Hilltop Holdings Inc. — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020. Hilltop is a financial holding company with banking, broker-dealer and mortgage origination businesses. It completed the sale of its insurance subsidiary, National Lloyds Corporation (NLC), on June 30, 2020; NLC is presented as discontinued operations.
Key financial results
Amounts below are in millions of dollars unless stated otherwise. Q2 comparisons are year over year; balance-sheet comparisons are to December 31, 2019.
| Metric | Q2 2020 | Q2 2019 | Change / context |
|---|---|---|---|
| Net interest income | $104.6 | $107.3 | Down 3% |
| Noninterest income | $468.1 | $276.7 | Up 69%, driven chiefly by mortgage activity |
| Provision for (reversal of) credit losses | $66.0 | ($0.7) | Significant increase amid CECL and COVID-19 outlook |
| Noninterest expense | $370.2 | $304.1 | Up 22%, including higher mortgage and broker-dealer compensation |
| Continuing pretax income | $136.4 | $80.6 | Up 69% |
| Income attributable to Hilltop | $128.5 | $57.8 | Includes $30.8 million after-tax discontinued-operations income |
| Diluted EPS | $1.42 | $0.62 | Continuing-operations EPS was $1.08 versus $0.64 |
| Consolidated net interest margin | 2.80% | 3.49% | Taxable-equivalent margin: 2.81% versus 3.49% |
Balance sheet, liquidity and capital
- Total assets were $16.9 billion; deposits were $11.65 billion, up from $9.03 billion at year-end 2019.
- Loans held for investment were $7.85 billion gross and $7.69 billion net. The allowance for credit losses was $156.4 million, or 1.99% of gross loans, versus $61.1 million at year-end.
- Cash and due from banks was $1.66 billion; cash, cash equivalents and restricted cash totaled $1.85 billion. The parent company reported $387.5 million of cash and cash equivalents.
- Short-term borrowings were $720.2 million, notes payable $450.2 million and junior subordinated debentures $67.0 million. Hilltop issued $200 million of subordinated notes in May, receiving $196.6 million net proceeds.
- Hilltop’s Tier 1 leverage ratio was 12.60% and common equity Tier 1 ratio was 18.46%. PlainsCapital’s ratios were 10.37% and 14.03%, respectively; it remained well-capitalized.
Cash flow and operating segments
- For the first six months, operating cash flow was negative $130.7 million, investing cash flow negative $646.9 million and financing cash flow positive $1.99 billion. Cash, cash equivalents and restricted cash increased by $1.21 billion. Mortgage loan originations and sales and balance-sheet funding flows materially affect these cash-flow totals.
- Mortgage origination pretax income rose to $138.3 million in Q2 from $21.8 million, as originations increased 54% to $6.10 billion and refinancing reached 47.5% of volume. Mortgage gains and origination income were a principal driver of consolidated results.
- Banking reported a Q2 pretax loss of $17.5 million, compared with income of $46.6 million, mainly because of the credit-loss provision. Broker-dealer pretax income increased to $27.8 million from $22.1 million.
Material changes and unusual items
- NLC sale: Cash proceeds were $154.1 million; Hilltop recognized a $32.3 million pretax disposal gain, net of transaction costs. The gain was not recognized for tax purposes as described in the filing. NLC’s Q2 results include a $30.8 million after-tax gain from discontinued operations.
- Credit-loss accounting and reserves: Hilltop adopted CECL on January 1, 2020. Adoption increased the loan allowance by $12.6 million and reduced opening retained earnings by $5.7 million after tax. The company recorded $100.6 million of provision for credit losses in the first half. Management expects future allowance changes to be volatile and based on uncertain economic forecasts.
- COVID-19 borrower support: The Bank approved $968.1 million of COVID-related loan modifications and funded more than 2,800 PPP loans totaling about $672 million. The Bank said the future performance of modified loans and their possible migration to non-accrual status were uncertain.
- Credit quality: Non-accrual loans were $59.1 million excluding held-for-sale loans; total nonperforming loans were $68.3 million. Nonperforming assets were $95.2 million, up from $54.3 million at year-end. Energy-related loans and unfunded commitments totaled $162.7 million, with $9.0 million of associated allowance.
- Liquidity actions: The company raised brokered deposits to $1.4 billion and increased cash buffers amid market disruption. The Bank targeted available liquidity of approximately $5–6 billion for the remainder of 2020.
- Capital returns: Hilltop paid $0.18 per share in dividends in the first half and declared a further $0.09 quarterly dividend in July. It suspended its stock-repurchase program on April 30, after repurchasing $15.2 million of shares in the first half.
- Controls: Management concluded disclosure controls were not effective at quarter-end because of a previously reported material weakness involving support for qualitative factors in the credit-loss allowance process. Remediation controls had been implemented, but the company said testing would continue and expected remediation before year-end 2020.
Outlook, risks and contingencies
- The filing gives no earnings or revenue guidance. Management said the effect of COVID-19 on the remainder of 2020 was uncertain, dependent on the pandemic, economic conditions, customer performance and government actions.
- PrimeLending retained servicing on 89% of Q2 mortgage loan sales, reflecting reduced third-party demand amid forbearance-related liquidity concerns. It expected to retain servicing on more than 75% of sales for the remainder of 2020.
- Key exposures include credit deterioration, real-estate and energy concentrations, interest-rate changes, mortgage servicing rights valuation and liquidity, securities-market volatility, cyber risk, funding costs, and PPP eligibility or guarantee disputes. The filing also discusses the transition away from LIBOR.
- Management stated that pending litigation was not expected to materially affect the company as a whole, while noting that adverse outcomes could be material in a particular reporting period. The mortgage indemnification reserve was $15.5 million, up from $11.8 million at year-end.
Important facts for investors to verify
- Whether mortgage origination volumes, margins and unusually high mortgage-related earnings are sustainable as rates and refinancing demand change.
- How COVID-related modifications perform, including the $968.1 million modified balance, and whether non-accruals, charge-offs or the $156.4 million allowance require further increases.
- Whether elevated liquidity is maintained and how brokered deposits, deposit sweeps and new subordinated debt affect funding costs and net interest margin.
- Final NLC sale adjustments and the post-sale effect on continuing earnings and capital allocation.
- Progress and testing of remediation for the material weakness in credit-loss allowance controls.
- Execution of the servicing-retention outlook and resulting MSR valuation, liquidity and indemnification risks.