Ladies and gentlemen, welcome to the Hilltop Holdings first quarter 2023 earnings conference call and webcast. My name is Glenn. I'll be the moderator for today's call. If you'd like to ask a question during the presentation, you may do so by pressing star one on your telephone keypad. I will now hand you over to your host, Erik Yohe, Executive Vice President of Hilltop Holdings. Erik, please go ahead.
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 expectation 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. 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.
Thank you, Erik. Good morning. For the first quarter, Hilltop reported net income of $26 million or $0.40 per diluted share. Return on average assets for the period was 0.7% and return on average equity was 5.1%. Although there was a considerable amount of volatility in the banking industry this past quarter, we entered the year with a strong balance sheet and feel very good about the position we are in. We have always managed our capital funding and liquidity for the long term and through various potential rate environments, so we can continue to support our customers during times like this. Specifically, we have over $7 billion in available liquidity, a Common Equity Tier 1 risk-based capital ratio of 18%, and a diversified and granular deposit base.
We will continue to prioritize the health and soundness of our balance sheet and believe this will create opportunities for us over time. PlainsCapital Bank generated $58 million of pre-tax income on $13.7 billion of assets, generating a return on average assets of 1.4%. Average loans at PlainsCapital Bank increased $133 million in the quarter or 8% annualized as both core bank commercial loans and retained mortgage balances increased. The growth was strong, we are starting to see a slowdown in our pipeline as clients react to higher interest rates. Average bank deposits remained relatively stable despite the turmoil in the banking industry. Our total deposits declined 3% for the quarter, importantly, our core bank customer deposits only declined by approximately 1% from levels immediately prior to the bank failures until the week after.
Deposit declines has occurred as customers deploy their cash into projects or seek higher yielding, often government alternatives, we have not seen any notable customer attrition directly related to the after effects of the recent bank failures. Out of an abundance of caution, though, we drew down FHLB advances, which our bank previously had not utilized at all in March, and we moved an additional $300 million from Hilltop Securities Sweep Deposit Program into the bank. These moves were purely offensive as we did not need the liquidity from an operational standpoint. We have not utilized the new Fed Bank Term Funding Program, and we do not foresee a need in the immediate future.
As a result of our actions and the strong liquidity position our bank entered the year with, we ended the quarter with over $1.7 billion in cash at the Fed. Credit quality remained strong during the quarter with Non-Performing Loans declining by $3 million or 10% from the fourth quarter and a net charge-off ratio to average bank loans of 2 basis points. Overall, our bank produced strong results from Net Interest Margin expansion, minimal credit costs, and a meaningful expense discipline. Moving to PrimeLending. Loan volume and profitability remain under pressure because of the impact to consumers from persistent low housing inventory, high mortgage rates, and high home prices. As well, continued excess industry capacity is driving a hyper-competitive pricing environment as too many lenders contend for too few origination opportunities.
Until relief of some or across all of these factors occurs, meaningful expansion of production volume, gain on sale margins, and overall profitability will remain challenged. In response to these circumstances and the approximate 60% reduction in industry volume since pandemic-induced record highs, PrimeLending has taken substantial measures to resize the business and correspondingly reduce its expense base. Headcount reductions, consolidation of unprofitable branches, and targeted fixed cost adjustments were executed during the quarter. PrimeLending originated $1.7 billion in volume with a gain on sale margin of loans sold to third parties of 193 basis points. Origination volume declined by 54% from the prior year, roughly in line with overall industry volume projections of 52%. We expect pressure on the mortgage business to continue as interest rates remain elevated and low inventories persist.
Our team at PrimeLending has done an excellent job of reducing fixed costs by taking difficult, necessary actions to resize the business for what we believe will be a smaller mortgage market for the foreseeable future. Hilltop Securities realized pretax income of $13 million on net revenues of $105 million during the quarter. Pretax profit improved compared to last year's first quarter due to a 45% increase in net revenues. The revenue improvement was primarily driven by a $26 million increase in trading profits from both structured finance and fixed income services, and a $13 million increase in sweep deposit revenues from our wealth management business. The growth in revenue in these areas helped offset a slower quarter for municipal issuance as volumes were down across the industry. Moving to page four.
As I stated earlier, Hilltop maintains strong capital levels with a Common Equity Tier 1 capital ratio of 18% at quarter end. Our tangible book value per share increased from Q4 2022 by $0.18 to $27.36. The improvement in tangible book value per share was driven by both net income and a decline of $8 million in our Accumulated Other Comprehensive Loss during the quarter. Though tangible book value per share declined year-over-year, it is important to note that was substantially driven by unrealized declines in our AOCI, as well as the substantial tender offer we completed in 2022. Although the tender was slightly dilutive to tangible book value, we believe the size and pricing of that capital deployment drove significant value for our shareholders.
