First American Financial - Q2 2023
July 27, 2023
Transcript
Operator (participant)
Greetings, welcome to the Q2 2023 First American Financial Corporation 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. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Craig Barberio, Vice President, Investor Relations. Please go ahead.
Craig Barberio (VP of Investor Relations)
Good morning, and welcome to First American's earnings conference call for the Q2 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 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 these 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 performance and performance of the company. Operational efficiency, excuse me, 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 (CEO)
Thank you, Craig. We posted good results in the Q2, given the continuing market headwinds. A seasonal uplift in our business, strong growth in net investment income, and a continued focus on expense management enabled us to deliver a pretax title margin of 12.1%, or 12.6% on an adjusted basis. On a consolidated basis, we earned $1.33 per diluted share or $1.35 on an adjusted basis. Demand in our residential purchase business continues to be pressured by affordability issues due to high mortgage rates, along with low inventory that has kept home prices elevated. The purchase market, however, appears to have stabilized, albeit at trough levels. For the first three weeks of July, we are seeing the typical seasonal decline in purchase orders, with open orders down 1% compared with June.
Refinance open orders remained at trough levels in the Q2, averaging 350 per day. As I indicated on last quarter's call, the current pool of mortgage loans outstanding would need to see rates drop well below 5% to incentivize a significant uplift in refinance activity, which is highly unlikely in the near future. The commercial market, which began to deteriorate in the back half of 2022, appears to have stabilized. While commercial revenue was down 39% year-over-year, it was up 20% on a sequential basis, in line with the typical seasonal trend. Commercial open orders for the first three weeks of July were down 26%, consistent with what we experienced in the Q2. There is still a high degree of uncertainty concerning the commercial market outlook.
Based on the feedback we are still getting from customers, we expect that transaction activity in the H2 will be better than the first, which is consistent with normal seasonal patterns. Our key purchase, commercial, and refinance markets appear to have troughed, the timing of a recovery in these markets remains unclear. Despite these challenging conditions, our financial discipline and strong balance sheet allow us to continue to invest in strategic initiatives for the long-term benefit of the company, as well as return capital to our shareholders. We continue to make progress at Endpoint, our digital title and settlement company. Our initiative to develop instant title decisioning for purchase transactions remains on track for deployment in two markets early next year. We've also made substantial progress at ServiceMac, our sub-servicing business, which delivered strong revenue growth and its Q1 profit.
Since the market began to deteriorate at the beginning of last year, we have returned $811 million to our shareholders through share repurchases and dividends. In closing, I am proud that First American has been selected as one of just 100 companies to Fast Company's Best Workplaces for Innovators for 2023. We are the only company in our industry to have ever received this recognition. This accomplishment is a testament to our ongoing commitment to innovation and is a tribute to our people, who, in addition to delivering best-in-class customer service, enable us to lead the digital transformation of our industry. I'd like to turn the call over to Mark for a more detailed discussion of our financial results.
Mark Seaton (EVP and CFO)
Thank you, Ken. This quarter, we earned $1.33 per diluted share, or $1.35 on an adjusted basis. Beginning this quarter, we are defining adjusted earnings for the first time to make our results more comparable to our peers. Our adjusted earnings exclude net investment gains and losses, as well as purchase-related intangible amortization. These adjustments will also apply to pretax margin. A reconciliation can be found in our press release. Revenue in our title segment was $1.5 billion, down 25% compared with the same quarter of 2022. Commercial revenue was $178 million, a 39% decline over last year.
Our average revenue per order for commercial transactions declined 12% this quarter to $11,600 due to a combination of lower valuations as prices in the commercial market reset and fewer large transactions. Purchase revenue was down 29% during the quarter, driven by a 30% decrease in the number of orders closed, partially offset by a 1% increase in the average revenue per order. Refinance revenue declined 59% relative to last year due to the increase in mortgage rates. In the agency business, revenue was $625 million, down 33% from last year. Given the reporting lag in agent revenues of approximately Q1, these results reflect remittances related to Q1 economic activity. Our information and other revenues were $244 million, down 20% 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 105% increase relative to the prior year. In the Q2, we saw escrow balances increase due to normal seasonality of the business. We also continued to generate higher rates on our balances as the Federal Reserve has hiked four times this year. We continued to manage expenses given the decline in transaction activity. Our success ratio was 50%, meaning that our personnel and other operating expenses declined $200 million, and our net operating revenue declined $399 million.
The provision for policy losses and other claims was $40 million in the Q2, or 3.5% of title premiums and escrow fees, down from the 4.0% loss provision rate in the prior year. The 3.5% loss rate reflects an ultimate loss rate of 3.8% for the current year, with a $3 million release for prior policy years. As Ken highlighted, we continue to invest in businesses and innovation initiatives that we believe will positively contribute to our profitability in the long term, but at this point in their life cycle, adversely impact our financial results. We have discussed three initiatives, ServiceMac, Endpoint, and instant decisioning for purchase transactions, which together generated a pretax loss of $15 million this quarter, impacting our pretax title margin by 130 basis points.
