Hilltop Holdings Inc

NYSE:HTH

Earnings Call Transcript 2020-Q2

[Operator]

Good morning. Welcome to Hilltop Holdings Second Quarter 2020 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. Please note that this event is being recorded.

I would now like to turn the conference over to Erik Yohe, Executive Vice President of Corporate Development. Please go ahead.

[Erik Yohe]

Thank you. 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 risk 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 report 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.

Additionally, this presentation includes certain non-GAAP measures, including tangible common equity and tangible book value per share. A reconciliation of these measures to the nearest GAAP measure may be found in the appendix to this presentation, which is posted on our website at ir.hilltop-holdings.com.

With that, I would like to turn the presentation over to President and CEO, Jeremy Ford.

[Jeremy Ford, President and Co-Chief Executive Officer]

Thank you, Erik, and good morning. Despite the ongoing pandemic and most of our team working from home, Hilltop had an unbelievable quarter, with record breaking mortgage earnings that more than offset a sizeable and judicious reserve build at the Bank. Before getting into the results of the quarter, I would like to start on Slide 3 and provide an update on our response to the COVID-19 pandemic.

From an operation standpoint, we are very fortunate to have realigned Hilltop over the past three years by building a robust holding company and integrating the functional departments of our operating company. Well, this has enabled us to ensure business continuity, while prioritizing the health and safety of our employees.

We continue to operate with the majority of our employees working remotely, so that essential staff can work safely from our offices. We are tracking all COVID-19 cases to ensure the quarantine of affected employees and to ensure impacted offices are cleansed, so that they can get back open as soon as possible.

We are also providing frequent and open communication, so that everyone adheres to safety protocols and feels connected. While we did see an increase in employee cases this past quarter, the overall number remains low and has not had a material impact on our businesses.

Since the start of the pandemic, we have been in constant contact with our clients to continue to serve their needs and, in particular, provide relief and support where required. By partnering with our borrowers that have been impacted by COVID-19, the Bank has provided deferrals on $1 billion of loan, of which $619 million were principal only and $349 million were principal and interest for the more severely impacted borrowers.

As the initial 90-day deferrals are starting to come due, the Bank has already received requests for approximately $120 million of second round modification. We will be reviewing each of these requests on a case-by-case basis to ensure they are need-based and assess their viability. Certain industries, including hotel and restaurants, have been more severely impacted.

So we anticipate a large portion of those credits will be requesting second deferral. As well, the Bank booked over 2,800 PPP loans, totaling $672 million. This was a huge effort by our bankers, who were able to help many customers in need.

As the pandemic persists, we will continue to provide personal banking assistance, including the waving of fee, increased daily spending limits, and the suspension of residential foreclosure activity.

Moving to Slide 4. For the second quarter of 2020, Hilltop reported net income of $128.5 million, or $1.42 per diluted share, resulting in a 3.3% return on average assets and a 23% return on average equity.

Net income from continuing operations was $97.7 million. As noted at the bottom of the page, the results for National Lloyds this period and the gain on its sale are included in discontinued operations.

This quarter illustrates the strength of our businesses and the importance of diversification, with the mortgage and broker dealer businesses, both delivering strong growth from fee income that alleviated the impact of the provision at the Bank. Favorable market conditions aided our results, but I’m most proud of our team for working closely together and executing on the opportunities that arose.

On June 30, the National Lloyds sale to Align Financial closed for total cash proceeds of $154 million, resulting in a net gain on sale of $32 million, which was non-taxable. This was a great outcome for both parties, and I thank the Hilltop team that worked so hard on National Lloyds for many years before and during the transaction.

Hilltop also had an important strategic accomplishment in the quarter with a successful issuance of $200 million of subordinated debt, which further bolsters our liquidity and capital to persevere the current recession and to enhance our position to take advantage of future opportunities.

As for managing risk, net charge-offs for the period were $16.4 million, which included $12.5 million that was a oil and gas credit that was reserved for in Q1 2020. The allowance for credit losses increased by $49.6 million this quarter, as Hilltop built its loan reserves to reflect the deteriorated economic outlook from Q1 2020. We also continue to enhance our liquidity position and ended the period with $6.6 billion of cash, securities and secured borrowing capacity.

