Q2 2022 First American Financial Corp Earnings Call
7% or 13, 9%, excluding net investment losses.
While we operate in a cyclical business, we have a strong presence in all market segments, including resale refinance commercial new home and default, which can provide a level of diversification.
So while rising interest rates have slowed our residential business. Our commercial business. For example has grown an impressive 30% this quarter and is on track to achieve another record year.
We are also beginning to realize the benefit of higher interest rates at our bank and on other escrow and tax deferred exchange balances investment income increased by $23 million in our title segment. This quarter and we now expect to add $200 million to annualized investment income by year end.
Up from the $150 million that we discussed with you on our last call.
As I suggested earlier, our residential purchase business declined this quarter.
Orders were down 12% with June down, 18% compared with last year.
So far in July this trend is continuing with open purchase orders down approximately 20% compared with last year.
Given the decline in residential real estate activity in the uncertain economic outlook. We continue our focus on expense management as you would expect we are acting most aggressively in the business units with the greatest exposure to the declining residential market, we will see much of the benefit from these reductions beginning.
In the third quarter.
Additional expense reductions are underway in July and we are closely monitoring order levels to further balance expense levels as needed going forward.
While we continue to manage our cost structure. We also remain steadfastly committed to investing in strategic initiatives that support our company's long term growth and operational efficiency.
Despite their impact on near term profitability.
Significant among these is endpoint or digital title and settlement company that we built from the ground up.
And point has attracted leading talent that has developed technology to streamline the closing process and power prop tech companies and investors looking to scale their operations.
After demonstrating strong customer acceptance in early test markets endpoint is rapidly building a national footprint and is currently operating in 27 states.
And by year end expect to be licensed in 43 states.
Another of these initiatives is service Mac, the mortgage Subservicing business servicing business, we acquired last year since its founding in 2018 service Mac rapidly achieve the sixth largest market share position.
While service Mac has high potential as a standalone business significant synergies exist with our other operations in particular, our bank, which can hold deposits administered by service Mac.
Lastly, while we have successfully automated the title production process for certain refinance transactions.
We are now focused on solving instant titled Decisioning for purchase transactions, which is more complex.
Our industry, leading property record entitled plant assets put us in a unique position to solve this problem, which when salt promises to improve the customer experience and increase our efficiency.
We expect to test this instant decisioning initiated with customers in two large markets by year end.
This quarter, we continued to prioritize share repurchases acquiring three 9 million shares and through July 27th an additional 963000 shares since.
Since the beginning of this year, we have repurchased approximately 6% of our shares outstanding as of the end of last year.
Reflecting its confidence in our long term prospects of our company. Our board recently approved a new $400 million share repurchase authorization, which enhances our capital deployment flexibility going forward.
Now I'd like to turn the call over to Mark for a more detailed discussion of our financial results.
Thank you Ken.
This quarter, we earned $1.01 per diluted share.
Included in this quarter's results were 96 of net investment losses, primarily related to the change in fair value of marketable equity securities.
Building. These losses, we earned $1 97 per diluted share.
Revenue in our title segment was $2 1 billion flat compared with the same quarter of 2021.
Commercial revenue was 289 million, a 30% increase over last year.
We continue to see strength in the commercial market is closed orders average revenue per order and a number of large liability transactions all showed growth over the prior year.
Our escrow balances totaled <unk> $14 billion at the end of the quarter up from $11 billion at year end, which indicates a healthy pipeline for commercial activity as we enter the second half of the year.
Purchase revenue was up 2% during the quarter driven by a 15% increase in the average revenue per order, partially offset by an 11% decline in the number of orders closed.
Our revenue per order for purchase transactions benefited from recent acquisitions of escrow companies in Southern California.
We include escrow revenue from these transactions with numerator without a corresponding title order in the denominator.
Excluding acquisitions average revenue per order would have been up 6%, which is more in line with what we would expect given home price appreciation.
Refinance revenue declined 58% relative to last year due to the increase in mortgage rates.
And the agency business revenue was $937 million up 4% from last year, given the reporting lag in agent revenues of approximately one quarter, we are experiencing growth in remittances related to Q1 economic activity.
Our information and other revenues were $305 million up 2% relative to last year.
Revenue growth was primarily due to the recently completed acquisitions of Servicemaster motor alone.
Investment income within the title insurance and services segment was $70 million or 49% increase relative to the prior year.
As we've stated previously we expect to generate $15 million to $20 million of annualized investment income and entitled for each 25 basis point increase in the federal funds rate.
We believe this estimate is still appropriate and expect to see the benefit of the Fed's July rate high beginning in August .
Based on the current forward curve for the federal funds rate, we expect our investment income to grow by approximately $200 million on an annualized basis in 2022.
