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

Greetings, and welcome to the Second Quarter 2023 First American Financial Corporation Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Craig Barberio, Vice President, Investor Relations. Please go ahead.

Good morning, and welcome to First American's Earnings Conference Call for the second quarter of 2023. Joining us today on the call will be our Chief Executive Officer, Ken DeGiorgio, 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 these 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 performance and performance of the company, operational efficiency, excuse me, 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 would now like to turn the call over to Ken DeGiorgio.

Thank you, Craig. We posted good results in the second quarter, given the continuing market headwinds, a seasonal uplift in our business, strong growth in net investment income and a continued focus on expense management enabled us to deliver a pretax title margin of 12.1% or 12.6% on an adjusted basis. On a consolidated basis, we earned $1.33 per diluted share or $1.35 on an adjusted basis. Demand in our residential purchase business continues to be pressured by affordability issues due to high mortgage rates, along with low inventory that has kept home prices elevated. The purchase market, however, appears to have stabilized, albeit at trough levels. For the first 3 weeks of July, we are seeing the typical seasonal decline in purchase orders with open orders down 1% compared with June. Refinance open orders remained at trough levels in the second quarter, averaging 350 per day. As I indicated on last quarter's call, the current pool of mortgage loans outstanding 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 commercial market, which began to deteriorate in the back half of 2022, appears to have stabilized. While commercial revenue was down 39% year-over-year, it was up 20% on a sequential basis, in line with the typical seasonal trend. Commercial open orders for the first 3 weeks of July were down 26%, consistent with what we experienced in the second quarter. There is still a high degree of uncertainty concerning the commercial market outlook. However, based on the feedback we are still getting from customers, we expect the transaction activity in the second half of the year will be better than the first, which is consistent with normal seasonal patterns. While our key purchase commercial and refinance markets appear to have troughed, the timing of a recovery in these markets remains unclear. Despite these challenging conditions, our financial discipline and strong balance sheet allow us to continue to invest in strategic initiatives for the long-term benefit of the company as well as return capital to our shareholders. We continue to make progress at Endpoint, our digital title and settlement company. Our initiative to develop instant title decisioning for purchase transactions remains on track for deployment in 2 markets early next year. We've also made substantial progress at ServiceMac, our subservicing business, which delivered strong revenue growth and its first quarterly profit. And since the market began to deteriorate at the beginning of last year, we have returned $811 million to our shareholders through share repurchases and dividends. In closing, I am proud that First American has been selected as 1 of just 100 companies to fast companies Best Workplaces for Innovators for 2023. We are the only company in our industry to have ever received this recognition. This accomplishment is a testament to our ongoing commitment to innovation and is a tribute to our people, who in addition to delivering best-in-class customer service enable us to lead the digital transformation of our industry. Now I'd like to turn the call over to Mark for a more detailed discussion of our financial results.

Thank you, Ken. This quarter, we earned $1.33 per diluted share or $1.35 on an adjusted basis. Beginning this quarter, we are defining adjusted earnings for the first time to make our results more comparable to our peers. Our adjusted earnings exclude net investment gains and losses, as well as purchase related intangible amortization. These adjustments will also apply to pretax margin. A reconciliation can be found in our press release. Revenue in our Title segment was $1.5 billion, down 25% compared with the same quarter of 2022. Commercial revenue was $178 million, a 39% decline over last year. Our average revenue per order for commercial transactions declined 12% this quarter to $11,600 due to a combination of lower valuations as prices in the commercial market reset and fewer large transactions. Purchase revenue was down 29% during the quarter, driven by a 30% decrease in the number of orders closed, partially offset by a 1% increase in the average revenue per order. Refinance revenue declined 59% relative to last year due to the increase in mortgage rates. In the Agency business, revenue was $625 million, down 33% from last year. Given the reporting lag in agent revenues of approximately 1 quarter, these results reflect remittances related to Q1 economic activity. Our information and other revenues were $244 million, down 20% relative to last year. This decline was the result of lower transaction levels across several business units driven by 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 $142 million, a 105% increase relative to the prior year. In the second quarter, we saw escrow balances increase due to normal seasonality of the business. We also continue to generate higher rates on our balances as the Federal Reserve has hiked 4x this year. 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 $200 million, and our net operating revenue declined $399 million. The provision for policy losses and other claims was $40 million in the second quarter or 3.5% of title premiums and escrow fees, down from the 4.0% loss provision rate in the prior year. The 3.5% loss rate reflects an ultimate loss rate of 3.8% for the current year with a $3 million release for prior policy years. 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 life cycle, adversely impact our financial results. We have discussed 3 initiatives: ServiceMac, Endpoint and instant decisioning for purchase transactions which together generated a pretax loss of $15 million this quarter, impacting our pretax title margin by 130 basis points, an improvement from the 150 basis point margin drag in Q1, primarily driven by profitability gains at ServiceMac, which generated a 10% pretax margin this quarter. Pretax margin in the title segment was 12.1% or 12.6% on an adjusted basis. Total revenue in our home warranty business totaled $106 million, a 4% increase compared with last year. Pretax income in home warranty was $14 million, up 61% from the prior year. The loss ratio in home warranty was 49%, down from 52% in 2022, driven by a lower frequency of claims, partially offset by higher claim severity. The effective tax rate for the quarter was 23.4%, lower than our normalized rate of 24% due primarily to the mix of income between our insurance and noninsurance businesses since our insurance business generally pays state premium taxes in lieu of income taxes. In the second quarter, we repurchased 273,000 shares for a total of $15 million at an average price of $56.04. Our debt-to-capital ratio as of June 30 was 29.2%. Excluding secured financings payable, our debt-to-capital ratio was 22.5%. In May, we entered into a new $900 million senior credit facility upsized from our prior $700 million facility. We currently have the entire amount available for liquidity. Now I would like to turn the call back over to the operator to take your questions.

[Operator Instructions] Our first question comes from Bose George with KBW.

First, I just wanted to ask about investment income. Can you give us an update on your expectations for investment income? And then can you remind me if there's something unusual in investment income in the second quarter?

Bose, thanks for the question. There's nothing really unusual in the second quarter. We've given different assumptions in the past for investment income. But at this point of the year, we're halfway down through the year. We've got a lot more visibility in terms of where balances are. And so in the Title segment, we should be somewhere between $550 million, $560 million of investment income for the full year. We'll have an increase in Q3, and then we're expecting a little bit of a decrease in Q4 just because of some balances that will run off related to ServiceMac, but we're looking at somewhere between $550 million, $560 million right now, full year.

Okay. Great. that's helpful. And then actually, with the sale of Home Point to Cooper, when that servicing -- if that does move over to Cooper, how much escrow could that move -- could you lose as that happens? And is there any sort of negative operating leverage while you sort of refill that ServiceMac?

Yes, thanks for the question. I mean we're anticipating that about 40% of the loans are going to offboard in September. And to get to the second part of your question on that, we're already making expense reductions associated with that. Now there's a healthy pipeline that we think will replace that. And -- but obviously, the time lines on those aren't quick, but there is a healthy pipeline. The remaining 60% they could -- they'll probably be there through the end of the year and could extend into next year. It's not exactly clear when the remaining 60% are going to come off. But we're hopeful they will at least be into the next year.

Okay. Great. And actually, can you remind me the interest income from the escrow at ServiceMac, does that come through corporate or is that in title?

It's in title. But most of it goes through our bank and our bank rolls up to our title segment. So it's in title .

Okay. So your guidance the number you gave sort of incorporates all the changes at ServiceMac as well?

It does, yet.

[Operator Instructions] Our next question comes from John Campbell with Stephens Inc.