First American Financial Q3 2023 Earnings Call Transcript

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October 26, 2023

There are 8 speakers on the call.

Operator

Greetings, and welcome to the First American Financial Corporation Third Quarter Earnings Conference Call. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. A copy of today's press release is available on First American's website at www.firstam.com /investor. Please note that the call is being recorded and will be available for replay from the company's investor website and for a short time by dialing 877-660-6853 or 201-612 7,415 and enter the conference ID 13,774,673.

Operator

We will now turn the call over to Craig Barberio, Vice President, Investor Relations to make an introductory statement.

Speaker 1

Good morning, everyone, and welcome to First American's earnings conference call for the Q3 of 2023. Joining us today on the call will be our Chief Executive Officer, Ken DiGiorgio and Mark Seaton, Executive Vice President and Chief Financial Officer. Some of the statements made today may contain forward looking statements that do not reflect or relate strictly to historical or current fact. These forward looking statements speak only as of the date they are made, and the company does not undertake to update forward looking statements to reflect circumstances or events that occur after the date The forward looking statements are made. Risks and uncertainties exist that may cause results to differ materially from those set forth in these forward looking statements.

Speaker 1

For more information on these risks and uncertainties, please refer to this morning's earnings release and the risk factors discussed in our Form 10 ks and subsequent SEC filings. Our presentation today contains certain non GAAP financial measures that we believe provide additional insight into the operational efficiency and performance of the company relative to earlier periods and relative to the company's competitors. For more details on these non GAAP financial measures, including presentation with In reconciliation to the most comparable GAAP Financials, please refer to this morning's earnings release, which is available on our website at www. 1stam.com. I would now like to turn the call over to Ken DiGiorgio.

Speaker 2

Thank you, Craig. The rapid increase in interest rates to levels not seen in many years continues to produce challenging market conditions. With housing affordability currently at its lowest point in over 3 decades, existing home sales this year have declined to the slowest annual pace Since the global financial crisis. Moreover, sales volumes in the commercial market have reverted to pandemic low levels and are down approximately 50% from the peak year of 2021. Despite these historically difficult conditions, Our continued focus on expense management and strong growth in net investment income enabled us to deliver a pre tax Title margin of 12% on an adjusted basis.

Speaker 2

On a consolidated basis, we generated adjusted earnings of $1.22 per diluted share. Our residential purchase business continues to reflect these market headwinds, But appears to have stabilized at trough levels. For the 1st 3 weeks in October, open purchase orders are down 7% compared with September, which is consistent with normal seasonality, but are up slightly compared with the prior year. While this performance is mostly driven by a historically low comparison period, it also reflects the results of our industry leading Home Builder division and its further indication that the market has stabilized. Refinance open orders remained at trough levels in the 3rd quarter averaging $350 per day, a level they have held all year.

Speaker 2

Given the current pool of mortgage loans outstanding and the outlook for interest rates, it remains unlikely we will see a significant uplift in refinance in the foreseeable future. Our commercial business revenues declined 39% compared with last year, consistent with the first half of the year. Average revenue per order also declined again this quarter for the 5th consecutive quarter, which suggests that price discovery is well underway as the market Correct. Commercial open orders for the 1st 3 weeks of October are down 5% compared with last year and are down 3% sequentially. There is still a high degree of uncertainty concerning the commercial market.

Speaker 2

However, based on our market intelligence, We continue to expect higher commercial revenues in the 4th quarter, which is consistent with the normal seasonal pattern. While our key purchase, commercial and refinance markets appear to have troughed, we expect the difficult market conditions to Well into next year. Despite the uncertainty of the timing of a recovery in these markets, the strength of our business Along with our financial discipline and strong balance sheet allow us to continue to invest for long term growth while returning capital to our shareholders. This quarter, we raised our common stock dividend by 2% to an annual rate of $2.12 per share. We also repurchased $9,000,000 of our shares in the 3rd quarter and have accelerated our purchases in October, Already purchasing an additional $9,000,000 of our common shares.

Speaker 2

In closing, Given the importance of people to our business, I am pleased that First American has been named one of the best workplaces for women By Great Place TO Work and Fortune Magazine for the 8th consecutive year. This accomplishment is a tribute to our workforce, Approximately 2 thirds of which are women. I'm proud that First American's commitment to advancing the careers of women and our world class culture enable us to achieve this recognition year after year. Now I'd like to turn the call over to Mark for a more detailed discussion of our financial results.

