First American Financial Corp Q1 FY2021 Earnings Call

Greetings, and welcome to the First American Financial Corporation First Quarter Earnings Conference Call. 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 by entering the conference ID, 13718763. We will now turn the call over to Craig Barberio, Vice President of Investor Relations, to make an introductory statement.

Good morning, everyone, and welcome to First American's earnings conference call for the first quarter of 2021. 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.

Good morning, and thank you for joining our first quarter earnings call. The year is off to a great start with our core businesses achieving strong financial results. Our outlook remains optimistic based on market trends, and we are confident that 2021 will be another good year. Today, I'll focus my remarks on the progress we are making on a number of key strategic initiatives as well as our venture investment program. A transformation is well underway in the real estate sector, as paper-intensive processes convert to digital. First American is investing the time, expertise and capital to continue to lead the change within the title and settlement industry. We continue to make significant investments in technology across all of our major businesses to enhance the customer experience through digital solutions. Many of these efforts are now finding success in the marketplace. In our commercial business, we've launched ClarityFirst, a platform that enables a streamlined closing process and provides greater transparency and efficiency relative to conventional methods. We believe this is the first end-to-end digital solution for commercial real estate transactions. Since the nationwide rollout in June, we have facilitated over 60,000 commercial transactions. Endpoint is another example of First America's commitment to innovation. A digital startup that we've launched in Seattle in 2019 to reimagine the closing experience has captured a 2% market share in that area. Encouraged by our success, we've recently entered 6 new markets, and we plan on growing to 20 markets by the end of the year.

Thank you, Dennis. We're pleased to report excellent results this quarter. We earned $2.10 per diluted share. Included in this quarter's results were $0.46 of net realized investment gains. Excluding these gains, we earned $1.64 per diluted share. I'll start with our title business. Revenue in our Title segment was $1.9 billion, up 45% compared with the same quarter of 2020. All 3 of our major markets, purchase, refinance and commercial, were favorable this quarter. Purchase revenue was up 27%, driven by a 15% increase in the number of closed orders, coupled with an 11% increase in the average revenue per order. Refinance revenue climbed at 79% relative to last year and was flat relative to the fourth quarter, as refinance closings continued to be elevated as a result of low mortgage rates. Notably, commercial showed its first year-over-year revenue increase since the pandemic. Commercial revenue was $163 million, a 2% increase over last year. A number of large transactions closed at the end of the quarter, signaling the overall strength in the commercial environment. On the agency side, revenue was a record $845 million, up 41% from last year. Given the reporting lag in agent revenues of approximately 1 quarter, we are experiencing a surge in remittances related to Q4 economic activity. Our information and other revenues were $275 million, up 32% relative to last year. This line item represents revenue from a collection of business lines that are not premium or escrow related and therefore, not risk-based. The largest component of information and other is revenue from our data and analytics business, which totaled $89 million, a 17% increase from last year. Investment income within the Title Insurance and Services segment was $43 million, down 29%, 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.

I wanted to ask some clarifying questions about Dennis, your comments around the title plants. Did I hear you correctly that you said you're looking to add 1,000 to the 500 you already have?

You did. And let me give you some background, Mark, on that. In the script, I talked about a few things. Number one that we wanted to set out to build a world-class property data company, which we have. We've got the largest repository of property information and title plant information in the industry right now. A couple of years ago, we set out to aggressively transform how we do data extraction from the documents into the plants, which used to be all manual data entry. We've got 11 patents, by the way, on that, which is probably not well understood. We have 11 patents for OCR data extraction that allows us to now extract over 60% of all the records fully automated. That percentage is growing fairly rapidly as we move forward. Because of that, we're touching basically 5 million documents a month or extracting from those documents virtually all document fields from the document, and we're going to start building another 1,000 go-forward plants this year. Now I used the term go-forward; we'll build up the back plant when we think it's necessary. So we're building 1,000 new plants. And it's just a follow-on to our strategy here that we think the data combined with the automation and technology are going to give us very unique strategic advantages over the long haul.

Okay. That's helpful. And I think historically, you've only focused on larger MSAs, where there is more scale. Does this automated extraction make it more scalable to build these in much smaller markets? And in fact, are there just no markets that are too small now that you can't build one just given the efficiencies of creating the plants?

Well, there may be markets that become too small just because of the non-transaction, but you're right. It allows us to approach basically in the MSA, where we can get the data extracted information and build a plant. And again, we're extracting now everything off the document to feed either our property record database or our title plant database. Now I want to make sure these are go-forward plants, so we still have to build a back plant. But when you start to think about this, the competitive advantage it will give us over the next 3, 5 or 10 years is significant.