On the expense side, we are reducing expenses in areas of the company that are being impacted by the slowdown in residential activity.
Year to date through July we had over 600 staff reductions. However, our overall employee count has increased <unk>.
Primarily related to our acquisition of mud alone.
In the second quarter, we incurred $11 million of severance expense.
Pre tax margin in the title segment was 11, 7% or 13, 9%, excluding net investment losses.
As Tim highlighted we continue to invest in businesses and innovation initiatives that we believe will positively contribute to our profitability over time, but at this point in our lifecycle detract from our financial results for.
The three initiatives, Ken discussed endpoint service Mac and instant Decisioning for purchase transactions together generated a pre tax loss of $28 million this quarter.
Impacting our pre tax margin by 150 basis points.
We expect service Mac to turn profitable by the end of this year.
And we expect endpoints losses to bottom out in 2022 with earnings improvement in 2023 and beyond.
Turning to the specialty insurance segment total revenue in our home warranty business totaled $102 million down 5% compared with last year.
Excluding net investment gains and losses total revenue increased 2% to $106 million.
Pre tax income and home warranty was $9 million down from 13 million in the prior year, excluding net investment gains and losses pretax income was $13 million up from $10 million last year.
The loss ratio and home warranty was 52, 4% down from 55, 5% in 2021, driven by lower frequency of claims.
The wind down of the property and casualty business remains on track for completion in the third quarter.
The business had a pre tax loss of $5 million this quarter.
As of June 30, the company had no active homeowner policies in a small number of renter policies remained in force.
The effective tax rate for the quarter.
Of 22, 1% is less than our normalized tax rate of 24, 5%.
As a result of fluctuations in forecasted earnings between our insurance and non insurance businesses since our insurance businesses generally paid state premium tax and Louisville, sometimes.
In the second quarter, we repurchased three 9 million shares for a total of $227 million at an average price of $57 93.
So far in Q3, we repurchased an additional 963.
963000 shares for a total of $52 million at an average price of $54 20.
Our debt to capital ratio as of June <unk> was 29, 6% or 25.0% excluding secured financing is payable.
At the end of the quarter, we had $750 million of accumulated other comprehensive loss, primarily due to unrealized losses in our fixed income portfolio related to the rise in interest rates.
This loss contributed 250 basis points toward debt to capital ratio over time, we expect our unrealized loss position to narrow.
As our duration is four five years, the average credit quality of double a plus and we don't have a need to liquidate the portfolio to generate cash.
Now I would like to turn the call back over to the operator to take your questions.
Yes.
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One moment, while we poll for questions.
First question comes from the line of Mark Devries with Barclays. You May proceed with your question.
Yes. Thanks.
Wanted to start on the commercial business I mean, it sounds like your pipeline is.
It was quite strong which is a bit surprising just based on at least what we're hearing anecdotally from some of.
The larger more institutional end of the market, where we're just hearing things are not transacting. So could you just give us a little bit better sense of kind of what the sources of strength or were there any cause of concern that that activity is about the decline in any kind of differences across different types of property types.
And markets.
Yes.
This is Kate I'll take the first crack at that as we mentioned we had a we had a great a great quarter and we're still seeing a lot of a lot of demand in the commercial space.
A lot of a lot of capital chasing deals and in the quarter. This was across asset classes. It was obviously led by multifamily and industrial but the demand was across asset classes across geographies, though some of the urban core markets like New York, San Francisco, L, a where weakest, but again across the geographies and <unk>.
Cross deal sizes as well, though in the quarter large transactions were probably up significantly but again, we saw it across across cross deal sizes, and frankly, we look good going into the into the second half.
As Mark mentioned escrow balances are up over year end.
So we see it's a strong strong pipeline.
We were anticipating and as we mentioned to have another another record setting year. So.
We may be it may be we're defying some of what we're what we're reading out there what youre seeing out there in the marketplace, but.
We're still seeing strong demand.
Okay.
That's helpful.
And then just turning to endpoint just kind of want to better understand what the endgame is there it sounds like it's.
Is going to be a drag on earnings for the indefinite future kind of work when do you see that becoming profitable or.
Is the the real contribution going to come from lift you're getting kind of core title.
Well.
I think I mean, we don't know exactly when yet it's going to turn profitable as we mentioned, we think that we think the losses are going to bottom out. This year and then we will start and then the earnings will start growing in 2023 and beyond but I think.
And game there is twofold, one is to improve the efficiency in our in our business, but secondarily, it's to meet the demand.
Changing customer base I mean, there are customers that want this digital first experience an endpoint is.
Is rapidly expanding to provide it and thats.
I guess, what you'd call the retail side and also with prop tech companies. So.