Speaker 3

Thank you, Ken. This quarter, we generated a loss of $0.02 per diluted share. Our adjusted earnings per share was $1.22 Our adjusted earnings exclude net investment losses of 164,000,000 Primarily due to unrealized losses recognized in the Venture portfolio and changes in the fair market value of equity securities, as well as purchase related intangible amortization of $10,000,000 As of September 30, the book value of our venture portfolio Total $301,000,000 which equates to approximately 7% of our equity and 2% of our total assets. Revenue in our title segment was $1,500,000,000 down 19% compared with the same quarter of 2022. Commercial revenue was $160,000,000 a 39% decline over last year.

Speaker 3

Our average revenue per order for commercial transactions declined 15% this quarter to $10,763 due to a combination of fewer large transactions And lower valuations as prices in the commercial market reset. Purchase revenue was down 15% during the quarter, driven by an 18% decrease in the number of orders closed, partially offset by a 3% increase in the average revenue per order. Refinance revenue declined 41% relative to last year due to the increase in mortgage rates. In the agency business, revenue was $665,000,000 down 27% from last year. Given the reporting lag in agent revenues of approximately 1 quarter, These results reflect remittances related to Q2 economic activity.

Speaker 3

Our information and other revenues were $240,000,000 down 14% relative to last This decline was the result of lower transaction levels across several business units, driven by the company's data and property information products and Post Close and Document Generation Services. Investment income within the Vital Insurance and Services segment was $142,000,000 a 35% increase relative to the prior year. The increase was primarily due to rising interest rates, which drove higher investment income from the company's cash Partially offset by lower average balances, primarily in the company's escrow and tax deferred exchange balances. We continue to manage expenses given the decline in transaction activity. Our success ratio was 50%, meaning that our personnel and other operating expenses declined $127,000,000 Our net operating revenue declined $253,000,000 The provision for policy losses and other claims was $35,000,000 in the quarter or 3.0 percent of title premiums and escrow fees, down from the 4.0% loss provision rate in the prior year and down from the 3.5 percent loss provision rate in the first half of this year.

Speaker 3

The 3.0% loss rate reflects ultimate loss rate of 3.75 percent for the current year with a $9,000,000 release for prior policy years. Over the last several quarters, we have highlighted the margin drag in the title segment related to 3 strategic initiatives, ServiceMac, Endpoint and Instant Decision for purchase transactions. This quarter, these initiatives together generated a pretax loss of 12,000,000 Impacting our pre tax title margin by 110 basis points, an improvement from the 130 basis point drag in Q2, primarily driven by deboarding fees received by Servicemac. Pretax margin in the Title segment was 10.5% or 12.0 percent on an adjusted Total revenue in our home warranty business totaled $108,000,000 a 3% increase compared with last year. Pre tax income in Home Warranty was $9,400,000 up 124% from the prior year.

Speaker 3

The loss ratio in Home Warranty 55%, down from 59% in 2022, driven by lower frequency and severity of claims. The effective tax rate for the quarter was 29.4%, higher than our normalized rate of 24%, due primarily to the mix of income between our insurance and non insurance businesses, since our insurance business generally pays state premium tax in lieu of income taxes. In the Q3, we repurchased 161,000 shares for a total of $9,000,000 at an average price of $57.87 So far in October, we have ramped up our purchases buying 162,000 shares for $9,000,000 at an average price of $52.90 Our debt to capital ratio as of September 30 was 29.7%. Excluding secured financings payable,

Operator

Thank you. We will now be conducting a question and answer Thank you. Our first question comes from the line of John Campbell with Stephens. Please proceed with your question.

Speaker 4

Hey, guys. Good morning.

Speaker 3

Good morning. Good morning, John.

Speaker 4

Hey, I just want to

Speaker 1

make sure

Speaker 4

I heard you correctly on the order commentary for October. You said that purchase It is trending up year over year thus far in October?

Speaker 3

Yes. So purchases, It's up slightly for the 1st 3 weeks in October, very slightly. And a lot of it is driven because Included within the purchase transactions is resale, which is most of them. And we also have new homes and new homes is performing Yes, we do have a slight increase in purchase, which is nice to see the lines cross here.