Yes. And that was my last question on this topic: how do we think about that? I mean do you see noticeable and sustainable share gains in markets where you have a plant and maybe, or the only one who has a plant in that market?

Not really historically, but there are nuances here. What I'm saying is historically, we built plants because of the cost of building one with the limited record layoffs. We don't have that historical limitation any longer. We're pulling everything off the documents. So we can put, ultimately, whatever we want in a plant, any document feed that we think ultimately will help us automate the process.

Okay. But that will that give you in those markets a margin advantage over all your competitors?

I'm probably not going to answer it that way. But what I will tell you, again, these are long-term buildings. We want to extract from all those data assets we have been building a long-term competitive advantage. Let's put it that way.

Dennis, I think you mentioned $100 million in pretax earnings from your data operations. Is that all third-party business? Does that include any allocations from your Title operation?

Yes, Mark, it does include allocations from our own First American operations. I mean when you look at our data business, they sell to title companies, lenders, lots of different customers. But one of those customers is First American. So it does include intercompany transactions.

But it's not the majority.

That maybe 1/3?

I would say less than 1/3, roughly about $30 million.

Okay. All right. And then anything to say about the order trends here in April first few weeks?

Yes. So far in April, our refinance orders are about 1,800 a day. In March, they were 2,000 a day, so it dipped a little bit, but still we would consider pretty healthy levels for refinance. On the purchase side, we're opening about 2,400 a day for the first 15 business days in April. That's an 80% increase over last year. But of course, last year, it was a little bit of an anomaly given what was going on in the market, but 2,400 purchase transactions so far in April.

How about commercial?

Commercial orders were about 600, reflecting an 81% increase compared to last year and an 8% increase from last month. We are currently at 600 commercial orders.

And I'll just add, I'll step back a little bit. Clearly, refinances are coming down. But when you step back, it's still at an elevated level. We're running about 1,800 orders per day right now. On purchase, very optimistic in the market going forward. We're very optimistic. We've got strong, strong tailwinds right now. Rates are very good. Demographics are very strong. We had all the issues that came from the pandemic, so very optimistic in purchase. And then I'll say the same thing about commercial. We said the same thing last quarter, but it's starting to really see a change in the recovery from the pandemic. The last two quarters are very strong, and we're optimistic going into '21 right now in commercial. And by the way, it's running at a very healthy margin.

I would like to ask one last question about margins. Your success ratio is impressive. Can you break down how much of the margin can be attributed to scale and the positive impact on the top line, compared to the efficiency improvements you mentioned? Also, do you have any updated thoughts on margin targets moving forward?

Well, obviously, we're really pleased with the 14% Title margin in the first quarter. It's a combination of both. Obviously, we've got tailwinds with all 3 of our markets: purchase, commercial, refinance. They're all strong. So that definitely helps the margin. But we're also seeing efficiencies too. You mentioned the 44% success ratio. I mean, we're doing a good job of managing our expenses given the market that we have. One of the things that we're seeing the benefit of is title automation, right? We don't have to process manually as much as we used to. So we've really seen a benefit of title automation in margins, too. So it's really a combination of top line and better efficiency both. And of course, we lowered the loss ratio to a 100 basis points.

So first, just on the venture investments that you made, will that continue to be a part of the capital allocation strategy? And should we think of that as going to the same run rate you've had now since the last couple of years? And then just as you've said, as your tech spend grows, is it always just something that complements title? Or is it something that could sort of stand-alone as a segment or a business at some point?

I think we heard the first part of your question, George, I'm sorry, just about the venture investment, but we missed the second. One thing I'll just comment on the venture investments is we've invested $225 million since 2019. It seems like it was front-loaded. We're not seeing quite as many opportunities as we did in 2019, 2020, but there's no question that we're going to continue to invest. We've got additional transactions we expect in the second quarter. And so that's going to be ongoing part of our capital allocation strategy, although probably not quite to the degree that we saw over the last, call it 2020.

Yes, this is Dennis. In response to your question, I want to clarify that this will be part of our capital allocation strategy moving forward, and it encompasses both financial and strategic aspects. I believe this may not be fully recognized by others. It allows us to closely engage with some of the emerging high-tech growth companies within the proptech ecosystem. Ultimately, we become strategic partners and potentially customers for our title or data services, or we may utilize some of their products and services to enhance our offerings. We see this as mutually beneficial. Currently, it is providing us with significant financial returns, and we believe it is the right choice for our shareholders in the long run. As for the second part of your question, we've had some challenges addressing it.

Do you want me to just repeat the second part?

Yes, we couldn't quite hear.

Okay. The second part was just longer-term, how you thought about this, whether it's always just would be something that complements Title? Or could it be a business that essentially could stand on its own?

