First American Financial Corp
NYSE:FAF
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First American Financial Corp
Earnings Call Analysis
Q2-2024 Analysis
First American Financial Corp
First American Financial Corporation reported a stable performance in the second quarter of 2024, despite facing a challenging market environment. The company achieved earnings of $1.11 per diluted share and adjusted earnings of $1.27 per diluted share. Total revenue for the quarter was $1.6 billion, indicating a slight decline compared to the previous year. The overall adjusted pretax margin for the title segment was 11.9%, slightly down from 12.6% the previous year. Earnings were bolstered by a significant seasonal pickup in demand, although the spring selling season was somewhat disappointing due to high mortgage rates and elevated home prices suppressing buyer affordability.
In the title segment, revenue totaled $1.5 billion, experiencing a 1% decrease from the same period in 2023. Purchase revenue saw a 4% increase, driven by a rise in the revenue per order, while commercial revenue slightly declined by 1% to $177 million. The number of closed commercial orders dropped by 2%, yet the average revenue per commercial transaction increased by 1%. The refinance market continues to struggle with a 9% revenue decline due to mortgage rates hovering near 7%, deterring significant refinance activities. The Agency business saw a minimal 1% revenue drop to $616 million, reflecting a one-quarter lag in revenue reporting from agents.
Investment income for the quarter was $126 million, a $16 million decrease from last year, driven primarily by lower interest-bearing balances and higher interest income from warehouse lending. The provision for policy losses and other claims was $35 million, reflecting a lower 3% loss provision rate versus 3.5% the previous year. The Home Warranty segment maintained consistent revenue of $107 million and achieved a 15% increase in pretax income to $17 million. The segment's adjusted pretax margin improved to 15.2% from 12.9%, primarily due to reduced claim severity despite slightly increased claim frequency.
First American is leading in title data with advanced assets, launching a pilot called Sequoia in April to automate purchase transaction underwriting using comprehensive title data. This system aims to provide an insurable title decision for at least 50% of residential properties in the pilot areas, enhancing efficiency and customer service. Additionally, the company has developed the Endpoint platform, which automates the closing process for residential transactions. These initiatives are expected to improve operations and offer a competitive edge.
In the second quarter, First American repurchased 752,000 shares for $41 million, averaging $54.14 per share. The debt-to-capital ratio stood at 29.7% (22.5% excluding secured financings), showcasing a robust financial position. The guidance for revenue growth remains modest, with expectations to match title margins from 2023. The effective tax rate was consistent at 23.2%, aligning with a normalized rate of 24%.
The company's outlook acknowledges ongoing market uncertainty but maintains a cautious optimism. Open purchase orders were down by 3% in early July; however, refinance activities showed improvement, indicating potential growth if conditions stabilize. The commercial segment faces uncertainties yet could see a rebound in the seasonally strong fourth quarter. First American's strategic emphasis on direct-to-consumer channels in the Home Warranty business is expected to drive profitability over the long term. Overall, the company is poised to weather market fluctuations while focusing on efficiency and innovation across its operations.
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Greetings, and welcome to the First American Financial Corporation Second Quarter 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 or (201) 612-7415, and enter the conference ID 13747727.
We will now turn the call over to Craig Barberio, Vice President, Investor Relations, to make an introductory statement.
Good morning, everyone, and welcome to First American's earnings conference call for the second 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 also 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 yesterday's earnings release, which is available on our website at www.firstam.com. I will now turn the call over to Ken DeGiorgio.
Thank you, Craig. While market conditions remained challenging in the second quarter, benefited from the seasonal pickup in demand. Total revenue was $1.6 billion, and our adjusted earnings per diluted share were $1.27. Our title segment delivered an adjusted pretax margin of 11.9% this quarter compared with 12.6% last year. In the purchase market, despite early positive signs the spring selling season proved to be disappointing. Our closed orders were up less than 1% compared with last year as affordability issues, high mortgage rates, and elevated home prices suppressed demand.
