First American Financial Corp
NYSE:FAF
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First American Financial Corp
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Greetings, and welcome to the First American Financial Corporation's 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 13711297.
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 third quarter of 2020. 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 facts. 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 due to the operational efficiency and performance of the company relative to earlier periods and relative to the company's competitors. For more information 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 will now turn the call over to Dennis Gilmore.
Good morning and thank you for joining our call. I'll start with a review of our third quarter results, provide perspective on the actions we are taking with our property and casualty business and discuss our outlook for the remainder of 2020. Mark will discuss our earnings in greater detail and provide an update on our company's capital position.
We delivered strong financial results in the third quarter. Revenues were $1.9 billion, up 15% and earnings per share of $1.62. Our pretax margin in our Title segment hit a record 19%. As volumes increased, we also kept our focus on cost efficiency, achieving a 40% success ratio, well ahead of our 60% target.
Purchase revenues were up 20% in the third quarter, driven by closed order growth and higher fee per file. Loan mortgage rates are driving substantial demand and given the limited inventory of houses for sale, price appreciation has been robust. Our pipeline is strong heading into the fourth quarter, as purchase open orders were up 14% in the third quarter and this trend continues in October.
Refinance revenues were up 92% in the third quarter, driven by strong growth in closed orders. Low rates continue to support elevated open orders, which were averaging 3,200 per day in the third quarter. So far in October, we are opening 2,800 orders per day.
Our commercial business revenues in the third quarter declined 29%, improving from the 39% decline of the second quarter. The overall commercial market continues its recovery with improvements varying by asset class. This quarter we started to see a return of large transactions. We are encouraged that our open orders improved throughout the third quarter, with orders down only 7% year-over-year. Commercial orders over the last six weeks are flat to last year.
Turning to our Specialty Insurance segment. We have initiated a process to sell the property and casualty business. While this business has performed well over the years, based on recent financial results we have decided to focus on our core business and redeploy our capital to areas with higher expected returns.
Our home warranty business delivered strong growth, improved retention rates and effective expense management throughout the quarter. The business continues to experience an increase in claim frequency, particularly in the appliance and funding trades, which we believe are attributable to the pandemic. Due in part to this trend, we are in the process of making policy changes and adjusting our pricing to offset cost pressure in the business. We expect the home warranty business to continue to generate strong margin performance this year.
Going into the fourth quarter we are optimistic that low rates and demographic tailwinds will continue to drive strong purchase and refinance activity. And as we have indicated throughout the year, we expect refinance volumes to remain elevated well into next year. While our improving commercial pipeline increases our optimism going forward, we do not anticipate the business will meet last year's record performance.
Throughout the third quarter we experienced elevated order volumes and the vast majority of our workforce continues to work remotely. Our performance has demonstrated the strength and flexibility of our business. And while the pandemic has greatly slowed major sectors of the economy, it has accelerated the digital innovation in our markets. Validating our strategy and the investments we've made over the past few years to secure our leadership position in data, title automation and digital closings.
I'd now like to turn the call over to Mark.
Thank you, Dennis. In the third quarter, we earned $1.62 per diluted share. This includes net realized investment gains totaling $45 million or $0.30 per diluted share and impairment on assets held for sale of $73 million or $0.49 per diluted share. Excluding these two items, we earned $1.80 per share.
In the Title Insurance and Services segment direct premium and escrow fees were up 12% compared with last year. This growth reflects a 30% increase in the number of closed orders, partially offset by a 13% decline in the average revenue per order. The average revenue per order decreased to $2,193 due to a shift in the mix of direct title orders to lower premium refinance transactions.
At a product level, we continue to see higher average revenue per order for purchase transactions, which increased 8% this quarter, as well as for refinance transactions, which increased 4%. The average revenue per order for commercial transactions declined 17% at the number of large transactions lagged the prior year.
Agent premiums, which are recorded on approximately a one quarter lag relative to direct premiums, were up 10%. The agent split was 79.3% of agent premiums. Information and other revenues totaled $283 million, up 38% compared with last year. A number of factors contributed to this growth, including the growth in mortgage originations that led to higher demand for the company's title information products and our acquisition of Docutech which isn't included in the prior year results. Additionally, we benefited from services provided to support a temporary pandemic-related government program in Canada.
