Hilltop Holdings Inc. — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019, compared with the same 2018 periods. 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 figures are generally in millions.
Financial performance and condition
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net interest income | $113.2 | $110.3 | $330.0 | $318.6 |
| Noninterest income | $341.4 | $269.7 | $906.7 | $784.3 |
| Noninterest expense | $350.1 | $335.7 | $1,002.9 | $982.4 |
| Income before taxes | $104.5 | $44.7 | $233.6 | $122.3 |
| Net income attributable to Hilltop | $79.4 | $35.8 | $176.0 | $93.3 |
| Diluted earnings per share | $0.86 | $0.38 | $1.89 | $0.98 |
| Net interest margin | 3.45% | 3.48% | 3.54% | 3.49% |
- Growth and earnings drivers: Q3 and nine-month pretax income rose 134% and 91%, respectively. Broker-dealer trading gains and mortgage origination income were major contributors. Mortgage origination pretax income was $31.5 million for Q3 and $56.2 million year to date; broker-dealer pretax income was $27.0 million and $65.5 million, respectively. Banking contributed $52.7 million and $140.9 million.
- Balance sheet at September 30: Assets were $14.84 billion; deposits $8.73 billion; loans held for investment, net, $7.27 billion; loans held for sale $1.98 billion; and stockholders’ equity $2.08 billion. The allowance for loan losses was $55.6 million, or 0.76% of gross loans held for investment.
- Debt and liquidity: Short-term borrowings were $1.50 billion, notes payable $245.3 million and junior subordinated debentures $67.0 million. The $150 million senior notes bear 5% interest and mature in April 2025. Consolidated cash, cash equivalents and restricted cash were $410.4 million, down from $778.5 million at year-end 2018. At the parent company, cash and cash equivalents were $87.4 million. Hilltop reported total capital to risk-weighted assets of 16.95%; PlainsCapital was classified as well-capitalized, with a 13.87% total capital ratio.
- Cash flows, nine months: Operating activities used $484.5 million, versus $318.8 million provided in 2018; investing activities used $547.3 million versus $304.5 million; financing activities provided $663.8 million versus $62.0 million used. The operating outflow reflects, among other factors, mortgage loan originations and sales.
Material changes versus prior comparable periods
- Noninterest income increased 27% in Q3 and 16% year to date. Broker-dealer trading and derivative gains rose substantially, including an $82.6 million year-over-year increase for the nine-month period. Mortgage noninterest income also increased year to date, while securities commissions and insurance premiums declined.
- Mortgage origination volume rose 30.6% in Q3 and 4.3% year to date. Refinancings increased to 29.2% of Q3 volume from 11.4% a year earlier, and to 21.6% year to date from 14.1%. Lower rates supported refinancing activity, but mortgage MSR fair value declined to $51.3 million from $66.1 million at December 31, 2018.
- Interest expense increased faster than interest income, reflecting higher deposit and other funding costs. Consolidated Q3 net interest margin was slightly lower year over year; the nine-month margin improved modestly.
- Insurance premiums earned declined 4.5% in Q3 and 3.2% year to date. Lower loss and LAE expenses helped improve combined ratios to 83.2% for Q3 and 94.4% year to date, compared with 93.5% and 96.6% in 2018.
- Shares outstanding declined following repurchases. Hilltop paid $73.4 million to repurchase 3.39 million shares during the first nine months, including a $48.4 million purchase of 2.18 million shares from Oak Hill Capital. The January 2019 $50 million repurchase program was fully utilized.
Outlook, commentary, risks and unusual items
- Management anticipated a higher share of refinancing volume for the remainder of 2019 if mortgage rates remained relatively unchanged, and expected mortgage origination through affiliated business arrangements to remain around 8%–10% of volume.
- Management expects acquired-loan purchase-accounting accretion to decline as acquired loans repay, refinance or renew. Technology and core-system investment costs are expected to remain significant in the near term, with anticipated longer-term efficiency benefits.
- CECL adoption was scheduled for January 1, 2020. Hilltop estimated an allowance for credit losses of approximately $80 million–$110 million at adoption, including the reserve for unfunded commitments; the increase, net of tax, was expected largely to reduce opening retained earnings. Management cautioned that the estimate could change with portfolio conditions and economic forecasts.
- Leadership changes and efficiency initiatives resulted in $9.4 million of pretax costs in the first nine months, including $8.0 million associated with leadership changes. Q3 and nine-month results also included $0.4 million and $1.4 million of efficiency-related charges, respectively. A $5.8 million retirement charge for former co-CEO Alan White was recognized in Q1.
- Hilltop identified material weaknesses in internal controls over aspects of the allowance-for-loan-losses analysis and customer-wire approvals. The weaknesses were not remediated as of September 30, 2019; management reported remediation work underway and planned to evaluate operation of revised controls in Q4. Management stated it found no material misstatement in the reported financial statements.
- Key risks include credit and real-estate concentration, interest-rate movements, deposit competition and funding costs, mortgage-volume and MSR valuation volatility, severe weather and catastrophe exposure, reinsurance recoverability, cybersecurity, regulatory and legal matters, and the execution and cost of technology initiatives. Management said pending litigation was not expected to materially affect the company as a whole, while noting adverse outcomes could be material in a particular period.
- Off-balance-sheet exposures included $2.2 billion of unused credit commitments and $91.2 million of standby letters of credit. A related-party lease for Hilltop’s future headquarters and the Oak Hill repurchase are also notable transactions.
Most important facts for investors to verify
- Whether broker-dealer trading gains and unusually strong mortgage refinancing activity persist, and how results respond to market and interest-rate changes.
- The final CECL allowance and its effects on retained earnings, regulatory capital and asset-quality measures.
- Progress in remediating the two disclosed material weaknesses and whether the revised controls operate effectively.
- Loan credit trends, including non-accrual loans of $35.5 million, nonperforming assets of $54.3 million, and the adequacy of the loan-loss allowance.
- Liquidity and funding developments, particularly growth in short-term borrowings and deposit costs, alongside the composition and availability of broker-dealer and mortgage funding.
- Insurance underwriting performance, catastrophe exposure and reinsurance recoveries; and changes in the mortgage indemnification reserve, which was $11.5 million.