Hilltop Holdings Inc. (HTH) Q1 2015 Earnings Report, Transcript and Summary

Hello. And welcome to the Hilltop Holdings First Quarter 2015 Earnings Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Ms. Isabell Novakov, Senior Vice President, Investor Relations. Please go ahead.

Good morning. Joining me on the call are Jeremy Ford, President and CEO, Hilltop Holdings; Alan White, CEO of PlainsCapital Corporation; Darren Parmenter, Principle Financial Officer, Hilltop Holdings; and John Martin, CFO of PlainsCapital Corporation. Before we get started, please note that this presentation and statements made by representatives of Hilltop Holdings Inc. during the course of this presentation include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the company’s actual results, performance or achievements to be materially different from any future results, performance or achievements anticipated in such statements. Forward-looking statements speak only as of the date they are made and except as required by law the company does not assume any duty to update forward-looking statements. Such forward-looking statements include but are not limited to, statements concerning such things with our business strategy, our financial condition, our litigation, our effort to make strategic acquisitions, our recent acquisition of SWS Group Inc., and integration thereof, our revenue, our liquidity, and sources of funding, market trends, operations and business, expectations concerning mortgage loan origination volume, expected losses on covered loans and related reimbursements from the Federal Deposit Insurance Corporation, projected losses on mortgage loans originated, anticipated changes in our revenues or earnings, the effects of government regulation applicable to our operation, the appropriateness of our allowance for loan losses, and provision for loan losses, the collectability of loans, the company’s other plans, objectives, strategies, expectations, and intentions, and other statements that are not statements of historical fact. For further discussion of such factors, see the Risk Factors described in Hilltop’s annual report on Form 10-K for the year ended December 31, 2014, and other reports filed with the Securities and Exchange Commission. All forward-looking statements are qualified in their entirety by this cautionary statement. And now, I would like to hand the presentation over to Jeremy Ford.

Thank you, Isabell. For the first quarter of 2015, net income to common stockholders was $113.4 million or $1.13 per share. The first quarter 2015 adjusted net income was $38.8 million or $0.39 per share, when excluding the bargain purchase gain transaction and integration costs related to the SWS merger. For the first quarter of 2014, net income was $23.8 million. For the first quarter, our ROA was 3.7% and our ROE was 27%. Our four operating segments reported $140 million of pretax, which included PlainsCapital contributing $81 million of pretax, with the bargain purchase gain of $39.5 million, Hilltop Securities Holdings contributing $39.9 million of pretax, including preliminary bargain purchase gain of $43.3 million, PrimeLending contributing $10 million, and National Lloyds contributing $9.1 million. Total stockholders equity increased to $1.8 billion, up $321 million from December 31, 2014. Hilltop remains well-capitalized with 12.68% Tier 1 leverage ratio and 20.8% total risk pay capital ratio. We have $59 million of freely usable cash at our parent and we have excess capital in all of our subs. On April 9, 2015, Hilltop issued $150 million of 10-year senior debt at a 5% rate and on April 28, 2015, we fully redeemed for $114.5 million of the proceeds from the debt issuance all of our SBLF preferred stock and we’ll continue to be disciplined and seek new bank M&A opportunities in Texas, while focusing internally on efficient integration of the broker dealers. Moving forward and I’ll touch on the items not already discussed. Our book value per share at quarter end stood at $16.63, a significant increase over the last year from earnings and from the SWS acquisition. Our net interest margin for the quarter was 3.53% and the decline here is due to the inclusion of the SWS securities lending business. Our assets of $12.6 billion, our loans of $5.4 billion and our deposits of $7.1 billion all at quarter end all increased due to the SWS transaction, and our MPAs to total assets held firm at 26 basis points. And now, I’ll turn the presentation over to Darren.

