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HTH > SEC Filings for HTH > Form 10-Q on 27-Oct-2016All Recent SEC Filings

Show all filings for HILLTOP HOLDINGS INC.

Form 10-Q for HILLTOP HOLDINGS INC.


27-Oct-2016

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 (this "Quarterly Report") and the financial information set forth in the tables herein.

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," "we," "us," "our" or "ours" or similar words are to Hilltop Holdings Inc. and its direct and indirect wholly owned subsidiaries, references to "Hilltop" refer solely to Hilltop Holdings Inc., references to "PlainsCapital" refer to PlainsCapital Corporation (a wholly owned subsidiary of Hilltop), references to "Securities Holdings" refer to Hilltop Securities Holdings LLC (a wholly owned subsidiary of Hilltop), references to "Hilltop Securities" refer to Hilltop Securities Inc. (a wholly owned subsidiary of Securities Holdings that was formerly known as Southwest Securities, Inc.), references to "HTS Independent Network" refer to Hilltop Securities Independent Network Inc. (a wholly owned subsidiary of Securities Holdings that was formerly known as SWS Financial Services, Inc.), references to the "Bank" refer to PlainsCapital Bank (a wholly owned subsidiary of PlainsCapital), references to "FNB" refer to First National Bank, references to "SWS" refer to the former SWS Group, Inc., references to "First Southwest" refer to First Southwest Holdings, LLC (a wholly owned subsidiary of Securities Holdings) and its subsidiaries as a whole, references to "FSC" refer to First Southwest Company, LLC (a former wholly owned subsidiary of First Southwest), references to "PrimeLending" refer to PrimeLending, a PlainsCapital Company (a wholly owned subsidiary of the Bank) and its subsidiaries as a whole, references to "NLC" refer to National Lloyds Corporation (a wholly owned subsidiary of Hilltop) and its subsidiaries as a whole, references to "NLIC" refer to National Lloyds Insurance Company (a wholly owned subsidiary of NLC) and references to "ASIC" refer to American Summit Insurance Company (a wholly owned subsidiary of NLC).

FORWARD-LOOKING STATEMENTS

This Quarterly Report includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934 (the "Exchange Act"), as amended by the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical fact, included in this Quarterly Report that address results or developments that we expect or anticipate will or may occur in the future, and statements that are preceded by, followed by or include, words such as "anticipates," "believes," "could," "estimates," "expects," "forecasts," "goal," "intends," "may," "might," "plan," "probable," "projects," "seeks," "should," "target," "view" or "would" or the negative of these words and phrases or similar words or phrases, including such things as our business strategy, our financial condition, our efforts to make strategic acquisitions, the integration of the operations acquired in the SWS Merger (as defined below), our revenue, our liquidity and sources of funding, market trends, operations and business, stock repurchases, dividend payments, expectations concerning mortgage loan origination volume, expected losses on covered loans and related reimbursements from the Federal Deposit Insurance Corporation ("FDIC"), expected levels of refinancing as a percentage of total loan origination volume, projected losses on mortgage loans originated, anticipated changes in our revenues or earnings, the effects of government regulation applicable to our operations, the appropriateness of our allowance for loan losses and provision for loan losses, the collectability of loans and the outcome of litigation 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, 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:

?our ability to estimate loan losses;

?changes in the default rate of our loans;

?changes in general economic, market and business conditions in areas or markets where we compete, including changes in the price of crude oil;

?risks associated with concentration in real estate related loans;


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risks associated with merger and acquisition integration, including our ability to promptly and effectively integrate our businesses with those acquired in the SWS Merger and achieve the anticipated synergies and cost savings in connection therewith, as well as the diversion of management time on acquisition- and integration-related issues;

severe catastrophic events in Texas and other areas of the southern United States;

?changes in the interest rate environment;

cost and availability of capital;

?effectiveness of our data security controls in the face of cyber attacks;

?changes in state and federal laws, regulations or policies affecting one or more of our business segments, including changes in regulatory fees, deposit insurance premiums, capital requirements and the Dodd-Frank Wall Street Reform and Consumer Protection Act;

