Q3 2022 First American Financial Corp Earnings Call
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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. If anyone should require operator assistance. During the conference. Please press star zero on your telephone keypad.
Copy of today's press release is available on first American's website at Www first am dotcom forward Slash investor.
Please note that the call is being recorded and will be available for replay.
And by entering the car from I'm, sorry from the company's Investor website and for a short time by dialing 8776606853 are 20161 to 7415.
And entering the conference I D 13733443.
I'll now turn the conference over to Craig Barberio, Vice President Investor Relations to make an introductory statement.
Good morning, everyone and welcome to first American's earnings conference call for the third quarter of 2022.
Joining us today on the call will be our Chief Executive Officer, Ken to Georgia, and Mark Seaton Executive Vice President and Chief Financial Officer.
Some of the statements made today may contain forward looking statements that do not speak.
Typically to historical or current facts.
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.
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-K, 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 and reconciliation to the most directly comparable GAAP financials. Please refer to this morning's earnings release, which is available on our website at www Dot first a M dot com.
I would now like to turn the call over to Ken to Georgia.
Thank you Craig.
The swelling economy and rapid increase in mortgage rates continue to pressure our residential title business.
Despite the challenging market conditions, we achieved revenue of $1 8 billion and earnings per diluted share of <unk>, <unk> or $1 62 per share excluding net investment losses.
In our title segment, we delivered a pretax margin of nine 9% or 13%, excluding net investment losses.
Two key factors along with our continued focus on expense management favorably impacted our third quarter financial results.
First our commercial business continued its strong performance and we remain on track to deliver another record year.
Second we continue to capture the benefit of higher interest rates at our bank on other escrow and tax deferred exchange balances and in our investment portfolio.
This quarter investment income in our title segment increased to $105 million up 114% compared to last year.
Based on the current forward curve for fed funds and assuming escrow balances remain at current levels. We believe investment income in our title segment could be $600 million in 2023.
Mark will go into greater detail concerning concerning these assumptions.
Refinance has been declining since early last year. So it is now near trough levels and no longer a significant contributor to our financial results.
Our open purchase orders were down 23% this quarter with orders declining each month throughout the quarter and so far in October . This trend has continued with purchase orders open orders down approximately 35% compared to last year.
As we discussed on our last call we remain committed to investing in strategic initiatives that support our company's long term growth and operational efficiency.
Despite their near term impact on profitability.
Our initiatives to deliver instant titled Decisioning for purchase transactions and endpoint or digital title and settlement company continue to make progress service Mac, our mortgage sub servicing business is rapidly achieving scale and we now expect service map will be profitable in the final quarter of the year.
A significant improvement from the $11 million pre tax losses booked in the second quarter.
Despite the challenging environment ahead of US we believe the company is well positioned to emerge from this cycle even stronger.
The market has shifted away from refinance towards purchase and commercial transactions, which is where we are stronger and consequently, we are growing our market share.
We are also the only title company that has a bank, which enables us to better capitalize on higher interest rates.
Our strong balance sheet will allow us to continue to invest in key strategic initiatives.
Pursue acquisitions as well as return capital to shareholders.
I note that since the beginning of this year, we have repurchased approximately 7% of our shares outstanding as of the end of last year.
In closing I want to thank our employees for all their hard work and accomplishments as we navigate our way through a difficult market relays.
Relationships are key to our business and it's our talented and dedicated people who provide the connection to our customers that ultimately drives our company's success.
Given the importance we place on our workplace culture I'm proud that first American was recently named one of the best workplaces for women by Great Places to work in Fortune magazine for a seventh consecutive year now.
Now I'd like to turn the call over to Mark for a more detailed discussion of our financial results.
Thank you Kent Alder.
I'll begin with commentary on this quarter's results followed by a discussion of a few key topics, including our venture portfolio our outlook for investment income and a financial impact of a few of our strategic initiatives.
