Hilltop Holdings Inc. — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015. Hilltop is a financial holding company with banking, broker-dealer, mortgage origination and property-and-casualty insurance businesses. Results include SWS Group from its January 1, 2015 acquisition; the prior-year comparison excludes SWS.
Financial performance and condition
| Metric | Q1 2015 | Q1 2014 / prior date |
|---|---|---|
| Net interest income | $93.4 million | $85.4 million |
| Noninterest income | $354.4 million | $170.1 million |
| Income before taxes | $130.6 million | $39.7 million |
| Net income | $115.2 million | $25.3 million |
| Income applicable to Hilltop common stockholders; diluted EPS | $113.4 million; $1.13 | $23.8 million; $0.26 |
| Taxable-equivalent net interest margin | 3.53% | 4.62% |
| Cash from operating activities | $(38.8) million | $154.3 million |
Reported Q1 2015 results included an $82.8 million preliminary bargain-purchase gain on SWS, recorded without income tax. Excluding that gain, noninterest income was $271.6 million. The 11.8% effective tax rate, versus 36.2% a year earlier, was also affected by the tax-free gain and a $2.1 million tax benefit; management said the quarter’s rate is not indicative of future rates.
At March 31, 2015, total assets were $12.56 billion, deposits $7.13 billion, stockholders’ equity $1.78 billion, and cash and cash equivalents $708.5 million. Net loans held for investment (covered and non-covered) were approximately $5.35 billion; loans held for sale were $1.22 billion. Other indebtedness totaled approximately $1.18 billion, including $999.5 million of short-term borrowings, $108.7 million of notes payable and $67.0 million of junior subordinated debentures. These figures exclude deposits.
Operating cash outflow reflected substantial mortgage-loan originations and sales and broker-dealer settlement balances. Investing activities provided $792.3 million, including securities proceeds and acquisition-related cash; financing activities used $858.0 million, including the reported net cash-flow reduction in deposits. Ending cash was down $104.5 million from year-end.
Changes and operating drivers
- SWS acquisition: Preliminary purchase consideration was $349.1 million. Hilltop issued about 10.1 million shares and paid $78.2 million cash; acquired operations added substantial assets, liabilities and business activity. The bargain gain and acquisition-related results make year-over-year comparisons less representative of recurring performance.
- Banking: Pretax income was $81.2 million, including a $39.5 million allocated bargain gain. Non-covered loans grew to $4.83 billion gross from $3.92 billion at year-end, primarily reflecting business growth and acquired loans. Non-covered nonperforming assets rose to $32.8 million from $23.2 million; covered nonperforming assets declined to $152.5 million from $171.2 million.
- Broker-dealer: Pretax income was $39.9 million, including a $43.3 million bargain gain. Acquired operations drove substantial increases in commissions, advisory fees, securities-lending activity and expenses; integration costs were incurred and integration was expected to continue into 2016.
- Mortgage origination: Pretax income was $10.0 million versus a $3.0 million loss. Origination volume increased 50.8% to $2.81 billion; refinancing rose to 40.0% of volume from 21.3%. The segment reported $120.5 million of gains on loan sales and other mortgage production income, plus $14.6 million of origination fees.
- Insurance: Pretax income was $9.1 million versus $11.4 million. Net premiums earned were $39.6 million, slightly below the prior year; the combined ratio increased to 81.8% from 77.5%, reflecting reserve development and higher operating initiatives.
The consolidated net interest margin declined year over year, despite acquisition-related accretion. Management attributed the reduction principally to lower asset yields and the mix and cost of funding; purchase-accounting accretion materially supported reported margins in both periods.
Outlook, risks and unusual items
- No numerical earnings or revenue guidance was provided. Management noted that mortgage results are more volatile than other segments and historically vary with seasonality and interest rates. It expects future revenue to be driven primarily by banking, with the other segments contributing the balance.
- Management described the banking segment as asset-sensitive, but interest-rate modeling showed a projected 1.37% decline in next-12-month net interest income under a 100-basis-point increase and a 4.55% increase under a 300-basis-point increase. Loan-rate floors may cause asset yields to adjust more slowly than market rates, compressing margins initially in a rising-rate environment.
- The Bank remained well-capitalized under Basel III: total risk-based capital ratio 17.19%, common equity Tier 1 ratio 16.46%, and leverage ratio 11.34%. Hilltop’s corresponding ratios were 20.82%, 18.05%, and 12.68%.
- On April 9, Hilltop issued $150 million of 5% senior notes due 2025, receiving approximately $148 million net. On April 28, it used proceeds to redeem all $114.1 million of Series B preferred stock, plus accrued dividends; the remainder was designated for general corporate purposes. These post-quarter events increase debt and replace preferred equity.
- Risks include SWS integration and appraisal-rights proceedings; a DOJ investigation of PrimeLending’s FHA mortgage practices (no allegations had been asserted, and liability could not be estimated); mortgage-loan repurchase and indemnification claims; FDIC loss-share estimates and potential future true-up; and insurance claims, including adverse development from hailstorm-related litigation. Management stated that it did not expect pending matters to have a material overall effect, while acknowledging adverse outcomes could be material in a particular period.
- The Bank had $1.6 billion of unused credit commitments and $43.0 million of standby letters of credit. The FDIC loss-share arrangement reimburses 80% of specified losses within defined thresholds, but provides no coverage for losses in the intermediate band and includes potential recovery and true-up obligations.
Key facts for investors to verify
- How much recurring earnings remain after separating the $82.8 million preliminary bargain gain, purchase-accounting accretion and SWS integration costs; and whether SWS synergies materialize.
- Final SWS purchase accounting and consideration, including the effect of appraisal-rights claims; key loan, intangible and tax valuations were preliminary.
- Trends in net interest margin, funding costs, deposits, loan quality and charge-offs, particularly the increase in non-covered nonperforming assets.
- Mortgage production margins, MSR valuation assumptions and repurchase claims; and insurance reserve development, retention and weather exposure.
- Post-quarter debt service and liquidity after the senior-note issuance and preferred-stock redemption, alongside regulatory capital and broker-dealer liquidity requirements.