Despite the muted transaction activity, tight inventory conditions led to home price appreciation, resulting in a 4% increase in our direct purchase revenue. Challenging conditions continue into the third quarter, with open purchase orders down 3% through the first three weeks of July. Closed refinance orders were down 5% in the second quarter. Refinance activity picked up as the quarter progressed. The double-digit open order growth we posted in June has so far accelerated in the first three weeks of July with open orders up 19%, but we are coming off a low base. with refinance accounting for less than 5% of direct revenue in the second quarter.
Our Commercial business is stable in the phase of continuing uncertainty in the market. Closed orders were down 2% in the second quarter. For the first three weeks of July, while open orders are up 4%, we expect the ongoing uncertainty to weigh on our Commercial business in the third quarter. We remain optimistic, however, that we will see a meaningful rebound in activity in the seasonally strong fourth quarter. Our Home Warranty segment again delivered strong results with an adjusted pretax margin of 15.2%, though our real estate channel is facing the same headwinds we are seeing in our Title Companies Purchase business, we are increasing our emphasis on the direct-to-consumer channel, which we expect to drive increased profitability over the long term. Turning to the progress we have made on our long-term strategic initiatives.
First American is the undisputed leader in title data with the most comprehensive, accurate and timely data assets in the industry. While for years, we've leveraged these data assets to automate underwriting of refinance transaction, we have had early success in our efforts to extend the competitive advantage of these assets to purchase transactions. In April, we successfully launched an ongoing pilot automated underwriting for purchase transactions, which is much more complex and heavily dependent on title data. This initiative, which we call Sequoia, was launched in Maricopa and Riverside counties with a goal of rendering an insurable title decision for at least 50% of residential properties. At Endpoint, we have successfully built a next-generation settlement platform that is bringing extensive automation to the closing process for residential transactions.
Going forward, we will focus on further enhancing this technology and deploying it in a broader organization. Over the long term, we expect that Sequoia, Endpoint, and other initiatives will enable us to service our customers faster and more efficiently than the competition. On our last earnings call, we indicated that we expect modest revenue growth this year which will enable us to achieve title margins similar to what we posted in 2023. After closing the books on the first half and looking at the order pipeline in July, while we maintain our perspective on our full year performance, our results will ultimately depend on the strength of a currently uncertain commercial market in the second half of the year, and in particular, the fourth quarter.
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 generated earnings of $1.11 per diluted share. Our adjusted earnings, which excludes the impact of net investment losses and purchase related amortization was $1.27 per diluted share. Turning to our Title segment. Revenue was $1.5 billion, down 1% compared with the same quarter of 2023. Purchase revenue was up 4% during the quarter, driven by a 4% increase in the average revenue per order. Commercial revenue was $177 million, a 1% decline over last year. Though our closed commercial orders fell 2%, the average revenue per order for commercial transactions increased 1%. Refinance revenue declined 9% 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 $616 million, down 1% from last year. Given the reporting lag in agent revenues of approximately one quarter, these results primarily reflect remittances related to Q1 economic activity. Information and other revenues were $241 million during the quarter, down 1% compared with 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 in direct premium and escrow fees.
Investment income was $126 million in the second quarter, down $16 million compared with the same quarter of last year. The decline was primarily driven by lower average interest-bearing escrow and tax-deferred property exchange balances partly offset by higher interest income from the company's warehouse lending business. The provision for policy losses and other claims was $35 million in the second quarter or 3.0% of title premiums and escrow fees, down from the 3.5% loss provision rate in the prior year.
The second quarter rate reflects an ultimate loss rate of 3.75% for the current policy year, and a net decrease of $9 million in the loss reserve estimate for prior policy years. Pretax margin in the Title segment was 11.7% or 11.9% on an adjusted basis excluding both net realized gains and purchase-related amortization. Total revenue in our Home Warranty business totaled $107 million, unchanged compared with last year. Pretax income in Home Warranty was $17 million, up 15% from the prior year. The loss ratio in Home Warranty was 46%, down from 49% in 2023 due to lower claim severity that was partially offset by higher claim frequency.
