First American Financial Corp Q4 FY2020 Earnings Call

Greetings, and welcome to the First American Financial Corporation Fourth Quarter and Full Year 2020 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. A copy of today's press release is available on First American's website. 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 entering the conference ID 13714735.

Good morning everyone, and welcome to our 2020 fourth quarter and year-end 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. Risks and uncertainties exist that may cause results to differ materially from those set forth in these forward-looking statements. For more information on these risks and uncertainties, please refer to this morning's earnings release and the risk factors discussed in our Form 10-K and subsequent SEC filings. Our presentation today contains certain non-GAAP financial measures that we believe provide additional insight into the operational efficiency and performance of the company relative to earlier periods and relative to the company's competitors. For more details on these non-GAAP financial measures including presentation with and reconciliation to the most directly comparable GAAP financials, please refer to this morning's earnings release, which is available on our website. I will now turn the call over to Dennis Gilmore.

Good morning and thank you for joining our fourth quarter earnings call. 2020 was another strong year for First American. Our revenues were running well above the prior year and then the pandemic hit, impacting our business overnight. Our top priorities were to protect our people and serve our customers, and we achieved both. We quickly transitioned the majority of our employees to working from home and still closed over one million real estate transactions in 2020. This accomplishment testifies to the dedication of our people and their commitment to our customers. This also validates our many digital investments we have made to improve the customer experience. I'd now like to shift my comments to the fourth quarter results. We generated earnings per share of $2.49. Excluding realized investment gains, earnings per share were $2.11. Revenues in our Title Insurance segment were up 26% in the fourth quarter and we effectively managed our expenses, achieving a 53% success ratio, which contributed to a pretax margin of 18.9%. Our focus on automating title production and digitizing the closing process paid off in 2020. In a year of rapidly surging volume, we closed 32% more orders this quarter than the prior year with just 6% more employees.

Thank you, Dennis. In the fourth quarter we earned $2.49 per diluted share. This includes net realized investment gains totaling $56 million or $0.38 per diluted share. Excluding these gains we earned $2.11 per share. In the Title Insurance and Services segment direct premium and escrow fees were up 24% compared with last year. This growth reflects a 32% increase in the number of closed orders, partially offset by a 6% decline in the average revenue per order. The average revenue per order decreased to $2,500 due to a shift in the mix of direct title orders to lower premium refinance transactions. However, at the product level, we continue to see higher average revenue per order for all order types. The average revenue per order for purchase transactions increased 11%, refinance increased 3% and commercial increased 2%. Agent premiums which are recorded on approximately a one-quarter lag relative to direct premiums were up 25%. The agent split was 79.1% of agent premiums. Information and other revenues totaled $282 million, up 39% 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. Investment income within Title Insurance and Services segment was $52 million, down 26%, primarily due to the impact of the decline in short-term interest rates on the investment portfolio and cash balances, partially offset by higher interest income from the company's warehouse lending business. This quarter our investment income benefited from a $4.4 million catch-up related to our warehouse lending business. On a go-forward basis, we expect investment income to be somewhere in the neighborhood of $45 million per quarter with short-term rates at current levels. Personnel costs were $515 million, up 14% from the prior year. This increase was primarily due to higher incentive compensation and salary expense and higher costs as a result of recent acquisitions. Other operating expenses were $300 million, up 34% 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 $81 million or 5.0% of title premiums and escrow fees, an increase from a 4.0% loss provision rate in the prior year.

Yes. Thank you. I was hoping you could discuss the net earnings impact of exiting the P&C business both in terms of the revenue lost and any offsets you may have from the redeployment of the capital that this frees up.

Yes. Thanks, Mark. So, in 2020, our P&C revenue was $138 million. And so, we're sort of in a wind-down mode right now. We're not issuing any new policies or we stopped quoting new policies as of February 1. It's going to take us roughly a year from the time we start non-renewing, which will be sometime around May. So it's going to take a little bit over a year to wind it down. We'll lose about $138 million of revenue. But again, because of the losses and the loss rates in P&C, in 2020, even if you exclude the impairments that we took in terms of goodwill, we lost $31 million in 2020. So we think it's going to be earning accretive over time. We just have to finish winding it down here.

Yes. Let me just add on that Mark to be clear. The business has been a loss for us. So it's a headwind, no question. That will continue for the first quarter, probably the second quarter. We look for the P&L itself to improve markedly by the third and the fourth quarters of 2020.

Okay. Yes. And in the press release, you mentioned freeing up capital. How material is that? And is that part of where the kind of the accretion comes from is being able to redeploy in more attractive uses?

