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HTH > SEC Filings for HTH > Form 10-Q on 2-Nov-2012All Recent SEC Filings

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Form 10-Q for HILLTOP HOLDINGS INC.


2-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the consolidated historical financial statements and notes appearing elsewhere in this Quarterly Report on Form 10-Q and the financial information set forth in the tables below.

Unless the context otherwise indicates, all references in this Management's Discussion and Analysis of Financial Condition and Results of Operations, or MD&A, to the "Company", "Hilltop", "HTH", "we", "us", "our" or "ours" or similar words are to Hilltop Holdings Inc. (formerly known as Affordable Residential Communities Inc.) and its direct and indirect wholly-owned subsidiaries.

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended by the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical fact, included in this report that address results or developments that we expect or anticipate will or may occur in the future, that are preceded by, followed by or include the words "believes," "expects," "may," "will," "would," "could," "should," "seeks," "approximately," "intends," "plans," "projects," "estimates" or "anticipates" or the negative of these words and phrases or similar words or phrases, including such things as our business strategy, our financial condition, our litigation, our efforts to make strategic acquisitions, our liquidity and sources of funding, our capital expenditures, our products, market trends, operations and business, are forward-looking statements.

These forward-looking statements are based on our beliefs, assumptions and expectations of our future performance taking into account all information currently available to us. These beliefs, assumptions and expectations are subject to risks and uncertainties and can change as a result of many possible events or factors, not all of which are known to us. If an event occurs or further changes, our business, business plan, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements. Certain factors that could cause actual results to differ include, among others:

fluctuations in the market price of our common stock and the related effect on the value of the merger consideration offered to PlainsCapital Corporation shareholders;

business uncertainties and contractual restrictions while the contemplated merger with PlainsCapital Corporation is pending;

the possibility that the proposed merger with PlainsCapital Corporation does not close when expected or at all because required regulatory or other approvals and other conditions to closing are not received or satisfied on a timely basis or at all;

required modifications to the terms of the proposed merger with PlainsCapital Corporation to obtain approvals or satisfy conditions;

diversion of management time on merger related issues;

changes in the financial condition and results of operations of PlainsCapital Corporation, including its failure to sustain its current revenues and earnings;

          inability to identify other suitable acquisition opportunities;

          the adverse impact of external factors, such as changes in interest
rates, inflation and consumer confidence;

          the condition of capital markets;

          actual outcome of the resolution of any conflict;

          our ability to use net operating loss carryforwards to reduce future
tax payments;

          the impact of the tax code and rules on our financial statements;

          failure of NLASCO, Inc.'s insurance subsidiaries to maintain their
respective A.M. Best ratings;

          failure to maintain NLASCO, Inc.'s current agents;

          lack of demand for insurance products;

          cost or availability of adequate reinsurance;

          changes in key management;

          severe catastrophic events in our geographic area;

          failure of NLASCO, Inc.'s reinsurers to pay obligations under
reinsurance contracts;

          failure of NLASCO, Inc. to maintain sufficient reserves for losses on
insurance policies;


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failure to successfully select and implement NLASCO, Inc.'s new information technology system; and

failure of NLASCO, Inc. to maintain appropriate insurance licenses.

For a further discussion of these and other risks and uncertainties that could cause actual results to differ materially from those contained in our forward-looking statements, please refer to "Risk Factors" in Part I, Item 1A of our Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 9, 2012, and other filings we have made with the Securities and Exchange Commission. Consequently, all of the forward-looking statements made in this report are qualified by these cautionary statements and those risk factors, and there can be no assurance that the actual results or developments anticipated by us will be realized, or even substantially realized, and that they will have the expected consequences to, or effects on, us and our business or operations. Forward-looking statements made in this report speak as of the date of this report or as of the date specifically referenced in any such statement set forth in this report. Except to the extent required by law, we undertake no obligation to update or revise any forward-looking statements in this report.

GENERAL STRUCTURE OF THE COMPANY

We are a holding company that has endeavored, and continues to endeavor, to make opportunistic acquisitions or effect a business combination. At September 30, 2012, Hilltop Holdings Inc. had approximately $524 million of available cash and cash equivalents that could be used for this purpose. No assurances, however, can be given that we will be able to identify suitable targets, consummate acquisitions or a combination or, if consummated, successfully integrate or operate the acquired business.