Moving to Slide 5. PlainsCapital Bank recorded a pre-tax loss of $17.5 million, largely due to our sizable CECL provision of $66 million, that was partially offset by stable net interest income and lower operating expenses. The Bank’s pre-provision net revenue increased 5% from the second quarter 2019. Notably, Jerry and the Bank team did a great job growing PPNR, while working tirelessly to process PPP loan and borrower deferral requests.

PrimeLending had an outstanding quarter and generated pre-tax income of $138 million, an increase of $116.5 million from Q2 2019. That was driven by a 54% increase in origination volume and a 35 basis point increase in gain on sale margin. Steve Thompson and the entire PrimeLending team worked overtime to process the overwhelming volume, and it took advantage of the industry’s oversupply by raising prices and retaining servicing.

Hilltop Securities increased pre-tax by $6 million to $28 million, driven by profitable growth in the fixed income services and structured finance businesses. Brad Winges and the Hilltop Securities team are well underway in raising the caliber and profile of the firm to become the preeminent municipal focused investment bank. Additionally, they completed a major system conversion for Hilltop Securities in the quarter.

Moving to Slide 6. Hilltop has a synergistic and durable business model. That is something we have been building towards throughout the life of our company. Through acquisitions, we initially integrated our company for capital and funding purposes. Over the past three years, we have largely implemented our platform for growth and efficiency initiatives by integrating the shared services departments and executing on efficiency projects to build a scalable platform.

And now, with the sale of National Lloyds, we have solidified our business model, which is a franchise anchored by PlainsCapital Bank and augmented with powerful fee income businesses in PrimeLending and Hilltop Securities. We have made significant investments in talent, professionals and systems and believe we are in a solid position to grow these core businesses.

With that, I now turn the presentation over to Will to talk further about the financial.

[William Furr, Chief Financial Officer]

Thank you, Jeremy. I’ll start on Page 7. As Jeremy discussed, for the second quarter of 2020, Hilltop reported consolidated net income attributable to common stockholders of $128.5 million, equating to $1.42 per diluted share.

Income from continuing operations attributable to common stockholders equated to $97.7 million, or $1.08 per diluted share. Hilltop’s continuing operations generated $202 million of pre-provision net revenue, or PPNR, during the second quarter, which brings the first-half of 2020 total PPNR to $302 million. PPNR increased by $125 million, or 162% versus the prior year period. Growth versus the prior year period was driven by our diversified revenue streams and led by strong mortgage originations.

During the second quarter, revenue related to purchase accounting was $3.3 million and expenses were $1.3 million, resulting in a net purchase accounting pre-tax impact of $1.9 million for the quarter.

In the current period, the purchase accounting expenses largely represent amortization of deposit and other intangible assets related to prior acquisition. We expect revenue from purchase loan accretion will continue to decline, as the purchase loan portfolio continues to run off. Further, we expect the revenue from purchase loan accretion will average between $3 million and $5 million per quarter for the remainder of 2020.

Given the significant growth in earnings, coupled with the successful sale of National Lloyds and the subordinated debt rate completed during the second quarter, Hilltop’s capital position has been significantly strengthened, as we both address the ongoing impacts of the pandemic and position the company to take advantage of opportunities that may be presented over time. Hilltop’s period-end common equity Tier 1 ratio equated to 18.46% and the Tier 1 leverage ratio equated to 12.6%.

I’m moving to Page 8. Net interest income from continuing operations for the second quarter equated to $104.6 million and declined by $2.7 million versus the second quarter of 2019. The decline in net interest income was driven by lower purchase loan accretion of $3.2 million, offset by interest income from higher loans held for sale and loans held for investment during the quarter.

During Q2, Hilltop’s consolidated average earning assets increased by $1.9 billion, as the business experienced significant inflows of customer deposits across all product types. Deposit growth, coupled with planned actions, including Hilltop’s $200 million sub-debt rate; an increase in acquired broker deposits of approximately $550 million; and proceeds from the sale of National Lloyds, all contributed to the increase in the ending period balance of cash on deposit of the Federal Reserve, which grew by approximately $1.2 billion versus the prior quarter. In addition, the Bank generated PPP loans of $672 million, net of approximately $21 million of deferred fees, which will be recognized over the life of loans.

Lastly, the mortgage warehouse lending business generated growth of approximately $120 million versus the prior quarter, as mortgage volume surge in the second quarter. In the second quarter, Hilltop consolidated net interest margin equated to 280 basis points and declined by 61 basis points versus the prior quarter. This decline was driven by the aforementioned growth in average earning assets; the build in liquidity; as well as lower yield on loans, securities, and deposits.