Thank you, Jeremy. As Jeremy mentioned, our net interest margin decreased by 119 basis points in the quarter to 3.53% compared to 4.72% in the fourth quarter. This was primarily due to the inclusion of the stock loan business from SWS. The average balance of earnings assets and borrows increased approximately $2 billion as a result of adding the stock loan business. Cost of interest-bearing deposits was down 11 basis points versus the fourth quarter. In the first quarter, the tax equivalent net interest margin for Hilltop was 69 basis points greater due to purchase accounting. This is driven mainly by the accretion of discounted loans of $17 million and the amortization of premium on acquired securities of $900,000. Moving forward to non-interest income, including the $82.8 million preliminary bargain purchase gain associated with the SWS merger, non-interest income for the quarter was $354.4 million. Excluding the preliminary bargain purchase gain, non-interest income for the quarter was $271.6 million, up 59.6% from prior year. Investment advisory fees and commissions increased $46.6 million from prior year to $68 million in the quarter, representing 25% of our non-interest income. Net gains from the sale of loans, other mortgage production income and mortgage loan origination fees increased $43.7 million or 47.8% from the first quarter of 2014 to $135 million in the first quarter of 2015, representing 50% of our non-interest income. Net insurance premiums earned remained flat at $39.6 million, representing 15% of our non-interest income. Moving forward to non-interest expense, our non-interest expense was $314.5 million in the quarter, up 48% from prior year. During the quarter, Hilltop incurred $5.6 million in transaction costs and another $4.4 million in integration costs associated with employee expenses, contractual costs and professional fees all related to the Southwest Securities merger. Compensation increased $76.1 million or 71.5% from the first quarter of 2014 to $182.6 million, representing 58% of the non-interest expense for the quarter. Lawson LAE and policy acquisition and other underwriting items expenses was $30.5 million in the quarter. Occupancy and equipment expenses increased $2.8 million or 10.8% from prior year to $29.2 million in the quarter. Other expenses increased $22.3 million or 44.8% first quarter of 2014 to $72.2 million. Amortization of identifiable intangibles for purchase accounting was $2.8 million in the quarter. Moving forward to our balance sheet highlights, total assets increased by $3.3 billion, primarily due to the inclusion of SWS. Gross non-covered loans held for investment increased $914 million or 23% from the fourth quarter to $4.8 billion. Gross covered loans decreased by $90.6 million or 14% from the fourth quarter to $552 million. This was due to our successful ongoing efforts to resolve troubled loans acquired in the First National Bank transaction. Our covered loans have decreased by $360.4 million or approximately 40% versus the first quarter of 2014. Covered OROE increased by $800,000 in the quarter due to foreclosures of properties related to covered loans. Our covered OREO has decreased $14.6 million or nearly 10% versus the first quarter of 2014. Gross loans held for investment covered and non-covered to deposit ratio increased to 75.6% from 71.6% in the fourth quarter. Total deposits increased to $759.4 million or 11.9% in the quarter to a total of $7.1 billion at the end of the quarter, 31.4% of our total deposits are non-interest bearing. Common equity increased by $321 million to $1.7 billion at the end of the first quarter, due to earnings and the inclusion of Southwest Securities. Subsequent to the quarter end Hilltop issued $150 million in senior notes and redeemed the SBLF preferred. With that, I’d like to turn the call over to Alan White.