Investment income within the Title Insurance and Services segment was $45 million down 38%, primarily due to the impact of the decline in short-term interest rates on the investment portfolio and cash balances. Personnel costs were $481 million up 8% from the prior year. This increase was primarily due to higher incentive compensation expense and salary expense, and higher costs as a result of recent acquisitions partially offset by lower employee benefit expense.
Other operating expenses were $251 million up 15% from last year. The increase was primarily due to higher production-related costs as a result of the growth in order volume. The provision for title policy losses and other claims was $70 million or 5.0% of title premiums and escrow fees, an increase from the 4.0% loss provision rate in the prior year.
Claims experience continued to be favorable relative to our expectations. Incurred title claims totaled $33 million in the third quarter, a 21% decline relative to 2019. To-date we have not seen an uptick in claims. Our intent is to maintain a 5% loss rate until, we have more visibility into how the current environment will affect our claims experience.
The depreciation and amortization expense was $36 million in the third quarter up $6 million or 21% compared with the same period last year, primarily, due to higher amortization of intangibles related to recent acquisitions.
Pre-tax income for the Title Insurance and Services segment was $337 million in the third quarter compared with $254 million in the prior year. Pre-tax margin was a record 19.0% compared with 16.5% last year. Excluding the impact of net realized investment gains, pre-tax margin was 17.1% this quarter compared with 16.4% last year.
As Dennis mentioned, we have initiated a plan to sell our property and casualty insurance business. For the first nine months of 2020, our property and casualty business recorded a pre-tax loss of $91.5 million. This amount includes two items: first, an impairment on assets held for sale of $73.3 million which was recorded this quarter and second a $5.6 million reserve strengthening recorded in the first half of 2020. The results of the property and casualty business will continue to be recorded in the Specialty Insurance segment until a sale is completed.
Net expenses in the corporate segment were $22 million up $3 million compared with last year, largely due to higher interest expense associated with our $450 million senior notes transaction, which closed in May. The effective tax rate for the quarter was 24.6% in line with our normalized tax rate.
Notes and contracts payable on our balance sheet totaled just over $1 billion as of September 30, which consists of $992 million of senior notes, $13 million of trustee notes and $6 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 conduction a question-and-answer session. [Operator Instructions] Thank you. Our first question is from John Campbell with Stephens Incorporated. Please proceed with your question.
Hey, guys. Good morning.
Good morning.
I just want to clarify a couple of things on the P&C business. So you guys are just selling -- I guess just P&C and not home warranty that's right?
That is correct, yes.
Okay. And then Mark, thanks for the earnings breakdown. But if you could maybe provide what the P&C revenue was over the last nine months?
Yes John. So year-to-date it's $101 million in revenue.
Okay. And I think you also said you're going to hold that in the specialty segment. You're not moving that to discontinued ops is that right?
Yes. We looked at that and it's just -- it's not material enough to move it to discontinued ops so it's just going to be recorded in Specialty Insurance just like it always has been. So we consummate a transaction.
Yes. John I'll just give you some additional detail. I mean, the results will stay in the specialty segment and we're looking to get the transaction completed by the first half of next year. So we'll give a further update at that point.
Okay. And then on the higher home warranty claims you guys highlighted the pandemic is maybe kind of influencing trends. How did you guys get to that conclusion? And I guess what is it about the pandemic? Is it just people at home more? Or just kind of more wear and tear on the home?
Exactly. It's kind of what we mentioned within the second quarter if I'm not mistaken and the business is doing really well. It's interest and our sales are really strong both consumer direct and our real estate channels. And I think John as you know a seasonally worst quarter our toughest quarter is always the third quarter. So no surprise there.
But inside the quarter we saw an uptick of our appliance trade, our clients' claims and our plumbing claims. And we can't draw a straight-line back to the pandemic, but it's just logical the way you relate about people are home more they're putting more stresses on our housing system. So we're going to take a look at some of our policies right there and do some price adjustments to make sure that our returns are appropriate for that business. But all in all that business is doing well. We think we'll have a very strong fourth quarter in 2021.
