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spk05: Good morning, ladies and gentlemen, and welcome to the Hilltop Holdings third quarter 2023 earnings conference call and webcast. At this time, all lines are in listen-only mode. Following the presentation, we will conduct a question and answer session. If at any time during this call you require immediate assistance, please press star zero for the operator. This call is being recorded on Friday, October 20th, 2023. I would now like to turn the conference over to Eric Yerby with Hilltop Holdings. Please go ahead.
spk01: Thank you, operator. Before we get started, please note that certain statements during today's presentation that are not statements of historical fact, including statements concerning such items as our outlook, business strategy, future plans, financial condition, allowance for credit losses, liquidity and sources of funding, the impact and potential impacts of inflation, stock repurchases and dividends, and impacts of interest rate changes, as well as such other items referenced in the preface of our presentation, are forward-looking statements. These statements are based on management's current expectations concerning future events that by their nature are subject to 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 and quarterly reports filed with the SEC. Please note that the information presented is preliminary and based upon data available at this time. 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. The 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 will now turn the presentation over to President and CEO, Jeremy Ford.
spk00: Thank you, Eric, and good morning. For the third quarter, Hilltop reported net income of $37 million, or $0.57 per diluted share. Return on average assets for the period was 0.9% and return on average equity was 7.1%. This was a favorable quarter for the organization, despite escalating interest rates and market pressures within each business. Hilltop produced solid consolidated profitability and continue to grow its book value with our conservative liquidity management. The dedication and adaptability of our teams in this uncertain environment has been commendable. I believe our proactive measures, strategic initiatives, and the strength of our franchise position Hilltop for resiliency in this challenging environment and sustained growth over the long term. For the quarter, Plains Capital Bank generated $53 million of pre-tax income on $13.3 billion of assets. representing a return on average assets of 1.2%. Average loans at the bank were relatively stable from the second quarter as slower client activity, particularly in commercial real estate, was partially offset by reduced paydowns. Higher borrowing costs and increased equity requirements needed to borrow have impacted the pipeline, and we expect this trend to continue until rates stabilize, whereby pricing can normalize and transaction volumes should pick up. Credit quality remains paramount to our bank, and we will continue to approach credit risk in the same judicious manner. Although we saw a minor amount of negative credit migration, the bank had a decline in non-performing assets and realized a net recovery in the quarter. Average bank deposits remained relatively stable during the quarter at $11.3 billion. So, we continue to see a migration from non-interest-bearing deposits into money market and CD accounts. which contributed to a 31 basis point increase in deposit costs. This increase is in line with expectations given the mixed shift in prior deposit data guidance. Overall, our bank continues to perform well despite NIM compression and softness in the loan pipeline. While we do expect the balance sheet to contract for a period, the business remains focused on bottom line profitability by managing margins where possible, being thoughtful about appropriate credit risk, and tightening down on expenses. Moving to prime lending. The residential mortgage industry remains under pressure given the increase in the 10-year rate and the resulting highest mortgage rates in over two decades. Additionally, other negative industry factors include a persistently low supply of retail housing, elevated home prices, and surplus capacity within the mortgage origination sector. These dynamics have collectively exerted substantial pressures on lender loan volumes home buyer confidence, and secondary margins. To weather these challenges, Prime Lending has taken several strategic and tactical measures to ensure resiliency and sustainability. These include a focus on optimizing operations and corporate staffing levels, a judicious approach to variable expenses, and a re-evaluation of brick-and-mortar utilization. We have begun to see the benefits of these initiatives in our expenses and in our margins. evident by the lower prepax loss in the business year over year, despite lower origination volumes and gain on sale margins. Prime lending originated $2.2 billion in volume, a decline of 26% from the same period prior year. Gain on sale margin during the period was relatively stable to the second quarter at 198 basis points, though down from 218 basis points in the third quarter of 2022. While the gain on sale margin is still lower than the same period prior year, origination fees have increased from 131 basis points to 185 basis points as more borrowers are choosing to buy down the higher mortgage rates. There was a positive trend in fixed costs during the period as they declined by $16 million or 21% from prior year. This is directly related to the resizing efforts previously mentioned. Notwithstanding the cost reductions, Prime Lending continues to focus on enhancing its sales force by recruiting quality loan originators that can bring on profitable volume in this difficult mortgage market. In addition to helping us navigate through near-term challenges, we believe that the strategic changes and improvements undertaken will position Prime Lending for higher margins and increased profitability when the industry recovers. We have confidence in our leadership team and are encouraged by the current favorable expense trends in the business. Hilltop Securities generated pre-tax income of $22 million on net revenues of $119 million during the quarter. Pre-tax profit and margins improved compared to last year's third quarter due to an increase in contribution to revenue from higher margin businesses. primarily associated with our sweep income that has benefited from higher short-term rates. Additionally, our structured finance business reaped the benefits of more volume from certain state housing programs, most notably in Florida. This highlights the quality of our team and the relationships they have fostered with different state housing agencies. Hilltop Securities has performed exceptionally well this year. which is a testament to the talented leadership and producers across its businesses. Moving to page four. Hilltop maintains robust capital levels with a common equity tier one capital ratio of 18.6% and our tangible book value per share increased from Q3 2022 by 54 cents to $27.67. Our capital ratios and tangible book value have grown as a result of our conservative securities management declining balance sheet, and durable profitability. In summary, while industry headwinds are adversely impacting our bank and mortgage businesses, this quarter's improved results again illustrate the strength of Hilltop's franchise and the hard work by our team. We will continue to prioritize the strength of our balance sheet to best serve our clients and best position Hilltop. With that, I will now turn the presentation over to Will to discuss the financials. Thank you, Jeremy.
