First American Financial Corporation (FAF) Earnings Call Transcript & Summary

Greetings, and welcome to the First American Financial Corporation Fourth Quarter and Full Year 2020 Earnings Conference Call. [Operator Instructions] A copy of today's press release is available on First American's website at www.firstam.com/investor. Please note that the call is being recorded and will be available for replay from the company's investor website and for a short time by dialing (877) 660-6853 and or 201-612-7415 and by entering the conference ID 13714735. We will now turn the call over to raig Barberio, Vice President of Investor Relations to make an introductory statement.

Good morning, everyone, and welcome to our 2020 fourth quarter and year-end earnings conference call. Joining us today will be our Chief Executive Officer, Dennis Gilmore; 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. 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.firstam.com. I will now turn the call over to Dennis Gilmore.

Good morning, and thank you for joining our fourth quarter earnings call. 2020 was another strong year for First American. Our revenues were running well above the prior year and then the pandemic hit, impacting our business overnight. Our top priorities were to protect our people and serve our customers, and we achieved both. We quickly transitioned the majority of our employees to working from home have still closed over $1 million real estate transactions in 2020. This accomplishment testifies to the dedication of our people and their commitment to our customers. It also validates our many digital investments we have made to improve the customer experience. I'd now like to shift my comments to the fourth quarter results. We generated earnings per share of $2.49, excluding realized investment gains, earnings per share were $2.11. Revenues in our Title Insurance segment were up 26% in the fourth quarter, and we effectively managed our expenses, achieving a 53% success ratio contributed to a pretax margin of 18.9%. Our focus on automating Title production and digitizing the closing process paid off in 2020. And a year of rapidly surging volume, we closed 32% more orders this quarter than the prior year with just 6% more employees. Our direct purchase revenue rose 32% in the fourth quarter. We experienced an 18% increase in closed transactions and an 11% increase in the average rent or per order. This growth is a sign of the continued strength of the housing market. Refinance revenue continued to benefit from low mortgage rates, with revenue rising 79% over the prior year. Commercial rebounded strongly in the fourth quarter. Since the onset of the pandemic, commercial slow to recover than residential. Commercial revenue was down 39% in the second quarter, 29% in the third quarter, and the fourth quarter improved to a 5% decline of an all-time high fourth quarter of 2019. We are encouraged that the order momentum over the last few months has picked up, and we expect to have a strong commercial year in 2021. Turning to our Specialty Insurance segment. Revenues were $141 million, a 7% increase over the prior year. As we disclosed in January, our property and casualty business entered into a book transfer agreements, which provide qualifying agents and customers an opportunity to easily transfer their policies. As of February 1, we are no longer porting new policies and expect to discontinue policy renewals in May. We anticipate the transfer will be complete by the end of the third quarter of 2022. This transaction enables us to maintain focus on our core business and redeploy the capital to areas with higher expected returns. In the fourth quarter, we raised our quarterly dividend from $0.44 to $0.46, and we repurchased 1.3% of our shares outstanding at an average price of $49.20 and have continued our bind in 2021. We believe both the short-term and long-term prospects of First American are stronger than the market is giving us credit for and as a result of aggressively repurchased shares. Turning to our outlook. Early indications are that the real estate market will remain robust this year. The strong order pipeline we built in the fourth quarter is converting to revenue at what is traditionally our slowest period. In January, our purchase orders were up 17%, and we opened 3,200 refinanced transactions per day, continuing the same trend we experienced for the last several months. And as previously mentioned, we think this will be another good year for our commercial business. While we are encouraged by the strength of our markets, we remain focused on the long-term opportunities of our business. In 2021, we will continue to invest in automation of our Title production process and the refinement of our digital closing platform. We plan to increase our technology spend in the areas of product development, cloud migration and security, and we are building digital solutions across our company to transform the customer experience. An example of this is Endpoint, our Title escrow company that was built from the ground up to deliver a reimagined closing experience. We believe these investments will enable us to continue to generate strong earnings for the years to come. I'd now like to turn the call over to Mark for a deeper dive into our financials.

