First American Financial Corporation (NYSE:FAF) Q1 2024 Earnings Call Transcript

First American Financial Corporation (NYSE:FAF) Q1 2024 Earnings Call Transcript April 25, 2024

First American Financial Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Greetings, and welcome to the First American Financial Corporation First 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. [Operator Instructions] A copy of today’s press release is available on First American’s website at www.firstam.com/investor. Please note that this call is being recorded and will be available for replay from the company’s investor website and for a short time by dialing 877-660-853 or 201-612-7415 and enter the conference ID 13745815. And we will now turn the call over to Craig Barberio, Vice President, Investor Relations to make an introductory statement.

Craig Barberio: Thank you, operator. Good morning, everyone and welcome to First American’s earnings conference call for the first quarter of 2024. 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 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 yesterday’s earnings release and the risk factors discussed on 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 risk and reconciliation to the most directly comparable GAAP financials please refer to yesterday’s earnings release which is available on our website at www.firstam.com. I will now turn the call over to Ken DeGiorgio.

Ken DeGiorgio: Thank you, Craig. Market conditions in the real estate and mortgage industries continued to be a challenge in the seasonally weak first quarter. Elevated mortgage rates and low albeit growing inventory levels have caused transaction volumes to remain near historically low levels. During this period, we’ve maintained our focus on managing operating expenses, while continuing to invest in long-term strategic initiatives such as expanding our title plant assets and building technology solutions to increase efficiency, reduce risk and enhance our customers’ experience. Although our financial results this quarter were a function of the tough mortgage origination market, we have recently started to see signs of a measured recovery.

In March, our open resale orders per day were up 5% and that positive trend has continued so far in April with open resale orders up 2%. Growth in our resale orders so far this year is the first positive change we’ve seen in this key market since June of 2021. We are also seeing improvement in our commercial business with open orders up 1% in the first quarter and we have seen further growth in April with open orders up 5%. Our home warranty segment had another strong quarter delivering a pre-tax margin of 19% and is positioned well for future growth. On our last earnings call, we stated that we expect modest revenue growth this year and that we can achieve title margins similar to what we posted in 2023. After closing the books on the first quarter and looking at the order pipeline in April, our expectations remain unchanged.

I’d like to take a moment to address the recent attention our industry has received from Washington D.C. This attention is the product of a broader effort, an effort at which all of us at First American wholeheartedly support to make the purchase of a home more affordable. The focus on our industry as part of this effort reveals however that as an industry we need to do a better job educating policymakers and other stakeholders about the critical role title insurance plays in protecting people’s investments in their homes which are the primary vehicle for wealth creation for a majority of Americans. This role includes not only paying claims when they arise, but also the extensive work we do to correct title defects before the transaction closes.

The cost of which is not reflected in our industry’s claims rate. This important curative work protects consumers and lenders, among others from hundreds of billions of dollars of title risk exposure per year. Moreover, title and settlement fees are among the smallest cost components over the life of a mortgage and as a result, are not a barrier to homeownership. The discussions in Washington are still in early stages, and we believe that ultimately, our industry will be successful in reaffirming the value of title insurance to policymakers. But irrespective, we are uniquely positioned to meet the demands of an evolving market because of our growing leadership in title data, which is fueled by our proprietary data extraction technology, our national closing at platform and deep distribution relationships, our extensive underwriting expertise, our commitment to and continued investment in cutting-edge technology such as Endpoint, our digital settlement platform and automated underwriting for purchase transactions and most importantly, our world-class workforce and culture which recently resulted in our recognition as one of the 100 best companies to work for by Great Place to Work and Fortune Magazine for the ninth consecutive year.

Though, we are the leader in the digital transformation of our industry, fundamentally, we are a people business, and it is the quality, talent and dedication of our people that ensure our company’s long-term success. Now, I’d like to turn the call over to Mark for a more detailed discussion of our financial results.

Mark Seaton: Thank you, Ken. This quarter, we generated earnings of $0.45 per diluted share. Our adjusted earnings per share, which excludes the impact of net investment gains and purchase related amortization was the same as our GAAP earnings at $0.45 per share as $0.07 of realized gains were offset by $0.07 of purchase-related amortization. Turning to our Title segment. Revenue was $1.3 billion, down 2% compared with the same quarter of 2023. Purchase revenue was up 2% during the quarter, driven by a 2% increase in the average revenue per order. Commercial revenue was $143 million, a 4% decline over last year. Though, our closed commercial orders fell 4%, the average revenue per order for commercial transactions increased 1%.

Refinance revenue declined 13% relative to last year. With mortgage rates hovering around 7%, they are still at levels materially above what is needed to generate a significant rise in refinance activity. In the Agency business, revenue was $564 million, down 5% from last year. Given the reporting lag in agent revenues of approximately one quarter, these results primarily reflect remittances related to Q4 economic activity. Our information and other revenues were $217 million, down 2% relative to last year. This decline was primarily due to an increase in the capture rate of title premiums from an affiliated title agent which caused a decline in information and other revenue and a comparable increase to direct premium and escrow fees. Investment income within the Title Insurance and Services segment was $117 million, down $8 million relative to the prior year due to lower average interest-bearing balances in the company’s escrow and tax-deferred property exchange business that were partly offset by higher interest income from the company’s warehouse lending business.

The provision for policy losses and other claims was $29 million in the first quarter or 3.0% of title premiums in escrow fees, down from the 3.5% loss provision rate in the prior year. The 3.0% loss rate reflects an ultimate loss rate of 3.75% for the current year with a $7 million release from prior policy years. Over the last several quarters, we have highlighted the margin drag in the title segment related to both endpoint and instant decisioning for purchase transactions. Together, these two strategic initiatives reduced our pretax margin in the title segment by 150 basis points this quarter. Pre-tax margin in the Title segment was 5.5% or 4.8% on an adjusted basis. These margins reflect a $6.2 million write-off of uncollectible balances impacting the margins by 50 basis points.

