First American Financial Corporation (NYSE:FAF) Q3 2023 Earnings Call Transcript

First American Financial Corporation (NYSE:FAF) Q3 2023 Earnings Call Transcript October 26, 2023

First American Financial Corporation beats earnings expectations. Reported EPS is $1.22, expectations were $1.09.

Operator: Greetings, and welcome to the First American Financial Corporation Third 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 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 or 201-612-7415 and enter the conference ID 13741673. We will now turn the call over to Craig Barberio, Vice President, Investor Relations to make an introductory statement.

Craig Barberio: Good morning, everyone and welcome to First American’s earnings conference call for the third 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 reflect or relate to 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 would now like to turn the call over to Ken DeGiorgio.

Ken DeGiorgio: Thank you, Craig. The rapid increase in interest rates to levels not seen in many years continues to produce challenging market conditions. With housing affordability currently at its lowest point in over three decades existing home sales this year have declined to the slowest annual pace since the global financial crisis. Moreover, sales volumes in the commercial market have reverted to pandemic low levels and are down approximately 50% from the peak year of 2021. Despite these historically difficult conditions, our continued focus on expense management and strong growth in net investment income enabled us to deliver a pre-tax title margin of 12% on an adjusted basis. On a consolidated basis, we generated adjusted earnings of $1.22 per diluted share.

Our residential purchase business continues to reflect these market headwinds, but appears to have stabilized at trough levels. For the first three weeks in October, open purchase orders are down 7% compared with September which is consistent with normal seasonality, but are up slightly compared with the prior year. While this performance is mostly driven by a historically low comparison period it also reflects the results of our industry-leading homebuilder division and is further indication that the market has stabilized. Refinance open orders remained at trough levels in the third quarter averaging 350 per day a level they have held all year. Given the current pool of mortgage loans outstanding and the outlook for interest rates it remains unlikely we will see a significant uplift in refinance in the foreseeable future.

Our commercial business revenue declined 39% compared with last year consistent with the first half of the year. Average revenue per order also declined again this quarter for the fifth consecutive quarter, which suggests that price discovery is well underway as the market corrects. Commercial open orders for the first three weeks of October are down 5% compared with last year and are down 3% sequentially. There is still a high degree of uncertainty concerning the commercial market. However, based on our market intelligence, we continue to expect higher commercial revenues in the fourth quarter which is consistent with the normal seasonal pattern. While our key purchase commercial and refinance markets appear to have troughed, we expect the difficult market conditions to persist well into next year.

Despite the uncertainty of the timing of a recovery in these markets, the strength of our business along with our financial discipline and strong balance sheet allow us to continue to invest for long-term growth, while returning capital to our shareholders. This quarter we raised our common stock dividend by 2% to an annual rate of $2.12 per share. We also repurchased $9 million of our shares in the third quarter and have accelerated our purchases in October already purchasing an additional $9 million of our common shares. In closing, given the importance of people to our business, I am pleased that First American has been named one of the best workplaces for women by Great Place to Work and Fortune Magazine for the eighth consecutive year.

This accomplishment is a tribute to our workforce approximately two-thirds of which are women. I’m proud that First American’s commitment to advancing the careers of women and our world-class culture enable us to achieve this recognition year after year. Now I’d like to turn the call over to Mark for more detailed discussion of our financial results.

Mark Seaton: Thank you Ken. This quarter we generated a loss of $0.02 per diluted share. Our adjusted earnings per share was $1.22. Our adjusted earnings exclude net investment losses of $164 million, primarily due to unrealized losses recognized in the venture portfolio and changes in the fair market value of equity securities, as well as purchase related intangible amortization of $10 million. As of September 30th, the book value of our venture portfolio totaled $301 million, which equates to approximately 7% of our equity and 2% of our total assets. Revenue in our title segment was $1.5 billion, down 19% compared with the same quarter of 2022. Commercial revenue was $160 million, a 39% decline over last year. Our average revenue per order for commercial transactions declined 15% this quarter to $10,763 due to a combination of fewer large transactions and lower valuations as prices in the commercial market reset.

Purchase revenue was down 15% during the quarter, driven by an 18% decrease in the number of orders closed, partially offset by a 3% increase in the average revenue per order. Refinance revenue declined 41% relative to last year due to the increase in mortgage rates. In the Agency business, revenue was $665 million down 27% from last year. Given the reporting lag in agent revenues of approximately one quarter these results reflect remittances related to Q2 economic activity. Our information and other revenues were $240 million, down 14% 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 35% increase relative to the prior year. The increase was primarily due to rising interest rates, which drove higher investment income from the company’s cash and investment portfolio, escrow balances and tax-deferred property exchange balances. The impact of higher interest rates was partially offset by lower average balances primarily in the company’s escrow and tax deferred exchange balances. 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 $127 million and our net operating revenue declined $253 million. The provision for policy losses and other claims was $35 million in the quarter or 3.0% of title premiums and escrow fees, down from the 4.0% loss provision rate in the prior year and down from the 3.5% loss provision rate in the first half of this year.