Thank you, Dennis. In the fourth quarter, we earned $2.49 per diluted share. This includes net realized investment gains totaling $56 million or $0.38 per diluted share. Excluding these gains, we earned $2.11 per share. In the Title Insurance & Services segment, direct premium and escrow fees were up 24% compared with last year. This growth reflects a 32% increase in the number of closed orders, partially offset by a 6% decline in the average revenue per order. The average revenue per order decreased to $2,500 due to a shift in the mix of direct Title orders to lower premium refence transactions. However, at the product level, we continue to see higher average revenue per order for all order types. The average revenue per order for purchase transactions increased 11%, refinance increased 3% and commercial increased 2%. Agent premiums, which are recorded on approximately a 1 quarter lag relative to direct premiums, were up 25%. The agent split was 79.1% of agent premiums. Information and other revenues totaled $282 million, up 39% compared with last year. A number of factors contributed to this growth including the growth in mortgage originations that led to higher demand for the company's Title information products and our acquisition of Docutech, which isn't included in the prior year results. Investment income with an Title Insurance & Services segment was $52 million, down 26%, primarily due to the impact of the decline in short-term interest rates on the investment portfolio and cash balances. Partially offset by higher interest income from the company's warehouse lending business. This quarter, our investment income benefited from a $4.4 million catch-up related to our warehouse lending business. On a go-forward basis, we expect investment income to be somewhere in the neighborhood of $45 million per quarter with short-term rates at current levels. Personnel costs were $515 million, up 14% from the prior year. This increase was primarily due to higher incentive compensation and salary expense and higher costs as a result of recent acquisitions. Other operating expenses were $300 million, up 34% from last year. The increase was primarily due to higher production-related costs as a result of the growth in order volume. The provision for Title policy losses and other claims was $81 million or 5.0% of Title premiums and escrow fees, an increase from a 4.0% loss provision rate in the prior year. To recap, we raised our loss provision rate in the first quarter of 2020 from 4% to 5% due to the extreme economic uncertainty in existing. Economic factors are a key variable in Title claims experience. And given the deterioration in some of those factors, we raised the loss provision rate. But the housing market and general economy have improved since then. By raising the loss provision rate of 100 basis points, we have added $52 million of additional IBNR reserves on our balance sheet. Yet our incurred claims in 2020 were $49 million below our internal expectations set at the beginning of 2020. Paid Title claims show a similar trend, with claims $30 million below our expectation. As always, we will monitor our claims experience and market conditions when evaluating our reserves and we'll evaluate it next in connection with our first quarter earnings report. Depreciation and amortization expense was $37 million in the fourth quarter, up 24% compared with the same period last year, primarily due to higher amortization of intangibles related to recent acquisitions. Pretax income for the Title Insurance & Services segment was $377 million in the fourth quarter compared with $284 million in the prior year. Pretax margin was a record 18.9% compared with 17.8% last year. Excluding the impact of net realized investment gains, pretax margin was 16.8%, equivalent to the prior year. In the Specialty Insurance segment, pretax income totaled $27 million. We recorded a benefit of $18.3 million related to a reversal of an impairment initially taken in the third quarter relating to our property and catastrophe business. In the third quarter, this accrual was taken, so the book value of our property and casualty business match the expected proceeds from the sale. We subsequently determined that a book transfer rather than a sale was a more attractive alternative. This decision required us to reverse this accrual and our property and casualty business is currently carried at tangible book value. The ultimate proceeds will earn into book transfer will be immaterial. Net expenses in the corporate segment were $22 million, up $4 million compared with last year, largely due to higher interest expense associated with our $450 million senior notes transaction, which closed in May. The effective tax rate for the quarter was 26.4%, higher than our normalized rate of 23% to 24%. The tax rate was adversely impacted by $7.4 million or $0.07 per diluted share due to a permanent tax difference related to the property and casualty business. I'd like to provide an update on matters arising from our 2019 information security incident. As previously disclosed, we received a well notice from the SEC in September 2020. We submitted our response in October and have had no substantive communications with the commission sense. We continue to believe that the SEC matter, along with all other matters relating to the security incident will be immaterial from a financial perspective. Finally, turning to capital management. 2020 was an active year for our balance sheet. We spent nearly $400 million on acquisitions, the largest of which being Docutech, which has been a great addition to our company. We also returned significant capital to our shareholders. We paid nearly $200 million in dividends and raised the dividend by 5% on 2 separate occasions during the year. Pursuant to 10b5-1 plans, we also repurchased $139 million in stock at an average price of $43.44 in 2020. We continued our repurchases under these plans early in 2021, deploying an additional $27 million at an average price of $52.97. During 2020, we also invested $83 million in venture investments in the Proptech Ecosystem, which gives us insight into high-growth technology companies, many of whom have become strategic partners. We believe our capital management activities have created value for shareholders, and we'll continue to hunt for opportunities with attractive risk-adjusted returns. I would now like to turn the call back over to the operator to take your questions.

