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Edited Transcript of HTH earnings conference call or presentation 26-Jul-19 1:00pm GMT

Q2 2019 Hilltop Holdings Inc Earnings Call

DALLAS Aug 3, 2019 (Thomson StreetEvents) -- Edited Transcript of Hilltop Holdings Inc earnings conference call or presentation Friday, July 26, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Erik Yohe

Hilltop Holdings Inc. - SVP of Corporate Development

* Jeremy Blue Ford

Hilltop Holdings Inc. - President, CEO & Director

* William B. Furr

Hilltop Holdings Inc. - Executive VP & CFO

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Conference Call Participants

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* Brady Matthew Gailey

Keefe, Bruyette, & Woods, Inc., Research Division - MD

* Brett D. Rabatin

Piper Jaffray Companies, Research Division - Senior Research Analyst

* Edward Christopher Gamaitoni

Compass Point Research & Trading, LLC, Research Division - MD & Head of Research

* Matthew Covington Olney

Stephens Inc., Research Division - MD

* Michael Edward Rose

Raymond James & Associates, Inc., Research Division - MD of Equity Research

* Michael Masters Young

SunTrust Robinson Humphrey, Inc., Research Division - VP and Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the Hilltop Holdings Second Quarter 2019 Earnings Conference Call and Webcast. (Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to Erik Yohe. Please go ahead.

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Erik Yohe, Hilltop Holdings Inc. - SVP of Corporate Development [2]

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Good morning. Joining me on the call this morning are Jeremy Ford, President and CEO; and Will Furr, CFO.

Before we get started, please note that certain statements during today's presentation that are not statements of historical fact, including statements concerning such items as our outlook, business strategy, future plans and financial condition 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 and financial condition 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, prepurchase accounting taxable equivalent net interest margin, 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 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.

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Jeremy Blue Ford, Hilltop Holdings Inc. - President, CEO & Director [3]

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Good morning. Before I get started, I would like to welcome Erik Yohe as our new Head of Investor Relations. Erik and I have worked together for a long time, and I know he will do a great job.

For the second quarter 2019, Hilltop reported net income of $57.8 million or $0.62 per diluted share, which represents a 77% increase compared with the $0.35 reported during the same quarter last year. Additionally, Hilltop delivered a return on average assets of 1.74% and a return on average equity of 11.6%. This quarter reflected the strength and diversification of our business model with the bank, mortgage business and broker-dealer all delivering significant year-over-year pretax income growth.

Average loans held for investment excluding broker-dealer loans grew by $740 million or 13% compared to the prior second quarter. The large drivers were our Bank of River Oaks acquisition in Q3 2018 and our national warehouse lending business, which increase its average balance by $225 million or 81% from second quarter 2018.

We continue to make paying a healthy pipeline of unfunded commitments and aim to prudently grow our loan portfolio by fostering our bank's valued relationships. This was a strong quarter for PrimeLending, as reflected by improvements versus Q2 2018 in both gain-on-sale margin and operating costs. Also the structured finance business at HilltopSecurities yielded a net revenue increase of $31 million compared to prior year from optimal market conditions and the strategic alignment with the capital market business.

Through the first 6 months of 2019, we have returned $40 million to our stockholders in dividends and share repurchases. Under our Board-authorized share repurchase program, $25 million remains available through January 2020.

Credit quality remains a high priority, and we continue to focus on maintaining our underwriting discipline. For the second quarter, nonperforming assets were $53 million, down slightly linked quarter and down $32 million compared to the second quarter 2018.

Moving to Page 4. The bank had a healthy quarter with pretax income increasing by $13.5 million or 41% from prior year. This increase was partially driven by a reduction in noninterest expense of $7.3 million attributed to a wire fraud and indemnification asset amortization in Q2 2018 as well as operational efficiency within the business. Additionally, higher yields on higher loans balances delivered net interest income growth of $5.5 million despite lower accretion during the period. In the second quarter, the bank closed 2 underperforming branches resulting in 62 full service branches.

