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Hilltop's Loss Swells, Expenses Rise

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On Friday, Hilltop Holdings Inc. (HTH - Free Report) filed its 10-Q to report results for the quarter ending September 30, 2012. For the third-quarter 2012, the company’s net loss attributable to common stockholders stood at $4.1 million or 7 cents per share, deteriorating from an income of $0.25 million or nil per share in the year-ago period. Loss per share also lagged the Zacks Consensus Estimate of earnings of 1 cent.

Results reflected higher premiums and investment income although deteriorated net realized gains limited top-line growth, whereas higher expenses adversely affected the combined ratio and bottom line. Particularly, higher-than-expected underwriting along with loss and loss adjustment expenses (LAE) expenses resulted in operating cash outflow and underwriting loss during the reported quarter.

During the reported quarter, Hilltop’s total revenue was $42.8 million, climbing 5.5% from $40.6 million in the year-ago quarter, also breezing past the Zacks Consensus Estimate of $42.0 million. The year-over-year upswing was primarily attributable to a 7.9% increase in net premiums earned of $37.7 million and net investment income grew 4.6% to $3.3 million. Other income improved 7.9% year over year to $1.9 million, while net realized investment gains plunged to $0.008 million from $0.81 million in the year-ago period.

Meanwhile, total expenses hiked 17.1% year over year to $48.8 million, primarily due to a 17.5% increase in policy acquisition and other underwriting expenses coupled with 26.7% surge in LAE. These were partially offset by a 27.2% dip in general and administration expenses and reduced depreciation and amortization expense, along with slightly lower interest expenses.

Subsequently, higher LAE and operating expenses swayed Hilltop’s combined ratio to deteriorate to 114.2% in the reported quarter from 99.6% in the year-ago quarter. Excluding catastrophic events, combined ratios for the third quarters of 2012 and 2011 would have been 96.1% and 89.3%, respectively.

Financial Update

As on September 30, 2012, Hilltop had cash and cash equivalents of $574.2 million (down from $578.5 million as on December 31, 2011) and investments worth $215.8 million (compared with $224.2 million at the end of 2011).

Total shareholder’s equity stood at $640.8 million at the end of the reported quarter, down from $655.4 million at 2011-end. Total assets also dipped to $915.5 million at the end of the reported quarter from $925.4 at 2011-end, while total liabilities increased to $274.7 million from $270.0 million at the end of 2011.

Furthermore, as on September 30, 2012, operating cash outflow stood at $13.4 million against $4.0 million at the end of the year-ago quarter. At September 2012-end, Hilltop had a deposit in custody for various investments in State Insurance Departments with carrying values of $9.4 million. No shares were repurchased during the reported quarter.

Moreover, Hilltop’s agreement to acquire U.S.-based financial services company – PlainsCapital Corp. – for about $536.9 million awaits the regulatory approval, although it has been sanctioned by the board of both the companies. The deal was inked in May 2012.

Our Take

While Hilltop remains sufficiently liquid, we believe management will probably deploy the excess capital for acquiring other insurance businesses, as evident from the proposed PlainsCapital acquisition. The company’s expanded distribution is also driving growth of existing insurance products and should further improve the top line. 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. Additionally, higher expenses, low interest rate and persistent economic volatility continue to mar investment and fundamental 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. The company should also be able to strengthen its competitive position amid arch-rivals – American Realty Capital Trust Inc. (ARCT - Free Report) and Granite Re Inc. (GRP) – once the markets rebound to improve pricing and reverse the cyclical declines.

Hence, given the long-term growth potential, we maintain a long-term Neutral recommendation on the stock, although current volatility warrants a Zacks Rank #2, which also implies a short-term Buy rating.

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