Hilltop Holdings Inc. — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012. Unaudited consolidated results; monetary amounts below are in millions unless otherwise noted.
Business context
Hilltop was a holding company pursuing acquisitions and operated primarily through property-and-casualty insurance subsidiaries National Lloyds and American Summit. On May 8, 2012, it agreed to acquire PlainsCapital Corporation for approximately 27.5 million Hilltop shares and $318 million cash. Shareholders approved the transaction, but regulatory approval remained pending; closing was not assured.
Key financial results
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Total revenue | $42.8 | $40.6 | $124.3 | $111.8 |
| Net premiums earned | $37.7 | $34.9 | $109.0 | $98.4 |
| Net investment income | $3.3 | $3.1 | $9.7 | $7.4 |
| Loss before tax | $(6.0) | $(1.1) | $(21.4) | $(19.3) |
| Net income (loss) | $(4.0) | $0.2 | $(14.4) | $(11.6) |
| Basic and diluted EPS | $(0.07) | $0.00 | $(0.26) | $(0.20) |
Premium growth was offset by higher claims and underwriting costs. The underwriting loss was $5.9 million in Q3 and $21.9 million for the nine months. The combined ratio was 114.2% in Q3 versus 99.6%, and 118.6% for nine months versus 116.4%; ratios above 100% indicate underwriting losses. The nine-month loss ratio rose to 84.1% from 82.2%.
At September 30, total assets were $915.5 million, including $574.2 million cash and cash equivalents and $215.8 million investments. Total liabilities were $274.7 million and stockholders’ equity was $640.8 million. Notes payable totaled $131.5 million, comprising $84.0 million fixed-rate and $47.5 million variable-rate debt. The filing estimates that a 0.125% rise in LIBOR and prime would increase annual interest expense by about $59,000.
For the nine months, operating cash flow was negative $13.4 million, investing cash flow positive $10.2 million, and financing cash flow negative $1.2 million, principally from share repurchases. Cash declined $4.4 million to $574.2 million. Approximately $524 million of cash was held by the parent and $50 million by NLASCO and its subsidiaries. Management said existing cash, investments, operating cash flows and subsidiary dividends should meet foreseeable liquidity needs.
Material changes and unusual items
- Nine-month revenue increased 11.1%, principally from 10.8% growth in earned premiums and higher investment income. Premium growth reflected distribution and product expansion; mobile-home premiums grew particularly quickly.
- Loss and loss-adjustment expenses rose 26.7% in Q3 and 13.4% for nine months. Management cited greater frequency and severity of wind and hail claims; 2012 wind and hail losses were $11.1 million higher year over year for the nine-month period.
- Q3 underwriting results also reflected $6.8 million of catastrophe losses below reinsurance retention, compared with $3.6 million a year earlier. Excluding catastrophe events, Q3 combined ratios were 96.1% and 89.3%, respectively.
- Underwriting expenses included a $1.7 million write-down of a policy-administration system the company could not successfully implement. Q3 general and administrative expense fell by $1.0 million, mainly due to lower acquisition-related professional fees.
- Nine-month net investment income rose $2.3 million, including income from the SWS Group loan. Fair values of the SWS loan and warrants were $44.1 million and $18.0 million, respectively, and depend on significant unobservable valuation inputs.
- Cash and deposits exceed FDIC insurance limits, though management reported no significant perceived credit risk. Insurance dividends are subject to regulatory and debt-agreement restrictions; approximately $11.9 million could be paid to NLASCO in 2012 without regulatory approval.
Outlook, risks and contingencies
No numerical earnings guidance was provided. The merger would leave Hilltop with approximately $200 million of parent-level cash after consideration and transaction expenses, according to management. Termination under specified circumstances could require a $17.5 million payment. The filing warns that merger approval or completion could be delayed or fail, and that Hilltop might need external financing for future acquisitions.
Key risks include catastrophe losses, reserve-estimation uncertainty, reinsurance availability and collectibility, insurance demand and competition, insurer ratings and regulatory constraints, merger execution, interest-rate and market changes, and realization of deferred tax assets. A $15.0 million deferred tax asset could require a valuation allowance if the merger does not close and management concludes some tax benefits are not realizable. Management said ordinary-course legal proceedings were not expected to have a material adverse effect. Insurance subsidiaries’ statutory surplus exceeded minimum requirements and their risk-based capital ratios exceeded regulatory-action thresholds. Disclosure controls were reported effective, with no material quarterly change in internal control over financial reporting.
Investor facts to verify
- Status and final terms of the PlainsCapital merger, including regulatory approval, share issuance, cash funding and any termination-fee exposure.
- Subsequent claims development, catastrophe losses, reserve adequacy and the effect of reinsurance recoverables and costs.
- Whether underwriting performance improves from the reported combined ratios, and whether the $1.7 million system write-down represents further implementation or operating costs.
- Parent-level liquidity after merger-related cash needs, debt service and regulatory limits on insurance-subsidiary dividends.
- The nine-month EPS is shown as $(0.26) in the financial statements; the MD&A narrative states $(0.25). Verify the discrepancy against the filed statements.