The 3.0% loss rate reflects an ultimate loss rate of 3.75% for the current year with a $9 million release for prior policy years. Over the last several quarters, we have highlighted the margin drag in the title segment related to three strategic initiatives: ServiceMac, Endpoint and instant decision for purchase transactions. This quarter these initiatives together generated a pre-tax loss of $12 million, impacting our pre-tax title margin by 110 basis points, an improvement from the 130 basis point drag in Q2, primarily driven by deep boarding fees received by ServiceMac. Pre-tax margin in the title segment was 10.5% or 12.0% on an adjusted basis. Total revenue in our home warranty business totaled $108 million, a 3% increase compared with last year.

Pre-tax income in home warranty was $9.4 million, up 124% from the prior year. The loss ratio in home warranty was 55%, down from 59% in 2022 driven by lower frequency and severity of claims. The effective tax rate for the quarter was 29.4% higher than our normalized rate of 24% due primarily to the mix of income between our insurance and non-insurance businesses since our insurance business generally pays state premium tax in lieu of income taxes. In the third quarter, we repurchased 161,000 shares for a total of $9 million at an average price of $57.87. So far in October we have ramped up our purchases buying 162,000 shares for $9 million at an average price of $52.90. Our debt-to-capital ratio as of September 30 was 29.7%. Excluding secured financings payable, our debt-to-capital ratio was 23.5%.

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

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Q&A Session

Operator: Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question comes from the line of John Campbell with Stephens. Please proceed with your question.

John Campbell: Hi guys. Good morning.

Ken DeGiorgio: Good morning.

Mark Seaton: Good morning, John.

John Campbell: Hey. I just want to I heard you correctly on the order commentary for October. You said that purchase is trending up year-over-year thus far in October?

Mark Seaton: Yeah. So purchases, it’s up slightly for the first three weeks in October very slightly. And a lot of it is driven, because included within the purchase transactions is resale which is most of them. And we also have New Homes and New Homes, is performing pretty well. So when you mix those two together yes we do have a slight increase in purchase which is again nice to see the lines cross here.

John Campbell: Yeah. Absolutely, I mean just given the backdrop of continued upward pressure on rates that’s a great outcome. New Home sales I think maybe a little bit less than 10% of the national mix. What does that look like for you guys a little bit higher?

Mark Seaton: It’s a little bit higher. Historically the long-term average is about 13% of our purchase orders are new home related. So far in October they’re 19% a little overweight. So that’s — our mix is a little bit higher than the average.

John Campbell: Okay. Thank you.

Ken DeGiorgio: I’d add to that John. I mean one thing to keep in mind we have an outsized share of the market in New Home which obviously is a good competitive advantage for us.

John Campbell: Yeah. Absolutely. And then last question here on the interest expense. That’s obviously been up a good bit the last two quarters. I wanted to get a better grip on that. I know that’s influenced by the bank deposits. So maybe if you could unpack that kind of you could decouple those two items just underlying interest expense versus the bank effect? And then how we should be thinking about the run rate of interest expense here just assuming that rates stay near current levels?

Mark Seaton: As a general statement, when you look at interest expense in our Corporate Segment it runs $12 million $13 million a quarter and that’s really primarily the interest expense that we pay on our bonds. We also have interest expense in our Title Segment. And that’s really driven by kind of the cost of funds in our banking operations, both at our bank First American Trust as well as our warehouse lending business pays interest expense too. So those are the two components that make up our — the $23.5 million of interest expense we had in the Title Segment this quarter.

John Campbell: Okay. That’s helpful. Thank you, guys.

Mark Seaton: Thanks, John.

Ken DeGiorgio: Thanks, John.

Operator: Our next question comes from the line of Soham Bhonsle with BTIG. Please proceed with your question.

Soham Bhonsle: Hey guys. Good morning. Hope, you are doing well.

Ken DeGiorgio: Good morning.

Soham Bhonsle: I guess the first one just on investment — on the interest income. Can you just Mark maybe update us on the year here? And then just maybe help us size what needs to be replaced from sort of the roll-off in ServiceMac? And how quickly you’d be able to sort of do that? Thanks.

Mark Seaton: Yeah. Thanks for the question Soham. So in terms of the year I mean we’re — obviously we’re three quarters done. When we look at Q4, we think based on what we’re seeing now investment income should dip a little bit in Q4 a few million — $5 million-ish let’s say plus or minus. And most of that is just driven by the fact that we did lose these Home Point loans which we’ve talked about for a couple of quarters. And in the last 30 days or so we’ve lost about $300 million of deposits related to that which was really earning let’s call it Fed funds. So that’s kind of the headwind that we’re going to see in the fourth quarter in terms of our investment income. I will say that about 75% of that though is going to be a reduction in interest expense in the title segment too. So it’s not all fall to the bottom-line, but about 25% of it will.