?approval of new, or changes in, accounting policies and practices;

?changes in key management;

?competition in our banking, broker-dealer, mortgage origination and insurance segments from other banks and financial institutions as well as investment banking and financial advisory firms, mortgage bankers, asset-based non-bank lenders, government agencies and insurance companies;

?our ability to obtain reimbursements for losses on acquired loans under loss-share agreements with the FDIC to the extent the FDIC determines that we did not adequately manage the covered loan portfolio;

?failure of our insurance segment reinsurers to pay obligations under reinsurance contracts; and

our ability to use excess cash in an effective manner, including the execution of successful acquisitions.

For a more detailed discussion of these and other factors that may affect our business and that could cause the actual results to differ materially from those anticipated in these forward-looking statements, see "Risk Factors" in

Part I, Item 1A of our Annual Report on Form 10-K for the year ended December
31, 2015 ("2015 Form 10-K"), which was filed with the Securities and Exchange Commission (the "SEC") on February 24, 2016, this Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations," Part II, Item 1A, "Risk Factors" herein and other filings we have made with the SEC. We caution that the foregoing list of factors is not exhaustive, and new factors may emerge, or changes to the foregoing factors may occur, that could impact our business. All subsequent written and oral forward-looking statements concerning our business attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements above. We do not undertake any obligation to update any forward-looking statement, whether written or oral, relating to the matters discussed in this Quarterly Report except to the extent required by federal securities laws.

OVERVIEW

We are a financial holding company registered under the Bank Holding Company Act of 1956. Our primary line of business is to provide business and consumer banking services from offices located throughout Texas through the Bank. We also provide an array of financial products and services through our broker-dealer, mortgage origination and insurance segments. The following includes additional details regarding the financial products and services provided by each of our primary business units.

PlainsCapital. PlainsCapital is a financial holding company headquartered in Dallas, Texas that provides, through its subsidiaries, traditional banking and wealth, investment management and treasury management services primarily in Texas and residential mortgage loans throughout the United States.

Securities Holdings. Securities Holdings is a holding company headquartered in Dallas, Texas that provides, through its subsidiaries, investment banking and other related financial services, including municipal advisory, sales, trading and underwriting of taxable and tax-exempt fixed income securities, equity trading, clearing, securities lending, structured finance and retail brokerage services throughout the United States.


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NLC. NLC is a property and casualty insurance holding company headquartered in Waco, Texas that provides, through its subsidiaries, fire and homeowners insurance to low value dwellings and manufactured homes primarily in Texas and other areas of the southern United States.

During the three and nine months ended September 30, 2016, our net income to common stockholders was $51.9 million, or $0.53 per diluted share, and $110.6 million, or $1.12 per diluted share, respectively.

We reported $85.5 million and $178.3 million of consolidated income before income taxes during the three and nine months ended September 30, 2016, respectively, including the following contributions from our four reportable operating segments.

The banking segment contributed $37.5 million and $90.4 million of income before income taxes during the three and nine months ended September 30, 2016, respectively;

The broker-dealer segment contributed $17.4 million and $39.5 million of income before income taxes during the three and nine months ended September 30, 2016, respectively;

The mortgage origination segment contributed $31.2 million and $68.4 million of income before income taxes during the three and nine months ended September 30, 2016, respectively; and

The insurance segment contributed $11.5 million and $8.1 million of income before income taxes during the three and nine months ended September 30, 2016, respectively.

During the three months ended June 30, 2016, the Bank discovered irregularities with respect to a non-covered loan that is currently in default, including the genuineness of certain underlying documents that supported the loan and the operations of the borrower's business. As a result of the payment default and other irregularities, the Bank increased its provision for loan losses and recorded a $24.5 million charge-off during the second quarter of 2016, representing the entire outstanding principal balance of the loan. The banking segment's financial results for the nine months ended September 30, 2016 reflect this charge-off. The Bank continues to investigate the loan relationship and is pursuing legal remedies to recover losses arising from this isolated incident, including litigation against the borrower and guarantors. Given the preliminary nature of the investigation and related legal proceedings, the Bank cannot currently estimate the amount of any future recoveries or additional expenses related to this charged-off loan.

