Hilltop Holdings Inc. — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017; comparisons are to the corresponding 2016 periods unless noted. Hilltop is a diversified financial holding company with banking, broker-dealer, mortgage origination and property-and-casualty insurance businesses. Amounts below are in U.S. dollars; financial statement amounts are converted to millions where useful.
Financial results and condition
- Third-quarter earnings: Net income attributable to Hilltop was $30.2 million, or $0.31 per diluted share, down from $51.9 million, or $0.53 per share. Income before tax was $48.4 million versus $85.5 million. Net interest income plus noninterest income was $403.5 million, compared with $453.6 million.
- Nine-month earnings: Net income attributable to Hilltop was $119.1 million, or $1.22 per diluted share, versus $110.6 million, or $1.12 per share. Income before tax was essentially unchanged at $178.3 million. Net interest income plus noninterest income was $1,227.7 million, down from $1,271.2 million.
- Interest income and margins: Net interest income increased 6% to $105.0 million in Q3 and 7% to $313.1 million year to date. Taxable-equivalent net interest margin declined to 3.52% from 3.67% in Q3 and to 3.71% from 3.74% for nine months. Management cited deposit and borrowing cost increases, loan rate floors and lower purchase-accounting accretion.
- Noninterest income and expenses: Noninterest income decreased 16% to $298.5 million in Q3 and 6% to $914.6 million year to date. Noninterest expense declined 3% to $353.8 million in Q3 and 2% to $1,040.6 million year to date. The nine-month results included $15.0 million of insurance proceeds for a 2016 loan loss and an $11.6 million pretax gain from resolution of SWS appraisal proceedings.
- Balance sheet and liquidity: Total assets were $13.53 billion at September 30, up from $12.74 billion at year-end 2016. Deposits rose to $7.66 billion from $7.06 billion; non-covered loans, net, rose to $6.09 billion from $5.79 billion. Cash and cash equivalents were $355.0 million, down from $690.8 million. Some cash is restricted: $207.3 million was segregated for broker-dealer regulatory purposes.
- Cash flow: For the first nine months, operating activities used $508.4 million, investing activities used $367.9 million and financing activities provided $540.5 million; cash and cash equivalents decreased $335.8 million. Mortgage loan production and sales and broker-dealer balance movements materially affect operating cash flow.
- Debt and capital: Short-term borrowings were $1.48 billion, notes payable $300.2 million and junior subordinated debentures $67.0 million. Hilltop’s total risk-based capital ratio was 18.71%; PlainsCapital’s was 15.23%, and the bank was classified as well capitalized. Total stockholders’ equity was $1.91 billion.
- Credit and insurance indicators: Non-covered nonperforming assets increased to $45.4 million from $30.1 million at year-end, primarily due to one commercial and industrial loan. The non-covered allowance was $58.8 million, or 0.96% of gross non-covered loans. Insurance statutory results were losses; combined ratio was 131.0% in Q3 and 120.2% year to date.
Material changes versus comparable periods
- Q3 earnings declined substantially, primarily as mortgage origination income weakened and the insurance segment moved to a loss, including hurricane-related costs. Nine-month earnings rose despite lower overall noninterest income, helped by lower loan-loss provision and the two unusual income items noted above.
- Mortgage originations fell 11.6% in Q3 and 6.2% year to date. Refinancings fell to 16.1% of originations for both periods, from 29.0% and 26.5%, respectively; purchase volume increased.
- Insurance premiums earned declined 11% in Q3 and 9% year to date. Net losses and loss-adjustment expenses rose to $31.2 million in Q3 and $86.1 million year to date, from $16.1 million and $75.2 million.
- Non-covered non-accrual loans rose to $40.1 million from $24.4 million at December 31, 2016. Covered nonperforming assets declined to $44.1 million from $55.5 million, largely as covered real estate owned was disposed of.
- Cash dividends were declared at $0.06 per share for Q3 and $0.18 per share year to date; no dividends were declared in the comparable 2016 periods. Hilltop repurchased 1.06 million shares for $27.4 million year to date.
Outlook, commentary, risks and contingencies
- Outlook: The filing provides no quantified earnings guidance. Management expected lower refinancing activity to persist through the remainder of 2017 and into 2018, while anticipating no significant near-term effect on home-purchase volume from higher mortgage rates. It also expected margin compression to continue until loan yields reprice above rate floors; purchase-accounting loan accretion is expected to decline as acquired loans pay down, refinance or renew.
- Hurricanes: Hurricanes Harvey and Irma had an estimated $9.8 million pretax impact on Q3 results. The insurance segment reported $19.6 million in gross hurricane losses and LAE; management cited $4.5 million of net retention and $1.5 million of reinstatement premiums. Hilltop said its businesses remained operational and noted approximately $701 million of bank loans in affected areas.
- Legal and regulatory matters: PrimeLending continues to cooperate with a DOJ investigation concerning FHA-insured mortgage underwriting and potential False Claims Act issues; the outcome and possible exposure are uncertain. SWS appraisal litigation was resolved at the trial-court level, producing the $11.6 million gain, but petitioners appealed and Hilltop filed a cross-appeal.
- Other contingencies: The mortgage indemnification reserve was $24.7 million, up from $18.2 million at year-end, including hurricane-related exposure. The FDIC loss-share arrangement carries a $16.1 million estimated future “true-up” accrual. The Bank also had $2.0 billion of unused credit commitments and $28.8 million of standby letters of credit.
- Key risks: Credit quality and real-estate concentrations, rising funding costs and interest-rate sensitivity, mortgage production and loan-sale margins, severe weather and reinsurance recoverability, broker-dealer market and counterparty exposure, mortgage repurchase claims, cyber risk, and pending legal or regulatory proceedings.
- Accounting outlook: The company was evaluating several forthcoming accounting standards. It expected lease adoption to increase reported assets and liabilities; the revenue standard could change broker-dealer revenue and expense presentation, potentially requiring gross rather than net reporting for certain items.
Important facts for investors to verify
- Whether hurricane claims, reinsurance recoveries and additional weather events change the insurance segment’s loss experience, capital or goodwill assessment.
- Whether the rise in non-covered nonperforming loans, particularly the cited commercial and industrial exposure, leads to further credit provisions or charge-offs.
- How quickly deposit and borrowing costs rise relative to loan yields, and whether rate floors continue to constrain net interest margin.
- Mortgage origination volume, gain-on-sale margins, refinancing mix, mortgage-servicing-rights valuations and the adequacy of the indemnification reserve.
- The outcome and potential financial consequences of the DOJ FHA inquiry and the SWS appraisal cross-appeal.
- Changes to the FDIC true-up estimate, broker-dealer funding and liquidity, and cash available at the parent company after capital returns.