Mortgage pretax income of $21.8 million for the quarter, an improvement of $8.4 million from Q2 2018, was the result of disciplined pricing and expense management despite a 4% decline in origination volume. Multiple initiatives implemented during the second half of 2018 resulted in $6 million lower fixed cost and $4.3 million higher origination and closing cost fees. Gain-on-sale margins increased by 15 basis points from Q2 2018, though remained stable over the trailing 12 months. With elevated refinancing volume, we expect margin compression to persist and remain focused on delivering profitable volumes through the second half of 2019.

The broker-dealer reported a very strong quarter with a pretax margin of 18.9% on increased net revenues of 35% versus prior year. The increase was largely driven by structured finance, which experienced higher production levels and strong secondary market margin at 10-year rates decline. We feel good about the path of our new CEO, Brad Winges, and his leadership team are on to build upon HilltopSecurities established business line.

Results were relatively stable compared to prior year in our insurance business as we reported a pretax loss of $2.8 million for the quarter with a combined ratio of 113%. Notably, we have begun to realize written premium growth in Texas and other core states.

In January, we introduced our platform for growth and efficiency initiatives, which includes a broad set of projects to operate -- to lower operating cost and build a foundation for future growth. During the quarter, we benefited from the previously referenced mortgage efficiency and capital market strategic alignment initiatives as well as realized savings from our consolidated shared services and strategic sourcing. While we expect the benefits to largely materialize in 2021, we are encouraged by the progress being made.

This past quarter, I traveled with several of our business leaders to our major markets in Texas and nationwide and met with employees from across all lines of businesses. It gave us the opportunity to have candid roundtable discussions and learn about what our people are seeing in their markets. I came back inspired by our leadership and overwhelmed by the quality of our people in the field. The strength of Hilltop is in our talented people and the impact they have on our customers and communities.

With that, I will now turn the presentation over to Will to walk through the financials.

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William B. Furr, Hilltop Holdings Inc. - Executive VP & CFO [4]

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Thank you, Jeremy. I'm starting on Page 5. As Jeremy discussed, for the second quarter of 2019, Hilltop reported $57.8 million of income attributable to common stockholders, equating to $0.62 per diluted share.

During the second quarter, Hilltop reported a $700,000 recovery and provision for loan losses. In the quarter, the bank recaptured $6.2 million of allowance for loan loss, principally related to ongoing improvement in the oil and gas portfolio and a significant recovery from a previously classified oil and gas loan.

The second quarter provision includes approximately $3 million of net charge-offs or 18 basis points of average bank loans on an annualized basis. Credit quality during the quarter remained solid. But even with the recent strong performance, we're monitoring our portfolio rigorously to evaluate areas that may be experiencing any weakness. Currently, we do not see any industries or concentrated exposures that are experiencing material deterioration.

During the second quarter, revenue-related purchase accounting accretion was $6.4 million and expenses were $2 million, resulting in a net purchase accounting pretax impact of $4.4 million for the quarter.

In the current period, the purchase accounting expenses largely represent amortization of deposits and other intangible assets related to prior acquisitions. Related to the purchase loan accretion, as the purchase portfolio balances continue to decline, we expect scheduled interest income related to purchase loan accretion to average between $4 million and $6 million per quarter for the remainder of 2019. Hilltop's capital position remains strong with a period end Common Equity Tier 1 ratio of 16.32% and a Tier 1 leverage ratio of 13%.

I'm moving to Page 6. Net interest income in the second quarter equated to $108 million, including $6.4 million of purchased loan accretion. Net interest income increased $3 million or 3% versus the same quarter in the prior year. The growth in net interest income was driven by asset growth, including the acquired loans in Houston and improvement in net interest margin, which expanded by 3 basis points versus the prior year period. Net interest margin equated to 3.49% in the second quarter and included 23 basis points of purchase accounting accretion. The prepurchase accounting taxable equivalent net interest margin equated to 3.26%, which improved by 8 basis points versus the same period in the prior year. On a linked-quarter basis, taxable equivalent prepurchase accounting net interest margin declined by 12 basis points, resulting from lower yields on loans held for sale and a 6 basis point increase in the interest-bearing deposit costs.

