Hilltop Holdings Inc.
Q1 2021 Earnings Call Transcript

Published: 23 Apr 2021

[Operator:]

Good morning everyone and welcome to the Hilltop Holdings First Quarter Year 2021 Earnings Conference Call and Webcast. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please also note today's event is being recorded. At this time, I would like to turn the conference call over to Erik Yohe. Sir, please go ahead.

[Erik Yohe:]

Thank you, operator. Before we get started, please note that certain statements during today's presentation that are not statements of historical fact, including statements concerning such items as our outlook, business strategy, future plans, financial conditions, allowance for credit losses, the impact and potential impact of COVID-19, stock repurchases and dividends, as well as such other items referenced in the preface of our presentation are forward-looking statements. These statements are based on management's current expectations concerning future events that, by their nature, are subject to risks and uncertainties.

[Jeremy Ford:]

Thank you, Erik, and good morning. For the first quarter 2020, Hilltop reported net income of $120 million, or $1.46 per diluted share, representing an increase from the first quarter 2020 of $71 million or $0.91 per diluted share. Return on average assets for the period were 2.9% and return on average equity was 20.6%. These results do include a $5.1 million reversal of provision compared to the first quarter of last year when we had a provision expense of $34.5 million as we entered in and the outlook for credit in the economy looked to be deteriorating. Most of the momentum around mortgages from 2020 continued into this first quarter. Notwithstanding higher long-term interest rates and refinance volumes slowing, the overall mortgage market remained strong and our origination business was able to deliver $6.2 billion in volume, a 71% increase from Q1 2020. Driven by PPP loan balances the bank average loans for the first quarter increased 7% from prior year and average deposits grew by $2.4 billion or 26% from prior year as well. While pre-tax margin at the broker-dealer was down slightly from Q1 2020, we did see growth in the structured finance business, which also benefited from a strong mortgage market, and the public financial business efforts to improve productivity and growth are showing positive return, as net revenue increased 8% from the first quarter 2020. During the period, Hilltop returned $50 million to shareholders through dividends and share repurchases. The $5 million of shares repurchased are part of the $75 million share authorization the Board granted in January. Liquidity and capital remained very strong with a tier 1 leverage ratio of 13% and a common equity tier 1 capital ratio of 19.6% at quarter end. We continue to see improvement in economic trends and during the quarter we had payoff and a return to contractual payments for a large portion of the modified loan portfolio. This portfolio, which at the end of June 2020 was $968 million is now down to $130 million as of March 31. Notably all COVID-19 modified retail and restaurant loans are now off deferral programs.

[Will Furr:]

Thank you, Jeremy. I'll start on Page 5. As Jeremy discussed, for the first quarter of 2021 Hilltop reported consolidated income attributable to common stockholders of about $120 million, recording a $1.46 per diluted share. During the first quarter, revenues related to purchase accounting were $4.9 million and expenses were $1.3 million, resulting in a net purchase accounting pre-tax income of $3.6 million for the quarter. In the current period purchase accounting expenses largely represent amortization of other intangible assets related to prior acquisitions. During the first quarter, the provision for credit losses reflected a net reversal of $5.1 million and included approximately $600,000 of net recoveries of previously written off credits. The improvement in the current macroeconomic environment, as well as the outlook for continued improvements and key economic methods positively impacted allowance for further losses during the quarter. Hilltop quarter end capital ratios remained strong with common equity Tier 1 of 19.63% and Tier 1 leverage ratio of 13.01%. Now moving to Page 6. Net interest income in the first quarter equated to $106 million, including $7.5 million of previously deferred PPP origination fees and purchase accounting accretion. Versus the prior year quarter, net interest income decreased by $4.7 million or 4%. Further net interest margin declined versus the fourth quarter of 2020 by 2 basis points. In the current period net interest margin benefitted from a recognition of deferred PPP origination fees, higher yields in stock loan, and lower deposit costs. Offsetting these benefits, were lower loan, HFI and HFS yields driven by market pricing and absolute yield flows in the mortgage market. Further, PCB's excess cash levels they will better reserve increased by $365 million from the fourth quarter putting an additional 5 basis points with pressure on the net interest margin. During the quarter, new loan commitments including credit renewals maintained an average book yield of 4%. This was stable with the fourth quarter of 2020. Total interest bearing deposit costs declined by 8 basis points in the quarter, as we continued to lower customer deposit rates and returned broker deposits during the first quarter. We expect continued consumer CD maturities and additional broker deposit costs in the coming quarters, both of which support continue steady decline in interest bearing deposit costs. Given the current market conditions, we expect net interest income and net interest margin will remain pressured as overall market rates remain low putting pressure on held for sale and commercial loan yields and the competition could remain aggressive over the coming quarters as we expect the loan demand will remain below historical levels.