Again, the end game with endpoint really is first and foremost to meet that customer demand, but we do expect we do expect it to generate efficiencies for the core the core business.
Okay got it thank you.
Our next question comes from the line of Bose George with <unk>. You May proceed with your question.
Hey, good morning, actually just sticking to endpoint 20.
$28 million in losses, you mentioned, how is that broken out between endpoints service snack.
And then another piece.
Thanks for the question both so.
In the second quarter, we had about $10 million a pre tax loss in service Mac, which as we mentioned we think that'll flip to breakeven later this year endpoint had about a $12 million pre.
Pre tax loss this quarter.
At our purchase automation initiative was about $6 million.
Okay, great. Thanks, and then actually I wanted to switch.
Ask about leverage.
Can you remind us where you think you want that to the range to be in 'twenty.
25% now how do you think about further buybacks or acquisitions.
Well, 25% as high as we've been in some time and we've always talked about our targeted debt to cap the around 20, but we're real comfortable operating at 25.
They are our covenant says we can't go above 35, so we've got plenty of room there.
One of the reasons why our debt to cap is shot up but the bigger reason is because of the.
The unrealized losses, we have in our fixed income portfolio, which were roughly about $900 million at the end of at the end of June . So we don't really need to liquidate the portfolio, we feel like those losses will eventually come back over time, and so we're real comfortable with with where we are at 25 right now.
Okay, and then did you.
Mentioned, the duration of the portfolio, so the timeline in which the $900 million would come back.
The duration of our when we think about our portfolio is like our bank portfolio and then our insurance covers the portfolio, but on a consolidated basis, the durations for and a half years little bit less in the bank a little bit higher in the insurance company and.
And so that should be the kind of the rough timeline for it to come back.
<unk> loss.
Yes, roughly yes, okay, I mean, it depends on what happens with interest rates, but yes, I mean, we feel like definitely by four and half years, we'll have recruited.
Okay, great. Thanks.
Thanks Bose.
Our next question comes from the line of Mark Hughes with <unk>. You May proceed with your question.
Yes.
Good morning.
Order trend in July for commercial.
We didn't but.
So far in July our open orders are down 10% from prior year in July .
And at that time.
When we think about your <unk>.
Greece, and the escrow balance.
Is that consistent with kind of a down 10% trend or.
What are you seeing an escrow funds employed a little better than that.
Well.
We track our commercial orders I wouldn't say, it's unlike on the residential side, where we've got a very consistent average fee per file the commercial we don't read too into the orders, if they're up 10% or down 10% just because the size of the deals matters. So much more in commercial.
And so yes orders were down 10%, but that.
It doesn't give us too much heartburn.
Well, we look at is our balances in terms of what the deal sizes are about to close.
We have our conversations with our customers and as Ken mentioned early in his remarks, we feel really good about the second half of this year, but yes orders were down 10%.
Very good and then.
The impact of the.
Decisioning soon assuming you have a success and that works out as you.
We anticipate what does that mean in terms of the cost structure.
Well.
The instant Decisioning initiative I mean, the primary reason for it is to improve the customer experience.
We've seen that with our instant decisioning for refinance transactions and we can get that would purchase transactions is very complex. We think we're in a unique ability to provide that given the data assets that we have so it's mostly.
And improve the customer experience initiatives. However, we do think theres going to be cost savings over time.
And so we'll have to see how those play out but if you can provide it instantly through data. It reduces your manual process and will be savings there Mark Mark I would add to it's very very early days with respect to this.
Particular title automation effort, it's going to as I mentioned, we're not we're not even do it and we're going to do an MVP in two large markets at the end of the year, but we're and we're in very early days. So we will probably know better than the.
In the coming months, if not years, what the exact cost savings will be.
And then your point on the <unk>.
And the point profitability.
<unk>.
Lost.
And with that would bottom this year and then it would be progressively less negative or would that breakeven in 2023, it would be less negative. So we'll have a pre tax losses.
The $50 million this year and that'll be that'll be that'll narrow next year and beyond we won't flip to profitability next year for the losses on their own.
Thank you very much.
Thanks Mark.
As a reminder, if you would like to ask a question. Please press star one on your telephone keypad.
Our next question comes from the line of Bryan Goldberg with BTG. You May proceed with your question.
Hi, Thanks, Good morning, everyone first questions on <unk> and the purchase business.
I think you said.
Plus 6%, excluding the escrow acquisitions can you just talk about how that trended through the quarter and how you expect that to trend over the over the rest of the year I think with.
Overall home price appreciation, probably more resilient than I expected, but some headwinds from higher interest rates.
Potentially in the second half of the year.
Thanks for the question. So when we look at these the purchase Arco and how it trended through the quarter its falling through the quarters. So in April .