During the second quarter, long-term interest rates and more directly 10-year rates continued the decline that began earlier in the year. Year-to-date, the 10-year treasury yield has declined by approximately 65 basis points, which has a direct impact on Hilltop's loans held-for-sale yields, albeit on a lag basis.

Overall, the average yield on loans held for sale during the second quarter dropped by 32 basis points to 460 basis points, putting pressure on net interest margin during the quarter. Given the continued declines in the 10-year rates during the second quarter, we expect that yields on loans held for sale will continue to decline further during the third quarter.

In addition, bank loan yields have increased as compared to the same period prior year, but the competitive pressure continues to intensify on both new and renewed loans. As expected, we've seen deposit betas continue to increase even as the Federal Reserve did not move short-term rates higher. Hilltop's cumulative beta for interest-bearing deposits from December of 2015 has been approximately 46%, remaining below our through-the-cycle model ranges of 50% to 60%.

With the change in market sentiment and the market's indication that the Fed could reduce rates throughout the remainder of 2019, we expect the deposit cost will reach peak levels later this year. With the combination of lower loan held-for-sale yields and somewhat higher deposit costs, we expect additional pressure on net interest margin for the remainder of the year. Therefore, we are maintaining our full year average prepurchase accounting net interest margin outlook of 3.25% plus or minus 3 basis points. We will continue to revisit our assumptions based on the outcome of future Federal Reserve rate movements, yield curve shifts and asset liability flows across our portfolios.

Quarterly average gross earning assets increased by $268 million versus the same period in the prior year. Second quarter earning asset growth was driven by the BORO acquisition and growth in our national warehouse lending business, which provides warehouse financing to third-party mortgage companies. Growth was impacted by lower average loans held for sale, which declined by $282 million versus the prior year period.

I'm moving to Page 7. Total noninterest income for the second quarter of 2019 equated to $313 million. Second quarter mortgage-related income and fees increased by $2.8 million versus the second quarter 2018. During the second quarter of 2019, the competitive environment in mortgage banking remained intense as Hilltop's mortgage origination volumes declined by $147 million or 4% versus the same period in the prior year. While mortgage volumes were challenged, gain-on-sale margins remained relatively stable during the second quarter at 333 basis points. With the recent decline in the primary mortgage rate, the business experienced improvement in the refinance market as refinance volumes grew by 28% versus the prior year. Given the improvements in the market related to lower long-term rates, we expect that full year origination volume in 2019 will be in line with full year 2018 production levels.

Regarding mortgage gain-on-sale margins, given the current competitive dynamics, our projected mix of origination business and our expectations on market rate, we expect the gain-on-sale margins will trend lower throughout the balance of 2019.

Other income increased by $35 million, driven primarily by improvements in sales and trading activities in both capital markets and structured finance businesses at HilltopSecurities. Favorable market conditions resulted in a 25% increase in structured finance mortgage-backed security volumes and improved secondary spreads. These businesses continue to realize the benefits of the investments we've been making to improve our structuring and distribution capabilities since the third quarter of 2018.

I'm moving to Page 8. Noninterest expenses increased in the same period in the prior year by $5 million to $344 million. The growth in expenses versus the prior year were driven by an increase in variable compensation of $18 million at HilltopSecurities and PrimeLending. This increase in variable compensation was going to strong fee revenue growth in the quarter. Over the past 5 quarters, we've continued to make progress in aligning our businesses to the current market conditions and driving efficiencies across the franchise. Through these efforts, headcount, non-variable compensation, professional services costs and marketing and development expenses continue to trend lower as we make progress against our efficiency initiatives.

During the second quarter, Hilltop incurred $2 million in costs related to the ongoing core system enhancements, and we do expect that these related expenses will increase for the remainder of 2019.

Moving to Page 9. Total average HFI loans grew by 11% versus the second quarter of 2018. Growth versus the same period in the prior year was driven by loans acquired in Houston during the third quarter of 2018 and growth in our mortgage warehouse lending business. Based on current production trends, seasonal and scheduled paydowns, the current competitive environment and our focus on high-quality conservative underwriting, we continue to expect the full year average HFI loans will grow between 4% and 6% in 2019.

