit Insurance Company		299		394		716		1,283

Regulations of the Texas Department of Insurance require insurance companies to maintain minimum levels of statutory surplus to ensure their ability to meet their obligations to policyholders. At June 30, 2019, the Company's insurance subsidiaries had statutory surplus in excess of the minimum required.

The NAIC has adopted a risk based capital (“RBC”) formula for insurance companies that establishes minimum capital requirements indicating various levels of available regulatory action on an annual basis relating to insurance risk, asset credit risk, interest rate risk and business risk. The RBC formula is used by the NAIC and certain state insurance regulators as an early warning tool to identify companies that require additional scrutiny or regulatory action. At June 30, 2019, the Company's insurance subsidiaries' RBC ratio exceeded the level at which regulatory action would be required.

17. Stockholders’ Equity

Dividends

During the six months ended June 30, 2019 and 2018, the Company declared and paid cash dividends of $0.16 and $0.14 per common share, or an aggregate of $15.0 million and $13.5 million, respectively.

On July 25, 2019, the Company announced that its board of directors declared a quarterly cash dividend of $0.08 per common share, payable on August 30, 2019, to all common stockholders of record as of the close of business on August 15, 2019.

42

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

Stock Repurchase Program

In January 2019, the Hilltop board of directors authorized a new stock repurchase program through January 2020, pursuant to which the Company is authorized to repurchase, in the aggregate, up to $50.0 million of its outstanding common stock, inclusive of repurchases to offset dilution related to grants of stock-based compensation.

During the six months ended June 30, 2019, the Company paid $25.0 million to repurchase an aggregate of 1,214,843 shares of common stock at an average price of $20.54 per share. These shares were returned to the Company’s pool of authorized but unissued shares of common stock. The purchases were funded from available cash balances. The Company’s stock repurchase program, prior year repurchases and related accounting policy are discussed in detail in Note 1 and Note 22 to the consolidated financial statements included in the Company’s 2018 Form 10-K.

18. Derivative Financial Instruments

The Company uses various derivative financial instruments to mitigate interest rate risk. The Bank’s interest rate risk management strategy involves effectively managing the re-pricing characteristics of certain assets and liabilities to mitigate potential adverse impacts from changes in interest rates on the Bank’s net interest margin. PrimeLending has interest rate risk relative to interest rate lock commitments (“IRLCs”) and its inventory of mortgage loans held for sale. PrimeLending is exposed to such interest rate risk from the time an IRLC is made to an applicant to the time the related mortgage loan is sold. To mitigate interest rate risk, PrimeLending executes forward commitments to sell mortgage-backed securities (“MBSs”) and Eurodollar futures. Additionally, PrimeLending has interest rate risk relative to its MSR asset and uses derivative instruments, including interest rate swaps and U.S. Treasury bond futures and options to hedge this risk. The Hilltop Broker-Dealers use forward commitments to both purchase and sell MBSs to facilitate customer transactions and as a means to hedge related exposure to interest rate risk in certain inventory positions. Additionally, Hilltop Securities uses both U.S. Treasury bond and Eurodollar futures to hedge changes in the fair value of their securities.

Non-Hedging Derivative Instruments and the Fair Value Option

As discussed in Note 4 to the consolidated financial statements, the Company has elected to measure substantially all mortgage loans held for sale at fair value under the provisions of the Fair Value Option. The election provides the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without applying complex hedge accounting provisions. The fair values of PrimeLending’s IRLCs and forward commitments are recorded in other assets or other liabilities, as appropriate, and changes in the fair values of these derivative instruments are recorded as a component of net gains from sale of loans and other mortgage production income. These changes in fair value are attributable to changes in the volume of IRLCs, mortgage loans held for sale, commitments to purchase and sell MBSs and MSR assets, and changes in market interest rates. Changes in market interest rates also conversely affect the value of PrimeLending’s mortgage loans held for sale and its MSR asset, which are measured at fair value under the Fair Value Option. The effect of the change in market interest rates on PrimeLending’s loans held for sale and MSR asset is discussed in Note 4 to the consolidated financial statements. The fair values of the Hilltop Broker-Dealers’ and the Bank’s derivative instruments are recorded in other assets or other liabilities, as appropriate.

Changes in the fair value of derivatives are presented in the following table (in thousands).

	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
Increase (decrease) in fair value of derivatives during period:
PrimeLending	$	(783)	$	(3,141)	$	17,405	$	6,865
Hilltop Broker-Dealers		12,581		2,991		10,774		(2,237)
Bank		(85)		30		(146)		160

43

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

Derivative positions are presented in the following table (in thousands).

	June 30, 2019				December 31, 2018
	Notional		Estimated		Notional		Estimated
	Amount		Fair Value		Amount		Fair Value
Derivative instruments:
IRLCs	$	1,530,535	$	33,584	$	677,267	$	17,421
Customer-based written options		31,200		(1)		31,200		(49)
Customer-based purchased options		31,200		1		31,200		49
Commitments to purchase MBSs		3,323,653		21,730		2,359,630		10,467
Commitments to sell MBSs		5,583,795		(21,406)		3,711,477		(19,315)
Interest rate swaps		7,663		(64)		15,104		82
U.S. Treasury bond futures and options (1)		309,000		—		367,200		—
Eurodollar futures (1)		120,000		—		104,000		—

(1)    Changes in the fair value of these contracts are settled daily with the respective counterparties of PrimeLending and the Hilltop Broker-Dealers.

PrimeLending had cash collateral advances totaling $18.8 million and $11.9 million to offset net liability derivative positions on its commitments to sell MBSs at June 30, 2019 and December 31, 2018, respectively. In addition, PrimeLending and the Hilltop Broker-Dealers advanced cash collateral totaling $2.5 million and $3.4 million on U.S. Treasury bond futures and options and Eurodollar futures at June 30, 2019 and December 31, 2018, respectively. These amounts are included in other assets within the consolidated balance sheets.

19. Balance Sheet Offsetting

Certain financial instruments, including resale and repurchase agreements, securities lending arrangements and derivatives, may be eligible for offset in the consolidated balance sheets and/or subject to master netting arrangements or similar agreements. The following tables present the assets and liabilities subject to enforceable master netting arrangements, repurchase agreements, or similar agreements with offsetting rights (in thousands).

							Gross Amounts Not Offset in
					Net Amounts		the Balance Sheet
	Gross Amounts		Gross Amounts		of Assets				Cash
	of Recognized		Offset in the		Presented in the		Financial		Collateral		Net
	Assets		Balance Sheet		Balance Sheet		Instruments		Pledged		Amount
June 30, 2019
Securities borrowed:
Institutional counterparties	$	1,569,362	$	—	$	1,569,362	$	(1,517,772)	$	—	$	51,590
Interest rate options:
Customer counterparties		1		—		1		—		—		1
Interest rate swaps:
Institutional counterparties		2		—		2		—		—		2
Reverse repurchase agreements:
Institutional counterparties		50,660		—		50,660		(50,575)		—		85
Forward MBS derivatives:
Institutional counterparties		21,732		—		21,732		(21,732)		—		—
	$	1,641,757	$	—	$	1,641,757	$	(1,590,079)	$	—	$	51,678
December 31, 2018
Securities borrowed:
Institutional counterparties	$	1,365,547	$	—	$	1,365,547	$	(1,307,121)	$	—	$	58,426
Interest rate options:
Customer counterparties		49		—		49		—		—		49
Interest rate swaps:
Institutional counterparties		88		—		88		—		—		88
Reverse repurchase agreements:
Institutional counterparties		61,611		—		61,611		(61,390)		—		221
Forward MBS derivatives:
Institutional counterparties		10,469		—		10,469		(10,469)		—		—
	$	1,437,764	$	—	$	1,437,764	$	(1,378,980)	$	—	$	58,784

44

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

							Gross Amounts Not Offset in
					Net Amounts		the Balance Sheet
	Gross Amounts		Gross Amounts		of Liabilities				Cash
	of Recognized		Offset in the		Presented in the		Financial		Collateral		Net
	Liabilities		Balance Sheet		Balance Sheet		Instruments		Pledged		Amount
June 30, 2019
Securities loaned:
Institutional counterparties	$	1,459,218	$	—	$	1,459,218	$	(1,410,580)	$	—	$	48,638
Interest rate options:
Institutional counterparties		1		—		1		—		—		1
Interest rate swaps:
Institutional counterparties		66		—		66		—		—		66
Repurchase agreements:
Institutional counterparties		488,042		—		488,042		(488,042)		—		—
Customer counterparties		20,801		—		20,801		(20,801)		—		—
Forward MBS derivatives:
Institutional counterparties		21,647		(239)		21,408		(11,061)		—		10,347
	$	1,989,775	$	(239)	$	1,989,536	$	(1,930,484)	$	—	$	59,052
December 31, 2018
Securities loaned:
Institutional counterparties	$	1,186,073	$	—	$	1,186,073	$	(1,136,033)	$	—	$	50,040
Interest rate options:
Institutional counterparties		49		—		49		—		—		49
Interest rate swaps:
Institutional counterparties		6		—		6		—		—		6
Repurchase agreements:
Institutional counterparties		533,441		—		533,441		(533,441)		—		—
Customer counterparties		43,266		—		43,266		(43,266)		—		—
Forward MBS derivatives:
Institutional counterparties		19,331		(15)		19,316		(7,728)		—		11,588
	$	1,782,166	$	(15)	$	1,782,151	$	(1,720,468)	$	—	$	61,683

Secured Borrowing Arrangements

Secured Borrowings (Repurchase Agreements) — The Company participates in transactions involving securities sold under repurchase agreements, which are secured borrowings and generally mature one to thirty days from the transaction date or involve arrangements with no definite termination date. Securities sold under repurchase agreements are reflected at the amount of cash received in connection with the transactions. The Company may be required to provide additional collateral based on the fair value of the underlying securities, which is monitored on a daily basis.

Securities Lending Activities — The Company’s securities lending activities include lending securities for other broker-dealers, lending institutions and its own clearing and retail operations. These activities involve lending securities to other broker-dealers to cover short sales, to complete transactions in which there has been a failure to deliver securities by the required settlement date and as a conduit for financing activities.

When lending securities, the Company receives cash or similar collateral and generally pays interest (based on the amount of cash deposited) to the other party to the transaction. Securities lending transactions are executed pursuant to written agreements with counterparties that generally require securities loaned to be marked-to-market on a daily basis. The Company receives collateral in the form of cash in an amount generally in excess of the fair value of securities loaned. The Company monitors the fair value of securities loaned on a daily basis, with additional collateral obtained or refunded, as necessary. Collateral adjustments are made on a daily basis through the facilities of various clearinghouses. The Company is a principal in these securities lending transactions and is liable for losses in the event of a failure of any other party to honor its contractual obligation. Management sets credit limits with each counterparty and reviews these limits regularly to monitor the risk level with each counterparty. The Company is subject to credit risk through its securities lending activities if securities prices decline rapidly because the value of the Company’s collateral could fall below the amount of the indebtedness it secures. In rapidly appreciating markets, credit risk increases due to short positions. The Company’s securities lending business subjects the Company to credit risk if a counterparty fails to

45

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

perform or if collateral securing its obligations is insufficient. In securities transactions, the Company is subject to credit risk during the period between the execution of a trade and the settlement by the customer.

The following tables present the remaining contractual maturities of repurchase agreement and securities lending transactions accounted for as secured borrowings (in thousands). The Company had no repurchase-to-maturity transactions outstanding at both June 30, 2019 and December 31, 2018.

	Remaining Contractual Maturities
	Overnight and						Greater Than
June 30, 2019	Continuous		Up to 30 Days		30-90 Days		90 Days		Total
Repurchase agreement transactions:
U.S. Treasury and agency securities	$	38,670	$	—	$	—	$	—	$	38,670
Asset-backed securities		470,173		—		—		—		470,173
Securities lending transactions:
Corporate securities		113		—		—		—		113
Equity securities		1,459,105		—		—		—		1,459,105
Total	$	1,968,061	$	—	$	—	$	—	$	1,968,061
Gross amount of recognized liabilities for repurchase agreement and securities lending transactions in offsetting disclosure above									$	1,968,061
Amount related to agreements not included in offsetting disclosure above									$	—
	Remaining Contractual Maturities
	Overnight and						Greater Than
December 31, 2018	Continuous		Up to 30 Days		30-90 Days		90 Days		Total
Repurchase agreement transactions:
U.S. Treasury and agency securities	$	131,848	$	—	$	—	$	—	$	131,848
Asset-backed securities		444,859		—		—		—		444,859
Securities lending transactions:
Corporate securities		113		—		—		—		113
Equity securities		1,185,960		—		—		—		1,185,960
Total	$	1,762,780	$	—	$	—	$	—	$	1,762,780
Gross amount of recognized liabilities for repurchase agreement and securities lending transactions in offsetting disclosure above									$	1,762,780
Amount related to agreements not included in offsetting disclosure above									$	—

20. Broker-Dealer and Clearing Organization Receivables and Payables

Broker-dealer and clearing organization receivables and payables consisted of the following (in thousands).

	June 30,		December 31,
	2019		2018
Receivables:
Securities borrowed	$	1,569,362	$	1,365,547
Securities failed to deliver		24,310		16,300
Trades in process of settlement		96,247		32,993
Other		17,330		25,447
	$	1,707,249	$	1,440,287
Payables:
Securities loaned	$	1,459,218	$	1,186,073
Correspondents		29,700		29,311
Securities failed to receive		37,562		75,015
Other		5,411		4,526
	$	1,531,891	$	1,294,925

46

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

21. Reserve for Losses and Loss Adjustment Expenses

A summary of NLC’s reserve for unpaid losses and LAE, as included in other liabilities within the consolidated balance sheets, is as follows (in thousands).

	June 30,		December 31,
	2019		2018
Reserve for unpaid losses and allocated LAE balance, net	$	20,189	$	16,498
Reinsurance recoverables on unpaid losses		1,184		3,214
Unallocated LAE		894		840
Reserve for unpaid losses and LAE balance, gross	$	22,267	$	20,552

A summary of claims loss reserve development activity is presented in the following table (dollars in thousands).

					June 30, 2019
					Total of
					IBNR Reserves
					Plus Expected		Cumulative
Accident	Six Months Ended June 30, 2019				Development on		Number of
Year	Paid		Incurred		Reported Claims		Reported Claims
2016	$	83,452	$	83,961	$	295		20,092
2017		86,913		87,737		538		20,656
2018		69,260		74,593		2,992		15,164
2019		24,716		37,898		5,382		7,757
Total	$	264,341	$	284,189
		341	All outstanding reserves prior to 2016, net of reinsurance
	$	20,189	Reserve for unpaid losses and allocated LAE, net of reinsurance

22. Reinsurance Activity

NLC limits the maximum net loss that can arise from large risks or risks in concentrated areas of exposure by reinsuring (ceding) certain levels of risk. Substantial amounts of business are ceded, and these reinsurance contracts do not relieve NLC from its obligations to policyholders. Such reinsurance includes quota share, excess of loss, catastrophe, and other forms of reinsurance on essentially all property and casualty lines of insurance. Net insurance premiums earned, losses and LAE and policy acquisition and other underwriting expenses are reported net of the amounts related to reinsurance ceded to other companies. Amounts recoverable from reinsurers related to the portions of the liability for losses and LAE and unearned insurance premiums ceded to them are reported as assets. Failure of reinsurers to honor their obligations could result in losses to NLC; consequently, allowances are established for amounts deemed uncollectible as NLC evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. At June 30, 2019, total reinsurance recoverables and receivables had a carrying value of $1.7 million, which is included in other assets within the consolidated balance sheets. There was no allowance for uncollectible accounts at June 30, 2019, based on NLC’s quality requirements.

47

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

The effects of reinsurance on premiums written and earned are summarized as follows (in thousands).

	Three Months Ended June 30,								Six Months Ended June 30,
	2019				2018				2019				2018
	Written		Earned		Written		Earned		Written		Earned		Written		Earned
Premiums from direct business	$	35,562	$	31,727	$	35,801	$	33,372	$	66,352	$	63,463	$	68,886	$	66,740
Reinsurance assumed		3,622		3,256		3,567		3,111		6,751		6,448		6,609		6,111
Reinsurance ceded		(1,517)		(1,517)		(2,335)		(2,378)		(3,242)		(3,242)		(4,345)		(4,431)
Net premiums	$	37,667	$	33,466	$	37,033	$	34,105	$	69,861	$	66,669	$	71,150	$	68,420

The effects of reinsurance on incurred losses and LAE are as follows (in thousands).

	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
Losses and LAE incurred	$	23,959	$	23,869	$	38,943	$	37,321
Reinsurance recoverables		1,022		540		964		2,620
Net loss and LAE incurred	$	24,981	$	24,409	$	39,907	$	39,941

Catastrophic coverage

At June 30, 2019, NLC had catastrophic excess of loss reinsurance coverage of losses per event in excess of $8 million retention by NLIC and $2 million retention by ASIC. ASIC maintained an underlying layer of coverage, providing $6 million of reinsurance coverage in excess of its $2 million retention to bridge to the primary program. The reinsurance for NLIC and ASIC in excess of $8 million is comprised of three layers of protection: $17 million in excess of $8 million retention and/or loss; $30 million in excess of $25 million loss; and $50 million in excess of $55 million loss. NLIC and ASIC retain no participation in any of the layers, beyond the first $8 million and $2 million, respectively. At June 30, 2019, total retention for any one catastrophe that affects both NLIC and ASIC was limited to $8 million in the aggregate.

Effective July 1, 2019, NLC renewed its catastrophic excess of loss reinsurance coverage for a one-year period. Changes from the coverages described above were limited to the reinsurance in excess of $8 million now being comprised of the following three layers of protection: $12 million in excess of $8 million retention and/or loss; $25 million in excess of $20 million loss; and $50 million in excess of $45 million loss.

Effective January 1, 2019, NLC renewed its underlying excess of loss contract that provides $10 million aggregate coverage in excess of NLC’s per event retention of $1 million and aggregate retention of $15 million for sub-catastrophic events. As of January 1, 2019, NLC retains 37.5% participation in this coverage, up from 17.5% participation during 2018.

23. Segment and Related Information

The Company currently has four reportable business segments that are organized primarily by the core products offered to the segments’ respective customers. These segments reflect the manner in which operations are managed and the criteria used by the chief operating decision maker, the Company’s President and Chief Executive Officer, to evaluate segment performance, develop strategy and allocate resources.

The banking segment includes the operations of the Bank, and since August 1, 2018, the operations acquired in the BORO Acquisition. The broker-dealer segment includes the operations of Securities Holdings, the mortgage origination segment is composed of PrimeLending and the insurance segment is composed of NLC.

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.

48

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

Balance sheet amounts not discussed previously and the elimination of intercompany transactions are included in “All Other and Eliminations.” The following tables present certain information about reportable business segment revenues, operating results, goodwill and assets (in thousands).