We expect that NIM will continue to be pressured in the third quarter, after which we expect that we will begin to see a modest rebound during the fourth quarter and into the first quarter of 2021. A significant driver of the improvement will be our efforts to reduce our cash and liquidity position over the second-half of the year to between $5 billion and $6 billion.

We continue to monitor capital markets, Hilltop’s mortgage volumes and overall market functions related to liquidity, and we will continue to balance our excess liquidity against the risk over time.

Turning to Page 9. The table on the bottom right of Page 9 highlights the liquidity that we maintain at the Bank as of June 30. The Bank ended the period with over $6.6 billion of liquidity, including both cash securities and secured borrowing sources. Further, at period-end, the parent maintained $388 million of cash, which equates to approximately four times annual expenses, dividends and debt service.

Moving to Page 10. Noninterest income for the second quarter equated to $468 million. During the period, mortgage applications in locks were very robust, as PrimeLending lost approximately $7.4 billion in new mortgages. This is a record rate last quarter for the business and reflected the impact of lower rates and better than expected demand for purchase mortgages across our markets.

The combination of strong lock-in origination volume and improving gain on sale spreads resulted in mortgage production and fee income increasing by $176 million versus the prior year period.

During the second quarter, gain on sale margins in our mortgage business did expand by 43 basis points versus the first quarter of 2020. We expect the gain on sale margins will move higher during the third quarter to between 430 and 450 basis points. Further, we expect that spreads will remain elevated versus historical levels, but begin to moderate during the fourth quarter of 2020.

During the second quarter, the securities business continued to show solid progress as fixed income capital markets delivered revenue growth of approximately $12 million and structured finance to our market conditions improve and revenue increased by $6.5 million versus the prior year.

At period – at the period-end, the mark on the structured finance loan pipeline stood at $15 million. It remains important to note that results from our fixed income and structured finance businesses can be volatile, as market rates, spreads and volumes can change significantly from period-to-period.

Turning to Page 11. Noninterest expenses increased from the same period in the prior year by $66 million to $370 million. The growth and expenses versus the prior year were driven by an increase in variable compensation of approximately $56 million in both PrimeLending and Hilltop Securities. This increase in variable compensation was directly linked to strong fee revenue growth in the quarter compared to the prior year period.

Non-variable personal expenses rose versus the prior year by $8 million, driven by increases in overtime hours worked, notably in our mortgage operations, as well as deferred compensation and project labor spend in the period.

Over the last nine quarters, we have continued to make progress in aligning our businesses to the current market conditions and driving efficiencies across the franchise. Through these efforts, headcount, professional service costs and marketing and development expenses continue to trend lower, as we make progress against our efficiency and objectives.

During the second quarter, Hilltop incurred $3.5 million costs on $5.6 million in spend related to our ongoing core system improvement. During the second quarter, we continue to make progress and are moving into the final stages of implementation of our three core system installation. The new core loan system has been installed throughout the mortgage business.

The securities team completed the Phase 1 implementation of the new operating platform of Hilltop Securities. And we have now begun the final deployment of the new general ledger and ERP system across Hilltop. We expect that all of these implementations will deliver significant value to our franchise and position Hilltop for profitable growth in the future.

I’m turning to Page 12. Total average held for investment loans grew by 9% versus the second quarter of 2019. Gross versus the same period in prior year was driven by $672 million of net PPP loan originations, coupled with growth in our mortgage warehouse lending business, which experienced growth of approximately $219 million versus the prior year period.

Other business loans declined versus the first quarter of 2020, as customer demand has remained solid. Loan yields have declined over the prior four quarters and continue to decline in the second quarter. Those lower market rates, including prime rate and LIBOR rates, coupled with lower personal accretion, has contributed to the yield decline. We do expect that loan yields will continue to be pressured in the coming quarters, as market rates remain low and we’ve added $672 million of PPP loans that yield 100 basis points.

Lastly, our loan pipeline remain stable, where many clients are delaying pricing and funding of new loan commitments until they have greater clarity through the economic impact of the pandemic.

Moving to Page 13. During the second quarter, Hilltop continue the process of building excess liquidity to prepare for the potential disruptions that may be caused by the pandemic and support outsized mortgage origination activity. Second quarter average total deposits were approximately $11.2 billion and have increased by $2.2 billion, or 25% versus the first quarter of 2020.

