Hilltop Holdings Inc. — Q2 2017 Form 10-Q
Business context and period. Hilltop is a diversified financial holding company with banking, broker-dealer, mortgage origination and property-and-casualty insurance businesses. This unaudited filing covers the quarter and six months ended June 30, 2017; balance-sheet comparisons are to December 31, 2016. Amounts below are in U.S. dollars.
Financial results and position
- Q2 earnings: Net interest income was $116.0 million; noninterest income was $344.7 million. Income before tax was $88.6 million, net income was $62.8 million, and income attributable to Hilltop was $62.5 million, or $0.63 diluted EPS.
- First-half earnings: Net interest income was $208.1 million and noninterest income was $616.1 million. Income before tax was $129.9 million, net income was $89.1 million, and income attributable to Hilltop was $88.9 million, or $0.90 diluted EPS.
- Margins and returns: Consolidated taxable-equivalent net interest margin was 4.05% in Q2 versus 3.80% a year earlier, and 3.81% for the first half versus 3.76%. Q2 return on average assets was 1.94% and return on average equity was 13.24%; first-half figures were 1.43% and 9.53%.
- Balance sheet at June 30: Total assets were $13.29 billion, up from $12.74 billion at year-end; deposits were $7.57 billion, up from $7.06 billion; non-covered loans, net, were $6.06 billion; loans held for sale were $2.00 billion; and stockholders’ equity was $1.89 billion.
- Funding and debt: Short-term borrowings were $1.52 billion, notes payable $300.3 million, and junior subordinated debentures $67.0 million. Notes payable declined from $317.9 million at year-end, while short-term borrowings rose from $1.42 billion. Cash and cash equivalents were $406.3 million, down from $690.8 million.
- Cash flows, first half: Operating cash flow was negative $461.4 million, investing cash flow negative $355.9 million, and financing cash flow positive $532.8 million. Cash and cash equivalents decreased $284.4 million. Mortgage originations and sales materially affect operating cash flows.
- Capital and liquidity: Hilltop’s total risk-based capital ratio was 18.57% and PlainsCapital’s was 14.72%; the bank was categorized as well-capitalized. Parent-company cash was $116.7 million. Management stated that Hilltop’s liquidity was sufficient for the foreseeable future.
Material changes versus comparable periods
- Q2 income attributable to Hilltop nearly doubled from $31.1 million in 2016; first-half income rose from $58.6 million. Provision for loan losses fell to $5.9 million in Q2 and $7.6 million for the first half, compared with $28.9 million and $32.3 million, respectively, in 2016. The prior-year periods included a $24.5 million charge-off of a single large loan.
- Q2 noninterest income was broadly unchanged year over year ($344.7 million versus $346.0 million); first-half noninterest income decreased to $616.1 million from $623.4 million. Increases in banking income included a $15.0 million insurance recovery; corporate income included an $11.6 million gain related to SWS appraisal proceedings.
- Net mortgage gains and production income were lower: first-half net gains from loan sales were $242.1 million versus $265.2 million. Origination volume declined 2.8% to $6.88 billion, as refinancing fell while home-purchase volume increased.
- Broker-dealer first-half pretax income increased to $25.3 million from $22.1 million, helped by lower SWS integration costs and higher interest-related fees, but municipal underwriting/advisory fees and trading-related income declined.
- Insurance first-half pretax loss widened to $8.6 million from $3.4 million. Net premiums earned declined to $72.2 million from $78.5 million, and the combined ratio rose to 115.1% from 108.9%.
- Non-covered nonperforming assets rose to $34.8 million from $30.1 million; covered nonperforming assets fell to $45.3 million from $55.5 million. The mortgage indemnification reserve increased to $22.4 million from $18.2 million.
Outlook, commentary, risks and unusual items
- Management expected the year-over-year decline in mortgage refinancing to continue through the rest of 2017, but did not expect recent mortgage-rate increases to significantly affect home-purchase volume. Joint ventures were expected to remain below 5% of mortgage volume.
- Management said loan discount accretion from acquired portfolios is expected to decline as loans repay, refinance or renew. It also said interest-margin compression could persist until rates rise enough for loans subject to rate floors to reprice above those floors.
- Q2 results included a $15.0 million insurance receivable related to forgery coverage for the previously charged-off loan. The bank is pursuing legal remedies; future recoveries and related expenses could not be estimated. The $11.6 million SWS appraisal gain followed the court’s May 2017 valuation decision; certain petitioners filed an appeal in July, which Hilltop said it would vigorously defend.
- PrimeLending continued to face a DOJ investigation concerning FHA loan origination and underwriting. The company disputed the DOJ’s sampling and loan analysis, was cooperating, and maintained an indemnification reserve. The filing states the outcome is inherently unpredictable and could have a material effect.
- The FDIC loss-share agreements may require a future “true-up” payment; Hilltop accrued $15.9 million at June 30 based on current estimates. Covered-asset estimates and the related indemnification asset may change.
- Other principal risks include credit and real-estate concentration, interest-rate and market exposure, severe weather losses, reinsurance collectability, regulatory proceedings, cyber risk, funding costs and integration or capital-allocation decisions. Management reported no material change to the risk factors in its 2016 Form 10-K.
- The company repurchased 605,431 shares for $16.0 million in the first half under a $50 million authorization through January 2018, and declared a $0.06-per-share dividend payable August 31, 2017. No specific full-year earnings guidance was provided in the filing text.
Most important facts for investors to verify
- How much reported earnings relied on the $15.0 million insurance recovery and $11.6 million SWS-related gain, and the eventual outcomes of the related matters.
- Whether mortgage production margins and volume can offset continued refinancing weakness and higher operating costs.
- Whether banking credit quality, nonperforming assets and allowance levels remain appropriate as the loan portfolio grows.
- How deposit and borrowing costs, loan repricing floors and declining acquired-loan accretion affect net interest margin.
- The trend in insurance premiums, combined ratio, catastrophe losses and reserve development, including the impact of competition and reinsurance.
- Potential exposure from the FHA investigation, mortgage indemnification claims, FDIC true-up obligation, and the company’s substantial off-balance-sheet commitments.