Hilltop Holdings Inc

NYSE:HTH

Earnings Call Transcript 2017-Q4

[Operator]

Good morning, and welcome to the Hilltop Holdings' Fourth Quarter Earnings Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] After today's presentation there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Isabell Novakov. Please go ahead.

[Isabell Novakov, SVP and IR]

Good morning. Joining me on the call this morning are Jeremy Ford, President and Co-CEO; Alan White, Vice Chairman and Co-CEO, and Will Furr, CFO. Before we get started, please note that certain statements during today's presentation that are not statements of historical facts, including statements concerning such items as our business strategy, future plans and financial condition 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, and financial conditions may differ materially from these statements, due to a variety of factors, including the precautionary statements referenced in our discussion today, 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 taxable equivalent net interest margin and taxable equivalent net interest margin before purchase accounting adjustments. A reconciliation of these measures to the nearest GAAP measure may be found in the appendix of this presentation, which is posted on our website at ir.hilltop-holdings.com.

And now, I would like to hand the presentation over to Jeremy Ford.

[Jeremy Ford, President and co-CEO]

Thank you, Isabell, and good morning. For the fourth quarter of 2017, net income was $13.4 million or $0.14 per diluted share. During the quarter the Tax Cuts and Jobs Act was passed and resulted in a one-time charge that reduced net income by $28.4 million, or $0.30 per share.

Excluding the impact of this tax related charge net income was $41.8 million or $0.44 per diluted share. We expect the new tax legislation will benefit Hilltop by reducing our effective tax rate going forward, which Will is going to cover in more detail.

During the quarter, Hilltop was able to grow core deposits and commercial loans, build on the earnings and margin momentum in the securities business and increase our overall mortgage market share. Delivering value to our shareholders remains our top priority. In 2017, Hilltop returned $50 million to shareholders through dividends and share repurchases. Including the SWS settlement shareholder returns totaled $98 million.

Meanwhile, our tangible book value per share has grown by 6% from the prior year. Additionally Hilltop's Board of Directors declared a quarterly cash dividend of $0.07 per common share payable on February 28, 2018 representing a 17% increase. We are dedicated to managing risk across the organization, particularly in regards to the bank’s credit quality and loan losses. For the full year 2017 we had net charge-offs of only $4.6 million, representing 8 basis points on the average bank non-covered loans.

Moving forward, fourth-quarter pretax earnings reflect solid performance across all of Hilltop’s businesses. Excluding the $5.3 million reduction in purchase accounting impact the bank’s core results improved from 7% non-covered loan growth. Through our continued focus on home purchase volume prime lendings pretax income declined modestly despite a 34% decrease in refinance volumes.

Hilltop Securities had a strong quarter with pretax income of $19 million, representing a 17% margin. The year-end tax bill drove up national issuances and resulted in a rebound by public finance. Additionally, Hilltop Securities was recently ranked the number one municipal financial advisor in the nation and Texas in 2017. National Lloyds experienced low storm losses, which is in line with seasonal expectations and drove this $14 million of pre-tax income.

2017 was a profitable and rewarding year for Hilltop for which I thank in credit our dedicated employees across all of our companies.

I'll now turn the presentation over to Will to walk through the financials.

[Will Furr, CFO]

Thank you, Jeremy. I'll start on page five. Hilltop's pretax income for the fourth quarter equated to $65 million, an increase from the fourth quarter of 2016 of $11.9 million. Pretax income for the full year 2017 equated to $243.3 million, an increase from the full year 2016 of $11.9 million.

As Jeremy stated, the fourth-quarter and full-year 2017 net income results reflect the impact of the Tax Cuts and Jobs Act that was passed in December. In my comments, I will refer to this bill as tax legislation. The passing of tax legislation resulted in Hilltop’s revaluation of deferred assets and liabilities and the review of the future deductibility of certain expenses. The net impact of these actions resulted in a nonrecurring, non-cash charge of $28.4 million during the fourth quarter.

