GRP Granite Real Estate

On Monday, Hilltop Holdings Inc. (HTH) filed its 10-Q to report results for the quarter ending June 30, 2012. For the second-quarter 2012, the company’s net loss attributable to common stockholders came in at $10.7 million or 19 cent per share, down from $13.2 million or 23 cents per share in the year-ago period. Earnings per share also lagged the Zacks Consensus Estimate of a loss of 18 cents by a penny.

Results reflected higher premiums and investment income along with improved net realized gains that drove the top line, while limited total expense aided the improvement in combined ratio. However, this growth was substantially offset by higher-than-expected underwriting expenses, which in turn resulted in operating cash outflow and underwriting loss during the reported quarter.

During the reported quarter, Hilltop’s total revenue was $41.3 million, escalating 13.2% from $36.5 million in the year-ago quarter, although it fell shy of the Zacks Consensus Estimate of $42.0 million. The year-over-year upswing was primarily attributable to an 11.0% increase in net premiums earned of $36.2 million and net investment income soaring 45.5% to $3.2 million. Other income improved 7.6% year over year to $1.85 million, while net realized investment gains jumped 41.7% over prior-year quarter to $0.17 million.

Meanwhile, total expenses grew 3.5% year over year to $357.2 million, primarily due to a 10.3% increase in policy acquisition and other underwriting expenses and higher general and administration expenses. These were partially offset by a 4.9% dip in loss and loss adjustment expenses (LAE) and reduced depreciation and amortization expenses along with slightly lower interest expenses.

In addition, lower LAE and operating expenses helped Hilltop’s combined ratio to improve to 141.8% in the reported quarter from 160.4% in the year-ago quarter. Excluding catastrophic events, combined ratios for the second quarters of 2012 and 2011 would have been 106.7% and 114.6%, respectively.

Financial Update

As on June 30, 2012, Hilltop had cash and cash equivalents of $576.4 million (down from $578.5 million as on December 31, 2011) and investments worth $215.9 million (compared with $224.2 million at the end of 2011).

Total shareholder’s equity stood at $638.7 million at the end of the reported quarter, down from $655.4 million at 2011-end. Total assets also inched down to $922.1 million at the end of the reported quarter from $925.4 at 2011-end, while total liabilities increased to $283.4 million from $270.0 million at the end of 2011.

Furthermore, as of June 30, 2012, operating cash outflow stood at $1.57 million against inflow of $0.89 million at the end of year-ago quarter. At June 2012-end, Hilltop had a deposit in custody for various investments in State Insurance Departments with carrying values of $9.4 million. No shares were repurchased during the reported quarter.

Business Update

On May 9, 2012, Hilltop announced its plan to purchase U.S.-based financial services company PlainsCapital Corp. for about $536.9 million. While the deal awaits the approval from the board of both the companies, the transaction is expected to culminate by the end of this year. Accordingly, total cash of $318 million along with 27.5 million Hilltop shares will be disbursed to PlainsCapital upon successful completion of the buyout. Additionally, each share of PlainsCapital will be valued at a cash of $9 and 0.776 shares of Hilltop. Based on Hilltop's closing price of $7.96 on May 8, 2012, the total value stands at $15.18 per PlainsCapital share, thereby summing up to $536.9 million.

Headquartered in Dallas, U.S., PlainsCapital operates through its subsidiaries PlainsCapital Bank, PrimeLending, and FirstSouthwest. All of these will be acquired by Hilltop as per the purchase agreement. PlainsCapital operates in 40 locations with over 3,400 employees. Consequently, the company will become one of the subsidiaries of Hilltop.

Our Take

While Hilltop remains sufficiently liquid, we believe management will probably deploy the excess capital for acquiring other insurance businesses, as evident from the proposedPlainsCapital acquisition. The company’s expanded distribution is also driving growth of existing insurance products and should further improve the top line. However, the company’s future performance will be dependent to a great extent upon the prudent deployment of its reserves, even as the sole dependence on subsidiary NLASCO continues to restrict its long-term growth. Additionally, higher expenses and continued economic volatility continue to mar fundamental growth.

Overall, we believe that Hilltop should continue to tread ahead with its strategic approach in order to reduce expenses and capitalize on the opportunities that the markets provide on stabilization. The company should also be able to strengthen its competitive position amid arch-rivals such as PennyMac Mortgage Investment Trust (PMT) and Granite Re Inc. (GRP), once the markets rebound to improve pricing and reverse the cyclical declines.

Hence, given the long-term growth potential, we maintain a long-term Neutral recommendation on the stock, although current volatility warrants a Zacks Rank #4, which also implies a short-term Sell rating.

 
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