Q1 2023 First American Financial Corporation Earnings Call
Okay.
Greetings and welcome to the first quarter 2023 first American Financial Corporation 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 a copy of today's press release is available on first American's website at Www Dot first a M dot com forward Slash 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 8776606853 or 20161 to 7415 and entering the conference I D 1373812 kit.
We will now turn the call over to Craig Barberio, Vice President Investor Relations to make an introductory statement. Please go ahead Sir.
Thank you good morning, everyone and welcome to first American's earnings conference call for the first quarter of 2023 joining.
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 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 at risk.
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 I'd like to turn the call over to Ken to Georgia.
Thank you Craig.
Ongoing challenges and market conditions in the first quarter continued to weigh on our results, although 136% increase in net investment income along with our expense management efforts enabled us to deliver our pretax title margin of six 5%.
Our home warranty segment had a strong quarter with a pretax margin of 15, 3%.
On a consolidated basis, we earned <unk> 44 cents per share or 49 cents before net investment losses.
A sharp decline in affordability driven by mortgage rates above 6%, along with low inventory and elevated home prices adversely impacted the housing market and as a result, our residential purchase business currently.
Currently however, the purchase market appears to have stabilized for the first three weeks of April we are seeing typical seasonal improvement in the purchase order trend with open orders up over 5% compared with March.
Refinance open orders remained at trough levels in the first quarter, averaging 350 per day.
The current pool of mortgage loans would need to see rates drop well below 5% to incentivize a significant uplift in refinance activity.
Which is highly unlikely in the near future.
The weakness in the commercial market, which began in the back half of 2022 also impacted our results this quarter with our commercial revenue down 39%.
The decline in activity was seen across all regions and asset classes, including industrial and multifamily and large deals were down 50% from last year.
Commercial open orders were down 28% in the first quarter and that order trend has continued into the first three weeks of April with orders down 30%.
Well there is a high degree of uncertainty concerning the commercial market outlook.
Just on feedback we're getting from customers, we remain optimistic the transaction activity will improve in the second half of the year given the progress made on price discovery during the first quarter and ample capital availability notwithstanding the potential impact of the banking crisis on available credit.
Our financial strength allows for continued investment in our innovation and other strategic initiatives, which are imperative to long term growth strategy. We continue to make progress at endpoint or digital title and settlement company, which now has a national presence.
This month endpoint announced the launch of its mobile notary platform, which streamlines the process of signing documents and real estate transactions.
Our title company has begun to use the platform. The first time that the broader company has leveraged endpoints proprietary technology as.
As endpoint continues to reengineer, the closing process it will drive efficiency and improve the customer experience not only for itself, but for other divisions of first American as well.
During the last few quarters, we have discussed our initiative to develop instant entitled Decisioning for purchase transactions, which also promises to improve our operational efficiency and expand our competitive advantage.
Given the success of our early testing, we expect to deploy it in two markets within the next year.
This next generation technology is made possible by a number of factors unique to first American, including our talented technology and data sciences and underwriting teams and the most comprehensive title and real property database in the industry, which is fueled by our proprietary data extraction.
Technology.
We also continue to make progress at Servicemaster, which turn cash flow positive last quarter and is now the fifth largest subservicer in the market after experiencing 62% revenue growth this quarter.
In closing I want to thank our employees, who have shown resiliency through difficult market conditions.
They've remained steadfast and committed to our company and our customers, enabling us to grow our market share by over two percentage points in 2022.
Each will pay dividends when the current cycle turns.
I'm also pleased to announce that first American has been named one of the hundred best companies to work for by Great place to work in Fortune magazine for the eighth consecutive year.
This accomplishment is a tribute to our unique culture and our people who in addition to delivering best in class service continuously find new and innovative ways to meet our customers' needs.
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 <unk> 44 cents per diluted share.
And this quarter's results were five of net investment losses. Excluding these losses, we earned 49 cents per diluted share.