In future periods, this tax legislation will result in a lower federal income tax rate for Hilltop. Based on our current outlook, we expect our GAAP effective tax rate will be between 23% and 25%. For the full year 2017, purchase accounting positively impacted pretax income by $29.1 million. The positive net impact of these items has declined approximately $18 million from the prior year. We expect the decline in purchase accounting impact to continue in 2018.

Further, on a scheduled basis we estimate that the pretax contribution, net of expenses, from purchase accounting will be between $4 million to $6 million per quarter on average for the year, and the purchase loan accretion will average $6 million to $8 million per quarter for the year. Hilltop’s capital position is strong with a period income and equity tier one ratio of 17.69%. The impact of tax legislation on the common equity tier one ratio was approximately 31 basis points.

Moving to page six, net interest margin equated to 3.63% in the fourth quarter of 2017. The impact of purchase accounting accretion included in the net interest margin equates to 44 basis points for the quarter. The pre-purchase accounting taxable equivalent net interest margin equated to 3.21% for the quarter, an increase of 10 basis points from the fourth quarter of 2016. This increase reflects the ongoing resets of our adjustable loan and securities portfolios and our ability to manage deposit costs through the first leg of the rate cycle.

Earning assets increased by approximately $728 million compared to the fourth quarter of 2016. Non-covered HFI bank loan growth of $354 million was somewhat offset by runoff in the covered loan portfolio of $77 million during the year. Further, Hilltop’s low risk securities portfolios grew by $637 million from the prior year.

At year-end, Hilltop’s securities did carry additional municipal securities inventory to support future business flows given the expected seasonal supply declines in the municipal markets coupled with the accelerated activities in public finance that could further reduce supply during the first quarter. Further, the liquidity profile at the bank continues to strengthen and those excess funds have been leveraged to increase the unencumbered securities mix in the discretionary portfolio.

Moving to page seven, total non-interest income for the fourth quarter of 2017 equated to $291 million. Fourth quarter mortgage-related income and fees declined by $17 million versus the fourth quarter of '16. This decline is driven by a reduction in mortgage originations of 7%, or $285 million compared to the prior year. The decline in mortgage originations reflects an ongoing market shift towards purchase mortgages as our refinance production declined by $387 million from the fourth quarter of ’16. As the refinance market contracts, pricing pressures have persisted. And as a result, net gain on sale of loans decreased 8 basis points from the fourth quarter of 2016 to 380 basis points. Given the continued competitive pressures, we expect that the gain on sale margins will remain pressured into 2018.

Securities-related fees increased versus the prior year by $6.3 million, driven by higher short-term rates and improvements in retail. Additionally, public finance recorded a strong fourth quarter as tax legislation drove higher national issuance in December.

Moving to page eight. Non-interest expenses improved from the fourth quarter of 2016 by $27 million, to $329 million. Fourth quarter 2016 professional services expenses included a $16 million legal settlement related to the Rhode Island matter. Further expenses were positively impacted by lower variable compensation, and business expenses related to lower production levels in certain of our businesses.

Insurance-related loss and loss adjustment expenses decreased $5.4 million versus the prior year driven by seasonally low storm activity during the quarter. Included in other expenses we released $1.4 million of the initial $1.5 million hurricane related reserve previously recorded in the mortgage segment.

Moving to page nine, total loans including margin loans at Hilltop Securities, and the covered loans housed within the bank grew by approximately $353 million or 6% versus the fourth quarter of '16. This performance was at the low end of our expectations but reflects discipline in managing credit quality and underwriting standards while being responsive to our clients’ financing needs.

Moving to page 10. Total deposits were approximately $8 billion, and have increased by $914 million or 13% versus the fourth quarter of 2016. The driver of the increase in interest bearing deposits is growth in our money market products and certificates of deposit. Deposit costs have increased modestly with short-term interest rates and we remain active in the market testing rates and Terms to ensure we remain competitive.

Hilltop’s interest bearing deposit beta since the beginning of this rate cycle is approximately 24%.

I'll now turn it to Alan to provide more insights on the business performance.