Thank you, Darren. I’m very pleased to report on the Bank and PrimeLending. We had an excellent quarter and our teams performed at a high level. Our non-covered held for investment loan growth was 19% in the quarter followed by the acquisition of Southwest Securities Bank. We have a favorable loan pipeline that continues to grow at $1.57 billion in unfunded commitments versus a $1.3 billion in the fourth quarter. We’ve hired seven new loan officers, two in Houston, two in the Valley and three in the Dallas-Fort Worth area, which we help continue to bring us solid loan growth, a number of it -- we always talk about loan growth but we never really talk about this number, I’m proud of it, but they are non-interest bearing deposits 31.4%, which is an excellent number and I just wanted to bring that to your attention. Our strong net interest margin was 4.59 for the quarter. We have 68 branches as of 3/31/15 and we continue to divest ourselves of unprofitable branches that we acquired in the FNB transaction. As a result, we closed 13 FNB branches in the quarter, 11 of those were in the Valley. PCB expects a pre-tax savings of approximately $4.8 million, which includes a reduction in staff and occupancy costs. In addition, we’ll save another $4.7 million pretax that will be rolling off high yielding CDs that we’ve had in the Bank that came with the purchase. As far as the closing the branches in the Valley, closed 11 branches and we still have 14 branches that went very well, we lost a minimum amount of business, it was handled very well by our staff. We have a strong team down there led by Bobby Normand and we’ve gone from a Bank down there trying to collect loans to a community bank and a player in the Valley and right now we’re making loans and we have a pipeline of $100 million. So we’re making lots of progress and we’re becoming a player in the Valley. In Corpus and the Coastal Bend area, we’ll be opening our flagship branch down on shoreline facing the Bay of Corpus. In September, it will be our flagship branch in Alice. The 14th of May, will be opening our new branch there. It’s the nicest branch in Alice and we’re excited to get that open. We are working in temporary quarters right now and then in Victoria in the summer, we’ll be opening our permanent space there, which we are operating in a temporary space there. So we’re excited to get those things going, it should help our Coastal Bend markets. In Houston, we continue to build our market there. Our flagship location will be at Kirby Grove in Richmond, that should be completed in early fall, that’s where we will build our base and build our headquarters. The Austin-San Antonio markets are strong, still lots of growth, population growth and our business is very good in those markets, lot of this continues to be a strong market for us as we continue to maintain market share and in Dallas-Fort Worth, Arlington, Weatherford, Frisco, all of those areas are, ,obviously growing and we’re going to work well in those areas. As far as our credit quality, it remains very strong. Our MPAs to consolidated assets is 0.26%, which is very good and then we’re very pleased with that. The question of the day is energy exposure. This continues to decline from 6.5% of our loan portfolio down to 5.8% and it’s continuing to come down. I think what we’re finding with our customers that they are adjusting to the market. And they’re cutting back on their loan request. And they’re managing their businesses accordingly. We still have not seen any deterioration in the portfolio but we are pleased to see that people are adjusting to the times. Our integration with Southwest Securities, we took over that bank on January 1st. And I’m really tickled to death to let you know that we have completely fully integrated the bank into our bank and completed that process on April 10. That’s a little over 90 days. So our people -- the integration team has really done an outstanding job to be able to do that. We end up with four branches from Southwest Securities. We closed seven locations, four branches and three loan processing offices and we’ll have a savings with the closure of those of about $1.4 million annually in occupancy and non-interest expense. The four branches we kept are in Granbury, Dallas Renaissance is the headquarters of Southwest Securities, Arlington and Waxahachie. In the acquisition, we picked up two major lines of business, the commercial lending side which amounts to about $400 million. We also picked up a mortgage purchase business that we’re very familiar with but we haven’t been in that business and we have found that to be very lucrative for us. We have about $500 million worth of -- not commitments but guidance lines out. We have about $250 million drawn down on those at this point. That’s up considerably from the time we took it over. We like this business. We know this business and we’re going to improve or increase our guidance lines of $750 million as we continue to recruit and to bring more loans into the fold. So that’s very good. We reduced the staff from 138 down to 60. We got savings on an annualized basis of about $8.3 million. That’s from salary and benefits. The good thing about this is we’re able to get in there and get it done quick. We did it very professionally and very thoroughly. I feel very good about it but we should now be able to benefit from our savings, cost savings and from what we’ve done and we’ll be able to benefit from that loan portfolio we picked up. So I think this has been a very good transaction. This is the second integration that we have done. And we learn each time from them. And I think we’re getting better and we look forward to the next one. PrimeLending, as you know it’s a cyclical business. Traditionally, the first quarter is not good. Second and third quarters are the strong quarters with the purchase side picking up and then the fourth quarter kind of tails off. This year is an exception. Our first quarter has been excellent. There’s been a refi boom again. We’re running about 60-40 on purchase refi. Our locks, as we call them, volume is up 66% over a year ago at $4.4 billion in our commitments and closings are up 51% over ‘14. And we’ve done all of this, which we’re very pleased and helps our overhead. We’ve done it with the same amount of staff. We’ve not added staff to close these loans or to do this. And we’ve also done it with 80 less loan officers. So we’re being able to maximize our efficiency and people are doing an excellent job. And of course, the results of that, obviously the bottom line. We try to kind of breakeven in the first quarter and obviously we’ve had a significant difference in the bottom line in the first quarter. Second quarter is always a strong purchase quarter. Right now, the refinance continues. The purchase side has picked up, just like we expected. And we’re probably running 70-30. So I think we’re poised at PrimeLending to have a good year. The MBA came out recently and said that volumes are going to move from $1 billion to -- $1 trillion to $1.2 trillion. That’s a 20% increase and if you were to put that 20% down on Prime’s numbers, you’ll look to see that we’ve done better than that. And then lastly, at Prime, which is something we really like and we really look at, we increased our market share from 0.92 to 0.98. And if we continue in the direction we’re going and we continue to get that 20% extra, we’re going to continue to see that line go up and that’s going to be very beneficial for the company in Prime. And that’s my report from the two operating companies at the bank in PrimeLending. Jeremy is going to talk about the securities and insurance company.

Okay, thank you very much, Alan. The next page here, we’ve got Hilltop Securities Holdings on top. From a business performance perspective, the highlights are the public finance business, which revenue was up $6.4 million year-over-year, with the addition of the SWS Bankers, continued refinancing by clients and improving market share. Also a highlight is the structured finance business, the legacy First Southwest CBA business that continues to see the improved year-over-year performance as the result of increased lock production. About the integration of the broker-dealers for the quarter, we’ve established some new leadership in some key areas. Bob Peterson has been appointed as the CEO of Southwest Securities broker-dealer. He plans all along and will continue to be there. Mr. Peterson will be President and COO of the combined broker-dealer once we’re able to affect that. And we’d like to welcome David Geschke who is onboard. He’s a new hire and he’ll lead our retail effort. Another important milestone that we accomplished this past quarter was after a thorough evaluation, we’ve chosen the system which is a service bureau provider for the combined broker-dealer. And so now, we’re really focused on executing on the systems integration and the regulatory approval for a timely integration. As far as National Lloyds is concerned, it did have a strong and profitable quarter. The earned premiums were flat with the policies in-force being down but rates being higher and the claim count was down year-over-year. We also had two new hires there in marketing and product that we hope will improve our distribution and our product analysis. With that, I’ll hand it over to John.