Revenue in our title segment was $1 3 billion down 32% compared with the same quarter of 2022.
Commercial revenue was 148 million a 39% decline over last year, our average revenue per order for commercial transactions declined 25% this quarter to $9900 due to a combination of lower valuations as prices in the commercial market reset.
And fewer large transactions.
Purchase revenue was down 32% during the quarter driven by a 33% decrease in the number of orders closed partially offset by a 2% increase in the average revenue per order.
Refinance revenue declined 75% relative to last year due to the increase in mortgage rates.
In the agency business revenue was $590 million down 38% from last year.
Even the reporting lag in agent revenues of approximately one quarter. These results reflect for minutes as related to Q4 economic activity.
Our information and other revenues were 222 million down 26% relative to last year.
This decline was the result of lower transaction levels across several business units, including the company's data and property information products and post close and document generation services.
Investment income within the title insurance and services segment was $125 million or 136% increase relative to the prior year right.
The rising short term interest rates are benefiting the interest income we receive on a cash and investment portfolio.
Balances in tax deferred property exchange balances.
Short term rates have risen we expect investment income to continue to be a tailwind for earnings in 2023.
On the expense side, 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 $206 million and our net operating revenue declined $409 million.
Well below our long term target of 60%. We believe our success ratio was a good outcome given the sharp decline in transaction activity and our commitment to continue to fund strategic initiatives.
The provision for policy losses, and other claims was $35 million in the first quarter or three 5% of title premiums and escrow fees down from the 4.0% loss provision rate in the prior year.
Three 5% loss rate reflects an ultimate loss rate of three 8% for the current year with a $3 million release for prior policy years as of now we expect to book at three 5% for the remainder of 2023, but that may change depending on claims activity.
As Ken highlighted we continue to invest in businesses and the 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. We have discussed three initiatives service Mac endpoint and instant decisioning for purchase transactions.
Which together generated a pre tax loss of $18 million this quarter impacting our pretax title margin by 150 basis points.
Pre tax margin in the title segment was six 5% or six 1% excluding net investment gains.
And this result were $10 million of intangible asset amortization related to acquisitions and 4 million of severance incurred during the quarter.
Beginning this quarter, we moved our property casualty results to our corporate sentiment and our disclosing our home warranty resulted a standalone reporting segment.
Total revenue at our home warranty business totaled 104 million slightly ahead of last year pre tax income and home warranty was 16 million unchanged from the prior year the loss ratio and home warranty was 47% up from 46% in 2022, driven by a higher severity of claims partially offset by lower frequency.
The effective tax rate for the quarter was 22, 8% lower than our normalized rate of 24% due primarily to the mix of in to the mix of income between our insurance and non insurance businesses since our insurance business generally paid state premium tax in lieu of income taxes.
In the first quarter, we repurchased 556000 shares for a total of $30 million at an average price of $54.75.
Our debt to capital ratio as of March 31 was 28, 4%.
This ratio was impacted by both our accumulated other comprehensive loss.
Secured financings payable excluding these two items, which is more in line with our banks through the ratio or debt to capital ratio was 21%.
As we discussed last quarter on February 1st we repaid $250 million of senior unsecured notes that matured using cash on hand at the holding company later in the year, we expect to draw on our line to partially replace this debt now I would like to turn the Gulf call back over to the operator to take your questions.
Yeah.
Thank you we will now be conducting a question and answer session. If you would like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate your line is in the question queue. You May press star two if he would like to remove your question from the queue.
For participants using speaker equipment, it may be necessary to pick up your handset before asking questions.
One moment please poll for questions.
Our.
Question comes from bus torch with K B W. Please proceed with your question.
Hey, guys good morning.
Wanted to ask about margins is there just given the weakness.
The broader markets can you just talk about margin expectations for the year and if this persists is there more you can do on the expense side to kind of address it.
Thanks for the question both.