					Mortgage						All Other and		Hilltop
Three Months Ended June 30, 2019	Banking		Broker-Dealer		Origination		Insurance		Corporate		Eliminations		Consolidated
Net interest income (expense)	$	93,423	$	11,410	$	(1,031)	$	592	$	(1,331)	$	4,813	$	107,876
Provision (recovery) for loan losses		(670)		(2)		—		—		—		—		(672)
Noninterest income		10,742		105,559		164,548		36,151		665		(4,794)		312,871
Noninterest expense		58,251		94,870		141,721		39,589		9,274		(28)		343,677
Income (loss) before income taxes	$	46,584	$	22,101	$	21,796	$	(2,846)	$	(9,940)	$	47	$	77,742
					Mortgage						All Other and		Hilltop
Six Months Ended June 30, 2019	Banking		Broker-Dealer		Origination		Insurance		Corporate		Eliminations		Consolidated
Net interest income (expense)	$	186,113	$	24,260	$	(1,499)	$	1,236	$	(2,661)	$	9,358	$	216,807
Provision (recovery) for loan losses		355		(76)		—		—		—		—		279
Noninterest income		21,362		196,865		282,580		72,643		1,390		(9,501)		565,339
Noninterest expense		118,977		182,677		256,398		69,926		24,836		(52)		652,762
Income (loss) before income taxes	$	88,143	$	38,524	$	24,683	$	3,953	$	(26,107)	$	(91)	$	129,105
					Mortgage						All Other and		Hilltop
Three Months Ended June 30, 2018	Banking		Broker-Dealer		Origination		Insurance		Corporate		Eliminations		Consolidated
Net interest income (expense)	$	87,958	$	12,890	$	704	$	793	$	(2,482)	$	4,985	$	104,848
Provision for loan losses		—		340		—		—		—		—		340
Noninterest income		10,644		73,589		162,759		36,546		1,436		(5,540)		279,434
Noninterest expense		65,542		77,967		150,026		39,712		5,340		(70)		338,517
Income (loss) before income taxes	$	33,060	$	8,172	$	13,437	$	(2,373)	$	(6,386)	$	(485)	$	45,425

					Mortgage						All Other and		Hilltop
Six Months Ended June 30, 2018	Banking		Broker-Dealer		Origination		Insurance		Corporate		Eliminations		Consolidated
Net interest income (expense)	$	174,596	$	25,441	$	1,645	$	1,580	$	(4,573)	$	9,579	$	208,268
Provision (recovery) for loan losses		(1,531)		64		—		—		—		—		(1,467)
Noninterest income		20,823		142,135		289,862		71,564		724		(10,531)		514,577
Noninterest expense		124,913		155,743		280,729		70,725		14,743		(134)		646,719
Income (loss) before income taxes	$	72,037	$	11,769	$	10,778	$	2,419	$	(18,592)	$	(818)	$	77,593

					Mortgage						All Other and		Hilltop
	Banking		Broker-Dealer		Origination		Insurance		Corporate		Eliminations		Consolidated
June 30, 2019
Goodwill	$	247,368	$	7,008	$	13,071	$	23,988	$	—	$	—	$	291,435
Total assets	$	10,411,934	$	3,345,345	$	1,876,091	$	252,848	$	2,333,835	$	(3,954,183)	$	14,265,870
December 31, 2018
Goodwill	$	247,368	$	7,008	$	13,071	$	23,988	$	—	$	—	$	291,435
Total assets	$	10,004,971	$	3,213,115	$	1,627,134	$	253,513	$	2,243,182	$	(3,658,343)	$	13,683,572

49

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

24. Earnings per Common Share

Net earnings, less any preferred dividends accumulated for the period (whether or not declared), is allocated between the common stock and participating securities pursuant to the two-class method, if applicable. Basic earnings per common share is computed by dividing net earnings available to common stockholders by the weighted average number of common shares outstanding during the period, excluding participating nonvested restricted shares. The Company calculated basic earnings per common share using the treasury method instead of the two-class method since there were no instruments which qualified as participating securities during the three or six months ended June 30, 2019 or 2018.

Diluted earnings per common share is computed in a similar manner, except that first the denominator is increased to include the number of additional common shares that would have been outstanding if potentially dilutive common shares, excluding the participating securities, were issued using the treasury stock method. During the three and six months ended June 30, 2019 and 2018, RSUs were the only potentially dilutive non-participating instruments issued by Hilltop. Next, the Company determines and includes in the diluted earnings per common share calculation the more dilutive effect of the participating securities using the treasury stock method or the two-class method. Undistributed losses are not allocated to the nonvested share-based payment awards (the participating securities) under the two-class method as the holders are not contractually obligated to share in the losses of the Company.

The following table presents the computation of basic and diluted earnings per common share (in thousands, except per share data).

	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
Basic earnings per share:
Net earnings available to Hilltop common stockholders	$	57,811	$	33,080	$	96,597	$	57,521
Weighted average shares outstanding - basic		93,399		95,270		93,533		95,625
Basic earnings per common share	$	0.62	$	0.35	$	1.03	$	0.60
Diluted earnings per share:
Income attributable to Hilltop	$	57,811	$	33,080	$	96,597	$	57,521
Weighted average shares outstanding - basic		93,399		95,270		93,533		95,625
Effect of potentially dilutive securities		19		88		1		102
Weighted average shares outstanding - diluted		93,418		95,358		93,534		95,727
Diluted earnings per common share	$	0.62	$	0.35	$	1.03	$	0.60

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SCHEDULE I – Insurance Incurred and Cumulative Paid Losses and Allocated Loss Adjustment Expenses,

Net of Reinsurance

(dollars in thousands)

	Incurred Losses and Allocated Loss Adjustment Expenses, Net of Reinsurance								June 30, 2019
									Total of
									Incurred
									But Not
									Reported
									Reserves Plus		Cumulative
									Development		Number of
Accident	June 30, 2019								On Reported		Reported
Year	2016		2017		2018		2019		Claims		Claims
2016	$	84,771	$	85,189	$	84,076	$	83,961	$	295	20,092
2017				87,899		88,025		87,737		538	20,656
2018						75,217		74,593		2,992	15,164
2019								37,898		5,382	7,757
							$	284,189
	Cumulative Paid Losses and Allocated Loss Adjustment Expenses, Net of Reinsurance
Accident	June 30, 2019
Year	2016		2017		2018		2019
2016	$	71,543	$	81,682	$	83,169	$	83,452
2017				77,675		86,319		86,913
2018						61,922		69,260
2019								24,716
Total							$	264,341
All outstanding reserves prior to 2016, net of reinsurance								341
Reserve for unpaid losses and allocated loss adjustment expenses, net of reinsurance							$	20,189

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

The following discussion should be read in conjunction with the consolidated historical financial statements and notes appearing elsewhere in this Quarterly Report on Form 10-Q (this “Quarterly Report”) and the financial information set forth in the tables herein.

Unless the context otherwise indicates, all references in this Management’s Discussion and Analysis of Financial Condition and Results of Operations, or MD&A, to the “Company,” “we,” “us,” “our” or “ours” or similar words are to Hilltop Holdings Inc. and its direct and indirect wholly owned subsidiaries, references to “Hilltop” refer solely to Hilltop Holdings Inc., references to “PCC” refer to PlainsCapital Corporation (a wholly owned subsidiary of Hilltop), references to “Securities Holdings” refer to Hilltop Securities Holdings LLC (a wholly owned subsidiary of Hilltop), references to “Hilltop Securities” refer to Hilltop Securities Inc. (a wholly owned subsidiary of Securities Holdings), references to “HTS Independent Network” refer to Hilltop Securities Independent Network Inc. (a wholly owned subsidiary of Securities Holdings), Hilltop Securities and HTS Independent Network are collectively referred to as the “Hilltop Broker-Dealers”, references to the “Bank” refer to PlainsCapital Bank (a wholly owned subsidiary of PCC), references to “FNB” refer to First National Bank, references to “SWS” refer to the former SWS Group, Inc., references to “PrimeLending” refer to PrimeLending, a PlainsCapital Company (a wholly owned subsidiary of the Bank) and its subsidiaries as a whole, references to “NLC” refer to National Lloyds Corporation (a wholly owned subsidiary of Hilltop) and its subsidiaries as a whole, references to “NLIC” refer to National Lloyds Insurance Company (a wholly owned subsidiary of NLC) and references to “ASIC” refer to American Summit Insurance Company (a wholly owned subsidiary of NLC).

FORWARD-LOOKING STATEMENTS

This Quarterly Report includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”), as amended by the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical fact, included in this Quarterly Report that address results or developments that we expect or anticipate will or may occur in the future, and statements that are preceded by, followed by or include, words such as “anticipates,” “believes,” “could,” “estimates,” “expects,” “forecasts,” “goal,” “intends,” “may,” “might,” “plan,” “probable,” “projects,” “seeks,” “should,” “target,” “view” or “would” or the negative of these words and phrases or similar words or phrases, including such things as our business strategy, our financial condition, our revenue, our liquidity and sources of funding, market trends, operations and business, taxes, information technology expenses, capital levels, mortgage servicing rights (“MSR”) assets, stock repurchases, dividend payments, expectations concerning mortgage loan origination volume and interest rate compression, expected levels of refinancing as a percentage of total loan origination volume, projected losses on mortgage loans originated, loss estimates related to natural disasters, total expenses and cost savings expected from PrimeLending’s cost reduction efforts, the effects of government regulation applicable to our operations, the appropriateness of, and changes in, our allowance for loan losses and provision for loan losses, including as a result of the “current expected credit losses” (CECL) model, anticipated investment yields, our expectations regarding accretion of discount on loans in future periods, the collectability of loans, cybersecurity incidents and the outcome of litigation are forward-looking statements.

These forward-looking statements are based on our beliefs, assumptions and expectations of our future performance taking into account all information currently available to us. These beliefs, assumptions and expectations are subject to risks and uncertainties and can change as a result of many possible events or factors, not all of which are known to us. If an event occurs, our business, business plan, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements. Certain factors that could cause actual results to differ include, among others:

● the credit risks of lending activities, including our ability to estimate loan losses as well as the effects of changes in the level of, and trends in, loan delinquencies and write-offs;

● changes in the interest rate environment;

● changes in general economic, market and business conditions in areas or markets where we compete, including changes in the price of crude oil;

● risks associated with concentration in real estate related loans;

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● effectiveness of our data security controls in the face of cyber attacks;

● severe catastrophic events in Texas and other areas of the southern United States;

● the effects of our indebtedness on our ability to manage our business successfully, including the restrictions imposed by the indenture governing our indebtedness;

● cost and availability of capital;

● changes in state and federal laws, regulations or policies affecting one or more of our business segments, including changes in regulatory fees, deposit insurance premiums, capital requirements and the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”);

● changes in key management;

● competition in our banking, broker-dealer, mortgage origination and insurance segments from other banks and financial institutions as well as investment banking and financial advisory firms, mortgage bankers, asset-based non-bank lenders, government agencies and insurance companies;

● legal and regulatory proceedings;

● failure of our insurance segment reinsurers to pay obligations under reinsurance contracts;

● risks associated with merger and acquisition integration; and

● our ability to use excess capital in an effective manner.

For a more detailed discussion of these and other factors that may affect our business and that could cause the actual results to differ materially from those anticipated in these forward-looking statements, see “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2018 (“2018 Form 10-K”), which was filed with the Securities and Exchange Commission (the “SEC”) on February 15, 2019, this Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” Part II, Item 1A, “Risk Factors” herein and other filings we have made with the SEC. We caution that the foregoing list of factors is not exhaustive, and new factors may emerge, or changes to the foregoing factors may occur, that could impact our business. All subsequent written and oral forward-looking statements concerning our business attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements above. We do not undertake any obligation to update any forward-looking statement, whether written or oral, relating to the matters discussed in this Quarterly Report except to the extent required by federal securities laws.

OVERVIEW

We are a financial holding company registered under the Bank Holding Company Act of 1956. Our primary line of business is to provide business and consumer banking services from offices located throughout Texas through the Bank. We also provide an array of financial products and services through our broker-dealer, mortgage origination and insurance segments. The following includes additional details regarding the financial products and services provided by each of our primary business units.

PCC. PCC is a financial holding company that provides, through its subsidiaries, traditional banking and wealth, investment and treasury management services primarily in Texas and residential mortgage loans throughout the United States.

Securities Holdings. Securities Holdings is a holding company that provides, through its subsidiaries, investment banking and other related financial services, including municipal advisory, sales, trading and underwriting of taxable and tax-exempt fixed income securities, equity trading, clearing, securities lending, structured finance and retail brokerage services throughout the United States.

NLC. NLC is a property and casualty insurance holding company that provides, through its subsidiaries, fire and homeowners insurance to low value dwellings and manufactured homes primarily in Texas and other areas of the southern United States.

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During the three and six months ended June 30, 2019, our net income to common stockholders was $57.8 million, or $0.62 per diluted share, and $96.6 million, or $1.03 per diluted share, respectively. We declared total common dividends of $0.08 and $0.16 per share during the three and six months ended June 30, 2019, respectively, which resulted in dividend payout ratios of 12.92% and 15.49%, respectively. Dividend payout ratio is defined as cash dividends declared per common share divided by basic earnings per common share.

We reported $77.7 million and $129.1 million of consolidated income before income taxes during the three and six months ended June 30, 2019, respectively, including the following contributions from our four reportable business segments.

● The banking segment contributed $46.6 million and $88.1 million of income before income taxes during the three and six months ended June 30, 2019, respectively;

● The broker-dealer segment contributed $22.1 million and $38.5 million of income before income taxes during the three and six months ended June 30, 2019, respectively;

● The mortgage origination segment contributed $21.8 million and $24.7 million of income before income taxes during the three and six months ended June 30, 2019, respectively; and

● The insurance segment incurred a loss before income taxes of $2.8 million during the three months ended June 30, 2019 and contributed $4.0 million of income before income taxes during the six months ended June 30, 2019.

At June 30, 2019, on a consolidated basis, we had total assets of $14.3 billion, total deposits of $8.5 billion, total loans, including loans held for sale, of $8.8 billion and stockholders’ equity of $2.1 billion.

Factors Affecting Results of Operations

Changes in Management

On February 21, 2019, we entered into a Separation and Release Agreement (the “Separation Agreement”) with Alan B. White, our Vice Chairman and Co-Chief Executive Officer, in connection with his retirement effective April 1, 2019 (the “Retirement Date”). Pursuant to the Separation Agreement, effective as of the Retirement Date, Mr. White resigned from all positions with Hilltop and its subsidiaries, including, without limitation, Vice Chairman of our Board of Directors and Co-Chief Executive Officer of Hilltop. The Separation Agreement also provides that Mr. White’s retention agreement with the Company, as amended, terminated on the Retirement Date, except for certain provisions that addressed, among other items, non-competition, non-solicitation, confidential information and arbitration. Effective April 1, 2019, Jeremy B. Ford became Hilltop’s sole Chief Executive Officer, Chairman of the Executive Committee of the Board of Directors of Hilltop and the Chairman of the Bank. The Separation Agreement, in accordance with Mr. White’s retention agreement, provided for aggregate payments of $12.4 million to Mr. White, subject to any delay required under Section 409A of the Internal Revenue Code. During the six months ended June 30, 2019, our financial results included the recognition within corporate of a pre-tax charge within employees’ compensation and benefits of $5.8 million in the first quarter of 2019 associated with Mr. White’s retirement. We do not intend to replace Mr. White.

On February 19, 2019, we entered into a retention agreement with Hill A. Feinberg (the “Feinberg Retention Agreement") to set forth the terms of his ongoing role with the Company. As disclosed in our current report on Form 8-K filed on December 12, 2018, we appointed M. Bradley Winges to succeed Mr. Feinberg as President and Chief Executive Officer of Hilltop Securities effective February 20, 2019. The Feinberg Retention Agreement provides that, as of February 20, 2019, Mr. Feinberg resigned as President and Chief Executive Officer of Hilltop Securities and from all other positions with Hilltop and its subsidiaries, other than as Chairman of the Board of Directors of Hilltop Securities, as a member of the Board of Directors of Hilltop and a member of Executive Committee of the Board of Directors of Hilltop. Pursuant to the Feinberg Retention Agreement, Mr. Feinberg served as the Chairman of the Board of Directors of Hilltop Securities until June 30, 2019, at which time he became Chairman Emeritus of Hilltop Securities and resigned from his membership on the Executive Committee of the Board of Directors of Hilltop. The Feinberg Retention Agreement provides for aggregate payments of $1.4 million to Mr. Feinberg upon his termination, resignation or death, of which $0.9 million was paid during the first quarter of 2019. Mr. Feinberg may resign or be terminated at any time. In connection with the appointment of Mr. Winges, Hilltop and Mr. Winges entered into an employment agreement providing for a sign-on cash bonus of $1.5 million, among other benefits, on the effective date of his employment. During the six months ended June 30, 2019, the broker-dealer segment’s financial results reflect aggregate pre-tax

54

charges within employees’ compensation and benefits noninterest expenses of $2.2 million related to these items, all of which were recognized in the first quarter of 2019.

During the six months ended June 30, 2019, the total impact of the above noted changes in management was $8.0 million before income taxes, all of which was recognized during the first quarter of 2019. These changes and the related impact on our results of operations are collectively referred to as the “Leadership Changes.”

Technology Enhancements and Corporate Initiatives

In furtherance of our goal of building a premier, diversified financial services company, we regularly evaluate strategic opportunities to invest in our business and technology platforms. Such investments are intended to support long-term technological competitiveness and improved operational efficiencies throughout our organization. During 2018, we began the significant investment in new technological solutions, substantial core system upgrades and other technology enhancements. Such significant investments specifically include single, enterprise-wide general ledger and procurement solutions, a mortgage loan origination system and a core system replacement within our broker-dealer segment (collectively referred to as “Core System Improvements”). In combination with these technology enhancements, we are continuing our efforts to consolidate common back office functions. We believe that costs incurred related to these Core System Improvements and the consolidation of common back office functions will continue to represent an increasingly significant portion of our noninterest expenses in the near term, but we are making such investments with the expectation that they will result in cost savings over the long term. Costs related to our Core System Improvements, disaggregated by segment between internal-use software costs that were capitalized as premises and equipment and costs that were recorded to noninterest expense, were as follows (in thousands).