Thank you, Jeremy. As both Alan and Jeremy have said, we had a good quarter at the bank, a good first quarter. Including the $39.5 million bargain purchase gain related to the SWS transaction, income before taxes at the bank was $81.2 million. For the same period of 2014, the bank’s income before tax was $31.9 million. The first quarter income also included about $1.8 million in employee expenses related to the integration of the former SWS Bank and about $4.4 million in gains from the sale of securities. The increase in net interest income was a result of growth in our non-covered loan portfolio and from operations acquired in the SWS Merger. The SWS Merger also provided higher non-interest income due to increases in service charges and fees on deposits. Non-interest expense declined as a result of lower operating costs relating to closing of unprofitable branches acquired in the FNB Transaction. The bank continues to provide a warehouse line of credit to PrimeLending, $1.5 million was available, of which $1.1 billion was drawn -- excuse me, $1.5 billion was available. The bank continues to maintain strong capital ratios with a Tier 1 leverage ratio of 11.34 compared to 10.31 at December 31, 2014. Loans held for investment at March 31st amounted to $5.4 billion, of which 42% were classified as commercial and industrial and 47% were classified as real estate. Total deposits grew to $7.1 billion, 32% of which were non-interest bearing. Credit quality remains strong with only $32.8 million in nonperforming assets at the end of the quarter. Loans held for investment include covered loans, which are loans subject to the loss share agreements with the FDIC and non-covered loans. Each of these portfolios include purchase credit impaired loans as well as non-purchase credit impaired loans. All of the covered loans were acquired in the FNB Transaction. At March 31, 2015 we had $360 million of covered PCI loans, $114.9 million of non-covered PCI loans, $192 million of covered non-PCI loans and $4.7 billion of non-covered, non-PCI loans. PlainsCapital Bank’s PCI portfolio amounted to -- had an unpaid principal balance of $750 million, with a discount of $275 million. So after the allowance, we’re carrying those loans at 62.5% of their unpaid principal balance. On our non-PCI loans, which amounted to $4.96 billion, we had a discount of $48.8 million and those are carried after allowance at 98.3%. In PrimeLending, Alan’s already mentioned that the -- we had a good first quarter pretax income of $10 million versus a pretax loss of $3 million in the first quarter of 2014. This was due to significantly higher origination volume in a quarter that usually is cyclically low for the business. Origination volume of $2.8 billion in the first quarter was $947 million greater than the first quarter of 2014 due to growth in both purchase and refinance business. The purchase volume decreased to 60% in Q1 from 78.7% in the first quarter of 2014, although the dollar volume was up $219 million. Refinance volume of $727 million or 183.1% from -- increased 183.1% from the first quarter of ‘14 to $1.125 million in the first quarter due to a drop in interest rates. Non-interest income increased $43.5 million or 47% from 2014 to $135 million in the first quarter of ‘15 due to higher origination volumes and stable margins. Non-interest expense increased $31.7 million or 35% from the first quarter to $122.3 million in the first quarter of ‘15 due to higher variable compensation associated with the higher origination volume. PrimeLending retained servicing of approximately 9% of the new loans originated in the first quarter. The net MSR value was $31.6 million at the first quarter of ‘15 on $3.6 billion of service loan volume. The fair value of the MSR declined $5 million during the quarter. With that, I’ll turn it back to Jeremy.

Okay. Thank you, John. So talking about Hilltop Securities Holdings for the quarter, just to note that the first quarter of 2015 includes the full quarter of operations with SWS. However, the prior year quarter only includes for Southwest. And for the quarter we had pretax income of $39.9 million. And this is due largely to preliminary bargain purchase gain of $43 million for the SWS Merger. Our Q1 results also included transaction costs, integration costs and professional fees related to the merger. And after adjusting for those costs, our pretax contribution from this segment was breakeven. Highlights are, as I said before, the public finance revenue increased as our volume by account was up 66% and our aggregate dollar volume was up 83%. And also, the U.S. agency to be announced business had fair value changes on derivatives that provided net gains of $8.6 million. Our non-interest expense increased $63 million to $91 million for the quarter and that was the inclusion of the SWS employee. One thing also I would note on this page and the key highlights you’ll see, today we are sweeping $550 million of the broker-dealer accounts to the bank and we have the ability to sweep an additional $1.3 billion. Moving forward to page 18 on National Lloyds, we had pretax income at National Lloyds of $9.1 million for the quarter versus $11.4 million for prior year quarter. The revenue was relatively flat and this was a result of our planned exposure management initiatives, which have been successful on reducing our exposure to volatile weather and contributing to lower loss experience since 2013. We did have in the quarter an increase in expenses driven by prior period adverse development related to the litigation emerging from a series of hailstorms within the 2012 and 2014 accident years. And we’ll continue to work through those. So our combined ratio for the quarter was 81.8%, which was strong versus 77.5% in the prior year. And now, I’ll hand it back over to Isabell.

