First American Financial Corp
NYSE:FAF
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First American Financial Corp
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Greetings, and welcome to 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 this call is being recorded and will be available for replay from the company investors' website and for a short time, by dialing 877-660-6853 or 201-612-7415, and entering the conference ID 13683867.
And now, I'll turn the call over to Craig Barberio, Vice President Investor Relations to make an introductory statement.
Good morning, everyone, and welcome to the First American Third Quarter 2018 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.
Risk and uncertainties exist that may cause results to differ materially from those set forth in these forward-looking statements. For more information on these risk and uncertainties, please refer to this morning's earning 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 financial measures, please refer to today's earnings release which is available on our website at www.firstam.com.
I will now turn the call over to Dennis Gilmore.
Thanks, Craig. Good morning and thank you for joining our call. I will review our third quarter results and then discuss our outlook. This quarter we posted earnings of $1.34 per share on revenues of $1.5 billion. At our title segment, purchase revenues were up 1% this quarter, driven by higher fee profiling. Revenues were up 5% our commercial business as we continue to experience healthy demand across the majority of our markets.
Refinance revenue dropped 23% during the quarter and now accounts for just 9% of our direct title revenue. Although rising rates continue to negatively impact our mortgage volumes, the increase in short term rates help drive our investment income up 61% relative to last year. The growth in investment income has had a material impact on our earnings throughout 2018, and this trend will continue as the Federal Reserve raises rates. Overall, our title segment posted a pretax margin of 14.6%.
Turning to our Specialty Insurance segment, revenues increased by 5% during the quarter and the segment posted a pretax margin of 5%. Our home warranty business continues to perform well with revenues up 8%. However, we experienced higher claims severity largely in-line with normal seasonal factors. The loss ratio for property and casualty business declined at this quarter due to lower claim frequency. Overall, the loss ratio for the Specialty Insurance segment was unchanged at 65%.
During the quarter, a number of factors reduced housing affordability contributing to a well-documented slowdown in the purchase market. In the third quarter, our purchase open orders declined 4%. For the first three weeks of October, this trend has continued with purchase orders down 5% compared to last year. In response, we continue to make the appropriate adjustments to our cost structure.
Heading into the fourth quarter, our commercial pipeline is strong and investment income will continue to rise as a result of the Federal Reserve September rate hike. Longer term, our continued focus on offered in efficiency combined with rising investment income and a healthy economy will enable us to maintain our strong financial performance. Given our unique assets and commitment to innovation, First American is well-positioned and remains focused on deploying capital in a manner that delivers long term value to our shareholders.
I'll now turn the call over to Mark for a more detailed review of our financial results.
Thank you, Dennis. In the Title Insurance and Services segment, direct premium and escrow fees were down 1% compared with last year. This decrease reflects the 14% decline in a number of direct title orders closed largely offset by a 15% increase in the average revenue per order. The average revenue per order increased to $2,667, primarily due to the increase in the average revenue per commercial owner, higher residential real estate values and a shift in the order mix to higher premium purchase and commercial transactions.
The average revenue per order from purchase transactions increased 6% while the average revenue per order for commercial transactions increased 10%. Agent premiums which are recorded on approximately one quarter lag related to direct premiums were down 2% largely driven by lower volume in California. The agent split was 78.9% of agent premiums.
Information and other revenues total $196 million, down 2% compared with last year. Declining revenues from lower mortgage origination and foreclosure activity were largely offset by revenues from recent acquisitions. Investment income within title the insurance and services segment was $61 million, up 61%.
Higher average balances and the increase in short term interest rates drove higher interest income in the company's investment portfolio and cash balances. Higher short term rate benefit our escrow deposits, offered in cash, tax deferred property exchange business at our bank where we held $4.8 billion in cash and debt securities as of September 30. We expect investment income to continue to grow on the fourth quarter, given the fed's September rate increase.