Our purchase of <unk>, 17% in May It was 16 in June it was 12 and so for the quarter when you waive that altogether.
Was up 15.
And so when we looked at Q3 I mean based on the trend just based off <unk>.
Cooling.
On price appreciation, we think it's going to obviously come down from the <unk>. So the run rate as of June is about 12.
<unk>.
And so we definitely are seeing it come down here.
Okay got it.
And I apologize if I missed this but I think last quarter, we talked about.
Revenue flat for the year is that do you think thats still on the cards or has have.
Have trends in residential kind of deteriorated more than we were expecting.
After <unk>.
I think things are deteriorating.
A little bit I mean, just based off of where purchase orders are.
But overall I think revenue will be down call. It low low single digits. I mean, we're not seeing anywhere the decline that you would probably see it in the headlines are in terms of mortgage origination so.
It'll be down a little bit.
Call it low low single digits.
Okay, great. Thanks very much.
Yes.
Our next question comes from the line.
John Campbell with Stephens you May proceed with your question.
Hey, guys. Good morning, Thanks for taking our questions.
Mark you briefly touched on the effect of the acquired ramp on the revenue per order I am trying to understand the mother Lode impact on your quarter count It sounds like.
If I understand it correctly Malone revenue came on.
You're not reflecting that in the order count so that drove the fee per file higher but maybe if you could provide a little bit more color on that and maybe specifically how mother load is going to impact the order count moving forward.
There's different ways to cut that I would say that kind of.
<unk> mother load when you just look at our purchase orders in Asia.
In July excluding mother load were about 23% down on a year over year basis. When you add mother load in there. It's about we're down about 20%. So it's added about a three percentage point difference in our purchase order change year over year.
Okay. That's helpful.
And I'm trying to better understand so how are you receiving the revenue without the orders.
Well.
There are certain orders that we get directly so when you look in the second quarter, we had.
About $37 million of revenue from other loan half of that was booked in direct revenue and where we're getting orders and.
We would take a 100% in premium we book in direct revenue. The other half of that revenue is booked in information and other where there is that we're really getting 88% of the premium but the other 12% on average is going to a different underwriter just because we haven't.
Fully captured those underwriting synergies yet so it's really split 50 50 and over time.
That will migrate more and more toward direct rhythm.
Okay that makes sense.
Then just from a geographic standpoint, I mean, it looks like from what we can tell the west coast and it's falling much sharper than the rest of the regions.
Is there a way I guess first the direct business sort of a title orders you guys report are obviously coming from direct business.
What is your weighting towards the West Coast, There and then maybe if there's any kind of anecdotal.
Callouts for kind of what you guys are seeing in the market there.
Well I would just say that like when we talk about our direct orders.
Those are really our direct operations were direct in 2007 states, which is mostly the west coast I mean, we're in Florida.
But mostly it's just the west coast and Thats one of the reasons why perhaps our agency business is outperforming and growing faster just because of the east coast is doing a little bit better.
Okay. That's very helpful. And then last question for me.
This is maybe a silly question, but.
You guys called out the $150 million investment endpoint was that a one time investment or is that essentially running through your P&L.
Well accumulate a $150 million of the time.
That was a that was a commitment maybe we're committed to make to make that investment. So I wouldn't consider it running through our P&L I think I'd focus on the numbers that Mark gave you with respect to what's what's running through the P&L, but we wanted to make it clear we were committed to invest at least that amount.
Okay that makes a lot of sense. Thanks, guys.
Thanks, Sean.
Our next question comes from the line of Geoffrey Dunn with Dowling <unk> Partners. You May proceed with your question.
Thanks, Good morning.
Mark can you review the company's.
Liquid resources for capital management, what was Holdco balance at year end, what's your remaining regulated capacity. This year nonregulated sources and are you still targeting a minimum 250 balance at Holdco.
We are targeting roughly $2 50 minimum as of the end of June we had $349 million of cash at the holding company.
When we looked at our the amount that we can dividend from our.
Insurance companies for the second half of the year, it's $474 million.
And we play out in terms of dividends, we expect to get and we Max out the dividends that our insurance companies that we have non insurance so.
We expect at this point that will dividend roughly about $500 million of cash from our both our regulated and nonregulated subs.
Second half of this year and of course, we have determined liquidity youre asking about we got all $700 million on our line none of it's drawn so we're in a good spot in terms of liquidity.
I assume though.
Specifically for share repurchase.
Surprised if you draw down more debt when you're already at 25% is that fair.
Yes, I think Thats fair I think that's fair.
In theory, we don't we don't really have an issue with borrowing to buy back stock, but I think what our debt to cap is at 25 and at this point in cycle, that's not something we would do.
Great. Thanks.
Thanks, John .
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