Adjusted pretax margin in the Home Warranty segment was 15.2%, up from 12.9% in 2023. The effective tax rate for the quarter was 23.2%, in line with our normalized tax rate of 24%. In the second quarter, we repurchased 752,000 shares for a total of $41 million at an average price of $54.14. Our debt-to-capital ratio as of June 30 was 29.7%. 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.
[Operator Instructions] And our first question comes from the line of Mark Hughes with Truist Securities.
The -- you talked about in the Warranty business, maybe a focus on the direct-to-consumer channel. What motivated that? What kind of impact could that have on profitability? Is that going to be kind of a upfront expense load. Curious about that.
Yes. Yes. Thanks for the question, Mark. I mean, A big part of what motivated is just looking to diversify the business, given the pressures that I had mentioned in my opening comments on the real estate channel. They're facing the real estate channel, which is selling home warranties in connection with purchase transactions is suffering the same headwinds we're seeing in our Title business. So there's -- there was an opportunity, and this has been ongoing for years, but there was an opportunity to pursue the direct-to-consumer channel, which -- it's obviously also a product of the fact that there's a lot of green space in the home warranty business. There's a lot of homes that aren't covered by home warranties, and one of the ways to capture that -- one of the best ways to capture that is with -- in the direct-to-consumer channel. And I think the implication of your question is right. There's an upfront investment associated with direct-to-consumer. It takes -- you need to get into the renewals to really start realizing the profitability of the DTC channel.
And then on the Sequoia initiative, what are the implications in terms of revenue per order, if you're successful there with instant decisioning. What does that mean in terms of the kind of the revenue opportunity going forward?
Well, Mark, I'll point out that as I mentioned in my comments, that we're -- this is at the pilot stage, very, very early. And we just rolled out the pilot in April. So it's very early to tell. But we think there will ultimately be real revenue opportunities associated with Sequoia because what -- the feedback we get from customers is they want things done, they want to know if there's a title issue faster, and we can tell them at Sequoia instantly. And we've proven that out so far, and again, what's piloted in Maricopa and Riverside counties. And then there will obviously also be efficiency gains if the pilot ultimately proves successful.
And then the Commercial, you expressed optimistic about the fourth quarter, but maybe hedged a little bit on 3Q. Did I hear that right? And what motivates that maybe a little more tempered view on 3Q.
Well, I mean we -- I look at 3Q is coming off of Q2. And as I mentioned, closed orders were down 2% and Q2 revenue was down. Yes, we did see open orders tick up in July in the first 3 weeks, 4%. But just based on what we're hearing and a little bit of the trend we saw in Q2, I think that you guys may be more optimistic than we are on Q3. but we are very optimistic on Q4. We saw in Q2, for example, a shift to refinance, which tells me that they're starting to work out some of the issues, particularly in office on loans that have been coming due. So that's a sign that things are starting to move a little bit. And we also saw increases in Q2, both year-over-year and sequentially in our average revenue per order, which we think is an indicator that price discovery is further along.
Our next question comes from the line of Mark DeVries with Deutsche Bank.
My first question is a follow-up on your last comments, Ken. On the optimism for the fourth quarter, are those last two factors, the main reason? Are there the conversations you're having that kind of make you optimistic about how with clients on how the end of the year is shaping up in terms of transaction size and velocity?
Yes. I mean it's a little bit of both. It's conversations. It's the factors I just described. I think it's an expectation that we might get some interest rate reductions, which I think are big. But I think the forward curve is anticipating three rate reductions before the end of the year. But of course, as I've said in the past, the forward curve is never accurate. But -- so it's a little bit of all of those things, and then obviously talking to our own people about what they're seeing in the pipeline and what their expectations are. But it's -- but listen, I'm getting weary of trying to predict what the commercial market is going to do because it is -- there's a lot of volatility and a lot of uncertainty, but we are optimistic.