[Alan White, Vice Chairman and co-CEO]

Thanks Will. Good morning. At the bank level first, we had a solid quarter and we had a solid year. Our loan growth ended up at 7%, which is a little below what we were expecting of 8% to 10%, but this occurs because of unexpected paydowns and it also occurs because the market is very competitive, and we are very conservative on our underwriting.

As we cautiously move through the times that we are in, our net interest margin is in great shape as we continue to increase and we are positioned well as we go forward. If you look at our markets, our strongest loan markets obviously are Dallas and Fort Worth. A very vibrant economy, lots of action going on but it is very competitive, and the other strong market is Austin, where again it is very vibrant with a lot of action and it is very competitive. But those are our three big markets.

Now the market that has the biggest potential would be Houston for us. As oil and gas improved; $65 oil, we are starting to see some opportunities that are starting to pop up. We also were hoping that you know, we will see some of these credits especially from the service side that have experienced some difficulty – maybe started making some positive move. So we are optimistic and we think we have got a lot of potential in Houston.

As Will said, our deposits increased 13%, and really net 11% after you take away the sweep balances we brought from Hilltop Securities, but we put in place in ’17 a challenge to our bankers to increase deposits and they far exceeded what we anticipated. So we are really pleased about that. Right now we are operating 63 branches, and everybody is doing a good job. We are really focused on recruiting now as we go forward.

When you look at prime lending, we had exactly what we expected. In the fourth quarter, we came very close to what we expected for the year. Seasonally the fourth quarter is what it is and it is very difficult. But when you look at our origination volume year-over-year it was down 7%. However, our purchase volume year-over-year was up 4%, and that was compared to the industry of being up 2%. In the industry overall market, we were down 7% – the industry was down 17%, so we continue to perform very well against the industry. Our market share actually increased year-over-year to 0.87% from 0.74%.

We continue to focus on our gain on sales [indiscernible] times are very competitive. We still have a lot of people moving from that refi market to the purchase market and chasing deals that makes it very competitive on the pricing side. We are going to sit there and compete with them. Not going to let them take our customers or our people, and so we have done a good job doing that and being able to maintain our profit picture and our volume picture.

The very positive thing on prime is we are up 80 loan losses over last year, which is a good position to be in going into this year as we need to continue to drive volume and build the market. Also, we have two new joint ventures that are good opportunities for us on the lending side and on the volume side at prime. That makes three in total and we will continue to focus on joint ventures, and we will continue to focus on recruiting. That is a [indiscernible] company.

Hilltop Securities, as both these gentleman said, had an excellent year and excellent quarter. Public finance, which is our bread and butter was very strong in the fourth quarter, and we are pleased with that. One thing that we really looked at because of interest rates – Hilltop benefits from the interest rate move there, and have now made $28 billion worth of municipal monies, which is certainly a good solid business for us and something that we have been able to grow quite a bit.

Retail and the clearing businesses have been very solid and a lot of improvement on the retail side. Those are really important to us because that is where the balances come that generate the $2.5 billion worth of excess funds that they have for [suites] that we can use for core deposits. So those businesses are good and doing better, and help solidify that $2.5 billion that we count on for liquidity purposes.

All in all, Hilltop Securities is in good shape. We got a great solid team that has worked together for a long time and are optimistic about its future. And when you come to National Lloyds, good quarter, good weather and good results. Imagine what happens when you have a little good weather and a little luck. We continue to focus on our premiums written. We are trying to turn that curve and starting to move back up, and looking hard at how we are marketing looking hard at our people working with our agents and our focus is really going to be on that as we try to move that line back up and continue to. They would be -- of the insurance business.

That concludes my remarks.

[Isabell Novakov, SVP and IR]

This concludes our prepared remarks, we will now take questions.

[Operator]

We will now begin the question and answer session. [Operator Instructions] The first question comes from Michael Young with SunTrust. Please go ahead.

[Michael Young, SunTrust]

Hi, good morning everyone.

[Jeremy Ford, President and co-CEO]

Good morning.