spk06: I'll start on page five. As Jeremy discussed, for the third quarter of 2023, Hilltop reported consolidated income attributable to common stockholders of $37 million, equating to 57 cents per diluted share. The quarter's results highlight the successful expense work we've been executing across the franchise, and most acutely at prime lending, coupled with solid credit metrics that remain resilient, at least through this point in the cycle. To address credit, In the changes in allowance, I am turning to page six. Hilltop's allowance for credit losses increased during the quarter of $1.5 million to $110.8 million. Improvement in the macroeconomic outlook, coupled with net recoveries of prior losses in the period, materially offset the impacts of loan growth and collective portfolio changes. Allowance for credit losses of $111 million yields an ACL to total loans HFI ratio of 1.35% as of September 30th, 2023. As we've seen over time, ACL can be volatile as it is impacted by economic assumptions as well as changes in the mix and makeup of the credit portfolio. We continue to believe that the allowance for credit losses could be volatile and the future changes in the allowance will be driven by net loan growth in the portfolio, credit migration trends, and changes to the macroeconomic outlook over time. Given the current uncertainties regarding inflation, interest rates, the future outlook for GDP growth and unemployment, we do expect that volatility in the ACL could be heightened over the coming quarters. Turning to page seven. As provided in the previous quarter, we wanted to show a little more detail into our CRE portfolio and the allowance distribution across some of the key loan segments. On September 30th, the CRE portfolio totaled approximately $3.3 billion, which we segregated into owner and non-owner occupied or investor real estate. Internally, we view owner-occupied real estate more like C&I lending, as for the most part, repayment is driven by the operating business that owns the real estate. Non-owner-occupied real estate makes up 57% of the CRE book, and as is noted in the upper right-hand chart, is diversified across multiple income-producing property types. In the bottom table, we provide a breakout of non-owner-occupied office and retail within the portfolio to highlight the differentiation in ACO coverage by loan segment type. Our view to date is that the office and retail markets across our footprint represent the highest exposure to both recession absorption and valuation risk in the portfolio. As such, you can see that those loan segments maintain a larger ratio coverage ratios than other non-owner occupied real estate products. We're currently monitoring the entire portfolio closely and not seeing any systemic risk emerge as of the third quarter. That said, we do expect that the ongoing cashflow challenges facing existing and new projects driven by higher interest rates and ongoing inflation could lead to further credit migration over time. Moving to page 8. Net interest income in the third quarter equated to $116 million, including $2.2 million of purchase accounting accretion. Versus the prior year, third quarter, net interest income decreased by $7.8 million, or 6%, driven primarily by higher yields on deposits. As we expected, net interest margin declined marginally versus the second quarter of 2023 from one basis point to 302 basis points. Our current outlook reflects a scenario whereby Fed funds moves to between 550 and 575 by the end of 2023 and remains stable for the majority of 2024. Further rate increases coupled with ongoing deposit competition could cause NII and NIM to decline further during the fourth quarter and into 2024. I'm moving to page 9. In the chart, we highlight the approximately $7.3 billion of available liquidity sources that Hilltop maintained as of September 30th. While we consider the Federal Reserve's discount window to be a source of liquidity, we do not plan to leverage that program under our internal liquidity modeling efforts, and as such, it's noted below our other collateralized borrowing sources. Further, comparable liquidity sources as of December 31st, 2022 equated to just over $7 billion and remained relatively stable throughout the prior quarters of the year. As is shown in the chart, at September 30th, Hilltop maintained $1.3 billion of excess reserves of the Federal Reserve. Additionally, In the bottom left chart, we provide detail on the pace of the deposit beta changes to date, noting that our current through-the-cycle beta for interest-bearing deposits is 62%. Further, we continue to expect that the marginal beta for any additional Federal Reserve rate actions will fall between 75% and 100%. As a result, we're now expecting that our through-the-cycle interest-bearing deposit betas will be within the 60% to 70% range. Turning to page 10, third quarter average total deposits are approximately $11.2 billion, remaining largely stable versus the second quarter of 2023. On an ending balance basis, deposits decreased by $61 million to $11.1 billion from the prior quarter, largely driven by a decline in