This quarter, we earned <unk> <unk> per diluted share.
Included in this quarter's results were $1 60, SaaS of net investment losses. Excluding these losses, we earned $1 62 per diluted share.
Three items contributed to our net investment losses this quarter.
First we incurred $126 million of unrealized losses related to our venture portfolio.
Second we recognized $15 million of losses related to mark to market adjustments in our public equity portfolio.
Finally, we realized $15 million of losses on our fixed income portfolio in connection with our tax planning strategies.
In terms of our venture portfolio, we booked 126 million of net unrealized losses this quarter.
This compares to $276 million of net unrealized gains in the third quarter of last year.
As of September 30, including our investment in offer pad, which is now publicly traded we have invested $398 million in our venture strategy, which has a carrying value of $448 million.
Revenue in our title segment was $1 9 billion down 12% compared with the same quarter of 2021.
Commercial revenue was $260 million, a 1% decline over last year, our escrow balances totaled $12 billion at the end of the quarter up from $11 billion at year end, which indicates a healthy pipeline for commercial activity as we approach the seasonally strong fourth quarter.
Purchase revenue was down 15% during the quarter driven by a 23% decrease in the number of orders closed partially offset by an 11% increase in the average revenue per order.
Our average revenue per order for purchase transactions continued to benefit from recent acquisitions of escrow companies in southern California.
We include escrow revenue from these transactions in a numerator without a corresponding title order that denominator, excluding acquisitions average revenue per order would have been up 1%.
Refinance revenue declined 68% relative to last year due to the increase in mortgage rates.
The agency business revenue was $910 million down 9% from last year.
Given the reporting lag in agent revenues of approximately one quarter. These results reflect remittance as related to Q2 economic activity.
Our information and other revenues were $279 million down 9% relative to last year. The decline was a result of lower transactional levels across several business units driven by the decline in residential mortgage originations, including the company's data property information in post closed services.
Investment income within the title insurance and services segment was $105 million or 114% increase relative to the prior year.
Wanted to take a minute to discuss how to think about our investment income for 2023.
As we've stated previously we expect to generate 15% to $20 million of annualized investment income in the title segment for each 25 basis point increase in the federal funds rate.
In the third quarter, we generated $105 million of investment income that.
That result, Didnt reflect the full quarter of defense 75 basis point increase in July or the 75 basis point increase in September .
In addition, according to the forward curve the market is projecting another seven rate hikes into the middle of next year.
We believe our investment income and entitled segment should be $600 million in 2023, assuming our escrow deposits remain at current levels.
This excludes any growth in third party banking deposits as well as the benefit from reinvesting paydowns principal maturities into higher yielding securities.
If our book yield in our investment portfolio was reset to the market yield it would increase our investment income by an additional $185 million annually.
Investors often asked what the street is missing about our company and our answer is that the market doesn't appreciate the benefit we received from investment income as a result of higher interest rates and because we own a bank we are better positioned to capitalize on a higher rate environment.
On the expense side, we are reducing expenses in areas of the company that are being impacted by the slowdown in residential activity.
Excluding acquisitions, our success ratio was 39%, meaning that our net operating revenue declined 22% relative to last year and our personnel and other operating expenses declined 13%.
Pre tax margin in the title segment was nine 9% or 13.0%, excluding net investment losses.
As Ken highlighted we continue to invest in businesses and innovation initiatives that we believe will positively contribute to our profitability in the long term, but at this point in their lifecycle adversely impact our financial results last quarter, we discussed three initiatives service Mac endpoint and instant decisioning for purchase transactions.
Which together generated a pretax loss of $16 million this quarter impacting our pretax title margin by 100 basis points.
However, the drag on margin improved by 50 basis points since the second quarter, primarily related to improvements at servicemaster.
Turning to the specialty insurance segment total revenue on our home warranty business totaled $105 million down 3% compared with last year.
Pre tax income and home warranty was $4 million down from $9 million in prior year excluding.
