14. Regulatory Matters

Bank

The Bank and Hilltop are subject to various regulatory capital requirements administered by the 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 us 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 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 Tier 1 and total capital (as defined) to risk-weighted assets (as defined). The Tier 1 capital (to average assets) ratio at December 31, 2012 was calculated using the average assets for the month of December 2012.

During September 2013, Hilltop and PlainsCapital contributed capital of $35.0 million and $25.0 million, respectively, to the Bank to provide additional capital in connection with the FNB Transaction.

The following table shows the Bank’s and Hilltop’s consolidated actual capital amounts and ratios compared to the regulatory minimum capital requirements and the Bank’s regulatory minimum capital requirements needed to qualify as a “well-capitalized” institution (dollars in thousands), without giving effect to the final Basel III capital rules adopted by the Federal Reserve Board on July 2, 2013.

									To Be Well Capitalized
					Minimum Capital				Minimum Capital
	Actual				Requirements				Requirements
	Amount		Ratio		Amount		Ratio		Amount		Ratio
September 30, 2013
Tier 1 capital (to average assets):
Bank	$	724,382	11.05	%	$	262,134	4	%	$	327,668	5	%
Hilltop	986,507		13.96	%	282,603		4	%	N/A		N/A
Tier 1 capital (to risk-weighted assets):
Bank	724,382		12.76	%	227,101		4	%	274,961		6	%
Hilltop	986,507		16.56	%	238,347		4	%	N/A		N/A
Total capital (to risk-weighted assets):
Bank	758,753		13.36	%	454,203		8	%	567,753		10	%
Hilltop	1,021,436		17.14	%	476,695		8	%	N/A		N/A

December 31, 2012
Tier 1 capital (to average assets):
Bank	$	542,307	8.84	%	$	245,495	4	%	$	306,869	5	%
Hilltop	871,379		13.08	%	266,514		4	%	N/A		N/A
Tier 1 capital (to risk-weighted assets):
Bank	542,307		11.83	%	183,308		4	%	274,961		6	%
Hilltop	871,379		17.72	%	196,670		4	%	N/A		N/A
Total capital (to risk-weighted assets):
Bank	546,598		11.93	%	366,615		8	%	458,269		10	%
Hilltop	875,670		17.81	%	393,340		8	%	N/A		N/A

To be considered “adequately capitalized” (as defined) under regulatory requirements, the Bank must maintain minimum Tier 1 capital to total average assets and Tier 1 capital to risk-weighted assets ratios of 4%, and a total capital to risk-weighted assets ratio of 8%. Based on the actual capital amounts and ratios shown in the previous table, the Bank’s ratios place it in the “well capitalized” (as defined) capital category under regulatory requirements.

Management continues to evaluate the final Basel III capital rules and their impact, which would apply to reporting periods beginning after January 1, 2015.

Financial Advisory

Pursuant to the net capital requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), FSC has elected to determine its net capital requirements using the alternative method. Accordingly, FSC is required to maintain minimum net capital, as defined in Rule 15c3-1, equal to the greater of $250,000 or 2% of aggregate debit balances, as defined in Rule 15c3-3. At September 30, 2013, FSC had net capital of $69.8 million (the minimum net capital requirement was $3.8 million), net capital maintained by FSC was 37% of aggregate debits, and net capital in excess of the minimum requirement was $66.0 million.

Under certain conditions, FSC may be required to segregate cash and securities in a special reserve account for the benefit of customers under Rule 15c3-3. Assets segregated under the provisions of the Exchange Act are not available for general corporate purposes. FSC was required to segregate $19.0 million in cash and securities at December 31, 2012, which is included in other assets within the consolidated balance sheet.

FSC was not required to segregate cash or securities in a special reserve account for the benefit of proprietary accounts of introducing broker-dealers at September 30, 2013 or December 31, 2012.

Mortgage Origination

As a mortgage originator, PrimeLending is subject to minimum net worth requirements established by the United States Department of Housing and Urban Development (“HUD”) and the Government National Mortgage Association (“GNMA”). On an annual basis, PrimeLending submits audited financial statements to HUD and GNMA documenting PrimeLending’s compliance with its minimum net worth requirements. In addition, PrimeLending monitors compliance on an ongoing basis and, as of September 30, 2013, PrimeLending’s net worth exceeded the amounts required by both HUD and GNMA.

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 National Association of Insurance Commissioners’ (“NAIC”) statutory accounting practices 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).

	September 30,		December 31,
	2013		2012
Capital and surplus:
National Lloyds Insurance Company	$	87,723	$	94,558
American Summit Insurance Company	24,946		25,761

	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2013		2012			2013			2012
Statutory net income (loss):
National Lloyds Insurance Company	$	2,645	$	(1,759	)	$	(7,296	)	$	(9,516	)
American Summit Insurance Company	167		(136		)	(962		)	(706		)

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 September 30, 2013, 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 December 31, 2012, the most recent date for which the RBC calculation was performed, the Company’s insurance subsidiaries’ RBC ratio exceeded the level at which regulatory action would be required. As of September 30, 2013, management was not aware of any changes in financial condition or structure that would cause the Company’s insurance subsidiaries to not be in compliance with the required RBC ratio.