broker-dealer sweep deposits held at Plains Capital Bank. As a result of our ongoing pricing efforts, interest-bearing deposit costs rose to 323 basis points and increased to 39 basis points from the prior quarter. It is our expectation that interest-bearing deposit costs will continue to move higher for the balance of 2023 given our stated views on the path of potential rate increases from the Federal Reserve and the updates we've made to our pricing approach. As it relates to deposit balances and costs, we remain focused on balancing our competitive position with our long-term customer relationships while we continue to focus on prudent management of net interest income over time. However, the current environment remains challenging, and as noted earlier, we expect that the intensity of competition for deposits will continue to pressure rates higher over the coming quarters. I'm moving to page 11. Total non-interest income for the third quarter of 2023 equated to $197 million. Third quarter mortgage-related income and fees decreased by $9 million versus the third quarter of 2022 driven by the ongoing challenges in mortgage banking, whereby the combination of higher interest rates, home price inflation, limited housing supply, and ongoing overcapacity in terms of mortgage originators across the U.S. has driven volumes and margins materially lower. Further, versus the prior year third quarter, purchase mortgage volumes decreased by $741 million, or 26%, and refinance volumes decreased by $59 million, or 28%. During the third quarter of 2023, gain on sale margins remained within the tight range we've seen over the last 12 months, remaining at what we believe are unsustainably low levels. We continue to expect that a full recovery in margins will occur slowly and likely will not be a straight line, as industry capacity and other constraints remain. During the third quarter, TBA locked volumes increased substantially from second quarter 2023 levels to just under $3 billion. Locked volumes were substantially impacted by certain states providing additional state funding to support their housing authorities and down payment assisted programs. While volumes are very strong, Secondary spreads in the market did contract substantially, reflecting the volatility in the current rate environment, causing net revenues to decline versus the prior year period. Somewhat offsetting the decline in structured finance revenues was an increase in fixed income capital markets fee revenues, which yielded a relatively stable other income versus the prior year period. As we've noted in the past, it's important to recognize that both the fixed income services and structured finance businesses at Hilltop Securities can be volatile from period to period as they're impacted by interest rates, overall market liquidity, and production trends. Turn into page 12. Non-interest expenses decreased from the same period in the prior year by $29 million to $260 million. The decrease in expenses versus the prior year third quarter was supported by decreases in variable compensation of approximately $14 million at prime lending and hilltop securities, which was linked to lower fee revenue generation and revenue mixed contribution. Further, fixed expenses at prime lending have been reduced by over $14 million versus the prior year period, reflecting the ongoing work to resize our mortgage operations to support the current environment. Looking forward, we expect expenses other than variable compensation will remain relatively stable around $190 million per quarter as the ongoing focused efforts related to streamlining our operations and improving productivity continue to support lower headcount and improve throughput across our franchise, helping to offset the ongoing inflationary pressures that persist in the market. I'm moving to page 13. Third quarter average HFI loans equated to $8 billion, stable with second quarter 2023 levels. On a period-end basis, HFI loans declined versus the second quarter of 2023 by $150 million driven by declines in mortgage warehouse lending and the net declines in the one to four family mortgage portfolio. We expect that loan growth will continue to slow into 2024 as one to four family retention levels remain low and commercial lending activity continues to contract. Currently, we are expecting full-year average bank loan growth of 2% to 4% during 2023, excluding mortgage warehouse lending and any retained mortgages from prime lending. Turning to page 14. Overall credit quality has remained resilient through the third quarter. That said, during the period, we did have a few credits move into special mention as those customers' cash flows and resulting coverage ratios have deteriorated. working with those customers and monitoring their performance closely to ensure that we take prudent steps to manage our exposure over time as shown in the bottom left chart we recognize net recoveries of 1.6 million dollars during the third quarter further the graph in the upper right highlights that npa levels have remained relatively stable in the third quarter of 2022 providing additional