					Mortgage						Hilltop
Three Months Ended June 30, 2019	Banking		Broker-Dealer		Origination		Insurance		Corporate		Consolidated
Premises and equipment	$	—	$	703	$	2,367	$	—	$	919	$	3,989
Noninterest expense		—		1,083		748		—		174		2,005
Total	$	—	$	1,786	$	3,115	$	—	$	1,093	$	5,994

					Mortgage						Hilltop
Six Months Ended June 30, 2019	Banking		Broker-Dealer		Origination		Insurance		Corporate		Consolidated
Premises and equipment	$	—	$	1,854	$	4,368	$	—	$	1,333	$	7,555
Noninterest expense		—		2,126		1,770		—		358		4,254
Total	$	—	$	3,980	$	6,138	$	—	$	1,691	$	11,809

					Mortgage						Hilltop
Three Months Ended June 30, 2018	Banking		Broker-Dealer		Origination		Insurance		Corporate		Consolidated
Premises and equipment	$	—	$	1,018	$	—	$	—	$	769	$	1,787
Noninterest expense		—		761		794		—		341		1,896
Total	$	—	$	1,779	$	794	$	—	$	1,110	$	3,683

					Mortgage						Hilltop
Six Months Ended June 30, 2018	Banking		Broker-Dealer		Origination		Insurance		Corporate		Consolidated
Premises and equipment	$	—	$	1,147	$	—	$	—	$	989	$	2,136
Noninterest expense		—		1,976		1,343		—		411		3,730
Total	$	—	$	3,123	$	1,343	$	—	$	1,400	$	5,866

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Factors Affecting Comparability of Results of Operations

Prior Year Acquisition

On August 1, 2018, we acquired privately-held, Houston-based The Bank of River Oaks (“BORO”) in an all-cash transaction (the “BORO Acquisition”). Pursuant to the terms of the definitive agreement, we paid cash in the aggregate amount of $85 million to the shareholders and option holders of BORO. The fair value of the assets acquired was $434.8 million, including $326.6 million in loans, while the fair value of liabilities assumed was $389.4 million, consisting primarily of $376.4 million in deposits. The operations of BORO were included in our operating results beginning August 1, 2018. The estimated fair value of the core deposit intangible asset acquired as of August 1, 2018 was $10.0 million and resulting goodwill was $39.6 million. In connection with the acquisition, we merged BORO into the Bank, and all customer accounts were converted to the PlainsCapital Bank platform.

Termination of FDIC Loss-Share Agreements

In the fourth quarter of 2018, the Bank terminated its loss-share agreements with the FDIC which were entered into in connection with the FNB Transaction, resulting in a $6.26 million payment from the FDIC to the Bank. Prior to the termination, the Bank recorded “true-up” accruals of $0.1 million and $0.3 million during the three and six months ended June 30, 2018, respectively, with respect to the FDIC-assisted transaction whereby the Bank acquired certain assets and assumed certain liabilities of Edinburg, Texas-based First National Bank (“FNB”) on September 13, 2013 (the “FNB Transaction”). The true-up accrual was based on a formula within the loss-share agreements, pursuant to which we agreed to reimburse the FDIC if actual losses incurred and billed to the FDIC through loss sharing were below a stated threshold. During the three and six months ended June 30, 2018, the Bank also recorded $1.9 million and $5.8 million, respectively, of amortization of excess book value of its receivables under the loss-share agreements (the “FDIC Indemnification Asset”) due to lower projected collections from the FDIC than were initially estimated at the acquisition date.

Segment Information

We have three primary business units, PCC (banking and mortgage origination), Securities Holdings (broker-dealer) and NLC (insurance). Under accounting principles generally accepted in the United States (“GAAP”), our business units are comprised of four reportable business segments organized primarily by the core products offered to the segments’ respective customers: banking, broker-dealer, mortgage origination and insurance. Consistent with our historical segment operating results, we anticipate that future revenues will be driven primarily from the banking segment, with the remainder being generated by our broker-dealer, mortgage origination and insurance segments. Operating results for the mortgage origination segment have historically been more volatile than operating results for the banking, broker-dealer and insurance segments.

The banking segment includes the operations of the Bank, and since August 1, 2018, the operations acquired in the BORO Acquisition. The banking segment primarily provides business and consumer banking services from offices located throughout Texas and generates revenue from its portfolio of earning assets. The Bank’s results of operations are primarily dependent on net interest income. The Bank also derives revenue from other sources, including service charges on customer deposit accounts and trust fees.

The broker-dealer segment includes the operations of Securities Holdings, which operates through its wholly owned subsidiaries Hilltop Securities and HTS Independent Network. The broker-dealer segment generates a majority of its revenues from fees and commissions earned from investment advisory and securities brokerage services. Hilltop Securities is a broker-dealer registered with the SEC and the Financial Industry Regulatory Authority (“FINRA”) and a member of the New York Stock Exchange (“NYSE”). HTS Independent Network is an introducing broker-dealer that is also registered with the SEC and FINRA. Hilltop Securities, HTS Independent Network and Hilltop Securities Asset Management, LLC, a wholly-owned subsidiary of First Southwest Holdings, 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.

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

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 23, Segment and Related Information, in the notes to our consolidated financial statements. The following table presents certain information about the 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.

	Three Months Ended June 30,				Variance 2019 vs 2018				Six Months Ended June 30,				Variance 2019 vs 2018
	2019		2018		Amount		Percent		2019		2018		Amount		Percent
Net interest income (expense):
Banking	$	93,423	$	87,958	$	5,465	6	%	$	186,113	$	174,596	$	11,517	7	%
Broker-Dealer		11,410		12,890		(1,480)	(11)	%		24,260		25,441		(1,181)	(5)	%
Mortgage Origination		(1,031)		704		(1,735)	(246)	%		(1,499)		1,645		(3,144)	(191)	%
Insurance		592		793		(201)	(25)	%		1,236		1,580		(344)	(22)	%
Corporate		(1,331)		(2,482)		1,151	46	%		(2,661)		(4,573)		1,912	42	%
All Other and Eliminations		4,813		4,985		(172)	(3)	%		9,358		9,579		(221)	(2)	%
Hilltop Consolidated	$	107,876	$	104,848	$	3,028	3	%	$	216,807	$	208,268	$	8,539	4	%
Provision (recovery) for loan losses:
Banking	$	(670)	$	—	$	(670)	—	%	$	355	$	(1,531)	$	1,886	123	%
Broker-Dealer		(2)		340		(342)	(101)	%		(76)		64		(140)	(219)	%
Mortgage Origination		—		—		—	—	%		—		—		—	—	%
Insurance		—		—		—	—	%		—		—		—	—	%
Corporate		—		—		—	—	%		—		—		—	—	%
All Other and Eliminations		—		—		—	—	%		—		—		—	—	%
Hilltop Consolidated	$	(672)	$	340	$	(1,012)	(298)	%	$	279	$	(1,467)	$	1,746	119	%
Noninterest income:
Banking	$	10,742	$	10,644	$	98	1	%	$	21,362	$	20,823	$	539	3	%
Broker-Dealer		105,559		73,589		31,970	43	%		196,865		142,135		54,730	39	%
Mortgage Origination		164,548		162,759		1,789	1	%		282,580		289,862		(7,282)	(3)	%
Insurance		36,151		36,546		(395)	(1)	%		72,643		71,564		1,079	2	%
Corporate		665		1,436		(771)	(54)	%		1,390		724		666	92	%
All Other and Eliminations		(4,794)		(5,540)		746	13	%		(9,501)		(10,531)		1,030	10	%
Hilltop Consolidated	$	312,871	$	279,434	$	33,437	12	%	$	565,339	$	514,577	$	50,762	10	%
Noninterest expense:
Banking	$	58,251	$	65,542	$	(7,291)	(11)	%	$	118,977	$	124,913	$	(5,936)	(5)	%
Broker-Dealer		94,870		77,967		16,903	22	%		182,677		155,743		26,934	17	%
Mortgage Origination		141,721		150,026		(8,305)	(6)	%		256,398		280,729		(24,331)	(9)	%
Insurance		39,589		39,712		(123)	(0)	%		69,926		70,725		(799)	(1)	%
Corporate		9,274		5,340		3,934	74	%		24,836		14,743		10,093	68	%
All Other and Eliminations		(28)		(70)		42	60	%		(52)		(134)		82	61	%
Hilltop Consolidated	$	343,677	$	338,517	$	5,160	2	%	$	652,762	$	646,719	$	6,043	1	%
Income (loss) before income taxes:
Banking	$	46,584	$	33,060	$	13,524	41	%	$	88,143	$	72,037	$	16,106	22	%
Broker-Dealer		22,101		8,172		13,929	170	%		38,524		11,769		26,755	227	%
Mortgage Origination		21,796		13,437		8,359	62	%		24,683		10,778		13,905	129	%
Insurance		(2,846)		(2,373)		(473)	(20)	%		3,953		2,419		1,534	63	%
Corporate		(9,940)		(6,386)		(3,554)	(56)	%		(26,107)		(18,592)		(7,515)	(40)	%
All Other and Eliminations		47		(485)		532	110	%		(91)		(818)		727	89	%
Hilltop Consolidated	$	77,742	$	45,425	$	32,317	71	%	$	129,105	$	77,593	$	51,512	66	%

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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 and is primarily earned by our banking segment. 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. Net interest income increased during the six months ended June 30, 2019, compared with the six months ended June 30, 2018, primarily due to an increase within our banking segment and, to a lesser extent within corporate, partially offset by decreases within our mortgage origination, broker-dealer and insurance segments.

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

(i)Income from broker-dealer operations. Through Securities Holdings, we provide investment banking and other related financial services. We generated $113.1 million and $117.3 million in securities commissions and fees and investment and securities advisory fees and commissions, and $77.1 million and $17.2 million in gains from derivative and trading portfolio activities (included within other noninterest income), during the six months ended June 30, 2019 and 2018, respectively.

(ii)Income from mortgage operations. Through PrimeLending, we generate noninterest income by originating and selling mortgage loans. During the six months ended June 30, 2019 and 2018, we generated $282.6 million and $288.2 million, respectively, in net gains from the sale of loans, other mortgage production income (including income associated with retained mortgage servicing rights), and mortgage loan origination fees.

(iii)Income from insurance operations. Through NLC, we provide fire and limited homeowners insurance for low value dwellings and manufactured homes. We generated $66.7 million and $68.4 million in net insurance premiums earned during the six months ended June 30, 2019 and 2018, respectively.

The increase in noninterest income noted in the segment results table previously presented was primarily due to an increase of $59.9 million in gains from derivative and trading portfolio activities primarily within our broker-dealer segment, partially offset by a decrease of $10.9 million in net gains from sale of loans and other mortgage production income within our mortgage origination segment.

We also incur noninterest expenses in the operation of our businesses. Our businesses engage in labor intensive activities and, consequently, employees’ compensation and benefits represent the majority of our noninterest expenses.

Consolidated Operating Results

Net income applicable to common stockholders during the three months ended June 30, 2019 was $57.8 million, or $0.62 per diluted share, compared with net income applicable to common stockholders of $33.1 million, or $0.35 per diluted share, during the three months ended June 30, 2018. Net income applicable to common stockholders during the six months ended June 30, 2019 was $96.6 million, or $1.03 per diluted share, compared with net income applicable to common stockholders of $57.5 million, or $0.60 per diluted share, during the six months ended June 30, 2018. The six months ended June 30, 2019 included costs incurred during the first quarter of 2019 associated with significant Leadership Changes and other efficiency initiative-related charges which, in the aggregate, totaled $8.7 million before income taxes.

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Certain items included in net income for the three and six months ended June 30, 2019 and 2018 resulted from purchase accounting associated with the merger of PlainsCapital Corporation with and into a wholly owned subsidiary of Hilltop on November 30, 2012 (the “PlainsCapital Merger”), the Federal Deposit Insurance Corporation (“FDIC”) -assisted transaction (the “FNB Transaction”) whereby the Bank acquired certain assets and assumed certain liabilities of FNB, the acquisition of SWS Group, Inc. in a stock and cash transaction (the “SWS Merger”) and the BORO Acquisition (collectively, the “Bank Transactions”). Income before taxes included the following purchase accounting items related to the Bank Transactions (in thousands).

Three Months Ended June 30, 2019		PlainsCapital Merger		FNB Transaction		SWS Merger		BORO Acquisition		Total
Net accretion on earning assets and liabilities	$	558	$	4,405	$	445	$	1,003	$	6,411
Amortization of identifiable intangibles		(1,001)		(76)		(174)		(714)		(1,965)

Six Months Ended June 30, 2019		PlainsCapital Merger		FNB Transaction		SWS Merger		BORO Acquisition		Total
Net accretion on earning assets and liabilities	$	1,102	$	9,938	$	1,006	$	2,980	$	15,026
Amortization of identifiable intangibles		(2,002)		(152)		(348)		(1,428)		(3,930)

Three Months Ended June 30, 2018		PlainsCapital Merger		FNB Transaction		SWS Merger		BORO Acquisition		Total
Net accretion on earning assets and liabilities	$	412	$	6,917	$	657	$	—	$	7,986
Amortization of identifiable intangibles		(1,418)		(106)		(193)		—		(1,717)

Six Months Ended June 30, 2018		PlainsCapital Merger		FNB Transaction		SWS Merger		BORO Acquisition		Total
Net accretion on earning assets and liabilities	$	940	$	15,294	$	1,230	$	—	$	17,464
Amortization of identifiable intangibles		(2,904)		(212)		(387)		—		(3,503)

We consider the ratios shown in the table below to be key indicators of our performance.

	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
Return on average stockholder's equity	11.63	%	6.95	%	9.86	%	6.07	%
Return on average assets	1.74	%	1.03	%	1.48	%	0.90	%
Net interest margin (1) (3) (4)	3.49	%	3.46	%	3.59	%	3.49	%
Net interest margin (taxable equivalent) (2) (3) (4)	3.49	%	3.47	%	3.59	%	3.50	%

(1) Net interest margin is defined as net interest income divided by average interest-earning assets.

(2) Net interest margin (taxable equivalent), a non-GAAP measure, is defined as taxable equivalent net interest income divided by average interest-earning assets. Annualized taxable equivalent adjustments are based on the applicable corporate federal income tax rate of 21%. The interest income earned on certain earnings assets is completely or partially exempt from federal income tax. See footnote 2 to the consolidated net interest income tables for the taxable equivalent adjustments to interest income.

(3) The securities financing operations within our broker-dealer segment had the effect of lowering both the net interest margin and taxable equivalent net interest margin by 44 basis points and 41 basis points during the three months ended June 30, 2019 and 2018, respectively, and 44 and 42 basis points during the six months ended June 30, 2019 and 2018, respectively.

(4) During the three months ended June 30, 2019 and 2018, purchase accounting contributed 23 basis points and 29 basis points, respectively, to both net interest margin and taxable equivalent net interest margin. During the six months ended June 30, 2019 and 2018, purchase accounting contributed 27 and 33 basis points, respectively, to both net interest margin and taxable equivalent net interest margin.

We present net interest margin in the table above, and net interest margin and net interest income below, on a taxable equivalent basis. 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.

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During the three months ended June 30, 2019 and 2018, purchase accounting contributed 23 and 29 basis points, respectively, to our consolidated taxable equivalent net interest margin of 3.49% and 3.47%, respectively. During the six months ended June 30, 2019 and 2018, purchase accounting contributed 27 and 33 basis points, respectively, to our consolidated taxable equivalent net interest margin of 3.59% and 3.50%, respectively, and primarily related to the following purchase accounting items associated with the Bank Transactions (in thousands).

Three Months Ended June 30, 2019		PlainsCapital Merger		FNB Transaction		SWS Merger		BORO Acquisition		Total
Accretion of discount on loans	$	687	$	4,405	$	413	$	939	$	6,444
Accretion (amortization) of discount (premium) on acquired securities		(129)		—		7		64		(58)

Six Months Ended June 30, 2019		PlainsCapital Merger		FNB Transaction		SWS Merger		BORO Acquisition		Total
Accretion of discount on loans	$	1,440	$	9,938	$	949	$	2,852	$	15,179
Accretion (amortization) of discount (premium) on acquired securities		(338)		—		14		128		(196)

Three Months Ended June 30, 2018		PlainsCapital Merger		FNB Transaction		SWS Merger		BORO Acquisition		Total
Accretion of discount on loans	$	749	$	6,917	$	677	$	—	$	8,343
Amortization of premium on acquired securities		(337)		—		—		—		(337)

Six Months Ended June 30, 2018		PlainsCapital Merger		FNB Transaction		SWS Merger		BORO Acquisition		Total
Accretion of discount on loans	$	1,687	$	15,294	$	1,290	$	—	$	18,271
Amortization of premium on acquired securities		(747)		—		—		—		(747)

The tables below provide additional details regarding our consolidated net interest income (dollars in thousands).

	Three Months Ended June 30,
	2019						2018
	Average		Interest		Annualized		Average		Interest		Annualized
	Outstanding		Earned or		Yield or		Outstanding		Earned or		Yield or
	Balance		Paid		Rate		Balance		Paid		Rate
Assets
Interest-earning assets
Loans held for sale	$	1,307,251	$	15,041	4.60	%	$	1,589,149	$	18,241	4.59	%
Loans held for investment, gross (1)		7,078,807		99,284	5.57	%		6,374,873		85,683	5.34	%
Investment securities - taxable		1,733,536		14,654	3.38	%		1,663,257		12,486	3.00	%
Investment securities - non-taxable (2)		227,953		1,687	2.96	%		252,591		1,912	3.03	%
Federal funds sold and securities purchased under agreements to resell		69,369		369	2.13	%		228,786		859	1.51	%
Interest-bearing deposits in other financial institutions		325,130		1,982	2.44	%		419,006		1,890	1.81	%
Securities borrowed		1,598,063		15,517	3.84	%		1,544,235		17,486	4.48	%
Other		68,990		1,682	9.77	%		69,297		1,691	9.77	%
Interest-earning assets, gross (2)		12,409,099		150,216	4.81	%		12,141,194		140,248	4.59	%
Allowance for loan losses		(59,437)						(63,944)
Interest-earning assets, net		12,349,662						12,077,250
Noninterest-earning assets		1,414,227						1,286,608
Total assets	$	13,763,889					$	13,363,858
Liabilities and Stockholders' Equity
Interest-bearing liabilities
Interest-bearing deposits	$	5,792,236	$	18,036	1.25	%	$	5,366,535	$	10,136	0.76	%
Securities loaned		1,462,370		13,470	3.69	%		1,382,984		15,075	4.37	%
Notes payable and other borrowings		1,389,295		10,674	3.06	%		1,588,132		9,981	2.51	%
Total interest-bearing liabilities		8,643,901		42,180	1.95	%		8,337,651		35,192	1.69	%
Noninterest-bearing liabilities
Noninterest-bearing deposits		2,549,792						2,492,253
Other liabilities		551,333						620,900
Total liabilities		11,745,026						11,450,804
Stockholders’ equity		1,995,811						1,910,316
Noncontrolling interest		23,052						2,738
Total liabilities and stockholders' equity	$	13,763,889					$	13,363,858
Net interest income (2)			$	108,036					$	105,056
Net interest spread (2)					2.86	%					2.90	%
Net interest margin (2)					3.49	%					3.47	%

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	Six Months Ended June 30,
	2019						2018
	Average		Interest		Annualized		Average		Interest		Annualized
	Outstanding		Earned or		Yield or		Outstanding		Earned or		Yield or
	Balance		Paid		Rate		Balance		Paid		Rate
Assets
Interest-earning assets
Loans held for sale	$	1,161,938	$	27,529	4.74	%	$	1,442,512	$	32,854	4.56	%
Loans held for investment, gross (1)		6,961,727		197,666	5.66	%		6,341,997		171,014	5.38	%
Investment securities - taxable		1,762,856		30,238	3.43	%		1,638,570		23,414	2.86	%
Investment securities - non-taxable (2)		224,795		3,344	2.98	%		255,644		3,942	3.08	%
Federal funds sold and securities purchased under agreements to resell		67,866		756	2.25	%		209,312		1,340	1.29	%
Interest-bearing deposits in other financial institutions		414,857		5,133	2.49	%		525,276		4,368	1.68	%
Securities borrowed		1,522,656		32,376	4.23	%		1,540,790		33,786	4.36	%
Other		65,148		3,353	10.35	%		70,071		3,143	9.02	%
Interest-earning assets, gross (2)		12,181,843		300,395	4.92	%		12,024,172		273,861	4.55	%
Allowance for loan losses		(59,493)						(64,569)
Interest-earning assets, net		12,122,350						11,959,603
Noninterest-earning assets		1,416,638						1,257,495
Total assets	$	13,538,988					$	13,217,098
Liabilities and Stockholders' Equity
Interest-bearing liabilities
Interest-bearing deposits	$	5,808,968	$	35,142	1.22	%	$	5,430,242	$	18,811	0.70	%
Securities loaned		1,379,149		28,208	4.12	%		1,374,082		28,814	4.23	%
Notes payable and other borrowings		1,228,258		19,939	3.26	%		1,393,146		17,507	2.52	%
Total interest-bearing liabilities		8,416,375		83,289	1.99	%		8,197,470		65,132	1.60	%
Noninterest-bearing liabilities
Noninterest-bearing deposits		2,535,007						2,456,189
Other liabilities		587,323						650,557
Total liabilities		11,538,705						11,304,216
Stockholders’ equity		1,977,274						1,910,736
Noncontrolling interest		23,009						2,146
Total liabilities and stockholders' equity	$	13,538,988					$	13,217,098
Net interest income (2)			$	217,106					$	208,729
Net interest spread (2)					2.93	%					2.95	%
Net interest margin (2)					3.59	%					3.50	%

(1) Average balance includes non-accrual loans.

