0001104659-12-033054.txt : 20120504 0001104659-12-033054.hdr.sgml : 20120504 20120504123505 ACCESSION NUMBER: 0001104659-12-033054 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 11 CONFORMED PERIOD OF REPORT: 20120331 FILED AS OF DATE: 20120504 DATE AS OF CHANGE: 20120504 FILER: COMPANY DATA: COMPANY CONFORMED NAME: Hilltop Holdings Inc. CENTRAL INDEX KEY: 0001265131 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 841477939 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-31987 FILM NUMBER: 12813041 BUSINESS ADDRESS: STREET 1: 200 CRESCENT COURT STREET 2: SUITE 1330 CITY: DALLAS STATE: TX ZIP: 75201 BUSINESS PHONE: 214.855.2177 MAIL ADDRESS: STREET 1: 200 CRESCENT COURT STREET 2: SUITE 1330 CITY: DALLAS STATE: TX ZIP: 75201 FORMER COMPANY: FORMER CONFORMED NAME: AFFORDABLE RESIDENTIAL COMMUNITIES INC DATE OF NAME CHANGE: 20030929 10-Q 1 a12-7648_110q.htm QUARTERLY REPORT PURSUANT TO SECTIONS 13 OR 15(D)

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

 

(Mark One)

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2012

 

OR

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number: 1-31987

 

Hilltop Holdings Inc.

(Exact name of registrant as specified in its charter)

 

MARYLAND

 

84-1477939

(State or other jurisdiction of incorporation or

organization)

 

(I.R.S. Employer Identification No.)

 

 

 

200 Crescent Court, Suite 1330

 

 

Dallas, Texas

 

75201

(Address of principal executive offices)

 

(Zip Code)

 

(214) 855-2177

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o
(Do not check if a smaller reporting company)

 

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

The number of shares of the Registrant’s common stock outstanding at May 4, 2012 was 56,362,273.

 

 

 



Table of Contents

 

HILLTOP HOLDINGS INC.

FORM 10-Q

FOR THE QUARTER ENDED MARCH 31, 2012

 

Item

 

Description

 

Page

 

 

 

 

 

PART I – FINANCIAL INFORMATION

 

 

 

 

 

1.

 

Financial Statements

 

 

 

 

Consolidated Balance Sheets as of March 31, 2012 (unaudited) and December 31, 2011

 

3

 

 

Consolidated Statements of Comprehensive Income for the Three Months ended March 31, 2012 and 2011 (unaudited)

 

4

 

 

Consolidated Statement of Stockholders’ Equity for the Three Months ended March 31, 2012 (unaudited)

 

5

 

 

Consolidated Statements of Cash Flows for the Three Months ended March 31, 2012 and 2011 (unaudited)

 

6

 

 

 

 

 

 

 

Notes to Consolidated Financial Statements (unaudited)

 

7

 

 

 

 

 

2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

21

 

 

 

 

 

3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

29

 

 

 

 

 

4.

 

Controls and Procedures

 

29

 

 

 

 

 

PART II – OTHER INFORMATION

 

 

 

 

 

2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

30

 

 

 

 

 

6.

 

Exhibits

 

30

 

2



Table of Contents

 

HILLTOP HOLDINGS INC.

CONSOLIDATED BALANCE SHEETS

AS OF MARCH 31, 2012 AND DECEMBER 31, 2011

(in thousands, except share and per share data)

(unaudited)

 

 

 

March 31,

 

December 31,

 

 

 

2012

 

2011

 

Assets

 

 

 

 

 

Investments:

 

 

 

 

 

Fixed maturities

 

 

 

 

 

Available for sale securities, at fair value (amortized cost of $133,122 and $135,166, respectively)

 

$

142,850

 

$

144,801

 

Equity securities

 

 

 

 

 

Available for sale securities, at fair value (cost of $18,969 and $16,813, respectively)

 

20,111

 

19,022

 

Other investments

 

 

 

 

 

Notes receivable, at fair value (amortized cost of $39,082 and $38,641, respectively)

 

41,026

 

38,588

 

Warrants, at fair value (cost of $12,068 and $12,068, respectively)

 

15,534

 

21,789

 

Total investments

 

219,521

 

224,200

 

 

 

 

 

 

 

Cash and cash equivalents

 

579,639

 

578,520

 

Accrued interest and dividends

 

1,430

 

1,576

 

Premiums receivable

 

25,197

 

24,390

 

Deferred acquisition costs

 

19,395

 

19,182

 

Reinsurance recoverable, net of uncollectible amounts

 

25,932

 

25,861

 

Prepaid reinsurance premiums

 

4,783

 

5,056

 

Income taxes receivable

 

48

 

77

 

Deferred income taxes

 

10,011

 

8,354

 

Goodwill

 

23,988

 

23,988

 

Intangible assets, definite life

 

5,765

 

6,074

 

Intangible assets, indefinite life

 

3,000

 

3,000

 

Property and equipment, net

 

2,139

 

2,128

 

Loan origination costs, net

 

2,426

 

2,471

 

Other assets

 

1,036

 

548

 

Total assets

 

$

924,310

 

$

925,425

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Liabilities:

 

 

 

 

 

Reserve for losses and loss adjustment expenses

 

$

47,861

 

$

44,835

 

Unearned premiums

 

82,796

 

80,661

 

Reinsurance payable

 

2,830

 

2,845

 

Accounts payable and accrued expenses

 

4,368

 

8,121

 

Notes payable

 

131,450

 

131,450

 

Other liabilities

 

3,708

 

2,130

 

Total liabilities

 

273,013

 

270,042

 

 

 

 

 

 

 

Stockholders’ Equity:

 

 

 

 

 

Common stock, $0.01 par value, 100,000,000 shares authorized, 56,360,846 and 56,500,828 shares issued and outstanding at March 31, 2012 and December 31, 2011, respectively

 

564

 

565

 

Additional paid-in capital

 

917,165

 

918,192

 

Accumulated other comprehensive income

 

10,582

 

13,983

 

Accumulated deficit

 

(277,014

)

(277,357

)

Total stockholders’ equity

 

651,297

 

655,383

 

Total liabilities and stockholders’ equity

 

$

924,310

 

$

925,425

 

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

3



Table of Contents

 

HILLTOP HOLDINGS INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

FOR THE THREE MONTHS ENDED MARCH 31, 2012 AND 2011

(in thousands, except per share data)

(unaudited)

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2012

 

2011

 

Revenue:

 

 

 

 

 

Net premiums earned

 

$

35,155

 

$

30,932

 

Net investment income

 

3,259

 

2,081

 

Other income

 

1,711

 

1,625

 

Net realized gains on investments

 

 

 

 

 

Other realized investment gains, net

 

21

 

19

 

Total realized investment gains, net

 

21

 

19

 

Total revenue

 

40,146

 

34,657

 

Expenses:

 

 

 

 

 

Loss and loss adjustment expenses

 

22,542

 

16,004

 

Policy acquisition and other underwriting expenses

 

12,915

 

11,985

 

General and administrative expenses

 

1,644

 

1,873

 

Depreciation and amortization

 

360

 

432

 

Interest expense

 

2,139

 

2,176

 

Total expenses

 

39,600

 

32,470

 

 

 

 

 

 

 

Income before income tax expense

 

546

 

2,187

 

Income tax expense

 

(203

)

(777

)

 

 

 

 

 

 

Net income attributable to common stockholders

 

$

343

 

$

1,410

 

 

 

 

 

 

 

Income per share attributable to common stockholders

 

 

 

 

 

Basic income per share

 

$

0.01

 

$

0.02

 

Diluted income per share

 

$

0.01

 

$

0.02

 

 

 

 

 

 

 

Weighted average share information

 

 

 

 

 

Basic shares outstanding

 

56,499

 

56,496

 

Diluted shares outstanding

 

56,555

 

56,496

 

 

 

 

 

 

 

Other comprehensive loss:

 

 

 

 

 

Unrealized losses on available-for-sale securities

 

(5,232

)

(631

)

Income tax benefit

 

1,831

 

221

 

Other comprehensive loss, net of tax

 

(3,401

)

(410

)

 

 

 

 

 

 

Comprehensive (loss) income attributable to common stockholders

 

$

(3,058

)

$

1,000

 

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

4



Table of Contents

 

HILLTOP HOLDINGS INC.