Speaker 4

Yes, absolutely. I mean, just given the backdrop of continued upward pressure on rates, that's a great outcome. New home sales, I think, maybe a little bit less 10% of the national mix, what does that look like for you guys, a little bit higher?

Speaker 3

It's a little bit higher. Historically, the long term average is About 13% of our purchase orders are new home related. So far in October, they're 19%, a little overweight. So that's our mix is a little bit higher than the average.

Speaker 2

I'd add to that, John. I mean, one thing to keep in mind is that we have an outsized share of the market in new home, Which obviously is a good competitive advantage for us.

Speaker 4

Yes, absolutely. And then last question here on the interest expense, that's obviously been up Look at that the last two quarters, I want to get a better grip on that. I know that's influenced by the bank deposits. So maybe if you could unpack that, kind of If you could decouple those two items, just the underlying interest expense versus the bank effect. And then how we should be thinking about The run rate of interest expense here, just assuming that rates stayed near current levels?

Speaker 3

As a general statement, when you look at interest expense in our corporate segment, it runs $12,000,000 $13,000,000 A quarter and that's really primarily the interest expense that we pay on our bonds. We also have Interest expense in our title segment and that's really driven by kind of the cost of funds in our banking operations both at our bank First American Trust as well as our warehouse lending business pays interest expense too. So those are the 2 components that make up our The $23,500,000 of interest expense we have in the title segment this quarter.

Speaker 4

Okay, that's helpful. Thank you guys.

Speaker 2

Thanks, John. Thanks, John.

Operator

Our next question comes from the line of Soham Bhonsle with BTIG. Please proceed with your question.

Speaker 5

Hey guys, good morning. Hope you're doing well.

Speaker 3

Good morning.

Speaker 5

I guess the first one just on investment on the interest income. Can you just, Mark, maybe update us on the year here? And then just maybe help us size What needs to be replaced from sort of the roll off in ServiceMac and how quickly you'd be able to sort of do that? Thanks.

Speaker 3

Yes. Thanks for the question, Salaam. So in terms of the year, I mean, obviously, we're 3 quarters down. When we look at Q4, We think based on what we're seeing now, investment income should dip a little bit in Q4, few million, dollars 5,000,000 ish, let's say, plus or minus. And most of that is just driven by the fact that we did lose these HomePoint loans, which we've talked about for a couple of quarters.

Speaker 3

And in the last 30 days or so, we've lost about $300,000,000 of deposits related to that, which was really earning, let's call it, Fed funds. So that's kind of the headwind that we're going to see in the Q4 in terms of our investment income. I will say that about 75% of that though It's going to be a reduction in interest expense in the title segment too. So it's not all fall to the bottom line, but about 25% of it will.

Speaker 5

Okay. And then on endpoint, Ken, I think you've previously talked about the opportunity there sort of being twofold, right? Like Where you could potentially get some efficiency gains, but then there's also sort of this enabling of better customer service. I was hoping you could maybe dig a little bit deeper on the efficiency piece of the value proposition there. What sort of efficiencies do you sort of envision And how does that maybe translate to margins versus call it the legacy title business?

Speaker 2

Yes. Thanks for the question. I mean, I think it's Early days to exactly measure the efficiencies, but we anticipate sort of Increasing the efficiency of an escrow officer fairly substantially. Again, it's hard to put a number on that at this point, But we know there will be efficiency gains as we automate some of the more mundane tasks That an escrow officer does and frees them up to do the more people intensive and people intensive task. There's also other sort of efficiencies that we'll gain.

Speaker 2

We have already started gaining from endpoint just by deploying some of their technology in other parts of our We've mentioned in the past about JOT, which is our mobile notary management system. We've relied on third parties for that in the past. We're now able to do it more efficiently in house and have made a lot of progress rolling that out in the Direct division, it will probably be fully rolled out in the Direct division sometime next year. Okay. And just one more, Mark.

Speaker 5

I think on the Loss provision rate, I guess you lowered it 25 basis points. But as we sort of go into next year and we potentially are in a more Sort of uneven macro environment, right? I mean, how are you thinking about that on that line, I guess?

Speaker 2

This is Ken. I'll start on that. And yes, we did lower the loss rate. And one thing I'll point out, as you recall during the pandemic, we actually took The rate up, which I think it reflects our pretty conservative approach when it comes to building our reserves. The concerns we had when we did that in the pandemic didn't come to fruition.