(2) Presented on a taxable equivalent basis with annualized taxable equivalent adjustments based on the applicable corporate federal income tax rate of 21% for the periods presented. The adjustment to interest income was $0.2 million for both the three months ended June 30, 2019 and 2018, and $0.3 million and $0.5 million for the six months ended June 30, 2019 and 2018, 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 by the banking segment, are eliminated from the consolidated financial statements.

On a consolidated basis, net interest income increased during the three and six months ended June 30, 2019, compared with the same periods in 2018, primarily due to changes attributable to both volumes and yields within our banking segment, partially offset by a decrease in accretion of discount on loans. 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.

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The provision (recovery) for loan losses is determined by management as the amount to be added to (recovered from) the allowance for loan losses after net charge-offs have been deducted to bring the allowance to a level which, in management’s best estimate, is necessary to absorb probable losses within the existing loan portfolio. Substantially all of our consolidated provision (recovery) for loan losses is related to the banking segment. During the six months ended June 30, 2019, the provision for loan losses was impacted by the banking segment’s release of a $2.0 million reserve associated with previously estimated hurricane loss exposures due to improved customer performance. The provision for loan losses was comprised of the following (in thousands).

	Three Months Ended June 30,					Six Months Ended June 30,
	2019		2018			2019		2018
Charges (recovery of charges) relating to newly originated loans and acquired loans without credit impairment at acquisition	$	(1,189)	$	1,336	$	(698)	$	(205)
Charges (recovery of charges) on PCI loans		517		(996)		977		(1,262)
Provision (recovery) for loan losses	$	(672)	$	340	$	279	$	(1,467)

Consolidated noninterest income increased during the three months ended June 30, 2019, compared with the same period in 2018, primarily due to increases in noninterest income within our broker-dealer and mortgage origination segments, partially offset by decreases within our insurance segment and corporate. Consolidated noninterest income increased during the six months ended June 30, 2019, compared with the same period in 2018, primarily due to increases in noninterest income within our broker-dealer and insurance segments and corporate, partially offset by a decrease within our mortgage origination segment.

Consolidated noninterest expense increased during the three and six months ended June 30, 2019, compared with the same periods in 2018, primarily due to increases within our broker-dealer segment and corporate, partially offset by decreases within our banking, mortgage origination and insurance segments.

Consolidated effective income tax rates during the three months ended June 30, 2019 and 2018, were 23.1% and 24.3%, respectively, and for the six months ended June 30, 2019 and 2018, were 22.9% and 23.9%, respectively, and approximated the applicable statutory rates for such periods.

Segment Results

Banking Segment

The following table presents certain information about the operating results of our banking segment (in thousands).

	Three Months Ended June 30,				Variance		Six Months Ended June 30,				Variance
	2019		2018		2019 vs 2018		2019		2018		2019 vs 2018
Net interest income	$	93,423	$	87,958	$	5,465	$	186,113	$	174,596	$	11,517
Provision (recovery) for loan losses		(670)		—		(670)		355		(1,531)		1,886
Noninterest income		10,742		10,644		98		21,362		20,823		539
Noninterest expense		58,251		65,542		(7,291)		118,977		124,913		(5,936)
Income before income taxes	$	46,584	$	33,060	$	13,524	$	88,143	$	72,037	$	16,106

Income before income taxes increased during the three and six months ended June 30, 2019, compared with the same periods in 2018, primarily due to an increase in net interest income associated with net volume and yield changes, partially offset by an increase in deposit rates and a decline in accretion of discount on loans. 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.

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The ratios shown in the table below include certain key indicators of the performance and asset quality of our banking segment.

	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
Efficiency ratio (1)	55.92	%	66.47	%	57.35	%	63.92	%
Return on average assets	1.43	%	1.09	%	1.38	%	1.20	%
Net interest margin (2) (4)	4.06	%	4.11	%	4.15	%	4.13	%
Net interest margin (taxable equivalent) (3) (4)	4.06	%	4.12	%	4.15	%	4.14	%
Net recoveries (charge-offs) to average loans outstanding	(0.18)	%	(0.11)	%	(0.14)	%	(0.01)	%

(1) Efficiency ratio is defined as noninterest expenses divided by the sum of total noninterest income and net interest income for the period.

(2) Net interest margin is defined as net interest income divided by average interest-earning assets.

(3) Net interest margin (taxable equivalent), a non-GAAP measure, is defined as taxable equivalent net interest income divided by average interest-earning assets. Annualized taxable equivalent adjustments are based on the applicable corporate federal income tax rate of 21% for the periods presented. The interest income earned on certain earning assets is completely or partially exempt from federal income tax. See footnote 2 to the following tables for the taxable equivalent adjustments to interest income.

(4) During the three months ended June 30, 2019 and 2018, purchase accounting contributed 31 basis points and 42 basis points, respectively, to net interest margin and taxable equivalent net interest margin. During the six months ended June 30, 2019 and 2018, purchase accounting contributed 37 basis points and 47 basis points, respectively, to net interest margin and taxable equivalent net interest margin.

The banking segment presents net interest margin in the table above, and net interest margin and net interest income in the following discussion and tables below, on a taxable equivalent basis. The interest income earned on certain earning assets is completely or partially exempt from federal income tax. As such, these tax-exempt instruments typically yield lower returns than taxable investments. To provide more meaningful comparisons of net interest margins for all earning assets, we use net interest income on a taxable equivalent basis in calculating net interest margin by increasing the interest income earned on tax-exempt assets to make it fully equivalent to interest income earned on taxable investments.

During the three months ended June 30, 2019 and 2018, purchase accounting contributed 31 and 42 basis points, respectively, to the banking segment’s taxable equivalent net interest margin of 4.06% and 4.12%, respectively. During the six months ended June 30, 2019 and 2018, purchase accounting contributed 37 and 47 basis points, respectively, to the banking segment’s taxable equivalent net interest margin of 4.15% and 4.14%, respectively. These purchase accounting items are associated with the Bank Transactions as detailed in the tables previously presented in the Consolidated Operating Results section.

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The tables below provide additional details regarding our banking segment’s net interest income (dollars in thousands).

	Three Months Ended June 30,
	2019						2018
	Average		Interest		Annualized		Average		Interest		Annualized
	Outstanding		Earned or		Yield or		Outstanding		Earned or		Yield or
	Balance		Paid		Rate		Balance		Paid		Rate
Assets
Interest-earning assets
Loans held for investment, gross (1)	$	6,562,887	$	92,311	5.58	%	$	5,822,978	$	79,173	5.40	%
Subsidiary warehouse lines of credit		1,180,367		14,064	4.71	%		1,462,319		15,444	4.18	%
Investment securities - taxable		1,185,925		7,650	2.58	%		943,411		5,333	2.26	%
Investment securities - non-taxable (2)		93,198		796	3.42	%		112,148		945	3.37	%
Federal funds sold and securities purchased under agreements to resell		454		—	0.18	%		585		1	0.73	%
Interest-bearing deposits in other financial institutions		167,583		1,004	2.40	%		190,984		851	1.79	%
Other		48,987		609	4.98	%		45,529		542	4.76	%
Interest-earning assets, gross (2)		9,239,401		116,434	5.00	%		8,577,954		102,289	4.73	%
Allowance for loan losses		(59,363)						(63,044)
Interest-earning assets, net		9,180,038						8,514,910
Noninterest-earning assets		931,815						881,822
Total assets	$	10,111,853					$	9,396,732
Liabilities and Stockholders’ Equity
Interest-bearing liabilities
Interest-bearing deposits	$	5,523,716	$	19,940	1.45	%	$	5,029,042	$	12,479	1.00	%
Notes payable and other borrowings		494,439		2,918	2.34	%		455,002		1,660	1.45	%
Total interest-bearing liabilities		6,018,155		22,858	1.52	%		5,484,044		14,139	1.03	%
Noninterest-bearing liabilities
Noninterest-bearing deposits		2,517,946						2,459,643
Other liabilities		74,802						45,262
Total liabilities		8,610,903						7,988,949
Stockholders’ equity		1,500,950						1,407,783
Total liabilities and stockholders’ equity	$	10,111,853					$	9,396,732
Net interest income (2)			$	93,576					$	88,150
Net interest spread (2)					3.48	%					3.70	%
Net interest margin (2)					4.06	%					4.12	%

	Six Months Ended June 30,
	2019						2018
	Average		Interest		Annualized		Average		Interest		Annualized
	Outstanding		Earned or		Yield or		Outstanding		Earned or		Yield or
	Balance		Paid		Rate		Balance		Paid		Rate
Assets
Interest-earning assets
Loans held for investment, gross (1)	$	6,461,968	$	183,621	5.66	%	$	5,808,832	$	158,364	5.43	%
Subsidiary warehouse lines of credit		1,059,085		25,149	4.72	%		1,338,227		27,143	4.03	%
Investment securities - taxable		1,150,060		14,742	2.56	%		924,125		10,159	2.20	%
Investment securities - non-taxable (2)		95,383		1,625	3.41	%		114,839		1,925	3.35	%
Federal funds sold and securities purchased under agreements to resell		435		—	0.15	%		540		2	0.57	%
Interest-bearing deposits in other financial institutions		241,540		2,918	2.44	%		286,140		2,325	1.64	%
Other		45,057		1,153	5.12	%		45,981		1,048	4.56	%
Interest-earning assets, gross (2)		9,053,528		229,208	5.05	%		8,518,684		200,966	4.70	%
Allowance for loan losses		(59,386)						(63,938)
Interest-earning assets, net		8,994,142						8,454,746
Noninterest-earning assets		938,574						886,028
Total assets	$	9,932,716					$	9,340,774
Liabilities and Stockholders’ Equity
Interest-bearing liabilities
Interest-bearing deposits	$	5,524,537	$	38,935	1.42	%	$	5,088,835	$	23,655	0.94	%
Notes payable and other borrowings		338,028		3,851	2.27	%		368,932		2,322	1.25	%
Total interest-bearing liabilities		5,862,565		42,786	1.47	%		5,457,767		25,977	0.96	%
Noninterest-bearing liabilities
Noninterest-bearing deposits		2,503,017						2,436,115
Other liabilities		83,503						47,580
Total liabilities		8,449,085						7,941,462
Stockholders’ equity		1,483,631						1,399,312
Total liabilities and stockholders’ equity	$	9,932,716					$	9,340,774
Net interest income (2)			$	186,422					$	174,989
Net interest spread (2)					3.58	%					3.74	%
Net interest margin (2)					4.15	%					4.14	%

(1) Average balance includes non-accrual loans.

(2) Presented on a taxable equivalent basis with annualized taxable equivalent adjustments based on the applicable corporate federal income tax rate of 21% for the periods presented. The adjustments to interest income were $0.2 million for both the three months ended June 30, 2019 and 2018, and $0.3 million and $0.4 million for the six months ended June 30, 2019 and 2018, respectively.

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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 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).

	Three Months Ended June 30,							Six Months Ended June 30,
	2019 vs. 2018							2019 vs. 2018
	Change Due To (1)						��	Change Due To (1)
	Volume		Yield/Rate		Change			Volume		Yield/Rate		Change
Interest income
Loans held for investment, gross	$	9,954	$	3,184	$	13,138		$	8,848	$	16,409	$	25,257
Subsidiary warehouse lines of credit		(2,937)		1,557		(1,380)			(2,808)		814		(1,994)
Investment securities - taxable		1,367		950		2,317			1,239		3,344		4,583
Investment securities - non-taxable (2)		(159)		10		(149)			(163)		(137)		(300)
Federal funds sold and securities purchased under agreements to resell		—		(1)		(1)			—		(2)		(2)
Interest-bearing deposits in other financial institutions		(104)		257		153			(182)		775		593
Other		41		26		67			(11)		116		105
Total interest income (2)		8,162		5,983		14,145			6,923		21,319		28,242
Interest expense
Deposits	$	1,227	$	6,234	$	7,461		$	1,018	$	14,262	$	15,280
Notes payable and other borrowings		142		1,116		1,258			(97)		1,626		1,529
Total interest expense		1,369		7,350		8,719			921		15,888		16,809
Net interest income (2)	$	6,793	$	(1,367)	$	5,426		$	6,002	$	5,431	$	11,433

(1) Changes attributable to both volume and yield/rate are included in yield/rate column.

(2) Annualized taxable equivalent.

Changes in the yields earned on interest-earning assets increased taxable equivalent net interest income during the three and six months ended June 30, 2019, compared to the same periods in 2018, primarily as a result of higher loan yields due to increased market rates, partially offset by decreases in accretion of discount on loans of $1.9 million and $3.1 million during the respective periods. Accretion of discount on loans is expected to continue 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, primarily due to increases in the loan portfolio as a result of the BORO Acquisition and seasonal increases in mortgage warehouse lending volume, increased taxable equivalent net interest income during the three and six months ended June 30, 2019, compared with the same periods in 2018. Changes in rates paid on interest-bearing liabilities decreased taxable equivalent net interest income during the three and six months ended June 30, 2019, compared with the same periods in 2018, due to increases in market interest rates. Our portfolio includes loans that periodically reprice or mature prior to the end of an amortized term. Some of our variable-rate loans remain at applicable rate floors, which may delay and/or limit changes in interest income during a period of changing rates. If interest rates were to fall, the impact on our interest income for certain variable-rate loans would be limited by these rate floors. In addition, declining interest rates may negatively affect our cost of funds on deposits. The extent of this impact will ultimately be driven by the timing, magnitude and frequency of interest rate and yield curve movements, as well as changes in market conditions and timing of management strategies. If interest rates were to rise, yields on the portion of our loan portfolio that remain at applicable rate floors would rise more slowly than increases in market interest rates. Any changes in interest rates across the term structure will continue to impact net interest income and net interest margin. The impact of rate movements will change with the shape of the yield curve, including any changes in steepness or flatness and inversions at any points on the yield curve.

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The banking segment’s noninterest income increased during the three and six months ended June 30, 2019, compared to the same periods in 2018, primarily due to year-over-year increases in service charge income due to the restructuring of our products.

The banking segment’s noninterest expenses decreased during the three and six months ended June 30, 2019, compared to the same periods in 2018, primarily due to a reduction in net expenses associated with previously covered assets, including the FDIC Indemnification Asset discussed in the “Factors Affecting Comparability of Results of Operations” section above. Additionally, during the second quarter of 2018, the Bank was the victim of a “spear phishing” attack which resulted in a wire fraud loss of approximately $4.0 million and approximately $0.3 million of other related expenses. We have not recorded an accrual for future claims related to this matter as we have not concluded that such a loss is probable.

Broker-Dealer Segment

The following table provides additional detail regarding our broker-dealer operating results (in thousands).

	Three Months Ended June 30,					Variance	Six Months Ended June 30,				Variance
	2019		2018			2019 vs 2018	2019		2018		2019 vs 2018
Net interest income:
Securities lending	$	2,047	$	2,411	$	(364)	$	4,168	$	4,972	$	(804)
Structured finance		1,472		3,324		(1,852)		3,625		5,232		(1,607)
Clearing		3,085		3,107		(22)		5,736		6,168		(432)
Other		4,806		4,048		758		10,731		9,069		1,662
Total net interest income		11,410		12,890		(1,480)		24,260		25,441		(1,181)
Noninterest income:
Securities commissions and fees by business line (1):
Capital markets		8,949		10,892		(1,943)		20,157		21,029		(872)
Retail		18,805		20,084		(1,279)		36,856		41,028		(4,172)
Clearing		8,484		8,854		(370)		17,269		17,859		(590)
Other		748		1,261		(513)		1,521		2,654		(1,133)
		36,986		41,091		(4,105)		75,803		82,570		(6,767)
Investment and securities advisory fees and commissions by business line:
Public banking		14,099		15,088		(989)		26,772		27,144		(372)
Capital markets		1,814		800		1,014		3,742		1,750		1,992
Retail		5,160		4,688		472		9,703		9,050		653
Structured finance		1,433		1,059		374		2,154		1,714		440
Clearing		320		285		35		595		577		18
Other		33		45		(12)		53		84		(31)
		22,859		21,965		894		43,019		40,319		2,700
Other:
Structured finance		37,819		5,336		32,483		61,547		9,900		51,647
Capital markets		7,648		4,863		2,785		15,558		7,324		8,234
Other		247		334		(87)		938		2,022		(1,084)
		45,714		10,533		35,181		78,043		19,246		58,797
Total noninterest income		105,559		73,589		31,970		196,865		142,135		54,730
Net revenue (2)		116,969		86,479		30,490		221,125		167,576		53,549
Noninterest expense:
Variable compensation (3)		44,833		26,036		18,797		79,414		50,630		28,784
Non-variable compensation and benefits		25,500		26,382		(882)		53,994		54,053		(59)
Segment operating costs (4)		24,535		25,889		(1,354)		49,193		51,124		(1,931)
Total noninterest expense		94,868		78,307		16,561		182,601		155,807		26,794
Income before income taxes	$	22,101	$	8,172	$	13,929	$	38,524	$	11,769	$	26,755

(1) Securities commissions and fees includes income of $2.9 million and $2.8 million during the three months ended June 30, 2019 and 2018, respectively, and $5.7 million and $5.6 million during the six months ended June 30, 2019 and 2018, respectively, that is eliminated in consolidation.