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

FOR THE THREE MONTHS ENDED MARCH 31, 2012

(in thousands)

(unaudited)

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

Additional

 

Other

 

 

 

Total

 

 

 

Common Stock

 

Paid-in

 

Comprehensive

 

Accumulated

 

Stockholders’

 

 

 

Shares

 

Amount

 

Capital

 

Income (Loss)

 

Deficit

 

Equity

 

Balance, December 31, 2011

 

56,501

 

$

565

 

$

918,192

 

$

13,983

 

$

(277,357

)

$

655,383

 

Net income

 

 

 

 

 

 

 

 

 

343

 

343

 

Other comprehensive loss, net of tax benefit of $1,831

 

 

 

 

 

 

 

(3,401

)

 

 

(3,401

)

Common stock issued to board members

 

1

 

 

 

12

 

 

 

 

 

12

 

Repurchase of common stock

 

(141

)

(1

)

(1,161

)

 

 

 

 

(1,162

)

Stock compensation expense

 

 

 

 

 

122

 

 

 

 

 

122

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, March 31, 2012

 

56,361

 

$

564

 

$

917,165

 

$

10,582

 

$

(277,014

)

$

651,297

 

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

5



Table of Contents

 

HILLTOP HOLDINGS INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHS ENDED MARCH 31, 2012 AND 2011

(in thousands)

(unaudited)

 

 

 

For the Three Months Ended March 31,

 

 

 

2012

 

2011

 

Cash flow from operating activities:

 

 

 

 

 

Net income

 

$

343

 

$

1,410

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

360

 

432

 

Deferred income taxes

 

174

 

837

 

Increase in unearned premiums

 

2,135

 

2,565

 

Increase in deferred acquisition costs

 

(213

)

(703

)

Realized gains on investments

 

(21

)

(19

)

Amortization of loan origination costs

 

45

 

49

 

Stock grant compensation expense

 

134

 

17

 

Decrease in payable to related party

 

 

(263

)

Increase in income taxes payable

 

29

 

81

 

Changes in operating assets and liabilities

 

(432

)

(689

)

Net cash provided by operating activities

 

$

2,554

 

$

3,717

 

 

 

 

 

 

 

Cash flow from investing activities:

 

 

 

 

 

Purchases of fixed assets

 

(62

)

(186

)

Purchases of available-for-sale securities

 

(2,556

)

(1,072

)

Proceeds from sales of available-for-sale securities

 

995

 

1,515

 

Proceeds from maturities of available-for-sale securities

 

1,350

 

3,303

 

Net cash (used in) provided by investing activities

 

$

(273

)

$

3,560

 

 

 

 

 

 

 

Cash flow from financing activities:

 

 

 

 

 

Repurchase of common stock

 

(1,162

)

 

Net cash used in financing activities

 

$

(1,162

)

$

 

Net increase in cash and cash equivalents

 

1,119

 

7,277

 

Cash and cash equivalents, beginning of period

 

578,520

 

649,439

 

Cash and cash equivalents, end of period

 

$

579,639

 

$

656,716

 

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

6



Table of Contents

 

HILLTOP HOLDINGS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2012

(unaudited)

 

1.              Business, Basis of Presentation and Summary of Significant Accounting Policies

 

Business

 

Hilltop Holdings Inc. is a holding company that is endeavoring to make opportunistic acquisitions or effect a business combination.  In connection with that strategy, we are identifying and evaluating potential targets on an ongoing basis.  We also conduct operations in the property and casualty insurance industry through our insurance subsidiaries, National Lloyds Insurance Company, or NLIC,  and American Summit Insurance Company, or ASIC.  National Lloyds Insurance Company commenced business in 1949 and currently operates in 14 states, with its largest market being the State of Texas.  American Summit Insurance Company was formed in 1955 and currently operates in 11 states, with its largest market being the State of Arizona.   Both of these insurance companies carry a financial strength rating of  “A” (Excellent) by A.M. Best, which was confirmed on March 30, 2012, and are regulated by the Texas Department of Insurance.  Our products include fire and homeowners insurance to low value dwellings and manufactured homes primarily in Texas and other areas of the south, southeastern and southwestern United States.

 

Our common stock is listed on the New York Stock Exchange under the symbol “HTH”.  We have no public trading history prior to February 12, 2004.

 

Basis of Presentation

 

The accompanying unaudited consolidated financial statements have been prepared in conformity with generally accepted accounting principles in the United States of America (“GAAP”), and in conformity with the rules and regulations of the Securities and Exchange Commission.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP, however, have been condensed or omitted pursuant to Article 10 of Regulation S-X.  The consolidated financial statements include the accounts of all wholly-owned subsidiaries of the Company.  All significant intercompany accounts and transactions have been eliminated in the consolidated financial statements.

 

In the opinion of management, these financial statements have been prepared on the same basis as the audited consolidated financial statements and include all adjustments necessary for the fair statement of the Company’s financial position, results of operations and cash flows. These adjustments were of a normal, recurring nature. The results of operations for the interim period ended March 31, 2012 may not be indicative of the results that may be expected for the year ended December 31, 2012. These financial statements should be read in conjunction with the financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2011.

 

We are required by GAAP to make estimates and assumptions that affect our reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of our financial statements and our reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates. These estimates and assumptions are particularly important in determining revenue recognition, reserves for losses and loss adjustment expenses, deferred policy acquisition costs, reinsurance receivables and potential impairment of assets.

 

7



Table of Contents

 

HILLTOP HOLDINGS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2012

(unaudited)

 

Summary of Significant Accounting Policies

 

Recently Adopted Accounting Pronouncements

 

In October 2010, the FASB issued ASU-2010-26 to address the diversity in practice for the accounting for costs associated with acquiring or renewing insurance contracts.  This guidance modifies the definition of acquisition costs to specify that a cost must be directly related to the successful acquisition of a new or renewal insurance contract in order to be deferred. If application of this guidance would result in the capitalization of acquisition costs that had not previously been capitalized by a reporting entity, the entity may elect not to capitalize those costs.  The updated guidance is effective for periods beginning after December 15, 2011. The Company adopted this guidance prospectively in the quarter ended March 31, 2012, and it had no material impact on the Company’s financial statements.