An improvement from the 150 basis point margin drag in Q1, primarily driven by profitability gains at ServiceMac, which generated a 10% pretax margin this quarter. Pretax margin in the title segment was 12.1% or 12.6% on an adjusted basis. Total revenue in our home warranty business totaled $106 million, a 4% increase compared with last year. Pretax income in home warranty was $14 million, up 61% from the prior year. The loss ratio in home warranty was 49%, down from 52% in 2022, driven by a lower frequency of claims, partially offset by higher claim severity.
The effective tax rate for the quarter was 23.4%, lower 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 taxes in lieu of income taxes. In the Q2, we repurchased 273,000 shares for a total of $15 million at an average price of $56.04. Our debt-to-capital ratio as of June 30th was 29.2%. Excluding secured financings payable, our debt-to-capital ratio was 22.5%. In May, we entered into a new $900 million senior credit facility, upsized from our prior $700 million facility. We currently have the entire amount available for liquidity. Now, I would like to turn the call back over to the operator to take your questions.
Operator (participant)
Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we pull for questions. Our first question comes from Bose George with KBW. Please go ahead.
Bose George (Managing Director)
Hey, guys. Good morning. First, I just wanted to ask about investment income. Can you give us an update on your expectations for investment income? Can you remind me if there's something unusual in investment income, in the Q2?
Mark Seaton (EVP and CFO)
Hey, good morning, Bose. Thanks for the question. There's nothing really unusual in the Q2. You know, we've given different assumptions in the past for investment income. At this point in the year, you know, we're halfway done through the year. We've got a lot more visibility in terms of where balances are. In the title segment, we should be somewhere between, you know, $550 million-$560 million of investment income for the full year. We'll have an increase in Q3, you know, we're expecting a little bit of a decrease in Q4 just because of some balances that will run off related to ServiceMac. We're looking at somewhere between $515 million-$550 million right now, full year.
Bose George (Managing Director)
Okay, great. Great, thanks. That's helpful. Actually, with the sale of Home Point to Cooper, when that, you know, servicing, if that does move over to Cooper, you know, how much escrow could, you know, could you lose as that happens? Is there any sort of negative operating leverage, you know, while you sort of refill that at ServiceMac?
Ken DeGiorgio (CEO)
Hi, Bose, Yeah, thanks for the question. I mean, we know we're anticipating that about 40% of the loans are gonna off-board in September. To get to the second part of your question on that, we're already, you know, making expense reductions associated with that. Now, there's a healthy pipeline that we think will replace that. You know, obviously, the timelines on those, you know, aren't quick, but there is a healthy pipeline. The remaining 60%, they'll probably be there through the end of the year and could extend into next year. It's not exactly clear when the remaining 60% are gonna come off, but we're, you know, hopeful they'll at least be, you know, into the next year.
Bose George (Managing Director)
Okay, great. Actually, can you remind me the interest income from the escrow at ServiceMac, does that come through corporate or is that in, that is in Title?
Mark Seaton (EVP and CFO)
It's in Title. Yep.
Bose George (Managing Director)
In title.
Mark Seaton (EVP and CFO)
Most of it goes through our bank, and our bank rolls up to our Title segment, so it's in Title.
Bose George (Managing Director)
Okay. Your guidance, the number you gave, sort of, incorporates all the changes at ServiceMac as well?
Mark Seaton (EVP and CFO)
It does, yes.
Bose George (Managing Director)
Okay, great. Thank you.
Operator (participant)
As a reminder, if you would like to ask a question, please press star one on your telephone keypad. Our next question comes from John Campbell with Stephens Inc. Please go ahead.
John Campbell (Analyst)
Hey, guys. Good morning.
Mark Seaton (EVP and CFO)
Morning.
Ken DeGiorgio (CEO)
Morning.
John Campbell (Analyst)
Hey, congrats on a great quarter. I wanted to touch on the July order data again. I might have missed this, I think you said that the first three weeks, commercial order is down 26%, a little bit better, obviously, than Q2. Could you maybe rehash on purchase, refi, and other?
Mark Seaton (EVP and CFO)
For the first three weeks, we're looking at purchase, we're looking down 14% versus prior year. Refi, we're looking at about 340 orders a day, that's down 39% from last year.
John Campbell (Analyst)
Okay.
Mark Seaton (EVP and CFO)
Yeah.
John Campbell (Analyst)
Very helpful.
Ken DeGiorgio (CEO)
Yeah.
John Campbell (Analyst)
Yeah, go ahead, Ken.
Ken DeGiorgio (CEO)
No, that's it.