Turning to Page 10. As previously noted and as shown on this chart on the top right of the slide, Hilltop's businesses have maintained solid credit quality as nonperforming assets have declined $32.5 million from the same period in the prior year. The allowance for loan loss to HFI loans ratio equates to 83 basis points at the end of the second quarter of 2019 and the decline from the first quarter of 2019 reflects the aforementioned allowance recapture. It is important to note that we maintain approximately $90 million of remaining discounts across the purchase loan pools, and these discounts provide additional coverage against future losses.

Moving to Page 11. Average total deposits are approximately $8.3 billion and have increased by $483 million versus the second quarter of 2018. Interest-bearing deposit costs have risen by 6 basis points from the first quarter of 2019 as competitive pressures remain and clients are actively seeking higher rates of return on their deposits by migrating monies from noninterest-bearing and savings products into higher-yielding money market, CD and investment products. We continue to focus on growing deposits through the expansion of existing relationships and new client acquisition while managing overall deposit cost as aggressively as possible while remaining competitive.

Moving to Page 12. During the second quarter of 2019, PlainsCapital Bank continued to demonstrate solid improvement in profitability, generating approximately $47 million of pretax income during the quarter. The quarter's results reflect the benefits of the growth in the Houston market, the aforementioned allowance recaptured, which equated to $6.2 million and improvement in the efficiency ratio versus the prior year period of 10.6%. The improvement in the efficiency ratio was driven by both revenue growth and lower expenses versus the prior year period. Of note, the second quarter of 2018 included $4 million of expense related to the previously reported wire fraud and $2 million loss share related expenses. The focus at PlainsCapital remains consistent: provide great service to our clients, drive profitable growth while maintaining a moderate risk profile and delivering positive operating leverage by balancing revenue growth and expense efficiency.

I'm turning to Page 13. PrimeLending generated a pretax profit of $22 million in the second quarter of 2019 driven by the efficiency efforts that the leadership team at PrimeLending executed during the third and fourth quarters of 2018 and has continued in the 2019. While origination volumes declined by 4% versus the same period in the prior year, the combination of back-office efficiencies and branch performance management have yielded significant reduction in operating expenses, which declined by approximately $6 million versus the same period in the prior year. Further supporting the improved results is our focus on pricing and fees. Mortgage origination fees have increased from the same period in the prior year by 12 basis points, which yielded a small increase in fees versus the prior year even as origination volumes declined. The focus for PrimeLending is to generate profitable mortgage volume, continue to focus on operational efficiencies and successfully launch our new mortgage loan operating system.

Turning to Page 14. HilltopSecurities delivered a pretax profit of $22 million for the second quarter of 2019, driven by solid execution in the structured finance and capital markets businesses, which have benefited from both our ongoing investments in structuring, sales and distribution and improved market conditions. While activity was strong in the quarter, results from both of these businesses can be volatile as market rates, spreads and volumes can change significantly from period to period.

Related to Public Finance, while revenues declined modestly versus the same period in the prior year, we are investing in our franchise to support long-term growth by strategically hiring bankers to support client expansion and acquisition. Based on current market activity, we expect results in this business to continue to improve throughout the remainder of 2019.

The focus for HilltopSecurities is to grow profitable revenue, optimize operating expenses, manage marketing liquidity risks within a moderate risk profile and finalize the deployment of the new core operating system.

Moving to Page 15. National Lloyds recorded a $3 million pretax loss for the quarter, which reflects seasonal increases in storm activity and client-related losses. During the second quarter, the business delivered modest improvement in written premiums in our core states. Growth in these core states remains the primary focus for 2019.

I'm moving to Page 16. For 2019, we're maintaining the full year outlook for our key balance sheet items, loans and deposits. Given the actual changes in market interest rates and our expectation for rates over the coming quarters, we are adjusting our full year net interest income range lower to reflect our asset-sensitive position at PlainsCapital, the impact of lower market rates on loan-held-for-sale yields and our expectation of increasing deposit costs.

