Hilltop Holdings Inc.
Q3 2020 Earnings Call Transcript

Published: 23 Oct 2020

[Operator:]

Good morning and welcome to the Hilltop Holdings third quarter 2020 earnings conference call and webcast. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today’s presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touchtone phone. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Erik Yohe. 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 condition, allowance for credit losses, and the impact and potential impacts of COVID-19 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. Our actual results, capital, liquidity and financial condition may differ materially from these statements due to a variety of factors, including the precautionary statements referenced in our presentation and those included in our most recent annual report and quarterly reports filed with the SEC. Except to the extent required by law, we expressly disclaim any obligation to update earlier statements as a result of new information.

[Jeremy Ford:]

Thank you Erik, and good morning. Before I get into the results for the quarter, I would like to applaud our teams across all three businesses and at the holding company for their unwavering commitment to serve our customers in a safe and highly effective manner. I believe this year has made us a stronger company and will provide the foundation for prudent future growth. In the third quarter, Hilltop delivered $153 million in net income and earnings per share of $1.70. This was an increase from the third quarter 2019 of $74 million or $0.84 per diluted share. Of note, Q3 2020 results include a final true-up of $736,000 related to the sale of National Lloyds. Importantly, Hilltop’s Q3 2020 exceptional results reflect outsized mortgage related earnings at PrimeLending and Hilltop Securities, as well as no provision for loan losses at the bank. However, we remain cautious that the COVID-19 pandemic may continue to adversely affect our businesses, including reduced mortgage volume and further credit deterioration in our loan portfolio. Our net revenue for the quarter of $604 million was higher on a year-over-year and linked quarter basis as both the mortgage purchase and refinance markets remain strong in this low rate environment. PrimeLending originated $6.5 billion in loans during the period, an increase of $1.7 billion from the third quarter 2019. Additionally, the gain on sale margin during this period expanded by 105 basis points year over year and by 72 basis points linked quarter. Total deposits increased by $2.5 billion or 29% compared to the third quarter 2019, a decline slightly on a lead quarter basis as we returned approximately $400 million in broker dealer suite deposits due to the bank’s fortified liquidity position. During the quarter, the broker dealer grew net revenues by 23% from the third quarter 2019 to $149 million and reported a pre-tax margin of 23.7%. The firm’s robust financial results in the quarter were driven by strong performance in the structured finance and fixed income services business as well as improvement in the public finance services business.

[William Furr:]

Thank you Jeremy. I will start on Page 6. As Jeremy discussed, for the third quarter of 2020 Hilltop reported consolidated net income attributable to common stockholders of $153.3 million, equating to $1.70 per diluted share. Income from continuing operations attributable to common stockholders equated to $152.5 million or $1.69 per diluted share. Hilltop’s continuing operations generated $205 million of pre-provision net revenue, or PPNR, during the third quarter, which brings year-to-date PPNR to $508 million, up from $223 million earned in the prior year period to date. Growth versus the prior year period was driven by our diversified revenue streams and led by strong mortgage originations. In the third quarter, provision for credit losses reflected a net recovery of approximately $600,000. The bank recorded no provision for credit losses during the third quarter as net charge-offs declined to $567,000 and the allowance for credit losses remained relatively stable during the period. During the quarter, a number of items impacted our assessment of the allowance for credit losses, including approximately $660 million of the loans that were on an active deferral plan at June 30 are no longer on an active deferral and have made a payment pursuant to their contractual terms. In addition, there was improvement in the base case economic scenario that was used to evaluate the loss content across our portfolio to September 30.

[Operator:]

Our first question will come from Michael Young with Truist Securities. Please go ahead.

[Michael Young:]

Hey, good morning. Thanks for taking the question, and congrats on the good quarter. Just wanted to start maybe on the capital side of the equation. I don’t know if you guys can provide any update on the modified Dutch auction and either progress there or what the plan would be, now that the stock’s above the high end of the targeted range there. Just any comments there would be helpful.

