Hilltop Holdings Inc. — 2011 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2011; it is not a standalone fourth-quarter filing. Hilltop was a holding company pursuing opportunistic acquisitions, with its operating business principally property and casualty insurance through NLASCO, NLIC and ASIC. The insurers focus on fire and homeowners coverage for lower-value dwellings and manufactured homes, primarily in Texas. In July 2011, Hilltop also made a $50 million loan to SWS Group and received warrants.
Financial performance and position
| Metric | 2011 | 2010 | Change / context |
|---|---|---|---|
| Total revenue | $152.2 million | $131.7 million | Up 15.5%, mainly from higher earned premiums and investment income |
| Net premiums earned | $134.0 million | $117.2 million | Up 14.4% |
| Net loss from continuing operations | $6.5 million | $0.5 million | Loss widened; 2011 included a $5.0 million tax benefit |
| Net loss attributable to common stockholders | $6.5 million; $0.12 per share | $13.5 million; $0.24 per share | Improved largely because 2010 included preferred dividends and a preferred-stock redemption loss |
| Underwriting result | Loss of $10.1 million | Gain of $2.1 million | Turned negative as claims costs rose |
| Loss and LAE ratio | 72.2% | 60.5% | Increased 11.7 percentage points |
| Expense ratio | 34.0% | 36.0% | Improved 2.0 percentage points |
| Combined ratio | 106.2% | 96.5% | Above 100% indicates an underwriting loss |
| Cash from operations | Used $3.3 million | Provided $9.9 million | Operating cash flow declined |
| Cash and cash equivalents | $578.5 million | $649.4 million | Includes $533.4 million at the parent and $45.1 million at NLASCO and subsidiaries |
| Total investments | $224.2 million | $149.0 million | Includes $60.4 million fair value of SWS loan and warrants |
| Total debt | $131.5 million | $138.4 million | $84.0 million fixed-rate notes and $47.5 million variable-rate insurance-company debt |
| Total assets / liabilities / equity | $925.4 million / $270.0 million / $655.4 million | $939.6 million / $286.6 million / $653.1 million | Year-end balances |
Direct premiums written were $155.1 million, up 11.3%; net premiums written were $141.7 million, up 16.5%. Net investment income rose to $10.5 million from $7.7 million. The company reported $0.8 million of net realized investment gains and no other-than-temporary investment impairments in 2011. The SWS loan carries 8% annual interest and has a five-year maturity; the related note and warrants were valued using significant unobservable inputs (Level 3).
Material changes and unusual items
- Five Texas storms in April and May 2011 generated $19.3 million in incurred losses; additional dispersed severe-weather events contributed $8.1 million. Fire losses also increased. Excluding catastrophe events, management reported combined ratios of 90.9% in 2011 and 86.0% in 2010.
- Gross loss and loss-adjustment-expense reserves fell to $44.8 million from $58.9 million, primarily as reinsurance recoverables declined following settlement and payment of prior catastrophe claims. Prior-period incurred losses included $1.0 million of favorable development.
- Hilltop’s fourth quarter produced $40.4 million revenue and $5.0 million net income, following a loss in the second quarter; the full year nevertheless ended with a $6.5 million net loss.
- In 2011 Hilltop purchased $6.9 million principal amount of its senior exchangeable notes through NLASCO at a premium of approximately $0.5 million; the intercompany purchase was eliminated in consolidation. Hilltop also sold/reclassified held-to-maturity securities, recording $0.8 million of realized gains; management described the sale as isolated and nonrecurring.
Outlook, risks and contingencies
Hilltop gave no quantitative earnings or revenue guidance. Management said it would continue evaluating strategic opportunities and believed existing cash, investments, operating cash flows and permitted insurance-subsidiary dividends would meet reasonably foreseeable liquidity needs. The company described property insurance markets in its operating area as generally soft at the start of 2012, while some coastal markets remained hard. It emphasized disciplined underwriting and had removed wind coverage from coastal Texas policies by the end of February 2011.
- Catastrophe concentration is significant: Texas represented approximately 72% of 2011 premiums. Reinsurance was stated to cover up to $170 million of event losses, subject to retentions and incomplete subscription of the highest layer; losses beyond coverage could materially affect results.
- Claims reserves are estimates and may develop adversely. Management estimated that reasonably likely changes in key assumptions could affect its reserve estimate by approximately plus or minus $1.9 million.
- Reinsurer nonpayment, higher reinsurance costs, severe weather, pricing errors, competitive pressure, regulatory changes and maintaining the insurers’ A.M. Best “A” ratings are key operating risks. A new IT system was being implemented and could disrupt operations.
- Insurance-company cash and dividends are subject to regulatory and debt restrictions. The subsidiaries exceeded minimum statutory surplus and risk-based-capital requirements; their 2012 dividend capacity without regulatory approval was reported as approximately $11.9 million.
- Hilltop owned 24.6% of SWS common stock as of March 1, 2012, and disclosed a risk that being deemed to control SWS could subject Hilltop to savings-and-loan holding-company regulation.
- Ordinary-course litigation was not expected to have a material adverse effect. The independent auditor gave an unqualified opinion and concluded internal control over financial reporting was effective.
Important facts for investors to verify
- Whether insurance underwriting performance improves from the 106.2% combined ratio, particularly after catastrophe and fire losses.
- The adequacy and development of loss reserves, including the effect of 2011 storm claims and the company’s reserve sensitivity estimate.
- The sufficiency, cost and collectability of catastrophe reinsurance, especially the partially subscribed top layer and reinsurer recoverables.
- The valuation and credit performance of the $50 million SWS loan and warrants, including the $60.4 million Level 3 fair value and subsequent SWS ownership position.
- How much of reported cash is freely available at the parent versus held within regulated insurance subsidiaries, and the effect of debt service and dividend restrictions.
- Whether acquisition activity, ongoing expenses and the absence of common dividends affect Hilltop’s capital allocation and liquidity.