So the the the challenge we have is obviously the market and when you look at purchase and commercial and refinance which really drives our business. I mean, all of those are going to be headwinds going into this year certainly relative to last year.
The good news is that we've seen evidence of the purchase and refi markets. It really bottomed out in commercial is really close to getting there, but yet we will still face year over year headwinds I think on the on the positive side for margins. This year investment income, obviously is going to be a tailwind for us looking at a year over year basis. We've got the full year of a few acquisitions. We did last year that will be incorporated this.
Year if.
It's not material, but it'll be a little a little bit of a help for us we still are going to get a lot of efficiencies based off of some of the expense measures. We took last year and we've talked about these strategic investments and we think that the loss will continue to narrow. This year you saw that we lowered the loss rate to 3.5%, obviously, that's going to help our margins and then.
Lastly, I'll just say that you know our P&C business lost 18 million last year, and obviously that loss is going to narrow this year. So when you mix. It all together I mean, even though we're at a what we think is gonna be a trough year, we're still looking at double digit margins this year.
And.
You know in terms of can we can we do can we do more I mean, there's always more that we can do if the market is sort of worse than our expectations, but were looking at at least double digit margins in 2023 based on based on what we see today.
Okay, Great. That's helpful. Thanks, and then actually on interest income you noted that it remains a tailwind.
Any change to the guidance you gave in the past obviously forward rate expectations have changed a little bit.
Well.
What I would say for that as well going back to Q3, we said that we could hit $600 million of investment income in 2023, assuming two things happened one is that the forward curve for fed funds rate played out like the market thought it was going to and the second thing.
<unk> was it balances were even with Q3 levels that they didn't change.
And what's happened now is you know the fed funds rate has really played out like the market has thought but balances have fallen and certainly our commercial business was down 40% sequentially from Q4 to Q1 and and and so so our investment income was down sequentially, just because balances fell so when we look at kind of the outlook for investment income this year.
We feel like our Q1 of $125 million of investment income entitled the trough, we don't see it getting any lower than that we sort of update you know we're going to update our guidance that we gave and we just took march balances and kept them flat in and you.
You know I'm, assuming the forward curve now we'd look at somewhere around 535 million of investment income this year, but again, that's based off of March balances in March balances are typically lower than the average balances. So its commercial sort of picks up throughout the year. We think we'll we'll hit higher than that so so weird.
We're still positive on investment income, but it was down this quarter just because the balances.
Okay, Great. That's helpful. Thank you.
Our next question comes from Mark Hughes Suntrust. Please proceed with your question.
Yeah. Thank you just a mark to your last point there about.
This is all to build as the year progresses.
There are decent visibility for that I think you gave the.
Commercial orders down was it 30% in the first three weeks of April but is.
Is there a reason to think the balances will work.
Will progress from here.
Hi, Mark this is a this is ken.
I'll answer that one I mean, you know I think there there is cause for optimism that the commercial market is going to is going to rebound in the second half of the year and obviously commercial drives those balances you know about 70% of our balances are tied to our commercial business and a lot of that is based on our as I mentioned in my comments our are cut.
Or feedback that are expecting a stronger second half, mostly because price discovery had will have concluded or largely concluded.
And Theres still you know at least we're hearing anecdotally, there's still adequate capital. Despite the despite the banking crisis you know obviously, we're watching that closely.
You know watching loan availability, particularly in the smaller to medium sized commercial market, but you know everything we're hearing so far that you know we anticipate habit that commercial is going to end up.
Fairly strong this year, so obviously it'll be down compared to a record 2022.
Yeah.
Do you think about the cost structure and just looking back your correct.
Direct premiums and escrow fees pretty similar this quarter to what you added <unk> 19.
When you had oh.
If I'm looking at approximately a 10% pretax margin in title on a lot less investment income.
Is.
Maybe give some perspective or thoughts on that is that the.
You know the extent Dr.