Okay. Fair enough. And then, Mark, I was hoping to get an update from you on the efforts you talked about on the last call to defend your deposits, some of the migration that you're going away, whether that was through offering a little rate. Could you just give us an update on what happened over the last quarter?
Yes, sure. So first of all, our investment income came in line with our expectations. I mean we talked on the last call about how we expected $120 million to $125 million of investment income in the Title segment for the rest of the year, and we came in at the high end of that range, which is kind of right in line with where we saw it. At last quarter, we talked about how 30% of our escrow deposits, we don't capture any economics from for different reasons. And it's stabilized this quarter. So in Q1, that number was 30%. In Q2, it was 29%. So I mean it's stabilized, and our initiatives haven't even really kicked in yet. We just started to kicking them in July. And so the benefit that we got was really just market-driven this quarter and the initiatives that we have to defend these deposits and deploy more incentive for customers to use our own banker are just now starting to kick in. So we feel good that things have stabilized on that front.
Our next question comes from the line of Soham Bhonsle with BTIG.
Soham Bhonsle here. Just following up on that -- the last question, Mark, on NII, it sounds like in the back half -- I mean, I guess it sounds like you've put in some things in place in July. Should we then expect maybe interest income or any cost to go up there as you defend these deposits? And then what's the outlook for the back half year on NII?
So there's a few things going on. For the second half of the year, we think right now, it will be at the lower end of that range, somewhere around $120 million a quarter for Q3 and Q4. One of the -- and there's really two reasons for that. The first is we lost the last of our home point loans, our original home point loans on July 1. And with those home point loans came $300 million of deposits. So we no longer have any of the original home point loans, and there's $300 million of deposits that we were basically turning Fed funds [ rate ] at, that left our bank as of July 1.
So there'll be a few million dollar drag there on investment income for the third quarter. But there's going to be a corresponding reduction in interest expense, too. So in terms of pretax, it's really not going to have an effect. And then when we look to the fourth quarter, if we actually do get three rate cuts in September and November and December, December won't really matter much. But that will put a little bit of pressure on investment income, too. So when we look at it now, we still feel like we'll be $120 million a quarter for Q3 and Q4 because of those factors.
Okay. And then just back to title margins, I was hoping to maybe understand the cadence of margin progression from here in the back half? Because obviously, last year, you had the cybersecurity issue. And so we can't really use that as sort of the base for the fourth quarter. But if I look back to sort of the fourth quarter of 2022, you did a [ 10.9% ] on margin. And that was still in an environment where I think commercial volumes are pretty decent. So yes, any thoughts on cadence for margins in the back half would be helpful as well.
A lot of it's going to depend on what Ken talked about was just how strong is the commercial market. I would just say that in a typical year where we don't have significant refi activity, Q2 is the peak of our pretax margins, and we think that's going to be the case this year, too. So we expect our normal seasonal decline in title margins as we progress through the year. We think Q2 kind of hit the high water mark because there's not much refi out there. And again, ultimately, it will depend on how strong the commercial market is. But we feel like margins have sort of peaked in Q2 this year.
Okay. And then, Ken, just last one on Endpoint. I was hoping maybe you could share whether that's recent wins or any anecdotes from customers that have used the technology, that sort of helps illustrating the appetite for what you're sort of building here? And then should we think of Endpoint more as like 1 plus 1 equals 2? Or is there going to be any sort of cannibalization and call it, the regular way of doing title longer term?
Yes. I mean I'll say sort of generally, the customers that have experienced Endpoint have liked the platform and like the approach that Endpoint is taking. But keep in mind that it's a pretty small sort of direct revenue base with Endpoint. And the focus on Endpoint going forward, in addition to operating as a stand-alone businesses, as I mentioned, further enhancing the capabilities of Endpoint, but then deploying it in the broader organization. And we think that's where the real opportunity lies in making our broader organization more efficient.