(2) Net revenue is defined as the sum of total net interest income and total noninterest income.

(3) Variable compensation represents performance-based commissions and incentives.

(4) Segment operating costs include provision for loan losses associated with the broker-dealer segment.

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Income before income taxes increased during the three and six months ended June 30, 2019, compared with the same periods in 2018, primarily as a result of 35% and 32% respective increases in net revenues, most notably in trading gains earned from our derivative and trading portfolio activities, primarily from our structured finance and capital markets businesses. The increases in trading gains during the three and six months ended June 30, 2019, compared to the same periods in 2018, were primarily due to a more favorable market environment resulting in 10% and 17% respective increases in trading volumes, enhanced spreads and 25% and 18% respective increases in the structured finance business line’s to-be-announced (“TBA”) mortgage-backed securities volume. We have experienced a more robust business environment in 2019 than we observed in 2018 primarily as a result of recent decreases in interest rates (see other noninterest income discussion that follows), increased customer demand, improved product distribution, and other strategic enhancements. These increases were offset by $18.8 million and $28.8 million respective increases in variable compensation based on more robust financial results and, with respect to the six months ended June 30, 2019, the $2.2 million in pre-tax costs recognized in the first quarter of 2019 associated with Leadership Changes as noted in the “Factors Affecting Results of Operations” section above.

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. Rapid or significant changes in interest rates could adversely affect the broker-dealer segment’s bond trading, sales, underwriting activities and other interest spread-sensitive activities described below. The broker-dealer segment also receives administrative fees for providing money market and FDIC investment alternatives to clients, which tend to be sensitive to short term interest rates. In addition, the profitability of the broker-dealer segment depends, to an extent, on the spread between revenues earned on customer loans and excess customer cash balances, and the interest expense paid on customer cash balances, as well as the interest revenue earned on trading securities, net of financing costs.

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. Net interest income decreased between the three and six months ended June 30, 2019, and the comparable periods in 2018, resulting from decreases in net interest income from our structured finance operations due to a decline in pool inventory from June 30, 2018 to June 30, 2019 and decreases in net interest income from the segment’s stock lending activities due to 15% and 13% respective decreases in average stock lending balances. These decreases were partially offset by increases in net interest earned on trading securities.

Noninterest income increased between the three and six months ended June 30, 2019, and the comparable periods in 2018, primarily due to increases in other noninterest income and investment and securities advisory fees and commissions, partially offset by decreases in securities commissions and fees.

Securities commissions and fees decreased during the three and six months ended June 30, 2019, compared with the same periods in 2018, primarily due to decreases in commissions earned on municipal bond, over-the-counter securities and insurance transactions.

Investment and securities advisory fees and commissions increased during the three and six months ended June 30, 2019, compared with the same periods in 2018, primarily due to improved trading volumes.

Other noninterest income increased during the three and six months ended June 30, 2019, compared with the same periods in 2018, primarily as a result of $35.5 million and $59.9 million respective increases in trading gains earned from our derivative and trading portfolio activities, most notably in our structured finance business, which accounted for $32.5 million and $51.6 million of the respective increases, while our capital markets business accounted for $2.8 million and $8.2 million of the respective increases. The $32.5 million and $51.6 million increases in our structured finance business were primarily due to the 41 and 69 respective basis-point declines in the 10-year treasury bond yield during the three and six months ended June 30, 2019 compared to 11 and 45 respective basis-point increases during the same periods in 2018, and 25% and 18% respective increases in the TBA mortgage-backed securities volume. The $2.8 million and $8.2 million respective increases in our capital markets business is attributable to an improved market environment, improved spreads and 10% and 17% respective increases in trading volume.

Noninterest expenses increased during the three and six months ended June 30, 2019, compared to the same periods in 2018, primarily due to increases in variable compensation and, with respect to the six months ended June 30, 2019, the

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$2.2 million in pre-tax costs recognized in the first quarter of 2019 associated with Leadership Changes as noted in the “Factors Affecting Results of Operations” section above.

Selected information concerning the broker-dealer segment follows (dollars in thousands).

	Three Months Ended June 30,						Six Months Ended June 30,
	2019				2018		2019				2018
Total compensation as a % of net revenue		60.1	%		60.6	%		60.3	%		62.5	%
FDIC insured program balances at the Bank (end of period)							$	1,304,744		$	1,278,694
Other FDIC insured program balances (end of period)							$	675,621		$	896,739
Customer margin balances (end of period)							$	336,729		$	355,561
Customer funds on deposit, including short credits (end of period)							$	325,427		$	354,277
Public banking:
Number of issues		350			368			563			604
Aggregate amount of offerings	$	14,347,624		$	15,066,403		$	26,139,362		$	25,715,524
Capital markets:
Total volumes	$	22,570,905		$	20,505,462		$	42,602,822		$	36,376,727
Net inventory (end of period)							$	553,586		$	376,388
Retail:
Retail employee representatives (end of period)								124			124
Independent registered representatives (end of period)								203			218
Structured finance:
Lock production/TBA volume	$	1,650,597		$	1,318,084		$	2,798,811		$	2,379,596
Clearing:
Total tickets		509,546			373,385			1,014,767			779,516
Correspondents (end of period)								148			152
Securities lending:
Interest-earning assets - stock borrowed (end of period)							$	1,569,362		$	1,491,182
Interest-bearing liabilities - stock loaned (end of period)							$	1,459,218		$	1,316,128

Mortgage Origination Segment

The following table presents certain information regarding the operating results of our mortgage origination segment (in thousands).

	Three Months Ended June 30,				Variance		Six Months Ended June 30,				Variance
	2019		2018		2019 vs 2018		2019		2018		2019 vs 2018
Net interest income (expense)	$	(1,031)	$	704	$	(1,735)	$	(1,499)	$	1,645	$	(3,144)
Noninterest income		164,548		162,759		1,789		282,580		289,862		(7,282)
Noninterest expense		141,721		150,026		(8,305)		256,398		280,729		(24,331)
Income before income taxes	$	21,796	$	13,437	$	8,359	$	24,683	$	10,778	$	13,905

The mortgage lending business is subject to variables that can impact loan origination volume, including seasonal and interest rate fluctuations. Historically, the mortgage origination segment has typically experienced increased loan origination volume from purchases of homes during the spring and summer, 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. As average mortgage interest rates have decreased between the three months ended June 30, 2018 and the comparable period in 2019, refinancing volume as a percentage of total origination volume has increased from 12.0% to 15.9%. Refinancing volume as a percentage of total origination volume for the six months ended June 30, 2019 and the comparable period in 2018 was relatively flat at approximately 16%. Changes in mortgage interest rates have historically had a lesser impact on home purchases volume than on refinancing volume. We anticipate that recent decreases in mortgage interest rates will increase the percentage of refinancing volumes relative to total loan origination volume for the remainder of 2019.

The mortgage origination segment primarily originates its mortgage loans through a retail channel, with limited lending through its affiliated business arrangements (“ABAs”). For the six months ended June 30, 2019, funded volume through ABAs was approximately 7% of the mortgage origination segment’s total loan volume. Currently, PrimeLending owns a 51% membership interest in four ABAs. We expect production within the ABA channel to increase to between 8% and 10% of the total loan volume of the mortgage origination for 2019.

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The following table provides certain details regarding our mortgage loan originations and selected information for the periods indicated below (dollars in thousands).

	Three Months Ended June 30,										Six Months Ended June 30,
	2019				2018						2019				2018
			% of				% of			Variance			% of				% of			Variance
	Amount		Total		Amount		Total			2019 vs 2018	Amount		Total		Amount		Total			2019 vs 2018
Mortgage Loan Originations - units		15,760				17,007				(1,247)		26,038				29,318				(3,280)
Mortgage Loan Originations - volume	$	3,960,089			$	4,107,375			$	(147,286)	$	6,407,131			$	7,067,172			$	(660,041)
Mortgage Loan Originations:
Conventional	$	2,388,216	60.31	%	$	2,529,836	61.59	%	$	(141,620)	$	3,879,150	60.54	%	$	4,289,069	60.69	%	$	(409,919)
Government		976,733	24.66	%		998,786	24.32	%		(22,053)		1,574,915	24.58	%		1,754,865	24.83	%		(179,950)
Jumbo		334,708	8.45	%		354,275	8.63	%		(19,567)		529,848	8.27	%		629,884	8.91	%		(100,036)
Other		260,432	6.58	%		224,478	5.46	%		35,954		423,218	6.61	%		393,354	5.57	%		29,864
	$	3,960,089	100.00	%	$	4,107,375	100.00	%	$	(147,286)	$	6,407,131	100.00	%	$	7,067,172	100.00	%	$	(660,041)
Home purchases	$	3,329,024	84.06	%	$	3,615,991	88.04	%	$	(286,967)	$	5,379,784	83.97	%	$	5,974,683	84.54	%	$	(594,899)
Refinancings		631,065	15.94	%		491,384	11.96	%		139,681		1,027,347	16.03	%		1,092,489	15.46	%		(65,142)
	$	3,960,089	100.00	%	$	4,107,375	100.00	%	$	(147,286)	$	6,407,131	100.00	%	$	7,067,172	100.00	%	$	(660,041)
Texas	$	758,016	19.14	%	$	764,337	18.61	%	$	(6,321)	$	1,227,468	19.16	%	$	1,328,961	18.80	%	$	(101,493)
California		376,086	9.50	%		449,994	10.96	%		(73,908)		613,820	9.58	%		836,232	11.83	%		(222,412)
Florida		288,711	7.29	%		309,413	7.53	%		(20,702)		485,798	7.58	%		526,721	7.45	%		(40,923)
Arizona		176,753	4.46	%		164,240	4.00	%		12,513		289,459	4.52	%		291,449	4.12	%		(1,990)
Ohio		174,581	4.41	%		184,169	4.48	%		(9,588)		278,118	4.34	%		300,960	4.26	%		(22,842)
South Carolina		151,620	3.83	%		138,012	3.36	%		13,608		250,331	3.91	%		233,635	3.31	%		16,696
Washington		158,251	4.00	%		155,215	3.78	%		3,036		245,004	3.82	%		261,855	3.71	%		(16,851)
Maryland		135,191	3.41	%		121,339	2.95	%		13,852		212,234	3.31	%		210,538	2.98	%		1,696
Missouri		135,248	3.42	%		137,557	3.35	%		(2,309)		210,061	3.28	%		228,145	3.23	%		(18,084)
North Carolina		116,058	2.93	%		128,157	3.12	%		(12,099)		197,954	3.09	%		222,105	3.14	%		(24,151)
All other states		1,489,574	37.61	%		1,554,942	37.86	%		(65,368)		2,396,884	37.41	%		2,626,571	37.17	%		(229,687)
	$	3,960,089	100.00	%	$	4,107,375	100.00	%	$	(147,286)	$	6,407,131	100.00	%	$	7,067,172	100.00	%	$	(660,041)
Mortgage Loan Sales - volume	$	3,338,070			$	3,526,603			$	(188,533)	$	6,049,184			$	6,712,041			$	(662,857)

The mortgage origination segment’s total loan origination volume during the three and six months ended June 30, 2019 decreased 3.6% and 9.3%, respectively, compared to the same periods in 2018, while income before income taxes during the three and six months ended June 30, 2019 increased 62.2% and 129.0%, respectively, compared to the same periods in 2018. The increase in income before taxes during the three months ended June 30, 2019, compared to the same period in 2018, was primarily due to a decrease in segment operating costs, and an increase in mortgage loan origination fees and other related income. These changes were partially offset by a decrease in the change in net fair value and related derivative activity of mortgage servicing rights asset. The increase in income before income taxes during the six months ended June 30, 2019, compared to the same period in 2018, was primarily due to a decrease in segment operating costs and variable compensation and increases in the change in net fair value and related derivative activity of interest rate lock commitments (“IRLCs”) and loans held for sale. These changes were partially offset by a decrease in net gains from sale of loans.

Net interest income (expense) decreased $1.7 million and $3.1 million during the three and six months ended June 30, 2019, respectively, compared to the same periods in 2018. Net interest income (expense) during the three and six months ended June 30, 2019 and 2018 was primarily comprised of interest incurred on warehouse lines of credit held with the Bank as well as related intercompany financing costs, partially offset by interest earned on loans held for sale. Year-over-year decreases in average mortgage interest rates contributed to a decrease in yield on loans held for sale in the mortgage origination segment. Also contributing to the decrease in net interest income was an increase in year-over-year average interest rates on mortgage warehouse lines.

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Noninterest income was comprised of the items set forth in the table below (in thousands).

	Three Months Ended June 30,				Variance		Six Months Ended June 30,				Variance
	2019		2018		2019 vs 2018		2019		2018		2019 vs 2018
Net gains from sale of loans	$	110,996	$	111,719	$	(723)	$	200,347	$	217,824	$	(17,477)
Mortgage loan origination fees and other related income		33,409		29,618		3,791		55,282		50,544		4,738
Other mortgage production income:
Change in net fair value and related derivative activity:
IRLCs and loans held for sale		18,722		17,032		1,690		21,925		12,494		9,431
Mortgage servicing rights asset		(5,198)		(1,688)		(3,510)		(7,864)		(2,830)		(5,034)
Servicing fees		6,619		6,078		541		12,890		11,830		1,060
Total noninterest income	$	164,548	$	162,759	$	1,789	$	282,580	$	289,862	$	(7,282)

The decreases in net gains from sale of loans during the three and six months ended June 30, 2019, compared with the same periods in 2018, were primarily a result of decreases in total loan sales volume, partially offset by increases in average loan sales margin during the three and six months ended June 30, 2019, compared with the same periods in 2018. The increases in mortgage loan origination fees were primarily the result of increases in average mortgage loan origination fees, partially offset by decreases in total loan origination volume, during three and six months ended June 30, 2019, compared with the same periods in 2018.

Noninterest income included the impact of changes between periods 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 mortgage loans held for sale. The increases during the three and six months ended June 30, 2019, were primarily the result of increases in the volume of IRLCs and loans held for sale, partially offset by decreases 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, the majority servicing released. During the three months ended June 30, 2019, the mortgage origination segment retained servicing on approximately 6% of loans sold, compared to 7% during the same period in 2018. During the six months ended June 30, 2019, the mortgage origination segment retained servicing on approximately 6% of loans sold, compared to 12% during the same period in 2018. 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. The related MSR asset was valued at $55.2 million on $5.2 billion of serviced loan volume at June 30, 2019, compared with a value of $67.9 million on $5.3 billion of serviced loan volume at December 31, 2018. 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 the banking segment. Gains and losses associated with such sales to the banking segment and the related MSR asset are eliminated in consolidation. The mortgage origination segment uses derivative financial instruments, including U.S. Treasury bond futures and options, Eurodollar futures and forward commitments to sell mortgage-backed securities, 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 losses of $5.2 million and $7.9 million during the three and six months ended June 30, 2019, respectively, compared to net losses of $1.7 million and $2.8 million during the three and six months ended June 30, 2018, respectively. Additionally, net servicing income was $3.5 million and $6.6 million during the three and six months ended June 30, 2019, respectively, compared with $2.9 million and $5.4 million during the same periods in 2018.

Noninterest expenses were comprised of the items set forth in the table below (in thousands).

	Three Months Ended June 30,				Variance		Six Months Ended June 30,				Variance
	2019		2018		2019 vs 2018		2019		2018		2019 vs 2018
Variable compensation	$	65,516	$	66,531	$	(1,015)	$	104,445	$	112,823	$	(8,378)
Non-variable compensation and benefits		40,933		45,182		(4,249)		81,047		89,949		(8,902)
Segment operating costs		27,241		29,007		(1,766)		56,168		60,705		(4,537)
Lender paid closing costs		4,925		6,134		(1,209)		8,423		10,826		(2,403)
Servicing expense		3,106		3,172		(66)		6,315		6,426		(111)
Total noninterest expense	$	141,721	$	150,026	$	(8,305)	$	256,398	$	280,729	$	(24,331)

During the third quarter of 2018, PrimeLending committed to close certain underperforming branches, while at the same time reducing its fulfillment and corporate support staff. The purpose of this initiative was to better align resources and

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lower PrimeLending’s cost structure. The decreases in non-variable compensation and benefits and segment operating costs during the three and six months ended June 30, 2019, compared to the same periods in 2018, were primarily the result of this initiative. Decreases in noninterest expense as a result of this initiative have been partially offset by costs related to the “Technology Enhancements and Corporate Initiatives” discussed in detail within the “Overview” above.

Total employees’ compensation and benefits accounted for the majority of noninterest expenses incurred during all periods presented. Specifically, variable compensation comprised 61.5% and 59.6% of total employees’ compensation and benefits expenses during the three months ended June 30, 2019 and 2018, respectively, and 56.3% and 55.6% during the six months ended June 30, 2019 and 2018, respectively. Variable compensation, which is primarily driven by loan origination volume, tends to fluctuate to a greater degree than loan origination volume because mortgage loan originator and fulfillment staff incentive compensation plans are structured to pay at increasing rates as higher monthly volume tiers are achieved. However, certain other incentive compensation plans driven by non-mortgage production criteria may alter this trend. The decreases in variable compensation and benefits between the three and six months ended June 30, 2019 and 2018 were partially offset by an increase in the average incentive rate paid.

While total loan origination volume decreased 3.6% and 9.3% for the three and six months ended June 30, 2019, respectively, compared to the same periods in 2018, the aggregate non-variable compensation and benefits and segment operating costs of the mortgage origination segment decreased 8.1% and 8.9%, respectively. The aforementioned decreases during the three and six months ended June 30, 2019, compared to the same periods in 2018, were primarily due to decreases in non-variable compensation and benefits, in addition to decreases in occupancy and advertising costs, partially offset by increases in software license and maintenance fees. In addition, during the three months ended June 30, 2019, compared to the same period in 2018, professional fees were relatively flat, while during the six months ended June 30, 2019, compared to the same period in 2018, professional fees decreased. The decreases in non-variable compensation and benefits and occupancy costs during the three and six months ended June 30, 2019, were due to a reduction in fulfillment and corporate staff and the closure of certain underperforming branches primarily resulting from PrimeLending’s cost reduction initiative discussed above and implemented during the third quarter of 2018.

In exchange for a higher interest rate, customers may opt to have PrimeLending pay certain costs associated with the origination of their mortgage loans (“lender paid closing costs”). Fluctuations in lender paid closing costs are not always aligned with fluctuations in loan origination volume. Other loan pricing conditions, including the mortgage loan interest rate, loan origination fees paid by the customer, and a customer’s willingness to pay closing costs, may influence fluctuations in lender paid closing costs.