This concludes our prepared remarks. We will now take questions.

Thank you. [Operator Instructions] Our first question comes from Brady Gailey at KBW.

Hey. Good morning, guys.

Good morning.

So, I’ll start with loan growth. I’m trying to back into what the organic loan growth would have been in the quarter without the SWS deal. How many loans ended up coming over from SWS? I know in the proxy, I think it was around $850 million after the mark. Did that hold at about that same level?

Let me flip to the page . It’s 8 -- our non-covered loans were $863 million. Yeah.

Okay, so the non -- so the loans added from SWS were $863 million?

Correct.

Okay. Okay. Okay. So that will back into organic loan growth of around 2% linked quarter annualized. How do you all feel about loan growth through the balance of the year?

Well, I’ll answer that. As far as budget, we were right on budget. But we still anticipate the 13% organic loan growth that’s coming down and if you look at the commitments that we have and they’ll start funding up, I think you’re going to see that. Some of those are real estate projects that are going to fund up and it’s just the normal growth. Like I say, the Valley is catching on. Corpus and Houston are catching on. We’re anticipating it and we still feel confident we’ll be able to hit that bigger.

Okay. Okay. Okay. And then energy balances, if you look at -- I know the percentage was down due to the SWS loans coming into the denominator but I think the energy balance is kind of flat around $380 million.

They’ve come down a little bit. They’re going to continue to come down. We have really not seen any deterioration from that standpoint. And again, like I said in my comments and we’re staying on top of it to keep an eye on our larger ones. They’re adjusting their business model to go with the times. And that means they’re reducing their credits and the amount of money they do need and how they run their business. And we’re not seeing any deterioration in our financials at this point. So, I still be very strong. Again, we’re not in the energy business. These people are people that have banked with us for a long time. They’re relationships and I see the exposure will continue to come down but have no concerns.

Okay.

Let me quantify that. It’s about a $4 million decrease.

Okay. Okay. And then finally…

$40 million.

$40 million decrease.

A $40 million. Okay. Okay. All right. And then finally, now that SWS is closed and in the books, you all still have excess capital. It sounds like going forward you all are going to be more focused on bank M&A and I’ve seen a couple of articles in the local Houston papers talking about how dedicated you all are to Houston and your desire to grow there. Can you just talk about bank M&A in general and then specifically your interest in acquiring something in the Houston market?

Sure, I’ll start with that and Alan can talk about the Houston opportunity. But we’re looking, right now and we continue to evaluate. I think we’ve said that we’re looking for depositories in Texas that really fit in our footprint. So we’re looking at anything that we can.

As far as you mentioning Houston, obviously it will be a market we like to be in. Obviously, we’re there in a small way and we’re going to continue to try to grow organically unless something comes our way that makes sense from a financial standpoint and a cultural standpoint. But there are a lot of other markets in Texas and we just assume grow into. So where we find the best deal that works culturally and financially is where we’re going to go. Houston would be ideal. I want to clarify something here because I focus on the bank and not so much the broker-dealer. When we said how much loans did we get from Southwest Securities, the bank itself did not get $850 million. A lot of that is the broker-dealer. So, I don’t want you to confuse that with the bank. The bank, as I say right now, the loan balances are $450 million and I know that’s up from when we took it over because we’ve grown that mortgage purchase business. So the other side of this is the broker-dealer. I just want to see and make sure you’re not confused because I was confused when they threw that number out there.

Okay. Yes. That’s helpful.

You got it. Because the bank has grown and that mortgage purchase business is growing and I’m excited about the bank because we’ve been able to cut the monkey’s tail off. And now we’re going to enjoy the benefits of what we did and that’s going to be continued loan growth. But the broker-dealer, that’s a different deal.

Yes. That’s helpful, Alan. All right. Great. Thanks for the color, guys.

Thank you.

The next question comes from Michael Young at SunTrust Robinson Humphrey.

Good morning, everyone.

Good morning.

Good morning.