Excluding net investment gains and losses pretax income was $6 million down from $9 million last year, the loss ratio and home warranty was 59% up from 57% in 2021, driven by a higher severity of claims in our property and casualty business. We had no revenue in the third quarter and only six policies remain.
We incurred $10 million of losses, mostly related to adverse claims development.
The effective tax rate for the quarter was 174% excluding the impact of our net investment losses, our tax rate would have been 23, 1% slightly less than our normalized tax rate of 24%.
In the third quarter, we repurchased one 3 million shares for a total of $72 million at an average price of $50 and $53 31.
So far in Q4, we repurchased an additional 339000 shares for a total of $16 million at an average price of $46 46.
Our debt to capital ratio as of September 30 was 35% this.
This ratio is impacted by both our accumulated other comprehensive loss and our secured financings payable.
Excluding these two items, which is more in line with how our banks view the ratio or debt to capital ratio was 22, 8%.
As of September 30th we recorded and accumulated other comprehensive loss of $1 billion.
This quarter, we elected to sell fixed income securities, which produced a $50 million capital loss in connection with our tax planning strategy, which will offset capital gains we recognized in 2019 2020 in 2021.
When combined with further actions, we will take in the fourth quarter, we expect to generate $24 million of cash at the holding company as a result of the strategy a.
Our remaining unrealized losses on our investment portfolio are split between our bank and our insurance companies, we don't need to liquidate the portfolio for liquidity purposes, and the average credit rating of the portfolio at a double a minus so we expect to recapture the amount of accumulated other comprehensive loss into equity barring any additional tax planning strategy.
Strategies, we may exercise now I would like to turn the call back over to the operator to take your questions.
Thank you.
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Our first question comes from the line of John Campbell with Stephens, Inc. Please proceed with your question.
Hey, guys good morning.
Good morning, John .
Mark I think you said it twice I want to make sure you said $600 million in title investment income for next year.
That's right that's assuming that the forward curve plays out like it is expected to end in our escrow balances remain at current levels and as that happens we should be around $600 million right. Yeah. I mean, I think even where consensus sits right now you could probably see much less of those hikes and probably lower deposit level and you're still gonna be way above that so.
Nice work there.
On the severance expense.
Could you talk to maybe the annualized kind of run rate savings from that and then.
Just as you think about the market if it's salaries a little bit from here, maybe the actions you guys would be looking to take.
I would just say you know, we've we've reduced our head count.
Places that are being affected by the residential markets.
We had $6 million of severance this quarter I think we had $5 million last quarter.
So that's just something we continue to capitalize on.
Yeah, and John all of that I mean, this obviously isn't the first downturn, we've seen in a 130 plus years and we're highly focused on expense management that we started on expense management. When we saw the downturn coming early very early this year.
And we will continue to calibrate our.
As to the to the market.
Okay makes sense and then just kind of thinking about the industry here I mean, I saw the rule changes from Fannie and Freddie around.
The acceptance of the attorney's opinion letter.
You guys have seen some I guess, we've seen some smaller proper prop tech players kind of launching new offerings and then couple of weeks ago, I think you'll see United wholesale talks about wrapping up its own offering and then also originate mortgages without the lenders title insurance I'm. Just curious about how you guys are viewing that and is that more noise or is that something that youre going to look to address.
Yes, yes, I mean, it's a good question I mean, obviously they've lead attorney opinion letters and generated a lot of press, but I don't think so far we haven't really seen much of an impact, but obviously we're monitoring it.
It closely I think that once lenders and in the GSE appreciate the limitations of <unk> meeting some of the things. We've seen for example that you have to prove negligence against lawyers, which is hard to do there might be a statute of limitations not cleared the coverages for the life of the loan and I think the biggest thing is there is there is.
No cost of defense in some of these in most of these policy that all these policies we've seen.
Which is interesting because I think they were they were originally built to help low and moderate income borrowers who actually are probably the least able to bear the costs associated with defending title.