Speaker 2

Some of the concerns we had during the current Also haven't come to bear. So we've built an extremely healthy level of reserves. In In fact, we're probably pushing the upper bounds. I mean, and I want to emphasize the upper bounds of reasonableness, and we think it was the right time to So we obviously continuously monitor our reserving level. The situation could change.

Speaker 2

But I think more directly to your question, I think we could probably expect

Operator

Our next question It comes from the line of Bose George with KBW. Please proceed with your question.

Speaker 6

Hey, guys. Good morning. First question, just On the de boarding fees from ServiceMac, how much was that this quarter? And is there more of that to come before that fully rolls off?

Speaker 3

Yes. Hi. Good morning, Bose. So this quarter, we had a $3,000,000 benefit because of de boarding fees And roughly about 40% of the loans were deborted. So we have another, call it, 60% to come At some point next year, we're not exactly sure about the timing.

Speaker 6

Okay, great. Thanks. And then can you just talk about capital return Priorities, could we see the cadence of the buybacks pick up? And just also from a leverage standpoint, what is that It constrained to keep in mind just curious how you're thinking about it more broadly.

Speaker 2

Thanks for the question. I'll start, Obviously, as we talked about earlier, we've accelerated the pace of buybacks. We've already In October, bought back shares at the same pace we did in the entire Q3. And right now, I think our stock is We've accelerated repurchases and we think it's very attractive. But obviously, we weigh repurchases Against other uses of capital such as reinvesting in the business and M and A, but we're obviously committed to return capital

Speaker 1

to our shareholders and we

Speaker 6

think buybacks right now are

Speaker 3

And Bose, I'll just comment on the debt Leverage part of that question. So our DentiCap, we look at excluding secured financings payable because there's sort of gross up there. And if you do that, it's 23.5 percent this quarter. We've talked about like 18% to 20% being our long term target. But we're very comfortable, Especially here at the trough of the market being higher than our target.

Speaker 3

So 23.5% is a very comfortable place to be. I think particularly since when you look at the balance sheet, we've got $1,000,000,000 of AOCI and we feel really great about the credit there. So So we think that's temporary and that'll just kind of help our debt to cap as we go along. So we're in a very comfortable place in terms of Or dead right now.

Speaker 6

Okay, great. Thanks. Actually just one more. In terms of investment income, if the investment income Coming from deposits at your bank versus escrow that you sent to 3rd parties, does it make a difference on the return? Are you kind of agnostic in terms of that?

Speaker 6

Or Could you sort of increase 1 or the other if the returns are better?

Speaker 3

There is a difference. I mean, typically, When we give our deposits to 3rd party banks, the general rule of thumb is that we'll typically earn Fed funds. When we invested at the bank, our cash that's at the bank will earn Fed funds. And then the rest of it, most of the escrow deposits we push to the bank, we buy mortgage backed securities. And so we're really getting kind of a mortgage backed security rate as opposed Fed Funds.

Speaker 3

And sometimes that could be higher and sometimes that could be lower than Fed Funds. Right now it's lower just because of the fact that rates have risen.

Speaker 6

Okay. That's helpful. Thanks a lot.

Speaker 3

Thanks,

Operator

Please proceed with your question.

Speaker 4

Thanks. Good morning.

Speaker 3

Good morning, Jeff.

Speaker 6

I was hoping you could talk

Speaker 4

a bit about the commercial market. In particular, where are the large deals down the most? I'm assuming it's office, but I'm interested in a little more color. And more importantly, where are the areas that you're seeing opportunity versus drag outside the office market?

Speaker 3

Well, a couple of things I'd say. First of all, when you just look at the large deals, We had 4, what we call, mega deals with premium over $1,000,000 this quarter and a year ago it was $7,000,000 We're not seeing the same level of large deals. The large deals that we are seeing are really half of them are multifamily. We had another one that was just a development site. But generally speaking, I would say the large deals are we're just at least just not there this quarter.

Speaker 3

In terms of our Top asset classes like where we see in business. Multifamily is 22% of our commercial revenue. So we're seeing a lot of activity there. Industrial has always been strong even through the pandemic. It's 17% of our revenue.