 

In May 2011, the FASB issued ASU-2011-04 to clarify ASC 820 and in some instances changed particular principles or requirements for measuring fair value or disclosing information about fair value measurements.  The amendments in this update result in common fair value measurement and disclosure requirements in U.S. GAAP and International Financial Reporting Standards (“IFRS”).   This updated guidance is effective for periods beginning after December 15, 2011. The adoption of this guidance in the quarter ended March 31, 2012 did not have a material impact on the Company’s financial statements.

 

In June 2011, the FASB issued ASU-2011-05, which eliminates the current option to report other comprehensive income and its components in the statement of changes in equity.  The new standard allows companies to report net income and other comprehensive income in a single, continuous statement, or in two separate, but consecutive statements.  The statement(s) would need to be presented with equal prominence as the other primary financial statements.  This updated guidance is effective for periods beginning after December 15, 2011. The adoption of this guidance in the quarter ended March 31, 2012 changed our current presentation of other comprehensive income; however, it did not have a material impact on the Company’s financial statements.

 

In December 2011, the FASB issued ASU-2011-12, which amended ASU-2011-05 and defers guidance related to the presentation of reclassification adjustments out of accumulated other comprehensive income.  All other requirements presented in ASU-2011-05 are not affected by this Update.  This updated guidance is effective for periods beginning after December 15, 2011. The adoption of this guidance in the quarter ended March 31, 2012 changed our current presentation of other comprehensive income; however, it did not have a material impact on the Company’s financial statements.

 

8



Table of Contents

 

HILLTOP HOLDINGS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2012

(unaudited)

 

2.              Investments

 

The amortized cost (original cost for equity securities), gross unrealized gains and losses, and fair value of available-for-sale and other investments by major security type and class of security at March 31, 2012 and December 31, 2011 were as follows (in thousands).

 

 

 

March 31, 2012

 

 

 

 

 

Gross

 

Gross

 

 

 

 

 

Cost/Amortized

 

Unrealized

 

Unrealized

 

Fair

 

 

 

Cost

 

Gains

 

Losses

 

Value

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

Fixed maturities:

 

 

 

 

 

 

 

 

 

Government securities

 

$

27,743

 

$

1,301

 

$

(2

)

$

29,042

 

Residential mortgage-backed securities

 

11,112

 

883

 

 

11,995

 

Commercial mortgage-backed securities

 

2,174

 

68

 

 

2,242

 

Corporate debt securities

 

92,093

 

7,524

 

(46

)

99,571

 

 

 

133,122

 

9,776

 

(48

)

142,850

 

 

 

 

 

 

 

 

 

 

 

Equity securities

 

18,969

 

1,146

 

(4

)

20,111

 

 

 

152,091

 

10,922

 

(52

)

162,961

 

 

 

 

 

 

 

 

 

 

 

Other investments:

 

 

 

 

 

 

 

 

 

Note receivable

 

39,082

 

1,944

 

 

41,026

 

Warrants

 

12,068

 

3,466

 

 

15,534

 

 

 

$

203,241

 

$

16,332

 

$

(52

)

$

219,521

 

 

 

 

December 31, 2011

 

 

 

 

 

Gross

 

Gross

 

 

 

 

 

Cost/Amortized

 

Unrealized

 

Unrealized

 

Fair

 

 

 

Cost

 

Gains

 

Losses

 

Value

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

Fixed maturities:

 

 

 

 

 

 

 

 

 

Government securities

 

$

27,729

 

$

1,439

 

$

(3

)

$

29,165

 

Residential mortgage-backed securities

 

11,708

 

944

 

 

12,652

 

Commercial mortgage-backed securities

 

2,277

 

36

 

(10

)

2,303

 

Corporate debt securities

 

93,452

 

7,406

 

(177

)

100,681

 

 

 

135,166

 

9,825

 

(190

)

144,801

 

 

 

 

 

 

 

 

 

 

 

Equity securities

 

16,813

 

2,462

 

(253

)

19,022

 

 

 

151,979

 

12,287

 

(443

)

163,823

 

 

 

 

 

 

 

 

 

 

 

Other investments:

 

 

 

 

 

 

 

 

 

Note receivable

 

38,641

 

 

(53

)

38,588

 

Warrants

 

12,068

 

9,721

 

 

21,789

 

 

 

$

202,688

 

$

22,008

 

$

(496

)

$

224,200

 

 

9



Table of Contents

 

HILLTOP HOLDINGS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2012

(unaudited)

 

The following tables summarize the length of time securities with unrealized losses at March 31, 2012 and December 31, 2011 have been in an unrealized loss position (in thousands).

 

 

 

March 31, 2012

 

 

 

Less than 12 Months

 

12 Months or More

 

Total

 

 

 

Estimated

 

Gross

 

Estimated

 

Gross

 

Estimated

 

Gross

 

 

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

 

 

Value

 

Losses

 

Value

 

Losses

 

Value

 

Losses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Government securities

 

$

723

 

$

(2

)

$

 

$

 

$

723

 

$

(2

)

Corporate debt securities

 

2,683

 

(46

)

 

 

2,683

 

(46

)

 

 

3,406

 

(48

)

 

 

3,406

 

(48

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity securities

 

 

 

95

 

(4

)

95

 

(4

)

 

 

$

3,406

 

$

(48

)

$

95

 

$

(4

)

$

3,501

 

$

(52

)

 

 

 

December 31, 2011

 

 

 

Less than 12 Months

 

12 Months or More

 

Total

 

 

 

Estimated

 

Gross

 

Estimated

 

Gross

 

Estimated

 

Gross

 

 

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

 

 

Value

 

Losses

 

Value

 

Losses

 

Value

 

Losses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Government securities

 

$

1,695

 

$

(3

)

$

 

$

 

$

1,695

 

$

(3

)

Commercial mortgage-backed securities

 

487

 

(10

)

 

 

487

 

(10

)

Corporate debt securities

 

5,254

 

(177

)

 

 

5,254

 

(177

)

 

 

7,436

 

(190

)

 

 

7,436

 

(190

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity securities

 

8,476

 

(253

)

 

 

8,476

 

(253

)

 

 

$

15,912

 

$

(443

)

$

 

$

 

$

15,912

 

$

(443

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other investments

 

 

 

 

 

 

 

 

 

 

 

 

 

Note receivable

 

38,588

 

(53

)

 

 

 

 

38,588

 

(53

)

 

 

$

54,500

 

$

(496

)

$

 

$

 

$

54,500

 

$

(496

)

 

For the quarter ended March 31, 2012, the Company did not record any other-than-temporary impairments.  While all of the investments are monitored for potential other-than-temporary impairment, our analysis and experience indicate that these investments generally do not present a greater risk of other-than-temporary impairment, as fair value should recover over time.  Factors considered in our analysis include the reasons for the unrealized loss position, the severity and duration of the unrealized loss position, credit worthiness, and forecasted performance of the investee.  While some of the securities held in the investment portfolio have decreased in value since the date of acquisition, the severity of loss and the duration of the loss position are not believed to be significant enough to warrant other-than-temporary impairment of the securities.  The Company does not intend, nor is it likely that the Company will be required to sell these securities before the recovery of the cost basis; and, therefore, we do not believe any other-than-temporary impairments exist as of March 31, 2012.

 

10



Table of Contents

 

HILLTOP HOLDINGS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2012

(unaudited)

 

Gross realized investment gains and losses for the three months ended March 31, 2012 and 2011 are summarized as follows (in thousands).