Hilltop indirectly owns all of the outstanding shares of NLASCO, Inc., or NLASCO. NLASCO, in turn, owns National Lloyds Insurance Company, or NLIC, and American Summit Insurance Company, or ASIC, both of which are licensed property and casualty insurers operating in multiple states. In addition, NLASCO also owns the NALICO General Agency that operates in Texas. NLIC commenced business in 1949 and currently operates in 14 states with its largest market being the State of Texas. NLIC carries a financial strength rating of "A" (Excellent) by A.M. Best. ASIC was formed in 1955 and currently operates in 13 states, its largest market being the State of Arizona. ASIC carries a financial strength rating of "A" (Excellent) by A.M. Best. Both of these companies are regulated by the Texas Department of Insurance.

Our common stock is listed on the New York Stock Exchange, or the NYSE, under the symbol "HTH".

OVERVIEW OF RESULTS

For the three months ended September 30, 2012, net loss attributable to common stockholders was $4.0 million, or $0.07 per share, as compared to a net income of $0.2 million, or $0.00 per share, for the same period in 2011. Net loss attributable to common stockholders increased by $4.3 million for the three months ended September 30, 2012, as compared to the same period in 2011, primarily due to higher loss and loss adjustment expenses of $6.3 million, higher policy acquisition and other underwriting expenses of $2.0 million, offset by higher net premiums earned of $2.7 million, lower general and administrative expenses of $1.0 million and higher income tax benefit of $0.6 million.

For the nine months ended September 30, 2012, net loss attributable to common stockholders was $14.4 million, or $0.25 per share, as compared to a net loss of $11.6 million, or $0.20 per share, for the same period in 2011. Net loss attributable to common stockholders increased by $2.8 million for the nine months ended September 30, 2012, as compared to the same period in 2011, primarily due to higher loss and loss adjustment expenses of $10.9 million, higher policy acquisition and other underwriting expenses of $4.1 million and lower income tax benefit of $0.8 million, offset by higher net premiums earned of $10.6 million and higher net investment income of $2.3 million.


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BUSINESS OBJECTIVES AND OPERATING STRATEGIES

Strategic Acquisitions. Hilltop has sought, and continues to seek, to make opportunistic acquisitions with its cash and, if necessary or appropriate, from additional equity or debt financing sources. In connection with this strategy, on May 8, 2012, we entered into a definitive agreement and plan of merger with PlainsCapital Corporation. In accordance with the merger agreement, PlainsCapital Corporation will become a wholly owned subsidiary of us. The purchase consideration to PlainsCapital Corporation shareholders includes approximately 27.5 million shares of our common stock and approximately $318 million of cash. PlainsCapital Corporation's and our respective shareholders approved the merger; however, regulatory approval is pending. No assurance can be given at this time as to when or if this transaction will be consummated.

Insurance Operations. NLASCO specializes in providing fire and homeowners insurance for low value dwellings and manufactured homes, primarily in Texas and other areas of the south, southeastern and southwestern United States. NLASCO targets underserved markets that require underwriting expertise that many larger carriers have been unwilling to develop given the relatively small volume of premiums produced by local agents. Within these markets, NLASCO attempts to capitalize on its superior local knowledge to identify profitable underwriting opportunities. NLASCO believes that it distinguishes itself from competitors by delivering products that are not provided by many larger carriers, providing a high level of customer service and responding quickly to the needs of its agents and policyholders. NLASCO applies a high level of selectivity in the risks it underwrites and uses a risk-adjusted return approach to capital allocation. NLASCO seeks to consistently generate underwriting profits.

Many insurance buyers, agents and brokers use the ratings assigned by A.M. Best and other rating agencies to assist them in assessing the financial strength and overall quality of the companies from which they purchase insurance. A.M. Best assigned NLIC and ASIC a financial strength rating of "A" (Excellent). An "A" rating is the third highest of 16 rating categories used by A.M. Best. In evaluating a company's financial and operating performance, A.M. Best reviews a company's profitability, leverage and liquidity, as well as its book of business, the adequacy and soundness of its reinsurance, the quality and estimated market value of its assets, the adequacy of its liabilities for losses and loss adjustment expenses, or LAE, the adequacy of its surplus, its capital structure, the experience and competence of its management and its market presence. This rating is intended to provide an independent opinion of an insurer's ability to meet its obligations to policyholders and is not an evaluation directed at investors. This rating assignment is subject to the ability to meet A.M. Best's expectations as to performance and capitalization on an ongoing basis, including with respect to management of liabilities for losses and LAE, and is subject to revocation or revision at any time at the sole discretion of A.M. Best. NLASCO cannot ensure that NLIC and ASIC will maintain their present ratings.

