Fidelity National Financial, Inc. (FNF) Earnings Call Transcript & Summary

Okay. Yes, that's super helpful. That's the best clarity you have guided on that. So that's great. The centralized refi channel, I think some of those people hear that. They think better margins, but 34% that's better than your commercial businesses at this point. So kind of walk through what you guys are doing there, why that's a different channel and how those margins are so strong in the channel?

Well, I mean, first and foremost, volume does a lot for you. And so we're running a lot more volume through there versus last year, but we're probably seeing more automation benefit in that probably close to 70% of our title production inside the centralized environment is very little or no touch. So they can scale a lot more without having to add a lot of bodies on the front end. So I think that's probably the answer. It's not fee. Their fee profile is about the same as it's been, I think, right, Tony, about 1,000?

Yes. And they're really doing it. I mean we have work-from-home throughout the company at certain levels, but when you say, Mike, they're probably a higher percentage of work-from-home than any of our offices.

Yes, they're running -- I think it's around 80% work from home in ServiceLink and probably in the field, that's I think we're running maybe 60% office, 40%, something like that. So you can see the difference in the distributed model versus the centralized. And it's been interesting with work from home. We've -- and again, volume helps, but we've actually seen higher productivity. And I think a lot of industries are reporting that. I don't -- I can't explain all the reasons why and how sustainable it is, but I think we certainly are seeing higher productivity with the work-from-home environment.

I don't think anybody wants to lose their job amidst the pandemic, so already employees working a little harder. But yes, I wanted to ask you though about the expense base. Tony, I know this is probably an impossible task at this point, but any sense for like what you've kind of saved this year not doing maybe industry conferences, maybe traveling with us versus kind of what happens next year? I know it's impossible to tell the future. Do we go back to normal, who knows. But let's assume we get back to quasi normal next year, how much of expense savings you think you've got this year?

Our run rate in savings on travel and entertainment is probably about $15 million a quarter. We didn't get all of that in the first quarter. But certainly, in the second quarter and the third quarter, we were lower by $15 million in each of those quarters relative to the same quarter of last year. So I think that's a pretty good number to use. We'll probably see that for the most part, again, in Q4. In fact, I'm almost sure, we will. I don't know where we end up next year and thereafter. I've read things that suggest that maybe 50% of those type -- business travel could go away permanently. That's probably an average. And I don't know if that -- if we'll see those same numbers or more or less, but I do think people are going to do things differently, obviously, this conference we would normally do in person, and we do a number of these conferences every year, and we, Chris and Mike and I travel to these things. It's just an example. But on an everyday basis, we have salespeople who are traveling around and spending money. And we're saving a lot of that. And some of it, I think, will be permanent.

Yes. I tend to agree. I mean, I think some of the -- as you think about airlines, you think about hotels, some of it's just money out of the pocket and staying in our pockets, if you will. I think that, to some degree, a permanent shift, I guess, want to wait and see to what extent. But just kind of segueing that into next year, and I know you guys just love this question, but shooters have to shoot. I got to take my shot on that. As far as margins next year, if we assume commercial is up, and rebounds a bit, but easier comps, maybe refi is down a little bit. Maybe that's an offset, I don't know. Some of the expense base probably comes back. But like how difficult do you think it is to kind of carry this type of margin into next year?

I think, again, as I said earlier, the wildcards really refi. If you think about the puts and takes to your point, we kind of feel like you just suggested that Commercial could be up a bit next year, given that it's kind of down this year, and the order trends are pointing to that. Purchase, we'd expect to be up. Not sure how much. The supply side weighs on that. But I think we're still thinking that there could be a plus on purchase. So those -- that's the good side of it. But it just depends on how refi behaves, if that falls 40% to 50%, that's a lot of revenue to make up. Yes. If it falls 10%, I think that's a different discussion. And then maybe we've got a bit more expense because of some of these things coming back. But I think it's really about refi. We'd expect it to be a very good year, but just hard to call vis-à-vis what 2020 is going to end up like.

Yes, sure. Absolutely. That's a good one. Now, one last thing on the call side. Tony, I want to ask -- I know there were some savings for moving to cloud. Have you guys recognized all that? I think it was maybe [indiscernible] million or so run rate, is that right?

Yes. We doubled up over the course of about 18 months, and we probably did have some incremental spend over that time period of maybe $15 million. I think going forward, we're going to save maybe $8 million to $10 million on an annual basis. So we should see some of those benefits. But I think the real benefit is the scalability of being in a cloud-based environment versus an infrastructure where it's in data centers and really to be able to ramp up and ramp down. I don't know if it's instantaneous, but it's so much more efficient, frankly, our work from home and even our 4,000 employees in India, we were able to have them working from homes so much quicker with being in the cloud environment than we ever would have been able to do had we still been having the data center environment. So I think as we move forward, the variable cost side of being cloud-based is going to be huge when -- as we all know, there's ebbs and flows in our business and being very flexible is very helpful there.