 

 

 

Three Months Ended March 31,

 

 

 

2012

 

2011

 

 

 

Gross

 

Gross

 

 

 

Gross

 

Gross

 

 

 

 

 

Gains

 

Losses

 

Total

 

Gains

 

Losses

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities

 

$

21

 

$

 

$

21

 

$

20

 

$

(1

)

$

19

 

 

 

$

21

 

$

 

$

21

 

$

20

 

$

(1

)

$

19

 

 

Sales of available-for-sale investment securities resulted in the following during the three months ended March 31, 2012 and 2011 (in thousands).

 

 

 

Three Months Ended March 31,

 

 

 

2012

 

2011

 

Proceeds

 

$

995

 

$

1,515

 

 

 

 

 

 

 

Gross gains

 

$

21

 

$

20

 

 

 

 

 

 

 

Gross losses

 

$

 

$

(1

)

 

11


 


Table of Contents

 

HILLTOP HOLDINGS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2012

(unaudited)

 

Expected maturities may differ from contractual maturities because certain borrowers may have the right to call or prepay obligations with or without penalties.  The schedule of fixed maturities of available-for-sale securities and other investments at March 31, 2012 and December 31, 2011, by contractual maturity are as follows (in thousands).

 

 

 

March 31, 2012

 

 

 

Amortized

 

Fair

 

 

 

Cost

 

Value

 

Available-for-sale fixed maturities:

 

 

 

 

 

Due within one year

 

$

19,065

 

$

19,555

 

Due after one year through five years

 

62,583

 

66,120

 

Due six years through ten years

 

37,275

 

41,993

 

Due after ten years

 

914

 

945

 

Mortgage-backed securities

 

13,285

 

14,237

 

 

 

$

133,122

 

$

142,850

 

 

 

 

 

 

 

Other investments:

 

 

 

 

 

Due after one year through five years

 

$

51,150

 

$

56,560

 

 

 

$

51,150

 

$

56,560

 

 

 

 

December 31, 2011

 

 

 

Amortized

 

Fair

 

 

 

Cost

 

Value

 

Available-for-sale fixed maturities:

 

 

 

 

 

Due within one year

 

$

12,608

 

$

12,942

 

Due after one year through five years

 

69,594

 

73,300

 

Due six years through ten years

 

38,065

 

42,766

 

Due after ten years

 

914

 

838

 

Mortgage-backed securities

 

13,985

 

14,955

 

 

 

$

135,166

 

$

144,801

 

 

 

 

 

 

 

Other investments:

 

 

 

 

 

Due after one year through five years

 

$

50,709

 

$

60,377

 

 

 

$

50,709

 

$

60,377

 

 

 

 

 

 

 

 

12



Table of Contents

 

HILLTOP HOLDINGS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2012

(unaudited)

 

Net investment income for the three months ended March 31, 2012 and 2011 is as follows (in thousands).

 

 

 

Three Months Ended March 31,

 

 

 

 

 

2012

 

2011

 

Change

 

Cash equivalents

 

$

183

 

$

617

 

$

(434

)

Fixed maturities

 

1,981

 

1,436

 

545

 

Equity securities

 

191

 

163

 

28

 

Other investments

 

1,000

 

 

1,000

 

 

 

3,355

 

2,216

 

1,139

 

 

 

 

 

 

 

 

 

Investment expense

 

(96

)

(135

)

39

 

 

 

 

 

 

 

 

 

Net investment income

 

$

3,259

 

$

2,081

 

$

1,178

 

 

At March 31, 2012, the Company had on deposit in custody for various State Insurance Departments investments with carrying values totaling $9.4 million.

 

3.              Fair Value Measurements

 

The Company’s estimates of fair value for financial assets and financial liabilities are based on the framework established in ASC 820, Fair Value Measurements and Disclosures. The framework is based on the inputs used in valuation and gives the highest priority to quoted prices in active markets.  It also requires that observable inputs be used in the valuations, when available. The disclosure of fair value estimates is based on whether the significant inputs into the valuation are observable. In determining the level of the hierarchy in which the estimate is disclosed, the highest priority is given to unadjusted quoted prices in active markets and the lowest priority to unobservable inputs that reflect the Company’s significant market assumptions. The three levels of the hierarchy are as follows:

 

·                 Level 1 - Unadjusted quoted market prices for identical assets or liabilities in active markets that the Company has the ability to access.

 

·                 Level 2 - Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in inactive markets; or valuations based on models where the significant inputs are observable (e.g., interest rates, yield curves, prepayment speeds, default rates, loss severities, etc.) or can be corroborated by observable market data.  Based on management’s understanding of the methodologies used by our pricing service, all applicable investments have been valued in accordance with GAAP valuation principles.

 

·                 Level 3 - Valuations based on models where significant inputs are not observable. The unobservable inputs reflect the Company’s own assumptions about the assumptions that market participants would use.

 

If the markets were to worsen, there can be no assurance that we will not experience losses on our investments and reductions to earnings.

 

13



Table of Contents

 

HILLTOP HOLDINGS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2012

(unaudited)

 

The following tables present the hierarchy used by the Company by asset and liability type to determine their fair value at March 31, 2012 and December 31, 2011 (in thousands).

 

 

 

As of March 31, 2012

 

 

 

Total

 

Level 1

 

Level 2

 

Level 3

 

Financial assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

579,639

 

$

579,639

 

$

 

$

 

Fixed maturities

 

 

 

 

 

 

 

 

 

Government securities

 

29,042

 

 

 

29,042

 

 

 

Residential mortgage-backed securities

 

11,995

 

 

 

11,995

 

 

 

Commercial mortgage-backed securities

 

2,242

 

 

 

2,242

 

 

 

Corporate debt securities

 

99,571

 

 

 

99,571

 

 

 

Equity securities

 

 

 

 

 

 

 

 

 

Common stock

 

17,687

 

17,687

 

 

 

 

 

Non-redeemable preferred stock

 

2,424

 

2,424

 

 

 

 

 

Other investments

 

 

 

 

 

 

 

 

 

Note receivable

 

41,026

 

 

 

 

 

41,026

 

Warrants

 

15,534

 

 

 

 

 

15,534

 

Total

 

$

799,160

 

$

599,750

 

$

142,850

 

$

56,560

 

 

 

 

As of December 31, 2011

 

 

 

Total

 

Level 1

 

Level 2

 

Level 3

 

Financial assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

578,520

 

$

578,520

 

$

 

$

 

Fixed maturities

 

 

 

 

 

 

 

 

 

Government securities

 

29,165

 

 

 

29,165

 

 

 

Residential mortgage-backed securities

 

12,652

 

 

 

12,652

 

 

 

Commercial mortgage-backed securities

 

2,303

 

 

 

2,303

 

 

 

Corporate debt securities

 

100,681

 

 

 

100,681

 

 

 

Equity securities

 

 

 

 

 

 

 

 

 

Common stock

 

18,774

 

18,774

 

 

 

 

 

Non-redeemable preferred stock

 

248

 

248

 

 

 

 

 

Other investments

 

 

 

 

 

 

 

 

 

Note receivable

 

38,588

 

 

 

 

 

38,588

 

Warrants

 

21,789

 

 

 

 

 

21,789

 

Total

 

$

802,720

 

$

597,542

 

$

144,801

 

$

60,377

 

 

Level 1 financial assets

 

The Company’s Level 1 investments include cash and cash equivalent balances and actively-traded equity securities.  Cash and cash equivalents are carried at amortized cost, which approximates fair value.  Fair value of actively traded debt and equity securities are based on unadjusted quoted market prices.  The Company receives the quoted market prices from a third party, nationally recognized, pricing service.

