Hilltop Holdings Inc. — FY 2017 Form 10-K
Reporting period: Year ended December 31, 2017; filed February 15, 2018. Hilltop is a diversified financial holding company with banking, broker-dealer, mortgage origination and property-and-casualty insurance operations. Banking is concentrated in Texas; mortgage, brokerage and insurance operations have broader reach but meaningful regional concentrations.
Financial performance and condition
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Net interest income | $421.7 million | $397.5 million | Up 6.1% |
| Noninterest income | $1,205.1 million | $1,287.0 million | Down 6.4% |
| Income before income taxes | $243.3 million | $231.4 million | Up 5.1% |
| Net income attributable to Hilltop common stockholders | $132.5 million | $145.9 million | Down 9.2% |
| Diluted earnings per share | $1.36 | $1.48 | Down 8.1% |
| Effective tax rate | 45.3% | 36.1% | Up 9.2 percentage points |
| Net interest margin | 3.61% | 3.68% | Down 7 basis points |
| Return on average assets / equity | 1.03% / 7.00% | 1.21% / 8.13% | Both lower |
- Balance sheet at year-end: Assets of $13.37 billion, deposits of $7.98 billion, stockholders’ equity of $1.91 billion, and total loans including loans held for sale of approximately $8.1 billion. Cash and cash equivalents were $487.4 million consolidated; Hilltop parent reported $96.8 million of freely available cash.
- Cash flow: Operating cash flow was negative $326.3 million, investing cash flow negative $358.0 million and financing cash flow positive $480.9 million. Cash and cash equivalents declined $203.4 million to $487.4 million. Mortgage loan production and related working-capital movements materially affect operating cash flow.
- Borrowings and liquidity: Year-end short-term borrowings were $1.21 billion, notes payable $208.8 million and junior subordinated debentures $67.0 million. The $150 million 5% senior notes mature in April 2025. Management said parent liquidity was sufficient for the foreseeable future, while noting dependence on subsidiary dividends and regulatory limits on distributions.
- Capital: Hilltop’s total risk-based capital ratio was 18.78% and common equity Tier 1 ratio 17.71%; PlainsCapital’s corresponding ratios were 15.29% and 14.47%. Both exceeded applicable requirements, including fully phased-in Basel III requirements.
- Shareholder returns: Hilltop paid $0.24 per common share in dividends and repurchased $27.4 million of stock in 2017. In January 2018, the board increased the quarterly dividend to $0.07 per share and authorized a new repurchase program of up to $50 million through January 2019.
Material changes versus prior year
- Net income fell despite higher pretax income, principally because income tax expense rose to $110.1 million. The 2017 effective tax rate included a $28.4 million estimated, noncash charge, primarily from revaluing deferred tax assets after the federal corporate tax rate fell from 35% to 21%.
- Net interest income increased, but consolidated and banking net interest margins declined. Management cited rising funding costs, loan-rate floors that slowed asset repricing, and lower purchase-accounting accretion. Banking margin was 4.31%, down from 4.65%.
- Provision for loan losses decreased to $14.3 million from $40.6 million; 2016 included a $24.5 million charge-off of a single loan. In 2017, Hilltop recorded $15.0 million of insurance proceeds related to document forgery on that loan.
- Mortgage originations declined 6.5% to $14.46 billion. Refinancing volume fell to $2.48 billion from $4.18 billion, while purchase volume rose to $11.97 billion. Mortgage segment pretax income decreased to $49.6 million from $77.8 million.
- Broker-dealer pretax income increased to $64.6 million from $39.5 million, helped by the absence of a $16.0 million legal reserve recorded in 2016 and higher interest-related revenue; investment banking and advisory fees declined.
- Insurance moved to a $4.1 million pretax loss from $21.4 million of income. Net premiums earned declined, and the combined ratio deteriorated to 106.5% from 90.9%.
Outlook, commentary, risks and unusual items
- Management anticipated a slight decrease in mortgage refinancing as a share of originations in 2018 and expected affiliated-business-arrangement volume to be approximately 5% of mortgage production. It anticipated lower municipal issuance in 2018 after issuers accelerated financing ahead of the Tax Cuts and Jobs Act. These are expectations, not earnings guidance.
- Management expected interest-rate compression to continue until contractual loan resets allow more of the portfolio to rise above rate floors. Rising rates may also pressure mortgage volumes, securities values and funding costs.
- Hurricanes Harvey and Irma had an estimated $8.2 million pretax impact on 2017 results. Insurance losses and loss-adjustment expenses from the hurricanes were $19.3 million gross; the reported net hurricane loss was $4.4 million after reinsurance, plus $1.4 million of reinstatement premiums. Texas concentration exposes Hilltop to regional economic and catastrophe risk.
- The FDIC loss-share agreements relate to acquired FNB assets. Hilltop recorded a $16.3 million accrual for a possible future “true-up” payment; the ultimate amount is uncertain. The FDIC indemnification asset declined to $29.3 million from $71.3 million, including $17.1 million of 2017 amortization.
- Non-covered nonperforming assets rose to $44.7 million from $30.1 million; nonperforming loans increased to $40.5 million. The filing also highlights real-estate concentration, credit loss estimation, cybersecurity, regulatory and litigation risks, and reinsurance recoverability.
- The insurance reporting unit had no goodwill impairment at the October 2017 test, but estimated fair value exceeded carrying value by only about 12%, down from the prior assessment. Further weather-related underperformance or less favorable assumptions could lead to an impairment charge.
- After year-end, Hilltop agreed to acquire The Bank of River Oaks for $85 million in cash, subject to approvals and other closing conditions; closing was expected in the third quarter of 2018. The appraisal proceeding related to the SWS merger produced an $11.6 million pretax increase to other noninterest income; an appeal remained pending.
Important facts for investors to verify
- Whether lower taxes under the new 21% corporate rate offset the 2017 deferred-tax revaluation charge, and whether the estimate changes before the measurement period ends in December 2018.
- Quarterly loan quality, particularly rising nonperforming loans, the adequacy of the allowance, real-estate concentrations and any additional losses from the 2017 hurricanes.
- The future path of net interest margin as loan floors reset, deposit costs rise and acquisition-related discount accretion declines.
- The collectability and timing of the FDIC indemnification asset, and the eventual true-up payment under the FNB loss-share agreements.
- Insurance pricing, premium trends, catastrophe and reinsurance exposures, the recoverability of reinsurance balances, and the remaining goodwill valuation cushion.
- Cash generation after mortgage lending and securities-financing working-capital movements, subsidiary dividend capacity, and funding for the River Oaks acquisition and shareholder returns.
- The status and potential financial effects of the FHA/DOJ inquiry and the appeal of the SWS appraisal decision.