Yes. No doubt. I want to touch on 2 more on the title segment, and I definitely want to get into F&G. On the reserves, loss revision rate -- I think we've all seen Stewart and FAF strengthen reserves a little bit. You guys do it more in main. So I think you give yourself a little more flexibility in quarter to quarter, but what are your views there? Why not strengthen -- like what does it take you seeing to make you feel a little uncomfortable, maybe if I can strengthen reserves?

Yes. I guess I need to see something. It would be my opinion. At this point, if you look at our last 10 years of policy years, our average over the 10 years is 3.8% losses. We're providing at 4.5%. So in my mind, we're already over-provisioning a little bit. Now at this point, every time we provision a little bit more, the actuarial model changes a little bit. And somehow, we don't pick up much of a redundancy. I'm okay with that. They can continue to be conservative as far as I'm concerned. But I do feel like we've built a $55 million or $60 million redundancy that's -- I'm comfortable with that because it's still very immaterial. But if it grows to $80 million or $100 million, I would be less comfortable with that and probably have to take a release. So at this point, I just want to continue to monitor the results. I don't think we're going to see mass foreclosures like we saw in the financial crisis. I don't think it will look anything like that. If we see signs that maybe I'm not right, we can adjust accordingly, and we will. But at this point, I don't feel compelled to go anywhere but continue to provide at that 4.5%.

Yes, makes sense. Last one is on competition. You guys get this question quite often as well. So just kind of get an update here. Lots of folks ask about state's title, that's one. But then there's the whole iBuyer movement. And I think some investors, at least some guys I talked to, I think maybe a little bit inappropriately think that you guys are being completely [indiscernible], which is being taken out of equation, but you guys are still providing that back stock, you're still underwriting. So if you can walk through your relationship with the iBuyers and kind of any updates anywhere else as far as competition?

Yes. As we've said before on iBuyers, I mean, it's another way for people to transact. And there's also a title opportunity in that transaction. And so you can capture that as a direct order from an iBuyer. And we've captured many of those orders and still capture some but the larger iBuyers like nonbanks, for example, have moved into captive title agencies, Zillow and Opendoor, are 2 great examples of that. And so that becomes a really an agency opportunity for us, as you know and investors know we're the largest agency underwriter in the industry. We're also the largest direct player in the industry. So we're largest in both channels. They're both very, very important to us. So we see it as an opportunity. It's a different type of opportunity. I think it's hard to know or tell just how big that becomes. And does that start to impact the traditional model that involves real estate agents I just don't know yet. But I would just say it's nothing new that entities that can control the placement of title orders consider having a title agency. It's been going on for decades.

Right. And as you go -- I usually think about agency. I usually go to kind of state to state, and I think about remittance rates. How does it work when you work with some of these national like an iBuyer, who's doing across multiple states. You have an arrangement at a national level, how does that work?

Generally -- so if we have like a multistate agency, is that the question?

Yes.

Yes. Generally, the race would -- there'd be state contracts. So you'd have a contract for each state, reflective of the nuances in that state, some are regulated, some aren't.

Okay. That makes sense. All right. Lets get into F&G. Chris, thanks for patiently waiting. If you could just maybe start off with kind of a high-level view. I think this is easily, easily the most misunderstood part of the story. So if you could just take a high-level view of simplistically the revenue model, how you guys make money? And why it's maybe not quite as [indiscernible]?