And this is just not in the area we have talked about in the past mainly, what we call Jot, which is mobile notary management. but in the production side, the operations side of the broader title company. So I think it will make us more -- it promises to make us more efficient. So I see it as a 1 plus 1 equals 3 opportunity.
Our next question comes from the line of Bose George with KBW.
Actually, I don't know if you gave this already, but what was the margin impact from Instant Titling and Endpoint, and then from Sequoia? Should we think of any margin drag from that as that builds out?
Thanks for the question, Bose. Yes, so the margin drag for -- I mean, historically, we've reported sort of Endpoint and Sequoia [ bundled ] together. And that number was 140 basis points drag this quarter. So it was slightly better. I think it was 150 basis points last quarter. And I think that over time, it will continue to creep down.
Okay. And the 140 basis points, that was Endpoint and Instant Titling or is that with Sequoia in there or is that for Sequoia going forward?
So Sequoia is our instant decisioning for purchase transactions [ that's used for automating purchase transactions ].
Okay. Perfect. And then actually just switching over to investment income. When I look at just the breakout like just through your call report, I mean, it looks like the bank's contribution to investment income it looks like maybe about 1/4 of it is coming from the bank versus the rest that on your own balance sheet. Is there a way to think about how much of the investment income is from the bank versus not from the bank?
Yes. Give me one second here. So this quarter, we had $126 million of investment income and $44 million of that came from the bank. The rest is really -- the majority of it is just our investment portfolio from our insurance companies, both onshore and offshore. I mean, that's just our fixed income portfolio. And we also have investment income from our escrow deposits that are third-party banks, too. That's most of it.
Our next question comes from the line of Terry Ma with Barclays.
So I think you guided to a similar margin for full year '24 as full year '23. As we look at kind of revenue performance in the first half, it was kind of down [ 1%, 2% ]. So do you need to see a reacceleration in revenue growth in the back half to hit that margin guide? It sounds like you're a little less optimistic on Q3 but a little bit more optimistic on Q4. So just wondering how to think about that.
Yes. So for the margin guide that we've given in terms of margins similar to last year. We talked about having moderate or low single-digit revenue growth. So we'll need [ 2%-ish ] revenue growth to have margins similar to last year. That's what we -- that's our current expectation which would imply some acceleration in revenue in the second half relative to the first.
Okay. Got it. And then on the investment income of $126 million this quarter, it was a little bit above the high end. Was there anything episodic in there? I think you mentioned some contribution from the Warehouse Lending business. Do you expect that to continue for the rest of the year?
Yes. That's a good point. I mean, we were a little bit higher than our top end of the range because of the Warehouse Lending business that's growing and doing great, and we think that will continue. So yes, we're going to continue to have benefit from Warehouse Lending. And there wasn't anything that was really like onetime an investment income that caused us to be above the range. It was just really stronger performance from Warehouse Lending than we expected.
Got it. Okay. So the $120 million per quarter guide is mainly just an adjustment for home point coming out.
Home point is really the exclusive reason why investment income, we think will be down in Q3. And then in Q4, a little bit because of what's expected to be declines in the Fed funds rate.
Our next question comes from the line of John Campbell with Stephens Inc.
On the purchase orders, the open orders down 3% thus far in July. I'm curious about how that's kind of look week-to-week. Maybe if you start in mid-June, I'm just curious if it's been a kind of steady deceleration or if you had a notable drop down in June and then it's kind of held that level.
So when you look week-to-week, the first week in July, our purchase orders were down 7.5%. The second week, we were down 0.5%. And the third week, we were down 1.5%.
Okay. That's helpful. And then back to the investment income, Mark, in your earnings call, I think you called out the metric of like 30% or so of the deposits not earning interest. I don't know if you have this on hand, but any sense for what the investment income upside is if you're able to get that back kind of to the teens level that you had in the past?
