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Hilltop Holdings Inc. - Q1 2011 10-Q Summary

Business Context and Reporting Period

This report covers the quarterly period ended March 31, 2011. Hilltop Holdings Inc. operates as a holding company pursuing opportunistic acquisitions while conducting property and casualty insurance operations through its subsidiaries, National Lloyds Insurance Company (NLIC) and American Summit Insurance Company (ASIC). Both subsidiaries hold an "A" (Excellent) financial strength rating from A.M. Best.

Key Financial Metrics

Material Changes vs. Prior Period

• Profitability Improvement: Net income attributable to common stockholders improved from a loss of $2.1 million in Q1 2010 to a profit of $1.4 million in Q1 2011. This $3.5 million swing was primarily driven by the redemption of Series A Preferred Stock in September 2010, eliminating $2.6 million in quarterly dividend payments.
• Revenue Growth: Total revenue increased 9.5% year-over-year. Net premiums earned rose 10.0% to $30.9 million due to higher volume and reduced catastrophe reinsurance costs. Net investment income increased 27.3% to $2.1 million, attributed to higher yields on cash balances.
• Underwriting Performance: The combined ratio improved to 89.0% from 92.1%. The loss and loss adjustment expense (LAE) ratio decreased to 51.7% from 54.4%, despite a 4.6% increase in absolute loss expenses due to higher premium volume. Underwriting gain increased 72.4% to $2.9 million.
• Cash Flow: Operating cash flow turned positive, providing $3.7 million in Q1 2011 compared to a use of $0.7 million in Q1 2010. Investing activities provided $3.6 million in 2011 (net proceeds from securities) compared to a use of $8.5 million in 2010 (net purchases).

Outlook, Risks, and Unusual Items

• Strategic Acquisitions: Hilltop holds approximately $597 million in available cash at the parent level for opportunistic acquisitions. On March 20, 2011, the company entered a Funding Agreement to extend a $100 million senior unsecured loan to SWS Group, Inc., with Hilltop contributing $50 million.
• Reserve Development: The company recorded $0.4 million in adverse development related to prior year losses (2010 accident year) due to late-reported claims in homeowners, liability, and fire lines.
• Catastrophic Events: Losses related to Hurricane Ike, Hurricane Dolly, and an Arizona wind/hail storm were incurred. However, these events exceeded reinsurance retentions and were fully recoverable, resulting in no net impact on loss expenses, though reinstatement premiums were incurred.
• Liquidity and Dividends: Dividends from insurance subsidiaries are restricted by Texas State Insurance Law. Without regulatory approval, approximately $11.9 million in additional dividends can be paid in 2011. The company maintains statutory surplus and Risk-Based Capital (RBC) ratios well above regulatory minimums.
• Market Risk: Total debt is $138.4 million, with 34.3% subject to variable interest rates. A 0.125% increase in rates would increase annual interest expense by approximately $59,000.

Investor Verification Checklist

• Verify the status and closing conditions of the $100 million loan agreement with SWS Group, Inc.
• Monitor the development of 2010 accident year loss reserves, specifically in homeowners and liability lines.
• Confirm the maintenance of "A" (Excellent) ratings from A.M. Best for NLIC and ASIC.
• Review the company's pipeline for strategic acquisitions given the $597 million cash position.
• Assess the impact of potential interest rate hikes on the variable-rate portion of the $138.4 million debt.