[Will Furr, CFO]

Good morning.

[Michael Young, SunTrust]

Why don’t you start maybe just on M&A what you're kind of seeing in the market and does the change in the tax laws effect maybe how you're evaluating your eagerness to do a deal in 2018?

[Will Furr, CFO]

Well, it's the same thing we said before, I think we are still pursuing acquisitions and we certainly factor in the change in effective tax rates and in our evaluations of that. And we're just going to continue to be patient with diligence and look for the right fit and also the right economics.

[Michael Young, SunTrust]

Okay. And Jeremy, maybe in the absence of the M&A, how higher you're willing to let capital levels build where its almost 18% common equity tier 1 ratio and a 13% leverage ratio and we're going to be accreting more capital now with the lower tax rates. So, do you kind of draw a line in the sand at some point?

[Jeremy Ford, President and co-CEO]

Well, what we've been endeavored to do in the last 18 months has been to kind of have a more progressive capital planning. And that we have our excess capital and we want to first use that for organic growth and we've been able to do that, we've increased our balance sheet.

We'd like for the excess capital for M&A to kind of stay where it is and then we've brought upon a dividend and also a share repurchase program that has had kind of an average return to shareholders so far about 30% when you combine those.

So, I don’t really we're not just adding to excess capital at this point. And we look at ourselves over a full cycle and our ability to deploy that capital and put it to work and we think that attractive M&A is the best use for that. It's something we think we'd demonstrate the ability to do.

We've just been a lot of times disciplined and getting deal done.

[Michael Young, SunTrust]

Okay. And this year buyback, that was announced a 50 million kind of what you've done on a normal basis but is that still just to offset delusion from share issuance?

[Will Furr, CFO]

It's primarily that's all we've done as to do that. This past year if you look collectively, we repurchased a little over a million shares and that was for 27 million. So, I think that we'll certainly repurchase what we issue in shares and probably a little bit more. And then if we think that there is the stock warrants attractive price repurchase and we'll do that as well.

[Michael Young, SunTrust]

Okay, great. Thanks.

[Operator]

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

[Brett Rabatin, Piper Jaffray]

Hi, good morning everyone.

[Jeremy Ford, President and co-CEO]

Hi, Brett.

[Alan White, Vice Chairman and co-CEO]

Good morning.

[Will Furr, CFO]

Good morning.

[Brett Rabatin, Piper Jaffray]

Why don’t you I guess first ask Alan on the mortgage side 2017 a bit of a step back from '16s really good numbers. If you continue to take share and just looking at the purchase forecast, it would seem like you could have better originations in '18 but that might be offset a little bit by continued pressure on gain on sale margins.

Can you give us maybe just your outlook for the year on the mortgage, please?

[Alan White, Vice Chairman and co-CEO]

Yes. A question of '16, Brett, was a year that came from mars or you know you had everything going for in the refinance was really big. Now yes, we might have percent there we loss in refinance but then that would have really been.

So, trying to get back to where we were and what we did to '16 is very difficult. We hear our target in '17 and came very close. '18, we're expecting a very competitive market, we're expecting quote with the MBI, we're expecting volumes to be down from the overall market that would be our expected purchases to be.

We expect to get our market share there. That certainly are our philosophy and our direction and so it's going to be very comparative. First quarter is just going to be just like the first quarter is normally, very hard, and then you start coming back into the desirably time of the year that's most beneficial, that's second.

Third portion drops off in the fourth course. Now, with all that said, what do where do we think we're going to end up? We think we're going to end up okay if everything moves away that it supposed to. And we're positioned way off. As I mentioned, I'm very pleased with the 80 million loan off source.

We didn’t enter this '17 with that. So, that these are 80 quality loan offers that we've entered over what we had and we're entering with two new joint ventures which also is very important to us as we continue to try to add joint ventures.

So, I think we're moving things in the right direction. And as the industry goes, we will outperform the industry just depending on what that is. So, I'm looking for a stern veer, I'm not looking for a year that's going to blow out the term like we did in '16. But I think we'll keep doing what we're doing and do a good job at it.