John Campbell (Analyst)
Okay, on the instant title decisioning for purchase, I feel like that's a side of the story that holds a lot of promise for you guys. I know it's very early stage. You guys are also, you know, tend to be very conservative in kind of how you roll that out. Maybe if you could give us some kind of early call-outs from the early round of pilots, and then, you know, what you might need to see to be comfortable and start to move that, you know, into a national expansion efforts. Also, what the initiative can do for your business over time? Is it more of a share gain, kind of, revenue driver, or is it a efficiency gain and margin driver?
Ken DeGiorgio (CEO)
Yeah, you know, I'll start on that, John. I mean, I think, you know, I think what we've seen from sort of our MVP effort. You know, we're confident that it's ready for rollout, as I've mentioned in my earlier comments for, you know, in to two counties at the beginning of next year. You're right, it is going to take some time, but I would anticipate, you know, that we will have, you know, a national rollout probably within the next two years. We'll continue to roll out markets, you know, as our development efforts progress. I think there's two aspects of the, you know, of the product that will drive results for it.
There will be efficiency gains, and again, the precise amount of that remains to be seen, but we'll certainly see some efficiency gains in the business. I think a big part of it is just the improvement in the customer experience, which we think ultimately will drive market share gains. Customers want to know early if there are title issues that are going to need to be resolved, and we're gonna be able to indicate to them initially, even before an order is placed, whether or not there's gonna be a title issue or whether or not we can issue a commitment.
John Campbell (Analyst)
Okay, great. Thanks for taking our questions, guys.
Mark Seaton (EVP and CFO)
Thanks, John.
Operator (participant)
If you would like to ask a question, please press star one on your telephone keypad. Next question comes from Soham Bhonsle with BTIG. Please go ahead.
Soham Bhonsle (VP and Senior Analyst)
Hey, good morning, guys. Thanks for taking the questions. Mark, I maybe want to just take a step back and think through, you know, title margin sensitivity here, more long term. Obviously, you have the investments that, you know, should moderate from here, and that should help margins. You know, as we think about volume sort of stabilizing and maybe even improving next year, how are you sort of thinking about the lift that you could see from that improvement? Clearly, you're able to write orders more efficiently today than in years past, that makes it sort of hard to look at, you know, the past as a precedent here. If you could just offer any sort of framework on how you're thinking about margins as, you know, volumes do end up improving here.
Mark Seaton (EVP and CFO)
Yeah, thanks for the question, Soham. Well, first of all, I'd say that for this year, you know, last quarter we talked about double-digit margins in Title this year, and we stand by that. I mean, we feel good about hitting that in a pretty tough economic environment. There's no question about that. When we look at 2024, we expect margins to improve on 2024. Even if volumes are flat, because we've got a few tailwinds. You pointed out the strategic investments, they're gonna be less of a drag next year. We also have, you know, efficiencies that we're ringing out of the business now that'll help us next year.
We'll also have, you know, depending on what the Fed does, at least some tailwind with investment income next year. Even in a flat, let's call it, origination market, we think we can improve margins. You know, the MBA has some pretty aggressive, you know, growth for mortgage originations. If that happens, we'll look really good. Even if we get half of that or a quarter of that growth, we should be even better. We feel like we'll definitely have margin expansion next year. The question is, well, just depends on how good the market is.
Soham Bhonsle (VP and Senior Analyst)
Got it. Okay. In the, in the second half here, just on success ratio, you know, obviously, seasonality-wise, volume should subside here, but is there any reason outside that, that your success ratios cannot sort of stay flattish? Any other items that we should be thinking about in the back half here?
Mark Seaton (EVP and CFO)
I mean, there's no extraordinary, you know, items to think about. For the H1, we've been at 50%, again, in our title segment, for the back half of the year, we think we'll be at around 50%. I mean, it could be, you know, plus or minus a little bit, 50% is what I would think for the second half therefore the full year as well.
Soham Bhonsle (VP and Senior Analyst)
Got it. If I could just squeeze one in. Ken, I just wanted to touch on commercial here for a second. It looks like, at least based on the ARPO, there was some mix shift, a little bit to the higher, you know, larger deals. As you look at your pipeline for the back half, I mean, what's sort of the mix looking like between small and large deals?
Ken DeGiorgio (CEO)
Well, I think, you know, I think we're anticipating, you know, particularly as you go into the, into the fourth quarter, we're probably anticipating to have, you know, some more large deals. I think on the ARPO going down, I think it's less about mix and more about price discovery, which we take as a good sign. Obviously, we don't like to see our ARPO go down. We like to see that the price discovery is going on because there's gonna that implies to us that once that's done, or completely done, there'll be a lot more transaction activity.
Soham Bhonsle (VP and Senior Analyst)
Got it. Thank you, guys.
Mark Seaton (EVP and CFO)
Thanks, Soham.
Operator (participant)
Since there are no further questions, this concludes today's teleconference. You may disconnect your line at this time. Thank you for your participation, and have a great day.