[Jeremy Ford:]

Sure. The short answer is we don’t have a lot to comment on there. We do have the tender open and outstanding, and it expires on October 30.

[Michael Young:]

Okay. I don’t know again if you can comment on this either, but after that process is over, depending on the amount that’s actually filled, would there be--you know, I guess if it wasn’t fully filled, would you guys look to still deploy that amount of excess capital into maybe an accelerated share repurchase, or just open market purchases?

[Jeremy Ford:]

I think we’re focused on the tender offer today, and thereafter we’ll continue to manage our capital as we’ve done so in the past.

[Michael Young:]

Okay, fair enough. Then moving to the mortgage business, Will, appreciate the comments on volume expectations, etc. Just looking at the gain on sale margin, though, was there a benefit from maybe having the pricing of the 50 basis point expected increase from the GSCs in there, but not actually having to pay that this quarter, that we should sort of normalize out going forward, or any other impacts we should think about on gain on sale margin?

[William Furr:]

I don’t think so. I think we were pleased to see that pricing change was pushed into the fourth quarter and that certainly, I think, has benefited customers and benefited the business. From our perspective, what you’ve seen is volumes have been sufficiently large to allow for spreads to remain reasonably wide. I would note we’ve continued to retain a substantial portion of the MSR, which we believe certainly through the second and third quarter was beneficial to us, and we believe the asset and the return on that asset are good at the prices that we’re able to get at this point. From our perspective, really, market dynamics as well as prudence around our overall pricing actions in our business, as we noted when we started to make the investments in our new mortgage loan origination system, we believed that system would allow us to provide greater oversight of overall pricing exceptions and the like, and I would say the PrimeLending leadership team has taken advantage of both the technology capabilities but also just enhanced rigor of overall pricing exceptions in the market over the last 90 to 180 days, which has allowed gain on sale margins to increase. Again, I think for the fourth quarter, we expect them to stay within--stay range bound here between 430 and 450 basis points.

[Michael Young:]

Okay, thanks. Sorry to jump around, but one last one just on the corporate and other segment. Was there anything unique or larger in this quarter that we shouldn’t expect o a go-forward basis?

[William Furr:]

I think what you’ll see there is incentive related compensation, variable compensation impacts there in principal.

[Michael Young:]

Okay, so maybe more of a true-up and then we return to more normal levels?

[William Furr:]

Correct.

[Michael Young:]

Okay, thanks. That’s all for me.

[William Furr:]

Thank you.

[Jeremy Ford:]

Thanks Michael.

[Operator:]

Our next question will come from Michael Rose with Raymond James. Please go ahead.

[Michael Rose:]

Hey, good morning guys, and thanks for taking my questions. Maybe asking the buyback question a little bit differently, you guys obviously sold the insurance business, generated a lot of proceeds from that, and capital level is really high. As I read the proxy for the Dutch tender, I think it does say that you can repurchase shares in the open market about 11 days after that’s complete. Jeremy, how should we think about the levels of excess liquidity and capital that you guys would hold as hopefully the pandemic subsides, now that the insurance business is no longer a part of the business mix, and where do you guys think that capital levels and liquidity basically should run in a more normalized period? Thanks.

[Jeremy Ford:]

Sure, thanks for the question. I think when we came up with the size range of having the $350 million, that was a combination of considering the go-forward capital that we’d want during this pandemic and also be able to pursue opportunities afterwards. We also viewed that in light of our institutional shareholders and where the demand would be, so that’s kind of--that’s what I can tell you on sizing it. I think that we’re focused on this tender offer and coming out of that, we’ll have to really evaluate our plans for what that bogey will be, given the opportunity set and the M&A environment.

[Michael Rose:]

Okay, so is M&A something that you guys are looking at here? Are you having conversations? It does seem like chatter is picking up, and is that part of the capital deployment strategy that we should be thinking about for you guys?

