Hilltop Holdings Inc. — 2019 Form 10-K Summary
Business context and reporting period
Annual report for the fiscal year ended December 31, 2019, filed February 27, 2020. Hilltop is a Texas-based financial holding company with banking, broker-dealer, mortgage origination and property-and-casualty insurance businesses. Banking is concentrated in Texas; mortgage, broker-dealer and insurance operations extend across multiple states.
Financial results and key metrics
| Metric | 2019 | 2018 |
|---|---|---|
| Net interest income | $441.3 million | $436.3 million |
| Noninterest income | $1.206 billion | $1.023 billion |
| Income before income taxes | $300.3 million | $160.8 million |
| Net income | $233.0 million | $125.7 million |
| Income attributable to Hilltop common stockholders | $225.3 million | $121.4 million |
| Diluted earnings per share | $2.44 | $1.28 |
| Return on average assets / equity | 1.66% / 11.18% | 0.93% / 6.33% |
| Net interest margin | 3.48% | 3.55% |
| Operating cash flow | $(433.0) million | $389.5 million |
At year-end, Hilltop reported $15.17 billion in assets, $9.03 billion in deposits, approximately $9.4 billion in loans including loans held for sale, and $2.13 billion in stockholders’ equity. Consolidated cash, cash equivalents and restricted cash were $642.8 million, down from $778.5 million. The negative operating cash flow primarily reflects mortgage loan originations and sales and changes in broker-dealer balances; investing cash outflow was $604.3 million and financing cash inflow was $901.6 million.
Other key measures: the allowance for loan losses was $61.1 million; nonperforming assets were $54.3 million, or 0.36% of assets; and net charge-offs were 0.08% of average loans. Hilltop’s total risk-based capital ratio was 17.55% and PlainsCapital Bank’s was 14.13%; the bank was classified as well-capitalized. Total deposits were $9.0 billion. The filing reports $1.8 billion of other indebtedness at year-end, including short-term borrowings, notes payable and junior subordinated debentures; the separate $150 million senior notes bear 5% interest and mature in 2025.
Material changes versus the prior comparable period
- Net income attributable to Hilltop rose 86% and diluted EPS increased from $1.28 to $2.44. Pretax income improved across banking, broker-dealer, mortgage origination and insurance.
- Noninterest income increased 18%, driven mainly by higher broker-dealer trading gains and mortgage production income. Broker-dealer pretax income rose to $89.8 million from $32.6 million; mortgage origination pretax income rose to $64.7 million from $12.9 million.
- Net interest margin declined to 3.48% from 3.55%, as higher funding costs and lower accretion on acquired loans offset asset growth and yield benefits. Interest expense rose to $173.5 million from $143.1 million.
- Banking pretax income increased to $182.2 million from $152.4 million, while the insurance segment improved to $17.5 million from $5.7 million. The insurance combined ratio improved to 91.8% from 97.0%.
- Mortgage originations increased 13.8% to $15.58 billion; refinancing share rose to 24.8% from 13.8%, reflecting lower mortgage rates. Home-purchase volume was broadly flat.
- Year-end assets increased from $13.68 billion to $15.17 billion, deposits from $8.54 billion to $9.03 billion, and loans held for investment, net, from $6.87 billion to $7.32 billion.
Outlook, risks, contingencies and unusual items
- Pending insurance sale: On January 30, 2020, Hilltop agreed to sell NLC for $150 million cash, subject to adjustments and regulatory and other closing conditions. Management expected closing in the second quarter of 2020; completion was not assured.
- Credit-loss accounting: CECL became effective January 1, 2020. Hilltop estimated an $80–$100 million increase in the allowance for credit losses, including a $6–$9 million reserve for unfunded commitments. The after-tax increase was expected to reduce opening retained earnings; Hilltop elected not to use the available three-year regulatory-capital phase-in.
- Control weakness: Management and the auditor concluded internal control over financial reporting was ineffective at year-end due to a material weakness in controls supporting qualitative factors used in the loan-loss allowance analysis. The weakness was not remediated by December 31, 2019. The auditor nevertheless gave an unqualified opinion on the financial statements, which it said were fairly presented in all material respects.
- Unusual costs and gains: 2019 included $11.0 million of pretax leadership-change and efficiency charges. Broker-dealer trading gains rose by $102.3 million, particularly in structured finance, benefiting from a more favorable market environment and increased trading volumes. Loan discount accretion contributed $28.7 million of interest income and is expected to decline as acquired loans run off.
- Capital returns: Hilltop paid $0.32 per share in 2019 dividends and repurchased $73.4 million of stock, including a $48.4 million negotiated repurchase from Oak Hill Capital. In January 2020, the board authorized up to $75 million in further repurchases and increased the quarterly dividend to $0.09 per share.
- Key risks: Texas and real-estate concentration; interest-rate and yield-curve changes; energy-price weakness; severe weather and catastrophe exposure; reinsurance collectability; mortgage-market and MSR valuation volatility; cybersecurity and operational risks; regulatory change, including expected CFPB supervision of the Bank beginning in 2020; and execution and approval risk for the NLC sale. The filing also cites a $4.0 million 2018 spear-phishing wire-fraud loss.
- Management cited ongoing core technology projects and expected related costs to remain significant through 2020 and 2021, with anticipated longer-term efficiency benefits. Mortgage purchase and refinancing volumes, expenses, and insurance losses are subject to seasonal and market variability; the filing provides no overall earnings guidance.
Investor verification priorities
- Verify the NLC sale’s closing status, final proceeds after adjustments, and any resulting changes to Hilltop’s earnings mix and capital allocation.
- Compare actual CECL adoption effects with the estimated $80–$100 million allowance increase and assess the resulting capital and credit-quality ratios.
- Track remediation and auditor testing of the material weakness in allowance-for-loan-loss controls.
- Assess the sustainability of 2019’s broker-dealer trading gains and mortgage origination profitability, including the influence of rates and nonrecurring or market-sensitive items.
- Monitor deposit pricing, funding costs, loan growth and asset quality, particularly commercial real estate, commercial and industrial, and Texas exposures.
- Reconcile consolidated cash-flow movements with mortgage production activity and review short-term borrowing needs, debt maturities, and subsidiary dividend capacity.
- Confirm the continued affordability and regulatory availability of dividends and repurchases, given capital requirements and the pending NLC transaction.