Just wanted to go back through the expense saves you kind of outlined. I get to about $19 million or so in total and if was curious if you could just provide some sort of outlook in terms of how much of that might actually drop to the bottom line, obviously with new branches coming online and hiring, et cetera.

I can’t give you an exact number on the new branches and hirings. Those are the savings in closing the branches and the adjustments. Obviously, there’s expense. We had it budgeted on these new branches being open. We budgeted the first of the year. These are additional cost saves that we’ve had so how much offsets that, I don’t know. How much business are we going to get and grow because of what we’re doing certainly offsets that. So, I’d say your $20 million number is pretty good and we’re going to feel the impact of that pretty good and not eat it up by growth, because hopefully the growth we get is going to be taken care of by the business we get. So, I don’t know if that answers your question but I don’t have a dead answer for that. I never looked at it from that way. I look at what we’re trying to do and how we’re trying to improve these markets and cut our costs. And the big ones down in the Valley and when you close 11 branches at one time, you expect some kind of reaction. We got no reaction. Those people understand what we’re doing. We had branches on top of branches and people didn’t have to go with two or three blocks to find their other bank and bank with us. And the good thing down there, we’re growing that market now and we’re doing what we do best and that’s being a community bank and making things happen and I’m pleased with the progress we made. We’re not just down there collecting bad loans that we acquired. We’re still trying to do that and we’ll continue to do that. But we’re down there trying to create business and do things. So that’s going to be of benefit to us more than what we anticipated. As I said, we had a $100 million pipeline. We didn’t expect it to grow anywhere near that much this year down there and I think they’ll exceed that by twice. So there’s something that I can throw at you that we don’t have in the budget versus the cost saves you’re talking about. So that’s hard to say.

Okay. That’s fair.

Do I have you totally confused?

No. And then Alan, I wanted to ask one more question just on the energy side, just real quick. You had mentioned the 6.5% down to 5.8%. But on that 4.5% number that you had kind of talked about previously of direct exposure, what did that drop to?

Let me tell you what that comes from. That comes from how we looked at that book when this thing first came up. And we took some loans out of it that we didn’t feel like needed to be in there, like a wholesale distribution business, a gasoline and oil products that service stations. We don’t feel like that should be in there or a storage depot that’s a large depot in California that sells diesel to large truck stops. We didn’t feel like that had anything to do with the oil and gas business. There was account in there secured by a home. There’s an account in there that’s secured by a margin account and we didn’t include those at the first run and that’s where we came up with the 4.5%. But the Fed looks at it different. Anything you classify when you make the loan and you check the box. And if their revenue comes from oil and gas, they throw it in there. Like the guy on the home loan, he was a fairly large sized home loan, $4.5 million. He has oil and gas revenue but his main business is a fixed base operator of FBOs across the country. So it really doesn’t have anything to do with it. So subsequently you’re going to see a lot of those come off. But that’s where we got the $4.5 million and then that’s how I got up to the $6.5 million. We had to add those and now you see it coming back. It’s actually 5.76 at the end of the quarter. I guess we rounded it up. That’d be something. I’d round down if it were me but it’s 5.76. I think you’re going to continue to see it come down. We’ve had pay downs but I go back, we’re on top of the big ones and the big ones are making the adjustments. And that’s what you like to see and they’re running the business like they need to. So again, we’re not involved in it very much, the energy side but I think we’re on top of it and I don’t see much downside.

Sure. I guess I was just trying to get, using your 4.5% number. Let’s say we agree on that being the more correct exposure. What did that decline to from a dollar?

That would have gone down if you used just what I said. It would be down -- I can’t tell you where, 4% or lower. But it would have definitely gone down. It continues to go down. And you’re going to see some of those credits I just mentioned. They’re going to come off as a reclassified and renewed or stuff. They’ll come off and I think at the end of next quarter you’re going to see that number down significantly again, unless we do something or make a loan to one of our customers in the energy business. But again, that’s a relationship, that’s who we’ve loaned money to. We’ve had relationships for years. The storage depot that I mentioned out in California, that gentleman has been our customer for 25 years and he’s a substantial individual. And he sells diesel to fuel stops -- fuel depots. So, I don’t think that should be in there and I’d argue all day with the regulators but I try to stay away from regulators.

Okay. Thanks.

The next question comes from Michael Rose at Raymond James.

Hey. Good morning, guys. How are you?

Good.

Hey. So, I hopped on a little bit late. I think you said you expected kind of the total cost saves from SWS to be either $19 million or $20 million but did I hear that correctly?

That’s the bank in Edinburg, Michael. It doesn’t have anything to do with the broker-dealer. It’s SWS Bank and it’s the cost savings from the closing of the branches in Edinburg.