At September 30, 2016, on a consolidated basis, we had total assets of $12.4 billion, total deposits of $7.0 billion, total loans, including loans held for sale, of $7.6 billion and stockholders' equity of $1.8 billion.

On January 1, 2015, we completed our acquisition of SWS in a stock and cash transaction (the "SWS Merger"), whereby SWS's broker-dealer subsidiaries, Southwest Securities, Inc. and SWS Financial Services, Inc., became subsidiaries of Securities Holdings, and SWS's banking subsidiary, Southwest Securities, FSB ("SWS FSB"), was merged into the Bank, an indirect wholly owned subsidiary of Hilltop. On October 5, 2015, Southwest Securities, Inc. and SWS Financial Services, Inc. were renamed "Hilltop Securities Inc." and "Hilltop Securities Independent Network Inc.", respectively. The operations acquired in the SWS Merger were included in our operating results beginning January 1, 2015 and such operations included a bargain purchase gain of $81.3 million.

On October 22, 2015, the Financial Industry Regulatory Authority ("FINRA") granted approval to combine FSC and Hilltop Securities, subject to customary conditions. Following this approval, we integrated the back-office systems of FSC and Hilltop Securities and, on January 22, 2016, merged FSC and Hilltop Securities into a combined firm operating under the "Hilltop Securities" name. We use the term "Hilltop Broker-Dealers" to refer to FSC, Hilltop Securities and HTS Independent Network prior to such date and Hilltop Securities and HTS Independent Network after such date.

Segment Information

We have three primary business units, PlainsCapital (banking and mortgage origination), Securities Holdings (broker-dealer) and NLC (insurance). Under accounting principles generally accepted in the United States ("GAAP"), our business units are comprised of four reportable business segments organized primarily by the core products offered to the segments' respective customers:
banking, broker-dealer, mortgage origination and insurance. Consistent with our historical segment operating results, we anticipate that future revenues will be driven primarily from the banking segment, with the remainder being generated by our broker-dealer, mortgage origination and insurance segments.


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Operating results for the mortgage origination segment have historically been more volatile than operating results for the banking, broker-dealer and insurance segments.

The banking segment includes the operations of the Bank, which primarily provides business and consumer banking services from offices located throughout Texas and generates revenue from its portfolio of earning assets. The Bank's results of operations are primarily dependent on net interest income, while also deriving revenue from other sources, including service charges on customer deposit accounts and trust fees.

The broker-dealer segment includes the operations of Hilltop Securities and HTS Independent Network. From the date of the SWS Merger until January 22, 2016, when we merged FSC into Hilltop Securities to form a combined firm operating under the "Hilltop Securities" name, our broker-dealer segment was operated through FSC, Hilltop Securities and HTS Independent Network as separate broker-dealers under coordinated leadership. The broker-dealer segment generates a majority of its revenues from fees and commissions earned from investment advisory and securities brokerage services. Hilltop Securities is a broker-dealer registered with the SEC and FINRA and a member of the New York Stock Exchange ("NYSE"), HTS Independent Network is an introducing broker-dealer that is also registered with the SEC and FINRA, and First Southwest Asset Management, LLC is a registered investment advisor under the Investment Advisors Act of 1940.

The mortgage origination segment includes the operations of PrimeLending, which offers a variety of loan products and generates revenue predominantly from fees charged on the origination of loans and from selling these loans in the secondary market.

The insurance segment includes the operations of NLC, which operates through its wholly owned subsidiaries, NLIC and ASIC. Insurance segment income is primarily generated from revenue earned on net insurance premiums less loss and loss adjustment expenses ("LAE") and policy acquisition and other underwriting expenses in Texas and other areas of the southern United States.

Corporate includes certain activities not allocated to specific business segments. These activities include holding company financing and investing activities, and management and administrative services to support the overall operations of the Company including, but not limited to, certain executive management, corporate relations, legal, finance, and acquisition costs.