RESULTS OF OPERATIONS

Comparison of the Three Months Ended September 30, 2012 to the Three Months Ended September 30, 2011

Revenue. Revenue for the three months ended September 30, 2012 was $42.8 million, as compared to $40.6 million for the same period in 2011. Net premiums earned were $37.7 million for the three months ended September 30, 2012, as compared to $34.9 million for the same period in 2011. The higher volume of earned premiums of $2.7 million was largely due to higher volume of gross earned premiums of $3.4 million, offset by an increase in the cost of reinsurance of $0.6 million. Net investment income was $3.3 million for the three months ended September 30, 2012, as compared to $3.1 million for the same period in 2011. Net realized gains on investments decreased $0.8 million during the three months ended September 30, 2012, as compared to the same period in 2011, due to the sale of held-to-maturity securities in the three months ended September 30, 2011. Other income was $1.9 million for the three months ended September 30, 2012, as compared to $1.8 million for the same period in 2011.


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Underwriting Results. The following table shows the components of the Company's underwriting (loss) gain for the three months ended September 30, 2012 and 2011. The Company's underwriting gain or loss consists of net premiums earned, less loss and LAE and policy acquisition and other underwriting expenses. The underwriting results are discussed below (in thousands).

                                       Three Months Ended
                                          September 30,
                                       2012           2011         Change      % Change
Direct premiums written             $    40,899    $   38,826    $    2,073          5.3 %
Net premiums written                $    37,519    $   35,762    $    1,757          4.9 %

Net premiums earned                 $    37,688    $   34,943    $    2,745          7.9 %
Loss and LAE                             30,136        23,794         6,342         26.7 %
Policy acquisition and other
underwriting expenses                    13,441        11,441         2,000         17.5 %
Underwriting loss                   $    (5,889 )  $     (292 )  $   (5,597 )     1916.8 %

Agency expenses                     $      (568 )  $     (445 )  $     (123 )       27.6 %
Loss and LAE ratio                         80.0 %        68.1 %        11.9 %
Underwriting expense ratio                 34.2 %        31.5 %         2.7 %
Combined ratio                            114.2 %        99.6 %        14.6 %

The loss and LAE ratio is loss and LAE divided by net premiums earned for the same period. The underwriting expense ratio is policy acquisition and other underwriting expense less agency expenses, divided by net premiums earned for the same period. Combined ratio gives you the sum of both ratios.

Loss and LAE increased $6.3 million in the three months ended September 30, 2012 as compared to the same period in 2011. This increase is primarily due to an increase in current accident year losses of $4.0 million, which is attributable to the frequency and severity of wind and hail claims. Losses from weather events in the three months ended September 30, 2012 increased $3.2 million, as compared to the same period in 2011, due to losses from April, May and June 2012 of $6.8 million from weather events, as compared to $3.6 million in weather events from April and May of 2011.

The Company seeks to consistently generate underwriting profitability. Management evaluates NLASCO's loss and LAE ratio by bifurcating the losses to derive catastrophic and non-catastrophic loss ratios. The non-catastrophic loss ratio excludes Property Claims Services (PCS) events that exceed $1.0 million of losses to NLASCO. Catastrophic events, including those that do not exceed our reinsurance retention, affect the Company's loss ratios. For the three months ended September 30, 2012, catastrophic events that did not exceed our reinsurance retention accounted for $6.8 million of the total loss and loss adjustment expense, as compared to $3.6 million for the same period in 2011. Excluding catastrophic events, our combined ratios for the three months ended September 30, 2012 and 2011 would have been 96.1% and 89.3%, respectively.

