Hilltop Holdings Inc. — Q3 2016 Form 10-Q
Business context and period. Hilltop is a diversified financial holding company with banking, broker-dealer, mortgage origination and property-and-casualty insurance businesses. This unaudited report covers the quarter and nine months ended September 30, 2016; comparisons are with the corresponding 2015 periods unless noted. Amounts below are in millions except per-share data and ratios.
Financial performance and position
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net interest income | $99.2 | $115.2 | $293.4 | $309.3 |
| Noninterest income | $354.5 | $296.5 | $977.8 | $950.7 |
| Provision for loan losses | $4.0 | $5.6 | $36.3 | $8.4 |
| Income before tax | $85.5 | $72.6 | $178.3 | $250.3 |
| Net income attributable to Hilltop common stockholders | $51.9 | $46.9 | $110.6 | $188.4 |
| Diluted EPS | $0.53 | $0.47 | $1.12 | $1.88 |
| Net interest margin, taxable equivalent | 3.67% | 4.20% | 3.74% | 3.84% |
- Q3 net income attributable to common stockholders rose about 11% year over year; nine-month income fell about 41%. The 2015 nine-month comparison included an $81.3 million tax-free SWS merger bargain-purchase gain ($0.81 per diluted share), while 2016 included a $24.5 million charge-off of a single loan.
- Q3 noninterest income increased $58.0 million; management attributed the main gains to mortgage origination and broker-dealer trading activity. For the nine-month comparison, 2016 noninterest income was $108.4 million above 2015 excluding the prior-year bargain-purchase gain.
- At September 30, total assets were $12.42 billion, deposits $7.03 billion, non-covered loans net of allowance $5.62 billion, covered loans net $292 million, loans held for sale $1.67 billion, and stockholders’ equity $1.85 billion.
- Reported borrowings comprised $1.27 billion of short-term borrowings, $313 million of notes payable and $67 million of junior subordinated debentures. Short-term borrowings increased $318 million from year-end 2015. The $150 million of 5% senior notes due 2025 are included in notes payable.
- Cash and cash equivalents were $569 million at quarter-end versus $669 million at year-end. Nine-month operating cash flow was negative $241 million and investing cash flow negative $363 million; financing cash flow was positive $503 million. Hilltop reported $68.4 million of freely available parent-company cash.
- Hilltop’s consolidated total capital ratio was 18.82%; the Bank was classified as well-capitalized, with a 15.90% total capital ratio and 12.65% Tier 1 leverage ratio. The Bank’s interest-rate sensitivity analysis projected higher net interest income under rate increases, but management noted that asset yields may rise more slowly because of loan rate floors.
Material changes and segment developments
- Banking: Pretax income was $37.5 million in Q3 and $90.4 million for nine months, versus $53.6 million and $140.6 million. Nine-month results were burdened by the $24.5 million charge-off and lower loan-discount accretion. The Bank’s taxable-equivalent margin fell to 4.53% in Q3 from 5.79%. A core banking-system conversion occurred during Q3.
- Broker-dealer: Pretax income was $17.4 million in Q3 and $39.5 million for nine months, compared with $1.5 million and a $3.9 million loss. Higher structured-finance trading gains and public-finance activity contributed; the FSC/Hilltop Securities combination closed in January 2016, with cost savings partly offset by integration costs.
- Mortgage origination: Pretax income was $31.2 million in Q3 and $68.4 million for nine months, compared with $12.1 million and $43.3 million. Originations rose 23.4% in Q3 and 12.5% year to date. Results benefited from higher loan-sale income and volume, alongside higher compensation and operating costs.
- Insurance: Pretax income was $11.5 million in Q3 and $8.1 million year to date, versus $12.0 million and $8.6 million. Premiums earned declined; the combined ratio was 75.0% in Q3 and 97.8% year to date.
Outlook, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management expects future revenue to be led primarily by banking and notes that mortgage results are historically more volatile. Loan-discount accretion is expected to decline as acquired loans repay, refinance or renew.
- The Bank is investigating irregularities in a defaulted commercial loan, charged off in full for $24.5 million in Q2. It is pursuing legal remedies; recoveries and any further related expense cannot currently be estimated.
- Other material exposures include the FDIC loss-share arrangements and a $10.8 million estimated future “true-up” accrual; mortgage representation-and-warranty indemnification reserves of $19.2 million; and $1.9 billion of unused credit commitments plus $37.4 million of standby letters of credit.
- Legal matters include SWS merger appraisal petitions covering approximately 5.2 million former SWS shares, a Rhode Island bond-related suit involving FSC, and a DOJ investigation of PrimeLending mortgage practices. Management said it could not estimate potential liability in the PrimeLending inquiry and believed pending matters would not have a material overall effect, while acknowledging an adverse outcome could be material in a particular period.
- Principal stated risks include credit losses, real-estate concentration, oil-price and broader economic conditions, interest rates, catastrophic weather, cybersecurity, regulation, integration execution, FDIC reimbursement, reinsurer performance and competition.
- After quarter-end, the Board declared a $0.06-per-share quarterly cash dividend, payable November 30, 2016. A $50 million repurchase authorization remained unused at September 30; the filing cautions that dividends and repurchases are discretionary.
Important facts for investors to verify
- How the $24.5 million loan loss investigation and potential recoveries develop, and whether credit quality or allowance needs change.
- Whether mortgage production, margins and expenses remain supportive as interest rates, refinancing volumes and seasonal demand change.
- Whether broker-dealer trading gains and integration savings persist, and how increased short-term funding affects liquidity and costs.
- Changes in FDIC-covered asset performance, the indemnification asset and the estimated $10.8 million true-up obligation.
- Developments in the PrimeLending investigation, SWS appraisal litigation, Rhode Island litigation and mortgage indemnification claims.
- Cash generation, debt and borrowing trends, regulatory capital headroom, and the Board’s future decisions on dividends and share repurchases.