[Operator:]

Ladies and gentlemen, at this time we will begin the question-and-answer session. Our first question today comes from Michael Young from Truist. Please go ahead with your question.

[Michael Young:]

Hey, good morning. Thanks for taking the question.

[Jeremy Ford:]

Hey, Michael?

[Michael Young:]

Why don’t you maybe just start on the mortgage business, obviously that's going to be swing factor this year with potentially lower revenue, lower gain-on-sale, but just on the expense side, I think in the comments you had made mention of sort of the fixed costs across the businesses being stable, but I would assume there's some opportunity there to bring the fixed costs down and obviously you know variable costs will move in accordance with how they have historically. So, any color to add there on the expense side for mortgage?

[Will Furr:]

Yes, I think the mortgage business as we sit here we've made substantial investments in technology through our loan origination system, some of the digital activities we're launching and continue to launch as it relates to customer engagement. So, all those things are going to allow us to streamline and continue to make good progress on reducing the cost to originate a loan, specifically as it relates to our middle and back office functions. And again, I think to your point, our expectation is that those costs remain stable kind of year-on-year and that's offsetting the inflationary costs naturally occur in the business whether that be increased salaries through merit or escalators and real estate costs or otherwise. So, from our perspective within the ongoing benefits of the investments are going to help us offset inflation and we hope to exceed that, but also, again maintain stable costs as volumes rationalize throughout the year.

[Michael Young:]

Okay. And then maybe a broader question just on new growth or revenue opportunities, are you guys looking at any new business opportunities or new winning verticals that could help with revenue growth as we move into 2021 in a softer mortgage year?

[Jeremy Ford:]

Yes, I think as far as our business model and the companies and the things that we have, we're not looking to do anything differently and we're looking to grow each business. I wouldn't think there is any new vertical or anything different from what we're doing.

[Michael Young:]

Okay. And then just last one, just on kind of, customer demand and appetite, you know I think you guys were still expressing a little bit of caution around credit quality in the back half of the year but are you seeing any potential signs of growth or new demand coming as well? I think a lot of banks kind of pointed to that. So, I just wanted to know you guys are seeing that within your customer base or in your geography?

[Jeremy Ford:]

Well currently commercial loan demand we think is soft, but we think there is optimism and we do feel like we have a pretty solid pipeline for where we're at today.

[Michael Young:]

Okay. I'll step back, thanks.

[Operator:]

Our next question comes from Michael Rose from Raymond James. Please go ahead with your question.

[Michael Rose:]

Hey guys, how are you doing?

[Jeremy Ford:]

Hey, how is it going?

[Michael Rose:]

All going well, thanks for asking. Just wanted to get a little color on the buyback, I know this question is kind of asked every quarter you guys have a ton of capital. Can you just kind of update us on your thoughts there? And maybe Jeremy, just your thoughts on M&A, just we've seen a fair amount of activity here in recent weeks and just wanted to see what your updated thoughts are? Thanks.