[Operator Instructions] Our first question has come from the line of Mark DeVries at Barclays.

Was hoping you could discuss kind of the net earnings impact to you of exiting the P&C business, both in terms of the revenue lost. And in any offsets you may have from the redeployment of the capital that this frees up?

Yes. Thanks, Mark. So in 2020 our P&C revenue was about $138 million. And so we're sort of in a wind-down mode right now. We're not issuing any new policies or we stop quoting new policies as of February 1. It's going to take us roughly a year from the time we start non renewing, which will be sometime around May. So it's going to take a little bit over a year to wind it down. We'll lose about $138 million of revenue. But again, because of the losses and the loss rates in P&C, in 2020, even if you exclude the impairments that we took in terms of goodwill, we lost $31 million in 2020. So we think it's going to be earning accretive over time. We just have to finish winding it down here.

Yes. Let me just add on that, Mark, to be clear, the business has been at a loss for us. So it's a headwind, no question. That will continue for the first quarter, probably the second quarter. When we look for the P&L itself to improve pretty marketably by the third and the fourth of 2020.

Yes. And in the press release, you mentioned kind of freeing up capital. How material is that? And is that part of where the kind of the accretion comes from is being able to redeploy in more attractive uses?

Not really. It's -- the accretion comes from less losses, right? The business has been under pressure performing wise. And the capital, it's not a material amount to us, but we will ultimately redeploy back to the core.

Okay.

$70 million of tangible capital as of 12/31.

Okay. Great. And then I was happy to see the repurchases. It's obviously been a while since that was a meaningful part of your capital deployment strategy. Just curious as kind of what's changed and that's made that for you an attractive use of the excess capital?

Well, it's always been something that we've looked at. I think admittedly, we've been conservative with respect to the prices that we buy back shares. And we don't do it just because we have excess capital, we don't do it just to increase our earnings per share. We do it when we think it's going to be a really good investment for our shareholders. We saw those conditions happen in in March and April when we bought back shares, I mean, obviously, it was a big correction then, and we kind of knew that we were going to do better than the market was giving us credit for. And those same conditions existed in the fourth quarter, too. I mean, when we look at our outlook, we just felt like it's a lot more optimistic than, again, what the market was getting us credit for. I'll say that we're not in the market at this moment right now, but I think there's a general consensus that we want to be more aggressive in buybacks in the future than we've been in the past.

Yes. And Mark, and I'll just add, you mentioned capital deployment overall. Our strategy has been very consistent. But what's -- what we've added is a new component to it, and Mark mentioned it in the script, we deployed $80 million last year in venture investments. And over the last 2 years, we deployed $200 million in venture investments, 12 individual companies, and we'll continue to look for those opportunities going forward, too. That really give us 2 things, bring us closer to new gen customers and allow us to help. So part of also part of our innovation strategy. So that will also be part of our strategy going forward.

Our next question is comes from the line of Jack Masaka with SIG.

I guess the $64,000 question on the volumes, this refi resiliency. I think Mark, you called out early a year ago. Stronger for longer. And here we are 4Q numbers are strong. The January numbers look strong. Maybe dating myself a little bit. I remember back in the day when we have normal refi cycles, there would be a little bit of a spike when rates moved a little bit higher, I think, as you had fence centers come off the sidelines. The January and the late 4Q trends, is that reflecting some of the move 10 basis points of mortgage rate isn't that much. But -- or is that just core continued sort of backlog working its way through the system? And how do you think about in '21. I mean, obviously, purchase should be pretty good still and commercial should begin, but you had a good deal last go around about a year ago on refi. How do we think about -- how are you thinking about that now or the books.

