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Text: Except to the extent required by law, we expressly disclaim any obligation to update earlier statements as a result of new information.
Despite the ongoing pandemic and most of our team working from home, Hilltop had an unbelievable quarter, with record breaking mortgage earnings that more than offset a sizable and judicious reserve build at the Bank.
Before getting into the results of the quarter, I would like to start on Slide 3, and provide an update on our response to the COVID-19 pandemic.
From an operation standpoint, we are very fortunate to have realized Hilltop over the past three years by building a robust holding company and integrating the functional departments of our operating companies.
This is enabled us to ensure business continuity while prioritizing the health and safety of our employees.
We continue to operate with the majority of our employees working remotely, so that essential staff can work safely from our offices.
We are tracking all COVID-19 cases to ensure the quarantine of affected employees and to ensure impacted offices are cleaned so that they can get back open as soon as possible.
We are also providing frequent and open communication so that everyone adheres to safety protocols and feel connected.
While we did see an increase in employee cases this past quarter, the overall number remains low and has not had a material impact on our businesses.
Since the start of the pandemic, we have been in constant contact with our clients to continue to serve their needs, and in particular provide relief and support where required.
By partnering with our borrowers that had been impacted by COVID-19, the Bank has provided deferrals on $1 billion of loans of which $619 million were principal only and $349 million for principal and interest for the more severely impacted borrowers.
As the initial 90-day deferrals are starting to come due, the Bank has already received requests for approximately $120 million of second-round modification.
We will be reviewing each of these requests on a case-by-case basis to ensure they are need-based and assess their viability.
Certain industries including hotel and restaurants, have been more severely impacted.
So we anticipate a large portion of those credits will be requesting second deferral.
As well, the Bank booked over 2,800 PPP loans totaling $672 million.
This was a huge effort by our bankers, who were able to help many customers in need.
As the pandemic persists, we will continue to provide personal banking assistance including the waving of fees, increased daily spending limit and the suspension of residential foreclosure activity.
Moving to Slide 4.
For the second quarter of 2020, Hilltop reported net income of $128.5 million or $1.42 per diluted share resulting in a 3.3% return on average assets and a 23% return on average equity.
Net income from continuing operations was $97.7 million.
As noted at the bottom of the page, the results for National Lloyds this period and the gain on its sale are included in discontinued operations.
This quarter illustrates the strength of our businesses and the importance of diversification.
With the mortgage and broker-dealer businesses both delivering strong growth from fee income that alleviated the impact of the provision at the Bank.
Favorable market conditions aided our results, but I'm most proud of our team for working closely together and executing on the opportunities that arose.
On June 30, the National Lloyds sales to Align Financial closed for total cash proceeds of $154 million, resulting in a net gain on sale of $32 million, which was non-taxable.
This was a great outcome for both parties.
Hilltop also had an important strategic accomplishment in the quarter.
With the successful issuance of $200 million of subordinated debt, which further bolsters our liquidity and capital to persevere the current recession and to enhance our position to take advantage of future opportunities.
As for managing risk.
Net charge-offs for the period were $16.4 million, which included $12.5 million that was the oil and gas credit that was reserved for in Q1 2020.
The allowance for credit losses increased by $49.6 million this quarter as Hilltop built its loan reserve to reflect the deteriorated economic outlook from Q1 2020.
We also continue to enhance our liquidity position and ended the period with $6.6 billion of cash, security and secured borrowing capacity.
Moving to Slide 5.
PlainsCapital Bank recorded a pre-tax loss of $17.5 million largely due to our sizable CECL provision of $66 million that was partially offset by stable net interest income and lower operating expenses.
The Bank's pre-provision net revenue increased 5% from the second quarter 2019.
Notably, Jerry and the Bank team did a great job growing PPNR while working tirelessly to process PPP loan and borrower deferral request.
PrimeLending had an outstanding quarter and generated pre-tax income of $138 million, an increase of $116.5 million from Q2 2019.
That was driven by a 54% increase in origination volume and a 35 basis point increase in gain on sale margins.