[Jeremy Ford:]

Sure. With regard to share repurchases, you know, we only repurchased $5 million in the first quarter that was largely due to limited open window period. And we have a $75 million repurchase authorization, so we have $70 million left that we can utilize before going back to the Board. And that LBR expectation as we sit today and we'll constantly evaluate where we feel like we are trading versus intrinsic value. And then on the M&A front, as we've all along stated, we do have a separate capital that we want to deploy towards M&A. They're still like the -- it's a relatively healthy environment. So, and makes it easier to have conversations about yields so there is less distressed deals we've done kind of historically in the past. So, as I said last quarter, our focus is going to be on trying to find the right strategic partner and something that we think will really enhance our collective shareholder value.

[Michael Rose:]

That's helpful. Just switching to mortgage, so you guys reiterated the origination expectations for the year '17 to '20 yesterday the MBA, big upward revision to second quarter refi, and if I annualize what you guys did in the first quarter, it implies much higher than the guide. So I guess the thought is that we all know mortgage is going to come off at some point, but any thought as to why you wouldn't be at the upper end of that range? Thanks.

[Will Furr:]

Yes. I think certainly the annualization effort would yield in there. I think our view is, the next couple of quarters will start to normalize and become more, I would say seasonal intrajectory as they rotate towards a more purchase oriented market. You know some of our considerations around how we think about it or the inventory challenges that are in the marketplace and the overall competitive challenges that we believe are going to emerge as volumes do come out of the market and organizations and competition is left to rationalize the outsized operations that they've built and left you know twelve to eighteen months. So, we think the $17 billion to $20 billion is a reasonable range and again it's our -- we'd like to be at the top in that range. But again from our perspective there are some headwinds going forward albeit the market remains certainly on the purchase side, remains constructive. And again, we think demand is reasonably strong, but the inventory challenges are real and present today.

[Michael Rose:]

I understood and that's good color. Finally from me, Jeremy, if you can just kind of walk us through the different pieces of the Fixed Income business and how what kind of the push and pull would be as rates rise and then if the Fed actually does increase rates at some point down the road? Just trying to get at, because again I know there are puts and takes within the business space on where rates are, but just trying to get an outlook for the expectations for that business over the next couple of quarters. Thanks.

[Jeremy Ford:]

For Hilltop Securities, you're talking about?

[Michael Rose:]

Yes, correct.

[Jeremy Ford:]

Okay great, yes sure. You know, I guess that we have four primary business lines in that business. One is Public Finance Services and I think that just given kind of the backdrop, we are positive on national issuance and we've also had a lot of really strong recruiting. So we feel good about the growth of that business. You know what's really been the dominant revenue creator in that, in Hilltop Securities has been Structured Finance, which is a mortgage related business. And just like we mentioned, it followed a similar pattern as Prime did in the first quarter. So, I think that will tie the interest rates like the purchase home, the purchase, the home purchase market will. Fixed Income Services, that's our municipal and taxable fixed income business, and that will, we're enhancing a lot of capabilities there. I think we've got room to grow. That it is subject to sudden changes in the direction of interest rates. And then Wealth Management is where we, when we have any kind of spread and short term interest rates that falls straight to the bottom line. So, in the first quarter its revenue was up $4.5 million, solely because of having 0% short term rates.

[Michael Rose:]

That's great color. Thanks for taking my questions guys.

[Jeremy Ford:]

Kind of the direction of interest rates is deferred as well. But I think in general, like even if rates increase we're not seeing rates increase to such a level that would preclude public finance issuance or a lot of these first time homebuyers in our Structured Finance business, and if they're, we don't see a period of time before that that short term rates will increase and alleviate the wealth .

[Michael Rose:]

Great, thank you.

[Operator:]

Our next question comes from Brad Millsaps from Piper Sandler. Please go ahead with your question.

[Jeremy Ford:]

Hey Brad.

[Brad Millsaps:]

Hey good morning. How are you? You got to address a lot of my questions. I did want to ask about the balance sheet, and kind of how you would expect to manage some of the existing excess liquidity and again on average, about $1.5 in cash, it didn't look like you grew the bond portfolio a lot in the first quarter, but just kind of curious kind of how you think about managing that cash, particularly with the long growth dynamics you're talking about and also the PPP forgiveness on the horizon?