 

Level 2 financial assets

 

When quoted market prices are unavailable, the Company utilizes a third party pricing service to determine an estimate of fair value, which is mainly used for its fixed maturity investments, such as private and corporate debt securities, federal agency and municipal bonds, and non-government mortgage and asset-backed securities.  The observable inputs utilized by the pricing service include interest rates, using either a market or income valuation approach to determine fair value.  The extent of the use of each market input depends on the asset class and the market conditions; and, for some securities, additional inputs may be necessary.  Based on management’s understanding of the methodologies used by this pricing service, all applicable investments have been valued in accordance with GAAP valuation principles.

 

14



Table of Contents

 

HILLTOP HOLDINGS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2012

(unaudited)

 

Level 3 financial assets

 

The Company’s Level 3 investments include the term loan issued to SWS Group, Inc., or SWS, and the warrants issued to us by SWS.  Fair values are based on inputs that are unobservable and significant to the overall fair value measurement, and involve management judgment.  Inputs used to determine fair value include market conditions, spread, volatility, structure and cash flows. The extent of the use of each market input depends on the asset class and the market conditions; and, for some securities, additional inputs may be necessary.

 

The SWS term loan cash flow model utilizes yield estimates based on comparable securities in the market. Interest rate is the most significant unobservable input.  An increase or decrease in the discount rate would result in an increase or decrease in the fair value measurement of the term loan. 

 

The warrants are valued utilizing a binomial model. SWS common stock price and its related volatility, an unobservable input, are the most significant inputs into the model and, therefore, increases or decreases to the stock price would result in a significant change in the fair value measurement of the warrants.

 

The following table is a roll-forward of the amounts at March 31, 2012 for financial instruments classified within Level 3.  The classification of a financial instrument within Level 3 is based upon the significance of the unobservable inputs to the overall fair value measurement.  The Company held no financial instruments classified within Level 3 as of the three months ended March 31, 2011.

 

 

 

Three Months Ended

 

 

 

March 31, 2012

 

 

 

 

 

Balance at December 31,

 

$

60,377

 

 

 

 

 

Net transfers in

 

 

Purchases

 

 

Sales

 

 

Realized losses

 

 

Change in unrealized losses

 

(3,817

)

 

 

 

 

Balance at March 31,

 

$

56,560

 

 

All net unrealized losses in the table above are reflected in the accompanying financial statements.  The Company had no transfers between Levels 1 and 2 as of March 31, 2012.

 

The following tables present the carrying value and fair value of liabilities where they differ in value at March 31, 2012 and December 31, 2011 (in thousands).

 

 

 

March 31, 2012

 

December 31, 2011

 

 

 

Carrying

 

Fair

 

 

 

 

 

 

 

Carrying

 

Fair

 

 

 

Value

 

Value

 

Level 1

 

Level 2

 

Level 3

 

Value

 

Value

 

Financial liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Notes payable

 

$

131,450

 

$

129,516

 

 

 

$

129,516

 

 

 

$

131,450

 

$

129,989

 

 

15



Table of Contents

 

HILLTOP HOLDINGS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2012

(unaudited)

 

4.              Reserve for Unpaid Losses and Loss Adjustment Expenses

 

A roll-forward of the reserve for unpaid losses and loss adjustment expenses for the three months ended March 31, 2012 and 2011 is as follows (in thousands).

 

 

 

Three Months Ended March 31,

 

 

 

2012

 

2011

 

 

 

 

 

 

 

Balance at January 1

 

$

44,835

 

$

58,882

 

Less reinsurance recoverables

 

(25,083

)

(43,773

)

Net balance at January 1

 

19,752

 

15,109

 

 

 

 

 

 

 

Incurred related to:

 

 

 

 

 

Current Year

 

20,393

 

15,580

 

Prior Year

 

2,149

 

424

 

Total incurred

 

22,542

 

16,004

 

 

 

 

 

 

 

Payments related to:

 

 

 

 

 

Current Year

 

(10,542

)

(8,679

)

Prior Year

 

(8,970

)

(5,149

)

Total payments

 

(19,512

)

(13,828

)

 

 

 

 

 

 

Net balance at March 31

 

22,782

 

17,285

 

Plus reinsurance recoverables

 

25,079

 

41,793

 

Balance at March 31

 

$

47,861

 

$

59,078

 

 

Incurred amounts related to prior years indicate that we experienced unfavorable development in incurred but not reported reserves as of December 31, 2011 and 2010, resulting in an expense in the quarter ending March 31, 2012 and 2011.  The deficiency is a result of development in late reported claims from the 2011 accident year. Primary lines of business contributing to the 2011 accident year development were homeowners and fire and allied claims.

 

5.              Reinsurance Activity

 

NLASCO, Inc., or NLASCO, our wholly-owned property and casualty insurance holding company, limits the maximum net loss that can arise from large risks or risks in concentrated areas of exposure by reinsuring (ceding) certain levels of risk. Substantial amounts of business are ceded; however, these reinsurance contracts do not relieve NLASCO from its obligations to policyholders. Such reinsurance includes quota share, excess of loss, catastrophe, and other forms of reinsurance on essentially all property and casualty lines of insurance. Net premiums earned, losses and loss adjustment expenses, or LAE, and policy acquisition and other underwriting expenses are reported net of the amounts related to reinsurance ceded to other companies.  Amounts recoverable from reinsurers related to the portions of the liability for losses and LAE and unearned premiums ceded to them are reported as assets.  Failure of reinsurers to honor their obligations could result in losses to NLASCO; consequently, allowances are established for amounts deemed uncollectible. NLASCO evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. At March 31, 2012, we had reinsurance recoverables of approximately $25.9 million, and no allowance.

 

NLASCO voluntarily participates as a Write Your Own carrier in the National Flood Insurance Program, or the NFIP.  The NFIP is administered and regulated by the Federal Emergency Management Agency (FEMA).  NLASCO operates as a fiscal agent of the Federal government in the selling and administering of the Standard Flood Insurance Policy.  This involves writing the policy, collecting premiums and paying covered claims.  All pricing is set by FEMA and all collections are made by the Company.

 

16


 


Table of Contents

 

HILLTOP HOLDINGS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2012

(unaudited)

 

The Company cedes 100% of the policies written by the Company on the Standard Flood Insurance Policy to FEMA; however, if FEMA were unable to perform, the Company would have a legal obligation to the policyholders.  The terms of the reinsurance agreement are standard terms, which require the Company to maintain its rating criteria, determine policyholder eligibility, issue policies on the Company’s paper, endorse and cancel policies, collect from the insureds and process claims.  NLASCO receives ceding commissions from NFIP for underwriting administration, claims management, commission and adjuster fees.

 

The effect of reinsurance on premiums written and earned for the three months ended March 31, 2012 and 2011 is as follows (in thousands).

 

 

 

Three Months Ended

 

 

 

March 31, 2012

 

March 31, 2011

 

 

 

Written

 

Earned

 

Written

 

Earned

 

Premiums from direct business

 

$

40,741

 

$

38,685

 

$

37,241

 

$

34,696

 

Reinsurance assumed

 

1,437

 

1,359

 

1,270

 

1,250

 

Reinsurance ceded

 

(4,616

)

(4,889

)

(4,810

)

(5,014

)

Net premiums

 

$

37,562

 

$

35,155

 

$

33,701

 

$

30,932

 

 

The effect of reinsurance on incurred losses for the three months ended March 31, 2012 and 2011 was as follows (in thousands).