I don't have that on me here, John. But what I'd say is that the investment income forecast that we've been talking about here, this $120 million, that assumes that 30% number which -- well it's really 29% here in the second quarter. That assumes that stays flat. So we don't expect that to change significantly until we have lower Fed funds rates, we can move that on the margins with some of these initiatives we're doing to provide more incentive. But if that 29%, 30% number falls, that's just upside to our guidance on investment income.
Okay. And then I guess maybe at the risk of oversimplifying it. On lower rates, it diminishes that competitive edge that some of your competitors have and the ability to offer a higher rate. Is that fair to say? .
That's right. For the -- if you're talking about for the [ banking of direct deposits], that's correct.
Okay. And then last one for me on the home point loans. Mark, I think you mentioned that basically everything rolled off July 1. You talked to the investment income impact, but is there another revenue impact? I'm thinking maybe something in info and other. And then if you can maybe also talk about to the offboarding fees, if there was anything sizable in the quarter?
There'll be some, I would just say, some de minimis impact to info and other because of the fees that we charge for servicing loans, you won't really see it because [ ServiceMac ] continues to grow. We continue to send new customers. You won't really see it because it's going to be immaterial. But there will be about a $3.5 million [ deboard ] onetime fee that we collected in July, which will hit Q3.
Our next question comes from the line of Mark Hughes of Truist Securities.
I wonder if we could just get kind of a regulatory update, the CFPB, the pilot project, that sort of thing? Any updated view you might have would be great.
Yes. Thanks for the question, Mark. There's probably not a lot of update, I think, from the last quarter. I mean, on the Title Waiver program, the Fannie, request for proposal is out. I think there's been a lot of push back on the -- from legislators, state attorneys general and the like. So I think there's a lot of political pressure coming down on Fannie's regulator, in particular. But I think it remains to be seen there. With the CFPB, their request for information on whether or not they should prohibit lenders from passing on the cost of title insurance. I mean that RFI is out.
Our trade group and other trade groups are responding. On that, I'll say our opinion is that probably bad for consumers. There have been a lot of push over the years to increase transparency and now this will decrease transparency to consumers. And I think it will probably increase cost to consumers, but it feels like the CFPB wants to push ahead. But at the end of the day, it's not going to necessarily be bad for us. In fact, it might actually be good for us. I mean, we have a strong centralized lender program that should enable us to perform well in the event that the CFPB goes in the direction, I think they want to go. So as always, we're watching these things carefully. And -- but it's evolving still.
And our next question comes from the line of Soham Bhonsle with BTIG.
Ken, just quickly on Home Warranty. It sounds like you're continuing to invest in that business, but I kind of want to understand the strategic rationale for holding it longer term. I think earlier this quarter, there was a pretty sizable acquisition in the space that looks like a pretty healthy multiple. And I know there's some differences between your business and theirs. But maybe just talk to us about what keeps you interested in the Home Warranty business and then maybe potential to put -- harvest some of that cash in the future, and maybe redeploy that into title or capital return if you guys sort of choose to do so.
Yes. Thanks for the question. I mean, clearly, Home Warranty is probably the furthest from our core Title and Settlement business, though I know it is a settlement business in connection with purchase transactions. But we like it. I think for a lot of the reasons that I mentioned in response to one of the earlier questions, I mean, the Home Warranty market is dramatically under penetrated. So we think there's a real opportunity to seize that market.
On the deal you mentioned, yes, I mean, there was -- it was a sizable multiple now for [ $210 million ]. But that company was primarily selling warranties into -- on new home on new home construction. It wasn't even really a risk-taking business. So it's hard to compare our home warranty company and what we would typically think of as home warranty companies with that business.
Thank you. There are no additional questions at this time. This concludes this morning's call. We'd like to remind listeners that today's call will be available for replay on company's website or by dialing (877) 660-6853 or (201) 612-7415, and enter the conference ID 13747727. The company would like to thank you for your participation, and this concludes today's conference call. You may now disconnect.