Okay. That's helpful. If I could squeeze in maybe one more on the P&C business. Any kind of rough estimate about the capital being released? Any kind of idea about proceeds and maybe what you would do with that?
Well, the carrying value on the book side of 9.30% was $50 million. So we're going through a process. And ultimately we don't know what the proceeds will be but the carrying value is $50 million right now.
John with regards to the process I mean the bottom-line here is this business has been a good business for over the years but it's been very volatile. It's a little drag on earnings over the last couple of years. And we're just going to redeploy back into more of our core business where we have a more consistent higher return profile.
Yes. Makes sense to me. Thank you, guys.
Thanks.
Our next question is from Bose George with KBW. Please proceed with your question.
Hey, guys. Good morning. Dennis you made a comment about the performance expectations for next year. Could you just repeat that? I wasn't sure if you're comparing it versus 2020 or 2019?
On -- in general or any specific segment?
The -- I think your comment was in general just -- I think it was just overall performance?
I just think we're optimistic actually going forward right now. It's been a super -- a really volatile year. But when we step back and look at things right now. Purchase is very strong. And I'll just give a little detail on purchase right now. We'll still come back into some of our seasonal patterns. But for example orders like in total that's 17% from a year ago. So we'll still see seasonality in the fourth and first quarter, but I'd say at an elevated lower volume. So, that's on purchase.
On refinance, we still think the 3,000 a day order volumes are good. We've got lenders building capacity. Spreads are still high. So, we think that's still a good number looking forward. And then probably the area where we're probably getting more optimistic faster than we may have thought even two quarters ago it's a commercial market. It's improving and a couple of things happened in the quarter that are interesting to us.
Over the last six weeks or so our order volumes were flat from a year ago. So that's very encouraging. While our revenue was down 29% the business is still very profitable businesses. So, it's a very strong business. And then inside the market we saw a return of some large deals. So, that's good.
We're seeing some more strength in segments right now as you probably would guess in commercial -- excuse me in warehouse or office buildings are starting to move. The weakness is still in hotels and some retail segments. But all in all, we're encouraged by commercial starting to heal faster than maybe we thought even two months ago.
Okay, great. Thanks a lot. And then -- actually just curious what your thoughts are on buybacks. Just in the stock -- earnings were great. The stock is down quite a bit. It's been lackluster for a little while. So, yes, just curious if you think that's a good use of capital here.
Yes, Bose this is Mark. Yes, I mean that's something that we're always looking at. We did feel like our earnings were strong. And one thing is too our earnings are higher than they were a year ago and yet our stock quite hasn't recovered not anywhere near what it was pre-pandemic. So, it's something that we're continually thinking about. I think we're taking a look at it right now. And it's just -- earnings are very strong and we're optimistic looking forward right now.
Okay, great. Thanks guys.
Our next question is from Jack Micenko with Susquehanna Financial Group. Please proceed with your question.
Good morning. I wanted to talk through revenue per order. Normally, you see a may step up 4Q from 3Q a lot of that is commercially driven. So, I'm thinking out loud here. You've got a purchase market that has kind of held in stronger than seasonally. Certainly, you've got the refi which is dilutive but you've also got the commercial market to come back and maybe there's sort of a catch-up dynamic at play here too as transactions maybe been postponed through the prior quarters.
Is it possible -- is what you're thinking from what you see today that the revenue per order that step-up could be abnormally higher sequentially than it maybe had been in prior years?
I would say -- when you look back historically we always have had a higher fee per file in Q4 because of the reasons you mentioned. Last year was up about $100 an order Q3 to Q4. It's hard to say but based on where we -- because a lot of it ultimately comes down to how strong commercial is going to be and that's something that's a little bit unknown.
But where we see now is we do think there's going to be a step-up like there always is. So we think fee per file will be higher in Q4. How much higher? It's just going to depend on the strength of the commercial market.