Additionally, we repurchased $4.5 million of shares and declared our dividend of $0.16 during the quarter, which is an increase from the same period in the prior year. Overall, the start to the year at the bank and Hilltop Securities were very positive. We grew core bank loans while continuing to improve overall asset quality. We did see deposit declines, which was expected. Anticipate the actions we have taken will slow the pace of declines and enable us to build them back once rates stabilize. Our balance sheet is in a strong position with robust capital and liquidity levels. The health and soundness of our balance sheet are paramount to the organization at this time. I am grateful for the collective efforts our team has put into fortifying it.
Moving forward, we remain confident in the value of our diversified business model, the strength of our employee base, and our ability to adapt and succeed in an ever-changing environment. With that, I will now turn the presentation over to Will to walk through the financials.
Thank you, Jeremy. I'll start on page five. As Jeremy discussed, for the first quarter of 2023, Hilltop reported consolidated income attributable to common stockholders of $25.8 million, equating to $0.40 per diluted share. During the quarter, solid year-over-year net interest income growth was offset by ongoing headwinds in the mortgage business as volumes and margins remained challenged. The first quarter's results do reflect certain discrete tax items that reduced the overall tax expense in the period. The estimated EPS impact of these items is $0.04 per share, we do not view these items as recurring. We expect that the full year GAAP tax rate will remain within the range of prior guidance at 22%-24%.
Turning to page six. Hilltop's allowance for credit losses increased by $2 million to $97.4 million as improvement in the macroeconomic outlook was offset by the impact of collective portfolio changes. The portfolio changes were driven by net loan growth in the portfolio, which accounts for approximately $4 million of the change, and the ongoing updating of risk grades as year-end financials were captured, which accounted for approximately $3.4 million of the change. Allowance for credit losses of $97.4 million yields an ACL to low total loans HFI ratio of 1.19% as of March 31st, 2023. Of note, we continue to believe that the allowance for credit losses could be volatile and that 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 volatility, we could expect heightened volatility over the coming quarters. Moving to page seven. Net interest income in the first quarter equated to $122 million, including $1.9 million of purchase accounting accretion. Versus the prior year first quarter, net interest income increased by $22 million or 22%, driven primarily by higher yields on loans, securities, and cash balances, which were somewhat offset by higher rates on deposits and variable rate borrowings. Net interest margin continued to improve versus the fourth quarter of 2022, increasing by 5 basis points to 328 basis points.
Our current outlook reflects a scenario whereby Fed funds moves to between 5 and 550 basis points during the first half of 2023 and remains stable for the balance of the year. We expect the deposit competition for both balances and rates will remain very intense for the remainder of the year, causing NII and NIM to begin declining during the second quarter. As we noted in our prior quarterly update, we do expect the deposit betas, which we have historically modeled at 50% of the cycle increases from the Federal Reserve, will exceed 60% during this cycle given the current competitive environment. Turning to page eight. In the chart, we highlight the approximately $7 billion of available liquidity sources that Hilltop maintained as of March 31st.
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. As such, it's noted below our other collateralized borrowing sources. Further, the comparable liquidity sources as of December 31st equated to just over $7 billion and remained relatively stable throughout the 1st quarter. As shown in the chart, as of March 31st, Hilltop maintained $1.6 billion of excess cash through deposits at the Federal Reserve. Included in the excess deposits at the Federal Reserve, during the 1st quarter, we swept approximately $650 million of additional deposits from our eligible Hilltop Securities FDIC insured balances into PlainsCapital. Those balances are reflected in the deposit balances in the chart on the right side of the page and on subsequent pages.
We borrowed $450 million from the Federal Home Loan Bank with terms of a few weeks. The next two to three quarters, we expect to maintain excess deposits of between $1.5 billion and $2 billion at the Federal Reserve. In the bottom left chart, we provide some detail on the pace of the deposit beta changes to date and note our expectations for future changes in interest-bearing deposit rates under the view that the Federal Reserve continues to move short-term rates higher. I move into page nine. First quarter average total deposits are approximately $11 billion, it declined by approximately $350 million or 3% versus the fourth quarter of 2022.
On an ending balance basis, deposits declined by $219 million to $11.1 billion from the prior quarter ending balance level. Of note, approximately $360 million of customer deposits moved from an on-balance sheet deposit account into money market mutual funds or treasury investments within the PlainsCapital Private Bank. We view this as a favorable outcome as we've retained the balances at our company while aiding the customer in achieving higher yields. We would expect that these balances could shift back into the bank deposits over time as market rates adjust through the next leg of the rate cycle.
