Hilltop Holdings Inc. quarterly report, Q1 FY2023

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Hilltop Holdings Inc. — Q1 2023 Form 10-Q

Business context and reporting period: Unaudited results for the three months ended March 31, 2023, compared with Q1 2022; balance-sheet comparisons are with December 31, 2022. Hilltop is a financial holding company with banking, broker-dealer and mortgage origination businesses, primarily through PlainsCapital Bank, Hilltop Securities and PrimeLending. Amounts below are in U.S. dollars; financial figures are rounded to millions unless noted.

Financial performance and condition

  • Revenue and earnings: Net interest income was $121.7 million, up 22% year over year, while noninterest income was $162.5 million, down 25%. Together, these revenue components totaled $284.2 million, down about 10%. Net income was $27.8 million versus $24.1 million; income attributable to Hilltop was $25.8 million versus $22.3 million. Diluted EPS rose to $0.40 from $0.28.
  • Drivers and costs: Interest expense increased to $69.7 million from $19.5 million, but net interest income benefited from higher yields. Noninterest expense declined 13% to $250.5 million, largely reflecting lower mortgage-segment compensation and operating costs. Credit-loss provision rose to $2.3 million from $0.1 million. Effective tax rate was 11.6%, compared with 19.4%.
  • Margins and returns: Consolidated net interest margin was 3.28%, versus 2.36% (2.37% on a taxable-equivalent basis in the related MD&A comparison). Return on average assets was 0.69% versus 0.53%; return on average stockholders’ equity was 5.12% versus 3.60%.
  • Cash flow: Operating activities used $108.5 million, compared with $388.6 million provided in Q1 2022. Investing activities used $142.3 million; financing activities provided $403.8 million. Cash, cash equivalents and restricted cash ended at $1.80 billion. The operating cash-flow swing reflected, among other factors, broker-dealer receivables/payables and mortgage loan production and sales.
  • Balance sheet and liquidity: Total assets were $17.03 billion, up from $16.26 billion at year-end. Deposits declined to $11.10 billion from $11.32 billion. Short-term borrowings rose to $1.57 billion from $970.1 million; notes payable were $376.4 million. The Bank reported $6.95 billion of available liquidity from listed sources, excluding Federal Reserve discount-window capacity. Since quarter-end, Hilltop said it added about $350 million of brokered deposits and was evaluating additional securities pledges; it had not used the discount window or Bank Term Funding Program.
  • Credit and capital: Loans held for investment, net, were $8.10 billion; the allowance was $97.4 million, or 1.19% of gross loans. Nonaccrual loans were $27.4 million, and nonperforming assets were $30.6 million. PlainsCapital was categorized as well capitalized; its common equity Tier 1 ratio was 14.97%, and Hilltop’s was 17.99%.
  • Shareholder returns: Hilltop paid a $0.16-per-share quarterly dividend and repurchased 144,403 shares for $4.5 million at an average $31.15 per share. A repurchase authorization permits up to $75 million through January 2024. The board declared another $0.16 dividend after quarter-end.

Material changes versus the prior comparable period

  • Banking: Pretax income increased to $58.2 million from $46.5 million. Net interest income rose with higher loan and securities yields, while funding costs also increased materially as deposit and borrowing rates reset.
  • Broker-dealer: Pretax income improved to $13.4 million from an $8.6 million loss. Higher trading, structured-finance and other revenues more than offset increased compensation and operating costs; trading revenue remains exposed to market volatility.
  • Mortgage origination: The segment reported a $24.1 million pretax loss versus $6.5 million pretax income. Originations fell 54% to $1.73 billion; net gains from loan sales fell to $30.9 million from $120.8 million, reflecting lower volume and margins. Expense reductions partly offset lower revenue.
  • Other notable movements: Available-for-sale securities had $116.8 million of net unrealized losses and held-to-maturity securities had $76.9 million, both improved from year-end levels. The filing attributes available-for-sale losses to market interest rates, not credit losses. Consolidated common equity to assets declined to 12.08% from 12.53% at year-end; tangible common equity to tangible assets was 10.62% versus 11.00%.

Outlook, risks and unusual items

  • Outlook: The filing gives no specific company earnings or revenue guidance. Management expects economic and funding uncertainty, deposit competition, inflation-related costs and banking-system disruption to persist through the remainder of 2023. It anticipates mortgage production and operating-result pressures to continue through 2023 and expects some deposit costs to rise. Its credit-loss scenario assumed a mild U.S. recession beginning in Q4 2023 and recovery from Q3 2024.
  • Liquidity and deposit risks: Management described increased competition for deposits following March 2023 bank failures, rising funding costs and possible reliance on secondary liquidity sources if withdrawals accelerate. The filing gives differing uninsured-deposit estimates in separate MD&A passages; see investor verification items below.
  • Interest-rate and valuation risks: The Bank reported an asset-sensitive position, but rate changes, deposit runoff, yield-curve movements and loan rate floors could alter net interest income. Challenged mortgage or broker-dealer performance could lead to goodwill impairment; no impairment charge was reported here. MSR fair value was $103.3 million and is sensitive to prepayment and discount-rate assumptions.
  • Credit, commitments and contingencies: The Bank had $2.4 billion of unused credit commitments and $72.0 million of standby letters of credit. Hilltop disclosed a FINRA claim alleging a $13 million loss; it considers the claim without merit but cannot estimate potential loss. PrimeLending and PlainsCapital Bank continue to respond to a U.S. Attorney inquiry regarding PrimeLending’s float-down option. The mortgage indemnification reserve was $18.3 million.
  • Unusual/other items: The Q1 2023 mortgage segment reported an operating loss ratio of 21.2%, which PrimeLending reported to HUD. The filing also notes a 2022 transfer of securities from available-for-sale to held-to-maturity; related unrealized losses continue to be amortized. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

  1. Uninsured deposits: The filing cites $3.1 billion (28% of deposits), or $2.7 billion excluding collateralized deposits, in one passage, but later reports $4.6 billion (42%), or $4.2 billion excluding collateralized deposits. Confirm the correct scope and figures with the company.
  2. Funding and liquidity: Reconcile the quarter’s deposit decline and increased short-term borrowings with subsequent brokered-deposit growth, available borrowing capacity and pledged collateral.
  3. Mortgage performance: Track production, sales margins, cost actions, servicing retention and MSR valuation, given the segment’s pretax loss and management’s expectation of continued pressure.
  4. Credit quality: Monitor commercial real estate exposures, including office loans, changes in nonaccruals, allowance assumptions and the impact of the recession scenario on expected losses.
  5. Contingencies and capital deployment: Follow developments in the disclosed legal/investigative matters, the indemnification reserve, dividends and use of the remaining share-repurchase authorization.