Hilltop Holdings Inc. — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016. The filing is unaudited. Hilltop is a Texas-focused financial holding company with banking, broker-dealer, mortgage origination, and property and casualty insurance businesses.
Financial results and position
- Earnings: Net income was $28.2 million; income applicable to Hilltop common stockholders was $27.6 million, or $0.28 per diluted share. Income before tax was $42.6 million.
- Revenue and margin: Net interest income was $93.5 million, up slightly from $93.4 million. Taxable-equivalent net interest margin was 3.70%, versus 3.53%. Noninterest income was $277.7 million, down from $352.8 million.
- Expenses and credit costs: Noninterest expense rose to $325.2 million from $314.5 million. Provision for loan losses was $3.4 million, compared with $2.7 million.
- Cash flow: Operating activities provided $9.9 million, versus $118.6 million used in Q1 2015. Investing activities used $174.1 million; financing activities provided $22.3 million. Cash and cash equivalents declined $141.9 million to $527.5 million.
- Balance sheet and liquidity: Total assets were $11.73 billion, down from $11.87 billion at year-end 2015. Deposits were $6.98 billion; non-covered loans, net of allowance, were $5.32 billion; covered loans, net, were $346.2 million. Total stockholders’ equity was $1.76 billion.
- Debt and capital: Short-term borrowings were $832.9 million; notes payable were $232.2 million; junior subordinated debentures were $67.0 million. The $150 million of 5% senior notes due 2025 were included in notes payable. Hilltop’s total capital ratio was 18.60%; the Bank’s was 15.87%, and the Bank remained “well-capitalized” under regulatory standards.
- Credit and insurance indicators: Non-covered nonperforming assets were $27.7 million (0.24% of assets), up from $25.4 million at year-end. Covered nonperforming assets declined to $82.5 million from $108.1 million, primarily as covered OREO fell. The insurance combined ratio increased to 88.5% from 81.8%.
Material changes versus the prior comparable period
- Common earnings fell from $111.9 million, or $1.11 per diluted share, in Q1 2015. The comparison is heavily affected by the $81.3 million SWS merger bargain purchase gain recognized in 2015; without that gain, prior-period noninterest income was $271.6 million, versus $277.7 million in 2016.
- Excluding the bargain purchase gain, higher mortgage income more than offset lower broker-dealer and banking noninterest income. Mortgage segment pretax income was $9.1 million versus $10.0 million; broker-dealer results improved to $3.8 million pretax income from a $3.5 million loss; banking pretax income declined to $31.2 million from $41.7 million; insurance pretax income declined to $6.2 million from $9.1 million.
- Mortgage originations increased 4.1% to $2.93 billion. Purchases accounted for 70.0% of volume, versus 60.0%; refinancing volume declined. Higher mortgage operating costs more than offset increased segment income.
- Hilltop merged FSC into Hilltop Securities on January 22, 2016. Management reported beginning cost savings, partly offset by integration costs expected through the first six months of 2016.
- The 2015 comparative cash-flow statement was revised for classification errors related to acquired SWS balances. The filing says the correction did not affect financial condition or results of operations; reported ending cash was unchanged.
Outlook, commentary, risks, and unusual items
- No specific numerical earnings or revenue guidance is provided. Management notes mortgage origination is seasonal and interest-rate sensitive; it expects integration costs to continue through the first half of 2016 while merger-related savings begin to accrue.
- Management describes the banking business as asset-sensitive overall, but notes loan-rate floors may cause asset yields and margins to rise more slowly than market rates. Its rate simulations showed mixed net-interest-income effects: +100 basis points was projected to reduce NII by 0.72%, while +200 and +300 basis points were projected to increase it by 3.44% and 8.18%, respectively.
- Severe weather increased insurance loss frequency and severity. Management cites weather exposure, real-estate loan concentration, oil-price and broader economic conditions, interest rates, competition, cyber risk, regulation, acquisition integration, and reinsurer performance among material risks.
- The Bank recorded a $7.5 million estimated FDIC loss-share “true-up” accrual. The FDIC had reimbursed $111.5 million; further reimbursement and ultimate true-up amounts depend on future covered-asset losses and recoveries.
- PrimeLending has a DOJ investigation concerning FHA mortgage origination and underwriting practices; the company says no claims or demands have been asserted and it cannot estimate potential liability. Other disclosed matters include SWS shareholder appraisal litigation and a Rhode Island 38 Studios-related lawsuit involving FSC. Management believes pending matters will not have a material overall effect, while noting adverse outcomes could be material in a particular period.
- Mortgage loan representation-and-warranty indemnification reserves were $17.1 million. The mortgage servicing rights asset declined to $39.9 million from $52.3 million at year-end, including a $14.1 million fair-value loss during the quarter.
- Q1 2016 included a $9.8 million downward valuation adjustment on covered OREO, including a significant property. The filing also reports $0.8 million of SWS transaction costs and $4.0 million of SWS integration costs for the quarter.
Most important facts for investors to verify
- How much of the earnings comparison reflects the nonrecurring 2015 SWS bargain purchase gain, and whether merger savings exceed ongoing integration costs.
- Trends in banking credit quality, loan-loss provisions, real-estate concentrations, and the $7.5 million FDIC true-up estimate.
- Whether mortgage production profitability can recover as operating costs rise and refinancing activity falls; monitor MSR valuation and sensitivity to prepayment assumptions.
- Insurance claims development and weather losses, and the impact of the revised reinsurance structure and reduced direct premium writings.
- Progress and potential financial exposure from the DOJ FHA inquiry, SWS appraisal litigation, Rhode Island litigation, and mortgage representation-and-warranty claims.
- Liquidity and funding risks, including broker-dealer financing and deposit concentration; the filing states the Bank’s 15 largest depositors represented 10.75% of deposits.