Not really. The accretion comes from fewer losses, right? The business has been under pressure performance-wise. And the capital, it's not a material amount to us, but we will ultimately redeploy back to the core.

$70 million of tangible capital as of 12/31.

Okay, great. And then I was happy to see the repurchases. It's obviously been a while since that was a meaningful part of your capital deployment strategy. Just curious as to what's changed that's made that for you an attractive use of the excess capital?

Well, it's always been something that we've looked at. I think admittedly, we've been conservative with respect to the prices that we buy back shares. I mean, we don't do it just because we have excess capital. We don't do it just to increase our earnings per share. We do it when we think it's going to be a really good investment for our shareholders. We saw those conditions happen in March and April, when we bought back shares. I mean, it was a big correction then, and we kind of knew that we were going to do better than what the market was giving us credit for. And those same conditions existed in the fourth quarter too. I mean when we look at our outlook, we just felt like it's a lot more optimistic than again, what the market was giving us credit for. I'll say that we're not in the market at this moment right now but I think there's a general consensus that we want to be more aggressive with buybacks in the future than we've been in the past.

Yes, I'll add to what Mark mentioned about capital deployment. Our strategy has remained consistent, but we have introduced a new element. Last year, we invested $80 million in venture investments. Over the past two years, we have invested $200 million across 12 different companies, and we will continue seeking such opportunities in the future. This approach not only connects us with emerging customers but also supports our innovation strategy, which will remain a key focus moving forward.

Okay, got it. Thank you.

Thanks, Mark.

Thank you. Our next question comes from the line of Jack Micenko with SIG. Please proceed with your questions.

Hi. Good morning, everyone. The key question regarding the volumes and this refi resilience is significant. Mark, you mentioned a year ago that we should expect stronger results for a longer period. Now we are seeing strong numbers for the fourth quarter, and January also looks promising. I might be showing my age a bit, but I recall when we had typical refi cycles; there was typically a slight increase when rates went up a little, often due to some fence sitters jumping back in. Are the trends we are seeing in January and late fourth quarter indicative of such a shift? A 10 basis point change in mortgage rates isn't substantial, so is this merely the ongoing backlog working through the system? How do you view 2021? Obviously, purchases should remain strong and commercial should do well, but you had a solid performance around this time last year related to refi. What are your thoughts on that and the current situation in January?

This is Dennis. I'll start. We're optimistic going into 2021. So you kind of mentioned really quick purchase is going to be strong we think in 2021. I'll probably get a question on commercial, but commercial we're very optimistic going into 2021. Refinance is always a harder one for us to forecast. But last year we were anticipating about 3,000 orders per day. We hit it pretty close actually. In the fourth quarter we were running at 2,900 orders per day. January we're running at 3,200. So we think still the 3,000 a day is good. And I think it's going to stay in the foreseeable future for a few reasons. Don't forget the lenders have all built a lot of capacity over 2020 and they will deploy that capacity in 2021 even if the spreads start to come in. And the other thing people should remember about us too, I think it gets sometimes lost is even if we start to trend down and refinance, and say it later in 2021, what's probably happening is the mortgage rates are starting to trend up and we're going to get the benefit in our investment income. So it goes both ways. If refinance starts to go down and investment income kind of recovers, we'll still be doing very well.

Okay. Thanks a lot. And then you had about an $80 million year-over-year growth rate in the information side. Obviously, Docutech's in there. Can you sort of size for us how much of the year-over-year growth in dollars was driven by Docutech versus volume growth versus growth in other products? You keep acquiring companies. Is there a way to sort of think of that $80 million in three different buckets and sort of how we think about modeling that on a go-forward?

Yes. So of the $80 million, we had about $22 million of that growth was Docutech. So for Docutech we had $22 million in the fourth quarter of revenue and we didn't own it a year ago. So zero a year ago. We've seen growth in our data and analytics business to the tune of about $19 million year-over-year. We continue to sell data and information products to customers and that's growing very nicely. We also have $15 million of growth in kind of our centralized mortgage business where we do a lot of post-close activity. And then finally, I'll just point out our international business was up about $10 million in terms of year-over-year growth in data.

Yes, this is Dennis. Looking ahead to 2021, I believe all those trends will persist. I want to emphasize that our data is truly gaining momentum right now for two reasons: first, it is coming together for us as we've discussed over the past few years, benefiting both our internal innovation and automation efforts. Additionally, it is progressing rapidly in terms of our ability to sell to partners and customers in the field.

All right. Thank you.

Thank you.

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.

