Hilltop Holdings Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Hilltop is a diversified financial holding company with banking, broker-dealer, mortgage origination and property-and-casualty insurance businesses. Amounts below are in U.S. dollars; financial statement figures are converted from thousands to millions unless noted.
Financial performance and condition
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net interest income | $110.3m | $105.0m | $318.6m | $313.1m |
| Noninterest income | $269.7m | $298.5m | $784.3m | $914.6m |
| Noninterest expense | $335.7m | $353.8m | $982.4m | $1,040.6m |
| Income before taxes | $44.7m | $48.4m | $122.3m | $178.3m |
| Net income attributable to Hilltop | $35.8m | $30.2m | $93.3m | $119.1m |
| Diluted earnings per share | $0.38 | $0.31 | $0.98 | $1.22 |
| Net interest margin, taxable-equivalent | 3.49% | 3.46% | 3.50% | 3.65% |
- Q3 pretax income declined despite higher net income attributable to Hilltop, as the effective tax rate fell to 17.0% from 37.2%. The nine-month effective tax rate was 21.4%, versus 33.0%.
- At September 30, 2018, total assets were $13.76bn, deposits $8.29bn, stockholders’ equity $1.96bn and net loans held for investment plus loans held for sale approximately $8.40bn. Cash and due from banks was $405.7m; regulatory-segregated assets were a further $220.1m and are not generally available for corporate use.
- Short-term borrowings were $1.22bn, notes payable $220.2m and junior subordinated debentures $67.0m. Deposits increased $312.1m from year-end 2017. Hilltop parent-company cash and cash equivalents were $49.3m.
- For the first nine months, operating cash flow was $318.8m, investing cash flow was negative $304.5m and financing cash flow was negative $62.0m. Cash, cash equivalents and restricted cash ended at $626.3m, down $47.7m for the period.
- Hilltop reported strong regulatory capital: total risk-based capital ratio 17.87% at Hilltop and 14.63% at PlainsCapital; PlainsCapital was classified as well-capitalized.
Material changes versus comparable periods
- Q3 net income attributable to Hilltop rose 18.5% year over year, while nine-month income fell 21.7%. Lower noninterest income, particularly mortgage and broker-dealer results, drove the nine-month decline. Prior-year results included nonrecurring $15.0m insurance proceeds related to a forgery loss and an $11.6m SWS appraisal-related gain.
- Mortgage production income weakened: nine-month mortgage loan originations were $10.72bn versus $10.85bn, and mortgage-segment pretax income was $15.5m versus $42.0m. Lower loan-sale margins and refinancing volume were important factors.
- Broker-dealer pretax income declined to $21.7m from $45.5m for the nine months, mainly reflecting lower structured-finance trading gains, lower municipal advisory fees and competitive pricing pressure.
- Insurance improved from prior-year catastrophe-affected losses: nine-month segment pretax income was $6.1m versus a $17.9m loss, and the combined ratio improved to 96.6% from 120.2%. Premiums earned nevertheless declined.
- Banking nine-month pretax income declined to $110.6m from $127.9m, reflecting lower purchase-accounting accretion, higher deposit costs, BORO acquisition expenses and a wire-fraud loss. Q3 banking pretax income increased to $38.6m from $36.3m.
Outlook, commentary, risks and unusual items
- Hilltop acquired The Bank of River Oaks on August 1 for $85m in cash. Preliminary values included $326.6m of loans, $376.4m of deposits, $10.0m of core-deposit intangibles and $39.6m of goodwill. Valuations remain preliminary; $6.6m of transaction and integration costs were recorded.
- Management expects loan discount accretion to continue declining as acquired loans repay, refinance or renew. It also noted that deposit-cost increases and loan-rate floors may limit the benefit of rising rates; short-term rates had risen faster than longer-term rates.
- PrimeLending began branch closures and staff reductions. Costs are expected to total up to $1.5m, mostly by year-end 2018; management expects approximately $1.0m of monthly savings beginning in 2019. Management did not anticipate further mortgage-rate increases would significantly alter the purchase/refinance mix through the remainder of 2018 and into 2019.
- Hilltop expects lower municipal issuance volume to continue through the remainder of 2018. Technology investments and back-office consolidation are expected to raise near-term expenses, with anticipated longer-term savings. Lower-than-forecast results in broker-dealer, mortgage and insurance units were to be considered in the October 1 goodwill impairment tests; the filing does not report an impairment charge.
- A spear-phishing incident caused a $4.0m wire-fraud loss and approximately $0.5m of related costs. Hilltop said customer information was stolen; future claims and recoveries were uncertain, and no future-claims accrual had been recorded.
- After quarter-end, the FDIC terminated its loss-share agreements with the Bank for a $6.26m payment. The $22.8m indemnification asset and $16.6m true-up accrual were removed with no further income-statement impact. The termination also raises the risk weighting of formerly covered assets from 20% to 100%; management did not expect a significant capital-ratio effect.
- After quarter-end, PrimeLending agreed to pay the DOJ and HUD $13.5m in total to resolve claims concerning certain FHA-insured loans, without admitting wrongdoing. The amount was included in the September 30 indemnification reserve; management said future periods would not be materially affected.
- Insurance management was evaluating potential Hurricane Michael losses. Other key risks include credit quality and real-estate concentration, interest-rate and mortgage-market conditions, catastrophic weather, litigation and regulatory inquiries, reinsurance collection, cybersecurity and technology implementation.
- The Bank had $2.2bn of unused credit commitments and $23.3m of standby letters of credit. Hilltop also disclosed a related-party Hilltop Plaza development involving Chairman Gerald J. Ford; the project includes company leases and build-to-suit accounting.
- The filing identified a cash-flow presentation error in the March and June 2018 quarterly reports concerning regulatory-segregated assets. Management concluded prior cash-flow statements were not materially misstated, elected to revise them in future filings, and reported no effect on financial condition or results of operations.
Most important facts for investors to verify
- Whether mortgage margins, origination volumes and PrimeLending cost savings develop as management expects.
- Whether broker-dealer trading and municipal advisory activity stabilize after the reported declines.
- Credit quality, real-estate concentrations, allowance adequacy and the eventual impact of CECL adoption, which management expected to increase the allowance and related costs.
- The final BORO purchase-price allocation, integration costs and contribution to earnings.
- Insurance exposure to Hurricane Michael and other catastrophe losses, plus the adequacy and collectability of reinsurance.
- Resolution of potential claims from the wire-fraud incident, and execution of technology initiatives and Hilltop Plaza commitments.