During the quarter, the Bank swept back to the securities business approximately $200 million of deposit, as the securities business can achieve a better return of those funds and the Bank can earn on excess cash.

Excluding the growth from PPP deposits, the sub-debt raise and the proceeds from the National – sale National Lloyds, customer deposits have continued to grow, as customers retain cash until clarity emerges related to the economic activity. As shown in the graph, the Bank has been able to deliver growth in noninterest-bearing deposits, which increased by approximately $600 million, or 21% versus the first quarter of 2020 on an ending balance basis.

Turning to Page 14. During this quarter, net charge-offs equated to $16.4 million, or 92 basis points of total bank held for investment loans on an annualized basis. Charge-offs during the quarter largely represent the final disposition of a single energy credit and the write-down of the assets related to two real estate properties that were all reserved for during the first quarter.

While non-performing assets improved as is a percentage of criticized loans in the second quarter. It is important to note that the Bank approved $968 million in COVID-19-related loan modifications during the second quarter, and these deferrals are not reflected in the graph on this page.

Further, in the graph on the bottom right, Hilltop allowance for credit losses, the Bank’s loans held for investment increased to 2.1% during the quarter. As it relates to the allowance to credit loss to bank loans ratio, we exclude PPP balances and our collateral maintenance loans, which we believe will have little loss content over time because of the collateral coverage of the loan types, which include broker dealer margin and correspondent loans and mortgage warehouse lending loans. The coverage ratio at the end of the period equates to 2.6%.

I’m turning to Page 15. During the second quarter, the macroeconomic outlook deteriorated materially from the outlook that we leveraged to evaluate allowance for credit losses during the first quarter. We have presented a few key metrics for comparison in the table at the bottom of the page.

The outlook we use as our base case for CECL modeling as of June 30, reflects that GDP will fall significantly in Q2 with the maturity in the third quarter of 2020 and then a slower, but steady improvement through the end of 2021. Further, our base case assumes U.S. unemployment rate elevated between 8% and 10% through at least Q4 2021.

The impact of these economic changes yielded a net allowance build of $60 million in the quarter, including the economic impacts, charge-off, and Pacific reserves. The allowance for credit losses increased by approximately $50 million in the second quarter.

In addition to the changes in economic factors, we incorporated model overlays to reflect ongoing reopening efforts, the potential impacts to the most at-risk portions of the portfolio included – including the COVID-19 loan modification portfolio, as well as the impact of government stimulus.

As it relates to future period, it remains very difficult to assess how the economy will react as the pandemic continues over the coming quarters. However, assuming the economic performance generally aligns with our current base case outlook, the primary factors affecting allowance will be credit portfolio migrations and new loan originations over time.

As we’ve noted in the past, we do expect that allowance for credit losses could be volatile in the future, given the potential for significant shifts in the economic outlook from one reporting period to another.

Turning to Page 16. We are updating our views of the COVID-19 impacted portfolio to represent those customer loans that requested and received a payment deferral during the period versus the broader portfolio views that we’ve discussed during the first quarter.

We believe that this group of loans represents the highest risk portfolio related to COVID-19 and that the relationship management credit teams are managing these relationships to monitor performance, as these clients progress through these very challenging times.

As previously mentioned, the Bank approved deferrals for $968 million of loan portfolio, representing approximately 13.5% of the total loan portfolio, excluding PPP loan. Importantly, $619 million were principal only deferrals and $349 million were principal and interest deferrals.

In the table, we provided detail on how $968 million stratified across industry segments and also the amount of allowance for credit loss in dollars and percent terms prior to these loans as of June 30. Notably, the ACL loan coverage on this portfolio is 7.1% as of period-end.

As of July 24, we have received requests for follow-on deferrals related to $122 million of loans and we’ll be evaluating those requests during the third quarter. Of the follow-on request, 56% are restaurant and bars and 36% are hotels. We do expect that many of our hotel clients will request additional deferrals, as those businesses continue to show significant stress.

As well as the case in the first round of deferrals, our top priority is protecting the principle of the bank, while working to aid our clients in progressing through these unprecedented times. Any follow-on deferrals will be need-based and our target will be to exchange for an additional 90-day period.

