15. 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.

On January 1, 2015, the new comprehensive capital framework (“Basel III”) for U.S. banking organizations became effective for the Bank and Hilltop for reporting periods beginning after January 1, 2015 (subject to a phase-in period through January 2019). Under Basel III, total capital consists of two tiers of capital, Tier 1 and Tier 2. Tier 1 capital is further composed of common equity Tier 1 capital and additional Tier 1 capital. Total capital is the sum of Tier 1 capital and Tier 2 capital.

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 addition, under the final rules, 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 (75% in 2015 and 100% in 2016). All of the debentures issued to the Trusts, less the common stock of the Trusts, qualified as Tier 1 capital as of March 31, 2015, under guidance issued by the Board of Governors of the Federal Reserve System.

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 in accordance with Basel III as measured at March 31, 2015 and applicable regulatory guidelines at December 31, 2014 (dollars in thousands).

									To Be Well Capitalized
					Minimum Capital				Minimum Capital
	Actual				Requirements				Requirements
March 31, 2015	Amount		Ratio		Amount		Ratio		Amount		Ratio
Tier 1 capital (to average assets):
Bank	$	945,922	11.34	%	$	333,675	4.0	%	$	417,094	5.0	%
Hilltop	1,556,506		12.68	%	491,149		4.0	%	N/A		N/A
Common equity Tier 1 capital (to risk-weighted assets):
Bank	945,922		16.46	%	$	258,619	4.5	%	$	373,561	6.5	%
Hilltop	1,386,467		18.05	%	345,650		4.5	%	N/A		N/A
Tier 1 capital (to risk-weighted assets):
Bank	945,922		16.46	%	344,826		6.0	%	459,767		8.0	%
Hilltop	1,556,506		20.26	%	460,866		6.0	%	N/A		N/A
Total capital (to risk-weighted assets):
Bank	987,755		17.19	%	459,767		8.0	%	574,709		10.0	%
Hilltop	1,598,829		20.82	%	614,488		8.0	%	N/A		N/A

									To Be Well Capitalized
					Minimum Capital				Minimum Capital
	Actual				Requirements				Requirements
December 31, 2014	Amount		Ratio		Amount		Ratio		Amount		Ratio
Tier 1 capital (to average assets):
Bank	$	845,656	10.31	%	$	328,025	4.0	%	$	410,031	5.0	%
Hilltop	1,231,724		14.17	%	347,619		4.0	%	N/A		N/A
Tier 1 capital (to risk-weighted assets):
Bank	845,656		13.74	%	246,099		4.0	%	369,148		6.0	%
Hilltop	1,231,724		19.02	%	259,078		4.0	%	N/A		N/A
Total capital (to risk-weighted assets):
Bank	888,744		14.45	%	492,198		8.0	%	615,247		10.0	%
Hilltop	1,275,023		19.69	%	518,157		8.0	%	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 of 4%, common equity Tier 1 capital to risk-weighted assets of 4.5%, Tier 1 capital to risk-weighted assets ratios of 6% (an increase from 4% prior to January 1, 2015), 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.

Broker-Dealer

Pursuant to the net capital requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), FSC and Southwest Securities have each elected to determine their respective net capital requirements using the alternative method. Accordingly, FSC and Southwest Securities are 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. SWS Financial 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 March 31, 2015, the net capital position of each of the Hilltop Broker-Dealers was as follows (in thousands).

				Southwest			SWS
	FSC			Securities			Financial

Net capital	$	66,844		$	164,058		$	1,055
Less required net capital	5,353			6,343			250
Excess net capital	$	61,491		$	157,715		$	805

Net capital as a percentage of aggregate debit items	25.0		%	51.73		%
Net capital in excess of 5% aggregate debit items	$	53,461		$	148,200

Under certain conditions, the Hilltop Broker-Dealers 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. The Hilltop Broker-Dealers were required to segregate $278.3 million and $76.0 million in cash and securities at March 31, 2015 and December 31, 2014, respectively.

The Hilltop Broker-Dealers were not required to segregate cash or securities in a special reserve account for the benefit of proprietary accounts of introducing broker-dealers at March 31, 2015 and December 31, 2014.

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 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 March 31, 2015, 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 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 of each insurance subsidiary is as follows (in thousands).

	March 31,		December 31,
	2015		2014
Capital and surplus:
National Lloyds Insurance Company	$	117,614	$	113,023
American Summit Insurance Company	29,983		28,964

	Three Months Ended March 31,
	2015		2014
Statutory net income:
National Lloyds Insurance Company	$	4,759	$	5,986
American Summit Insurance Company	909		1,131

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 March 31, 2015, 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 March 31, 2015, the Company’s insurance subsidiaries’ RBC ratio exceeded the level at which regulatory action would be required.