Okay. And then on the specialty loss ratio. I know that obviously the severity and the volatility from the P&C business is much, much greater. But if we were to sort of back out the P&C volatility, conceptually how should we think about that loss ratio with just home warranty on a go-forward basis?
The loss ratio for home warranty is very seasonal, right? So, we got a lot of claims in the summertime when air conditioners go out. We don't get many claims in the wintertime. Through the cycle on an annualized basis, typically we're somewhere in the 52% to 54% range somewhere in there. But obviously that's going to be higher or lower depending on the quarter. But annually it's about 52% to 54%.
Sure. And then you said you're putting in some changes -- policy changes besides price would that look like maybe like I don't know like a freeze period upfront or something before you can make a claim? Just curious to kind of some of the changes you're making to address the higher claims?
Sure. Yes. It's a multiple thing. You look at price, you look at coverage, you look at service fees, so you'll get a lot of different issues to make sure you're priced appropriate for the returns.
Okay, all right. Thank you.
Thank you.
Our next question is from Chad Key with Intrinsic Edge. Okay. Moving on to Mark Hughes with SunTrust. Please proceed with your question.
Yes. Thank you. Good morning. The 8% appreciation in residential ARPO and the purchase ARPO. Was that a mix shift or how much of that might have been just home price appreciation?
It was really -- the vast majority of it was home price appreciation. So, as you know Mark our future file that we report is really on our Directors and it's really our direct operations which are on the west -- mainly the western states. But like when you look at it first state California was our biggest state, we had a fee per file increase in California of 8%. I can go along the list Oregon, Washington, Arizona they were all plus or minus in that range. So, it's really just home price appreciation and not really a big shift in the mix.
And your agent premium was up 10%, a pretty strong number but is reported on a one quarter lag your direct was down 4% last quarter. Is that a mix shift? It seems pretty strong if I'm thinking about it properly.
Yes, I would just say that like most of the time the one quarter lag is a good proxy of four out of five quarters. So, this quarter it really won. So, you're right. We would have expected to have a lower agency growth based on what happened in Q2. But remittances came in. Refis are really strong. Commercial is really strong for agencies. So, there's -- it's not really a mix shift. I think it's just timing of remit is more than anything else.
Yes, it seemed like you closed more of the orders than you have historically it's hard to judge precisely. Any comments other than the obvious which is people are pretty committed to the refi and purchase at this time but anything on top of that?
Are you talking about the direct business or the agency business?
I'm talking about the direct business. Just that you seem to close a higher proportion of the open orders.
I would say, we're very busy and we're very efficient right now. So, I wouldn't go any deep in that. We're just -- we're doing a very good job. And the operation is running very efficiently.
Thank you.
Thank you.
[Operator Instructions] Our next question is from Mark DeVries with Barclays. Please proceed with your question.
Yeah. Thanks. I had a clarifying question, around commercial. I think as you alluded to obviously, you're already seeing a return of big deals. And I think that's reflected in the ARPO being up pretty materially in commercial. Are you continuing to see an increase in larger deal sizes in your pipeline, and should we expect that commercial ARPO to continue to drift higher, in the fourth quarter?
Yeah. Thanks for the question. Yes, we are. So kind of like I mentioned, we're starting to see the return of the large deals, you'll see the impact in the fourth quarter. I do want to caution that, we're not going to match fourth quarter 2019. That was a record quarter. But the market started to improve faster than we thought it would be even two quarters ago. So we're encouraged right now from what we're seeing in commercial.
Okay. But remind me what the normal lag is between opening and closing a commercial order? And is there anything in this environment that's like pushing that out at all?
No. I mean, I would say that the normal lag is similar to a purchase transaction roughly 55 days to 60 days. The one thing with commercial though, is it's a lot more -- there's a lot more dispersion around the mean right?
We can open an order we might not close it for a year, we can open we could close it two weeks later. So, it really is -- it doesn't follow the same open to close, as a purchase of refi we've got a lot of certainty. Commercials a lot more dispersed around the mean.
