Hilltop Holdings Inc.
Q2 2019 Earnings Call Transcript

Published: 26 Jul 2019

[Operator:]

Good day, and welcome to the Hilltop Holdings Second Quarter 2019 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 note this event is being recorded. I would now like to turn the conference over to Erik Yohe. Please go ahead.

[Erik Yohe:]

Good morning. Joining me on the call this morning are Jeremy Ford, President and CEO; and Will Furr, CFO. 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 and financial conditions are forward-looking statements.

[Jeremy Ford:]

Good morning. Before I get started, I would like to welcome Erik Yohe as our new Head of Investor Relations. Erik and I have worked together for a long time and I know he will do a great job. For the second quarter of 2019, Hilltop reported net income of $57.8 million, or $0.62 per diluted share, which represents a 77% increase compared with the $0.35 reported during the same quarter last year. Additionally, Hilltop delivered a return on average assets of 1.74% and a return on average equity of 11.6%. This quarter reflected the strength and diversification of our business model with the bank, mortgage business and broker dealer all delivering significant year-over-year pre-tax income growth. Average loan held for investment excluding broker dealer loans grew by $740 million, or 13% compared to the prior second quarter. The large drivers were our Bank of River Oaks acquisition in Q3 2018 and our National Warehouse Lending business, which increased its average balance by $225 million, or 81% from second quarter of 2018. We continue to maintain a healthy pipeline of unfunded commitments and aim to prudently grow our loan portfolio by fostering our bank’s valued relationships. This was a strong quarter for PrimeLending as reflected by improvements versus Q2 2018 in both gain on sale margin and operating costs. Also, the structured finance business at Hilltop Securities yielded a net revenue increase of $31 million compared to prior year from optimal market conditions and the strategic alignment with the capital markets business. Through the first six months of 2019, we have returned $40 million to our stockholders in dividends and share repurchases. Under our board authorized share repurchase program, $25 million remains available through January 2020. Credit quality remains a high priority and we continue to focus on maintaining our underwriting discipline. For the second quarter, non-performing assets were $53 million, down slightly linked quarter and down $32 million compared to second quarter of 2018.

[Will Furr:]

Thank you, Jeremy. I’m starting on Page 5. As Jeremy discussed, for the second quarter of 2019, Hilltop reported $57.8 million of income attributable to common stockholders equating to $0.62 per diluted share. During the second quarter, Hilltop reported a $700,000 recovery and provision for loan losses. In the quarter, the bank recaptured $6.2 million of allowance for loan loss, principally related to ongoing improvement in the oil and gas portfolio and a significant recovery from a previously classified oil and gas loan. The second quarter provision includes approximately $3 million of net charge-offs or 18 basis points of average bank loans on an annualized basis. Credit quality during the quarter remains solid. But even with the recent strong performance, we are monitoring our portfolio rigorously to evaluate areas that may be experiencing any weakness. Currently, we do not see any industries or concentrated exposures that are experiencing material deterioration. During the second quarter, revenue-related purchase accounting accretion was $6.4 million and expenses were $2 million, resulting in a net purchase accounting pretax impact of $4.4 million for the quarter. In the current period, the purchase accounting expenses largely represent amortization of deposits and other intangible assets related to prior acquisitions. Related to the purchase loan accretion, as the purchase portfolio balances continued to decline, we expect scheduled interest income related to purchase loan accretion to average between $4 million and $6 million per quarter for the remainder of 2019. Hilltop’s capital position remains strong with a period in Common Equity Tier 1 ratio of 16.32% and a Tier 1 leverage ratio of 13%. I’m moving to Page 6. Net interest income in the second quarter equated to $108 million, including $6.4 million of purchased loan accretion. Net interest income increased $3 million or 3% versus the same quarter in the prior year. The growth in net interest income was driven by asset growth, including the acquired loans in Houston and improvement in net interest margin, which expanded by 3 basis points versus the prior year period.