Moving to Page 17. During the second quarter, the energy portfolio declined by $42 million. The decline was driven by customer pay down and the final resolution in charge-off of large energy credit we referenced during Q1 of 2020.

In total, the energy portfolio represents $104 million of outstanding balances and $59 million of unfunded commitments for a total exposure of $163 million. As of June 30, our allowance for credit losses only energy portfolio equates to $9 million, or 8.7% of the outstanding balances.

Turning to Page 18. During the second quarter of 2020, PlainsCapital Bank incurred a pre-tax loss of $17.5 million, driven by a $66 million provision expense, as previously reviewed. The quarter’s results reflect stable net and noninterest income and ongoing improvement in our operating expenses. The efficiency ratio during the quarter equated to 54% and reflects the ongoing efforts to reduce deposit costs, lower operating costs, and drive proven revenue growth over time.

During the first quarter, and in response to the pandemic and the unknown economic impacts, we suspended the retention of single-family mortgages by the Bank. As we move forward and assuming markets continue to function in an orderly fashion and consumer credit remains stable, we expect to begin retaining PrimeLending originating mortgages during the second-half of 2020.

Turning to Page 19. PrimeLending generated a pre-tax loss of $138 million during the second quarter of 2020, driven by strong origination volumes that increased from the prior year by $2.1 billion, or 54%. As noted earlier, gain on sale margins expanded during the second quarter versus the prior year, as market volumes and pricing actions provided for higher spreads.

During the period, refinanced activity represented 47% of total origination. Further, we expect that during the third quarter, the portion of originations that are refinanced transactions, will remain elevated from our historical level.

During the second quarter, Hilltop retained approximately 89% of the mortgage servicing rights related to loans sold during the period. Beginning in March and hearing into the second quarter, the market for servicing deteriorated substantially as concerns regarding funding, servicer advances, as well as margin requirements escalated as the pandemic accelerated.

Given Hilltop’s strong liquidity and capital position, we were able to retain the mortgage servicing rights and the asset is now approximately $82 million. We do expect that we will continue retaining a significant portion of the servicing rights for the loans sold over the coming quarters and the asset could grow to between $150 and $175 million by year-end.

The results of our mortgage business during the quarter were very solid, and we’re pleased with how our mortgage origination team is executed under some very challenging circumstances during the second quarter.

Turning to Page 20. Hilltop Securities delivered a pre-tax profit of $28 million in the second quarter of 2020. In the quarter, fixed income services generated solid revenue growth as their traders were able to happily negotiate challenging conditions, both in terms of pricing and liquidity.

The performance of the team demonstrates the progress we have and continue to make in this business. We made substantial investments in the team and our broad set of capabilities, and those investments are returning dividends in 2020.

Structured finance business delivered growth versus the same period in the prior year of $6.5 million, as the secondary markets for mortgage-related bonds improved from the market dislocation in March. It remains important to note the results from our fixed income and structured finance businesses can be volatile, as market rates, spreads and volumes can change significantly from period-to-period.

As noted earlier, the securities team made significant progress in launching their new operating system during the second quarter. While this is a significant milestone, the team will continue working over the coming quarters to enhance and optimize the system.

Turning to Page 21. Given the uncertainty surrounding the economy, specifically related to the pandemic, we’re updating our 2020 commentaries, but we’re not providing updated guidance or outlook. While it is not clear exactly how the economy will rebound, or the timeline of that rebound, which we believe will be directly linked to the success in managing the virus and subsequent outbreaks. We remain focused on delivering against those items that we can control.

We’re committing to the – we’re committed to the ongoing safety of our associates and our clients, as well as helping our clients work through these unprecedented challenges that the pandemic has presented us all. We remain committed to executing our platform growth and efficiency initiatives and delivering against our 2021 commitments.

Lastly, and most important, we are focused on delivering prudent growth across all of our business lines, while maintaining a moderate risk profile and delivering long-term shareholder value.

Operator, that concludes our prepared comments, and we will turn the call over to you for the Q&A section of the call.

[Operator]

We will now begin the question-and-answer session. [Operator Instructions] Our first question is from Michael Young from SunTrust. Go ahead.

[Michael Young, SunTrust Robinson Humphrey Inc]

Hey, good morning.

[Jeremy Ford, President and Co-Chief Executive Officer]

Hey, Michael.

[William Furr, Chief Financial Officer]

Hey, Michael.