support that at this point the cycle remains reasonably benign currently We do not see any prevailing trends that cause us outsized concern. We are monitoring our loans and borrowers closely as higher interest rates, potentially lower utilization rates in certain segments of commercial real estate, and an expected slowdown in economic activity could have a negative impact on our clients and our portfolio. As is shown on the graph at the bottom right of the page, the allowance for credit loss coverage at the bank ended the third quarter at 1.41%, including mortgage warehouse lending. I'm turning to page 15. As we move into the fourth quarter of 2023, there continues to be a lot of uncertainty in the market regarding interest rates, inflation, and the overall health of the economy. That said, we revised some of our outlook metrics to reflect the shorter window of time remaining in 2023. We are pleased with the work that our team has delivered to position our company for times like these, and our teammates across our franchise remain focused on delivering great customer service to our clients attracting new customers to our franchise, supporting the communities where we serve, maintaining a moderate risk profile, and delivering long-term stockholder value. Current outlook for 2023 reflects our current assessment of the economy and the markets where we participate. Further, as the market changes and we adjust our business to respond, we will provide updates to our outlook on future quarterly calls. Operator, that concludes our prepared comments, and we'll turn the call back to you for the Q&A section of the call.
spk05: Thank you. Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press the star followed by the one on your touch-tone phone. You will hear a three-tone prompt acknowledging your request. Should you wish to decline from the polling process, please press the star followed by the two. If you're using a speakerphone, please lift the handset before pressing any keys. One moment for the first question. Just as a reminder, to register for a question, please press the star followed by the one on your touchstone phone. One moment for the first question. Thank you. Our first question comes from Thomas Wendler from . Please go ahead. Your line is open.
spk02: Hey, good morning, everyone. Good morning. I just wanted to touch on the CNI contraction we saw last quarter. Can you give us some color there? Was it lower utilization or what drove those lower balances?
spk06: CNI includes our mortgage warehouse lending business. And by virtue of that, we saw a decline there just over $90 million in the quarter. Drove the majority of it.
spk02: Thank you. Then just moving over to broker-dealer contracts. Typically, we see a strong close for the year in 4Q. Should we be expecting the same there this year?
spk00: I think that the public finance business typically builds throughout the year and has a pretty solid fourth quarter. So I think in public finance, we would, we're optimistic about that. Albeit, you know, I think that we did have a pretty strong quarter of Hilltop Securities in our structured finance business, which is volatile.
spk02: and uh we could see that um decline from from this third quarter okay thank you i appreciate the color and then uh one final one for me uh with the stock now trading near tangible value what's your appetite for a buyback
spk00: We're, you know, we constantly evaluate it, and we've shown that we will act when we think it's appropriate. You know, I think also in the context of the environment, we've been cautious this year.
spk02: All right. I appreciate all the color. Thank you.
spk05: Thank you. Our next question comes from Woody Lay from KBW. Please go ahead. Your line is now open.
spk03: Hey, good morning, guys. Good morning. Good morning. Wanted to start on the increase to special mention loans. Any color you could give on sort of what drove that increase quarter over quarter?
spk06: You know, I think we had a few credits move over. One in particular out of our C&I business that, again, we're just monitoring the cash flows. We're monitoring across our portfolio. They've seen some deterioration. Again, so we're, as is noted there in special mention, we're monitoring it much more closely and following up very regularly with the client, working with them to try to help them work through a challenging environment here. But nothing, again, no large portfolio for other concentrations across the real estate book, principally a C&I client that is experiencing some cash flow challenges.
spk03: Got it. And so if I look on the ACL breakdown on slide six and the 2.7 release related to economic conditions, is that related to the to the Moody's forecast, or is that driven by qualitative factors? Any color you can give there?
spk06: That's the Moody's forecast, just period on period. We maintain consistently the S7 scenario, so we were using the S7 scenario both prior quarter and current quarter, and just modest improvements in the overall economic outlook, both timing and depth of potential recession in the future. But not a qualitative assessment.