Okay. Well maybe, Jeremy, if you can address this, I’m sorry if I missed it -- can you just talk about now with the quarter in of SWS, what you fully expect for cost savings? Obviously, the employee count has gone from 138 to 60.

No, that’s the bank again. You’re getting confused.

Okay. That’s the bank.

That’s the bank.

Okay. Let me ask another way. They had about a $196 million -- $197 million in expenses. SWS did collectively for their last fiscal year. What should we expect to kind of come out of that run rate?

We’re not prepared to give guidance at this time on that.

Okay. No problem. And then switching gears a little bit, can we talk about the margin? Obviously, a full quarter impact from SWS. How should we think about kind of core margin trends from here? Should we expect them to continue to come down ex-the PAA?

Well, the margin coming down is really got more to do with putting on about $2 billion of stock lending business. It is a low margin broker-dealer business and that’s something we’re evaluating. I think I would probably look for those balances to probably go down over the next couple quarters. But that’s what dragged the margin down predominantly.

Of course. Can you give us a sense of magnitude for what you’d expect those balances to come down to, like what’s the normalized type of level?

Well, normalized level they’ve been traveling at has been kind of $1.5 billion to $2 billion. And we’re just evaluating that business for what normalized level we’re going to have going forward. So I don’t have an exact number for you right now.

Okay. That’s helpful to guide. And then just one final question. It looks like the non-covered, non-performing assets, at least on a dollar basis, went up a little bit, $7 million, $8 million. Anything in there related to energy…

Some of them are scratch and dent loans at PrimeLending of about $3 million and then there is a $6 million loan in Austin to a bunch of doctors that’s being restructured that we put on there. Those are the only two things. But my God, you’re talking about a $5 billion loan portfolio, I think that’s pretty insignificant to the whole deal. Let me make a comment about net interest margin. The bank is 4.59. If you look for the last several quarters, it’s always been 4.59 and then you take, quote, accretion and you get back to 3.5o. Since we merged in 2012 with Hilltop, we have always had accretion and we’ve always had a net interest margin, that’s been pretty close every quarter. Knowing our business model and where we’re going and what we have in front of us that net interest margin is going to stay basically about where it is at 4.59 because we’re going to continue to have accretion and we’re going to continue to do that. So you start talking about normalizing stuff, I feel strong that that’s our net interest margin and not 3.5 because of the business model we have set up. So I’m just making my point on the net interest margin. Now, that doesn’t have anything to do with what Jeremy is talking about. This is the bank and we’ve got a lot of loans in the bank.

Understood. I appreciate that color, Alan. Just going back to the MPA question though, so none of the increase related to energy. Maybe did you have any downgrades or classification increased in energy this quarter?

No.

Okay. And then is any of the provision this quarter related to environmental factors around energy at all?

No.

Okay. All right. Thanks for taking my questions, guys.

The next question is from Matt Olney at Stephens.

Hi, morning guys. It’s Matt Sealy on for Matt Olney. I’ve got a question. I want to circle back on the expenses for a minute. Now that Southwest is closed, could you add some just general color and commentary on where the efficiency ratio might end up by the end of 2015 post cost saves and now that we’ve decided on the systems for the broker-dealer?

You’re talking about a consolidated efficiency ratio or a bank efficiency ratio?

Correct, consolidated.

We don’t have a good -- no, we don’t have anything we can give you as far as what it’s going to be at year end. I think I would probably focus, Matt, mostly on the bank’s efficiency ratio and I think given the integration that we’ve been able to do this quickly.

Think about 50%.

John just told you.

Okay. Great. And one other thing, follow-up. Any thoughts on where you see reserve ratio trending on from here for the rest of the year? Should we see that build on or kind of stay where it’s at, at around 50 bps?

The allowance?

Yes, allowance reserve ratio.

It should -- it will grow in the absolute terms just because we expect loan growth and as the marked loans begin to accrete off, there will be additional allowance. But I think it’s not going to be that significant.

And you’ll need to look through the purchase -- the acquired loans to see kind of what the true allowance to the non-acquired loans are and that’s built.

Okay.

I want to clarify one thing we said a moment ago. We did build some environmental factors into our allowance for loan loss for our energy exposure. It was pretty modest and the increase that came in was probably about $2 million, but it was offset by other reductions in the allowance requirement, but we did build in a small amount for energy exposure.

Okay. Great. Any allowance built in for specific energy credit over the past two quarters?

No.

Okay. One last going back to mortgage volumes over the quarter, as we head into 2Q and 3Q, any thoughts on volumes here and maybe gain on sales, I think volumes were up about 4%?