Steve Thompson and the entire PrimeLending team worked over time to process the overwhelming volumes and they took advantage of the industry's oversupply by raising prices and retaining servicing.
HilltopSecurities, increased pre-tax by $6 million to $28 million, driven by profitable growth in the fixed income services and structured finance businesses.
Brad Winges and the HilltopSecurities team are well under way in raising the caliber and profile of the firm to become the preeminent municipal focused investment bank.
Additionally, they completed the major system conversion for HilltopSecurities in the quarter.
Moving to Slide 6.
Hilltop has a synergistic and durable business model, that is something we have been building toward -- throughout the life of our company.
Through acquisitions, we initially integrated our company for capital and funding purposes.
Over the past three years, we have largely implemented our platform for growth and efficiency initiatives by integrating the shared services departments and executing on efficiency projects to build a scalable platform.
And now with the sale of National Lloyds we have solidified our business model, which is a franchise anchored by PlainsCapital Bank and augmented with powerful fee income businesses in PrimeLending and HilltopSecurities.
We have made significant investments in talented professionals and system, and believe we are in a solid position to grow these core businesses.
I'll start on Page 7.
As Jeremy discussed, for the second quarter of 2020, Hilltop reported consolidated net income attributable to common stockholders of $128.5 million, equating to $1.42 per diluted share.
Income from continuing operations attributable to common stockholders equated to $97.7 million or $1.08 per diluted share.
Hilltop's continuing operations generated $202 million of pre-provision net revenue or PPNR during the second quarter, which brings the first half of 2020 total PPNR to $302 million.
PPNR increased by $125 million or 162% versus the prior year period.
Growth versus the prior-year period was driven by diversified revenue streams and led by strong mortgage originations.
During the second quarter revenue related to purchase accounting was $3.3 million and expenses were $1.3 million resulting in a net purchase accounting pre-tax impact of $1.9 million for the quarter.
In the current period, the purchase accounting expenses largely represent amortization of deposit and other intangible assets related to prior acquisitions.
We expect that revenue from purchased loan accretion will continue to decline as the purchase loan portfolio continues to run off.
Further, we expect the revenue from purchased loan accretion will average between $3 million and $5 million per quarter for the remainder of 2020.
Given the significant growth in earnings, coupled with the successful sale of National Lloyds, and the subordinated debt raise completed during the second quarter Hilltop's capital position has been significantly strengthened as we both address the ongoing impacts of the pandemic and position the company to take advantage of opportunities that may be presented over time.
Hilltop's period end Common Equity Tier 1 ratio equated to 18.46% and the Tier 1 leverage ratio equated to 12.6%.
I'm moving to Page 8.
Net interest income from continuing operations for the second quarter equated to $104.6 million and declined by $2.7 million versus the second quarter of 2019.
The decline in net interest income was driven by lower purchase loan accretion of $3.2 million offset by interest income from higher loan held for sale and loans held for investment during the quarter.
During Q2, Hilltop's consolidated average earning assets increased by $1.9 billion as the business experienced significant inflows of customer deposits across all product types.
Deposit growth coupled with planned actions including Hilltop's $200 million subdebt raise, an increase in acquired brokered deposits of approximately $550 million and proceeds from the sale of National Lloyds all contributed to the increase in the ending period balance of cash on deposit at the Federal Reserve which grew by approximately $1.2 billion versus the prior quarter.
In addition, the Bank generated PPP loans of $672 million, net of approximately $21 million of deferred fees which will be recognized over the life of loans.
Lastly, the mortgage warehouse lending business generated growth of approximately $120 million versus the prior quarter, as mortgage volumes surged in the second quarter.
The second quarter Hilltop consolidated net interest margin equated to 280 basis points and declined by 61 basis points versus the prior quarter.
This decline was driven by the aforementioned growth in average earning assets, the build in liquidity as well as lower yields on loans, securities and deposits.
We expect that NIM will continue to be pressured in the third quarter, after which we expect that we will begin to see a modest rebound during the fourth quarter and into the first quarter of 2021.
A significant driver of the improvement will be our efforts to reduce our cash and liquidity position over the second half of the year to between $5 billion and $6 billion.