While we expected deposits to decline during the first quarter, given the level and speed of market interest rate adjustments, coupled with our decision to manage interest-bearing deposit costs with a significant lag, we have seen that customer activity has significantly shifted as customers are seeking higher interest rates, and their focus has resulted in higher price elasticity at each tier and product level. During the quarter, we adjusted our deposit pricing approach to become more competitive across our most liquid products. As a result, interest-bearing deposit costs rose to 201 basis points, an increase of 44 basis points from the prior quarter. It is our expectation that interest-bearing deposit costs will move higher during the second and third quarters, 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 continuing to focus on prudent management of Net Interest Income over time. The current environment remains challenging and as noted earlier, we expect that the intensity of competition for deposits will continue to pressure rates higher in the short and medium terms. I move into page 10. Total non-interest income for the first quarter of 2023 equated to $162.5 million.
First quarter mortgage-related income and fees decreased by $74 million versus the first 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 the ongoing overcapacity in terms of mortgage originators across the U.S. has driven volumes materially lower and moved margins to levels we've not seen in recent history. Further, versus the prior year first quarter, purchase mortgage volumes decreased by $1.1 billion or 42%, and refinance volumes decreased by $900 million or 88%. During the first quarter of 2023, gain on sale margins continued what has been a multi-quarter decline, with gain on sale margin for loans sold to third parties declining 18 basis points to 193 basis points.
While gain on sale margins have been pressured, we are continuing to see that customers are paying to buy down their interest rate. As such, mortgage origination fees have declined less sharply versus the prior year period. We expect the gain on sale margins will continue to be pressured. While they have begun to stabilize at these lower levels, it is not clear when and by how much the market will rebound during 2023, given the current constraints in the marketplace that I noted earlier. Other income increased by $29 million, driven primarily by improved lock volume and trading activity in our structured finance business at Hilltop Securities.
It is 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, volatility, and production trends. Turning to page 11. Non-interest expenses decreased from the same period in the prior year by $36 million to $250 million. The decline in expenses versus the prior year first quarter was driven by decreases in variable compensation of approximately $31 million at PrimeLending, which was linked to lower fee revenue generation in the quarter compared to the same period prior year. Additionally, non-compensation variable expenses, particularly mortgage production related expenses, which are captured in other expenses in the table in the upper right of the slide, declined as production volumes declined versus the first quarter prior year.
Looking forward, we expect expenses other than variable compensation will remain relatively stable 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. Turning to page 12. First quarter average HFI loans equated to $7.9 billion in 2023, relatively stable with the prior year first quarter levels. On a period-ending basis, HFI loans grew versus the fourth quarter of 2022 by $100 million, driven by improving commercial loan growth, particularly in commercial real estate and the retention of 1-4 family mortgages originated by PrimeLending.
Given the current market conditions, including the inverted yield curve, which has substantially impacted the economic value of holding mortgage loans on the balance sheet, we expect to substantially reduce our one to four family mortgage retention levels from $75 million-$150 million per quarter to between $0 and $20 million per quarter for the remainder of 2023. We do expect commercial loan production to begin to slow in the second quarter and throughout the balance of 2023. Currently, we are expecting full year average loan growth of 0%-2% for the full year of 2023. Turning to page 13. In the graph in the upper right of the page, we show the progress made in reducing NPAs throughout 2022, which has continued into this year.
Credit quality has remained solid through the first quarter, and while we do not see any prevailing trends that cause us outsized concern in our portfolio, we are watching the portfolio 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 loan 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 first quarter at 1.23%, including mortgage warehouse lending. Turning to page 14. As we move into the second 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.
We're 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 shareholder value. As is noted in the table, our current outlook for 2023 reflects our current assessment of the economy and the markets where we participate. 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.
Thank you. Ladies and gentlemen, if you'd like to ask a question, please press star followed by one on your telephone keypad now. When preparing to ask your question, please ensure your phones are muted locally. We have our first question, comes from Brady Gailey from KBW. Brady, your line is now open.
Yeah, it's Brady. Good morning, guys.
Brady.
Good morning.
I wanted to start just with mortgage. You know, I know the headwinds that exist there. You know, if you look at the last three quarters, it's been at a pretty notable loss position for the bank. Is there an opportunity to further reduce, you know, non-variable expenses at mortgage to, you know, get that business to at least a point of breakeven? What are your thoughts on continued mortgage expense rightsizing and when we should expect to see that unit, you know, get out of the red and back into the black?
