Hilltop Holdings Inc. 10-Q

Item 3. Quantitative and Qualitative Disclosures About Market Risk. ​ Our assessment of market risk as of March 31, 2024 indicates there are no material changes in the quantitative and qualitative disclosures from those previously reported in our 2023 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 82 Table of Contents 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. To help mitigate net interest income spread compression between our assets and liabilities as the Federal Reserve increases interest rates, management continues to execute certain derivative trades, as either cash flow hedges or fair value hedges, that benefit the banking segment as interest rates rise. 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. ​ 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. ​ 83 Table of Contents As illustrated in the table below, the banking segment is currently 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). ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ March 31, 2024 ​ 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 ​ $ 4,079,513 ​ $ 1,407,964 ​ $ 1,805,243 ​ $ 697,883 ​ $ 547,259 ​ $ 8,537,862 ​ Securities ​ 510,369 ​ 215,805 ​ 413,366 ​ 324,916 ​ 976,249 ​ 2,440,705 ​ Federal funds sold and securities purchased under agreements to resell ​ 1,605,930 ​ — ​ — ​ — ​ — ​ 1,605,930 ​ Other interest sensitive assets ​ 8,202 ​ — ​ — ​ — ​ 29,732 ​ 37,934 ​ Total interest sensitive assets ​ 6,204,014 ​ 1,623,769 ​ 2,218,609 ​ 1,022,799 ​ 1,553,240 ​ 12,622,431 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Interest sensitive liabilities: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Interest bearing checking ​ $ 6,293,800 ​ $ — ​ $ — ​ $ — ​ $ — ​ $ 6,293,800 ​ Savings ​ 255,223 ​ — ​ — ​ — ​ — ​ 255,223 ​ Time deposits ​ 441,218 ​ 633,525 ​ 67,025 ​ 51,781 ​ — ​ 1,193,549 ​ Notes payable and other borrowings ​ 442,935 ​ 80 ​ 265 ​ 361 ​ 1,589 ​ 445,230 ​ Total interest sensitive liabilities ​ 7,433,176 ​ 633,605 ​ 67,290 ​ 52,142 ​ 1,589 ​ 8,187,802 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Interest sensitivity gap ​ $ (1,229,162) ​ $ 990,164 ​ $ 2,151,319 ​ $ 970,657 ​ $ 1,551,651 ​ $ 4,434,629 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Cumulative interest sensitivity gap ​ $ (1,229,162) ​ $ (238,998) ​ $ 1,912,321 ​ $ 2,882,978 ​ $ 4,434,629 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Percentage of cumulative gap to total interest sensitive assets ​ (9.74) % (1.89) % 15.15 % 22.84 % 35.13 % ​ ​ ​ ​ 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 50 to 100 basis points 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. ​ The table below shows the estimated impact of a range of changes in interest rates on net interest income and on economic value of equity for the banking segment at March 31, 2024 (dollars in thousands). ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Change in ​ Changes in ​ ​ Changes in Interest Rates ​ Net Interest Income ​ ​ Economic Value of Equity (basis points) Amount Percent Amount Percent +200 ​ $ 38,647 9.39 % ​ $ 190,042 11.77 % +100 ​ $ 20,780 5.05 % ​ $ 116,837 7.23 % -50 ​ $ (10,666) (2.59) % ​ $ (84,482) (5.23) % -100 ​ $ (21,660) (5.26) % ​ $ (181,143) (11.22) % -200 ​ $ (44,876) (10.90) % ​ $ (399,065) (24.71) % ​ The projected changes in the table above were in compliance with established internal policy guidelines, with the exception of the estimated change in economic value of equity impact based on a -200 basis points change in interest rates which marginally exceeded management’s internal policy limit. These projected changes are based on numerous assumptions. Upon implementation of pending assumption updates based on the expected transition into the next interest rate cycle, management anticipates that over time the estimated change in economic value of equity impact will return to compliance with established internal policy limit. Furthermore, the projected changes in net interest income are being impacted by the heightened level of cash balances, which represent a significant portion of the Bank’s sensitivity given simulation analysis assumptions/limitations. As a result, the timing and magnitude of future changes in interest rates and any runoff of deposits, and related decline in cash, may impact projected changes in net interest income as noted in the table above. Given projected impacts on net interest income associated with the expected transition into the next phase of 84 Table of Contents the interest rate cycle, we continue to evaluate our current GAP position, which may result in a repositioning of the banking segment towards a more neutral or liability sensitive balance sheet. ​ 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 funding sources, which include customer and correspondent cash balances, bank borrowings, repurchase agreements and securities lending activities, also expose the broker-dealer to interest rate risk. Movement in short-term interest rates could reduce the positive spread between the broker-dealer segment’s interest income and interest expense. ​ 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 and receivables are indexed and can vary daily. Our funding sources are generally short term with interest rates that can vary daily. 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). ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ March 31, 2024 ​ ​ ​ 1 Year ​ > 1 Year ​ > 5 Years ​ ​ ​ ​ ​ ​ ​ or Less ​ to 5 Years ​ to 10 Years ​ > 10 Years ​ Total ​ Trading securities, at fair value ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Municipal obligations ​ $ 3,012 ​ $ 38,392 ​ $ 67,501 ​ $ 151,778 ​ $ 260,683 ​ U.S. government and government agency obligations ​ ​ 5,095 ​ ​ (5,958) ​ ​ (19,941) ​ ​ 238,871 ​ ​ 218,067 ​ Corporate obligations ​ ​ 6,883 ​ ​ 26,798 ​ ​ 43,052 ​ ​ 31,291 ​ ​ 108,024 ​ Total debt securities ​ ​ 14,990 ​ ​ 59,232 ​ ​ 90,612 ​ ​ 421,940 ​ ​ 586,774 ​ Corporate equity securities ​ ​ — ​ ​ — ​ ​ — ​ ​ — ​ ​ — ​ Other ​ ​ 10,301 ​ ​ — ​ ​ — ​ ​ — ​ ​ 10,301 ​ ​ ​ $ 25,291 ​ $ 59,232 ​ $ 90,612 ​ $ 421,940 ​ $ 597,075 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Weighted average yield ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Municipal obligations ​ ​ 0.24 % ​ 2.18 % ​ 3.18 % ​ 3.46 % ​ 3.23 % U.S. government and government agency obligations ​ ​ 4.30 % ​ 4.53 % ​ 1.96 % ​ 4.77 % ​ 4.39 % Corporate obligations ​ ​ 5.67 % ​ 5.90 % ​ 5.65 % ​ 4.09 % ​ 5.35 % ​ 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. 85 Table of Contents ​ Mortgage Origination Segment ​ Within our mortgage origination segment, our principal market exposure is to interest rate risk due to the impact on our mortgage-related assets and commitments, including mortgage loans held for sale, IRLCs and MSR. Changes in interest rates could also materially and adversely affect our volume of mortgage loan originations. ​ IRLCs represent an agreement to extend credit to a mortgage loan applicant, whereby the interest rate on the loan is set prior to funding. Our mortgage loans held for sale, which we hold in inventory while awaiting sale into the secondary market, and our IRLCs are subject to the effects of changes in mortgage interest rates from the date of the commitment through the sale of the loan into the secondary market. As a result, we are exposed to interest rate risk and related price risk during the period from the date of the lock commitment until (i) the lock commitment cancellation or expiration date or (ii) the date of sale into the secondary mortgage market. Loan commitments generally range from 20 to 60 days, and our average holding period of the mortgage loan from funding to sale is approximately 30 days. An integral component of our interest rate risk management strategy is our execution of forward commitments to sell MBSs to minimize the impact on earnings resulting from significant fluctuations in the fair value of mortgage loans held for sale and IRLCs caused by changes in interest rates. ​ We have expanded, and may continue to expand, our residential mortgage servicing operations within our mortgage origination segment. As a result of our mortgage servicing business, we have a portfolio of retained MSR. One of the principal risks associated with MSR is that in a declining interest rate environment, they will likely lose a substantial portion of their value as a result of higher than anticipated prepayments. Moreover, if prepayments are greater than expected, the cash we receive over the life of the mortgage loans would be reduced. The mortgage origination segment uses derivative financial instruments, including U.S. Treasury bond futures and options, futures contracts and forward MBS commitments, as a means to mitigate market risk associated with MSR assets. No hedging strategy can protect us completely, and hedging strategies may fail because they are improperly designed, improperly executed and documented or based on inaccurate assumptions and, as a result, could actually increase our risks and losses. The MSR portfolio exposes us to interest rate risk and, correspondingly, the volatility of our earnings, especially if we cannot adequately hedge the interest rate risk relating to our MSR. ​ The goal of our interest rate risk management strategy within our mortgage origination segment is not to eliminate interest rate risk, but to manage it within appropriate limits. To mitigate the risk of loss, we have established policies and procedures, which include guidelines on the amount of exposure to interest rate changes we are willing to accept. ​ Consolidated ​ At March 31, 2024, total debt obligations on our consolidated balance sheet, excluding short-term borrowings and unamortized debt issuance costs and premiums, were $350 million, and was all subject to fixed interest rates. If interest rates were to increase by one eighth of one percent (0.125%), the increase in interest expense on the variable rate debt would not have a significant impact on our future consolidated earnings or cash flows. ​ As noted above within the discussion for each business segment, on a consolidated basis, our primary component of market risk is sensitivity to changes in interest rates. Consequently, and in large part due to the significance of our banking segment, our consolidated earnings depend to a significant extent on our net interest income. Refer to the discussion in the “Banking Segment” section above that provides more details regarding sources of interest rate risk and asset/liability management policies and procedures employed to manage our interest-earning assets and interest-bearing liabilities, and potential future repositioning of our GAP position, thereby attempting to control the volatility of net interest income, without having to incur unacceptable levels of risk. 86 Table of Contents ​ The table below shows the estimated impact of a range of changes in interest rates on net interest income on a consolidated basis at March 31, 2024 (dollars in thousands). ​ ​ ​ ​ ​ ​ ​ ​ Change in ​ Changes in ​ Interest Rates ​ Net Interest Income ​ (basis points) Amount Percent +200 ​ $ 51,379 11.38 % +100 ​ $ 27,118 6.01 % -50 ​ $ (13,712) (3.04) % -100 ​ $ (27,734) (6.14) % -200 ​ $ (56,999) (12.63) % ​ The projected changes in the table above 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. The projected changes in net interest income are being impacted by the heightened level of cash balances, which represent a significant portion of our asset sensitivity given simulation analysis assumptions/limitations. As a result, the timing and magnitude of future changes in interest rates including runoff of deposits, and related decline in cash, may impact projected changes in net interest income as noted in the table above. ​