We continue to monitor the capital markets, Hilltop's mortgage volumes and overall market functions related to liquidity and we will continue to balance our excess liquidity against the risk over time.
Turning to Page 9.
The table on the bottom right of Page 9 highlights the liquidity that we maintain at the bank as of June 30.
The Bank ended the period with over $6.6 billion of liquidity, including both cash, securities and secured borrowing sources.
Further, at period end, the parent maintained $388 million of cash, which equates to approximately 4 times annual expenses, dividends and debt service.
Moving to Page 10.
Noninterest income for the second quarter equated to $468 million.
During the period mortgage applications and locks were very robust as PrimeLending locked approximately $7.4 billion in new mortgages.
This is a record rate lock quarter for the business and reflected the impact of lower rates and better-than-expected demand for purchase mortgages across our markets.
The combination of strong lock-in origination volume and improving gain on sale spreads resulted in mortgage production and fee income increasing by $176 million versus the prior year period.
During the second quarter, gain on sale margins in our mortgage business did expand by 43 basis points versus the first quarter of 2020.
We expect the gain on sale margins will move higher during the third quarter to between 430 and 450 basis points.
Further, we expect that spreads will remain elevated versus historical levels, but begin to moderate during the fourth quarter of 2020.
During the second quarter, the securities business continued to show solid progress as fixed income capital markets delivered revenue growth of approximately $12 million and structured finance saw market conditions improve and revenue increased by $6.5 million versus the prior year.
At the period end, the mark on the structured finance loan pipeline stood at $15 million.
It remains important to note, that results from our fixed income and structured finance businesses can be volatile as market rates, spreads and volumes can change significantly from period to period.
Turning to Page 11.
Noninterest expenses increased from the same period in the prior year by $66 million to $370 million.
The growth in expenses versus the prior year were driven by the increase in variable compensation of approximately $56 million at both PrimeLending and HilltopSecurities.
This increase in variable compensation was directly linked to strong fee revenue growth in the quarter compared to the prior year period.
Non-variable personnel expenses rose versus the prior year by $8 million driven by increases in over time hour at work, notably in our mortgage operations as well as deferred compensation and project labor spend in the period.
Over the last nine quarters, we continue to make progress in aligning our businesses to the current market conditions and driving efficiencies across the franchise.
Through these efforts, headcount, professional service costs and marketing and development expenses continued to trend lower as we make progress against our efficiency and objectives.
During the second quarter, Hilltop incurred $3.5 million in costs on $5.6 million of spend related to our ongoing core system improvement.
During the second quarter, we continued to make progress and are moving into the final stages of implementation of our three core system installations.
The new core loan system has been installed throughout the mortgage business.
The securities team completed the Phase 1 implementation of the new operating platform HilltopSecurities.
And we have now begun the final deployment of the new general ledger and ERP system across Hilltop.
We expect that all of these implementations will deliver significant value to our franchise and position Hilltop for profitable growth in the future.
I'm turning to Page 12.
Total average held for investment loans grew by 9% versus the second quarter of 2019.
Growth versus the same period in the prior year was driven by $672 million of net PPP loan originations, coupled with growth in our mortgage warehouse lending business, which experienced growth of approximately $219 million versus the prior year period.
Other business loans declined versus the first quarter of 2020, as customer demand has remained soft.
Loan yields have declined over the prior four quarters and continue to decline in the second quarter.
Lower market rates, including the prime rate and LIBOR rates coupled with lower purchase loan accretion has contributed to the yield decline.
We do expect that loan yields will continue to be pressured in the coming quarters as market rates remain low and we've added $672 million in PPP loans that yield 100 basis points.
Lastly, our loan pipeline remains stable, but many clients are delaying pricing and funding on new loan commitments until they have greater clarity on the economic impact of the pandemic.
Moving to Page 13.
During the second quarter, Hilltop continued the process of building excess liquidity to prepare for the potential disruptions that may be caused by the pandemic and support outsized mortgage origination activity.
Second quarter average total deposits were approximately $11.2 billion and have increased by $2.2 billion or 25% versus the first quarter of 2020.
