Hilltop Holdings Inc. quarterly report, Q3 FY2023

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Hilltop Holdings Inc. — Q3 2023 Form 10-Q

Business context and reporting period

Hilltop is a financial holding company with banking operations primarily in Texas, a nationwide broker-dealer business, and a nationwide mortgage origination business. This unaudited 10-Q covers the quarter and nine months ended September 30, 2023; comparisons below are with the corresponding 2022 periods unless noted.

Financial performance and position

  • Q3 earnings: Net interest income was $115.7 million, down 6% to $123.5 million. Noninterest income was $196.8 million, down 5%; noninterest expense was $260.0 million, down 10%. Income before taxes rose to $52.5 million from $42.5 million; net income attributable to Hilltop was $37.0 million versus $32.1 million. Diluted EPS was $0.57 versus $0.50.
  • Nine-month earnings: Net interest income increased 6% to $355.6 million, while noninterest income declined 17% to $550.0 million and noninterest expense fell 11% to $777.5 million. Income before taxes was $111.0 million versus $119.9 million; Hilltop-attributable income was $81.0 million versus $87.6 million. Diluted EPS was $1.25 versus $1.21.
  • Margins and returns: Consolidated net interest margin was 3.02% in Q3 versus 3.19%; for nine months it was 3.11% versus 2.75%. Q3 return on average equity was 7.11% and return on average assets 0.94%; nine-month figures were 5.26% and 0.70%, respectively.
  • Segment trends: Banking pretax income was $53.2 million in Q3 and $151.2 million for nine months, down 16% and 6%, respectively. Broker-dealer pretax income was $21.6 million and $53.4 million, up 23% and 197%. Mortgage origination reported pretax losses of $8.2 million and $46.9 million; the nine-month loss widened from $11.0 million.
  • Balance sheet and funding: Total assets were $16.40 billion at September 30, up from $16.26 billion at December 31, 2022. Deposits were $11.10 billion, down from $11.32 billion; noninterest-bearing deposits fell to $3.20 billion from $3.97 billion. Loans held for investment, net, were $8.09 billion, and the allowance for credit losses was $110.8 million, up from $95.4 million. Stockholders’ equity totaled $2.11 billion.
  • Debt and liquidity: Short-term borrowings were $883.0 million and notes payable were $347.0 million. Cash, cash equivalents and restricted cash were $1.565 billion at quarter-end. The Bank reported $7.30 billion of available liquidity across stated FHLB capacity, available investment portfolio and excess Fed deposits; it was not using FHLB borrowing capacity at quarter-end. Hilltop reported $198.9 million of parent-company cash and cash equivalents.
  • Cash flow: Nine-month operating cash flow was $179.9 million, down from $1.236 billion; investing activities provided $42.0 million versus using $695.8 million, and financing activities used $305.0 million versus $1.698 billion. Management’s cash-flow statement reflects substantial broker-dealer receivable/payable and mortgage-loan origination and sale movements.
  • Capital and securities: PlainsCapital’s common equity Tier 1 ratio was 15.31% and total capital ratio 16.45%; Hilltop’s corresponding ratios were 18.60% and 21.54%. Available-for-sale securities had $150.3 million of net unrealized losses, and held-to-maturity securities had $121.7 million of unrealized losses at September 30.

Material changes versus comparable periods

  • Higher interest rates lifted interest income, but sharply higher deposit and borrowing costs pressured Q3 net interest income and banking margins. The Bank’s average rate paid on interest-bearing deposits reached 3.86% in Q3, versus 0.95% a year earlier.
  • Mortgage origination volume fell 26.3% in Q3 and 39.5% for nine months; nine-month volume was $6.43 billion versus $10.62 billion. Lower mortgage production and sale margins drove a $133.8 million decline in mortgage-segment noninterest income for the nine-month period.
  • Broker-dealer results improved, supported by stronger wealth management, public finance and trading activity over the nine-month period, while Q3 fixed-income and structured-finance results faced pressure.
  • The nine-month credit-loss provision rose to $17.1 million from $4.7 million. The allowance increased to $110.8 million, with management citing portfolio changes and a weaker commercial real estate outlook. Net non-accrual loans were $31.5 million, and potential problem loans rose to $35.4 million from $4.0 million at year-end 2022.
  • Hilltop’s accumulated other comprehensive loss was $145.1 million, compared with $133.5 million at year-end 2022, reflecting securities and hedge valuation movements. The company’s securities portfolio declined to $2.86 billion from $3.29 billion.

Outlook, management commentary, risks and contingencies

  • Management expected economic headwinds to continue through the rest of 2023, including tight housing inventory, weak mortgage demand, elevated rates, deposit competition, higher funding costs, inflation-related expense pressure and geopolitical supply-chain risks. It provided no specific earnings or revenue guidance in the supplied filing text.
  • Management expected Bank deposit costs to continue rising. Estimated uninsured deposits were $4.4 billion, about 40% of deposits (about 37% excluding collateralized deposits). The company described maintaining diverse funding sources as important amid banking-sector liquidity concerns.
  • For credit-loss estimation, Hilltop used a Moody’s alternative scenario that anticipated a mild U.S. recession beginning in Q1 2024. Management noted particular risk in commercial real estate, including office exposure. Model sensitivity analysis indicated the allowance could be approximately $35 million lower under an upside scenario or $47 million higher under a downside scenario; these are modeled sensitivities, not forecasts.
  • Mortgage operations remained loss-making. Management said mortgage production and operating trends were expected to continue through year-end 2023 and noted cost-structure actions, including staffing reductions expected to lower annualized pretax expenses by about $10 million. A Q2 interim goodwill impairment test found mortgage goodwill fair value above carrying value, but further underperformance could prompt an impairment charge.
  • Hilltop declared a $0.16-per-share quarterly dividend payable November 28, 2023. Its repurchase authorization was up to $75 million through January 2024; $4.5 million had been spent repurchasing shares during the first nine months.
  • Legal matters include a FINRA claim alleging $13.0 million of losses in a senior-living bond sale; Hilltop Securities disputes the claim and cannot estimate potential loss. PrimeLending also continued to respond to a U.S. Attorney investigation concerning its mortgage “float down” option. Management said it could not rule out a material adverse outcome in a particular reporting period.
  • A third-party vendor security incident likely exposed information about substantially all Bank customers, including Social Security and account numbers. Hilltop was assessing costs and impact and did not expect a material effect on future consolidated financial statements, but noted possible litigation and regulatory scrutiny.
  • Other principal risks include interest-rate and yield-curve changes, deposit outflows and uninsured-deposit concerns, real-estate concentration, credit losses, cybersecurity, regulation, competition, market volatility and the possibility of additional goodwill impairment.

Important facts for investors to verify

  • Whether deposits stabilize and the cost of interest-bearing deposits continues to rise; assess uninsured-deposit levels and access to contingent liquidity.
  • Commercial real estate credit trends, especially office loans; monitor potential problem loans, non-accruals, charge-offs and future allowance builds.
  • Mortgage origination volumes, margins, cost reductions and the risk of a goodwill impairment charge.
  • Whether securities valuation losses, interest-rate exposure and securities-funding activity affect capital, liquidity or earnings.
  • Developments and potential costs related to the customer-data incident, the FINRA claim, the PrimeLending inquiry and mortgage indemnification claims.
  • Capital distributions and the company’s ability to sustain dividends or repurchases while balancing funding, capital and operating needs.