Personnel cost was $426 million, up 1% from the prior year. This increase was primarily driven by higher personnel cost associated with recent acquisitions and higher employee benefit cost which was significantly offset by a decline in incentive compensation.
Other operating expenses were $201 million, up 2% from last year. The increase was driven by a $5.7 million expense related to a legacy regulatory matter. The provision for title policy, losses and other claims was $46 million or 4.0% at title premiums and escrow fees, unchanged related to the prior year. The current quarter rate reflects an ultimate loss rate of 4.0% for the current policy year with no change in the loss reserve estimates for prior policy years.
Pretax income for the Title Insurance and Services segment was $207 million in the third quarter compared with $181 million in the third quarter of 2017. Pretax margin was 14.6% compared with 13.0% last year. Next expenses in the corporate segment were $17 million, a decline of $152 million due to an expense related to the completion of the company's pension plan termination in the third quarter of 2017. The effective tax rate for the quarter was 22.6%, in-line with our normalized tax rate of 24%.
Cash provided by operations was $231 million, up 4% compared with last year. Notice and contracts payable on our balance sheet totaled $735 million as of September 30, which consist of $547 million on senior notes, $160 million on our credit facility, $20 million of trustee notes and $8 million of other notes and obligations.
I would now like to turn the call back over to the operator to take your questions.
Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Jason Deleeuw with Piper Jaffray. Please proceed with your question.
Good morning and thanks for taking my questions. The title revenue was down but the margins were up and helped by the investment income. Can you just help us think about the margins going forward? Can we still get some expansion there even with the slower purchase order volume?
Jason, this is Dennis. We think our margin objective we set out to 11 to 13 is absolutely available for 2019. I think the purchase market is going to go through a little bit of a reset as it's happening right now, but to our benefit right now will be growth -- investment income growth in our commercial business. All in all, we think the range we've given is accurate. I think we're confident going in the 2019 right now.
Okay. Sounds good. And then the next one, just on the competitive strategy or how you're thinking about the next year if the Fidelity-Stewart acquisition is approved. Is there any change in your thinking competitively or anything that you would do differently if that transaction is approved?
No. We'll continue to do what we've been doing. We'll continue to actively recruit both direct employees and agents.
Got it. And then just the last one. The order volumes for First American there were a little bit softer than the industry trends. Is there any specific factor you can call out as to explain the difference?
Yes. I don't actually think that's accurate, by the way. I think we were following industry trends. We were down 4% in the quarter which is matching our -- and that continued by the way into the October time frame. So we're actually tracking industry trends. We're not losing shares. So I think when you're referencing the competitor, you probably should back out the acquisitions on that side.
Got it. Thanks for that and that's all I have. Thank you.
Thank you.
Thank you. Our next question comes from the line of Mark Hughes with SunTrust Robinson Humphrey. Please proceed with your question.
Yes. Thank you. Good morning. I just want to get your latest thoughts on shared buybacks, a little volatility in the market, strong balance sheet -- how you are looking at that these days.
Thanks for the question, Mark. It's something we're discussing. We're evaluating the buybacks relative to the other opportunities we have. We've got a real strong capital position and every day that passes, it just gets stronger and stronger. Given the recent sell off, buybacks are certainly more expensive now than they've been in some time.
And then I think you have suggested commercial pipeline is strong, anything, order flows, any other specifics here at the start of the fourth quarter?
No other than good third quarter and that strength going in the fourth quarter. So we've got a very strong pipeline going into the fourth quarter. We're also optimistic on commercial heading in the 2019. We're offered in the very strong economy and across almost all of our markets we've got strength.
Thank you very much.
Thank you.
Thanks Mark.
Thank you. Our next question comes from the line of Mark DeVries with Barclays. Please proceed with your question.
Yes. Staying with the commercial business. The ARPO there was up a fair amount year-over-year. Were you seeing a mixed shift towards larger transactions in the quarter and how does that mix for larger versus smaller look in your pipeline?