[Brett Rabatin, Piper Jaffray]

Okay, great. And then Jeremy, on the broker dealer, you've kind of always talked about a $100 million revenue run rate in 4Q was above that. Is it the thought that that number is moving higher or was 4Q exceptionally strong. Can you maybe give us some thoughts on your outlook on that business?

[Jeremy Ford, President and co-CEO]

Well, there's some seasonality to that as well. And that the fourth quarter is typically the strongest quarter for a public finance business with this, which is the key business that we have is really from security. And it had a really strong fourth quarter with the enactment of the new tax bill, really drove up national issue and been done. And they did great.

So, that I would say it exceeded expectation but we also expect the fourth quarter to be the highest. I think for if we look out for the next year or so, I mean I think you got to be careful a little bit like we did last time is the first quarter is actually the seasonally the slowest quarter for Hilltop's securities typically.

And I would still kind of I still kind of view $400 million of a $100 million on quarter is should be a pretty safe revenue number to be thinking about.

[Brett Rabatin, Piper Jaffray]

Okay, fair enough. And then may if I can just sneak one last one and on the margin with two or three rate hikes this year probably. Can you give us some thoughts on the margin, it would seem like it could have a little bit of tenor, some loans repricing but was curious on your thoughts on the margin.

[Will Furr, CFO]

Yes. So, this is Will. As we look at net interest margin, if we talk about tax equivalent prepurchase accounting. It was 321 for the fourth quarter. Our guidance with kind of no rate increases for 2018, 315 plus a modest three. We do recognize there is increasing deposit pressure from a cross perspective.

And we're we've been very diligent in our pricing strategy to this point. And we would continue to do that and expecting and to do that in 2018. I'll tell you with rate increases we would expect the NIM obviously will increase or drift north overtime. But again with the current rates as they are, our guidance will be 315 plus or minus three, which is an increase from the 310 plus or minus three previously.

[Brett Rabatin, Piper Jaffray]

Okay great for sharing the color.

[Will Furr, CFO]

Thank you.

[Operator]

The next question comes from Matt Olney with Stephens Inc. Please go ahead.

[Matt Olney, Stephens Inc.]

Hi thanks, good morning guys.

[Jeremy Ford, President and co-CEO]

Hi, Matt.

[Matt Olney, Stephens Inc.]

I want to start with the operating expenses. I think in the past you've talked about managing that the expense base and moving some back offer systems under one platform. Can you just update us on this initiative, how much of this is in the run rate and what's still to come?

[Will Furr, CFO]

Well, we are -- this is Will. We are in the process of I think going through our organization in evaluating those places where it makes sense to create synergy from a technology perspective and implementation. I tell you 2017 was a development and kind of planning year. We are in the process as we've acknowledge of implementing a new core system at Hilltop securities and we can talk more about that.

But at the end of the day as we look forward, 2017 was a planning year, 2018 will be a large part an implementation year and then we would expect to see the run rate benefit late starting late '18 going into '19.

[Matt Olney, Stephens Inc.]

Got it. And I believe Will, we talked about part of that expense managements to offset some of the run off of the purchase accounting accretion and given the guidance it sounds like there is a step down as far as the accretion levels in '18 versus '17.

Anything behind that stepdown?

[Jeremy Ford, President and co-CEO]

Yes, I will talk to the stepdown. But I kind of think just minding the -- I don’t think those are necessarily related as for projects for the accretion going down. We're just you know we look at it, we got four businesses and we're endeavoring to find ways to operate as one. And with a applied formula we can leverage and create efficiency.

And I'll let Will talk.

[Alan White, Vice Chairman and co-CEO]

Purchase accounting.

[Will Furr, CFO]

Yes. So, purchase accounting as we noted and we try to be a little more descript about kind of the overall pretax contribution down this year from the 47 million in pretax to 29 million. We do expect that the portfolio runs off that about the accretion and the pretax implication of purchase accounting decline.

