Hilltop Holdings Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018; comparative periods are the corresponding 2017 periods. Amounts are in millions unless otherwise indicated. Hilltop is a diversified financial holding company with banking, broker-dealer, mortgage origination and property-and-casualty insurance businesses.
Financial performance
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Net interest income | $104.8 | $116.0 | $208.3 | $208.1 |
| Noninterest income | $279.4 | $344.7 | $514.6 | $616.1 |
| Net interest income plus noninterest income | $384.3 | $460.7 | $722.8 | $824.2 |
| Noninterest expense | $338.5 | $366.3 | $646.7 | $686.7 |
| Income before tax | $45.4 | $88.6 | $77.6 | $129.9 |
| Net income attributable to Hilltop | $33.1 | $62.5 | $57.5 | $88.9 |
| Diluted earnings per share | $0.35 | $0.63 | $0.60 | $0.90 |
Q2 income attributable to Hilltop fell about 47% year over year; first-half income fell about 35%. The decline reflected lower mortgage and broker-dealer income, lower bank purchase-accounting accretion and unusual income in 2017. Noninterest expense declined, partly offsetting the revenue weakness. The 2017 comparison included a $15.0 million banking insurance recovery and an $11.6 million gain from resolving SWS appraisal proceedings.
- Margins and returns: Consolidated net interest margin was 3.46% in Q2 and 3.49% for the first half, versus 3.98% and 3.74% in 2017. Return on average assets was 1.03% and 0.90%, respectively; return on average equity was 6.95% and 6.07%.
- Cash flow: First-half operating cash flow was negative $261.2 million, investing cash flow negative $147.2 million and financing cash flow positive $274.8 million. Cash and cash equivalents declined $133.5 million to $353.8 million. Operating cash flow reflects the scale and timing of mortgage loan originations and sales.
- Balance sheet and liquidity: At June 30, total assets were $13.69 billion, loans held for investment (net) $6.48 billion, loans held for sale $1.95 billion, deposits $7.81 billion and stockholders’ equity $1.92 billion. Deposits declined $164.5 million from year-end 2017.
- Borrowings and debt: Short-term borrowings rose to $1.61 billion from $1.21 billion at year-end. Notes payable were $227.7 million and junior subordinated debentures $67.0 million. Hilltop reported strong regulatory capital: total risk-based capital ratio of 18.58%; PlainsCapital was classified as well capitalized.
- Credit quality: Non-covered nonperforming assets were $45.1 million, or 0.33% of total assets, compared with $44.7 million at year-end. The non-covered allowance was $60.0 million, or 0.94% of gross non-covered loans. The six-month loan-loss provision was a recovery of $1.5 million.
Material changes and segment results
- Banking: Pretax income was $33.1 million in Q2 and $72.0 million for the first half, down from $59.8 million and $91.6 million. Deposit costs rose, purchase-accounting accretion declined, and the segment recorded a $4.3 million wire-fraud loss and related costs. Loan growth and improved loan yields partly offset these pressures.
- Broker-dealer: Pretax income was $8.2 million in Q2 and $11.8 million for the first half, below 2017. Trading income fell, including weaker structured-finance results, while municipal advisory and underwriting fees also declined. Lower variable compensation and improved net interest income provided partial offsets.
- Mortgage origination: Pretax income was $13.4 million in Q2 and $10.8 million for the first half, versus $19.3 million and $29.2 million. First-half originations increased 2.7% to $7.07 billion, but lower loan-sale margins and fair-value/derivative income reduced earnings. Purchases accounted for 84.5% of first-half originations; refinancings were 15.5%.
- Insurance: The segment recorded a $2.4 million pretax loss in Q2, but $2.4 million pretax income for the first half. Results improved year over year as weather-related losses declined, although earned premiums fell. The combined ratio improved to 111.1% in Q2 and 98.1% for the first half.
Outlook, risks and unusual items
- No consolidated earnings or revenue guidance is provided. Management expects lower mortgage refinancing activity to persist, but did not expect further rate increases to significantly affect home-purchase volume during the remainder of 2018. It expected lower municipal issuance to continue through 2018.
- Management said technology upgrades and corporate initiatives would increase near-term costs, with expected longer-term efficiency benefits. Accretion from acquired loans is expected to continue declining as those loans repay, refinance or renew. Rising funding costs and loan-rate floors may constrain margin improvement.
- Hilltop agreed to acquire The Bank of River Oaks for $85 million in cash. Shareholders and regulators had approved the transaction; closing was expected on or about August 1, 2018, with customer account conversion expected by year-end. The company intended to fund the purchase through Bank short-term borrowings.
- The Bank’s May 2018 spear-phishing incident resulted in a $4.0 million wire-fraud loss plus about $0.3 million of response costs. Some customer personal information may have been accessed. Insurance coverage and recovery efforts were ongoing; future claims and recoveries could not be estimated clearly.
- PrimeLending remained under a Department of Justice investigation concerning FHA mortgage underwriting and a possible False Claims Act violation. The company disputed the government’s sampling and analysis, was cooperating, and maintained an indemnification reserve of $23.9 million for mortgage-loan representations and warranties.
- The FDIC loss-share arrangements may require a future true-up payment; Hilltop had accrued $16.6 million at June 30. Management also cited catastrophe exposure, real-estate loan concentration, cybersecurity, interest-rate risk, acquisition integration and the expected material effect of the CECL standard, effective January 1, 2020.
- The board declared a $0.07-per-share quarterly dividend payable August 31, 2018. First-half share repurchases totaled $38.8 million; in July the authorized repurchase program was increased from $50 million to $100 million.
Important facts for investors to verify
- Whether operating performance stabilizes as acquired-loan accretion declines and deposit and borrowing costs rise.
- The drivers of lower mortgage margins and broker-dealer trading and municipal-finance activity.
- The ultimate financial, legal and customer impact of the wire-fraud incident and the status of insurance or other recoveries.
- Developments in the DOJ FHA inquiry, mortgage indemnification reserve and FDIC true-up estimate.
- Completion, funding and integration costs of the Bank of River Oaks acquisition, alongside planned technology spending and share repurchases.
- Credit quality, real-estate concentration, insurance catastrophe losses and the eventual CECL allowance impact.