Hey, Brady, it's Will. You know, you highlight the issue. It's been a challenging few quarters, and really last year for the mortgage business. You know, as we are evaluating that franchise first, you know, it's worth noting, it's a significant portion. It has been a significant portion of our business over the years and will continue to be. As we evaluate it, we are solely focused on long term and making sure that we maintain a robust franchise to take advantage of that market when it does rebound. I think acutely to your point around profitability, you know, profitability for the full year is going to be challenging, certainly given where the first quarter came in.
We did take, I'd say substantial actions in March and early April to continue to reduce fixed cost. You know, objectively, we expect the loss, the loss level to continue to decline for the balance of the year and move us to a position where for 2024, we would expect to be at a run rate level of break even or better, just given where the market dynamics are. I think as we sit here, we are being careful and prudent given the gain on sale margins at 193 basis points to third parties, as well as the overall volume in the marketplace. We think that gain on sale level is unsustainable and will recover at some point.
I think the challenge is kind of when, and by how much, and I tried to, tried to cover that in my comments. Again, from a cost perspective, we continue to make steps every month and every quarter with the leadership team at Prime, and again, with a focus on improving, or reducing the overall loss each quarter. Again, the market dynamics and a one handle in front of the gain on sale makes profitability a real challenge.
I'm hopeful that this is the bottom on margins, that, you know, the overcapacity is really being pulled out of the business. You are seeing some M&A and some other activity with like Wells Fargo and everything in the last quarter that, you know, would lead us to believe that we are the cycle is turning, but it's still not profitable.
Okay. In the first quarter, was there any meaningful adjustment to the MSR valuation?
We had a, you know, we had about a $5.7 million negative adjustment to the value of the MSR, really reflecting, I think the market's view that and a valuation view that the current loans going on the books or going into the MSR with a 6%, 6.5% rate, are going to have a higher propensity to refi if you, if you believe the Fed's going to move rates lower in the short term. We did make that valuation adjustment. That's a pre-tax. It was a pre-tax.
Okay. Pre-tax number. Okay. The $5.7 million, is that net of hedges? Did you guys hear me?
Yes.
Yeah, it was net of hedges.
That's correct.
Yes.
Okay. Yes, net of hedges. All right. My final question is just on the tax rate. I know it was, you know, abnormally low in the first quarter. You're still sticking to the 22%-24% guidance. That would kind of suggest that the effective tax rate, you know, ticks up to like, I don't know, 26%-27% for the rest of the year. Am I thinking about that right?
I think, yeah, I mean, historically, the first quarter. Well, the discrete items, you know, did bring the effective tax rate down to 11.4%. You know, I think, what we're expecting is as you saw, you know, second half of last year, 25%-26% is probably the normal run rate. First quarter is always historically low from an effective tax rate perspective due to some of the stock compensation related items that normally go through. It's historically a below trend ETR. That said, we would expect, you know, 24%-26% for the recurring for the remaining three quarters.
That will bring us in and likely will bring us in toward the lower end of that range for the full year.
Okay. And one more, just, I mean, you guys still have excess capital. I know that M&A is tough right now given the backdrop, but I also know that Hilltop tends to, you know, buy stuff that's out of favor in tough times. Maybe just an update on how you're thinking about M&A and is that a possibility today?
Sure. Well, I mean, I clearly think that, you know, last quarter was a sea change. You know, we're still interested in doing M&A. We're still interested in doing deals that are strategic fits for our business. You know, on balance, just with the, change in market prices, you know, it better positions us and our currency.
All right. Great. Thanks, guys.
Thanks.
Thank you.
Thank you, Emma. Apologies, Brady. We have our next question comes from Brad Mielke from Piper Sandler. Brad, your line is now open.
Hey, good morning, guys.
Morning.
Am I coming through? Okay. Thanks for taking my question. Was just curious if you could talk a little bit about the change in guidance on the broker-dealer segment. Just kinda curious is the areas you're seeing even more strength or is it, you know, really a function of, you know, feeling better about revenues sort of hanging in this range. I guess you had that, you know, really low first quarter last year, so it kind of throws the, you know, year-over-year growth off a little bit. Just kinda curious what you're seeing and kinda how to think about, you know, the change in the broker-dealer guidance.
Let me speak, and then Will talk specifically to the guidance. You know, I think for first of all, in the first quarter of last year, we had, you know, it was a really challenging quarter, and we had some a really muted structured finance first quarter. This has been the opposite this quarter, and we've had some really strong trading gains in the quarter. I don't necessarily know if we're gonna rely on those to persist throughout the year. What is persistent is our sweep revenue, just given the rate environment, and that was up to $15 million for the quarter.