spk03: Got it. And then last for me, just another question on capital. I mean, CET1 continues to increase from here. Capital levels are super strong. It sounds like buybacks in this current environment might be unlikely. Is the top priority for deploying that capital through M&A or any thoughts there?
spk00: We believe that through the cycle, deploying capital in M&A will be the highest return. You know, and so we're actively evaluating that. I think on the capital front in the near term, as we've seen, you know, muted loan growth and, you know, we saw some contraction in our balance sheet in the quarter, and then we'll also be generating capital and earnings. You know, I would see our capital continue to go higher. All right. Thanks to the caller. Thank you.
spk03: Thank you.
spk05: Thank you. Our next question comes from Grove Dike from Piper Sandler. Please go ahead. Your line is open.
spk04: Hey, good morning, guys. Morning. Morning. So I just wanted to kind of touch on some of the NIM and balance sheet topics here, specifically noninterest bearing. Obviously, it took another step down this quarter, which is kind of what we've seen across the industry. I'm just wondering if you guys have any color on trends so far this quarter and what kind of you're expecting going forward and maybe when you think balances might level out on non-interest bearing.
spk06: Yeah, so you said that we've seen, I'd say, a reasonably consistent trend down in non-interest bearing from a mixed perspective. We expect that likely continues. We've got a good solid base of non-interest bearing related to our treasury services. offerings that we provide to customers. That said, as rates move higher, obviously the appetite from customers to move their excess deposits into interest-bearing products continues to grow. And so we would expect to see non-interest-bearing deposits decline, at least from our perspective, in the next couple of quarters. and uh really remixing into interest bearing so uh our view is deposits remain reasonably steady and stable from here for the next couple of quarters uh but we continue to remix from non-interest bearing into uh interest bearing products uh over time okay great that's helpful um and then i guess just on the on the on the nii um and the name obviously maybe a little bit
spk04: if your guide's 2.5% to 2% to 5%, I guess, for the full year, are you guys implying maybe that NII and 4Q takes a similar step down as we saw this quarter, I guess on a smaller balance sheet, and then them kind of holds in a little bit better?
spk06: Yeah, I think from a, you know, so we'll talk about NII first. So from an NII perspective, we're expecting it will continue to trend modestly lower, not a significant step function lower, but modestly lower As you noted, the balance sheet has contracted modestly, and from an overall yields perspective, we are expecting deposit costs to continue to move higher. So, without a significant shift or change in the Fed funds rate, our loan yields are moving higher, but moving higher at a much more pace versus where deposit yields are, and we do expect to see those deposit yields move higher. So, from an NII perspective, we'd expect it to continue to step lower. From a NIM perspective, we'd also expect that to continue to trend lower. I think we've said that NIM over time likely moves toward 295, and I think depending on the number of rate movements through the Federal Reserve, which With each rate movement, we've said we would expect further deterioration in NIM. I think we're expecting NIM to be between 290 and 3%, given our current rate expectations that we outlined in our prepared comments.
spk04: That's very helpful. I guess the last thing I wanted to hit on was just the provision going forward. Obviously, you guys tightened the guidance a little bit this quarter. I'm just kind of wondering what you guys are seeing into 2024 as it relates to the provision line and charge-offs, and it sounded like, I mean, just based on the guidance, that you guys are a little bit more optimistic or the scenario is a little more optimistic on the economy from here.
spk06: Yeah, I think, you know, as we try to say in our prepared comments, the ACL, which, you know, changes, which drives the provision, can be volatile from quarter to quarter. As you saw last quarter, we took a pretty significant provision, just under $15 million this quarter, near zero. you know, the economic outlook can move and change. That obviously will impact it pretty substantially. From a credit management perspective, you know, as I noted in my comments, we haven't seen any material deterioration in large swaths of the portfolio, as we noted. We're looking at office closely. We're looking at retail closely. We're looking across the portfolio for any negative migration as it relates to interest rates and overall interest payments relative to cash flows. But again, to date, we haven't seen anything systemic in the portfolio that would cause us to expect the charge off step up materially. But again, we highlight in all of our comments and try to put the announcement out there that the allowance and therefore provision can be volatile based on the economic scenarios quarter to quarter.
spk04: Okay, I understand. That's helpful. Thanks, guys.
spk02: Thank you.
spk05: Thank you. There are no further questions. Ladies and gentlemen, this concludes today's conference call. We thank you for your participation and ask you to please disconnect your lines.
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