Structure was built up these last few years as you had very strong volume and are.
And there's.
That could be taken out if.
If you didn't see a rebound coming I know you've.
About the <unk>.
Vestments youre, making in these growth initiatives.
I was just wondering if you could.
Give some reflections on how the cost structure is different now than it might've been.
For years as a while ago, but.
But it's a striking a comparison.
Well I would just say back in 2019, you know it was it was certainly a better market, particularly when you look at the number of transactions. So you look at what really the big three markets that drive our business commercial purchase refi and it was all much stronger back in 2019.
23 leased so far in terms of transaction counts were seeing him.
Bose, we haven't seen since the great financial crisis, and even before that some of those markets.
So when you look at like the cost structure of our individual business units, whether it's our commercial business or direct its very similar its just.
We have been investing more in some of these initiatives that we've been talking about and just technology in general.
So that's what I'd, just say well into 2019.
Yeah.
Yeah.
Mark the one thing I would add to it.
Hmm.
I'm sorry.
Mark I guess, the one thing I would add too is when it comes to these strategic initiatives and the and as Mark mentioned in his comments the investments.
Our significant we can obviously slow those down or shut them off we don't want to do that we don't think it makes sense from a long term strategic perspective, but we that's a lever we have.
Yeah, and then on the home warranty business.
One of you could.
Maybe give some thoughts about what you think might happen with the topline there.
Yeah, I think that you know well our home warranty business had a had a strong quarter as we as we noted I you know I think on the topline I mean, there's two channels in the home warranty business, the real estate channel and the direct to consumer channel.
The real estate channel, there's a there's a high degree of correlation with our purchase business. So as we see real estate transactions fall if they continue to fall.
That will put pressure on their revenue, but they've they've had a lot of.
Success in the direct to consumer and the direct to consumer business in the first quarter. For example, it was up it was up 12%, whereas in the real estate channel was down almost 35%. So theres opportunity there. The other thing. We're seeing is is that you know some good performance with respect to renewals.
In both channels actually the real estate channel the renewals have been up five almost 5% in direct to consumer or just over 14%. So we think theres. Some some opportunity there but that they're facing are certainly in the real estate channel. The same headwinds that are you know our residential title businesses.
Thank you very much I appreciate it.
As a reminder, if you would like to ask a question. Please press star one on your telephone keypad.
Our next question comes from Mark <unk> with Barclays. Please proceed with your question.
Yeah. Thanks, I wanted to drill down a little more on on the commercial outlook for the back half of the year I. Appreciate all the color you provided.
One question is the price discovery issue is.
Is that impacting the larger transactions.
As more and if so as we you know.
Find an equilibrium at these higher rates does that kind of have an upward impact on on the fee per file and then the second question is how much concern there from hearing from your customers that you know even as they begin to to reach that equilibrium and find price discovery that you know banks tightened.
In the wake of this regional banking crisis kind of tightened disproportionately on on their CRE business and can you see kind of a a lack of supply of credit just as commercial investors are looking to transact.
Yeah, you know Mark I think you know I mean, it's not it's not clear if the price discovery is impacting large transactions larger much more substantially than others.
I guess, we could probably infer from the fact that our large transaction volume counts were down 50% in the first quarter, probably suggests that you know that price discovery is having an impact on them now with respect to the you know the fee per file.
I think if we see large transactions come back into the market yet that'll have a positive impact on the on our on our average revenue per order, but you know, but that said, we're anticipating that on the old you know large transactions are going to go down in value as well I mean, we're seeing you know 10% to 15% decline in prices in the you know in the commercial.
Mark is 25% in office.
So prices across the spectrum I think we're going to come down.
Okay got it and any concerns.
Around the availability of funding from banks.
Yeah, I mean as I had mentioned, we're hearing anecdotally that there is adequate capital, but no. There is we we have some moderate concerned about it and where you know where we're keeping an eye on it you certainly read a lot in the you know in the trade media about you know, particularly mid tier banks, making credit available to you know a lot smaller.