For the three months ended September 30, 2012, the Company had development in losses related to two 2008 catastrophes, Hurricane Ike and Hurricane Dolly, of $0.3 million, compared to favorable development of $7.2 million for the same period in 2011. The redundancy in losses in the three months ended September 30, 2011 relate primarily to the reduction of Hurricane Ike reserves of $7.0 million in September 2011. For the three months ended September 30, 2012, the Company incurred losses of $0.1 million related to a catastrophic wind and hail storm in Arizona that occurred in October of 2010, compared to $0.2 million for the same period in 2011. These losses have no effect on net loss and LAE incurred because the catastrophic events exceeded our retention and are fully recoverable from reinsurers. The primary financial effect is the net change in reinstatement premium payable to the affected reinsurers. For the three months ended September 30, 2012, the Company incurred $30 thousand dollars in reinstatement premiums, as compared to a $0.3 million reduction in reinstatement premium for the same period in 2011.


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Premiums. The property and casualty insurance industry is very competitive and is affected by soft and hard market business cycles. During a soft market, price competition tends to increase as insurers are willing to reduce premium rates in order to maintain growth in premium volume. The soft market makes it more difficult to attract new business, as well as retain exposures that are adequately priced. Although we recognize the need to remain competitive in the marketplace, the Company remains committed to its disciplined underwriting philosophy accepting only risks that are appropriately priced, while declining risks that it believes are under priced for the level of coverage provided.

Direct premiums written by major product line for the three months ended September 30, 2012 and 2011, are presented in the table below (in thousands).

                             Three Months Ended
                               September 30,
                              2012         2011     Change    % Change
Direct Premiums Written:
Homeowners                 $    19,128   $ 18,204   $   924        5.1 %
Fire                            12,712     12,400       312        2.5 %
Mobile Home                      6,779      6,110       669       10.9 %
Commercial                       2,160      1,973       187        9.5 %
Other                              120        139       (19 )    -13.7 %
                           $    40,899   $ 38,826   $ 2,073        5.3 %

Total direct premiums written increased for the three months ended September 30, 2012 for all insurance products, except for other, primarily due to expanded distribution of additional insurance products and growth on existing insurance products. Higher value homeowners and commercial insurance products generated $0.6 million in direct premiums written for the three months ended September 30, 2012. Direct premiums written in Texas, Oklahoma, Georgia and Tennessee increased a combined total of $1.1 million on existing products in the three months ended September 30, 2012, as compared to the same period in 2011.

Net premiums written by major product line for the three months ended September 30, 2012 and 2011, are presented in the table below (in thousands).

                         Three Months Ended
                           September 30,
                          2012         2011     Change    % Change
Net Premiums Written
Homeowners             $    17,551   $ 16,758   $   793        4.7 %
Fire                        11,660     11,425       235        2.1 %
Mobile Home                  6,216      5,633       583       10.3 %
Commercial                   1,982      1,819       163        9.0 %
Other                          110        127       (17 )    -13.4 %
                       $    37,519   $ 35,762   $ 1,757        4.9 %

Total net premiums written increased $1.8 million for the three months ended September 30, 2012, for all insurance products, except for other, due to an increase in volume of direct written premiums of $2.1 million, offset by an increase in catastrophic reinsurance costs of $0.6 million.


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Net premiums earned by major product line for the three months ended September 30, 2012 and 2011, are presented in the table below (in thousands).

                         Three Months Ended
                           September 30,
                          2012         2011     Change    % Change
Net Premiums Earned:
Homeowners             $    17,561   $ 16,314   $ 1,247        7.6 %
Fire                        11,725     11,180       545        4.9 %
Mobile Home                  6,305      5,543       762       13.7 %
Commercial                   1,988      1,785       203       11.4 %
Other                          109        121       (12 )     -9.9 %
                       $    37,688   $ 34,943   $ 2,745        7.9 %

Net premiums earned for the three months ended September 30, 2012 increased $2.7 million, as compared to the same period in 2011, which is a result of higher direct written premiums of $2.1 million for the quarter ended September 30, 2012, as well as growth in written premiums experienced in prior periods. Direct premiums written have increased over the last four quarters and are $10.6 million higher for the twelve months ended September 30, 2012 as compared to the same period in 2011. The consistent growth in direct premiums written should generate increased premiums earned in future periods.