We do feel good about the momentum and the revenue and several other businesses performing well at Hilltop Securities group, you know, really throughout the rest of the year.
Brad, I think that covers it. You'll see the sweep revenue show up in retail and clearing services in the revenue items at the broker-dealer. That's really the primary contributor to the increase in the overall outlook, coupled with as Jeremy mentioned, a stronger first quarter than we might have otherwise expected.
Will, just back to the expense conversation. What really most of the expense saves coming at Prime? I did notice too that the expenses, at least on a linked quarter basis, I know that's maybe not the best comparison we're down two at the bank, but just kind of curious if you could, you know, maybe delve into the kind of sources of or the primary sources of the expense saves? Is it really just kind of across the franchise?
You know, I think the preponderance of the expense saves have occurred at Prime. That said, we are with the work we're doing there to rightsize the business to meet the market from a profitability perspective. You know, across as we have and as we've continued, we are looking for productivity improvements and enhancements across the bank as we reevaluate a series of core processes there. That team is doing a very nice job kind of managing expenses over time in what's otherwise been a pretty inflationary environment. I would say exactly the same for Hilltop Securities. Again, continue to evaluate large processes where we can improve productivity and throughput, and we're doing that across.
It's been across the franchise where we've seen kind of head count declines and overall productivity improvement, but the preponderance of the cost saves have come from PrimeLending.
Got it. Just final one for me to follow up on Brady's question on M&A. I mean, you guys historically have, you know, been proactive when things, you know, look toughest for the sector. Can you just talk about, you know, sort of how you think about maybe buying a bank that, you know, might have really low TCE because of marks, you know, marks that you would potentially have to take on a bond portfolio? You guys are typically a cash buyer, and or can put a lot of cash in a deal to make it work. Just kind of curious how your approach, you know, might be different or not in this environment, kind of given, you know, everything that's gone on and opportunities you may or may not see?
Sure. Well, you know, from a balance sheet perspective, we feel like we have a very strong balance sheet that can be, can solve for issues of a potential target, you know, certainly, and the combined entity can get past a lot of this overhang that's out there. Just by nature of where stocks have drifted and where we've kind of always been around tangible book value, our ability to transact is better, you know, whether it's cash or our stock.
Jeremy, what would an ideal candidate, you know, look like? I mean, you know, smaller banks tend to have a lot more CRE. Obviously that is, you know, not in vogue right now, but just kind of curious, you know, if you, if you were drawing it up, you know, what would it look like? Would it be necessarily, you know, certainly in Texas or might you look elsewhere? Just kind of curious what your criteria might be. I mean, I think it would make a better strategic fit to be in Texas and to be similar business. look, I mean, I think we're working hard to stay on top of what's going on in the market. we also are gonna be, you know, patient and careful in this environment, not just from a balance sheet liquidity standpoint, but also from a potential credit standpoint.
Okay, great. Thank you, guys.
Thank you.
Thank you. We have our next question comes from Thomas Wendler from Stephens Inc.. Thomas, your line is now open.
Hey, good morning, everyone.
Morning.
Morning.
Lots of moving pieces this quarter in excess liquidity. Bring on the sweep deposits and some borrowings from the FHLB. Can you give us an idea of what kind of levels of excess liquidity you're looking to hold on the balance sheet moving forward?
Yeah. You know, this will, you know, as I noted in my comments, objectively we are looking to hold, you know, between one and a half and $2 billion of deposits at the Fed. We'll, you know, we'll manage the levels and manage the levels to do that, the levers we have to do that really out of an abundance of caution. That's not an operating level that we necessarily need. As we sit here today with the uncertainty around the economy, potentially uncertainty around, you know, the banking segment, we want to make sure, we're nimble, and agile in the event something else were to occur.
Thank you. One final one for me. I think you were a little less active in the buyback than we were expecting. Can you just give me an idea of your appetite from here in your buyback program?
Sure. For the first quarter, I mean, if you recall, we filed our 10-K. It was filed kind of late in the quarter, our window was pretty narrow. We were just trying to do a little bit of activity while we had an open window. You know, since then, I, you know, with our share repurchase authorization, we still got about $70 million left. I think we're going to proceed cautiously there, clearly, given the state of, you know, balance sheets and liquidity, and.
All right. Thank you for answering my question.
Thank you.
Thank you. We have no further questions on the line. Ladies and gentlemen, this concludes today's call. Thank you for joining. You may now disconnect your lines.