Between January 1, 2010 and June 30, 2019, the mortgage origination segment sold mortgage loans totaling $113.7 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 2010, it does not anticipate experiencing significant losses in the future on loans originated prior to 2010 as a result of investor claims under these provisions of its sales contracts.

When a claim for indemnification of a loan sold is made by an agency, investor, or other party, the mortgage origination segment evaluates the claim and determines if the claim can be satisfied through additional documentation or other deliverables. If the claim is valid and cannot be satisfied in that manner, the mortgage origination segment negotiates with the claimant to reach a settlement of the claim. Settlements typically result in either the repurchase of a loan or reimbursement to the claimant for losses incurred on the loan.

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Following is a summary of the mortgage origination segment’s claims resolution activity relating to loans sold between January 1, 2010 and June 30, 2019 (dollars in thousands).

	Original Loan Balance			Loss Recognized
			% of			% of
			Loans			Loans
	Amount		Sold	Amount		Sold
Claims resolved with no payment	$	207,260	0.18%	$	—	0.00%
Claims resolved because of a loan repurchase or payment to an investor for losses incurred (1)		199,918	0.18%		9,380	0.01%
	$	407,178	0.36%	$	9,380	0.01%

(1) Losses incurred include refunded purchased servicing rights.

For each loan it 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.

At June 30, 2019 and December 31, 2018, the mortgage origination segment’s indemnification liability reserve totaled $10.8 million and $10.7 million, respectively. The related provision for indemnification losses was $0.8 million and $1.0 million during the three months ended June 30, 2019 and 2018, respectively, and $1.3 million and $1.7 million during the six months ended June 30, 2019 and 2018, respectively.

Insurance Segment

The following table presents certain information regarding the operating results of our insurance segment (in thousands).

	Three Months Ended June 30,				Variance		Six Months Ended June 30,				Variance
	2019		2018		2019 vs 2018		2019		2018		2019 vs 2018
Net interest income	$	592	$	793	$	(201)	$	1,236	$	1,580	$	(344)
Noninterest income		36,151		36,546		(395)		72,643		71,564		1,079
Noninterest expense		39,589		39,712		(123)		69,926		70,725		(799)
Income (loss) before income taxes	$	(2,846)	$	(2,373)	$	(473)	$	3,953	$	2,419	$	1,534

The increase in loss before income taxes during the three months ended June 30, 2019, compared with the same period in 2018, was primarily due to a decrease in net insurance premiums earned, including the effects of the non-renewal of commercial policies and the discontinuation of writing new policies five in non-core states, in addition to an increase in loss and LAE. The increase in income before income taxes during the six months ended June 30, 2019, compared with the same period in 2018, was primarily due to a larger increase in the fair value associated with the equity securities held by the insurance segment, partially offset by a decline in net insurance premiums earned, including the effects of the factors previously discussed.

The insurance segment is subject to claims arising out of severe weather, the incidence and severity of which are inherently unpredictable. Generally, the insurance segment’s insured risks exhibit higher losses in the second and third calendar quarters due to a seasonal concentration of weather-related events in its primary geographic markets. Although weather-related losses (including hail, high winds, tornadoes, monsoons and hurricanes) can occur in any calendar quarter, the second calendar quarter, historically, has experienced the highest frequency of losses associated with these events. Hurricanes, however, are more likely to occur in the third calendar quarter of the year.

The insurance segment periodically reviews the pricing of its primary products in each state of operation utilizing a consulting actuarial firm to supplement normal review processes resulting in filings to adjust rates as deemed necessary. The benefit of these rate actions are not fully realized until all policies under the old rates expire, which typically occurs one year from the date of rate change implementation. Concurrently, business concentrations are reviewed and actions initiated, including cancellation of agents, non-renewal of policies and cessation of new business writing on certain products in problematic geographic areas. The insurance segment has historically utilized rate actions to reduce the rate of premium growth for targeted areas when compared with the patterns exhibited in prior quarters and years and reduced the insurance segment’s exposure to volatile weather in these areas, but competition and customer response to

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rate increases has negatively impacted customer retention and new business. The insurance segment aims to manage and diversify its business concentrations and products to minimize the effects of future weather-related events. We believe that current initiatives to evaluate product offerings and pricing, streamline business activities and expenses and mitigate the impact of future significant weather-related events are critical to improving the insurance segment’s long-term financial condition and operating results.

The insurance segment’s operations resulted in combined ratios of 113.0% and 111.1% during the three months ended June 30, 2019 and 2018, respectively, and 99.8% and 98.1% during the six months ended June 30, 2019 and 2018, respectively. The increases in the combined ratios during the three and six months ended June 30, 2019, compared with the same periods in 2018, were primarily driven by increases in the loss and LAE ratio. The combined ratio is a measure of overall insurance underwriting profitability, and represents the sum of loss and LAE and underwriting expenses divided by net insurance premiums earned.

Noninterest income during the three months ended June 30, 2019 and 2018, was primarily comprised of net insurance premiums earned of $33.5 million and $34.1 million, respectively. Noninterest income during the six months ended June 30, 2019 and 2018, was primarily comprised of net insurance premiums earned of $66.7 million and $68.4 million, respectively. The year-over-year decrease in net insurance premiums earned were driven by the effect of historical decreases in net premiums written.

Direct insurance premiums written by major product line are presented in the table below (in thousands).

	Three Months Ended June 30,				Variance		Six Months Ended June 30,				Variance
	2019		2018		2019 vs 2018		2019		2018		2019 vs 2018
Direct Insurance Premiums Written:
Homeowners	$	14,840	$	14,248	$	592	$	26,825	$	26,721	$	104
Fire		10,809		10,967		(158)		20,576		21,171		(595)
Mobile Home		9,913		9,848		65		18,951		19,579		(628)
Other		—		738		(738)		—		1,415		(1,415)
	$	35,562	$	35,801	$	(239)	$	66,352	$	68,886	$	(2,534)

The aggregate direct insurance premiums written for our three largest insurance product lines increased by $0.5 million and decreased by $1.1 million during the three and six months ended June 30, 2019, respectively, compared with the same periods in 2018. The decrease in total direct insurance premiums written during the six months ended June 30, 2019, compared to the same period in 2018, was due to competition, rationalization of product offerings, including the non-renewal of commercial policies, and continued review of geographic concentrations. In the fourth quarter of 2018, in connection with a strategic initiative to focus on our insurance segment’s key markets, we discontinued writing new insurance policies in five non-core states. The premiums written and earned related to the commercial policies and the five non-core states is included within “Other” in the table above and the table that follows. Approximately 2% of total net insurance premiums earned during both the three and six months ended June 30, 2019 were from these five non-core states, compared to 3% of total net insurance premiums earned during both the three and six months ended June 30, 2018. As our insurance policies are generally in effect for one year, we anticipate that the full impact of this initiative on premiums earned will be complete by the end of 2019.

Net insurance premiums earned by major product line are presented in the table below (in thousands).

	Three Months Ended June 30,				Variance		Six Months Ended June 30,				Variance
	2019		2018		2019 vs 2018		2019		2018		2019 vs 2018
Net Insurance Premiums Earned:
Homeowners	$	14,029	$	13,605	$	424	$	26,953	$	26,540	$	413
Fire		10,142		10,444		(302)		20,674		21,028		(354)
Mobile Home		9,295		9,353		(58)		19,042		19,446		(404)
Other		—		703		(703)		—		1,406		(1,406)
	$	33,466	$	34,105	$	(639)	$	66,669	$	68,420	$	(1,751)

Net insurance premiums earned during the three and six months ended June 30, 2019 decreased compared to the same periods in 2018, primarily due to the decrease in direct insurance premiums written noted above.

Noninterest expenses during the three and six months ended June 30, 2019 and 2018 include both loss and LAE expenses and policy acquisition and other underwriting expenses, as well as other noninterest expenses. Loss and LAE are recognized based on formula and case basis estimates for losses reported with respect to direct business, estimates of unreported losses based on past experience and deduction of amounts for reinsurance placed with reinsurers. Loss and

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LAE ratios during the three months ended June 30, 2019 and 2018, were 74.6% and 71.6%, respectively, and during the six months ended June 30, 2019 and 2018, were 59.9% and 58.4%, respectively. The increases in the loss and LAE ratios during the three and six months ended June 30, 2019, compared to the same periods in 2018, were primarily driven by 0.1% and 2.3% respective increases in loss and LAE expense, while premiums earned decreased by 1.9% and 2.6%, respectively.

Policy acquisition and other underwriting expenses encompass all expenses incurred relative to NLC operations, and include elements of multiple categories of expense otherwise reported as noninterest expense in the consolidated statements of operations.

The following table details the calculation of the underwriting expense ratio for the periods presented (dollars in thousands).

	Three Months Ended June 30,						Variance			Six Months Ended June 30,						Variance
	2019			2018			2019 vs 2018			2019			2018			2019 vs 2018
Amortization of deferred policy acquisition costs	$	9,102		$	9,478		$	(376)		$	17,194		$	18,568		$	(1,374)
Other underwriting expenses		4,760			5,046			(286)			11,322			10,577			745
Total		13,862			14,524			(662)			28,516			29,145			(629)
Agency expenses		(1,019)			(1,061)			42			(1,884)			(1,982)			98
Total less agency expenses	$	12,843		$	13,463		$	(620)		$	26,632		$	27,163		$	(531)
Net insurance premiums earned	$	33,466		$	34,105		$	(639)		$	66,669		$	68,420		$	(1,751)
Expense ratio		38.4	%		39.5	%		(1.1)	%		39.9	%		39.7	%		0.2	%

Corporate

Corporate includes certain activities not allocated to specific business segments. These activities include holding company financing and investing activities, merchant banking investment opportunities and management and administrative services to support the overall operations of the Company. Hilltop’s merchant banking investment activities include the identification of attractive opportunities for capital deployment in companies engaged in non-financial activities through its merchant bank subsidiary, Hilltop Opportunity Partners LLC.

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 during the three and six months ended June 30, 2019, was primarily comprised of dividend income from merchant banking investment activities, in addition to interest income earned on intercompany notes.

Interest expense during each period was primarily associated with recurring quarterly interest expense of $1.9 million incurred on our $150.0 million aggregate principal amount of 5% senior notes due 2025 (“Senior Notes”). Additionally, we incurred interest expense of $1.0 million and $0.9 million during the three months ended June 30, 2019 and 2018, respectively, and $2.0 million and $1.7 million during the six months ended June 30, 2019 and 2018, respectively, on junior subordinated debentures of $67.0 million issued by PCC (the “Debentures”).

Noninterest income during the three and six months ended June 30, 2019, included activity associated with our investment in the development of the land and an office building that will serve as our future headquarters. Noninterest income during the three and six months ended June 30, 2018, also included net noninterest income associated with activity within our merchant bank subsidiary.

Noninterest expenses during the three and six months ended June 30, 2019 and 2018, were primarily comprised of employees’ compensation and benefits, occupancy expenses and professional fees, including corporate governance, legal and transaction costs. Noninterest expenses increased $3.9 million and $10.1 million during the three and six months ended June 30, 2019, respectively, compared to the same periods in 2018. The increase during the three months ended June 30, 2019, compared to the same period in 2018, was primarily due to the technology enhancements and corporate initiatives discussed in the “Overview” section. In addition to costs incurred related to the aforementioned technology enhancements and corporate initiatives, the increase during the six months ended June 30, 2019, was due to costs incurred during the first quarter of 2019 of $5.8 million associated with the Leadership Changes and other efficiency initiative-related charges which, in the aggregate, totaled $6.5 million before income taxes.

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Financial Condition

The following discussion contains a more detailed analysis of our financial condition at June 30, 2019, as compared with December 31, 2018.

Securities Portfolio

At June 30, 2019, investment securities consisted of securities of the U.S. Treasury, U.S. government and its agencies, obligations of municipalities and other political subdivisions, primarily in the State of Texas, as well as mortgage-backed, corporate debt, and equity securities. We may categorize investments as trading, available for sale, held to maturity and equity securities.

Trading securities are bought and held principally for the purpose of selling them in the near term and are carried at fair value, marked to market through operations and held at the Bank and the Hilltop Broker-Dealers. Securities classified as available for sale may, from time to time, be bought and sold in response to changes in market interest rates, changes in securities’ prepayment risk, increases in loan demand, general liquidity needs and to take advantage of market conditions that create more economically attractive returns. Such securities are carried at estimated fair value, with unrealized gains and losses recorded in accumulated other comprehensive income (loss). Equity investments are carried at fair value, with all changes in fair value recognized in net income. Securities are classified as held to maturity based on the intent and ability of our management, at the time of purchase, to hold such securities to maturity. These securities are carried at amortized cost.

The table below summarizes our securities portfolio (in thousands).

	June 30,		December 31,
	2019		2018
Trading securities, at fair value
U.S. Treasury securities	$	5,203	$	7,945
U.S. government agencies:
Bonds		6,194		1,494
Residential mortgage-backed securities		246,943		309,455
Commercial mortgage-backed securities		2,204		4,239
Collateralized mortgage obligations		149,449		206,813
Corporate debt securities		54,729		59,293
States and political subdivisions		116,202		126,748
Unit investment trusts		15,919		19,913
Private-label securitized product		1,267		5,680
Other		3,414		3,886
		601,524		745,466
Securities available for sale, at fair value
U.S. Treasury securities		10,745		11,538
U.S. government agencies:
Bonds		86,507		85,611
Residential mortgage-backed securities		472,133		385,074
Commercial mortgage-backed securities		12,135		11,772
Collateralized mortgage obligations		334,270		276,399
Corporate debt securities		49,534		53,302
States and political subdivisions		44,600		51,962
		1,009,924		875,658
Securities held to maturity, at amortized cost
U.S. Treasury securities		9,961		9,903
U.S. government agencies:
Bonds		39,019		39,018
Residential mortgage-backed securities		20,031		21,903
Commercial mortgage-backed securities		113,570		87,065
Collateralized mortgage obligations		130,326		142,474
States and political subdivisions		52,998		50,649
		365,905		351,012
Equity securities, at fair value		19,592		19,679
Total securities portfolio	$	1,996,945	$	1,991,815

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We had net unrealized gains of $10.1 million and net unrealized losses of $11.1 million at June 30, 2019 and December 31, 2018, respectively, related to the available for sale investment portfolio, and net unrealized gains of $2.6 million and net unrealized losses of $9.9 million associated with the securities held to maturity portfolio at June 30, 2019 and December 31, 2018, respectively. We had net unrealized gains of $0.7 million and net unrealized losses of $0.9 million at June 30, 2019 and December 31, 2018, respectively, related to equity securities.

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 the U.S. government and its agencies, obligations of municipalities in the State of Texas and other high grade fixed income securities to minimize credit risk. At June 30, 2019, the banking segment’s securities portfolio of $1.3 billion was comprised of trading securities of $2.5 million, available for sale securities of $916.5 million, equity securities of $0.1 million and held to maturity securities of $365.9 million, in addition to $13.3 million of other investments included in other assets within the consolidated balance sheets.

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 $599.0 million at June 30, 2019. 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 obligations may exceed the amount recognized in the financial statements. These securities, which are carried at fair value and reported as securities sold, not yet purchased in the consolidated balance sheets, had a value of $45.4 million at June 30, 2019.

Insurance Segment

The insurance segment’s primary investment objective is to preserve capital and manage for a total rate of return. NLC’s strategy is to purchase securities in sectors that represent the most attractive relative value. Our insurance segment invests the premiums it receives from policyholders until they are needed to pay policyholder claims or other expenses. At June 30, 2019, the insurance segment’s securities portfolio was comprised of $93.4 million in available for sale securities, $19.4 million of equity securities and $5.9 million of other investments included in other assets within the consolidated balance sheets.

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Loan Portfolio

Consolidated loans held for investment are detailed in the tables below, classified by portfolio segment and segregated between those considered to be purchased credit impaired, or PCI, loans and all other originated or acquired loans (in thousands). PCI loans showed evidence of credit deterioration on the date of acquisition that made it probable that all contractually required principal and interest payments would not be collected.

	Loans, excluding		PCI		Total Loans Held
June 30, 2019	PCI Loans		Loans		for Investment
Commercial real estate	$	2,911,894	$	25,349	$	2,937,243
Commercial and industrial		1,442,313		5,908		1,448,221
Construction and land development		950,561		67		950,628
1-4 family residential		641,663		54,872		696,535
Mortgage warehouse		555,327		—		555,327
Consumer		44,269		4		44,273
Broker-dealer		570,377		—		570,377
Loans held for investment, gross		7,116,404		86,200		7,202,604
Allowance for loan losses		(51,188)		(3,989)		(55,177)
Loans held for investment, net of allowance	$	7,065,216	$	82,211	$	7,147,427

	Loans, excluding		PCI		Total Loans Held
December 31, 2018	PCI Loans		Loans		for Investment
Commercial real estate	$	2,912,407	$	27,713	$	2,940,120
Commercial and industrial		1,501,892		6,559		1,508,451
Construction and land development		932,445		464		932,909
1-4 family residential		620,936		58,327		679,263
Mortgage warehouse		243,806		—		243,806
Consumer		47,537		9		47,546
Broker-dealer		578,363		—		578,363
Loans held for investment, gross		6,837,386		93,072		6,930,458
Allowance for loan losses		(56,594)		(2,892)		(59,486)
Loans held for investment, net of allowance	$	6,780,792	$	90,180	$	6,870,972

Banking Segment

The loan portfolio constitutes the major 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 loan losses, were $8.0 billion and $7.5 billion at June 30, 2019 and December 31, 2018, respectively. The banking segment’s loan portfolio includes warehouse lines of credit extended to PrimeLending of $2.0 billion, of which $1.4 million and $1.2 billion was drawn at June 30, 2019 and December 31, 2018, respectively. 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.

At June 30, 2019, 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, construction and land development loans and non-construction residential real estate loans, which represented 44.3%, 14.3% and 10.5%, respectively, of the banking segment’s total loans held for investment (excluding warehouse lines of credit extended to PrimeLending) at June 30, 2019. The banking segment’s loan concentrations were within regulatory guidelines at June 30, 2019.

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Broker-Dealer Segment

The loan portfolio of the broker-dealer segment consists primarily of margin loans to customers and correspondents. 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 loan losses, were $570.3 million and $578.2 million at June 30, 2019 and December 31, 2018, respectively. This decrease from December 31, 2018 to June 30, 2019 was primarily attributable to a decrease of $10.7 million, or 4.4%, 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).

	June 30,		December 31,
	2019		2018
Loans held for sale:
Unpaid principal balance	$	1,426,514	$	1,213,068
Fair value adjustment		48,562		44,707
	$	1,475,076	$	1,257,775
IRLCs:
Unpaid principal balance	$	1,530,535	$	677,267
Fair value adjustment		33,584		17,421
	$	1,564,119	$	694,688

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 June 30, 2019 and December 31, 2018 were $2.4 billion and $1.4 billion, respectively, while the related estimated fair values were ($10.3) million and ($11.6) million, respectively.

