Derivative Financial Instruments

3 Months Ended

Mar. 31, 2020

Derivative Financial Instruments

Derivative Financial Instruments

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 U.S. Treasury bond, Eurodollar futures and municipal market data, or MMD, rate locks to hedge changes in the fair value of its 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 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 March 31,
	2020		2019
Increase (decrease) in fair value of derivatives during period:
PrimeLending	$	19,876	$	18,187
Hilltop Broker-Dealers		(8,141)		(1,807)
Bank		(135)		(61)

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

	March 31, 2020				December 31, 2019
	Notional		Estimated		Notional		Estimated
	Amount		Fair Value		Amount		Fair Value
Derivative instruments (not designated as hedges):
IRLCs	$	3,063,446	$	93,412	$	914,526	$	18,222
Customer-based written options		31,200		—		31,200		—
Customer-based purchased options		31,200		—		31,200		—
Commitments to purchase MBSs		5,431,558		65,666		3,346,946		3,321
Commitments to sell MBSs		9,698,119		(133,762)		5,988,198		(5,904)
Interest rate swaps		41,455		(192)		15,012		(178)
U.S. Treasury bond futures and options (1)		66,100		—		283,500		—
Eurodollar futures (1)		18,000		—		934,000		—
Derivative instruments (designated as hedges):
Interest rate swaps designated as cash flow hedges	$	105,000	$	(3,605)	$	50,000	$	528

(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 $100.7 million and $4.5 million to offset net liability derivative positions on its commitments to sell MBSs at March 31, 2020 and December 31, 2019, respectively. In addition, PrimeLending and the Hilltop Broker-Dealers advanced cash collateral totaling $1.0 million and $3.7 million on U.S. Treasury bond futures and options and Eurodollar futures at March 31, 2020 and December 31, 2019, respectively. These amounts are included in other assets within the consolidated balance sheets.