[Operator:]

Thank you. We will now begin the question-and-answer session. Our first question today comes from Brady Gailey with KBW. Please go ahead.

[Brady Gailey:]

Hey good morning, guys.

[Jeremy Ford:]

Good morning.

[Brady Gailey:]

Another really strong quarter from the broker-dealer and a pre-tax margin almost 19%. I know we’ve talked about kind of a longer-term rate – range in that 10% to 12%, but you look at it this year, you’re well on top of that. So maybe just talk about – obviously, the setup is great for this business, but your longer term, is that 10% to 12% pre-tax margin still the right way to think about it? Or could that be a little better?

[Jeremy Ford:]

I think it could be a little better, but I think in some of the quarter, the real outperformance was in our structured finance business that benefited from the lower 10-year rate throughout the quarter, favorable market conditions. And that’s had the higher-margin business. So there are some – and so I think kind of over – and the other businesses that are kind of lower margin businesses will kind of fluctuate through, we’ll have, I think, 12% to 15% is probably where we’re at now from a pre-tax margin basis on an ongoing basis.

[Brady Gailey:]

And then I know when you had a nice quarter last quarter in Q1. We talked about roughly $12 million of fees that were kind of onetime in nature coming out of the broker-dealer that you wouldn't really expect to be recurring going forward, but what is that number for the second quarter?

[Will Furr:]

Second quarter kind of onetime pipeline marks, et cetera, of approximately $6 million. If I just double-click there a little bit, I think what you saw is that at the end of the first quarter, we had a rally or the 10-year declined materially in the last couple of weeks of March and so that created a price mark volatility at the very end of the quarter. During the second quarter, the 10-year declined more ratably through the period when – more ratably through the period and so the gains that came from that were – that were at the quarter, that were onetime in nature, were smaller. And the overall portfolio balances of securities was lower as we've continued to kind of move volume through.

[Brady Gailey:]

All right. And then finally for me, Will, you left the net interest margin range unchanged, but you kept spread income guidance down a little bit. So is the offset just higher average earning assets from mortgage loans held for sale? Is that the right way to think about it?

[Will Furr:]

I think what we're expecting is the national warehouse lending business, which we had noted a few times is having a better-than-expected year. So we are seeing some benefit from that, from an average earning asset perspective, while we do expect again continued pressure on NIM. That said, if you remember, first quarter taxable equivalent preprovision was 3.38% and then it obviously dropped to 3.26% in this quarter. We're expecting that number to continue to trend lower through the year, but on a full year average basis to be within the range we provided.

[Brady Gailey:]

Got it. Thanks guys.

[Will Furr:]

Thank you.

[Operator:]

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

[Michael Rose:]

Hey guys. Just when I look at the loan growth outlook, is the way to explain what would seemingly imply a drop off in the back half of the year is the mortgage warehouse volumes?

[Will Furr:]

I think that's a way to think about it. So we've got two things happening. First, the Houston asset, Houston business that we acquired last year, August 1, will come into the comparative period in the third quarter. So that will have an impact. When we purchased that bank, it had loans of about $327 million at the close, so obviously that will come in from an average comparative perspective. And then the national warehouse business, as we've said, is outperforming and we do expect they will have seasonal declines in balances as those business flows naturally occur later in the third and fourth quarters.

[Michael Rose:]

Okay. That’s helpful. And then just going back to the margin. What are you guys assuming for, I guess, deposit costs or betas in the back half of the year? And perhaps if we do get to Fed rate cuts, I mean, should we think about continued pressure on the margin into 2020? Thanks.

[Will Furr:]

I think we expect margin again will be under some pressure in the back half of the year, more so on the asset side than on the deposit side. As I noted in my comments, we expect deposit costs will peak in the second half. We are expecting two Fed rate reductions that's within our current forecast internally. And as a result of that, we expect that deposit costs will peak and then we'll – we will lag. There will be a lag between whenever the reserve – Federal Reserve moves and our ability to actually reduce rates on clients because, again, what we're seeing and we've said this, is a really competitive deposit market, especially for those – for our competitors that have higher loan to deposit ratios. They remain focused on growing their deposits and by virtue of that, that's keeping deposit costs higher and will cause us to need to lag a bit.