Yes, happy to do that. So probably the simplest way to describe it is, think of this more as a spread lender, than a traditional insurance company. So we're a fixed annuity provider. Our most basic product is an insurance company's version of the CD. Someone gives us $100,000. We promise them a rate of return guaranteed for 5 years. We give them the premium back, but unlike a bank, we are able to offer a higher rate and offer a rate that's tax deferred. On a fixed index annuity, it's the exact same concept, but instead of paying you, say, 2% in cash every year, we buy an option on your behalf. So there's a couple of misnomers. The first is you guys don't do well in a low rate environment. We've proven now for, I don't know how long. It's one of our favorite charts. We show the 10-year treasury has gone everywhere from 300 basis points to 40 basis points and our spread remains the same. So we've been able to earn a healthy spread, in frankly, pretty much any kind of interest rate environment. So that's probably the biggest first misnomer. So with that, we take premiums in, they're very sticky. So typical duration for us is about a 6-year contract that can be as long as a 10-year contract. There are surrender charges and penalties, which the clients are aware of when they buy them. So these are very sticky liabilities unlike a bank which might borrow short and invest long. We're borrowing long and investing long. The second piece is the partnership with Blackstone. They're the largest originator of credit in the world. And so if they're able to source attractive investment-grade private debt that's proprietary and not available, not traded by investment banks or in part of the liquid markets, we pick up extra spread, and that allows us to be more competitive. So frankly, our model is fairly simple. We grow assets under management. At the end of the day, we take home net of everything, including taxes, about 1% on assets. Now in a good quarter, that could be 110. If there's rate pressure, that could be 95. But it's pretty consistent. So if you could model our asset growth, you apply 1%. You have a good sense of what core earnings for the franchise should be. And we've got a great demographic tailwind. I mean we're selling savings products to a population that is looking for these types of products. And as you know, right now, banks are just drowning in deposits. We rolled out with Raymond James earlier in the year, and it's just far exceeded, I think, our expectation and theirs.

Yes. That's a great overview. I mean it's simple -- it's AUM times about 1%, right, on the net spread, and there you have it, so...

The beauty of the insurance world is, we have a lot of people that want to make sure that it seems more complicated than it needs to be. So I can give you the 12-hour tutorial on STAT versus GAAP accounting, but it is literally just about that simple.

Yes. So talk to us about maybe the like 2 or 3 things that you think you guys do such some well that helps you kind of stay in that tight spread range, the 95 to 110 or whatever. How do you constantly stay in that range if the tenure goes to 15 or if it stays where it's at?

Sure. Yes. So the first most important thing to understand with insurance investing is the liability side, it's actually not the asset side. So the product we talked about where we're giving you a participation in an index. We're saying, look, you can't lose money. If you put your money in this contract for the next 5 years, and you'll get -- making this up, half of the return of the S&P 500 capped at an annual return of 6%. You're not going to get rich, but you have a decent shot of doing better than what a CD might pay you. So that's the core value proposition. That rate or participation rate resets every year. So that's probably the other big misnomer. Unlike a life insurance company that may write a policy with that's going to be on the books for 30 years, and they locked in an interest rate assumption and are hoping that it plays out that way. Every year, we have a new option budget. So if rates have come down, which they did dramatically last year, we can reprice as those contracts come up for renewal. So you don't want to abuse that. You want to make sure you have a good value proposition for the customer. But if rates have moved dramatically, maybe your participation rate is now 45% as opposed to 50%. So that is a critical element. And then the other piece of spread is, what can you do on the asset side? So I go back to my example of Blackstone is the largest originator of credit in the world. So if they can source an A-rated loan that is paying a couple of hundred basis points over an A-rated corporate bond, you don't need a lot of that in your portfolio to give you a pretty significant edge. In fact, 10% or 15% of that, you can do the math, you've got a 20 or 25 basis point edge. So in our business, that's the difference between being the most competitive player on the shelf or one of the least competitive players.

Yes. That makes sense. So I think we've broken down pretty simplistic AUM times net spread. The AUM side seems to be really interesting for you guys. You had at 1 point, I think said you think you guys can double the AUM in 5 years. So with all things considered, is that still a reasonable goal? And then if you can talk about how you get there, maybe through broker channel and whatnot?

Yes, absolutely. So rough math, today, we play in a category that's about $150 billion per year. I think that's going to expand, and I'll come back to that at the end, but just assume it's $150 billion a year of sales. Right now, we're going to do, I don't know, $4 billion, $4.5 billion of sales this year. And that was selling through 1 distribution channel, independent insurance agents. That's about 40% of that $150 billion. We've now rolled out into banks and broker-dealers, less the 60% piece of the pie. And as I mentioned before, I think in our third month with Raymond James, they've told us we're actually their #1 selling carrier in their system. And so as we add new distribution channels, we're now playing in the whole pie, not 40% of the pie. So I do think over time, we can get to similar numbers, 3$ billion, $4 billion, even $5 billion a year of sales in some of those bank in broker-dealer channels. I mentioned banks, in particular, fixed annuities are a core product for them. They have more deposits than they know what to do with right now. The loan demand isn't what it was before. And so this is an obvious place for a lot of those deposits to go. The third channel for us, which we'll be launching early next year, is the pension buyout space. Think of it as the bulk annuity business where a plan sponsor wants to get rid of its pension plan or wants to get rid of maybe just the retiree component of their pension plan, but it's the same critical success factors. Do you have an investment edge? Do you understand how to manage longevity risk? It's just a great business. So we started 2020 with 1 distribution channel and grew when the market was shrinking. We're going to hit 2021 with 3 or 4 distinct distribution channels. So yes, I think we can easily double the top line or more in the next 4 or 5 years, and you will see that translate into AUM growth.