To reflect the strength in our fee businesses, we are adjusting our noninterest income outlook higher to reflect the results during the first half of 2019 and the improvement in current market conditions. Our noninterest expense outlook range is slightly higher as variable expenses will continue to be correlated to our fee revenue businesses.

Lastly, as credit quality has remained solid and as a result of performance in the first half of 2019, we are adjusting our full year provision outlook range lower.

This outlook represents our current expectations with respect to the markets, rates and overall economic activity. These, however, may change throughout the remainder of the year, and we will provide updates as necessary on our quarterly calls going forward.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question today comes from Brady Gailey with KBW.

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Brady Matthew Gailey, Keefe, Bruyette, & Woods, Inc., Research Division - MD [2]

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

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Jeremy Blue Ford, Hilltop Holdings Inc. - President, CEO & Director [3]

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

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Brady Matthew Gailey, Keefe, Bruyette, & Woods, Inc., Research Division - MD [4]

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

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William B. Furr, Hilltop Holdings Inc. - Executive VP & CFO [5]

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Second quarter kind of onetime pipeline marks, et cetera, of approximately $6 million. If I just double-click there a little bit, I think what you saw is that at the end of the first quarter, we had a rally or the 10-year declined materially in the last couple of weeks of March and so that created a price mark volatility at the very end of the quarter. During the second quarter, the 10-year declined more ratably through the period, it wasn't perfectly straight line, but more ratably through the period. And so the gains that came from that were -- that were at the end of the quarter, that were onetime in nature, were smaller. And the overall portfolio balances of securities was lower as we've continued to kind of move volume through.

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Brady Matthew Gailey, Keefe, Bruyette, & Woods, Inc., Research Division - MD [6]

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

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William B. Furr, Hilltop Holdings Inc. - Executive VP & CFO [7]

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

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Operator [8]

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Our next question comes from Michael Rose with Raymond James.

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Michael Edward Rose, Raymond James & Associates, Inc., Research Division - MD of Equity Research [9]

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

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William B. Furr, Hilltop Holdings Inc. - Executive VP & CFO [10]

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I think that's a way to think about it. So we've got 2 things happening. First, the Houston asset, the Houston business that we acquired last year, August 1, will come into the comparative period in the third quarter. So that will have an impact. When we purchased that bank, it had loans of about $327 million at the close, so obviously that will come in from an average comparative perspective. And then the national warehouse business, as we've said, is outperforming and we do expect they will have seasonal declines in balances as those business flows naturally occur later in the third and fourth quarters.

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Michael Edward Rose, Raymond James & Associates, Inc., Research Division - MD of Equity Research [11]

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

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William B. Furr, Hilltop Holdings Inc. - Executive VP & CFO [12]

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I think we expect margin again will be under some pressure in the back half of the year, more so on the asset side than on the deposit side. As I noted in my comments, we expect deposit costs will peak in the second half. We are expecting 2 Fed rate reductions that's within our current forecast internally. And as a result of that, we expect that deposit costs will peak and then we will lag. There will be a lag between whenever the Reserve -- Federal Reserve moves and our ability to actually reduce rates on clients because, again, what we're seeing and we've said this, is a really competitive deposit market, especially for those -- for our competitors that have higher loan to deposit ratios. They remain focused on growing their deposits and by virtue of that, that's keeping deposit costs higher and will cause us to need to lag a bit.

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Michael Edward Rose, Raymond James & Associates, Inc., Research Division - MD of Equity Research [13]

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

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Jeremy Blue Ford, Hilltop Holdings Inc. - President, CEO & Director [14]

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Yes. Well, I mean we -- so as we said, we have $25 million left of the authorization and we endeavor to be active during the open-market period.

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Operator [15]

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Our next question comes from Michael Young with SunTrust.

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Michael Masters Young, SunTrust Robinson Humphrey, Inc., Research Division - VP and Analyst [16]

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

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William B. Furr, Hilltop Holdings Inc. - Executive VP & CFO [17]

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I think our perspective is that the expenses in the quarter are a solid place to start from a run rate perspective. Obviously, we continue to focus on driving efficiencies. As we noted in our prepared comments, the second quarter of 2018 did have 2 significant items whether -- both the fraud loss that we noted as well as some loss share related expenses that are no longer kind of in the run rate, but again the baseline that we have, this is a pretty clean quarter from an expense perspective.