I wouldn't say we saw a shift in terms of huge deals, like the million-dollar plus premium deals. What we're seeing is we're just seeing a lot of just high quality assets straight at hand that our nationals go [indiscernible]. A lot of them have the multi-state portfolio deals we're doing. We're continuing to see a real broad base strength in commercial and we see the pipelines pretty strong heading into the fourth quarter here.
Okay. I think Dennis kind of answered this, but can you give us an update -- sorry if I missed this -- on where we stand, so far quarter-to-date on both the residential purchase and commercial order accounts?
Yes. Let me take the residential side. We were down 4% on the quarter on transactions on purchase orders. That term is going on, continuing into October. Right now, month-to-date, we got about 5%. So no real difference from the quarter. I think what's going on right now is the housing markets. The purchase market is really all just geared towards resetting, recalibrating and probably moving more towards the market to a dollar's market. I think we're looking for 2019 at home products depreciation starting to slow down, we anticipate inventory levels going up, probably time on market going up. Now, I think we're moving, probably going with a more balanced market, but when we go through that transition, we'll probably be choppy.
The other thing, too, just to make sure everybody is clear, we're optimistic going in the 2019. Let's not forget we're off into a very strong economy, we've got wage growth going on, we've got a very strong demographics happening that, too, are favor right now for housing. So while we're probably going through this resetting, we're optimistic going into 2019 especially with spring selling season.
Okay. And on the higher ARPO on the residential side, is that just all hump price, or you're also seeing a bit of a mixed shift towards states with just generally higher prices?
Mostly it's just rising housing prices. We think that over the next several quarters, we'll start to see our purchased ARPO fall a little bit simply because housing prices leveling up and the fact that when we had raised rates a year ago and start to assume that it's starting to lap, but we're still seeing positive purchase ARPO growth and it's primarily being driven by rising housing prices. Not really a mixed shift geographically.
Okay, got it. Thank you.
Thank you, Mark.
Thank you. Our next question comes from the line of Mackenzie Aron with Zelman & Associates. Please proceed with your questions.
Thanks. Question just on what we're seeing on the agent revenue side being a little bit weaker than the trend and the direct premium in escrows over the last few quarters. I know there were some changes in California a few quarters ago. I just wanted to dig in on what we're seeing there when those changes should be lapped.
It's happening right now. We were down $14 million and that's all California. So we continue to reprice California. There's also an agent with purchase from California that have impacted us, but we continue to de-emphasize California unless we can get the right price points. But I think that that trend will probably run itself on the course over the next quarter or two.
Okay, that's helpful. And then is there any update you can provide on just M&A opportunities that the agents are smaller or on the other side of the businesses in terms of the M&A pipeline as well?
Sure. We actually had quite a quarter. We were close on a few deals and we're actually built a part on with the market changing again using the term rebalancing. We just didn't think the prices were dollar at that point. We were ready to do the deal. Looking forward, I think we'll see better opportunities in 2019 as this market goes through this transition. We've got a lot of excess capital from that perspective and if the deal makes sense to us and it's the market we'd like to get inner, we'll be aggressive.
Thank you.
Thank you. Our next question comes from the line of John Campbell with Stephens Inc. Please proceed with your question.
Hey, guys. This is Carter Trent taking the place for John Campbell. Thank you for taking my questions. On the residential market, I know we're in a bit of a reset stage currently, but when do you expect to shift to buyer's market as far as timing next year? I know you don't have a crystal ball, but if you had to guess, do you think purchases lines will be down next year?
Hard to make the call right now. The 'resetting' is happening right now. So obviously the key part of the year flows will be the spring selling season and again, we're optimistic going into that time frame.
Right. Got it. That's all for me. Thanks.
Thank you. Our next question comes from the line of Bose George with KBW. Please proceed with your question.
Hey, guys. Good morning.
Good morning.