Let me tell you, Matt, second and third quarters are always our best quarters and especially from the purchase side. They’re going to be our best quarters, again, this year that doesn’t change. And when you look at the MBA coming out and saying the volumes increased into $1.2 trillion and if we get our market share part of that, we’re going to exceed what we think we’re going to do. So I anticipate second and third quarters are going to be good. Our gain on sale margin year-over-year has remained flat and so we think we will continue to see that. So I say the prospects look favorable, especially with the first quarter.

Great. Well, that’s all for me, guys. I really appreciate it.

Your next question comes from Brett Robinson at Piper Jaffray.

Wanted just to go back clarification on the energy, you mentioned you didn’t have any downgrades this quarter. So does that mean you still have those three classified credits and I guess I was just curious and…

There hasn’t really been any changes from that standpoint in the portfolio other than going down some, pay downs. But they haven’t gone off and they haven’t gone away, but they are coming down.

So those credits have decreased in size? So those credits that you had classified, have those decreased in size as they’ve paid off?

Yes, they’re coming down in size.

Okay. All right. And then I guess the other thing I was curious about that wasn’t addressed is if you guys had any sense of the pace of discount accretion maybe in the next two quarters relative to 1Q?

We would expect the next few quarters to be consistent with the first quarter.

Okay. So it’ll be about the same pace. Okay. Great. Everything else has been answered. Thank you.

Your next question comes from John Moran at Macquarie.

Hi, John

I just wanted to follow up and make sure I understood the dynamics on the loans that came in from Southwest. Alan, it sounded like $450 million of it was at the bank and I just wanted to make sure I got that number down right.

Yes. Well, now I don’t know. As far as what came in, we had $627 million come in at the bank. $417 million of that -- currently $417 million of that is C&I and real estate and there’s $224 million right now on mortgage purchase. We’re running -- at the end of the quarter we ran at $641 million versus $627 million. We’ve seen the C&I book go down because we’ve exited some credits, but we’ve seen the mortgage purchase business up by $100 million.

And then the balance are, let’s see, margin loans is a broker-dealer.

Dealer.

Okay. That’s helpful. And then you mentioned that the guidance line on that mortgage purchase business, you guys are thinking about taking that up.

We took it up to $750 million.

Okay. Perfect.

We had it at $500 million and normally what you see on those deals, about half of that gets funded and those things turn quick. And it’s a good business. We’ve just stayed away from it because we were in the mortgage business and I don’t know why, but it’s a good business. It’s low risk and we’re working that hard. That’s a good opportunity for us.

That is helpful. The other one that I wanted to just circle back on is the stock loan business. It sounds like Jeremy, you guys, it’s been averaging $1.5 billion to $2 billion lower margin, but I think a pretty profitable business or it sort of sounded like you’re evaluating it, what’s the right size for it and is there thought to kind of exit that or should we expect that it’s going to stick around in some way, shape, or form?

It’s absolutely going to stick around because it’s built off and related to our clearing business that we’re now just bigger and stronger and it’s a good business and it’s a good business for a rising rate environment. So we’re committed to it, but what we’re going to evaluate just what’s kind of our level of capital is the easy to borrow balances in it, which make up a lot of the balance and a lot less of the income.

Got it. This might be a dumb one from a bank guy that is not necessarily used to looking at stock, but is there -- does that business run seasonal, is there sort of weird seasonal factors or trends in that?

Not seasonal. It -- no, not seasonal, but the spread will be really tied to short-term interest rates. So if short-term interest rates rise then that business will be a lot more profitable.

Okay. Got it. And then the last one for me is kind of a ticky-tack modeling question. Just tax rate came in low this quarter and I know that it was messy and a lot of things going on there. Do you have a sense of where that can run on a consolidated basis for…

I’d say about 36.

Yes.

Okay. Perfect. Thanks very much, guys.

All right. Thanks.

Our next question comes from Michael Young from SunTrust Robinson Humphrey.

Hey, Jeremy. Just wanted to go back to the Hilltop Securities and cost savings, but maybe approach it from a different direction. It may be a little too early to know the magnitude of the cost savings, but could you give us a sense for timing and when that may occur, if it’s dependent on the system conversion and integration and when that might occur? Any update there.

Yes. And that’s a good way to put it is the difficulty here is these are very systems reliant businesses. And we’ve got to really get them all on the same platform. And at the same time, you’ve got to get the regulatory approval from FINRA to do it. So it is a process. Now that said, our goal is to really be complete with the conversion by year end, the first quarter of ‘16. And at that point, I think we start to really -- and along the way, though, we’re going to be doing things to put these together. So I think it’s going to come over the next year and hopefully get completed sometime around the year end.

Okay. That’s great. Thanks.

This does conclude today’s conference. Thank you for attending. You may now disconnect.