So we're watching it.
But so far it hasn't been real impactful.
That's helpful. Thank you guys.
Thanks, Sean.
Thank you. Our next question comes from the line of Mark <unk> with Barclays. Please proceed with your question.
Yes. Thanks.
Was hoping you could discuss.
What youre seeing in the commercial.
Pipeline here kind of relative areas of strength and weakness, how that's kind of been evolving in recent months.
So how that may differ from what we can see.
Looking at the more visible kind of institutional.
Larger side of the commercial real estate market.
Yeah, I'll I'll start Mark and then Mark can chime in as necessary, but I think as we'd indicated we had a very strong Q3 revenue.
Our revenue was only down 1% compared to a very strong Q3 of 2021, so I think that sort of.
Bodes well for how we're going to go into the fourth quarter and I think as Mark mentioned in his in his remarks.
Our escrow balances are up which indicates a real a pretty strong pipeline.
And we've actually we've seen strength in the third quarter across geographies and asset classes and it's probably all the things you'd expect multifamily was doing very well industrial and development site.
You are looking into looking at into 2023, I think we probably see commercial coming off a bit probably more towards what we would say our normalized levels. There are still some capital chasing deals, but it is it is softening a bit but again keep in mind, when I say going towards more normal levels.
We're coming off of a record setting 2021, what we expect to be a record setting 2022, the 2022 will be 2021.
So we think commercial will still be pretty strong next year.
Okay got it.
And then just turning back to the investment portfolio, Mark or are you looking to extend duration.
At all where you can to try and take advantage of the higher rates here.
It's not part of our strategy our duration has extended I mean, typically when you look at it on a consolidated basis.
Our duration has been a low fours and today, it's in the high fours, just because mortgages have an extended but I wouldn't say that's part of our strategy to go longer the average duration of our our liabilities is around five years and so we feel pretty comfortable with where we are right now.
Okay got it.
Thank you <unk>.
Qualified the investment income guidance around escrow deposits staying where they are what do you think directionally are they just given all the different market dynamics, you see them more likely to have higher or lower kind of hold this level here.
There's a few different things at play Mark.
You know roughly a rough number is about 70% of our escrow deposits are commercial related so.
If commercial is down next year everything else being equal our escrow deposits will be down but the one thing that we have that offset that is that we're growing our deposits from third party banks, we talk about service Mac.
We've got $1 billion of sub servicing deposits at our bank today than a year ago zero.
And we think that number will continue to grow and that's going to help offset some of the potential softness that we might see so those are two kind of competing things and we'll have to come.
See how that plays out over the next couple of years.
Okay. That's helpful. Thank you.
Thanks Mark.
Thank you, ladies and gentlemen, as a reminder, if you'd like to join the question queue. Please press star one on your telephone keypad.
Our next question comes from the line of Mark Hughes with <unk> Securities. Please proceed with your question.
Yeah. Thank you I appreciate it.
<unk>.
Mark you mentioned that you.
You would have the potential.
Absolutely capture another $185 million in investment income.
If you've got the pull benefited at the higher rates is that.
If we assume your durations in the high fours.
Portfolio is turning over normally you capture.
You know 2025% of that.
Maybe over the coming 12 months am I thinking about that properly.
I think thats the right way to think about it yes, so so the $600 million.
So we're talking about that is variable I mean, that's just assuming the fed raises in all of our cash balances and our variable rate securities will will reset pretty immediately.
But we also have this fixed income portfolio that just takes longer and so thats, what that 185 isn't given the duration of high fours.
Roughly 20% to 25% of that I will turn over every year and that is so that so that will that would be a benefit to us. In addition to the 600 million.
And then could you give us.
Order trends so far for October you've given some good general thoughts about the outlook could you give any specific numbers for October .
In October our <unk>.
Purchase.
Orders, our open purchase orders are down, 38%, sorry, 35%, 35% relative to last year, our refinance orders are about 400 a day.