Okay. Got it. And just finally, as you alluded to in your prepared comments, the success ratio came in much better than your target. Should we expect a catch-up on that? Or is that -- does that reflect some expense discipline which should keep your success ratio below target for the near-term?
There's not going to be a catch-up. We're running -- just running very efficiently. The decisions we made by the way earlier in this year cannot layout and goes into the second quarter, which was not even a right decision it was a smart decision. We didn't have to hire anybody back.
And then, all the efforts we've been doing on title automation both in our data strategy and our digital closing strategies are all paying off right now. So, we're seeing the benefit in our operations right now.
Okay. Are you now running at closer to fuller capacity, such that if you see more volume you may need to at least be closer to that, 60% target to scale up?
I can't predict the future. But we're staffed accordingly right now. So we don't have any issues with that. We've augmented our staff role, slightly with some temps to deal with some of the volume searches. But we're feeling good about the business. We're feeling good about our position right now.
Got it. Thank you.
Thank you.
Our next question is from Mark Hughes with SunTrust. Please proceed with your question.
Yeah. The Canada revenue you referenced in the release, how much was that? And is that continuing into the fourth quarter here?
In the third quarter was $18 million. We're talking about the temporary revenue that we're getting from this Government's relief program that we're a subcontractor too. So, its $18 million in the third quarter and it really ends in October. So there'll be a little bit in the fourth quarter, but most of it will go away in Q4.
Thank you.
Our next question is from John Campbell with Stephens Incorporated. Please proceed with your question.
Hi guys. Thanks. Just a quick follow-up, we haven't -- obviously since the crisis we haven't talked much about the default business. I mean, obviously, for next year everybody's got a lot of concerns. You guys are raising reserves. I think Stuart is obviously raising reserves as well kind of anticipation of that.
But there's also the positive impact, I guess of default. But if you can maybe just kind of walk through the assets you have there now? What the revenue impacts have been with the moratorium? And maybe what that could look like next year, if default activity kind of picks up.
Yeah. Thanks John. So, we have a really good default business. And it serves as a great hedge for us right? As you mentioned before back, in the last financial crisis, the default business was like our highest profit center in the company, by a huge margin. As things have recovered here these last 10 years or so, the volumes have really fallen off. But it's great to be there in case things in foreclosures use by that.
So far this year, our default business is running at about $35 million of revenue or so year-to-date. And it's basically flat, versus last year. So we haven't seen a pickup in our really default activity. But again, we haven't seen a pickup in foreclosures too. So we do see that then our default business will start to come up.
Yeah. And John, it's Dennis. So just longer term, we were the first to move our reserve rate up, thinking that we would see uptick in default. And I still think that's a possibility going into 2021, as the moratoriums kind of roll off and the advances roll off. But countering that right now is the real strong appreciation going on the housing market. And I think as you know if people have equity in their house they're typically not going to let go for closure. So I think the equity situation is going to -- I'll say want any significant real increase in defaults at this stage right now.
Okay. That's helpful. And I think Dennis, I think we might have talked about this last quarter, but where are you guys right now as far as the -- where you're running reserves versus actually the estimate? And I think you said maybe over 10% you have to release, is that right?
That's correct. And I'll let Mark give the first part of that answer.
Yeah. So as of 9.30, we're about 5% over the actuary and again we still have -- we're not close to that 10% range, but we're in a very healthy reserve position right now.
Absolutely. Okay. Thank you guys.
Thank you.
Our next question is with Mark Hughes with SunTrust. Please proceed with your question.
Yes. Thanks for indulging me. If we think about the impact in the home warranty business from appliances and the plumbing, would it be fair to say that's kind of the 8 points you went from a loss ratio of 61 to 69. Is it fair to say that that represents the increased of frequency that you saw?
Yes. No that's definitely fair mark. The home warranty business which we talked about is really great. People are staying home. As Dennis mentioned, we're getting higher claims and that's really attributable to people staying at home more. So appliance deployment trade those are causing higher losses for us.
Okay. Thank you very much.
Thank you.
Thank you, Mark.
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 13711297. The company would like to thank you for your participation. This concludes today's conference call. You may now disconnect.