[Will Furr:]

Yes, so you're also right. The excess cash is obviously top of mind for us. I think as we've said historically, we're not looking to take on excessive amounts of duration exposure right here. And so given where kind of absolute rates are, although they have backed up since prior quarters, so you saw the investment portfolio with the bank kind of ended into the period about $2 billion. We expect that it will drift higher I don't expect it to take, a step function higher, but I do expect it to drift higher as we put somebody to work there in places where we feel like we don't have kind of outside exposure. We are retaining the $30 million to $50 million. I think our expectation is, we do the top end of that retention range of PrimeLending originated mortgages for the balance of the year notwithstanding stronger commercial demand and we're expecting at this time. And then we do expect again during the second quarter and into the third and fourth, we do expect commercial loan demand to pick up if that doesn't impact the curve, and we'll react to that and make some adjustments to the approach. But we're going to continue to be prudent and continue to make, I'd say marginal steps in terms of overall deployment. Lastly, I'd say, we tried to mention in my comments, we do have a series of broker deposits on the balance sheet. We expect those will mature and our expectations or they will run off throughout the balance of this year. So, in terms of kind of overall liquidity and access to rationalization of broker deposits, as well as mortgage retention on the balance sheet, and then I'd say the securities portfolio drifting higher over the $2 billion level quarter-by-quarter.

[Brad Millsaps:]

Okay, great, that's helpful. And just to follow up on asset quality. I think you commented again this quarter in the slide deck that you expect the provision expense to potentially be elevated in the back half of the year. It seems like you guys have pretty massive reserve at 2% of loans even higher if I were to maybe make some other adjustments. Just kind of curious kind of how to square that with what's seemingly an improving economic picture and credit environment, with all the reserve building you've done in the past. I wonder if you could maybe frame up sort of what you what you believe would be an elevated provision expense in the back half kind of given all those factors?

[Will Furr:]

Yes, so, I think from a credit perspective, as you noted and we noted in our comments, we are seeing some rays of light and opportunity in certain of the portfolios, but then continue to see challenges in others. So, as Jeremy mentioned in his comments, loans and active deferrals from a retail and restaurant perspective have now moved to zero, so that is a substantial improvement from June of last year. And what we're continuing to see is challenges certainly in the hotel space as it relates to those properties that are principally business oriented, those that are a little more destination oriented which is we do have some of those, have outperformed, but those business specific and business kind of targeted properties continue to be challenged and we've got about $130 million, the wholesale portfolio of those active deferrals make up about $108 million of that. So I think that's important to note. On top of that we're looking at the office portfolio across the State of Texas. I think it's reasonably well known there are growing trends of vacancy and subletting kind of going on. And so, we remain cautious on that portfolio as well. So while there are clearly reasons to be more optimistic, there's also some places where we continue to have heightened focus on our credit measurement and evaluation. As it relates to kind of charge offs in the second half again, I think as we look at it, we do, there's just an expectation currently that some of these loans on active deferral once they kind of run through this deferral window here, there'll be some tough decisions having to be made and that likely will yield some charge offs in the in the second half of the year. And again, we continue to be aggressive in working with our clients and trying to help every client get through what has been an unprecedented environment. With that said, our expectation is there will be some charge offs in the second half.

[Brad Millsaps:]

You know, kind of under that framework, I mean do you think you'd be in position to sort of move kind of general reserves to maybe some of these specific situations, just trying to think about the P&L impact I suppose?

[Will Furr:]

Yes I think that's right. I mean as you get more clarity into which properties and kind of which entities you will be more specific about that, I think you'll see that articulate over time kind of outside .

[Brad Millsaps:]

Okay great, thank you guys.

[Will Furr:]

Thank you.

[Operator:]

Our next question comes from Matt Olny from Stephens. Please go ahead with your question.