[Jeremy Ford:]

Well, it hasn’t changed since--you know, it’s the same strategy we’ve always had. That is we are interested in pursuing M&A opportunities, but we’re going to be patient given the environment and be aggressive when we find the right one.

[Michael Rose:]

Okay. Maybe just one more for me. I look the quarter’s provision, slightly negative. We see MPA migration, we see criticized balances essentially double. How should we think about the pace of future provisioning? Is it more matching charge-offs from here? I understand the credit metrics are still very benign, but we did see some migration this quarter, so just trying to gauge how you guys think about provision as we move forward. Thanks.

[William Furr:]

This is Will. As we think about allowance, it’s going to be a quarter by quarter assessment. As I mentioned, we had a lot of activity in this quarter, whether it be credit migration, deferral activity, as well as the economic assumptions, so again those will continue to be the drivers. The economic assumptions will be a significant impact, as well as credit migration in the portfolio. We did see, as you noted, and I think we moved aggressively to downgrade assets that we believed were displaying impairment from a cash flow and from an ability to pay perspective. We expect that through both the deferral programs as well as just the normal matriculation of credit that losses likely don’t start to substantially materialize into the late first quarter, second quarter, third quarter next year, so into 2021, at which point obviously as that matriculation occurs or credit migration occurs, whether favorable or unfavorable, we’ll evaluate the allowance as it relates to that. It’s difficult to say what the allowance will do on a quarterly basis given the CECL analyses and the amount of impact of economic forward looking; but again, I think it’s important to note our view is that the charge-offs won’t start to materialize until towards the middle of 2021.

[Michael Rose:]

Okay, so fair to assume that if the economic scenarios don’t really change, that we probably are at or near peak for the reserve? Is that fair?

[William Furr:]

Well, I’d say we feel adequately reserved given the economic outlook we used for our analysis for the third quarter.

[Michael Rose:]

Okay. Thanks for taking my questions, guys.

[William Furr:]

Thank you.

[Operator:]

Our next question will come from Matt Olney with Stephens. Please go ahead.

[Matt Olney:]

Hey, good morning. Thanks guys. Wanted to go back to the mortgage discussion and just remind me of the strategy around the MSR. You increased the asset a lot in the third quarter, more in the fourth quarter. Just remind me of the strategy behind this, and does that mean you are not releasing the servicing with your sales, so gain on sale margins could have been even stronger?

[William Furr:]

Well, let me try to unpack that a little bit. First as it relates to the strategy, as we noted late in March and certainly into the second quarter, the overall demand by those who service for--to buy servicing was pretty muted, if not non-existent. There were some periods where there was a no bid for servicing, and so as a result of our liquidity and our capital position, we were able to take advantage of that and decided to retain servicing, understanding that it hasn’t historically been an asset we were overly focused on growing. We thought that the pricing dislocation allowed us an opportunity to take advantage of that. As it relates to the third quarter and going forward, we are continuing to monitor the market based on the values we can receive and the value that we can sell on a flow originated basis. Those spreads, the overall market has improved, and the spread that we believe that is the value that we believe the asset’s worth versus what the market is willing to pay has certainly tightened, but we still believe there’s value in the asset in excess of what we would otherwise get paid on a flow basis, for at least a large portion of the asset. In terms of the impact on the overall gain on sale, the way you recognize MSR is you book the asset, you book the income, so it flows through as the capitalization rate. I would say that that had a favorable impact on gain on sale in the second quarter, just given the fact that there was, as I mentioned, virtually a no bid for servicing, and then during the third quarter again we’re capitalizing at the market rate today, market sales rate, so limited impact. It was favorable, but a limited favorable impact as it relates to MSR impact on the 440. The 440, again more impacted by the overall market volumes and the full pipelines across the mortgage set and the competitive set, coupled with again, as I mentioned earlier, the strong pricing actions and the focus that our PrimeLending leadership team has taken on pricing given our new tools, but also the focus on managing pricing exceptions.