Medium sized commercial deal. So it is a concern if its something were watching but at least what we're hearing from our customer base as you know they they don't they don't they don't see an issue right now, but you know obviously you know theres much remains to be seen.
Okay got it.
Next question I mean, you know that this this environment has got to be particularly challenging for subscale players in the title business are you seeing improving opportunities to do acquisitions here just given some of the distress somebody's players maybe under and if so are you kind of prepared to be aggressive in acquiring.
Yeah, I mean, you know, it's it's interesting Mark I mean, we're not we haven't seen a lot of attractive opportunities, we see some opportunities, particularly like in the prop tech space that are not too compelling.
But given where the market is a we expect to see some opportunities. If the current challenges you know ultimately prove to be prolonged yeah, I think there will be opportunities and the the good news is we have the capital to seize on them, but you know as always we'll be very discipline will be very disciplined about.
The amp about our M&A activity, but we think they are coming.
Okay, great. Thank you.
Our next question comes from Geoffrey Dunn with Dowling and partners. Please proceed with your question.
Thanks, Good morning.
Mark I know you put it in the Q, but can you front ran in and give the actual balances for escrow deposits in 10 31 as of the end of the quarter.
Yeah.
Yeah. Thanks, Jeff.
At the end of the quarter, we had $2 1 billion of 10 31 exchange deposits.
Was that your question temporary one yeah. That's part of it do you have the escrow as well Oh I'm sorry, yeah. So escrow.
Total escrow deposits, we had 10 points about 10 billion.
So that's flat.
Uh huh.
Sequentially It was.
11 billion, yeah. So we're going from 11, but it was a different I'm looking at a bank balances within the queue. We report book bounces slight difference on timing, but and at the end of the year in terms of bank balances for escrow we had.
11.0 billion and.
As of March 31, we had 10 3 billion. So they were down sequentially.
That's an escrow.
Okay. So I guess I mean, so sequentially. Your your net investment income was down a decent amount.
What type of yield are you getting on 10 31. It seems like it's a really big swing for a 700 million decline in 10, 31 balances where your your balance sheet assets are up.
And your S grows flat.
I need to dig into that a little bit more.
Yeah. So the so the average rate that we're getting on on 10 31, right now is about well it's average average for the quarters for five five but as a general statement, we get fed funds, obviously fed funds change throughout the quarter. So that's a general statement, we're getting fed funds for FERC temporary one business.
And how does that compare to escrow.
Escrow were getting about fed funds as well same thing, maybe maybe a little bit less so we get probably a little bit more on 10 31, but it's generally about fed funds.
Okay Alright.
And then the other question, obviously, you just talked about M&A and having the capital for that.
How do you weigh.
Buyback capital return in a tougher macro environment.
You know last year, you indicated you were going to increase that activity you did how do you think about that in the current macro challenges.
Yeah. Joe This is Ken I mean, you know this is not our priority has always remained the same year. One is to reinvest in the business, which you know as we've talked about a couple of times today, where were doing with endpoint entitled Decisioning and other.
Innovations and strategic initiatives, and then M&A, you know, which which I talked about earlier and then you know certainly returning capital to shareholders with respect to repurchases I mean, the the current price is certainly are certainly attractive.
Q1, we repurchased over 550000 shares last year, we repurchased over 7% of our shares outstanding but you know we're gonna be opportunistic given all the demands on our capital, including as I had mentioned our expectation that there's going to be some attractive M&A opportunities.
Cities are forthcoming.
Okay. Thank you.
Yeah.
As a reminder, if you would like to ask a question. Please press star one on your telephone keypad.
Our next question comes from John Campbell with Stephens. Please proceed with your question.
Hey, guys good morning.
Good morning.
Hey, so back to the margin.
