Hilltop Holdings Inc. — Q3 2011 Form 10-Q
Business context and reporting period. This unaudited quarterly report covers the three and nine months ended September 30, 2011, compared with the corresponding 2010 periods. Hilltop is a holding company pursuing opportunistic acquisitions and operates property and casualty insurance through NLASCO and its insurer subsidiaries, which held A.M. Best “A” ratings.
Financial performance
Amounts below are in millions of dollars except per-share data and ratios.
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Total revenue | $40.6 | $33.9 | $111.8 | $98.4 |
| Net premiums earned | $34.9 | $30.1 | $98.4 | $87.5 |
| Net investment income | $3.1 | $2.0 | $7.4 | $5.5 |
| Loss before tax | $(1.1) | $0.9 | $(19.3) | $(2.3) |
| Net income (loss) | $0.2 | $0.6 | $(11.6) | $(1.6) |
| Net income (loss) attributable to common stockholders | $0.2 | $(7.2) | $(11.6) | $(14.5) |
| Basic and diluted EPS attributable to common stockholders | $0.00 | $(0.13) | $(0.20) | $(0.26) |
| Underwriting result | $(0.3) | $1.6 | $(17.5) | $0.5 |
| Combined ratio | 99.6% | 93.1% | 116.4% | 97.6% |
Revenue and premium growth were offset by substantially higher claims. The nine-month loss and loss adjustment expense (LAE) ratio rose to 82.2% from 61.2%; the underwriting expense ratio improved to 34.2% from 36.4%. Excluding catastrophe events, management reported nine-month combined ratios of 96.9% in 2011 and 89.6% in 2010. Q3 net income attributable to common stockholders was positive but EPS rounded to $0.00.
Balance sheet, cash flow, debt and liquidity
- At September 30, 2011, total assets were $934.0 million, total liabilities $291.4 million, and stockholders’ equity $642.6 million. Cash and cash equivalents were $584.1 million, versus $649.4 million at December 31, 2010; investments were $212.6 million, versus $149.0 million.
- Cash from operations was negative $4.0 million for the first nine months, compared with positive $2.5 million in 2010. Investing used $61.3 million, including the $50.0 million SWS investment. Cash decreased $65.3 million to $584.1 million. There was no financing cash flow in 2011; 2010 financing outflow included redemption of preferred stock.
- Notes payable were $138.4 million, unchanged from year-end; their reported fair value was $135.4 million. Debt included $90.9 million fixed-rate and $47.5 million variable-rate obligations. A 0.125% rise in LIBOR and prime was estimated to reduce annual earnings and cash flows by about $59,000.
- Management identified approximately $542 million of cash as held by the parent and $42 million by NLASCO and subsidiaries. Insurer dividends are subject to regulatory and debt-agreement restrictions; approximately $11.9 million of additional 2011 dividends could be paid to NLASCO without regulatory approval. Insurer statutory surplus exceeded minimum requirements and RBC ratios exceeded regulatory-action levels.
Material changes, outlook and risks
- Claims and underwriting: Five Texas storms in April and May generated $18.3 million of incurred losses; other exceptional weather losses and higher fire-loss frequency and severity also weighed on results. Nine-month loss and LAE increased $27.3 million year over year. Management cited late-reported claims and further development of storm losses. NLASCO stopped underwriting wind coverage along the Texas seacoast in March 2011 amid catastrophe losses and higher reinsurance costs.
- Growth and investment: Nine-month earned premiums increased 12.4%, supported by marketing, new products and higher written premiums. Hilltop made a $50 million SWS Group senior unsecured loan on July 29, bearing 8% interest and maturing in five years, and received a warrant for 8,695,652 SWS shares at $5.75 per share. The note and warrant were Level 3 fair-value investments.
- Investment accounting: NLASCO sold portions of three held-to-maturity securities in Q3, realizing a $0.8 million gain, and reclassified its remaining held-to-maturity securities as available-for-sale. Management described the sale as isolated and unusual. No other-than-temporary impairment was recorded for the 2011 periods presented.
- Taxes and unusual comparison: The nine-month 2011 tax benefit was $7.8 million, including a $1.0 million benefit from reversal of an uncertain-tax-position allowance; management reported no uncertain tax positions at quarter-end. The 2010 common-stockholder comparison includes $7.0 million of preferred dividends and a $5.9 million preferred-stock redemption loss; the preferred shares were redeemed in September 2010.
- Outlook and risks: Management said existing cash, investments, expected operating cash flows and permitted insurer dividends should meet foreseeable liquidity needs, while noting external financing may be needed for acquisitions and cannot be assured. No earnings guidance was provided. Risks include catastrophe severity, reserve adequacy and claims development, reinsurance availability and collectability, insurance demand and ratings, acquisition execution, capital markets, interest rates, and realization of deferred tax assets. Management expected to realize the $15.2 million net deferred tax asset despite cumulative losses, citing future taxable income, reversals of timing differences and tax-planning strategies.
- Subsequent event: On November 2, 2011, the board authorized repurchases of up to $100 million of common shares through November 1, 2012.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. Ordinary-course legal proceedings were not expected to have a material adverse effect.
Key investor verification points
- Assess whether the 2011 storm and fire losses, claim development and reserve assumptions are adequately reflected, and whether underwriting profitability can recover.
- Review reinsurance recoverables, reinsurer credit exposure, catastrophe-layer coverage and the retained 21% of the highest catastrophe layer.
- Verify cash available at the parent versus regulated insurance subsidiaries, dividend restrictions, debt service needs and funding for acquisitions or the share repurchase authorization.
- Evaluate the SWS loan and warrant valuation, terms, credit risk and potential dilution or ownership exposure.
- Reconcile reported losses, tax benefits, deferred tax asset assumptions and the 2010 preferred-stock effects when comparing common-stockholder results.