Allowance for Loan Losses

The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of probable losses inherent in our existing loan portfolio. Management has responsibility for determining the level of the allowance for loan losses, subject to review by the Loan Review Committee of the Bank’s board of directors.

The allowance for loan losses is subject to regulatory examination, which may take into account such factors as the methodology used to calculate the allowance and the size of the allowance. While we believe we have an appropriate allowance for our existing loan portfolio at June 30, 2019, additional provisions for losses on existing loans may be necessary in the future.

For additional information regarding the allowance for loan losses, refer to the sections captioned “Allowance for Loan Losses” and “Critical Accounting Policies and Estimates” in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our 2018 Form 10-K. There have been no significant changes in our application of critical accounting policies related to the allowance for loan losses since December 31, 2018.

The Bank acquired certain assets and assumed certain liabilities of FNB in connection with the FNB Transaction. The FNB Transaction is discussed in detail in Note 6 to the consolidated financial statements included in the Company’s 2018 Form 10-K. As discussed in the “Factors Affecting Comparability of Results of Operations” section above, the loss-share agreements with the FDIC were terminated during the fourth quarter of 2018. Accordingly, loans which were previously referred to as either “covered loans” if covered by the loss-share agreements or otherwise “non-covered loans” are now collectively referred to as “loans held for investment.”

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The following tables present the activity in our allowance for loan losses within our loan portfolio for the periods presented (in thousands). Substantially all of the activity shown below occurred within the banking segment.

	Three Months Ended June 30,				Six Months Ended June 30,
Loans Held for Investment	2019		2018		2019			2018
Balance, beginning of period	$	58,809	$	63,194	$	59,486		$	63,686
Provision (recovery) for loan losses		(672)		340		279			(1,467)
Recoveries of loans previously charged off:
Commercial real estate		—		—		—			—
Commercial and industrial		322		666		970			3,140
Construction and land development		—		—		—			—
1-4 family residential		17		75		31			103
Mortgage warehouse		—		—		—			—
Consumer		12		36		22			48
Broker-dealer		—		—		—			—
Covered		—		3		—			6
Total recoveries		351		780		1,023			3,297
Loans charged off:
Commercial real estate		—		18		—			18
Commercial and industrial		2,430		2,233		4,248			3,416
Construction and land development		—		—		—			—
1-4 family residential		871		6		899			12
Mortgage warehouse		—		—		—			—
Consumer		10		30		464			43
Broker-dealer		—		—		—			—
Covered		—		57		—			57
Total charge-offs		3,311		2,344		5,611			3,546
Net charge-offs		(2,960)		(1,564)		(4,588)			(249)
Balance, end of period	$	55,177	$	61,970	$	55,177		$	61,970
Allowance for loan losses as a percentage of gross loans held for investment						0.77	%		0.95	%

The distribution of the allowance for loan losses among loan types and the percentage of the loans for that type to gross loans, excluding unearned income, within our loan portfolio are presented in the tables below (dollars in thousands).

	June 30, 2019				December 31, 2018
			% of				% of
			Gross				Gross
Loans Held for Investment	Reserve		Loans		Reserve		Loans
Commercial real estate	$	25,114	40.78	%	$	27,100	42.42	%
Commercial and industrial		20,414	20.11	%		21,980	21.77	%
Construction and land development		4,396	13.20	%		6,061	13.46	%
1-4 family residential		4,924	9.67	%		3,956	9.80	%
Mortgage warehouse		—	7.71	%		—	3.52	%
Consumer		283	0.61	%		267	0.69	%
Broker-dealer		46	7.92	%		122	8.34	%
Total	$	55,177	100.00	%	$	59,486	100.00	%

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 PCI loans because PCI loans exhibited evidence of credit deterioration at acquisition that made it probable that all contractually required principal payments would not be collected. Within our loan portfolio, we had five credit relationships totaling $6.8 million of potential problem loans at

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June 30, 2019, compared with seven credit relationships totaling $17.8 million of potential problem loans at December 31, 2018.

Non-Performing Assets

The following table presents components of our non-performing assets (dollars in thousands).

	June 30,			December 31,
	2019			2018			Variance
Loans accounted for on a non-accrual basis:
Commercial real estate	$	5,276		$	5,324		$	(48)
Commercial and industrial		14,152			14,870			(718)
Construction and land development		1,413			3,278			(1,865)
1-4 family residential		11,136			10,437			699
Mortgage warehouse		—			—			—
Consumer		34			41			(7)
Broker-dealer		—			—			—
	$	32,011		$	33,950		$	(1,939)
Non-performing loans as a percentage of total loans		0.36	%		0.41	%		(0.05)	%
Other real estate owned	$	20,753		$	27,578		$	(6,825)
Other repossessed assets	$	—		$	68		$	(68)
Non-performing assets	$	52,764		$	61,596		$	(8,832)
Non-performing assets as a percentage of total assets		0.37	%		0.45	%		(0.08)	%
Non-PCI loans past due 90 days or more and still accruing	$	77,425		$	83,131		$	(5,706)
Troubled debt restructurings included in accruing loans held for investment	$	2,256		$	1,339		$	917

At June 30, 2019, non-accrual loans included 19 commercial and industrial relationships with loans secured by accounts receivable, life insurance, oil and gas, livestock and equipment. Non-accrual loans at June 30, 2019 also included $3.4 million of loans secured by residential real estate which were classified as loans held for sale. At December 31, 2018, non-accrual loans included 16 commercial and industrial relationships with loans secured by accounts receivable, life insurance, oil and gas, livestock, and equipment. Non-accrual loans at December 31, 2018 included $3.4 million of loans secured by residential real estate which were classified as loans held for sale.

Other real estate owned (“OREO”) decreased from December 31, 2018 to June 30, 2019, due to $9.6 million of disposals and fair valuation decreases related to 51 properties, partially offset by the addition of 25 properties totaling $2.8 million. At both June 30, 2019 and December 31, 2018, OREO was primarily comprised of commercial properties.

Non-PCI loans past due 90 days or more and still accruing at June 30, 2019 and December 31, 2018, were primarily comprised of loans held for sale and guaranteed by U.S. government agencies, including loans that are subject to repurchase, or have been repurchased, by PrimeLending. Loans past due 90 days or more and still accruing include Government National Mortgage Association related loans subject to repurchase within our mortgage origination segment.

At June 30, 2019, troubled debt restructurings (“TDRs”) were comprised of $2.3 million of loans that are considered to be performing and non-performing loans of $12.8 million reported in non-accrual loans. At December 31, 2018, TDRs were comprised of $1.3 million of loans that are considered to be performing and non-performing loans of $5.9 million reported in non-accrual loans.

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Current Expected Credit Loss (CECL) Standard

In June 2016, the FASB issued ASU 2016-13 which sets forth a “current expected credit loss” (CECL) model for measuring credit losses on certain exposures. The new model will require the measurement of expected credit losses to reflect the lifetime of an exposure (or pool of exposures) represented by certain financial instruments to be based on historical experience, current conditions and reasonable and supportable forecasts. Under the current “incurred loss” model, the allowance for loan losses is based only on estimates of loan losses that currently exist in the portfolio as of the reporting date. The new model will become effective on January 1, 2020, and applies to most debt instruments, trade receivables, lease receivables, reinsurance receivables, financial guarantees and loan commitments. Our ongoing CECL transition efforts include reassessing risk ratings, developing and validating the new model, collecting and processing new data and establishing internal controls and accounting policies. New model development has increased expenses associated with the collection and processing of data, and these increases in expenses will continue for the remainder of 2019 as we perform parallel calculations of our allowance for credit losses under both the current allowance model and under the CECL model. We expect that the CECL model will require a material increase in our allowance for credit losses upon adoption on January 1, 2020.

Insurance Losses and Loss Adjustment Expenses

At June 30, 2019 and December 31, 2018, our gross reserve for unpaid losses and LAE was $22.3 million and $20.6 million, respectively, including estimated recoveries from reinsurance of $1.2 million and $3.2 million, respectively. The liability for insurance losses and LAE represents estimates of the ultimate unpaid cost of all losses incurred, including losses for claims that have not yet been reported, less a reduction for reinsurance recoverables related to those liabilities. Separately for each of NLIC and ASIC and each line of business, our actuaries estimate the liability for unpaid losses and LAE by first estimating ultimate losses and LAE amounts for each year, prior to recognizing the impact of reinsurance. The amount of liabilities for reported claims is based primarily on a claim-by-claim evaluation of coverage, liability, injury severity or scope of property damage, and any other information considered relevant to estimating exposure presented by the claim.

NLC’s liabilities for unpaid losses represent the best estimate at a given point in time of what it expects to pay claimants, based on facts, circumstances and historical trends then known. During the loss settlement period, additional facts regarding individual claims may become known and, consequently, it often becomes necessary to refine and adjust the estimates of liability. This process is commonly referred to as loss development. To project ultimate losses and LAE, our actuaries examine the paid and reported losses and LAE for each accident year and multiply these values by a loss development factor. The selected loss development factors are based upon a review of the loss development patterns indicated in the companies’ historical loss triangles (which utilize historical trends, adjusted for changes in loss costs, underwriting standards, policy provisions, product mix and other factors) and applicable insurance industry loss development factors. Estimating the liability for unpaid losses and LAE is inherently judgmental and is influenced by factors that are subject to significant variation. Liabilities for LAE are intended to cover the ultimate cost of settling claims, including investigation and defense of lawsuits resulting from such claims.

The reserve analysis performed by our actuaries provides preliminary central estimates of the unpaid losses and LAE. At each quarter-end, the results of the reserve analysis are summarized and discussed with our senior management. The senior management group considers many factors in determining the amount of reserves to record for financial statement purposes. These factors include the extent and timing of any recent catastrophic events, historical pattern and volatility of the actuarial indications, the sensitivity of the actuarial indications to changes in paid and reported loss patterns, the consistency of claims handling processes, the consistency of case reserving practices, changes in our pricing and underwriting, and overall pricing and underwriting trends in the insurance market.

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 entitled “Liquidity and Capital Resources — Banking Segment” below, is constantly changing due to the banking segment’s needs and market conditions.

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The table below presents the average balance of, and rate paid on, consolidated deposits (dollars in thousands).

	Six Months Ended June 30,								Year Ended December 31,
	2019				2018				2018
	Average		Average		Average		Average		Average		Average
	Balance		Rate Paid		Balance		Rate Paid		Balance		Rate Paid
Noninterest-bearing demand deposits	$	2,535,007	0.00	%	$	2,456,189	0.00	%	$	2,504,599	0.00	%
Interest-bearing demand deposits		4,250,036	1.04	%		3,849,009	0.45	%		4,025,259	0.66	%
Savings deposits		182,356	0.19	%		216,385	0.13	%		201,328	0.11	%
Time deposits		1,376,576	1.92	%		1,364,848	1.30	%		1,341,886	1.42	%
	$	8,343,975	0.85	%	$	7,886,431	0.45	%	$	8,073,072	0.57	%

Borrowings

Our borrowings are shown in the table below (dollars in thousands).

	June 30, 2019				December 31, 2018
			Average				Average
	Balance		Rate Paid		Balance		Rate Paid		Variance
Short-term borrowings	$	1,338,893	2.62	%	$	1,065,807	2.15	%	$	273,086
Notes payable		231,923	5.14	%		228,872	4.95	%		3,051
Junior subordinated debentures		67,012	5.98	%		67,012	5.47	%		—
	$	1,637,828	3.24	%	$	1,361,691	2.70	%	$	276,137

Short-term borrowings consisted of federal funds purchased, securities sold under agreements to repurchase, borrowings at the Federal Home Loan Bank (“FHLB”) and short-term bank loans. The increase in short-term borrowings at June 30, 2019, compared with December 31, 2018, included an increase in borrowings in our banking segment primarily associated with the increased utilization of available internal funds partially offset by a net decrease in securities sold under agreements to repurchase and short-term bank loans used by the Hilltop Broker-Dealers to finance their activities. Notes payable at June 30, 2019, was comprised of $148.7 million related to the Senior Notes, net of loan origination fees, FHLB borrowings with an original maturity greater than one year within the banking segment of $4.0 million, insurance segment term notes of $27.5 million, and mortgage origination segment borrowings of $51.7 million.

Liquidity and Capital Resources

Hilltop is a financial holding company whose assets primarily consist of the stock of its subsidiaries and invested assets. Hilltop’s primary investment objectives, as a holding company, are to support capital deployment for organic growth and to preserve capital to be deployed through acquisitions, dividend payments and potential stock repurchases. At June 30, 2019, Hilltop had $67.0 million in cash and cash equivalents, an increase of $23.1 million from $43.9 million at December 31, 2018. This increase in cash and cash equivalents was primarily due to $71.3 million of dividends from subsidiaries, partially offset by $25.0 million of purchases under our stock repurchase program, $15.0 million in cash dividends declared, and other general corporate expenses. Subject to regulatory restrictions, Hilltop has received, and may also continue to receive, dividends from its subsidiaries. If necessary or appropriate, we may also finance acquisitions with the proceeds from equity or debt issuances. We believe that Hilltop’s liquidity is sufficient for the foreseeable future, with current short-term liquidity needs including operating expenses, interest on debt obligations, dividend payments to stockholders and potential stock repurchases.

Dividend Declaration

On July 25, 2019, our board of directors declared a quarterly cash dividend of $0.08 per common share, payable on August 30, 2019 to all common stockholders of record as of the close of business on August 15, 2019.

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.

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Stock Repurchase Program

In January 2019, our board of directors authorized a new stock repurchase program through January 2020, pursuant to which we are authorized to repurchase, in the aggregate, up to $50.0 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.

During the six months ended June 30, 2019, we paid $25.0 million to repurchase an aggregate of 1,214,843 shares of common stock at an average price of $20.54 per share. The purchases were funded from available cash balances.

Senior Notes due 2025

The Senior Notes bear interest at a rate of 5% per year, payable semi-annually in arrears in cash on April 15 and October 15 of each year, commencing on October 15, 2015. The Senior Notes will mature on April 15, 2025, unless we redeem the Senior Notes, in whole at any time or in part from time to time, on or after January 15, 2025 (three months prior to the maturity date of the Senior Notes) at our election at a redemption price equal to 100% of the principal amount of the Senior Notes to be redeemed plus accrued and unpaid interest to, but excluding, the redemption date. At June 30, 2019, $150.0 million of our Senior Notes was outstanding.

Junior Subordinated Debentures

The Debentures have a stated term of 30 years with maturities ranging from July 2031 to February 2038 with interest payable quarterly. The rate on the Debentures, which resets quarterly, is 3-month LIBOR plus an average spread of 3.22%. The total average interest rate at June 30, 2019 was 5.66%. The Debentures are callable at PCC’s discretion with a minimum of a 45- to 60- day notice. At June 30, 2019, $67.0 million of PCC’s Debentures were outstanding.

Regulatory Capital

We are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements may prompt certain actions by regulators that, if undertaken, could have a direct material adverse effect on our financial condition and results of operations. Under capital adequacy and regulatory requirements, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. Our capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

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 phase-in of the capital conservation buffer requirements began on January 1, 2016 for Hilltop and PlainsCapital, and the requirements were fully phased in as of January 1, 2019.

Bank holding companies with less than $15 billion in assets as of December 31, 2009 are allowed to continue to include junior subordinated debentures in Tier 1 capital, subject to certain restrictions. However, if an institution grows to above $15 billion in assets as a result of an acquisition, or organically grows to above $15 billion in assets and then makes an acquisition, the combined trust preferred issuances must be phased out of Tier 1 and into Tier 2 capital. All of the debentures issued to the PCC Statutory Trusts I, II, III and IV (the “Trusts”), less the common stock of the Trusts, qualified as Tier 1 capital as of June 30, 2019, under guidance issued by the Board of Governors of the Federal Reserve System.

At June 30, 2019, Hilltop had a total capital to risk weighted assets ratio of 17.14%, Tier 1 capital to risk weighted assets ratio of 16.77%, common equity Tier 1 capital to risk weighted assets ratio of 16.32% and a Tier 1 capital to average assets, or leverage, ratio of 13.00%. Accordingly, Hilltop’s actual capital amounts and ratios in accordance with Basel III exceeded the regulatory capital requirements including conservation buffer in effect at the end of the period.

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At June 30, 2019, PlainsCapital had a total capital to risk weighted assets ratio of 14.48%, Tier 1 capital to risk weighted assets ratio of 13.84%, common equity Tier 1 capital to risk weighted assets ratio of 13.84% and a Tier 1 capital to average assets, or leverage, ratio of 12.53%. Accordingly, PlainsCapital’s actual capital amounts and ratios in accordance with Basel III resulted in it being considered “well-capitalized” and exceeded the regulatory capital requirements including conservation buffer in effect at the end of the period.

We discuss regulatory capital requirements in more detail in Note 16 to our consolidated financial statements, as well as under the caption “Government Supervision and Regulation — Corporate — Capital Adequacy Requirements and BASEL III” set forth in Part I, Item I. of our 2018 Form 10-K.

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 asset and liability 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 the Federal Reserve and borrowings under lines of credit with other financial institutions. For intermediate liquidity needs, we utilize advances from the FHLB. To supply liquidity over the longer term, we have access to brokered time deposits, term loans at the FHLB and borrowings under lines of credit with other financial institutions.

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. 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, excluding Hilltop and Hilltop Securities, accounted for 8.21% of the Bank’s total deposits, and the Bank’s five largest depositors, excluding Hilltop and Hilltop Securities, accounted for 4.37% of the Bank’s total deposits at June 30, 2019. 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 non-interest-bearing client credit balances, correspondent deposits, securities lending arrangements, repurchase agreement financings and other payables to finance their assets and operations, subject to their respective compliance with broker-dealer net capital and customer protection rules. At June 30, 2019, Hilltop Securities had credit arrangements with five unaffiliated banks with maximum aggregate commitments of up to $725.0 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 a committed revolving credit facility with an unaffiliated bank of up to $50.0 million. At June 30, 2019, Hilltop Securities had borrowed $231.0 million under its credit arrangements and had no borrowings under its credit facility.

Mortgage Origination Segment

PrimeLending funds the mortgage loans it originates through warehouse lines of credit maintained with the Bank which have an aggregate commitment of $2.0 billion, of which $1.4 billion was drawn at June 30, 2019. PrimeLending sells substantially all mortgage loans it originates to various investors in the secondary market, the majority with servicing

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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 outstanding at June 30, 2019.