The elimination of intercompany transactions are included in "All Other and Eliminations." Additional information concerning our reportable segments is presented in Note 22, Segment and Related Information, in the notes to our consolidated financial statements. The following tables present certain information about the operating results of our reportable segments (in thousands).

                                                                          Mortgage                                     All Other and        Hilltop
Three Months Ended September 30, 2016    Banking      Broker-Dealer      Origination      Insurance     Corporate      Eliminations       Consolidated
Net interest income (expense)            $ 90,549    $         7,823    $     (3,076)    $       716    $  (1,854)    $         5,012    $       99,170
Provision for loan losses                   4,179              (189)                -              -             -                  -             3,990
Noninterest income                         12,711            103,511          202,560         41,170             -            (5,494)           354,458
Noninterest expense                        61,536             94,094          168,303         30,415        10,041              (256)           364,133
Income (loss) before income taxes        $ 37,545    $        17,429    $      31,181    $    11,471    $ (11,895)    $         (226)    $       85,505

                                                                          Mortgage                                    All Other and        Hilltop
Nine Months Ended September 30, 2016     Banking      Broker-Dealer      Origination     Insurance     Corporate      Eliminations       Consolidated
Net interest income (expense)           $ 268,682    $        22,314    $     (7,941)    $    2,213    $  (5,413)    $        13,552    $      293,407
Provision for loan losses                  36,292               (19)                -             -             -                  -            36,273
Noninterest income                         39,012            287,293          541,779       124,366             2           (14,614)           977,838
Noninterest expense                       181,016            270,135          465,463       118,506        22,373              (806)         1,056,687
Income (loss) before income taxes       $  90,386    $        39,491    $      68,375    $    8,073    $ (27,784)    $         (256)    $      178,285

                                                                           Mortgage                                     All Other and        Hilltop
Three Months Ended September 30, 2015     Banking      Broker-Dealer      Origination      Insurance     Corporate      Eliminations       Consolidated
Net interest income (expense)            $ 105,758    $         8,301    $     (2,538)    $       838    $  (1,799)    $         4,651    $      115,211
Provision for loan losses                    5,615               (22)                -              -             -                  -             5,593
Noninterest income                          13,935             83,817          159,794         43,534             -            (4,611)           296,469
Noninterest expense                         60,518             90,683          145,113         32,366         6,028            (1,206)           333,502
Income (loss) before income taxes        $  53,560    $         1,457    $      12,143    $    12,006    $  (7,827)    $         1,246    $       72,585


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                                                                          Mortgage                                    All Other and        Hilltop
Nine Months Ended September 30, 2015     Banking      Broker-Dealer      Origination     Insurance     Corporate      Eliminations       Consolidated
Net interest income (expense)           $ 280,081    $        24,320    $     (7,829)    $    2,294    $  (3,289)    $        13,693    $      309,270
Provision for loan losses                   8,405                 33                -             -             -                  -             8,438
Noninterest income                         48,293            243,593          463,314       128,216        81,289           (13,990)           950,715
Noninterest expense                       179,378            271,826          412,234       121,893        17,546            (1,582)         1,001,295
Income (loss) before income taxes       $ 140,591    $       (3,946)    $      43,251    $    8,617    $   60,454    $         1,285    $      250,252

How We Generate Revenue

We generate revenue from net interest income and from noninterest income. Net interest income represents the difference between the income earned on our assets, including our loans and investment securities, and our cost of funds, including the interest paid on the deposits and borrowings that are used to support our assets. Net interest income is a significant contributor to our operating results. Fluctuations in interest rates, as well as the amounts and types of interest-earning assets and interest-bearing liabilities we hold, affect net interest income. We generated $293.4 million in net interest income during the nine months ended September 30, 2016, compared with net interest income of $309.3 million during the same period in 2015. Changes in net interest income included decreases within our banking and broker-dealer segments, as well as interest expense incurred on our $150.0 million aggregate principal amount of 5% senior notes due 2025 ("Senior Notes") that were not issued until the second quarter of 2015.

