Hilltop Holdings Inc. — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014; comparative periods ended September 30, 2013. Financial statement amounts below are in millions unless otherwise noted. Hilltop is a Texas-focused financial holding company with banking, mortgage origination, insurance and financial advisory businesses. The filing is unaudited.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net interest income | $85.8 | $71.9 | $269.6 | $207.6 |
| Noninterest income | $212.1 | $215.1 | $585.5 | $667.6 |
| Net interest income plus noninterest income | $297.9 | $287.0 | $855.1 | $875.2 |
| Provision for loan losses | $4.0 | $10.7 | $12.8 | $35.0 |
| Noninterest expense | $254.7 | $216.6 | $718.6 | $692.0 |
| Net income | $25.1 | $39.6 | $79.1 | $95.7 |
| Income applicable to common stockholders | $23.4 | $38.2 | $74.2 | $91.5 |
| Diluted earnings per share | $0.26 | $0.43 | $0.82 | $1.05 |
Taxable-equivalent net interest margin was 4.38% in Q3 versus 4.46% a year earlier, and 4.72% year to date versus 4.39%. Management said acquired-loan accretion and related purchase-accounting items added 87 basis points to Q3 margin and 108 basis points to the nine-month margin in 2014.
At September 30, total assets were $9.18 billion, deposits $6.24 billion, and stockholders’ equity $1.42 billion. Cash and cash equivalents were $647.6 million. Non-covered loans, net, were $3.73 billion and covered loans, net, were $747.5 million; loans held for sale were $1.27 billion. Hilltop reported approximately $153 million of freely available holding-company cash.
Short-term borrowings increased to $846.0 million from $342.1 million at year-end 2013, primarily reflecting $525 million of FHLB notes and mortgage warehouse funding needs. Notes payable were $55.7 million and junior subordinated debentures $67.0 million. Deposits fell $486.6 million from year-end to $6.24 billion, including declines in time and money-market deposits.
For the first nine months, operating cash flow was negative $50.0 million, investing cash flow was positive $84.1 million, and financing cash flow was negative $132.5 million. Cash and cash equivalents declined $98.4 million from year-end. Management attributed the operating cash-flow decline versus 2013 largely to mortgage origination activity; 2013 investing cash flow included $362.7 million of net cash from the FNB transaction.
Changes versus prior comparable periods
- Q3 net income applicable to common stockholders declined 39%, and nine-month income declined 19%. Lower mortgage production income and higher expenses weighed on results; the 2013 comparisons also included a $12.6 million FNB bargain-purchase gain.
- Net interest income rose, primarily because the FNB-acquired operations were included for a full 2014 period. Lower loan and warehouse-line yields partly offset the benefit of higher asset volumes.
- Nine-month mortgage loan originations fell 19% to $7.65 billion; refinancing volume declined 56%, while home-purchase volume was broadly unchanged. Mortgage-segment income before tax fell to $17.3 million from $34.9 million year to date, despite a Q3 improvement to $11.1 million from $3.8 million.
- Insurance results improved: nine-month pretax income was $14.1 million versus a $9.9 million loss, and the combined ratio improved to 93.4% from 113.7%. Management cited milder weather-related claims, premium growth and pricing actions.
- Non-covered nonperforming assets decreased to $27.0 million from $28.2 million at year-end. Covered nonperforming assets increased to $167.1 million from $144.6 million, including covered non-accrual loans of $40.3 million versus $1.8 million.
Outlook, material developments and risks
- SWS merger: Hilltop expected to complete its announced SWS Group merger before year-end 2014, subject to regulatory and SWS shareholder approvals. Consideration was 0.2496 Hilltop shares plus $1.94 cash per SWS share; the cash component was estimated at approximately $78 million. Merger-related litigation sought, among other relief, to enjoin the transaction; Hilltop said it considered the claims without merit.
- Subsequent event: On October 2, Hilltop exercised its SWS warrant for 8.70 million shares, using cancellation of its $50 million SWS note to pay the exercise price. Hilltop then owned approximately 21% of SWS. It expected to lose approximately $1.0 million of quarterly cash interest income from the note beginning in Q4.
- Mortgage outlook: Management anticipated refinancing’s share of originations would increase through Q1 2015 following recent mortgage-rate declines. Mortgage activity remains sensitive to interest rates, production volume, pricing competition and seasonal factors.
- Bank branches: After quarter-end, the Bank announced closures of 13 FNB-acquired branches effective January 30, 2015, in addition to two Houston-area closures effective November 7, 2014. Management expected improved operating efficiency and planned to serve affected customers through other branches.
- Credit and FDIC protection: Covered assets are subject to FDIC loss-share terms, including an uninsured loss band between $240.4 million and $365.7 million and possible future recovery or “true-up” obligations. The Bank estimated covered losses and reimbursable expenses were above $240.4 million but not above $365.7 million at quarter-end; it had billed $46.6 million of covered net losses, of which $37.7 million was reimbursable. Covered OREO write-downs were $14.4 million in Q3 and $17.4 million year to date.
- Legal and regulatory matters: PrimeLending received a DOJ Civil Investigative Demand concerning FHA mortgage origination and underwriting and was cooperating. Management did not expect pending litigation or inquiries to have a material overall effect, but noted adverse outcomes could be material in a particular period. Mortgage-loan representation-and-warranty reserves were $19.1 million.
- Capital and interest-rate exposure: The Bank was categorized as well capitalized under then-current rules; its Tier 1 leverage ratio was 9.95%, Tier 1 risk-based ratio 13.48%, and total capital ratio 14.21%. Hilltop said it expected to meet Basel III requirements, effective beginning in 2015 with phase-in thereafter. Management described the banking segment as asset-sensitive overall, but its rate simulation showed estimated net interest income declines of 4.52% for a 100-basis-point rise and 2.82% for a 200-basis-point rise. Low rates and loan floors could delay asset-yield increases.
- Other risks: Key exposures include loan-loss estimation, real-estate concentrations, FDIC reimbursement and true-up uncertainty, deposit movements, mortgage market conditions, severe weather and reinsurance collectability, regulatory changes, and merger execution, integration costs and dilution. The filing provided no earnings guidance.
Important facts for investors to verify
- Progress, approvals, closing terms and integration costs for the SWS merger, including the effect of merger litigation and the warrant exercise.
- Whether the decline in mortgage originations and mortgage-related income stabilizes, and how rate changes affect production margins and refinancing activity.
- Trends in covered nonperforming loans and OREO, valuation assumptions, FDIC reimbursements, and potential loss-share true-up exposure.
- Deposit retention and funding mix following the deposit decline and branch closures; monitor growth in short-term borrowings and warehouse funding.
- Insurance claims development, catastrophe exposure, pricing actions and reinsurance recoveries, particularly after the improved 2014 weather experience.
- Implementation of Basel III and any resulting effects on capital, dividends, liquidity or regulatory costs.