This is Dennis. I'll start. We're optimistic going into '21. So you kind of mentioned really quick, purchase is going to be strong, we think, in '21. I'll probably get a question on commercial, but commercial, we're very optimistic going into refinance is always a harder 1 for us to forecast. But last year, we were anticipating about 3,000 orders per day, and we hit it pretty close, actually. In the fourth quarter, we were running at 2,900 orders today. January running at 3,200. So we think still the 3,000 a day is good. And I think it's going to stay there in the foreseeable future for a few reasons. Don't forget the lenders have all built a lot of capacity over '20 and they will deploy that capacity in '21, even if the spreads start to come in. And the other thing people should remember about us, too, I think it gets sometimes lost is even if we start to trend down and refinance and say later in '21 what's probably happening is the mortgage rates are starting to trend up, and we're going to get the benefit in our investment income. So it goes both ways. If refinances start to go down and investment income kind of recovers, we'll still be doing very well.

Okay. And then you had about an $80 million year-over-year growth rate in the information side. Obviously, Docutech one can you sort of size for us how much of the year-over-year growth in dollars was driven by Docutech versus volume growth versus growth in other products, you keep acquiring companies is there a way to sort of think of that $80 million in 3 different buckets and sort of how we think about modeling that on a go forward?

Yes. So of the $80 million, we had about $22 million of that growth was Docutech. So we had -- so for Docutech, we had $22 million in the fourth quarter of revenue, and we didn't own it a year ago, 0 a year ago. We've seen growth in our data and analytics business to the total of about $19 million year-over-year. We continue to sell data and information products to customers, and that's growing very nicely. We also have $15 million of growth in kind of our centralized mortgage business where we do a lot of post close activity. And then finally, I'll just point out, our international business was up about $10 million in terms of year-over-year growth in

Yes. And looking forward, this is Dennis, looking forward in '21, I think all those trends will continue. But I would like to highlight the data is really hitting its stride right now. For 2 issues. Number one, the data is really coming together for us, as we've talked about over the last few years for both internally for our own innovation efforts and our own automation efforts. And it's really moving forward fast on our opportunity to sell to our partners and our customers out in the field.

Our next question is come from the line of Bose George with KBW.

The commercial recovery year-over-year, obviously, is strong. Just curious, do you think there's some sort of a catch-up happening in that sector? Or just curious how you characterize what's going on because it looks like you're getting close to somewhat normalized levels there.

Yes, great question. I don't think it is a catch-up, and let me explain. We were down with 39% in the second quarter, commercial, 29% down in the third quarter. And then the fourth quarter rolls around, and we really gained momentum in November, December. The momentum's continued in January. We were only down 5% on revenue of the fourth of '19, which was a record quarter for us. And interesting enough, inside of those numbers, we were lagging still on large deals. And so it's broad-based, it's kind of, I call it, more the run of the mill kind of deals and I actually think we have the opportunity to see the large deals to start to kick back up in '21. So I mean, I'm not sure -- I know '21 will be a record year for us, but it will be a strong commercial year number, what I believe, second, I think also probably investors didn't appreciate through the whole cycle of 2020, we were meaningfully profitable to our commercial division in the whole year long.

Okay. Great. That's helpful. And then actually, just can you revisit normalized Title margins? You've given a range in the past, can you just talk about where you see that, whether anything in terms of what happened this year in your business mix, et cetera, and it changes up?

Yes. Those, I think, we don't give a guidance on that. But I think what people should understand is regardless of what the market brings to us, we're always going to strive to have incrementally improving margins year after year. And most of the time, we can achieve that. So looking at '21, I'm optimistic that we've got a strong purchase market. At least for the beginning part of the year, we think we'll have a strong refinance market, which I think will last a little longer than people think, and commercial is strong. We're seeing great leverage on the business right now, and we're seeing real benefits from our automation, from Title automation under digital closing, and we're seeing real strength in their data businesses. So we're going to -- what we're going to always do is look to have top tier performance, top quartile margin performance, but never expensive the long term. We're going to continue to invest in this business, as I mentioned in the script. So it's always going to be a balanced source, but we think it's going to be a good year in '21.

Our next questions come from the line of Mark Hughes with Truist Securities.

ARPO was quite good in the quarter. Could you comment on how much of that might have been mix versus in price appreciation?