Hilltop Holdings Inc. quarterly report, Q3 FY2013

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Hilltop Holdings Inc. — Q3 2013 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2013. Amounts below are U.S. dollars; financial statement figures are converted from thousands to millions unless otherwise noted.

Business context and reporting period

Hilltop is a financial holding company with banking, mortgage origination, insurance and financial advisory businesses. Results include PlainsCapital, acquired November 30, 2012, for the first time in the full 2013 comparative periods; the prior-year company was principally an insurer, so consolidated year-over-year comparisons are not directly comparable.

On September 13, 2013, PlainsCapital Bank acquired substantially all assets and assumed substantially all liabilities of First National Bank (FNB) in an FDIC-assisted transaction. FNB contributed only briefly to Q3 results; management expected its operations to have a significant effect beginning in Q4.

Financial performance and condition

  • Revenue and earnings: Q3 net interest income was $71.5 million and noninterest income was $205.8 million. Net income was $33.3 million; income applicable to Hilltop common shareholders was $31.8 million, or $0.36 diluted EPS. For nine months, net interest income was $207.1 million, noninterest income $658.3 million, and net income $89.3 million; common income was $85.1 million, or $0.98 diluted EPS. The comparable 2012 periods showed common losses of $4.0 million and $14.4 million, respectively, but reflect a substantially different business mix.
  • Margins and returns: Consolidated taxable-equivalent net interest margin was 4.45% for Q3 and 4.38% for nine months. Loan discount accretion increased margin by an estimated 92 and 95 basis points, respectively. Return on average assets was 1.73% and 1.63%; return on average equity was 10.92% and 9.95%.
  • Segment results: Q3 pretax income was $42.3 million in banking, $3.4 million in mortgage origination, $4.3 million in insurance and $0.1 million in financial advisory. Nine-month insurance results were a pretax loss of $10.6 million, principally reflecting severe second-quarter storms.
  • Credit: Provision for loan losses was $10.7 million in Q3 and $35.0 million year to date. The non-covered loan-loss allowance was $33.2 million, or 1.00% of non-covered loans held for investment. Non-covered nonperforming assets were $30.5 million, up from $13.4 million at year-end 2012; nonperforming loans were $21.9 million. Covered loans acquired from FNB totaled $1.10 billion at quarter-end.
  • Assets, funding and liquidity: Total assets were $9.09 billion, versus $7.29 billion at December 31, 2012. Deposits rose to $6.94 billion from $4.70 billion, mainly due to $2.2 billion of FNB deposits. Cash and cash equivalents were $1.02 billion. Hilltop separately reported approximately $177 million of freely available holding-company cash.
  • Debt and capital: Short-term borrowings were $305.3 million, notes payable $140.1 million and junior subordinated debentures $67.0 million. Total stockholders’ equity was $1.21 billion. The Bank was well-capitalized: total risk-based capital ratio 13.36%, Tier 1 risk-based ratio 12.76%, and Tier 1 leverage ratio 11.05%.
  • Cash flow: Nine-month operating cash flow was $462.7 million, investing cash flow was $257.5 million and financing cash outflow was $430.3 million. Investing cash flow included $362.7 million of net cash from the FNB transaction. Operating cash flow also reflects substantial mortgage loan originations and sales.

Material changes versus prior comparable periods

  • Reported earnings, interest income and noninterest income expanded substantially with the inclusion of PlainsCapital’s banking, mortgage and financial advisory businesses. Management attributed $204.6 million of nine-month net interest income to acquired PlainsCapital operations and $516.6 million of nine-month noninterest income to the acquired mortgage and financial advisory segments.
  • Mortgage originations were $2.85 billion in Q3, approximately 20% below Q2. Refinancing volume fell to $0.51 billion from $1.2 billion, while purchase volume was broadly unchanged.
  • Available-for-sale securities had net unrealized losses of $26.5 million at September 30, 2013, compared with net unrealized gains of $12.5 million at year-end 2012, primarily reflecting higher market interest rates.
  • Short-term borrowings declined $423.0 million from year-end, mainly because of lower warehouse-line funding needs as mortgage balances declined.

Outlook, commentary, risks and unusual items

  • Management provided no formal earnings guidance. It expected FNB to affect banking results significantly from Q4 onward. Purchase accounting contributed $15.2 million of net accretion on acquired earning assets and liabilities in Q3; the aggregate after-tax impact of specified purchase-accounting items increased Q3 net income by $6.4 million. The FNB bargain-purchase gain was a preliminary, one-time $3.3 million and could be revised.
  • Management cited higher mortgage rates and uncertain consumer confidence as risks to mortgage volume. It reduced non-origination headcount by about 10% in Q3, with additional reductions initiated in Q4, and expected related savings to begin in Q4. Q3 mortgage pretax income fell about 81% sequentially as costs remained relatively unchanged despite lower volume.
  • Interest-rate exposure is material. Although the banking segment’s gap analysis showed overall asset sensitivity, its simulation estimated that a 100-basis-point rate increase would reduce next-12-month net interest income by 8.86%, partly reflecting rate floors and repricing assumptions.
  • FNB’s FDIC loss-share agreements cover specified acquired loans and real estate, but reimbursement depends on compliance and eligible losses. The Bank bears 100% of losses between $240.4 million and $365.7 million under the stated loss-sharing structure, and may owe a future “true-up” to the FDIC if actual losses are below the FDIC estimate.
  • Other risks include loan defaults and real-estate concentration, acquisition integration, mortgage representations-and-warranties claims, severe weather and reinsurer performance, regulatory changes, and uncertain acquired-loan valuations. The mortgage indemnification reserve was $21.0 million. Ordinary-course legal proceedings were not expected to have a material adverse effect.
  • After quarter-end, Hilltop called its 7.5% senior exchangeable notes for redemption. As of November 8, 2013, exchanges had resulted in issuance of 2,896,316 common shares; $51.7 million principal remained outstanding, including notes held by insurance subsidiaries.

Most important facts for investors to verify

  • Final FNB purchase accounting, including covered-loan valuations, the $190.0 million FDIC indemnification asset and the preliminary bargain-purchase gain.
  • Whether FNB integration proceeds as planned and the FDIC continues to recognize losses as eligible under the loss-share agreements.
  • Trends in non-covered credit quality, allowance adequacy, nonperforming assets and real-estate loan concentrations.
  • Mortgage origination volumes, margins, cost-reduction results and future representations-and-warranties claims.
  • Effects of interest-rate changes on net interest income, securities values and mortgage hedging results, and the share dilution or cash cost from note exchanges and redemption.