And so, where we were got it into 12 per quarter in and like our net interest income but purchase loan accretion we are moving that guidance to six to eight. And again that's just a reflection of the both our schedule basis as well as lower loans and overall run offs in the portfolio.

[Matt Olney, Stephens Inc.]

Understood. Okay, thanks guys.

[Will Furr, CFO]

Thank you.

[Jeremy Ford, President and co-CEO]

Thanks.

[Operator]

The next question comes from Jesus Bueno with Compass Point. Please go ahead.

[Jesus Bueno, Compass Point]

Hi, how is it going? Just on the mortgaging and in fact the total mortgaging's almost down but it looks like in on loan sales and origination fees held up pretty well. You have some impacts from what seems hedging last quarter. Did you see that again this quarter and could you provide some color around that?

[Will Furr, CFO]

I would have called hedging generally stable quarter-to-quarter. I'll tell you the gain on sale as we reported here is the gain on sale is explicitly going to be the kind of reported gain on sale number divided by total loan sales.

So, it's and again what we're saying there is the pricing in the marketplace when we talk about under pressure, the pricing in the marketplace has been pressured. And so, overall rate to the client is down. I'll tell you the team and we've said this before we've got a great team in our revenue management unit as prime.

And they are spending, they spend kind of a lot of time focused on how do we manage exceptions pull through and overall kind of pricing. And so, that team is vigilantly kind of maintaining and being diligent about managing the margin. However, we do expect it to be under pressure from the 380 level in 2018.

[Jesus Bueno, Compass Point]

Got it, that's helpful. And just going to ask on kind of residual effects from Harvey. You had some impact last quarter, it was positive to see you release the reserve you mentioned that to mortgage. Are you confident and the impacts are limited and as far as fees did you see any impact in the fourth quarter?

[Alan White, Vice Chairman and co-CEO]

Yes, I'll say. What we think we in the bank and the mortgage company, we haven’t seen any impacts. Nothing is really developed at this point on the either side. Those mortgages we released well because we conservatively ran our thoughts and it proved to be.

But we haven’t seen any really developed nor in any kind of substantial loan problems from either one or especially Harvey which was a bigger one that affected us.

[Will Furr, CFO]

Yes. Just that I mean so we took a bank reserve as we noted in the third quarter, that exists, that continues this to be in the allowance and where we continue to watch loans but that Alan said we haven’t seen any development there. We did go through all the loans that we would have anticipated be impacted at Prime.

And that resulted in the release of the 1.4 million versus the 1.5 that we booked in the third quarter. And as the insurance company, we feel like we adequately reserve for any exposure that was born there in the third quarter.

[Jesus Bueno, Compass Point]

That's great, thanks. If I can just slip in, I just want a follow-up on M&A. you mentioned being opportunistic, are you so focused entirely on a bank acquisition. I mean, would you be willing to look at other areas perhaps on the broker dealer side or perhaps even on the mortgage side in terms of doing something that are not bank M&A?

[Jeremy Ford, President and co-CEO]

No, our focus is on bank M&A. we want to continue to build our bank assets and that really questioned our strategic plan of having the bank be the cornerstone that provides permanent financing for our mortgage company and utilizes the sweeps from the broker dealer.

[Jesus Bueno, Compass Point]

That's fine. Just that you didn’t use the whole buyback authorization last year. I guess, well why just given where your stocks trading, relative peers and opportunity out there in the market. I guess that, what's your thinking behind? I guess, why not using the whole thing and just again just given your capital position, it don’t seem like a large amount?

[Alan White, Vice Chairman and co-CEO]

Well, we look at it on a quarterly basis and we don’t have a set program. So, we're just doing it during open market periods and between quarters and I would just kind of evaluate it. We definitely don’t want to be moving the market when we're doing.

[Jesus Bueno, Compass Point]

Sure. Thank you for taking my questions.

[Operator]

Okay. This concludes our question and answer session. And today's conference call has now concluded. Thank you, for attending today's presentation. You may now disconnect.