 

 

 

Three Months Ended March 31,

 

 

 

2012

 

2011

 

Loss and loss adjustment expense (LAE) incurred

 

$

24,071

 

$

17,946

 

Reinsurance recoverables

 

(1,529

)

(1,942

)

Net loss and LAE incurred

 

$

22,542

 

$

16,004

 

 

Multi-line excess of loss coverage

 

For all lines of business, the Company has excess of loss reinsurance covering $775,000 in excess of $225,000 retention on losses on any one risk.

 

Catastrophic coverage

 

As of January 1, 2012, the Company renewed its catastrophic reinsurance contract for its first and second layers of reinsurance.  Per the contract renewal, the Company changed its underlying coverage at ASIC to $6.5 million in excess of $1.5 million retention.  The Company has reinsurance for up to $162 million in losses per event in excess of the $8 million retention.  The reinsurance from $8 million to $50 million loss is comprised of two layers of protection: $17 million in excess of $8 million loss; $25 million in excess of $25 million loss.  The third layer provides coverage for $50 million in excess of $50 million loss; the fourth layer provides coverage of $50 million in excess of $100 million loss and the fifth layer provides coverage of $20 million in excess of $150 million loss. The fifth layer is not fully subscribed, with participants accounting for 79% of the total layer.  Accordingly, NLASCO retains 21% of the losses in the fifth layer.    NLIC and ASIC do not retain participation in any of the layers, other than the first $8 million and $1.5 million retention, respectively.   During 2012, all five layers can be reinstated one time for 100% of the original premium.  The third and fourth layer reinsurance contract is expected to renew after June 30, 2012.

 

17



Table of Contents

 

HILLTOP HOLDINGS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2012

(unaudited)

 

6.              Income Taxes

 

The significant components of the provision for income taxes are as follows (in thousands).

 

 

 

Three Months Ended March 31,

 

 

 

2012

 

2011

 

 

 

 

 

 

 

Current tax expense

 

$

(29

)

$

(52

)

Deferred tax expense

 

(174

)

(725

)

 

 

 

 

 

 

Income tax expense

 

$

(203

)

$

(777

)

 

The decrease in income tax expense is a direct result of the decreased income from operations as the effective tax rate remained substantially unchanged.

 

7.              Statutory Net Income and Capital and Surplus

 

The Company’s insurance subsidiaries, which are domiciled in the State of Texas, prepare their statutory financial statements in accordance with accounting principles and practices prescribed or permitted by the Texas Department of Insurance, which Texas recognizes for determining solvency under Texas State Insurance Law. The Commissioner of the Texas Department of Insurance has the right to permit other practices that may deviate from prescribed practices. Prescribed statutory accounting practices are those practices that are incorporated directly or by reference in state laws, regulations, and general administrative rules applicable to all insurance enterprises domiciled in Texas. Permitted statutory accounting practices encompass all accounting practices that are not prescribed; such practices differ from state to state, may differ from company to company within a state, and may change in the future.  The Company’s insurance subsidiaries do not utilize permitted statutory accounting practices.

 

The Company’s insurance subsidiaries’ statutory financial statements are presented on the basis of accounting practices prescribed or permitted by the Texas Department of Insurance. Texas had adopted the National Association of Insurance Commissioners’ (NAIC) statutory accounting practices as the basis of its statutory accounting practices with certain differences, which are not significant to the companies’ statutory equity.

 

Following is a summary of statutory capital and surplus and statutory net income of each insurance subsidiary for the three months ended March 31, 2012 and 2011 (in thousands).

 

 

 

Three Months Ended March 31,

 

 

 

2012

 

2011

 

 

 

 

 

 

 

National Lloyds Insurance Company

 

 

 

 

 

Capital and surplus

 

$

95,947

 

$

97,798

 

Statutory net income

 

$

1,128

 

$

3,650

 

American Summit Insurance Company

 

 

 

 

 

Capital and surplus

 

$

24,953

 

$

24,577

 

Statutory net income

 

$

93

 

$

(724

)

 

18



Table of Contents

 

HILLTOP HOLDINGS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2012

(unaudited)

 

8.              Capital and Dividend Restrictions

 

The funding of the cash requirements (including debt service) of NLASCO is primarily provided by cash dividends from NLASCO’s wholly-owned insurance subsidiaries. Dividends paid by the insurance subsidiaries are restricted by regulatory requirements of the Texas Department of Insurance. Under Texas State Insurance Law for property and casualty companies, all dividends must be distributed out of earned surplus only. Furthermore, without the prior approval of the Commissioner, dividends cannot be declared or distributed which exceed the greater of ten percent of NLASCO’s surplus, as shown by its last statement on file with the Commissioner, and 100% of net income for such period. At March 31, 2012, the maximum dividends that may be paid to NLASCO in 2012 without regulatory approval is approximately $11.9 million.

 

Regulations of the Texas Department of Insurance require insurance companies to maintain minimum levels of statutory surplus to ensure their ability to meet their obligations to policyholders. At March 31, 2012, the Company’s insurance subsidiaries had statutory surplus in excess of the minimum required.

 

Also, the NAIC has adopted the risk based calculation (“RBC”) formula (RBC ratio) for insurance companies that establishes minimum capital requirements relating to insurance risk, asset credit risk, interest rate risk and business risk. The formula is used by the NAIC and certain state insurance regulators as an early warning tool to identify companies that require additional scrutiny or regulatory action. At March 31, 2012, the Company’s insurance subsidiaries’ RBC ratio exceeded the level at which regulatory action would be required.

 

9.              Equity and Income per share

 

The following reflects the calculation of income per share on a basic and diluted basis (in thousands, except per share information).

 

 

 

Three Months Ended March 31,

 

 

 

2012

 

2011

 

Income per share from operations

 

 

 

 

 

Income from operations

 

$

343

 

$

1,410

 

Income attributable to common stockholders

 

$

343

 

$

1,410

 

 

 

 

 

 

 

Basic income per share from operations

 

$

0.01

 

$

0.02

 

Diluted income per share from operations

 

$

0.01

 

$

0.02

 

 

 

 

 

 

 

Income per share available to common stockholders:

 

 

 

 

 

Income available to common stockholders

 

$

343

 

$

1,410

 

 

 

 

 

 

 

Basic income per share available to common stockholders

 

$

0.01

 

$

0.02

 

Diluted income per share available to common stockholders

 

$

0.01

 

$

0.02

 

 

 

 

 

 

 

Weighted average share information:

 

 

 

 

 

Basic shares outstanding

 

56,499

 

56,496

 

Diluted shares outstanding

 

56,555

 

56,496

 

 

 

 

 

 

 

Weighted average equivalent shares excluded from diluted loss per share because they would be anti-dilutive:

 

 

 

 

 

Senior exchangeable Notes

 

6,208

 

6,718

 

Stock options

 

700

 

100

 

Total

 

6,908

 

6,818

 

 

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HILLTOP HOLDINGS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2012

(unaudited)

 

10.       Commitments and Contingencies

 

Liabilities for loss contingencies arising from claims, assessments, litigation, fines and penalties and other sources are recorded when it is probable that a liability has been incurred and the amount of the assessment and/or remediation can be reasonably estimated.