[Matthew Olny:]

Thanks for taking my question. I want to circle back on mortgage, and I think in the first quarter typically each year we see mortgage volumes build each consecutive month as we move into the spring selling season, but this year obviously we have that the falling refi volumes. So curious if you can provide any commentary on volumes in recent months and what you're seeing more recently? Thanks.

[Will Furr:]

Yes, I'd say, through the first quarter as Jeremy mentioned in his comments, it was certainly seasonally high. We had a 47% purchase percentage and so the refinance volume was high. We saw that start to decline if you will, in March as the tenure rate backed up for 160, 170 basis points and that would settle back in the 150s. But that portion of the volume is obviously very rate sensitive and we saw that pullback in the month of March and I think that's continued in April. So we continue to believe that this market is going to roll forwards and move towards a more purchase oriented market which from my perspective is strength of ours and how we've positioned our business over time. But again, we do believe that refinance volume will be more challenged even in the second quarter, but certainly in the second half of the year.

[Matthew Olny:]

Okay, thanks for that Will. And then on the gain on sale margins, I think what we're seeing from the marketplace, pretty considerable divergence of margins, getting hit a lot harder on the wholesale side versus retail. Do just remind us of your of your mix of wholesale versus retail on the mortgage side?

[Will Furr:]

We're 100% retail. We don't have any wholesaler corresponding business.

[Matthew Olny:]

Okay, and then just lastly from me on the MSR, just update us on the strategy. I saw you executed the sale in the first quarter. Was there any material impact on the financials in the first quarter? And then thinking about the are you just trying to manage that asset around that $140 million level moving forward?

[Will Furr:]

Yes, so we did have a sale, we had a positive outcome there. So I'll take you back a little to the last year. So the strategy last year was to retain that servicing as the market for servicing really deteriorated to the point where there were periods of kind of no bid for servicing assets in the second quarter and early third quarter last year. That has started to heal. Obviously, you saw the MSR balance increase during the period, during the period of 2020 as a result of that strategy we were able to do that because of our liquidity and balance sheet strength. So we were able to be opportunistic in doing that. It's not our long-term objective to have a $140 million and $150 million MSR asset. Well that will likely move lower over time. In my comments, I tried to note, we do expect to continue to execute additional bulk sales to the extent the market is there for that, and the market is robust and currently it has been favorable for that. But again, I think our target historically has been at $50 million to $75 million range. It may travel a little higher than that for the balance of 2021, but again, objectively it is not a strategic objective of ours to maintain an outsized MSR. But again we did, we do believe the strategy that we executed last year and end of the first quarter has borne favorable outcomes, both in terms of kind of price recognition and gain through some of these executed sales.

[Matthew Olny:]

Okay, thanks for taking my question.

[Will Furr:]

Yes.

[Operator:]

And our next question comes from Woody Lay from KBW. Please go ahead with your question.

[Woody Lay:]

Hey, good morning, guys.

[Will Furr:]

Good morning.

[Jeremy Ford:]

Good morning.

[Woody Lay:]

So on the PPP front, do you have the amount of net origination fees that are unearned at this point, and expect to recognize over the forgiveness process?

[Will Furr:]

As of 3/31, it was about $13.9 million.

[Woody Lay:]

Okay, got it. And then last from me, could you just remind us the average yield on these consumer mortgage loans that you plan to retain?

[Will Furr:]

The other loans that were lost during the quarter they will come on the balance sheet over the coming months about 287 basis points.

[Woody Lay:]

Okay, great, thanks guys.

[Will Furr:]

When that will, as with these periods now that mortgage rates are higher, we do expect that will drift over 3% on loss into the future and loans come on the balance sheet, but again, for the first quarter loss about 287 basis points.

[Woody Lay:]

Got it. That's helpful. All right, thanks guys.

[Jeremy Ford:]

Thank you.

[Operator:]

Again ladies and gentlemen with that, we will conclude today's Hilltop Holdings first quarter 2021 earnings conference call and webcast. We do thank you for attending today's presentation. You may now disconnect your lines.