For title I mean, if we back out the investment income and an impact and then if you add back the severance charge and then the 18 million in investment headwinds you guys called out I'm getting to like a negative 2% kind of underlying title pretax margin I think you'd have to go back to 1209. So during the housing crisis to see a similar margin.
On marks question.
You guys provided a couple moving parts, there, but I'm trying to get a better sense for maybe the excess costs you might be carrying because it does sound like you guys expect.
Things to improve a bet on the resi side as well as commercial which we agree with it for sure but as a hypothetical if you. If you looked at next year next once you. If you just hold everything flat.
What type of margin lift do you think you might get from just kind of paring. Some of these investments and then may be taking cost actions. If if the if this current environment kind of holds.
Well, there's a few things there so I mean, one thing I'd say is that.
Just backing out our investment income like you have and others have and we've done that same thing to it.
It really discounts all of the like operating costs that we have add businesses to generate the income. So for example, our bank. If you just exclude all the you know the revenue from the bank.
And you have all the personnel cost and all the other operating expenses associated with the bank and not just the banquet or 10 31 business.
You know, it's it's not quite apples and oranges I would say you know the other thing is our bank pays interest expense too. So you sort of have to back that out. So that's that's one one thing I'd point to.
Again going back to 2019, it's just tough because again it was it was sort of an Olympic cycle ago, but basically when we think about the margins I mean as I said, we're looking at a double digit margins this year and and we feel like that's a good outcome considering just the tough market conditions. So.
When we look out 2020 for 2025 and beyond we feel like we're going to get a lot of lists for a few different areas number one obviously, we'll have hopefully market.
Tailwind number two is a lot of our you know just I'll call. It normal operating expense management will continue to pay off and we've seen that with the successors revisions last couple of quarters and three hopefully some of these strategic initiatives will continue to pay dividends for us and so when you wrap that all together you know we've really the highest margins.
We've seen at least our company's 15% we saw that in 2021 now we're having a trough market. This year, but we will inch closer to 15, you know and you know in the outer years once these things materialize.
Okay. That's that's a great. That's a great point I didn't really think about the incremental excess cost that comes with that higher level of investment income. So that's a good point.
On the outlook, Mark you mentioned kind of expectation for a baseline or at the low point of like at least 10% title pre tax margins, if you're I'm curious if that's 100% contingent on the resi market improving as long as commercial.
At least what you saw in <unk> or do you think you'd still be able to get there you know with colfax into the market a little bit.
No I would say that that's assuming a pretty tough environment. I mean, we're sitting here in April . So we have visibility into you know sort of June revenue based off of the order count so for the first half we pretty much know what we're gonna do more or less the second half theres still uncertainty, particularly on commercial particularly you know how strong is Q4 going to be.
But I would say that that double digit margin assumption doesn't assume the market picks up we don't we're not assuming a.
You know a big recovery on the residential side, it's it assumes kind of a flat purchase market and no pick up in Refis and in some normal seasonality with commercial so there's not a there's no stretch assumptions with that.
Okay. That's helpful and last one for me just a housekeeping question with with P. N C being moved into corporate just want make sure I get a better grip on that I saw the $1 7 million of claims cost how much incremental expenses tied to P&C, that's falling into commercial now.
Excuse me into corporate.
Yeah.
So.
For the quarter, we had.
About $5 million of.
Of losses at corporate because of P&C, we think that's really going to narrow to a couple of million here in the next quarter or two we don't have any remaining policies outstanding. We've got roughly about 300 claims that were still kind of working through the pipeline and we just have very minimal operating expense. So I would say, it's negligible from here on out.
Okay. Thanks, guys.
Thanks, John .
There are no additional questions at this time.
This concludes this morning's call we'd like to remind listeners that today's call will be available for replay on the company's website or by dialing 8776606853 or 20161 to 7415, and then entering the conference I'd 13738.
One key to the company would like to thank you for your participation. This concludes today's conference call you may now disconnect.
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