[Michael Rose:]

Yes. There's a few of those banks with higher loan to deposit ratios in Texas. Maybe just final one for me, just on the share repurchase. It looks like you guys used half of the authorization this quarter. How should we think about the pace of buybacks going forward, given still a pretty strong capital level. Thanks.

[Will Furr:]

Yes, I mean. We still – we have $25 million run through the authorization and they're going to be active during the open-market period.

[Michael Rose:]

Okay, thanks for taking my questions.

[Will Furr:]

Thank you.

[Operator:]

Our next question comes from Michael Young with SunTrust. Please go ahead.

[Michael Young:]

Good morning. Congrats on a good quarter. Wanted to start off. Obviously, the revenue growth this quarter was very strong across all the businesses, but underlying that, the expense curtailment was – also looked pretty strong. So I wanted to maybe just start on the bank side. It looked like the non-comp-related expenses dropped down pretty significantly. Is that kind of a good run rate going forward, or should we think about it more from an efficiency ratio standpoint? Any color you can provide there?

[Will Furr:]

I think our perspective is that the expenses in the quarter are a solid place to start from a run rate perspective. Obviously, we continue to focus on driving efficiencies. As we noted in our prepared comments, the second quarter of 2018 did have two significant items whether both the fraud loss that we noted as well as some loss share related expenses that are no longer kind of in the run rate. But again, the base line that we have which was a pretty clean quarter from an expense perspective.

[Michael Young:]

Okay. So moving forward, I mean, do you think expense cuts could maybe offset some of the purchase accounting accretion decline and we could stay in this sort of 56% efficiency ratio paradigm? Or will we see some pressure on that with the NIM pressure you are talking about?

[Will Furr:]

Well, we are not going to – we don’t guide capital segment level efficiency ratio, but I think our focus is to continue to grow revenue prudently, albeit with the NIM pressure we are talking about at the bank that will be – revenue growth will be under some pressure, but overall, expense management and the efficiency efforts we are putting in, we do expect to be accretive to help support that.

[Michael Young:]

Okay. And then, maybe switching to the broker dealer. Same question on the expense side, the kind of fixed expenses dropped a fair bit there. It looks like maybe that’s sustainable. And could you just talk about, is that the implementation of some of the cost save initiatives that you’ve implemented or is that systems? Maybe just give a little color behind what’s driving the decline in expenses there?

[Jeremy Ford:]

Well, that is a non-comp expense, but I’d probably look at that as a pretty good proxy for our run rate. And then the other expenses were elevated obviously related to variable compensation.

[Michael Young:]

Okay. And then maybe just lastly on the deposit side, you guys have had a kind of 40% or 50% of beta on the interest bearing side. It sounded like you expected kind of a lag in terms of seeing some improvement there. But as we move into 2020, if we get the rate cuts that are out there, is there anything that would kind of structurally offset your ability to lower deposit or funding costs that you see on the horizon?

[Will Furr:]

No. I think as I tried to say, the competitive pressure is really the items that we are continuing to watch. We are prudently going to market. We’ve got a very solid liquidity position and so we are prudently going to market in terms of our overall pricing and cost of deposits and kind of what we are pursuing. And we are fundamentally looking to grow deposits through the expansion of existing relationships in the acquisition of new clients. But the competitive landscape across our banking footprint is very aggressive and from a deposit cost perspective. So that will to some extent provide a slower or a lagged kind of reduction in deposit costs versus kind of when the Fed moves.

[Michael Young:]

Okay. Thanks.

[Will Furr:]

Thank you.

[Operator:]

Our next question comes from Matt Olney with . Please go ahead.