[Matt Olney:]

Okay, that’s helpful, Will. Thank you for that. Then just a comment, you mentioned briefly, Will, in the prepared remarks of the various system upgrades throughout the entire company. Can you just give us an update on where we are on these various upgrades? It seems like it was a two-year initiative that was going to run through the end of this year. Is that correct?

[William Furr:]

Yes, so what we had asserted was we were going to improve PPNR by $84 million on a run rate basis through the end of ’21. I think as we sit here today, we feel very good about the efforts that have been launched specifically as it relates to your question around the three mortgage programs. We had a mortgage loan origination system implementation which we would say is virtually complete - there’s still some minor rollouts for a few very modest products left, but that process and program is effectively fully launched. Our FIS system core system enhancement at Hilltop Securities was launched in May of this year and we continue to work aggressively on day two enhancements with that overall program, so still some day two work to be done there, but again we’re looking to bring that in principle to close by the end of the year. Then we also had a financial ERP, principally the general ledger and all the accompanying installations around that, and I would say we have one business left to bring onto the general ledger, but we have implemented that general ledger across three of our operating units as we speak, and like I say, we’ve got one remaining implementation there that will occur in the early second quarter of next year. We’re certainly on target in terms of the deployment. We’re already seeing some of the cost saves and benefits, whether it be at the mortgage company around some of the pricing rigor we’re talking about or some of the controls and productivity that we expected to receive from that system, or some of the benefits we’re seeing from the general ledger and other. Also in that $84 million growth and efficiency program, we had efforts as it relates to our focus on purchasing, procurement and integration of all of those things. That work is complete and functioning as designed as we sit here today. So again, as it relates to the overall program, we’ll give a more fulsome update on our January call, but we feel very good about the progress we’ve made heretofore.

[Matt Olney:]

Okay, that’s great. Just lastly from me, Will, you mentioned in the prepared remarks some comments around excess liquidity and how you expect to manage that. I didn’t quite get all that. Can you just go over the highlights of that again? Thanks.

[William Furr:]

Yes, so I think two primary items

[Matt Olney:]

Okay, that’s helpful. Congrats on the quarter. Thank you.

[William Furr:]

Thank you.

[Operator:]

Our next question will come from Michael Young of Truist Securities. Please go ahead.

[Michael Young:]

Hey, thanks for the follow-up. Just wanted to touch base on the mortgages you’re going to retain. Are those going to be qualified or would those be some that are just outside of qualified, and then also what are your expectations for rate on those?

[William Furr:]

Principally qualified, so we would be able to, as we did during the second quarter, in the event we felt like we needed to sell those, we were able to execute that sale back through the agencies in the second quarter, so principally qualified. These are going to be high quality mortgages. I would tell you the target FICO score is going to be 750 plus on an average basis, while the range there, historically we’ve averaged 750 to 775 on the retained assets. From a yield perspective, it will be 15-year and 30-year product, so we’re expecting that yield to between 275 and 325 basis points, depending on the mix on any given period.

[Michael Young:]

Okay, and as a follow-up, it seems like this would be a fairly effective strategy to leverage some of the excess capital into creating more earnings, maybe over more the medium term because if it’s salable product, you could always ratchet that back down with an M&A deal and sell off the mortgage portfolio. Is that something we should expect to maybe grow even as part of the strategy going forward?

[William Furr:]

I think I’d answer that in the context of some prior comments. One is we’re going to manage it in the context of our overall liquidity position and how the pandemic and the economy continue to mature, and then second, we’re balancing it against commercial loan growth. Obviously we’d like to be doing more business with our core commercial business customers, but if that demand remains soft for the foreseeable future, at least it’s our expectation it will remain soft, we are using these assets to backfill both the liquidity position but also offset some of that softer demand.

[Michael Young:]

Okay, makes sense. Thanks for the follow-up.

[William Furr:]

Thank you.

[Jeremy Ford:]

Thanks Michael.

[Operator:]

At this time, there are no further questions, so this will conclude our Q&A session. The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.