 

We are a party to various legal actions resulting from our operating activities. These actions consist of litigation and administrative proceedings arising in the ordinary course of business, some of which are covered by liability insurance, and none of which is expected to have a material adverse effect on our consolidated financial condition, results of operations or cash flows taken as a whole.

 

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ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion should be read in conjunction with the consolidated historical financial statements and notes appearing elsewhere in this Quarterly Report on Form 10-Q and the financial information set forth in the tables below.

 

Unless the context otherwise indicates, all references in this Management’s Discussion and Analysis of Financial Condition and Results for Operations, or MD&A, to the “Company”, “Hilltop”, “HTH”, “we”, “us”, “our” or “ours” or similar words are to Hilltop Holdings Inc. (formerly known as Affordable Residential Communities Inc.) and its direct and indirect wholly-owned subsidiaries.

 

FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended by the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical fact, included in this report that address results or developments that we expect or anticipate will or may occur in the future, that are preceded by, followed by or include the words “believes,” “expects,” “may,” “will,” “would,” “could,” “should,” “seeks,” “approximately,” “intends,” “plans,” “projects,” “estimates” or “anticipates” or the negative of these words and phrases or similar words or phrases, including such things as our business strategy, our financial condition, our litigation, our efforts to make strategic acquisitions, our liquidity and sources of funding, our capital expenditures, our products, market trends, operations and business, are forward-looking statements.

 

These forward-looking statements are based on our beliefs, assumptions and expectations of our future performance taking into account all information currently available to us. These beliefs, assumptions and expectations are subject to risks and uncertainties and can change as a result of many possible events or factors, not all of which are known to us. If an event occurs or further changes, our business, business plan, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements. Certain factors that could cause actual results to differ include, among others:

 

·                  changes in the acquisition market;

·                  our ability to find and complete strategic acquisitions with suitable merger or acquisition candidates or find other suitable ways in which to invest our capital;

·                  the adverse impact of external factors, such as changes in interest rates, inflation and consumer confidence;

·                  the condition of capital markets;

·                  actual outcome of the resolution of any conflict;

·                  our ability to use net operating loss carryforwards to reduce future tax payments;

·                  the impact of the tax code and rules on our financial statements;

·                  failure of NLASCO, Inc.’s insurance subsidiaries to maintain their respective A.M. Best ratings;

·                  failure to maintain NLASCO, Inc.’s current agents;

·                  lack of demand for insurance products;

·                  cost or availability of adequate reinsurance;

·                  changes in key management;

·                  severe catastrophic events in our geographic area;

·                  failure of NLASCO, Inc.’s reinsurers to pay obligations under reinsurance contracts;

·                  failure of NLASCO, Inc. to maintain sufficient reserves for losses on insurance policies;

·                  failure to successfully implement NLASCO, Inc.’s new information technology system;  and

·                  failure of NLASCO, Inc. to maintain appropriate insurance licenses.

 

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For a further discussion of these and other risks and uncertainties that could cause actual results to differ materially from those contained in our forward-looking statements, please refer to “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 9, 2012. Consequently, all of the forward-looking statements made in this report are qualified by these cautionary statements and those risk factors, and there can be no assurance that the actual results or developments anticipated by us will be realized, or even substantially realized, and that they will have the expected consequences to, or effects on, us and our business or operations. Forward-looking statements made in this report speak as of the date of this report or as of the date specifically referenced in any such statement set forth in this report. Except to the extent required by law, we undertake no obligation to update or revise any forward-looking statements in this report.

 

GENERAL STRUCTURE OF THE COMPANY

 

We are a holding company that is endeavoring to make opportunistic acquisitions or effect a business combination.  In connection with that strategy, we are identifying and evaluating potential targets on an ongoing basis.  At March 31, 2012, Hilltop Holdings Inc. had approximately $528 million of available cash and cash equivalents that could be used for this purpose.  No assurances, however, can be given that we will be able to identify suitable targets, consummate acquisitions or a combination or, if consummated, successfully integrate or operate the acquired business.

 

Hilltop indirectly owns all of the outstanding shares of NLASCO, Inc., or NLASCO.  NLASCO, in turn, owns National Lloyds Insurance Company, or NLIC, and American Summit Insurance Company, or ASIC, both of which are licensed property and casualty insurers operating in multiple states.  In addition, NLASCO also owns the NALICO General Agency that operates in Texas.   NLIC commenced business in 1949 and currently operates in 14 states with its largest market being the State of Texas.  NLIC carries a financial strength rating of “A” (Excellent) by A.M. Best.  ASIC was formed in 1955 and currently operates in 11 states, its largest market being the State of Arizona.  ASIC carries a financial strength rating of “A” (Excellent) by A.M. Best. Both of these companies are regulated by the Texas Department of Insurance.

 

Our common stock is listed on the New York Stock Exchange, or the NYSE, under the symbol “HTH”.

 

OVERVIEW OF RESULTS

 

For the three months ended March 31, 2012, net income attributable to common stockholders was $0.3 million, or $0.01 per share, as compared to a net income of $1.4 million, or $0.02 per share, for the same period in 2011.  Net income attributable to common stockholders decreased by $1.1 million for the three months ended March 31, 2012, as compared to the same period in 2011, primarily due to higher loss and loss adjustment expenses of $6.5 million.  Offsetting these losses, were increases in net premiums earned of $4.2 million and net investment income of $1.2 million.

 

BUSINESS OBJECTIVES AND OPERATING STRATEGIES

 

Strategic Acquisitions.  Hilltop is seeking to make opportunistic acquisitions with its cash and, if necessary or appropriate, from additional equity or debt financing sources.

 

Insurance Operations.  NLASCO specializes in providing fire and homeowners insurance for low value dwellings and manufactured homes, primarily in Texas and other areas of the south, southeastern and southwestern United States. NLASCO targets underserved markets that require underwriting expertise that many larger carriers have been unwilling to develop given the relatively small volume of premiums produced by local agents. Within these markets, NLASCO attempts to capitalize on its superior local knowledge to identify profitable underwriting opportunities. NLASCO believes that it distinguishes itself from competitors by delivering products that are not provided by many larger carriers, providing a high level of customer service and responding quickly to the needs of its agents and policyholders. NLASCO applies a high level of selectivity in the risks it underwrites and uses a risk-adjusted return approach to capital allocation, which NLASCO believes allows it to consistently generate underwriting profits.

 

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Table of Contents

 

Many insurance buyers, agents and brokers use the ratings assigned by A.M. Best and other rating agencies to assist them in assessing the financial strength and overall quality of the companies from which they purchase insurance. A.M. Best assigned NLIC and ASIC a financial strength rating of “A” (Excellent).   An “A” rating is the third highest of 16 rating categories used by A.M. Best. In evaluating a company’s financial and operating performance, A.M. Best reviews a company’s profitability, leverage and liquidity, as well as its book of business, the adequacy and soundness of its reinsurance, the quality and estimated market value of its assets, the adequacy of its liabilities for losses and loss adjustment expenses, or LAE, the adequacy of its surplus, its capital structure, the experience and competence of its management and its market presence. This rating is intended to provide an independent opinion of an insurer’s ability to meet its obligations to policyholders and is not an evaluation directed at investors. This rating assignment is subject to the ability to meet A.M. Best’s expectations as to performance and capitalization on an ongoing basis, including with respect to management of liabilities for losses and LAE, and is subject to revocation or revision at any time at the sole discretion of A.M. Best. NLASCO cannot ensure that NLIC and ASIC will maintain their present ratings.

