Hilltop Holdings Inc. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. Hilltop provides banking, broker-dealer and mortgage origination services. Its insurance subsidiary, National Lloyds Corporation (NLC), was sold on June 30, 2020; its results are presented as discontinued operations.
Financial performance and position
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net interest income | $101.9 million | $112.6 million | $316.8 million | $328.2 million |
| Noninterest income | $502.7 million | $306.5 million | $1,242.5 million | $799.2 million |
| Income from continuing operations before taxes | $205.9 million | $97.9 million | $407.9 million | $223.0 million |
| Income attributable to Hilltop | $153.3 million | $79.4 million | $331.4 million | $176.0 million |
| Diluted EPS, including discontinued operations | $1.70 | $0.86 | $3.67 | $1.89 |
| Net interest margin | 2.56% | 3.45% | 2.90% | 3.54% |
- Balance sheet at September 30: Total assets were $16.94 billion; deposits $11.26 billion; loans held for investment, net, $7.79 billion; and total stockholders’ equity $2.44 billion.
- Credit reserves: Allowance for credit losses on loans held for investment was $155.2 million, up from $61.1 million at year-end 2019. The nine-month provision was $100.0 million; Q3 included a $0.6 million reversal.
- Asset quality: Nonaccrual loans were $82.1 million versus $36.1 million at year-end 2019. Nonperforming assets totaled $107.7 million, or 0.64% of assets, compared with $54.3 million, or 0.36%.
- Cash flow, nine months: Operating activities provided $74.7 million, investing activities used $863.1 million, and financing activities provided $1.65 billion. Cash, cash equivalents and restricted cash ended at $1.50 billion.
- Borrowings: Short-term borrowings were $780.1 million, notes payable $396.0 million, and junior subordinated debentures $67.0 million. Hilltop issued $200 million of subordinated notes in May, generating $196.6 million net proceeds.
- Capital: Hilltop’s common equity Tier 1 ratio was 19.85% and leverage ratio 13.03%; PlainsCapital’s ratios were 14.64% and 10.19%, respectively. PlainsCapital was categorized as well capitalized.
Material changes versus the prior comparable period
- Q3 continuing pretax income more than doubled, principally as mortgage origination income rose sharply. Mortgage origination segment pretax income was $145.9 million versus $31.5 million; loan originations increased 35% to $6.45 billion.
- For the first nine months, mortgage segment pretax income increased to $324.1 million from $56.2 million. Lower rates and high refinancing activity supported production; refinancing represented 39.8% of volume versus 21.6% a year earlier.
- Q3 noninterest income increased 64%, while noninterest expense rose 24%, including higher variable compensation and operating costs associated with mortgage and broker-dealer activity.
- Net interest margin declined, reflecting lower asset yields, including lower rates and PPP loan yields, as well as changes in funding and business mix. Lower deposit and borrowing costs partly offset the decline.
- The nine-month credit-loss provision rose substantially, primarily due to CECL adoption and COVID-19 economic assumptions. The allowance was also affected by $18.5 million of net charge-offs.
- NLC’s sale generated an aggregate $33.1 million gain, including a $0.7 million third-quarter post-closing adjustment. The gain is included in discontinued operations; NLC contributed $34.7 million of after-tax income in the nine-month period.
- Comparisons are also affected by $9.4 million of 2019 leadership-transition and efficiency-related pretax charges.
Outlook, commentary and risks
- Management said the pandemic’s effects on clients, the economy and Hilltop’s full-year performance remained uncertain, and provided no specific earnings guidance. It expected PrimeLending to retain servicing on approximately 50%–75% of mortgage loan sales for the remainder of 2020, compared with 89% in Q2 and Q3, as CARES Act forbearance reduced third-party servicing demand.
- Active COVID-related loan deferrals totaled $291.4 million at quarter-end, including about $208 million with an additional deferral. About $662 million of modified loans had returned to contractual terms and made at least one payment; management characterized these loans as elevated risk.
- Management’s September baseline credit forecast improved from June, but additional fiscal stimulus assumptions were reduced and the duration and severity of the downturn remained uncertain. The filing’s modeled downside scenario would increase the allowance by approximately $85 million; the upside scenario would reduce it by approximately $21 million. These are scenario analyses, not forecasts.
- COVID-19, economic deterioration, real-estate and energy exposure, borrower performance, interest-rate movements, mortgage servicing liquidity and credit-loss estimates are significant risks. The filing also identifies PPP compliance, SBA guarantee and litigation risks.
- Hilltop announced a modified Dutch auction tender offer for up to $350 million of common stock at $18.25–$21.00 per share, scheduled to expire October 30, 2020 unless extended or terminated. Management expected to use cash on hand; the Federal Reserve had no objection. The board had suspended the separate $75 million repurchase program in April.
- The company reported a material weakness in controls over support for qualitative factors in the credit-loss allowance process. Management said remediation controls were implemented and expected remediation before year-end 2020, but continued testing was required. Management nevertheless stated the interim statements fairly presented results in all material respects.
- Technology and core-system projects were expected to remain a meaningful expense through 2020 and into 2021, with anticipated long-term efficiency benefits. LIBOR transition work was in early implementation stages.
Important facts for investors to verify
- How much of the unusually strong mortgage earnings reflects sustainable production and margins versus rate-driven volume, fair-value changes and derivative activity.
- Whether deferred and modified borrowers resume payments, and how COVID-19, commercial real estate, energy and nonaccrual trends affect future provisions and charge-offs.
- Whether the $155.2 million loan allowance and $9.3 million unfunded-commitment reserve remain adequate as economic forecasts and portfolio performance change.
- The final tender-offer participation, cash use and resulting share count, alongside liquidity and capital needs.
- Whether the credit-loss control weakness is fully remediated and operating effectively, and whether new general-ledger systems create control or reporting issues.
- Progress and proceeds from the planned approximately $18 million mortgage servicing-rights sale, scheduled to close October 31, 2020, and the effect of retained servicing on liquidity and valuation.