Speaker 3

And then development sites, which is for these greenfield sites, is So those are our top 3. Retail is 10%. Office, you mentioned that, Jeff. Office is 5%. So that gives you a little bit more Flavor in terms of our revenue.

Speaker 3

Now that doesn't all add up to 100. There's other asset classes we got to add. We've got energy, hospitality, but I referenced the big ones.

Speaker 2

Yes. The thing I would add to, Jeb, in terms of sort of the outlook going forward on asset classes, I think probably the more attractive ones are going to be the ones where we've already Seeing the most price discovery like suburban office and multifamily and energy It's also probably going to be a big asset class for us. And then thinking back on multifamily and when I say suburban office, it's going to be anything that's going to be outside of the big CBD areas,

Speaker 1

you're just

Speaker 2

not going to the central business districts are under Strain right now for obvious reasons.

Speaker 4

Right. So as you look out to 'twenty four, your commentary is cautious in your press release. What is your number one concern? Is it commercial? Is it direct resi?

Speaker 4

And what one is more Uncertain at this point in your clients.

Speaker 2

Well, I mean, I'm uncertain and concerned about all of them, Except refi, I know that's not going to get better. So I think there is concern in all of them. I think if you force me to weigh the 2, I'm probably A little more optimistic about commercial just because I feel like we're making our way through this price discovery. And I think we anticipate to see transaction levels tick up a little bit in commercial next year, albeit, keep in mind at lower prices. So we'll see more orders, but they'll be at lower prices given this price discovery.

Speaker 2

But I'm we're cautious about all of it Now we may get some relief with if interest rates go down. When I last checked the forward curve, which was yesterday, I don't know where it is today, where they had 3 rate decreases next year beginning in the middle of next year. Now the forward curve is historically inaccurate, but If that comes to fruition, that will help, but that's middle to end of next year.

Speaker 4

Right. Okay. Thank you.

Operator

Our next question comes from the line of Mark Hughes with Truist Securities. Please proceed with your question.

Speaker 4

Yes, thank you. I'm not sure

Speaker 7

if this may be too granular, but I'm curious whether you saw any impact in the purchase market Through these weeks of October with the interest rate fluctuations.

Speaker 3

No, we haven't seen it, Mark. And it's been a little surprising, because when you look at the when you look at our purchase orders, They've been following the typical long term seasonality pattern all year long. So our purchase orders on the residential side, mean, they're at low levels now, but they haven't gotten any worse. They're getting worse now just because of seasonality. But when you look at the normal seasonality curve for the last 9.5 months, it's been right on the normal curve.

Speaker 3

And that's surprising, especially recently, given the fact that mortgage rates have Climbed, particularly in the last 90 days here, we're tickling 8%. So but to answer your question, no, we haven't seen any fall off in purchase orders because of the recent climbing rates.

Speaker 7

And then in the warranty business, I think I've heard you say that direct to consumer has been Good channel with real estate being weak. How is that holding up? Are you seeing success there?

Speaker 2

Yes. I mean, we are in general seeing success with DTC. And I think we've demonstrated we turned the dial up on our marketing expense that we see the almost well, we see the immediate impact on contracts DTC though, it takes some time for profitability to be realized. I think the story with the home warranty is that they've done a really good Job of managing claims in an inflationary environment, so that's been helping. Frequency is down because of lower policy counts, but Severity is down.

Speaker 2

And then we're realizing more of the time goes on, the benefit of some pricing actions We've taken. So we're pretty we're very positive on home warranty and we're real positive On the strides that that group has made on the VTC channel. So there's real opportunity there.

Speaker 7

Understood. And then finally, any update on instant decisioning either from a rollout, Potential benefit expense standpoint?

Speaker 2

Yes. It's still early days there, Though we are anticipating rolling out 2 markets on a test basis at the beginning of next year, so they're hitting their milestones And we're real positive about that. And as we've mentioned in the past, the great thing is it's hard to do. It's impossible to do if you don't have the data and we've got more data than anyone. And so it's trending well.

Speaker 7

Thank you very much. Thanks, Mark.

Operator

Thank you. We have reached the end of the allotted time we had for questions And that concludes this morning's call. We would like to remind listeners that today's call will be available for replay on the company's website or by dialing 877-660-6853 or 201-612-7415 and enter the conference ID 13,741,673. The company would like to thank you for your participation. This concludes today's conference call.

Operator

You may now disconnect.

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