The commercial recovery year-over-year obviously is strong. Just curious do you think there's some sort of a catch-up happening in that sector? Or just curious how you would characterize what's going on, because it looks like you're getting close to somewhat normalized levels there.

Yes, that's a great question. I don't believe it's a catch-up, and let me explain. We experienced a decline of 39% in commercial during the second quarter and a 29% decline in the third quarter. However, in the fourth quarter, we really picked up momentum in November and December, and that momentum has continued into January. We were only down 5% in revenue compared to the fourth quarter of 2019, which was a record quarter for us. Interestingly, even within those numbers, we were still lagging on large deals. Overall, it's a broad-based recovery; I would describe it as typical deals. I truly believe we have an opportunity to see large deals start to come back in 2021. While I doubt that 2021 will be a record year for us, I do think it will be a strong commercial year. Additionally, investors may not have recognized that throughout the entire cycle of 2020, our commercial division was significantly profitable all year long.

Okay, great. That's helpful. Thanks. And then actually just can you revisit normalized title margins. You've given a range in the past, can you just talk about where you see that, whether anything in terms of what's happened this year your business mix, etc., kind of changes that?

Yes, we do not provide guidance on that. However, it’s important to note that no matter what the market presents us with, we will always aim for year-over-year improvements in our margins, and we are typically able to achieve that. As we look ahead to 2021, I am optimistic about a strong purchase market. At least at the start of the year, we expect a solid refinance market that may last longer than anticipated. The commercial segment is performing well, and we are benefiting significantly from our automation efforts in title processing and digital closing, alongside strong performance in our data businesses. Our goal will always be to maintain top-tier performance and to achieve top quartile margins, but never at the expense of our long-term strategy. As I indicated earlier, we will continue to invest in this business. Balancing these factors will always be essential for us, but we believe 2021 will be a positive year.

Okay, great. Thanks.

Thank you. Our next question comes from the line of Mark Hughes with Truist Securities. Please proceed with your question.

ARPO was quite good in the quarter. Could you comment on how much of that might have been mix versus price appreciation?

It's difficult to pinpoint exactly. A significant portion was due to housing price appreciation. Generally, when housing prices rise by $1, we can expect around $0.60 to flow into our purchase fee profile. Additionally, our California business saw a 15% increase on the direct side, as California has higher housing prices. Therefore, I would attribute most of it to housing price appreciation, with some influence from the mix. Importantly, we haven't raised rates, so there are no increases contributing to this. It's solely a matter of housing price appreciation and mix.

Operating expenses, the margin was obviously quite good. Were there any unusual items in that? When you look at it sequentially, it was up a bit. Just curious.

The question about any unusual items in the quarter, I couldn't quite hear you there.

The unusual items in the other operating expenses. Your margin was very good overall, but other expenses were up a bit sequentially. So just curious.

No, no. I think in the other operating expense line item there was nothing unusual there.

Thank you. Our next question comes from the line of John Campbell with Stephens. Please proceed with your question.

Hey, guys. Good morning. Congrats on a great quarter.

Thank you.

Mark in the Specialty segment, I'm getting to I think of about a 15% pre-tax margin for just the home warranty business for 2020. So first, is that about the right mark there? And then if that's the case would you guys expect a kind of an improvement on a run rate basis as you guys get away from some of the COVID-driven higher claims for the home warranty business?

Yes. The answer is, yes, yes. We were impacted this last year as the whole industry was on the COVID-related claims our clients and Mark Fleming. They were up about 18% by the way in the fourth quarter. But the business is growing nicely both in our real estate channel and our direct-to-consumer. So what we've done is adjust our prices and some policy coverage issues. And those will flow in over the next 12 months as the policies renew.

Okay. And then I'm guessing, we could probably get this in the 10-K, but I don't know if you guys have this on hand. But what was the provision rate for just the home warranties business in 2020?

The loss provision rate?

Right.

The loss provision was 53% in 2020, and it was 50% in 2019. So we have seen, as we've been talking about, higher claims. But obviously, still pretty attractive loss rates for that business.

John, the one thing to remember on that business is that we have extreme weather in the summer months. We're going to see an uptick in our air conditioning claims. So, there is a weather component on that one in the summer months typically.

Okay, that makes sense. Regarding the macro situation, you all have had an impressive ability to predict trends lately. Dennis, you certainly made an accurate call on refinancing last year. It appears that the MBA is projecting a nearly 25% decline year-over-year, which seems a bit too pessimistic to us. However, you have mentioned several times that you anticipate a fairly strong market this year. I'm interested in hearing your thoughts on that outlook. Additionally, I'm not sure what Fleming's insights are regarding the market for 2021.

