Hilltop Holdings Inc. — Q2 2015 Form 10-Q
Reporting period: Three and six months ended June 30, 2015. Unless stated otherwise, amounts are in U.S. dollars; financial statement figures are in millions. Hilltop is a diversified financial holding company with banking, broker-dealer, mortgage origination and property-and-casualty insurance businesses. The results include SWS Group from its January 1, 2015 acquisition, so year-over-year comparisons are not fully like-for-like.
Key financial results
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net interest income | $100.7 | $98.4 | $194.1 | $183.9 |
| Provision for loan losses | $0.2 | $5.5 | $2.8 | $8.8 |
| Noninterest income | $301.4 | $203.3 | $653.6 | $373.4 |
| Noninterest expense | $353.3 | $251.2 | $667.8 | $463.8 |
| Income before taxes | $48.6 | $45.0 | $177.0 | $84.6 |
| Net income attributable to Hilltop common stockholders | $29.6 | $27.1 | $140.9 | $50.8 |
| Diluted EPS | $0.30 | $0.30 | $1.40 | $0.56 |
- Margins: Consolidated taxable-equivalent net interest margin was 3.75% in Q2 versus 5.18% a year earlier, and 3.66% for the six-month period versus 4.90%. The company attributed much of the consolidated margin pressure to securities-financing activity in the broker-dealer business. Banking-segment margin was 5.02% in Q2 versus 5.52%.
- Balance sheet at June 30: Total assets were $12.48 billion; deposits $6.80 billion; non-covered loans, net, $4.92 billion; covered loans, net, $493.3 million; and loans held for sale $1.40 billion. Total stockholders’ equity was $1.67 billion.
- Debt and funding: Short-term borrowings were $1.10 billion, notes payable $245.4 million and junior subordinated debentures $67.0 million. These, together with short-term borrowings, totaled about $1.41 billion of reported borrowings. Hilltop issued $150 million of 5% senior notes due 2025, using proceeds in part to redeem $114.1 million of preferred stock.
- Liquidity and cash flow: Cash and cash equivalents ended the six months at $605.9 million, down $207.2 million from year-end. Operating cash flow was $26.5 million, investing cash flow $737.3 million and financing cash flow negative $971.0 million. The filing cites, among other factors, deposit and borrowing movements, SWS acquisition cash flows and mortgage activity.
- Capital: At June 30, Hilltop’s total capital to risk-weighted assets ratio was 19.29%, and the Bank’s was 17.17%; the Bank was classified as well-capitalized under applicable requirements.
Material changes versus prior periods
- Six-month common income rose to $140.9 million from $50.8 million, substantially reflecting the SWS acquisition and an $80.7 million preliminary bargain-purchase gain. Excluding that gain, six-month noninterest income was $572.9 million, as presented by management.
- Q2 common income increased to $29.6 million from $27.1 million, while diluted EPS remained $0.30. The bargain-purchase gain was recorded in Q1, not Q2.
- Noninterest income and expense both expanded with SWS and higher mortgage and broker-dealer activity. Six-month SWS transaction and integration costs totaled $14.5 million. Compensation and benefits were a major contributor to the rise in expenses.
- Mortgage originations increased 35.1% in Q2 to $3.83 billion; six-month volume increased 41.3% to $6.65 billion. The mortgage segment’s pretax income rose to $21.0 million in Q2 and $31.0 million for six months.
- The insurance segment recorded a Q2 pretax loss of $12.5 million and a six-month pretax loss of $3.4 million, versus a six-month profit of $6.0 million in 2014. Its combined ratio worsened to 135.8% in Q2 from 118.2%, and to 109.0% for six months from 97.9%.
- Non-covered nonperforming assets increased to $31.2 million from $23.2 million at year-end; covered nonperforming assets decreased to $140.6 million from $171.2 million.
Outlook, risks and unusual items
- Outlook: The filing provides no quantified earnings or revenue guidance. Management expects SWS operations to have a significant effect on future broker-dealer results and says integration costs are expected to continue into 2016. Mortgage results are described as more volatile than those of other segments; mortgage volumes are sensitive to interest rates and seasonality.
- Acquisition accounting: SWS purchase accounting remains preliminary, including loan and tax valuations, and merger consideration could change because of appraisal proceedings. A Q2 adjustment reduced the preliminary bargain-purchase gain from $82.8 million to $80.7 million; management said certain figures in the Q1 2015 filing will be revised in future filings.
- Credit and FDIC exposure: The Bank’s real-estate lending concentrations, loan-loss estimates and collection performance are key sensitivities. FDIC loss-share coverage on acquired FNB assets includes reimbursement thresholds and a possible “true-up” payment years later. Covered assets and related reimbursements are subject to estimates and contractual terms.
- Insurance risk: Severe weather frequency and severity, prior-period hail-storm litigation development and reinsurance recoverability affect claims and earnings. NLC renewed catastrophe coverage effective July 1, 2015, with total coverage reduced to $125 million under the revised program.
- Legal and regulatory matters: Disclosed matters include SWS merger-related stockholder litigation and appraisal claims, a Rhode Island bond-advisory lawsuit involving a broker-dealer subsidiary, and a DOJ investigation of PrimeLending’s FHA mortgage practices. No allegations had been asserted against PrimeLending; the company said it could not estimate potential liability. Management did not expect pending matters to have a material overall effect, while acknowledging an adverse outcome could be material in a particular period.
- Other risks: The filing identifies interest-rate and funding risk, indebtedness and covenant constraints, SWS integration, mortgage repurchase and indemnification claims, deposit concentration, catastrophic losses, regulatory changes and the ability to realize acquired tax assets. The six-month 19.0% effective tax rate was unusually low because the bargain-purchase gain was tax-free and a tax benefit was recorded; management cautioned it is not indicative of future rates.
Most important facts for investors to verify
- How much of reported six-month earnings growth reflects recurring operations versus the $80.7 million preliminary SWS bargain-purchase gain and purchase-accounting accretion.
- Whether SWS integration achieves expected benefits, how long integration costs persist, and whether the Q1 2015 revisions materially alter previously reported results.
- Trends in the consolidated and banking net interest margins, including the effects of securities financing, funding costs and interest-rate changes.
- Credit quality developments, allowance adequacy, real-estate concentrations, covered-loan performance and the assumptions underlying potential FDIC reimbursements or true-up obligations.
- Insurance claims and reserve development, catastrophe exposure, and the impact of the revised reinsurance program on retained losses.
- Debt service capacity, holding-company liquidity, deposit stability and the use of remaining authorization under the $30 million share-repurchase program.
- Developments in the disclosed litigation and DOJ inquiry, and any resulting financial, operational or reputational exposure.