That's amazing for me. I think we can [indiscernible] get a better feel for how you guys get type of -- the accretion or synergies you guys have kind of talked to. But Tony, I don't know if you can -- you or Chris, if you could either one of you guys want to talk about our run back through which he went -- went through the last earnings call. I think it's about $70 million or $80 million of kind of adjusting net earnings out of F&G. What's wrong with doing the simple math and multiplying that by 4?

I don't think there's much wrong with multiplying that by 4 as long as you start with the right numbers. When we attempted to do this in the second quarter, frankly, we only had 1 month under our belt. And so there were some moving pieces, including purchase accounting, which, as we all know, it probably takes a year to lock down. And so intangible assets were moving around and amortization was and bond accretion was because we had to mark the bond portfolio to market and then accrete that back over the life of the bonds. And so we were dealing with the purchase accounting number that wasn't nailed down. So rolling forward. And that's why we, I don't know if guided is the right word, but certainly suggested that we might be in the high 70s on a quarterly basis in adjusted operating income, which is an after-tax number. Since then the third quarter after nailing down some of this stuff, the best way to look at it is $65 million was the historical run rate of after-tax earnings that F&G was generating. You add back $7 million because we retired the preferred shares that they had. And then you take off about $8 million in purchase accounting gets you roughly to the mid-60s, multiply that by 4, and that's kind of where you are with upside, and that upside is the growth that Chris talks about. If we're looking at maybe 10% portfolio growth at 100 basis points, you can do the math to see what you'd add on to that roughly $260 million, $270 million of annualized after-tax operating income.

Okay. And John, if you go back to that 1%, it fits fairly nicely, right, because you're starting there, you're growing, as Tony said, because of AUM. We're also growing because we did repricing last year that is now kicking into the portfolio because we did have the big onetime drop in interest rates on the floating rate book. So you aren't going to be too far off. We'll start the year with $27 billion or $28 billion of assets and growing. So if you do the average assets under management, you throw 1% on that, and you're just directionally pretty good. And obviously, our job is to hopefully, go out there and beat it.

Yes. See audience it's not that complicated. I think you guys just laid it out perfectly. That was great. Last question for me, just kind of tying all this back or tying in F&G to FNF and thinking about capital allocation. Investors, you're not getting -- it doesn't seem like you guys are looking at stock price. You don't get a hold on credit for F&G. It is driving a very real earnings and it's sustainable and sticky. I don't know if that led into some of the higher dividend, how you think about that driving a higher dividend over time. But talk to us about what F&G helps you do as far as buybacks, dividends and just capital allocation in general?

Yes. Well, I mean, the cash flow generation that we experienced in the third quarter was significant, and that was certainly the start of this discussion. We had used a lot of our free cash flow at the parent company to actually acquire F&G. So back in the second quarter, we didn't have much to talk about. In the third quarter, we generated that cash flow. So the Board, to your point, John, raised the dividend about 9%, and they typically look at the dividend in the fourth quarter. So I wasn't surprised by that. But -- so that's 1 use, and it uses about $400 million of annual cash flow to pay that dividend. We also announced a buyback of $500 million buyback over the course of the next 12 months. And that really is more about having the capital and also recognizing that where the stock price is, we feel like it's undervalued, oversold and feel like it's probably the best or certainly one of the top best uses of what we can do with that cash. Not to mention, we expect to generate strong cash flow in the fourth quarter, and nothing tells us that we won't have real strong cash flow generation as we work our way through 2021. So I think that right now, I mean there's probably M&A opportunities that come and go, whether they're in the title side, in the F&G side or maybe somewhere else. And we'll look at those as we always have. But right now, we've got plenty of capital to deploy toward shareholder-type returns like dividends and buybacks. And of course, our debt is in a great position because we were able to really extend out our debt at very low rates for 10 years. Just this year because the rates being so low. So that was attractive as well.

Yes. I mean I look at, of course, all of your business from the top to the bottom. I mean, commercial is the 1 area that has been weak, but it looks like it's kind of bouncing back pretty nicely that it seems like you're coming from a real position of strength. I've been surprised to see where the stocks are. I think you guys are too. So I'm glad you're acting on that, for sure. A lot of investors are probably doing the same way. So with that, that's all I've got, guys. I really appreciate your time. It's always a pleasure to speak with you, and we will talk with you soon.

Thanks, John. Great. Appreciate it.

Thank you.