[Michael Young, SunTrust Robinson Humphrey Inc]

I wanted to start actually with the broker dealer. A lot of kind of moving pieces here between the investment and the municipal business, the – I guess, the TBA business having a good quarter and then you’ve got kind of the new system coming online. So I guess, there’s a lot of moving pieces, but just trying to think about the outlook for that business, both in terms of the cost savings from the new system and revenue potential kind of in the second-half, given what could – or transpire in the TBA-related business?

[Jeremy Ford, President and Co-Chief Executive Officer]

Yes, there’s a lot there. Well, I would kind of just raise that a little bit. And then Brad Winges came on to be as CEO in the first quarter of 2019. And he has done an incredible job. Him and the team over the past year, they’ve accomplished so much. And we feel really good about the business and he has embraced the businesses, he has inherited, and he has really done a lot to prove them well with the team.

And so I think the prospects are really strong for that business. The recruiting has really picked up in public finance and fixed income services and also in our wealth management businesses. And that’s why my commentary was, they’re really raising the profile and the caliber of the firm. The structured finance business is really tied to the mortgage, but it has a lot of streets in it with a limited supply in the first-time homebuyer appetite and we’re growing clients there.

So we’re very positive about what they’re doing. And now with the systems converge, there has been something that’s been worked on for several years. I think, we’ll have a better platform to really market sort of our corresponding clearing clients, as well as our wealth management rep.

So anyway, that’s what I’d say kind of high-level on that. And as far as revenue is concerned, we had a really strong net revenue for the quarter of $130 million. They kind of had a slow start to the year, given some of the market dynamics and the impact of the structured finance business.

But I would look for the second-half of the year to be kind of as strong as last year. And like last year, I think, it’ll build it. We have a positive outlook on the national issuance on the municipal debt.

[Michael Young, SunTrust Robinson Humphrey Inc]

Okay. And maybe with the TBA business, specifically, how much is the gain this quarter was kind of fair value or mark-to-market versus volume-driven?

[William Furr, Chief Financial Officer]

Well, as we acknowledged in the first quarter call that we had – during the month of March had experienced about $20 million negative mark, which left the pipeline market kind of negative $9 million for the period. As I noted in my comments, during – at June 30, the mark of the pipeline was positive $15 million.

So that obviously yields a $24 million change, understanding that that’s a different pipeline. I mean, that pipeline turned over, obviously, during the window there, so it’s a different group of loans, et cetera. And then from there, you saw strong origination volumes from a TBA volume perspective year-on-year. And we expect to just – kind of given the mortgage trends that, that likely will continue.

[Michael Young, SunTrust Robinson Humphrey Inc]

Okay. And I’ll ask just one more and then step back. But kind of a higher-level question, Jeremy, just on M&A and M&A outlook. There’s a lot of kind of volatility right now, and maybe a difficulty in price discovery on what you may or may not acquire. So just maybe a comment on kind of what you would be looking for in M&A transaction, and what would give you comfort to begin to look at something given kind of the volatility in the credit dynamics right now?

[Jeremy Ford, President and Co-Chief Executive Officer]

Sure. Well, I mean, we do have a specific amount of excess capital that we’d like to deploy, largely through bank M&A. We also feel that we need to be patient. We’ve got our own issues to work through as far as the deferral amount that we have. And then we really hope to be aggressive with the right opportunities.

And I just think, if you look at the industry, we all have the material amount of deferral balances, and in most cases, nonperforming assets have declined this quarter. And until those two things converge, which I would expect they would, there’s not a lot to motivate the related transaction.

[Michael Young, SunTrust Robinson Humphrey Inc]

Okay. So kind of clear that pipeline now for the industry, and that would give you more confidence probably to step in?

[Jeremy Ford, President and Co-Chief Executive Officer]

Yes. The confidence part is going to be harder, because we still don’t know what the future of a lot of these asset classes are going to be like. But we would be ready to – we’re actively monitoring and ready to look at anything that we find appealing.

[Michael Young, SunTrust Robinson Humphrey Inc]

Okay, thanks. I’ll step back.

[Operator]

Our next question is from Brady Gailey from KBW. Go ahead.

[Brady Gailey, Keefe, Bruyette & Woods, Inc.]

Hey, thanks. Good morning, guys.

[Jeremy Ford, President and Co-Chief Executive Officer]

Good morning.

