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Higher Expenses Hurt Hilltop's 1Q

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On Friday, Hilltop Holdings Inc. (HTH - Free Report) filed its 10-Q to report results for the quarter ending March 31, 2012. For the first quarter of 2012, net income attributable to common stockholders decreased to $0.3 million or 1 cent per share from $1.4 million or 2 cents per share in the year-ago period. Earnings per share also lagged the Zacks Consensus Estimate of 4 cents.

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

During the reported quarter, Hilltop’s total revenue was $40.1 million, escalating 15.6% from $34.7 million in the year-ago quarter, although it fells shy of the Zacks Consensus Estimate of $41.0 million. The year-over-year upswing was primarily attributable to a 13.9% increase in net premiums earned of $35.2 million and net investment income soaring 56.7% to $3.3 million. Besides, other income improved 5.3% year over year to $1.7 million, while net realized investment gains were almost at par with prior-year quarter at $0.2 million.

Meanwhile, total expenses jumped 21.8% year over year to $39.6 million, primarily due to a 40.9% surge in loss and loss adjustment expenses (LAE) along with a 7.8% increase in policy acquisition and other underwriting expenses. These were partially offset by reduced general and administration and depreciation and amortization expenses along with lower interest expenses.

Besides, higher LAE and underwriting expenses also deteriorated Hilltop’s combined ratio to 99.6% in the reported quarter from 89.0% in the year-ago quarter. Excluding catastrophic events, combined ratios for the first quarters of 2012 and 2011 would have been 96.1% and 87.0%, respectively.

Financial Update

Additionally, as on March 31, 2012, Hilltop had cash and cash equivalents of $579.6 million (up from $578.5 million as on December 31, 2011) and investments worth $219.4 million as compared with $224.2 million at the end of 2011.

Total shareholder’s equity stood at $651.3 million at the end of the reported quarter, down from $655.4 million at 2011-end. Total assets inched down to $924.3 million at the end of the reported quarter from $925.4 at 2011-end, while total liabilities decreased to $273.0 million from $270.0 million at the end of 2011.

Furthermore, as on March 31, 2012, operating cash flow stood at $2.6 million against $3.7 million at the end of year-ago quarter. At March 2012-end, Hilltop had a deposit in custody for various investments in State Insurance Departments with carrying values of $9.4 million. Besides, the company repurchased 0.14 million shares for about $1.2 million in a  privately negotiated transaction.

Our Take

While Hilltop remains sufficiently liquid, we believe management will probably deploy the excess capital in acquiring other insurance businesses to expand their operations and further improve the top line. The company’s expanded distribution is also driving growth of existing insurance products. However, the company’s future performance will be dependent to a great extent upon the prudent deployment of its reserves, even as the sole dependence on subsidiary NLASCO continues to restrict its long-term growth.

Overall, we believe that Hilltop should continue to tread ahead with its strategic approach in order to reduce expenses and capitalize on the opportunities that the markets provide on stabilization. We believe that the company should also be able to strengthen its competitive position amid arch-rivals such as MI Developments Inc. and Capital Trust Inc. once the markets rebound to improve pricing and reverse the cyclical declines.

Hence, given the upside potential, we maintain a long-term Outperform rating on the stock, with a Zacks Rank #1, which also implies a short-term Buy recommendation.

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