During the quarter, the bank swept back to the securities business approximately $200 million in deposit as the securities business can achieve a better return of those funds then the bank can earn on excess cash.
Excluding the growth from PPP deposits, the subdebt raise and the proceeds from the National Lloyds, customer deposits have continued to grow as customers retain cash until clarity emerges related to the economic activity.
As shown in the graph, the bank has been able to deliver growth in noninterest bearing deposits, which increased by approximately $600 million or 21% versus the first quarter of 2020 on an ending balance basis.
Turning to Page 14.
During this quarter, net charge-offs equated to $16.4 million or 92 basis points of total bank held for investment loans on an annualized basis.
Charge-offs during the quarter largely represent the final disposition of a single energy credit and the writedown of the assets related to real estate properties that were all reserved for during the first quarter.
While non-performing assets improved as is a percentage of criticized loans in the second quarter, it is important to note that the Bank approved $968 million in COVID-19-related loan modifications during the second quarter, and these deferrals are not reflected in the graph on this page.
Further, in the graph on the bottom right, Hilltop allowance for credit losses, the Bank's loans held for investment increased to 2.1% during the quarter.
As it relates to the allowance to credit loss to bank loans ratio, if we exclude PPP balances and our collateral maintenance loans, which we believe will have little loss content over time because of the collateral coverage of the loan types which include broker dealer margin and correspondent loans and mortgage warehouse lending loans, the coverage ratio at the end of the period equates to 2.6%.
I'm turning to Page 15.
During the second quarter, the macroeconomic outlook deteriorated materially from the outlook that we leveraged to evaluate allowance for credit losses during the first quarter.
We have presented a few key metrics for comparison in the table at the bottom of this page.
The outlook we use as our base case for CECL modeling as of June 30, reflects that GDP will fall significantly in Q2 with a material rebound during the third quarter of 2020 and then a slower, but steady improvement through the end of 2021.
Further, our base case assumes US unemployment remains elevated between 8% and 10% through at least Q4 2021.
The impact of these economic changes yielded a net allowance build of $60 million in the quarter, including the economic impacts, charge-off, and specific reserves, the allowance for credit losses increased by approximately $50 million in the second quarter.
In addition to the changes in economic factors, we incorporated model overlays to reflect ongoing reopening efforts, the potential impacts to the most at-risk portions of the portfolio included -- including the COVID-19 loan modification portfolio as well as the impact of government stimulus.
As it relates to future period, it remains very difficult to assess how the economy will react as the pandemic continues over the coming quarters.
However, assuming the economic performance generally aligns with our current base case outlook, the primary factors affecting allowance will be credit portfolio migrations and new loan originations over time.
As we've noted in the past, we do expect that allowance for credit losses could be volatile in the future, given the potential for significant shifts in the economic outlook from one reporting period to another.
Turning to Page 16.
We are updating our views of the COVID-19 impacted portfolio to represent those customer loans that requested and received a payment deferral during the period versus the broader portfolio views that we've discussed during the first quarter.
We believe that this group of loans represents the highest risk portfolio related to COVID-19 and that the relationship management credit teams are managing these relationships to monitor performance as these clients progress through these very challenging times.
As previously mentioned, the Bank approved deferrals for $968 million of loan portfolio representing approximately 13.5% of the total loan portfolio, excluding PPP loans.
Importantly, $619 million were principal only deferrals and $349 million were principal and interest deferrals.
In the table, we provided detail on how the $968 million stratified across industry segments and also the amount of allowance for credit loss in dollars and percent terms prior to these loans as of June 30.
Notably, the ACL loan coverage on this portfolio is 7.1% as of period end.
As of July 24, we have received requests for follow-on deferrals related to $122 million of loans and we'll be evaluating those requests during the third quarter.
Of the follow-on request, 56% are restaurant and bars and 36% are hotels.
We do expect that many of our hotel clients will request additional deferrals as those businesses continue to show significant stress.
As well as the case in the first round of deferrals, our top priority is protecting the principle of the bank, while working to aid our clients in progressing through these unprecedented times.