[William Furr, Chief Financial Officer]

Good morning.

[Brady Gailey, Keefe, Bruyette & Woods, Inc.]

Maybe just a follow-up on the M&A dialogue. When the time is right, it feels like you guys will be ready. Can you just remind us how big of a deal would you consider as far as a target’s assets? And then clearly, you have a big Texas franchise. Would you consider franchises outside of Texas like in the Southeast ?

[Jeremy Ford, President and Co-Chief Executive Officer]

On size, I think that we would consider really anything and it will just depend on the level of stock consideration that would be included in the transaction. And I think, by and large, we believe that, right now, we prefer to do something of more scale than less. We still think that, there’s a lot of strategic reasons to try to partner with somebody in Texas and we’d hope to do that.

But at the same time, I think, particularly if there’s something of scale out of state, we would do that as well. But at the end of the day, we’re going to make sure that there’s a strategic rationale that drives the deal. And so I think that, that will really define our interest.

[Brady Gailey, Keefe, Bruyette & Woods, Inc.]

All right. That’s helpful. And then looking at the mortgage business, the gain on sale margin was up 43 basis points last quarter. You’re guiding – if you look at the 430 to 450 gain on sale margin guidance for this quarter, and that’s up another – at the midpoint is up another 72 basis points.

So it’s just – it doesn’t feel like the mortgage business is slowing down at all. I mean, volumes are still robust, the gain on sale margin has gone up. I mean, you could even have a better mortgage quarter next quarter than this one. Is that a fair way to think about it?

[William Furr, Chief Financial Officer]

I think the thing to remember about the gain on sale is, when you calculate the way we calculate gain on sale, as we disclose it here, it is at the final disposition of the loans, so the final sale measure. As it relates to kind of the revenue recognition, we recognized 75% to 80% of the revenue at rate lock. So that’s why during my comments, we talked about the rate lock volume, which was record in the second quarter, close to $7.4 billion.

But that rate lock is really the, if you will, a defining revenue moment in the context of the overall life and earnings of that asset. I do – I would say, I think, we said it in some of our 2020 commentary, we have continued to see solid pull-through of mortgage volumes and applications through early parts of the third quarter. It’s not our expectation that we have a repeat quarter. But we certainly are seeing, again, the pull-through of strong activity in the early parts of the third quarter in terms of application volumes going forward.

So we’ll, it can be – we expect, it’s going to be volatile. We expect it’s going to be related a little bit to overall consumer confidence and how people feel about the resolution of the pandemic, as well as overall economic activity. So, again, we’re not guiding forwards, but again, we are seeing some reasonable pull-through in the third quarter – early parts of the third quarter as it relates to the mortgage loan.

[Brady Gailey, Keefe, Bruyette & Woods, Inc.]

All right. And then just finally from me. I mean, excess liquidity is notable here. Any thoughts on deploying some of that excess liquidity, like into the bond book? And I realize, your bond yields aren’t great today, but it’s better than cash?

[William Furr, Chief Financial Officer]

Yes. And that – and I think that’s, to some extent, what I was trying to suggest in my comments. I mean, we’re going to work through the second-half that excess liquidity position. We think we’ll work it down into the $5 billion to $6 billion range, again, is – but we are monitoring. And again, the reason it got as high as – certainly intra-period, we had some very high mortgage volumes, which we – we’ve articulated.

But I’d also say, we were preparing for some potential market disruptions that could have occurred from the pandemic. And we get the Treasury a lot of credit for a lot of work they’ve done to kind of stabilize the overall liquidity markets over time. And it’s functioning in an orderly fashion really over the last – second-half of the second quarter and continue to do so.

So we’ll work those down and we will be principally working down through cash. So we will likely be deferring or putting some of that cash to work in terms of security purchases, which again, to your point, we’re seeing a yield there of 100 to 125 basis points on average.

And then we’ll also be considering kind of the sweet deposit income in Hilltop Securities. And then we’ll allow some of the broker deposit actions that we brought in, as I mentioned, we brought in about a little over $0.5 billion of it during the second quarter. We kept those very short from a duration perspective and we’ll allow a lot of that to mature in the third and fourth quarter.

[Brady Gailey, Keefe, Bruyette & Woods, Inc.]

Okay, great. Thanks for the color.

[William Furr, Chief Financial Officer]

Thank you.

[Operator]

This concludes our question-and-answer. The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.