Going back to investment income, the math that you've given earlier, the $12 million of investment income to raise 25 basis point, is that still good especially as you have this one raise in September, maybe several next year? Can you just talk about how that works? Does it diminish as that moves forward? Thanks.
Well, when you look back over the last year, we've obviously gotten a lot more than $12 million for a few reasons. But going forward, every time the fed raises 25 basis points, probably more realistic number now is more like $15 million and the reason it's higher is just because our balances have risen. When we gave that $12 million number a year or so ago, we had a lot fewer balances than we do now, so it's more like $15 million assuming that our balances remain confident and we actually are able to get a 25 basis point increase on the deposit rates. I think $15 million is a more realistic run rate.
Okay, great. Thanks. And then actually just in terms of the cash balance, it looked like that went up meaningfully. Was there some consolidation on to the balance sheet and there was something else happening there?
It's really just the timing. We had some very large deposits that just carried over quarter end's large commercial transactions we were closing. So it looks like we have a lot of cash on the balance sheets which we did $2.2 billion as of September 30. That has come down even post quarters it really has to do with the timing of ins and outs.
Okay. And then just actually going back to the M&A question, just on the data side, are there things you're looking at that could complement what you've done in terms of those acquisitions?
There are. There are actually a couple of deals right now we're looking at in the pipeline. We'll see how they play out. We continue to look at data deals.
Okay. Great. Thank you.
Thank you.
[Operator Instructions] Our next question comes from the line of Geoffrey Dunn with Dowling & Partners. Please proceed with your question.
Thanks. Good morning. I wanted to follow up on the commercial question from before. It seems like a trend we've seen over several quarters. Has been maybe a bit of a slowdown in closing rates and very strong growth in the ARPO. I'm curious if there's just a general composition shift in the marketplace or something else going on. It's not unique to First American, but the growth really is being driven by these ARPO numbers versus the closing results. So if somebody can maybe expand on that a little bit from an industry standpoint if anything is really changing in commercial.
Geoff, just maybe to go a little bit deeper on there, we look at stratification of the size of deals that we close infomercial and when you look like the large deals we closed, we're getting $1 million a premium. That's a very large transaction. We had four of those this quarter. A year ago, we have five. So we're not really seeing growth as I mentioned earlier. What we are seeing though is when you look at deals in the $250,000 to $1 million range, this quarter we had 53 of those deals and a year ago it was 39. So we have seen an increase in like I said before, it's higher quality transactions. Not the mega-deals, but a higher frequency as the middle range deals that's driving ARPO a lot.
And what type of a deal is that $250,000 to $1 million type of range?
Just all kinds of commercial properties. I don't have a great answer for that, but I just said the mid-market continues to be really strong. We've seen softness in New York, which we have talked about, but a lot of other offices are doing strong. In terms of types of properties whether it's industrial, or hotels, or multi-family, again, we're seeing broadening pretty strength across all of that demographic.
All right. So this is really kind of mid-market to general?
Yes.
Okay. And then Dennis, I know you typically give this first three weeks of purchase, but assume the similar number overall for the first three weeks sequentially down mid-single digit for overall orders?
On purchase, yes, we're down 5%. So tracking last quarter.
But overall, probably a similar number you're resizing them to?
Resize, we're running about 800 a day, Geoff.
Geoff, we dropped from about 900 to 800 a day in the quarter. But again, it's kind of volatile right now. I would point out, that Geoff, we're on refinance. It's not less than 9% of our direct revenue. It's not a significant contributor of profitability.
That's why I kind of assume the overall number is probably similar to the purchase.
Obviously we hope it's stabilizing soon, but it is what it is.
All right. Thanks.
Thank you.
Thanks, Geoff.
Thank you. There are no additional questions at this time. That concludes this morning's call. We'd like to remind listeners that today's call will be available for replay on the company's website or by dialing 877-660-6853 or 201-612-7415 and enter the conference ID 13683867. The company would like to thank you for your participation. This conclude today's conference call. You may now disconnect.