Total revenue in our home warranty business totaled $105 million, a 1% increase compared with last year. Pre-tax income in home warranty was $20 million, up 28% from the prior year. The loss ratio in home warranty was 42% down from 47% in 2023 driven by lower frequency and severity of claims. Adjusted pre-tax margin in the home warranty segment was 18.8%, up from 15.2% in 2023. The effective tax rate for the quarter was 19.9%, lower than our normalized rate of 24% due primarily to research and development tax credits recognized during the quarter. In the first quarter, we repurchased 58,600 shares for a total of $3.5 million at an average price of $59.37. Our debt-to-capital ratio as of March 31st was 30.3%. Excluding secured financings payable, our debt-to-capital ratio was 22.5%.

Now I would like to turn the call back over to the operator, to take your questions.

See also 30 Wealthiest People in India and Republican Congress Members and Insiders are Buying These 10 Stocks.

Q&A Session

Operator: Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] And the first question comes from the line of Bose George with KBW. Please proceed with your question.

Bose George: Hey everyone. Good morning. I wanted to first ask just about investment income. I mean Mark you noted the reduction year-over-year was lower escrow. And I think on 1031 balances. Can you just dig into some of the drivers of that?

Mark Seaton: Sure, Bose. So one of the things we’ve seen here as interest rates have risen is that, more of our customers are electing to earn interest on their escrow per deposits. We have two — I’m simplifying here, but we have two basic types of deposits savings deposits and checking deposits. And more of our customers are electing for savings deposits. And in itself that should really have an impact on our investment income, because one of the advantages that we have is we can monetize savings deposits when a lot of our peers can’t because of our bank. But the second dynamic that’s happening in addition to the shift to savings deposits is that more of those savings deposits are going to third-party banks, as opposed to our own bank First American Trust.

A lot of it is really the economic reasons, because third-party banks will pay a higher rate than First American Trust. And so if we have a higher mix of our deposits at third-party banks, we can earn interest on those. So when you look at the total mix of deposits that we don’t earn interest on today it’s 30%. A year ago, it was 18%. So that’s — that mix shift has been a little bit of a headwind for us for investment. And then the second factor of course is just the 1031 businesses volumes are lower today than they were a year ago.

Bose George: Yeah. Great. That’s helpful. And just to be clear, is it the commercial customers who have the ability to kind of direct that escrow versus residential? Or how does that work?

Mark Seaton: Everybody has the ability to do it, whether you’re a consumer, a large commercial client you have the ability to request a savings account, but typically commercial customers are the ones that really drive that trend.

Bose George: Okay. Great. And then just in terms of sort of expectations for that investment income line item for the remainder of the year, can you just talk about that?

Mark Seaton: Yeah. Sure. So — when we look out the next couple of quarters, we think our investment income in the title segment will be somewhere between $120 million and $125 million per quarter. We’ll probably be at the higher end of that range in Q2 and a little bit lower as the year goes on in that range. And that assumes a couple of things. One, just the normal seasonality of the business, typically Q1 is kind of a low point in terms of investment income just because escrow balances are lower there. The second thing is, we have — we talked about these home point balances. And we expect the home point balances to leave somewhere around Q2. So that assumes that home point balances will leave. That’s going to be about $20 million of annualized investment income.

And by the way it’s also going to be about $20 million of annualized interest expense. So it sort of washes on a net basis. But if you’re just looking at our investment income it will go down about $5 million a quarter once we lose those balances. And the third thing it assumes is just two Fed rate cuts. Now I know I was looking at this morning in markets assuming one Fed rate cut, but we had two Fed rate cuts at the end of the year. So when you mix that all together, we think we should be somewhere between 120 and 125 per quarter in the type of segment.

Bose George: Okay. Great. Thank you.

Mark Seaton: Thanks, Bose.

Operator: And the next question comes from the line of Terry Ma with Barclays. Please proceed with your question.

Terry Ma: Hey, thanks. Good morning. Can you maybe just speak at a high level about your confidence level in achieving the revenue growth and margin guide? It’s a pretty uncertain macro and interest rate outlook.

Ken DeGiorgio: Yes, Terry, thanks for the question. This is Ken. Yes, I mean, listen, we think that the challenging conditions will persist for the year, though we think 2024 will be slightly better. And I think we have a high degree of confidence in that. But again, I want to excite it’s slightly better. And we look at things like the commercial business while it was weak in the first quarter, we’re seeing open orders as we mentioned up 1% in the quarter, up 5% in April so far. In the commercial business our ARPO will have the typical seasonal decline, it is up 1% over the prior year, which suggests that maybe the price discovery has concluded or at least well along the way. And I noted that there was an article in the Wall Street Journal earlier this week about Blackstone things that commercial real estate is at bottom.

And obviously they have their finger on the pulse of the commercial real estate market. So that gives us some confidence on the purchase — on the commercial market. On the purchase market, affordability will continue to be a challenge with mortgage rates prices low supply. But we are seeing some green shoots there with, as I’ve mentioned open resale orders up 5% in March, and 2% so far in April. So, again, we’re pretty confident that the 2024 will be better than 2023, but it isn’t going to be meaningfully better.

Terry Ma: Got it. That’s helpful color. And then my second question just on the margin drag from Endpoint and instant decision. I think you said it was 150 basis points this quarter. I think you guys quoted 130 last quarter. So what drove the delta? And how should we think about that drag kind of evolving throughout the rest of the year?