PrimeLending owns a 100% membership interest in PrimeLending Ventures Management, LLC (“Ventures Management”) which holds an ownership interest in and is the managing member of certain ABAs. At June 30, 2019, these ABAs had combined available lines of credit totaling $120.0 million, $70.0 million of which was with a single unaffiliated bank, and the remaining $50.0 million of which was with the Bank. At June 30, 2019, Ventures Management had outstanding borrowings of $64.4 million, $12.7 million of which was with the Bank. In July 2019, Ventures Management entered into an additional $30.0 million line of credit with the aforementioned unaffiliated bank.

Insurance Segment

Our insurance operating subsidiary’s primary investment objectives are to preserve capital and manage for a total rate of return. NLC’s strategy is to purchase securities in sectors that represent the most attractive relative value. Bonds, cash and short-term investments of $130.6 million, or 83.8%, equity investments of $19.4 million and other investments of $5.9 million comprised NLC’s $155.9 million in total cash and investments at June 30, 2019. NLC does not currently have any significant concentration in both direct and indirect guarantor exposure or any investments in subprime mortgages. NLC has custodial agreements with an unaffiliated bank and an investment management agreement with DTF Holdings, LLC.

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 the U.S. government, its agencies and various other governmental regulatory authorities.

Off-Balance Sheet Arrangements; Commitments; Guarantees

In the normal course of business, we enter into various transactions, which, in accordance with GAAP, are not included in our consolidated balance sheets. We enter into these transactions to meet the financing needs of our customers. These transactions include commitments to extend credit and standby letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in our consolidated balance sheets.

We enter into contractual loan commitments to extend credit, normally with fixed expiration dates or termination clauses, at specified rates and for specific purposes. Substantially all of our commitments to extend credit are contingent upon customers maintaining specific credit standards until the time of loan funding. We minimize our exposure to loss under these commitments by subjecting them to credit approval and monitoring procedures. We assess the credit risk associated with certain commitments to extend credit and have recorded a liability related to such credit risk in our consolidated financial statements.

Standby letters of credit are written conditional commitments issued by us to guarantee the performance of a customer to a third party. In the event the customer does not perform in accordance with the terms of the agreement with the third party, we would be required to fund the commitment. The maximum potential amount of future payments we could be required to make is represented by the contractual amount of the commitment. If the commitment is funded, we would be entitled to seek recovery from the customer. Our policies generally require that standby letter of credit arrangements contain security and debt covenants similar to those contained in loan agreements.

In the aggregate, the Bank had outstanding unused commitments to extend credit of $2.3 billion at June 30, 2019 and outstanding financial and performance standby letters of credit of $92.4 million at June 30, 2019.

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In the normal course of business, the Hilltop Broker-Dealers execute, settle and finance various securities transactions that may expose the Hilltop Broker-Dealers to off-balance sheet risk in the event that a customer or counterparty does not fulfill its contractual obligations. Examples of such transactions include the sale of securities not yet purchased by customers or for the 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.

Critical Accounting Policies and Estimates

Our accounting policies are fundamental to understanding our management’s discussion and analysis of our results of operations and financial condition. We have identified certain significant accounting policies which involve a higher degree of judgment and complexity in making certain estimates and assumptions that affect amounts reported in our consolidated financial statements. The significant accounting policies which we believe to be the most critical in preparing our consolidated financial statements relate to allowance for loan losses, reserve for losses and LAE, goodwill and identifiable intangible assets, mortgage loan indemnification liability, mortgage servicing rights asset and acquisition accounting. Since December 31, 2018, there have been no changes in critical accounting policies as further described under “Critical Accounting Policies and Estimates” and Note 1 to the Consolidated Financial Statements in our 2018 Form 10-K, except that we no longer consider estimates related to the FDIC Indemnification Asset to be a critical accounting policy.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Our assessment of market risk as of June 30, 2019 indicates there are no material changes in the quantitative and qualitative disclosures from those previously reported in our 2018 Form 10-K, except as discussed below.

The primary objective of the following information is to provide forward-looking quantitative and qualitative information about our potential exposure to market risks. Market risk represents the risk of loss that may result from changes in value of a financial instrument as a result of changes in interest rates, market prices and the credit perception of an issuer. The disclosure is not meant to be a precise indicator of expected future losses, but rather an indicator of reasonably possible losses, and therefore our actual results may differ from any of the following projections. This forward-looking information provides an indicator of how we view and manage our ongoing market risk exposures.

Banking Segment

The banking segment is engaged primarily in the business of investing funds obtained from deposits and borrowings in interest-earning loans and investments, and our primary component of market risk is sensitivity to changes in interest rates. Consequently, our earnings depend to a significant extent on our net interest income, which is the difference between interest income on loans and investments and our interest expense on deposits and borrowings. To the extent that our interest-bearing liabilities do not reprice or mature at the same time as our interest-bearing assets, we are subject to interest rate risk and corresponding fluctuations in net interest income.

There are several common sources of interest rate risk that must be effectively managed if there is to be minimal impact on our earnings and capital. Repricing risk arises largely from timing differences in the pricing of assets and liabilities. Reinvestment risk refers to the reinvestment of cash flows from interest payments and maturing assets at lower or higher rates. Basis risk exists when different yield curves or pricing indices do not change at precisely the same time or in the same magnitude such that assets and liabilities with the same maturity are not all affected equally. Yield curve risk refers to unequal movements in interest rates across a full range of maturities.

We have employed asset/liability management policies that attempt to manage our interest-earning assets and interest-bearing liabilities, thereby attempting to control the volatility of net interest income, without having to incur unacceptable levels of risk. We employ procedures which include interest rate shock analysis, repricing gap analysis and balance sheet decomposition techniques to help mitigate interest rate risk in the ordinary course of business. In addition, the asset/liability management policies permit the use of various derivative instruments to manage interest rate risk or hedge specified assets and liabilities.

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An interest rate sensitive asset or liability is one that, within a defined time period, either matures or experiences an interest rate change in line with general market interest rates. The management of interest rate risk is performed by analyzing the maturity and repricing relationships between interest-earning assets and interest-bearing liabilities at specific points in time (“GAP”) and by analyzing the effects of interest rate changes on net interest income over specific periods of time by projecting the performance of the mix of assets and liabilities in varied interest rate environments. Interest rate sensitivity reflects the potential effect on net interest income resulting from a movement in interest rates. A company is considered to be asset sensitive, or have a positive GAP, when the amount of its interest-earning assets maturing or repricing within a given period exceeds the amount of its interest-bearing liabilities also maturing or repricing within that time period. Conversely, a company is considered to be liability sensitive, or have a negative GAP, when the amount of its interest-bearing liabilities maturing or repricing within a given period exceeds the amount of its interest-earning assets also maturing or repricing within that time period. During a period of rising interest rates, a negative GAP would tend to affect net interest income adversely, while a positive GAP would tend to result in an increase in net interest income. During a period of falling interest rates, a negative GAP would tend to result in an increase in net interest income, while a positive GAP would tend to affect net interest income adversely. However, it is our intent to remain relatively balanced so that changes in rates do not have a significant impact on earnings.

As illustrated in the table below, the banking segment is asset sensitive overall. Loans that adjust daily or monthly to the Wall Street Journal Prime rate comprise a large percentage of interest sensitive assets and are the primary cause of the banking segment’s asset sensitivity. To help neutralize interest rate sensitivity, the banking segment has kept the terms of most of its borrowings under one year as shown in the following table (dollars in thousands).

	June 30, 2019
	3 Months or			> 3 Months to			> 1 Year to			> 3 Years to
	Less			1 Year			3 Years			5 Years			> 5 Years			Total
Interest sensitive assets:
Loans	$	4,751,017		$	1,215,740		$	1,562,396		$	271,849		$	229,779		$	8,030,781
Securities		166,968			155,199			306,038			147,853			508,127			1,284,185
Federal funds sold and securities purchased under agreements to resell		521			—			—			—			—			521
Other interest sensitive assets		200,483			—			—			—			29,241			229,724
Total interest sensitive assets		5,118,989			1,370,939			1,868,434			419,702			767,147			9,545,211
Interest sensitive liabilities:
Interest bearing checking	$	3,992,288		$	—		$	—		$	—		$	—		$	3,992,288
Savings		180,747			—			—			—			—			180,747
Time deposits		400,974			862,871			105,698			9,450			51,004			1,429,997
Notes payable and other borrowings		620,192			505			3,528			580			4,879			629,684
Total interest sensitive liabilities		5,194,201			863,376			109,226			10,030			55,883			6,232,716
Interest sensitivity gap	$	(75,212)		$	507,563		$	1,759,208		$	409,672		$	711,264		$	3,312,495
Cumulative interest sensitivity gap	$	(75,212)		$	432,351		$	2,191,559		$	2,601,231		$	3,312,495
Percentage of cumulative gap to total interest sensitive assets		(0.79)	%		4.53	%		22.96	%		27.25	%		34.70	%

The positive GAP in the interest rate analysis indicates that banking segment net interest income would generally rise if rates increase. Because of inherent limitations in interest rate GAP analysis, the banking segment uses multiple interest rate risk measurement techniques. Simulation analysis is used to subject the current repricing conditions to rising and falling interest rates in increments and decrements of 1%, 2% and 3% to determine the effect on net interest income changes for the next twelve months. The banking segment also measures the effects of changes in interest rates on economic value of equity by discounting projected cash flows of deposits and loans. Economic value changes in the investment portfolio are estimated by discounting future cash flows and using duration analysis. Investment security prepayments are estimated using current market information. We believe the simulation analysis presents a more accurate picture than the GAP analysis. Simulation analysis recognizes that deposit products may not react to changes in interest rates as quickly or with the same magnitude as earning assets contractually tied to a market rate index. The sensitivity to changes in market rates varies across deposit products. Also, unlike GAP analysis, simulation analysis takes into account the effect of embedded options in the securities and loan portfolios as well as any off-balance-sheet derivatives.

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The table below shows the estimated impact of increases of 1%, 2% and 3% and a decrease of 0.5% in interest rates on net interest income and on economic value of equity for the banking segment at June 30, 2019 (dollars in thousands).

Change in	Changes in				Changes in
Interest Rates	Net Interest Income				Economic Value of Equity
(basis points)	Amount		Percent		Amount		Percent
+300	$	47,110	13.31	%	$	326,980	18.81	%
+200	$	31,738	8.97	%	$	260,963	15.01	%
+100	$	16,275	4.60	%	$	153,686	8.84	%
-50	$	(6,408)	(1.81)	%	$	(98,514)	(5.67)	%

The projected changes in net interest income and economic value of equity to changes in interest rates at June 30, 2019 were in compliance with established internal policy guidelines. These projected changes are based on numerous assumptions of growth and changes in the mix of assets or liabilities.

Our portfolio includes loans that periodically reprice or mature prior to the end of an amortized term. Some of our variable-rate loans remain at applicable rate floors, which may delay and/or limit changes in interest income during a period of changing rates. If interest rates were to fall, the impact on our interest income would be limited by these rate floors. In addition, declining interest rates may negatively affect our cost of funds on deposits. The extent of this impact will ultimately be driven by the timing, magnitude and frequency of interest rate and yield curve movements, as well as changes in market conditions and timing of management strategies. If interest rates were to rise, yields on the portion of our portfolio that remain at applicable rate floors would rise more slowly than increases in market interest rates. Any changes in interest rates across the term structure will continue to impact net interest income and net interest margin. The impact of rate movements will change with the shape of the yield curve, including any changes in steepness or flatness and inversions at any points on the yield curve.

Broker-Dealer Segment

Our broker-dealer segment is exposed to market risk primarily due to its role as a financial intermediary in customer transactions, which may include purchases and sales of securities, use of derivatives and securities lending activities, and in our trading activities, which are used to support sales, underwriting and other customer activities. We are subject to the risk of loss that may result from the potential change in value of a financial instrument as a result of fluctuations in interest rates, market prices, investor expectations and changes in credit ratings of the issuer.

Our broker-dealer segment is exposed to interest rate risk as a result of maintaining inventories of interest rate sensitive financial instruments and other interest earning assets including customer and correspondent margin loans and receivables and securities borrowing activities. Our exposure to interest rate risk is also from our funding sources including customer and correspondent cash balances, bank borrowings, repurchase agreements and securities lending activities. Interest rates on customer and correspondent balances and securities produce a positive spread with rates generally fluctuating in parallel.

With respect to securities held, our interest rate risk is managed by setting and monitoring limits on the size and duration of positions and on the length of time securities can be held. Much of the interest rates on customer and correspondent margin loans are indexed and can vary daily. Our funding sources are generally short term with interest rates that can vary daily.

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The following table categorizes the broker-dealer segment’s net trading securities which are subject to interest rate and market price risk (dollars in thousands).

	June 30, 2019
	1 Year			> 1 Year			> 5 Years
	or Less			to 5 Years			to 10 Years			> 10 Years			Total
Trading securities, at fair value			���
Municipal obligations	$	68		$	1,899		$	31,384		$	82,851		$	116,202
U.S. government and government agency obligations		499			4,380			(1,436)			395,379			398,822
Corporate obligations		2,017			8,942			6,973			7,515			25,447
Total debt securities		2,584			15,221			36,921			485,745			540,471
Corporate equity securities		(6,217)			—			—			—			(6,217)
Other		19,332			—			—			—			19,332
	$	15,699		$	15,221		$	36,921		$	485,745		$	553,586
Weighted average yield
Municipal obligations		1.96	%		1.82	%		1.88	%		3.18	%		2.81	%
U.S. government and government agency obligations		2.10	%		1.98	%		2.05	%		5.29	%		5.14	%
Corporate obligations		2.45	%		2.64	%		3.27	%		5.33	%		3.49	%

Derivatives are used to support certain customer programs and hedge our related exposure to interest rate risks.

Our broker-dealer segment is engaged in various brokerage and trading activities that expose us to credit risk arising from potential non-performance from counterparties, customers or issuers of securities. This risk is managed by setting and monitoring position limits for each counterparty, conducting periodic credit reviews of counterparties, reviewing concentrations of securities and conducting business through central clearing organizations.

Collateral underlying margin loans to customers and correspondents and with respect to securities lending activities is marked to market daily and additional collateral is required as necessary.

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

Our management, with the supervision and participation of our Principal Executive Officer and Principal Financial Officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report.

Based upon that evaluation, our Principal Executive Officer and Principal Financial Officer concluded that, as of the end of such period, our disclosure controls and procedures were effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in the reports that we file or submit under the Exchange Act and are effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to the Company’s management, including our Principal Executive Officer and Principal Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during the fiscal quarter covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

For a description of material pending legal proceedings, see the discussion set forth under the heading “Legal Matters” in Note 13 to our Consolidated Financial Statements, which is incorporated by reference herein.

Item 1A. Risk Factors.

There have been no material changes to the risk factors disclosed under “Item 1A. Risk Factors” of our 2018 Form 10-K. For additional information concerning our risk factors, please refer to “Item 1A. Risk Factors” of our 2018 Form 10-K.

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

On June 30, 2019, we issued an aggregate of 6,937 shares of common stock under the Hilltop Holdings Inc. 2012 Equity Incentive Plan to certain non-employee directors as compensation for their service on our board of directors during the second quarter of 2019. The shares were issued pursuant to the exemption from registration under Section 4(a)(2) of the Securities Act.

The following table details our repurchases of shares of common stock during the three months ended June 30, 2019.

Period	Total Number of Shares Purchased	Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (1)
April 1 - April 30, 2019	—	$	—	—	$	50,000,000
May 1 - May 31, 2019	962,408		20.51	962,408		30,235,802
June 1 - June 30, 2019	252,435		20.64	252,435		25,019,744
Total	1,214,843	$	20.54	1,214,843

(1) On January 25, 2019, we announced that our board of directors authorized a new stock repurchase program under which we may repurchase, in the aggregate, up to $50.0 million of our outstanding common stock through January 2020, which is inclusive of repurchases to offset dilution related to grants of stock-based compensation. As of June 30, 2019, we had repurchased an aggregate of $25.0 million of our outstanding common stock under this stock repurchase program.

Item 5. Other Information.

Stockholder Proposals and Nominees for Director

We held our annual meeting on July 25, 2019 (the “2019 Annual Meeting”) and first released related materials to stockholders on June 13, 2019. Accordingly, stockholder proposals intended to be presented at our 2020 annual meeting of stockholders pursuant to Rule 14a-8 under the Exchange Act must be received by us at our principal executive offices no later than 5:00 p.m., Dallas, Texas local time, on February 14, 2020 and must otherwise comply with the requirements of Rule 14a-8 in order to be considered for inclusion in the 2020 proxy statement and proxy. However, pursuant to such rule, if the 2020 annual meeting is not held within 30 days of July 25, 2020, then a stockholder proposal submitted for inclusion in our proxy statement for the 2020 annual meeting must be received by us a reasonable time before we begin to print and mail our proxy statement for the 2020 annual meeting.

In order for director nominations and proposals of stockholders made outside the processes of Rule 14a-8 under the Exchange Act to be considered “timely” for purposes of Rule 14a-4(c) under the Exchange Act and pursuant to our current bylaws, the nomination or proposal must be received by us at our principal executive offices not before January 1, 2020, and not later than 5:00 p.m. Dallas, Texas local time, on January 31, 2020; provided, however, that in the event that the date of the 2020 annual meeting is advanced by more than 30 days or delayed by more than 60 days from July 25, 2020, notice by the stockholder in order to be timely must be received no earlier than the 120th day prior to the date of the 2020 annual meeting and not later than 5:00 p.m. Dallas, Texas local time, on the later of the 90th day prior to the date of the 2020 annual meeting or, if the first public announcement of the 2020 annual meeting is less than 100 days prior to the anniversary of the date of the 2019 Annual Meeting, the 10th day following the day on which public announcement of the date of the 2020 annual meeting is first made. Stockholders are advised to review our charter and

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bylaws, which contain additional requirements with respect to advance notice of stockholder proposals and director nominations, copies of which are available without charge upon request to our corporate secretary at the address of our principal executive offices.

Item 6. Exhibits.

Exhibit Number	Description of Exhibit
2.1	Termination Agreement among Federal Deposit Insurance Corporation, as Receiver of First National Bank, Edinburg, Texas, PlainsCapital Bank and Federal Deposit Insurance Corporation, acting in its corporate capacity, dated as of October 17, 2018 (filed as Exhibit 99.1 to the Registrant’s Current Report on Form 8-K file October 22, 2018 (File no. 001-31987) and incorporated herein by reference).
31.1*	Certification of Principal Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.
31.2*	Certification of Principal Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.
32.1*	Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS*	XBRL Instance Document – the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
101.SCH*	XBRL Taxonomy Extension Schema
101.CAL*	XBRL Taxonomy Extension Calculation Linkbase
101.DEF*	XBRL Taxonomy Extension Definition Linkbase
101.LAB*	XBRL Taxonomy Extension Label Linkbase
101.PRE*	XBRL Taxonomy Extension Presentation Linkbase

* Filed herewith.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	HILLTOP HOLDINGS INC.
Date: July 25, 2019	By:	/s/ William B. Furr
		William B. Furr
		Chief Financial Officer (Principal Financial Officer and duly authorized officer)

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