 

RESULTS OF OPERATIONS

 

Comparison of the Three Months Ended March 31, 2012 to the Three Months Ended March 31, 2011

 

Revenue.  Revenue for the three months ended March 31, 2012 and 2011 was $40.1 million and $34.7 million, respectively.  Net premiums earned were $35.2 million for the first quarter in 2012, as compared to $30.9 million for the same period in 2011, primarily due to higher volume of earned premiums of $4.0 million and a decrease in the cost of catastrophe reinsurance of $0.2 million.  Net investment income was $3.3 million for the first quarter of 2012, as compared to $2.1 million for the same period in 2011, primarily due to SWS investment at HTH parent only and higher yields on cash balances in 2012.  Other income was $1.7 million for the first quarter in 2012, as compared to $1.6 million for the first quarter in 2011.

 

Underwriting Results.  The following table shows the components of the Company’s underwriting gain for the three months ended March 31, 2012 and 2011.  The Company’s underwriting gain or loss consists of net premiums earned, less loss and LAE and policy acquisition and other underwriting expenses.  The underwriting results are discussed below (in thousands).

 

 

 

Three Months Ended March 31,

 

 

 

 

 

 

 

2012

 

2011

 

Change

 

% Change

 

Direct premiums written

 

$

40,741

 

$

37,241

 

$

3,500

 

9.4

%

Net premiums written

 

$

37,562

 

$

33,701

 

$

3,861

 

11.5

%

 

 

 

 

 

 

 

 

 

 

Net premiums earned

 

$

35,155

 

$

30,932

 

$

4,223

 

13.7

%

Loss and LAE

 

22,542

 

16,004

 

6,538

 

40.9

%

Policy acquisition and other underwriting expenses

 

12,915

 

11,985

 

930

 

7.8

%

Underwriting (loss) gain

 

$

(302

)

$

2,943

 

$

(3,245

)

-110.3

%

 

 

 

 

 

 

 

 

 

 

Agency expenses

 

$

(447

)

$

(433

)

$

(14

)

3.2

%

Loss and LAE ratio

 

64.1

%

51.7

%

12.4

%

 

 

Policy acquisition and other underwriting expense less agency expense ratio

 

35.5

%

37.3

%

-1.8

%

 

 

Combined ratio

 

99.6

%

89.0

%

10.6

%

 

 

 

The loss and LAE ratio is loss and LAE divided by net premiums earned for the same period.  The policy acquisition and other underwriting expense ratio is policy acquisition and other underwriting expense less agency expenses, divided by net premiums earned for the same period.  Combined ratio gives you the sum of both ratios.

 

Our combined ratio for the three months ended March 31, 2012 is 99.6%, as compared to 89.0% for the same period in 2011.  The 10.6% increase was due to an increase in loss and LAE and policy acquisition and underwriting expenses, moderated by an increase in net premiums earned primarily from accident year 2011. Net premiums earned increased 13.7% in the three months ended March 31, 2012, as compared to the same period in 2011, due to increase in volume of written premiums.  Loss and LAE expenses increased 40.9% in the quarter ending March 31, 2012, as compared to 2011, due to increased risk associated with a 13.7% increase in earned premiums, adverse weather development and prior year adverse development.  Policy acquisition and other underwriting expenses increased 7.8% for the three months ended March 31, 2012, as compared to 2011, which is a direct result of increased direct written premiums, as the underwriting ratio was favorable by 1.8%.

 

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The Company seeks to consistently generate underwriting profitability.  Management evaluates NLASCO’s loss and LAE ratio by bifurcating the losses to derive catastrophic and non-catastrophic loss ratios.  The non-catastrophic loss ratio excludes Property Claims Services (PCS) events that exceed $1.0 million of losses to NLASCO.  Catastrophic events, including those that do not exceed our reinsurance retention, affect the Company’s loss ratios. For the three months ended March 31, 2012, retained catastrophic events accounted for $1.2 million of the total loss and loss adjustment expense, as compared to $0.7 million for the same period in 2011.  Excluding catastrophic events, our combined ratios for the three months ended March 31, 2012 and 2011 would have been 96.1% and 87.0%, respectively.

 

For the three months ended March 31, 2012, the Company incurred a benefit related to three catastrophes, Hurricane Ike and Hurricane Dolly and a 2010 Arizona storm, of $0.1 million, as compared to a loss of $1.8 million for the same period in 2011.  The benefit in the three months ended March 31, 2012 relates primarily to decreased reserves on previously settled hurricane claims and additional reporting of Arizona claims. These losses have no effect on net loss and LAE incurred because the catastrophic events exceeded our retention and are fully recoverable from reinsurers.  The primary financial effect is additional reinstatement premium payable to the affected reinsurers.  For the three months ended March 31, 2012 and 2011, the Company incurred a benefit from reinstatement premiums of $5 thousand for the quarter ended March 31, 2012, as compared to an expense of $0.4 million in 2011.

 

Premiums.  The property and casualty insurance industry is affected by soft and hard market business cycles.  During a soft market, price competition tends to increase as insurers are willing to reduce premium rates in order to maintain growth in premium volume.  The soft market makes it more difficult to attract new business, as well as retain exposures that are adequately priced.  Although we recognize the need to remain competitive in the marketplace, the Company remains committed to its disciplined underwriting philosophy by accepting only risks that are appropriately priced, while declining risks that are under priced for the level of coverage provided.

 

Direct premiums written by major product line for the three months ended March 31, 2012 and 2011, are presented in the table below (in thousands).

 

 

 

Three Months Ended March 31,

 

 

 

 

 

 

 

2012

 

2011

 

Change

 

% Change

 

Direct Premiums Written:

 

 

 

 

 

 

 

 

 

Homeowners

 

$

17,672

 

$

16,305

 

$

1,367

 

8.4

%

Fire

 

12,780

 

12,211

 

569

 

4.7

%

Mobile Home

 

8,110

 

6,677

 

1,433

 

21.5

%

Commercial

 

2,122

 

2,008

 

114

 

5.7

%

Other

 

57

 

40

 

17

 

42.5

%

 

 

$

40,741

 

$

37,241

 

$

3,500

 

9.4

%

 

Total direct premiums written increased for the three months ended March 31, 2012 for all insurance products due to expanded distribution and growth on existing insurance products.  Higher value homeowner and commercial insurance products generated $1.0 million in the three months ended March 31, 2012. Our existing products increased $2.6 million because of growth in premium production in Texas, Oklahoma, Georgia, Tennessee and Arizona in the same period in 2012.

 

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Table of Contents

 

Net premiums written by major product line for the three months ended March 31, 2012 and 2011, are presented in the table below (in thousands).

 

 

 

Three Months Ended March 31,

 

 

 

 

 

 

 

2012

 

2011

 

Change

 

% Change

 

Net Premiums Written:

 

 

 

 

 

 

 

 

 

Homeowners

 

$

16,293

 

$

14,755

 

$

1,538

 

10.4

%

Fire

 

11,783

 

11,051

 

732

 

6.6

%

Mobile Home

 

7,477

 

6,042

 

1,435

 

23.8

%

Commercial

 

1,957

 

1,817

 

140

 

7.7

%

Other

 

52

 

36

 

16

 

44.4