Hilltop Holdings Inc. — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014; financial statements are unaudited. Hilltop is a financial holding company with banking, mortgage origination, insurance and financial advisory businesses. Comparisons are with the corresponding 2013 periods unless stated otherwise. Amounts below are in millions, except per-share data.
Financial results and position
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net interest income | $98.4 | $68.4 | $183.9 | $135.7 |
| Noninterest income | $203.3 | $239.2 | $373.4 | $452.5 |
| Income before taxes | $45.0 | $36.0 | $84.6 | $88.5 |
| Net income attributable to Hilltop common stockholders | $27.1 | $20.9 | $50.8 | $53.3 |
| Diluted EPS | $0.30 | $0.24 | $0.56 | $0.61 |
| Taxable-equivalent net interest margin | 5.18% | 4.33% | 4.90% | 4.34% |
- Second-quarter common earnings rose despite lower noninterest income, helped by higher net interest income and a lower loan-loss provision ($5.5 million versus $11.3 million). First-half common earnings and diluted EPS declined year over year.
- Management said higher net interest income primarily reflected the FNB acquisition. Acquisition-related accretion contributed materially to reported margins: 140 basis points to consolidated Q2 margin and 121 basis points to the first-half margin in 2014.
- Mortgage production was weaker: originations were $2.84 billion in Q2, down 20.0%, and $4.70 billion for the first half, down 28.7%. Lower mortgage gains, production income and origination fees drove most of the noninterest-income decline.
- Insurance improved substantially year over year as weather-related claims severity eased, but the segment still recorded a Q2 pretax loss of $5.5 million and a 118.2% combined ratio. First-half insurance pretax income was $6.0 million; its combined ratio was 97.9%.
Balance sheet and funding at June 30: Total assets were $9.40 billion, up from $8.90 billion at December 31, 2013; stockholders’ equity was $1.40 billion. Cash and cash equivalents were $688.8 million, including approximately $158 million of freely available holding-company cash. Deposits were $6.16 billion, down from $6.72 billion. Short-term borrowings increased to $1.19 billion from $342.1 million, including $750 million of FHLB notes. Notes payable were $55.6 million and junior subordinated debentures were $67.0 million.
Non-covered loans, net of allowance, were $3.68 billion; covered loans, net, were $840.9 million; loans held for sale were $1.41 billion. The non-covered allowance was $36.4 million (0.98% of non-covered loans held for investment), and the covered allowance was $4.1 million.
Cash flow for the first half: Operating activities used $291.7 million, compared with $14.6 million provided in 2013, primarily reflecting mortgage loan origination and sale activity. Investing activities provided $40.6 million; financing activities provided $193.9 million, including $845.1 million of net short-term borrowing inflows and a $647.1 million net decrease in deposits. Cash and cash equivalents fell $57.2 million to $688.8 million.
Material changes and management outlook
- FNB operations were included from September 14, 2013, affecting year-over-year comparisons. The acquisition added banking assets, deposits and expenses. Management attributed the first-half increase in net interest income primarily to FNB.
- Mortgage-originations revenue and pretax income fell with lower volume. Management expected mortgage volumes for the rest of 2014 to follow historical seasonal patterns, with refinancing remaining a smaller share of production; this is an outlook, not quantified earnings guidance. Cost reductions lowered recurring quarterly mortgage operating costs by approximately $8 million since Q3 2013.
- The SWS merger agreement provides for 0.2496 Hilltop shares and $1.94 cash per SWS share. The cash component was estimated at approximately $78 million in total, funded from available cash. Closing was expected before year-end 2014, subject to regulatory and SWS shareholder approvals and other conditions.
- Hilltop and the Bank reported regulatory capital ratios above applicable minimums; the Bank was classified as well-capitalized. Management believed both would meet fully phased-in Basel III capital requirements. Basel III implementation begins in 2015, with phase-in through 2019. A completed SWS merger could push Hilltop above $10 billion in assets and trigger stress-testing requirements.
Risks, contingencies and unusual items
- Covered nonperforming loans rose to $16.6 million from $1.8 million at year-end, increasing covered nonperforming assets to $158.8 million. Covered OREO remained substantial at $142.2 million. The FDIC loss-share agreements reimburse specified portions of covered losses, but include recovery obligations and a possible true-up payment about ten years after the FNB closing.
- Two consolidated SWS shareholder lawsuits seek, among other relief, to enjoin the merger. Hilltop disputed the claims and intended to defend them. PrimeLending was also cooperating with a HUD Inspector General inquiry into mortgage-related practices.
- Mortgage repurchase and representation-and-warranty indemnification reserve was $19.7 million. The filing notes that estimates may change as claims develop.
- Insurance results remain exposed to severe weather, especially in the second and third quarters. Management cited $14.3 million of estimated ultimate losses from storms through June 30, 2014; reserve estimates also included adverse development related to 2012 hail-storm litigation.
- Interest-rate risk remains important. Although the banking segment was asset-sensitive under gap analysis, simulation projected lower net interest income under rate increases of 100 and 200 basis points (5.68% and 4.75%, respectively), reflecting rate floors and other modeled assumptions.
- Other material risks identified include credit-loss estimation, real-estate loan concentrations, FDIC reimbursement and integration risks, deposit outflows, mortgage-market competition, reinsurance recoverability, regulatory changes and merger costs or failure to close. No specific full-year earnings guidance was provided in the filing.
Important facts for investors to verify
- Track mortgage origination volumes, margins, servicing-retention decisions and the valuation of mortgage servicing rights.
- Assess the increase in covered nonaccrual loans and covered-loan allowances, OREO disposition progress, and the assumptions supporting FDIC indemnification assets and loss-share recoveries.
- Monitor deposit trends and concentration, the increased reliance on short-term borrowings, and funding needs as the mortgage warehouse line changes.
- Confirm SWS merger approvals, litigation status, expected cash and share consideration, integration costs, and potential regulatory-capital and stress-testing effects.
- Evaluate insurance claims development, weather exposure, pricing actions and reserve adequacy; verify whether mortgage-indemnification or regulatory matters change materially.