Hilltop Holdings Inc. — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015. Dollar amounts below are in millions unless stated otherwise. Hilltop is a financial holding company with banking, broker-dealer, mortgage origination and property-and-casualty insurance businesses. Results include SWS Group from its January 1, 2015 acquisition; comparisons with 2014 are therefore not fully like-for-like.
Financial performance and condition
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net interest income | $115.2 | $85.8 | $309.3 | $269.6 |
| Noninterest income | $296.5 | $212.1 | $950.7 | $585.5 |
| Income before tax | $72.6 | $39.1 | $250.3 | $123.8 |
| Net income | $47.2 | $25.1 | $191.4 | $79.1 |
| Income applicable to common stockholders | $46.9 | $23.4 | $188.4 | $74.2 |
| Diluted EPS | $0.47 | $0.26 | $1.88 | $0.82 |
- Revenue drivers and expenses: Mortgage origination and broker-dealer activity expanded substantially, aided in part by SWS. Nine-month noninterest income included an $81.3 million preliminary bargain purchase gain from SWS. Total noninterest expense rose to $333.5 million for Q3 from $254.7 million, and to $1,001.3 million for nine months from $718.6 million; compensation was the largest expense category. SWS transaction and integration costs totaled $17.2 million for the first nine months.
- Margins: Consolidated taxable-equivalent net interest margin was 4.20% in Q3 versus 4.38% a year earlier, and 3.84% for nine months versus 4.72%. Management cited securities-financing activity and acquisition-related funding as factors affecting consolidated margin. The banking segment’s Q3 margin was 5.79%, including substantial purchase-accounting accretion. Insurance combined ratio was 75.4% for Q3 and 97.6% for nine months, versus 84.8% and 93.4%, respectively.
- Credit: Provision for loan losses was $5.6 million in Q3 and $8.4 million for nine months, compared with $4.0 million and $12.8 million in 2014. Non-covered loans, net, were $4.96 billion at quarter-end; allowance was $43.0 million. Non-covered nonperforming assets were $30.0 million, up from $23.2 million at year-end. Covered nonperforming assets fell to $108.8 million from $171.2 million, largely reflecting loan and property dispositions.
- Cash flow: Nine-month operating cash flow was a use of $1.6 million, investing cash flow provided $581.6 million, and financing cash flow used $841.5 million. Cash and cash equivalents decreased $261.5 million to $551.6 million. Operating cash flow includes large mortgage-loan origination and sale flows and broker-dealer balance changes.
- Balance sheet and funding: At September 30, total assets were $12.39 billion, deposits $6.82 billion, and stockholders’ equity $1.72 billion. Cash and cash equivalents were $551.6 million. Short-term borrowings were $910.5 million; notes payable were $243.6 million and junior subordinated debentures $67.0 million. Hilltop issued $150 million of 5% senior notes due 2025 and used proceeds principally to redeem $114.1 million of preferred stock. The company reported $41.1 million of freely available holding-company cash.
- Capital: Hilltop’s total capital-to-risk-weighted-assets ratio was 19.29% and common equity Tier 1 ratio 18.36%; the Bank was classified as well-capitalized under Basel III.
Material changes versus comparable periods
- Q3 common income rose to $46.9 million from $23.4 million; nine-month common income rose to $188.4 million from $74.2 million. The nine-month comparison includes the SWS bargain gain and SWS results, absent from the 2014 reported results.
- Management attributed higher net interest income to SWS inclusion and the favorable resolution of certain significant loan relationships in Q3. Nine-month mortgage originations rose 34.4% to $10.29 billion; mortgage segment pretax income increased to $43.3 million from $17.3 million.
- Broker-dealer revenue and expenses increased with the acquired SWS businesses; that segment recorded a $3.9 million pretax loss for nine months versus $1.7 million income in 2014, including acquisition-related costs.
- Hilltop revised preliminary SWS acquisition accounting, reducing the bargain purchase gain from $82.8 million to $81.3 million. It also identified a cash-flow statement classification error in previously filed 2015 interim reports; management said it was not material and planned to revise those statements in future filings. The error did not affect financial condition or results of operations.
- The company repurchased and retired $30.0 million of common stock, or about 1.39 million shares, completing its authorized program. It redeemed all Series B preferred stock using proceeds from the senior-note issuance.
Outlook, risks and contingencies
- Management expected broker-dealer cost savings to begin in 2016 after combining FSC and Hilltop Securities, while warning that further integration costs would partly offset savings. FINRA approval was granted subject to customary conditions.
- Management described mortgage origination results as historically more volatile than other segments. The effects of new TRID mortgage disclosure requirements, effective October 3, 2015, on closings, processing, volume and costs were not yet known.
- Insurance results face severe-weather frequency and severity risk. Nine-month reserves included $5.8 million of prior-period adverse development, primarily litigation related to hail storms in 2012–2014. Reinsurance recoverables and reinsurer performance are additional exposures.
- Other material risks include real-estate loan concentrations, credit-loss estimation, interest-rate movements, acquisition integration, reliance on FDIC loss-share reimbursements, and broker-dealer counterparty and securities-financing risks. The FDIC loss-share agreements include a potential true-up payment approximately ten years after the 2013 bank closing.
- Pending matters include SWS merger-related shareholder litigation and appraisal proceedings, and a DOJ investigation of PrimeLending mortgage practices under the False Claims Act. The filing states no allegations had been asserted against PrimeLending and that potential liability could not be reasonably estimated. Management did not expect pending matters to have a material overall effect, but noted adverse outcomes could be material in a particular period.
- Hilltop reported effective disclosure controls. Management cautioned that forward-looking statements are subject to risks and that interim results are not necessarily indicative of full-year results.
Important facts for investors to verify
- How much of reported nine-month earnings depends on the $81.3 million SWS bargain purchase gain, acquired-loan accretion and other purchase-accounting effects.
- Whether broker-dealer integration delivers the anticipated 2016 savings, and the remaining integration costs and timetable.
- Underlying credit quality and allowance adequacy as non-covered nonperforming assets rose and real-estate concentrations remained significant.
- Insurance reserve development, weather losses, reinsurance recoverability and the effect of premium-rate actions on retention and growth.
- Liquidity and funding needs, including freely available holding-company cash, short-term borrowings, and any restrictions on subsidiary dividends or debt service.
- Final SWS appraisal-rights consideration, resolution of litigation and DOJ inquiry, and the planned corrections to earlier interim cash-flow presentations.