Yes, I have a projection on that. It aligns closely with our budget for 2021. We are somewhat more optimistic than the $25 million figure. I believe that the spreads will narrow, and the lenders will utilize this capacity. Therefore, this situation might persist longer than many anticipate. That's my current perspective.

Okay. And then

Where I was going to go though is irrespective, we're starting really strong in the year both purchase and refinance, which is obviously good for us in our typical seasonally slowest quarter. So a real strong start to the year and we'll see how it plays out.

Okay. That's helpful. And then last one for me. On commercial, as you guys kind of look at the pipeline, could you just kind of broadly talk to what that mix looks like purchase versus refi, if that's pretty similar to resi? Or if you guys are seeing a little bit more purchase strength?

The mix hasn't really changed much. I mean, when you look at our commercial revenue, about 25% of our revenue is refi-related. In the fourth quarter, it was the same number. It was 25% in the fourth quarter of 2019. So we've seen a pretty consistent mix of refi. Obviously, we don't have the volatility there that we have on the residential side.

Okay. Great. Thanks guys.

Thank you.

Thank you. Our next questions come from the line of Geoffrey Dunn with Dowling & Partners. Please proceed with your question.

Thanks. Good morning. Dennis, I wanted to get some high-level thoughts from you on technology and digitization efforts. Can you just discuss a little bit going forward, how important is automated underwriting of refi, automated underwriting of purchase relative to really digitizing the front end and back-end experience with the customer? It seems like we kind of blend the concept of digitization but there's different aspects here in terms of what could be meaningful for production, meaningful from an expense standpoint, etc. So can you hash that out a little bit more?

Yes, that's a great question. We do integrate these aspects, but they are distinct issues. Let’s break them down. At its core, title automation, where we've made significant progress and will continue to, is fundamentally driven by data. We've made considerable advancements in our data collection, now having the largest public record database. Over the past few years, we've improved our ability to capture data automatically, allowing us to cover larger content and wider geographical areas. This positions us to develop significantly more title plans in the future, where we currently lead the market. I mention this because it is essential for title automation for both refinancing and purchasing. Regarding the title automation itself, we’re continually adding data scientists and others to enhance title automation for purchasing and refinancing, with more developments to come. The second aspect is closing, which will likely see gradual improvements due to regional differences. This is part of our Docutech and other initiatives aimed at digitizing the closing process, including our Endpoint adjustment, which may not be receiving enough attention. We initiated Endpoint, a fully digital closing platform, about 1.5 years ago, gaining traction since its launch in Seattle with a growing market share. We’ve since launched in three additional markets this year with plans for more. There's considerable potential in Endpoint, and we have committed $70 million internally to support the reimagining of the closing process. All of this ties back to the margin discussion. We will always aim for top-tier margin performance, but not at the expense of long-term investments that advance our business towards a digital future.

And what about the front end experience aspect of it?

Geoff, quantifying it is a little tough, so I know exactly what you mean by the front end?

It seems like we saw some news out of FNF and I believe you all saw it too regarding a secure digital opening site. I think escrow deposits and fraud prevention are significant areas of focus. What I'm also trying to get at is...

Geoff, let me respond to that. We're implementing our secure portal, which we've been developing for several years and achieving significant progress. You can think of this as an incremental approach. On the other hand, Endpoint represents a more substantial and different strategy. One is about gradual improvements, while Endpoint offers a more revolutionary solution.

Okay. And I guess the ultimate conclusion I'm looking for here is, it strikes me that this is more about better operating leverage on future business not necessarily having to expand the expense base as much as you might have traditionally needed to on top line growth rather than a material expense reduction development. Is that the right way to think about technology?

It's absolutely the right way to think about it. I mentioned in my script we're upping our spend in technology, product development and other things. We're trying to wrap up this year with the majority of it in our cloud migration, which will allow us even greater flexibility. So if anything Geoff, we are not cutting back expenses on technology we are accelerating them. And you saw it in our fourth quarter numbers by the way. Look our orders were up 30% and our headcount was up 6%, 400 people. That would have never been the case Geoff, as you know 5 years, 10 years ago ever. So this isn't about for us at all cutting expenses. This is about looking forward and getting greater automation out of the business.

All right. Great. Thanks. I appreciate the comments.

Thank you.

Thank you. There are no additional questions at this time. That does conclude 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 entering the conference ID 13714735. The company would like to thank you for your participation. This concludes today's conference call. You may now disconnect.