[Matt Olney:]

Hey, good morning and thanks for taking my question. I wanted to circle back on the mortgage discussion. I believe Will mentioned that the gain-on-sale margin could be pressured for the remainder of the year. Did I hear that correctly? And is that based off a 333 baseline margin from 2Q. It looks like it bottomed in 1Q, improved in 2Q. Just want to appreciate your outlook there.

[Will Furr:]

Yes. So from a gain-on-sale margin perspective, we obviously troughed last year Q2, 317, and we’ve been – I think reasonably in a range of 330 to 335. And so, I wouldn’t pick a single basis point starting spot. But in that 330 or 335, what we are seeing is, as the market moves to something of a refinanced market, which with lower rates and we see higher refinance percentages in our portfolio and we are seeing that volume start to increase as we did in the second quarter. That will have an impact on yields and then the competitive pressures that are in the marketing and if you will the oversupply in the marketplace in the context of just mortgage loan officers mortgage bankers not abated materially. And so we are continuing to see price pressure there, but really it's a mix of our overall origination that we'll call that gain-on-sale margin to be under pressure through the second half.

[Matt Olney:]

Okay, got it. And then going back to the structured finance business, even if I strip out that $6 million benefit that, as you noted, could be considered onetime in nature, it looks like that business still had a really good quarter. Just trying to understand how sustainable the 2Q results are x the $6 million. Is that a seasonal business that we should be looking at year-over-year? Just any color about how to forecast that? Thanks.

[Jeremy Ford:]

Well the $6 million is kind of an inherent gain. But just given the lower rate environment and mortgage-related business, it is a mortgage business, so it's seasonally higher in the second and third quarters. And year-over-year, the second quarter had a 25% increase in volume. I think where interest rates are today and the housing market and down payment assistant programs, I would assume that this will continue to have a pretty good year.

[Matt Olney:]

Got it. Okay, thank you guys.

[Jeremy Ford:]

Thank you.

[Operator:]

The next question comes from Chris Gamaitoni with Compass Point. Please go ahead.

[Chris Gamaitoni:]

Hi, good morning everyone.

[Jeremy Ford:]

Good morning.

[Chris Gamaitoni:]

I wanted to start, is there – of your kind of efficiency PPNR improvement target? Can you give us a sense kind of how much is in the current run rate today?

[Jeremy Ford:]

We haven't disclosed that and we will – as we will provide kind of updates towards – throughout the year, but will have a more fulsome review of that at the end of this year in our January call. But as Jeremy noted, we are making progress. We make progress every single day on those endeavors and it is top of mind with everything we do.

[Chris Gamaitoni:]

Okay. And maybe get back to the gain on sale commentary. I'm still a little confused on seeing pressure. Generally across, most banks are seeing improvement, employment year-over-year was down 4%; by the last mark, apps are up 38%. I'm just not seeing anywhere else where there is gain on sale pressure, so maybe help me understand that more.

[Will Furr:]

I think without speaking to kind of others from our perspective, we have been historically a purchase origination business, which has – and we got a solid government franchise within that. And what we're seeing is that, that market, as the market shifts, as you can see in our results, the purchase volume declined approximately $300 million versus the prior year and refinance volume increased by the 28% I noted earlier, couple of hundred million dollars. So by virtue of that and the mix and then the lower percentage of government volume that you might see as a result of that, we expect volumes to be under pressure again. The bigger driver is volume mix and origination mix, which we try to call out. And even if volume's increase, if it's refinance volume increasing, that's a lower margin business for us.

[Chris Gamaitoni:]

Okay. Thank you.

[Operator:]

The next question comes from Brett Rabatin with Piper Jaffray. Please go ahead.

[Brett Rabatin:]

Hey good morning.

[Will Furr:]

Hey, Brett.