The other component of our revenue is noninterest income, which is primarily comprised of the following:

(i) Income from broker-dealer operations. Through the Hilltop Broker-Dealers, we provide investment banking and other related financial services. We generated $202.8 million and $205.5 million in securities brokerage commissions and fees and investment advisory fees and commissions, and $81.0 million and $37.7 million in gains from derivative and trading portfolio activities (included within other noninterest income) during the nine months ended September 30, 2016 and 2015, respectively.

(ii) Income from mortgage operations. Through PrimeLending, we generate noninterest income by originating and selling mortgage loans. During the nine months ended September 30, 2016 and 2015, we generated $541.1 million and $463.2 million, respectively, in net gains from the sale of loans, other mortgage production income (including income associated with retained mortgage servicing rights), and mortgage loan origination fees.

(iii) Income from insurance operations. Through NLC, we provide fire and limited homeowners insurance for low value dwellings and manufactured homes. We generated $117.2 million and $121.1 million in net insurance premiums earned during the nine months ended September 30, 2016 and 2015, respectively.

In the aggregate, we generated $977.8 million and $950.7 million in noninterest income during the nine months ended September 30, 2016 and 2015, respectively. Excluding the bargain purchase gain of $81.3 million related to the SWS Merger, our noninterest income during the nine months ended September 30, 2015 was $869.4 million. We are presenting this financial measure because certain investors may use it to evaluate our business and financial results. This year-over-year increase in noninterest income, other than bargain purchase gain, is predominantly attributable to increases in noninterest income in our mortgage origination and broker-dealer segments.

We also incur noninterest expenses in the operation of our businesses. Our businesses engage in labor intensive activities and, consequently, employees' compensation and benefits represent the majority of our noninterest expenses.


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Consolidated Operating Results

Net income applicable to common stockholders during the three months ended September 30, 2016 was $51.9 million, or $0.53 per diluted share, compared with net income applicable to common stockholders of $46.9 million, or $0.47 per diluted share, during the three months ended September 30, 2015. Net income applicable to common stockholders during the nine months ended September 30, 2016 was $110.6 million, or $1.12 per diluted share, compared with net income applicable to common stockholders of $188.4 million, or $1.88 per diluted share, during the nine months ended September 30, 2015. The consolidated operating results during the nine months ended September 30, 2016 included the previously mentioned $24.5 million charge-off of a single large loan by the Bank during the second quarter of 2016. The consolidated operating results during the nine months ended September 30, 2015 included the recognition of a bargain purchase gain related to the SWS Merger of $81.3 million, or $0.81 per diluted share. Included in the bargain purchase gain is a reversal of a $33.4 million valuation allowance against SWS deferred tax assets. This amount is based on our expected ability to realize these acquired deferred tax assets through our consolidated core earnings, the implementation of certain tax planning strategies and reversal of timing differences. SWS's net operating loss carryforwards are subject to an annual limitation on their usage because of the ownership change effected in connection with the SWS Merger. In addition, the bargain purchase gain reflects our acquisition date fair value allocation to identifiable intangible assets of $7.5 million.

Our consolidated operating results during the nine months ended September 30, 2016 also include transaction costs related to the SWS Merger, and integration-related costs associated with employee expenses (such as severance and retention), professional fees (such as consulting and legal) and contractual costs (such as vendor contract termination and lease), incurred as a result of the integration of the operations and systems acquired in the SWS Merger. During the nine months ended September 30, 2016, we incurred $6.7 million in pre-tax transaction costs related to the SWS Merger, while pre-tax integration-related costs associated with employee, professional fee and contractual expenses during this same period were $2.9 million, $2.8 million, and $0.1 million, respectively. During the nine months ended September 30, 2015, we incurred $4.3 million in pre-tax transaction costs related to the SWS Merger, while pre-tax integration-related costs associated with employee, professional fee and contractual expenses during this same period were $7.3 million, $3.3 million and $2.4 million, respectively. On October 22, 2015, FINRA granted approval to . . .

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