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Michael Masters Young, SunTrust Robinson Humphrey, Inc., Research Division - VP and Analyst [18]

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

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William B. Furr, Hilltop Holdings Inc. - Executive VP & CFO [19]

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

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Michael Masters Young, SunTrust Robinson Humphrey, Inc., Research Division - VP and Analyst [20]

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

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Jeremy Blue Ford, Hilltop Holdings Inc. - President, CEO & Director [21]

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Well, I guess on the -- just the non-comp expense, I would probably look at that as a pretty good proxy for our run rate and then the other expenses were elevated, obviously related to variable compensation.

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Michael Masters Young, SunTrust Robinson Humphrey, Inc., Research Division - VP and Analyst [22]

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

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William B. Furr, Hilltop Holdings Inc. - Executive VP & CFO [23]

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

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Operator [24]

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Our next question comes from Matt Olney with Stephens.

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Matthew Covington Olney, Stephens Inc., Research Division - MD [25]

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I wanted to circle back on the mortgage discussion. I believe Will mentioned that the gain-on-sale margin could be pressured for the remainder of the year. Did I hear that correctly? Is that based off a 3.33% baseline margin from 2Q? It looks like it bottomed in 1Q and improved in 2Q. Just want to appreciate your outlook there.

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William B. Furr, Hilltop Holdings Inc. - Executive VP & CFO [26]

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Yes. So from a gain-on-sale margin perspective, we obviously troughed last year Q2 3.17%, and we've been I think reasonably in a range of 3.30% to 3.35%. And so I wouldn't pick a single basis point starting spot. But in that 3.30% to 3.35%, what we're seeing is as the market moves to something of a refinance market, which would lower rates and we see higher refinance percentages in our portfolio and we're seeing that volume start to increase as we did in the second quarter, that will have an impact on yields. And then the competitive pressures that are in the market and if you will, the oversupply in the marketplace in the context of just mortgage loan officers, mortgage bankers has not abated materially. And so we are continuing to see price pressure there, but really it's a mix of our overall origination that will cause that gain-on-sale margin to be under pressure through the second half.

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Matthew Covington Olney, Stephens Inc., Research Division - MD [27]

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

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Jeremy Blue Ford, Hilltop Holdings Inc. - President, CEO & Director [28]

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

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Operator [29]

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The next question comes from Chris Gamaitoni with Compass Point.

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Edward Christopher Gamaitoni, Compass Point Research & Trading, LLC, Research Division - MD & Head of Research [30]

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

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William B. Furr, Hilltop Holdings Inc. - Executive VP & CFO [31]

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

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Edward Christopher Gamaitoni, Compass Point Research & Trading, LLC, Research Division - MD & Head of Research [32]

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

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William B. Furr, Hilltop Holdings Inc. - Executive VP & CFO [33]

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

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Operator [34]

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Next question comes from Brett Rabatin with Piper Jaffray.

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Brett D. Rabatin, Piper Jaffray Companies, Research Division - Senior Research Analyst [35]

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

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William B. Furr, Hilltop Holdings Inc. - Executive VP & CFO [36]

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

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Brett D. Rabatin, Piper Jaffray Companies, Research Division - Senior Research Analyst [37]

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

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Jeremy Blue Ford, Hilltop Holdings Inc. - President, CEO & Director [38]

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

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Operator [39]

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Next question is a follow-up question from Michael Young with SunTrust.

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Michael Masters Young, SunTrust Robinson Humphrey, Inc., Research Division - VP and Analyst [40]

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

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Jeremy Blue Ford, Hilltop Holdings Inc. - President, CEO & Director [41]

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

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Michael Masters Young, SunTrust Robinson Humphrey, Inc., Research Division - VP and Analyst [42]

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

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Jeremy Blue Ford, Hilltop Holdings Inc. - President, CEO & Director [43]

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

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Operator [44]

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