[Brett Rabatin:]

Wanted to go back to the NII guide and just thinking about the back half of the year in terms of the balance sheet and the margin. It would seem like the guidance on NII would – it basically is really conservative and assumes margin as kind of top of the back half of the year, we get the reasons for part of that, but it would seem like given the balance is, particularly given the second quarter loan growth that, that would be conservative. Can you just talk about what you're assuming in terms of the loan portfolio and the securities book yields in the back half of the year and then how much pressure you're expecting on deposits because it kind of seems like the guidance on the back half number is a little tough?

[Will Furr:]

Well, again I’d say, just as a note to remember, again the acquisition of the Houston bank in August will change obviously the growth rate from a reference period perspective in the second half. So that's the first leg, if there's any. Then the second piece there and to your point, so loan held for sale yields, we are expecting to travel materially lower in the second half just given where the 10-year has rallied to here at or around 210 basis points. We are expecting to see deposit costs maintain their trajectory of increase through the balance peaking in the second half of the year, and so that – with that trajectory that they are on, we would expect to continue. And then from there, as we noted on prior discussion, as the Fed moves, we don't expect necessarily to be able to see or reap those benefits immediately. We do expect there's going to be a lag impact to that – any benefit to come from the Federal Reserve's decline. That said, for a loan portfolio, that's adjustable, that's related to kind of LIBOR of short-term rates. They will reset within the month that they are set to. So we'll have kind of asset yield pressure. We will have deposit yield we think going up and then the lag there, lag implication, and then again loans held for sale, which is just really a market function more than anything.

[Brett Rabatin:]

Okay. Fair enough. And then everyone has pointed out that the broker-dealer had a really good quarter again and obviously market conditions are a part of that. As we think about that business over a longer period of time and you talked some about the margins going forward, but as we think about that business over time, I guess, Jeremy, is that something you want to continue to emphasize versus the commercial bank? Or can you give us some color around how you think about the priority of that business versus the other pieces of Hilltop?

[Jeremy Ford:]

I think they're all similar of importance and the way the business model works is it provides a tremendous amount of diversified fee income. It also provides about $2 billion of suite deposits to the bank. And I'm really excited about Brad Winges in the leadership team. And I do think that what we're working on with him has the prospects for continued growth.

[Brett Rabatin:]

Okay, great. Appreciate the color.

[Jeremy Ford:]

Thanks.

[Will Furr:]

Thank you.

[Operator:]

The next question is a follow-up question from Michael Young with SunTrust. Please go ahead.

[Michael Young:]

Hey, thanks. Just wanted to follow-up on the insurance business. Obviously, pretty good quarter, more similar to what we saw in terms of loss experience last year. Just wanted to get an outlook on may be what happened thus far into the third quarter in terms of losses there? If those have picked up at all or should we expect kind of a similar trend year-over-year in the third quarter in terms of a combined ratio?

[Jeremy Ford:]

We can’t comment on anything that happened so far in July. But I think overall we would expect similar – kind of similar loss patterns as we historically had in the third quarter and you know, that's the thing, it can hit you with the hurricane, but we're well reserved for it – excuse me, well reinsured for it. So I think for the year in this business, we were pleased that at the midway through, and profitable and – from year-to-date perspective and second half of the year is when it typically makes its income.

[Michael Young:]

Okay. And then just one kind of big picture question back on whole bank M&A, I think you've commented before that not a lot of opportunities out there, just curious if you're seeing any shift in the environment there? Any more conversations or any more willingness on your part to look at either smaller or larger deals.

[Jeremy Ford:]

Sure. I think, obviously, the big deal for the quarter was Prosperity and Legacy. Other than that, couple of deals that were announced since this past week, and we are getting some inbound calls on some smaller deals and we'll evaluate that, see if it's franchise enhancing. Otherwise, our focus has been on getting our earnings up so that we are better positioned and that's what we're trying to do and for anything they will be patient.

[Michael Young:]

Okay. Thanks.

[Operator:]

This concludes our question-and-answer session. The conference is now also concluded. Thank you for attending today's presentation. You may disconnect.