Hilltop Holdings Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; unaudited. Hilltop is a financial holding company with banking, broker-dealer and mortgage origination operations. Its insurance business, National Lloyds Corporation (NLC), was classified as discontinued operations following a pending sale.
Financial performance and condition
| Metric | Q1 2020 | Q1 2019 / prior period |
|---|---|---|
| Net interest income | $110.3 million | $108.3 million |
| Noninterest income | $271.7 million | $216.0 million |
| Continuing pre-tax income | $65.6 million | $44.6 million |
| Net income attributable to Hilltop | $49.6 million | $38.8 million |
| Diluted EPS, including discontinued operations | $0.55 | $0.41 |
| Consolidated net interest margin | 3.41% | 3.69% |
| Cash from operating activities | $(582.8) million | $326.1 million |
- Combined net interest income and noninterest income was $382.0 million, up from $324.3 million. Mortgage origination income was the principal growth driver: segment pre-tax income rose to $39.8 million from $2.9 million as originations increased 48% to $3.62 billion.
- Banking segment pre-tax income fell to $11.5 million from $41.6 million, principally reflecting the credit-loss provision. Broker-dealer pre-tax income increased to $18.2 million from $16.4 million despite market disruption.
- Provision for credit losses was $34.5 million versus $1.0 million. The allowance for investment loans increased to $106.7 million from $61.1 million at year-end; the increase reflected CECL adoption and deteriorating COVID-19 economic forecasts.
- Nonaccrual loans were $87.4 million, up from $36.1 million at December 31, 2019; nonperforming loans were 0.89% of total loans versus 0.38%. The allowance was 1.45% of gross investment loans, compared with 0.84%.
- At March 31, total assets were $15.7 billion, deposits $9.95 billion and stockholders’ equity $2.16 billion. Deposits rose from $9.03 billion at year-end. Loans held for investment, net, were $7.24 billion; loans held for sale were $2.43 billion.
- Short-term borrowings were $1.33 billion; notes payable were $244.0 million and junior subordinated debentures were $67.0 million. Hilltop’s $150 million senior notes mature in 2025. Cash, cash equivalents and restricted cash totaled $761.7 million, including restricted and held-for-sale balances; Hilltop parent-company cash and cash equivalents were $70.7 million.
- Operating cash use mainly reflected mortgage-loan production and working-capital movements. Financing activities provided $718.1 million, including deposit growth; cash and restricted cash increased $118.9 million during the quarter.
Material changes versus comparable periods
- Mortgage originations increased to $3.62 billion from $2.45 billion, and refinancing rose to 35.4% of volume from 16.2%. Net gains on loan sales and other mortgage production income benefited from higher volume and fair-value changes.
- Consolidated noninterest expense was nearly flat at $281.9 million versus $278.7 million. Higher mortgage compensation and operating costs were largely offset by lower broker-dealer and corporate expenses, including prior-year leadership-transition and efficiency charges.
- Consolidated net interest margin narrowed to 3.41% from 3.69%; the filing attributes pressure in part to lower rates and securities-financing activity. Banking-segment margin was 3.81% versus 4.24%.
- NLC contributed $3.2 million of after-tax income, down from $5.4 million. Its results are presented as discontinued operations, so continuing-operations comparisons exclude insurance.
Outlook, risks and unusual items
- Management provided no quantified full-year earnings guidance and said the effects of COVID-19 on 2020 performance were uncertain. It cited risks from economic deterioration, credit losses, market volatility, reduced liquidity in some markets and lower interest rates.
- Hilltop agreed to sell NLC for $150 million in cash, subject to post-closing adjustments and regulatory approvals; closing was expected in Q2 2020. Management anticipated a net gain, but the amount was not specified.
- In response to COVID-19, Hilltop raised wholesale funding and brokered deposits, swept additional deposits from Hilltop Securities into the Bank, and reduced broker-dealer trading inventory limits. The Bank reported $5.13 billion of specified secured funding capacity at quarter-end.
- The Bank had approved 11 COVID-related loan modifications totaling $1.8 million by March 31; by April 23, approvals had risen to 519 modifications totaling $253.1 million. PPP applications and activity were also substantial; the filing reports funded loans of approximately $584.9 million through April 23.
- PrimeLending expected servicing retention to exceed 75% of mortgage loan sales during at least the next two quarters, versus about 9% in Q1, amid reduced third-party demand for servicing rights. Management did not expect a significant liquidity impact, but noted potential servicing-advance and investor-eligibility risks.
- The board suspended the stock repurchase program in light of uncertainty and its priority on capital and liquidity. Hilltop had repurchased $15.0 million of shares in Q1; it declared a $0.09-per-share dividend for payment in May.
- CECL adoption on January 1 resulted in an opening retained-earnings reduction of $5.7 million after tax and an aggregate opening allowance of $83.6 million. Management warned future credit-loss allowances may be volatile.
- Disclosure controls were deemed ineffective because of a material weakness concerning support for qualitative factors in the credit-loss allowance estimate. Management said remediation controls had been implemented but still required testing and validation; it expected remediation before year-end 2020. The filing reported no resulting financial-statement misstatement.
- Pending litigation was not expected by management to materially affect the Company as a whole, though an adverse outcome could be material in a particular period. Other risks include real-estate and energy exposures, mortgage representations and warranties, interest-rate changes, LIBOR transition, and cybersecurity.
Important facts for investors to verify
- Whether the NLC sale closed on schedule, its final proceeds and gain, and any resulting strategic or earnings effects.
- Subsequent credit quality, loan modifications, criticized loans and allowance changes as COVID-19 impacts and economic forecasts evolve.
- Mortgage origination profitability and sustainability, including sales margins, refinance volumes, servicing retention, MSR valuation and liquidity needs.
- Deposit mix and funding costs, liquidity availability, short-term borrowing levels and regulatory capital after the CECL transition effects.
- Progress in testing and completing remediation of the disclosed material weakness in internal control over financial reporting.