Hilltop Holdings Inc. quarterly report, Q1 FY2018

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Hilltop Holdings Inc. — Q1 2018 Form 10-Q

Reporting period: Three months ended March 31, 2018; balance-sheet comparisons are with December 31, 2017. Hilltop is a diversified financial holding company with banking, broker-dealer, mortgage origination and property-and-casualty insurance businesses, primarily operating in Texas and the southern United States.

Financial performance and condition

  • Income: Net interest income was $103.4 million, up 12.3% from $92.1 million. Noninterest income declined 13.4% to $235.1 million from $271.4 million. Income before taxes was $32.2 million, down from $41.3 million; net income was $24.7 million versus $26.3 million. Income attributable to Hilltop was $24.4 million, or $0.25 per diluted share, compared with $26.4 million, or $0.27.
  • Margins and returns: Consolidated net interest margin was 3.52%, versus 3.47% (taxable-equivalent: 3.53% versus 3.49%). Return on average assets was 0.77% versus 0.88%; return on average equity was 5.19% versus 5.73%.
  • Costs and credit: Noninterest expense decreased to $308.2 million from $320.5 million. The loan-loss provision was a recovery of $1.8 million, compared with a $1.7 million provision in Q1 2017. Non-covered nonperforming assets were $42.2 million, down from $44.7 million at year-end; the non-covered allowance was $60.4 million, or 0.97% of gross non-covered loans.
  • Cash flow: Operating activities provided $173.9 million, compared with $349.3 million in Q1 2017. Investing activities used $13.6 million and financing activities used $177.1 million. Cash and cash equivalents decreased $16.9 million during the quarter to $470.5 million.
  • Balance sheet and liquidity: Total assets were $13.35 billion; deposits were $7.96 billion; non-covered loans, net, were $6.16 billion; covered loans, net, were $167.8 million; and stockholders’ equity was $1.93 billion. Hilltop reported $1.06 billion of short-term borrowings, $202.7 million of notes payable and $67.0 million of junior subordinated debentures. The holding company separately had $51.7 million of cash and cash equivalents and management stated liquidity was sufficient for the foreseeable future.
  • Capital and shareholder returns: Hilltop’s total risk-based capital ratio was 19.63%, common equity Tier 1 ratio 18.60%, and leverage ratio 13.26%; PlainsCapital was described as well capitalized. The quarterly dividend was $0.07 per share. Hilltop repurchased 68,307 shares for $1.7 million during the quarter.

Material changes and segment results

  • Higher loan yields and balances, increased broker-dealer securities-lending income, and lower loan-loss expense supported net interest income. However, higher deposit and borrowing costs partly offset asset-yield gains.
  • Lower broker-dealer trading gains and municipal advisory fees, and lower mortgage loan-sale gains, drove the decline in noninterest income. The effective tax rate fell to 23.3% from 36.4%, primarily reflecting the reduction in the federal corporate tax rate to 21% under the Tax Cuts and Jobs Act.
  • Banking: Pretax income increased to $39.0 million from $31.8 million; taxable-equivalent net interest margin was 4.16% versus 4.23%. Management cited loan growth and higher yields, partly offset by deposit repricing and lower purchase-accounting accretion.
  • Broker-dealer: Pretax income fell to $3.6 million from $9.5 million. Trading gains and investment/advisory fees declined, partly offset by stronger net interest income and lower variable compensation.
  • Mortgage origination: Pretax loss was $2.7 million, versus $9.9 million of pretax income. Origination volume rose 4.8% to $2.96 billion, but lower sale margins and loan-sale gains weighed on results. Refinancings were 20.3% of originations.
  • Insurance: Pretax income rose to $4.8 million from $1.8 million, mainly because weather-related losses were lower. The combined ratio improved to 85.2% from 98.4%, while net earned premiums declined to $34.3 million from $36.1 million.

Outlook, risks and unusual items

  • No specific consolidated earnings guidance was provided. Management expected 2018 income tax expense to be lower than in 2017. It anticipated lower municipal issuance volume in 2018 than in 2017 and said accretion from acquired loans is expected to decline as those loans repay, refinance or renew.
  • Hilltop agreed to acquire The Bank of River Oaks for $85 million in cash, subject to customary conditions, regulatory approvals and target shareholder approval; closing was expected in Q3 2018. The target reported approximately $454 million of assets, $344 million of gross loans and $406 million of deposits at December 31, 2017.
  • The FDIC loss-share arrangements may require a future “true-up” payment if realized losses are below the FDIC’s initial estimate. Hilltop recorded a $16.5 million accrual and reported $3.9 million of quarterly amortization of the FDIC indemnification asset.
  • PrimeLending remained subject to a Department of Justice investigation concerning FHA-insured mortgage origination and underwriting under the False Claims Act. The company disputed the DOJ’s sampling methodology and continued discussions; the filing does not quantify a clear potential loss for this matter.
  • Other risks include interest-rate sensitivity, real-estate loan concentrations, mortgage repurchase and indemnification claims, severe weather and reinsurance counterparty exposure, regulatory and litigation matters, broker-dealer trading volatility, cyber risk and technology implementation. Unused credit commitments were $1.9 billion and standby letters of credit were $23.8 million.
  • Adoption of financial-instrument accounting guidance moved subsequent fair-value changes on equity investments into earnings and reclassified amounts within equity. The company reported a $6.7 million other comprehensive loss, largely from unrealized available-for-sale securities losses; it recorded no other-than-temporary impairment of securities.

Important facts for investors to verify

  1. Whether weaker broker-dealer and mortgage profitability persists, and how loan-sale margins, trading gains and municipal issuance develop.
  2. Loan portfolio quality, criticized and nonperforming exposures, reserve adequacy, and the effects of the forthcoming CECL standard.
  3. Final acquisition terms, approvals, closing timing and the effect of the Bank of River Oaks acquisition on capital and liquidity.
  4. Potential exposure from the DOJ FHA investigation, mortgage indemnification claims and the FDIC true-up; the ultimate amounts and timing remain uncertain.
  5. Deposit pricing and funding costs relative to asset repricing, and the impact of rate changes on net interest income and the value of mortgage servicing rights.