HTH - Hilltop Holdings: Reducing Our Exposure Post Rally

Summary

• HTH has an attractive business model, desirable footprint, and elite management team.
• However, up 20% in the last six months and now trading at close to 1.2x TBV, we were selling into strength this week.
• We see a less desirable risk-reward opportunity given the potential of meaningful economic headwinds in 2023.

Snapshot

Although Hilltop Holdings (HTH) has been a core holding since 2010, we regularly add to and lighten our exposure as the stock develops.

Up 20% in the last six months and now trading at close to 1.2x tangible book value ((TBV)) we were selling into strength this week. The move shifts HTH from an overweight position in our portfolio to parity.

As noted below, since identifying HTH as our best idea ( Hilltop Holdings: Our Top Idea - Inexpensive, Tangible Catalysts, And Elite Leadership ), the stock has materially outperformed the S&P500.

This is a valuation call. The stock remains a significant holding, but we will further reduce our position should shares continue to rally.

Background

Headquartered in Dallas, TX, HTH was founded in 1998 as a real estate investment firm specializing in manufactured home communities.

In 2005, Gerald Ford, the company’s current Chairman and largest shareholder, joined the Board and transformed HTH into a financial holding company via a series of acquisitions and divestitures.

Today, the firm's primary line of business is providing traditional commercial and consumer banking services through PlainsCapital Bank and its wholly-owned subsidiary PrimeLending.

In addition, HTH's broker-dealer subsidiaries (Hilltop Securities Inc. and Hilltop Securities Independent Network Inc.) provide a full complement of securities brokerage, institutional, and investment banking services, as well as, clearing services and retail financial advisory.

HTH has roughly $17 billion in assets and operates 59 bank branches in Texas, 290 mortgage locations in 45 states, and 51 broker-dealer offices in 19 states.

The firm distributes an annual dividend of $0.60 per share, which equates to a 1.9% yield.

Thesis

HTH has been a core holding in our portfolio for over 10 years as it offers multiple winning attributes.

Great Management

The firm’s chairman and largest shareholder, Gerald Ford, is one of the nation's most accomplished financial services executives. Ford has made a career, and billions of dollars, investing in the bank sector.

For two decades beginning in 1975, Ford bought distressed banks, mainly taking advantage of "firesales" during the savings and loan crisis. In total, he bought 30 banks and five thrifts and eventually sold them for multiples of the original capital invested.

Subsequently, in 2004, Ford struck gold again when he bought First Nationwide Bank for $1.1 billion, bundled the firm with a few small banks, and then sold the integrated business to Citigroup for $5.3 billion.

And since joining HTH, Ford has spearheaded five acquisitions driving the share price four-fold, from ~$8 per share to ~$32 today.

Significant Insider Ownership

Not only is management seasoned and accomplished, but also perfectly aligned with shareholders. Insiders own almost 30% of shares outstanding, including Ford's stake of over 24%. This dynamic incentives management to maximize profitability and shareholder value.

Shareholder-Friendly Capital Allocation

Likely due to its weighty ownership stake, management is laser-focused on prudent capital allocation. For example, HTH has raised the quarterly dividend seven consecutive years and currently offers a ~2% yield.

In addition, the firm has been aggressively buying back shares below book value. Over the last two years, HTH has reduced shares outstanding by over 28%.

Robust Balance Sheet

Despite the regular dividend payout and opportunistic share repurchases, HTH maintains a rock-solid balance sheet. With a tier 1 capital ratio of 17.5%, the firm is significantly overcapitalized.

When it comes to deploying this war chest, Ford’s first choice is M&A. As mentioned previously, he has a proven, multi-decade track record of creating outsized shareholder returns using a roll-up strategy in the banking sector. But Ford is patient, comfortable holding out for a highly opportunistic scenario.

Potential Headwinds

The current economic environment is creating a series of near-term challenges for HTH. Per the 3Q22 earnings call , management noted:

1. Higher rates and inflation are negatively impacting loan production;
2. The reduction in number of homebuyers is pressuring mortgage volumes; and
3. Loan loss reserves are likely to increase.

Final Thoughts

We're fans of HTH. The firm has an attractive (diversified) business model, desirable footprint, and elite management team.

However, up 20% in the last six months and now trading at close to 1.2x TBV, we are taking a more cautious approach. This week, we sold into strength, reducing our previous overweight position.

We believe the current valuation ignores the potential of a weaker U.S. economy in 2023 and a reduction of share repurchases as the exercise is no longer accretive to TBV.

Although the stock remains a significant holding, we will continue to reduce our position should shares appreciate from here. We would expect to be completely out in the mid-$30's.

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