Any follow-on deferrals will be need-based and our target will be to extend for an additional 90-day period.
Moving to Page 17.
During the second quarter, the energy portfolio declined by $42 million.
The decline was driven by customer pay downs and the final resolution in charge-off of large energy credit we referenced during Q1 of 2020.
In total, the energy portfolio represents $104 million of outstanding balances and $59 million of unfunded commitments for a total exposure of $163 million.
As of June 30, our allowance for credit losses on the energy portfolio equates to $9 million or 8.7% of the outstanding balance.
Turning to Page 18.
During the second quarter of 2020, PlainsCapital Bank incurred a pre-tax loss of $17.5 million, driven by a $66 million provision expense, as previously reviewed.
The quarter's results reflect stable net and noninterest income and ongoing improvement in our operating expenses.
The efficiency ratio during the quarter equated to 54% and reflects the ongoing efforts to reduce deposit costs, lower operating costs and drive prudent revenue growth over time.
During the first quarter, and in response to the pandemic and the unknown economic impacts, we suspended the retention of single-family mortgages by the Bank.
As we move forward and assuming markets continue to function in an orderly fashion and consumer credit remains stable, we expect to begin retaining PrimeLending originating mortgages during the second-half of 2020.
Turning to Page 19.
PrimeLending generated a pre-tax profit of $138 million during the second quarter of 2020, driven by strong origination volumes that increased from the prior year by $2.1 billion or 54%.
As noted earlier, gain on sale margins expanded during the second quarter versus the prior year, as market volumes and pricing actions provided for higher spreads.
During the period, refinanced activity represented 47% of total origination.
Further, we expect that during the third quarter, the portion of originations that are refinanced transactions, will remain elevated from our historical level.
During the second quarter, Hilltop retained approximately 89% of the mortgage servicing rights related to loans sold during the period.
Beginning in March and carrying into the second quarter, the market for servicing deteriorated substantially as concerns regarding funding, servicer advances as well as margin requirements escalated as the pandemic accelerated.
Given Hilltop's strong liquidity and capital position, we were able to retain the mortgage servicing rights and the asset is now approximately $82 million.
We do expect that we will continue retaining a significant portion of the servicing rights for loans sold over the coming quarters and the asset could grow to between $150 million and $175 million by year end.
The results of our mortgage business during the quarter were very solid, and we're pleased with how our mortgage origination team is executed under some very challenging circumstances during the second quarter.
Turning to Page 20.
HilltopSecurities delivered a pre-tax profit of $28 million in the second quarter of 2020.
In the quarter, fixed income services generated solid revenue growth as their traders were able to happily negotiate challenging conditions, both in terms of pricing and liquidity.
The performance of the team demonstrates the progress we have and continue to make in this business.
We made substantial investments in the team and our broad set of capabilities, and those investments are returning dividends in 2020.
The structured finance business delivered growth versus the same period in the prior year of $6.5 million as the secondary markets for mortgage-related bonds improved from the market dislocation in March.
It remains important to note the results from our fixed income and structured finance businesses can be volatile as market rates, spreads and volumes can change significantly from period-to-period.
As noted earlier, the securities team made significant progress in launching their new operating system during the second quarter.
While this is a significant milestone, the team will continue working over the coming quarters to enhance and optimize the system.
Turning to Page 21.
Given the uncertainty surrounding the economy, specifically related to the pandemic, we're updating our 2020 commentaries, but we're not providing updated guidance or outlook.
While it is not clear exactly how the economy will rebound, or the timeline of that rebound, which we believe will be directly linked to the success in managing the virus and subsequent outbreaks, we remain focused on delivering against those items that we can control.
We're committing to the -- we're committed to the ongoing safety of our associates and our clients as well as helping our clients work through these unprecedented challenges that the pandemic has presented us all.
We remain committed to executing our platform growth and efficiency initiatives and delivering against our 2021 commitments.
Lastly, and most important, we are focused on delivering prudent growth across all of our business lines, while maintaining a moderate risk profile and delivering long-term shareholder value.

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q2 earnings per share $1.08 from continuing operations.
q2 earnings per share $1.42 including items.

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