And Thats, a down 73% from last year.
And then anything on the commercial side.
Our commercial side, our open orders were down about 30%.
Relative to last year.
And then.
In the I think I'd tell you had still a $10 million.
The loss from the reserve strengthening on the P&C business.
What's the magnitude of the reserves that are still left over there and.
This catches all of that or Theres still potential for more.
Right now, we've got about $20 million and and reserves for our P&C business and it's in the final stages of winding down so looking into next year, though the losses will be negligible.
Yeah, Okay, alright, thank you very much thanks Mark.
Yeah.
Thank you. Our next question comes from the line of Bose George with <unk>. Please proceed with your question.
Hey, guys good morning.
From a share buyback perspective, it does the increase in your leverage because if your negative OCI marks create any constraints or do you look through those marks and in your comments you noted that the banks look to us as well.
I wouldn't say it creates any any any.
Any constraints I mean, obviously every company has some constraints but.
Looking at our debt to cap at 22% now that's a really comfortable place to be it gives us a lot of flexibility to execute any buyback or M&A strategies, we might have.
Okay. So that makes sense, so basically think especially as you focus more on the leverage ex the Aoc and Mark when you were making those submissions that's right.
Okay, Great and then actually switching over to.
You noted that the endpoint and surface Mac drag on the margins because I guess like 100 basis points this quarter.
Do you see that trending over the next few quarters.
Hmm.
When you look at them all together, we think it's going to just keep getting better I mean, we're really pleased with our service Mac is progressing.
Theyre going to breakeven here in the fourth quarter, and we feel like they're well on their way to profitability next year and that doesn't include any benefit that we get at the bank for their deposits too so.
It's hard to say where that 100 basis points is going to go but.
But we feel pretty confident that the losses will narrow in the fourth quarter and continued to narrow into next year.
Okay, great. Thank you.
Thanks Bose.
Thank you once again as a reminder, please press star one to join the question Paul.
Our next question is a follow up from the line of John Campbell with Stephens Inc. Please proceed with your question Hey.
Hey, guys. Thanks for the follow up I, just wanted to jump back to the specialty insurance segment, mainly on just home warranty.
Two part question first I'm, just curious about how to kind of think about the growth path from here I know the real estate channel is a pretty important kind of driver of that growth I wanted to check maybe on the health of the other channels and then also just kind of get an update on pricing and then the second part of that just curious about pretax margin just for home warranty I think last year it was right around 13%.
<unk> seen that are a bit higher in past years. So just kind of what how to think about a kind of good margin target there.
Yes, I'll start and Mark can finish up on it but.
We feel good about the home warranty company I think as we noted the revenue was down 3% and Thats largely driven by as you indicated that real estate channel.
Anything thats.
Tied to real estate transactions is going to going to suffer but we have had an offset to the decline in real estate channel from prices. So we have been raising price and theres. Some additional theres going to be some additional opportunities to raise excuse me to raise price and we will do that.
Also our we're getting a lot of traction in our direct to consumer channel.
So that's performing well and then we're also seeing renewal rates perform.
Yes performed much better so on the whole, we're pretty optimistic about where the home warranty company is going.
Just in terms of the margins job this quarter homework, he had a 6% margin, but it's a it's typically.
Yes.
A very seasonal business and it's counter seasonal to our title business. So typically Q4 and Q1 are the are the most profitable quarter. So really we think about on an annualized basis. The home warranty business is 12% to 13 as pre tax margin.
Okay excellent. Thank you guys.
Thanks, John .
Thank you ladies and gentlemen, there are no additional questions at this time.
That concludes this mornings call I'd like to remind listeners that today's call will be available for replay on the company's website or by dialing 8776606853.
Or 201617415 and entering the conference I'd number 13733443.
The company would like to thank you for your participation. This concludes today's conference call. You may now disconnect your lines.
Okay.