Loss and Loss Adjustment Expenses. Loss and LAE are recognized based on formula and case basis estimates for losses reported with respect to direct business, estimates of unreported losses based on past experience and deduction of amounts for reinsurance placed with reinsurers. Loss and LAE for the three months ended September 30, 2012 was $30.1 million, as compared to $23.8 million for the same period in 2011. The increase is primarily a result of increased severity of wind and hail losses from April, May and June 2012 weather events.

The loss and LAE ratio is calculated by taking the ratio of incurred losses and LAE to net premiums earned for the same period. The loss and LAE ratio for the three months ended September 30, 2012 and 2011 was 80.0% and 68.1%, respectively.

Policy Acquisition and Other Underwriting Expenses. Policy acquisition and other underwriting expenses for the three months ended September 30, 2012 and 2011 were as follows (in thousands):

                                          Three Months Ended
                                            September 30,
                                          2012          2011        Change      % Change
Amortization of deferred policy
acquisition costs                      $     9,675    $   8,931    $     744         8.3 %
Other underwriting expenses                  3,766        2,510        1,256        50.0 %
Total policy acquisition and other
underwriting expenses                       13,441       11,441        2,000        17.5 %
Agency expenses                               (568 )       (445 )       (123 )      27.6 %
Total policy acquisition and other
underwriting expenses excluding
agency expenses                        $    12,873    $  10,996    $   1,877        17.1 %
Net premiums earned                    $    37,688    $  34,943    $   2,745         7.9 %
Expense ratio                                 34.2 %       31.5 %        2.7 %

Total policy acquisition and other underwriting expenses, excluding agency expenses, were $12.9 million for the three months ended September 30, 2012, as compared to $11.0 million for the same period in 2011. Policy acquisition and other underwriting expenses increased $2.0 million primarily due to the write down of a policy administration system the Company was unable to successfully implement of $1.7 million in the three months ended September 30, 2012.

General and Administrative Expense. General and administrative expense for the three months ended September 30, 2012 was $2.8 million, as compared to $3.8 million for the same period in 2011. The decrease is primarily due to a decrease in professional services related to acquisition costs at the holding company of $1.0 million.

Depreciation and Amortization Expense. Depreciation and amortization expense for the three months ended September 30, 2012 and 2011 was $0.3 million and $0.4 million, respectively.


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Interest Expense. Interest expense for the three months ended September 30, 2012 remained largely unchanged, it was $2.1 million as compared to $2.2 million for the three months ended September 30, 2011, a decrease of $0.1 million, or 4.5%.

Income Taxes. The Company had a $1.9 million income tax benefit for the three months ended September 30, 2012, compared to $1.3 million tax benefit for the same period in 2011. The increase in income tax benefit is primarily due to the increased loss from operations.

Net Loss Attributable to Common Stockholders. As a result of the foregoing, our net loss attributable to common stockholders was $4.0 million for the three months ended September 30, 2012, as compared to net income of $0.2 million for the three months ended September 30, 2011. The principal reasons for the loss in the third quarter of 2012 was the development on weather events from April, May and June 2012, as well as increased frequency and severity of wind and hail losses.

Comparison of the Nine Months Ended September 30, 2012 to the Nine Months Ended September 30, 2011

Revenue. Revenue for the nine months ended September 30, 2012 was $124.3 million, as compared to $111.8 million for the same period in 2011. Net premiums earned were $109.0 million for the first nine months in 2012, as compared to $98.4 million for the first nine months in 2011. The higher volume of earned premiums of $10.6 million is primarily attributable to our marketing efforts and new homeowners products, offset by an increase in the cost of catastrophic reinsurance. Net investment income was $9.7 million for the first nine months of 2012, as compared to $7.4 million for the same period in 2011, such increase due to earnings on the loan transaction with SWS Group, Inc. and higher yields on cash and investments at NLASCO. Net realized gains decreased $0.8 million during the nine months ended September 30, 2012, due to the sale of securities in September 2011. Other income was $5.5 million for the first nine months in 2012, as compared to $5.1 million for the same period in 2011.

Underwriting Results. The following table shows the components of the Company's underwriting loss for the nine months ended September 30, 2012 and 2011. The Company's underwriting gain or loss consists of net premiums earned, less loss . . .

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