As we're sitting here today, Bose, we don't see our venture investments as its own segments or anything like that. It's very complementary to our core Title business. And so it's just kind of integrated in terms of that. We don't anticipate breaking it out anytime soon.

Okay. Great. And then sort of, I guess, a related question. But without naming specific companies, any thoughts on companies or technologies that are out there now that are part of their value propositions that they can sort of disrupt the title market as it exists now? Any thoughts on that or comments?

We are exploring several areas of interest, particularly technologies that can enhance our efficiency. Our main focus is on the digital closing process, title automation, and developing a robust data business. We see opportunities to invest in technologies that can significantly boost these initiatives. Additionally, there are new players emerging who aim to enhance the home buying experience and digitalize the mortgage process, which is another key area of our attention.

Congrats on a great quarter. I want to touch back on the venture investments. I think that's super interesting. And Dennis, I agree, I think that's an underappreciated side of your story, but it's similar to that kind of Bose's question, but I mean you guys have chalked up some pretty good gains, OfferPad's obviously out there, and it sounds like is maybe on the path towards monetizing at some point. But just curious, do you take those returns and just kind of let it ride? Do you let this grow? Or do you keep that invested capital kind of at a certain level and then you redeploy some of that back into the core title? Just kind of how you think about that, if there's a structured process around that?

Yes. So it's relatively new for us. I mean, again, we did our first investment in 2019, and we found just tremendous value. A lot of it, again, as Dennis mentioned, is on the strategic side. But now we're finally starting to see big financial upside as well. It's going to be a while before we're actually able to monetize some of these investments, and we'll kind of cross that bridge when we come to it. But they've been very strategic partners as a broad statement.

Yes. But John, I would probably just add that we want to continue to have those strategic partners, but it depends on how we ultimately go into it. It depends ultimately on how they hit the markets. We're not going to ultimately want to have highly concentrated single positions in public companies.

Makes sense. On the commercial orders, it looks like the open order is up 5% year-over-year. I mean, the 1Q comp was actually pretty difficult. So that's encouraging to see. If you guys can maybe just kind of talk to the pipeline. I don't know if it's kind of the size or characteristics of the deals. And then any additional color on kind of regional asset class performance?

Yes. Let me start on that and Mark can probably add more. It's just strong. As we mentioned last quarter, we definitely noticed the strength picking up. There was a slow recovery in the residential market, but the strength has accelerated into the fourth quarter. It's currently broad-based across asset classes. We are beginning to see the return of significant deals, which is encouraging. While I won’t claim we’ll see a record like in 2019, we are becoming more optimistic over time regarding this channel. I also want to note, even though your question wasn’t directed at this, that it was a tough market for us in commercial during the middle of the year. However, that doesn’t deter us from investing in the business. As I mentioned, we’ve launched what we believe is a market-leading new platform for our commercial business, with 60,000 transactions already done. Regardless of the market conditions, we will continue to invest in these businesses to enhance efficiencies.

One thing I want to add regarding our commercial pipelines is that we monitor our open orders closely. Additionally, we pay attention to our escrow deposits, as they provide insight into the size of the orders. This year, our escrow deposits sent to the bank have increased significantly. In January, we had $4 billion in deposits; in February, it rose to $4.2 billion; by March, it reached $4.9 billion. Typically, there is a decline at the end of the month due to transaction closings. However, in April so far, our deposits have grown to $5.1 billion at the bank. A substantial amount of our commercial deposits are placed there. Therefore, a rise in our escrow balance serves as a strong indicator of economic activity in the commercial sector.

Yes, that's great. That's good insight for sure. Last one for me. On the April open purchase orders, it sounds like 2,400. Obviously, that's up pretty substantially versus last year on the COVID comp. But how does that compare to March just kind of sequentially?

Sequentially, it's basically flat month-over-month. 2,400 is what we had in March, same thing.

I wanted to follow up on the venture investments just a little more detail in terms of just some of the logistics of it. Where are these investments taking place? Are they within the regulated entities or outside of it? And are you taking all direct equity investments? Are you going through any of the VC funds out there? Are you sticking to equities? Are there different funding vehicles? Can you just give a little bit more color?

Yes, Geoff. We are making these investments from the holding company, not from our First American Title underwriter investment portfolio. These are funded by the company's excess cash. Most of what we discussed today involves direct investments. We are investing directly into the company and have made about 10 direct investments. Additionally, we have invested in three proptech venture firms, which are earlier stage companies, typically Series A type investments. This approach allows us to reach into earlier stage companies. Most of our direct investments fall within Series B and Series C, where we have revenue and a product. Therefore, we engage in both direct and indirect investments, but the majority have been direct.

Okay. I want to get a better understanding of the resources within the holding company. When considering common dividends, buybacks, and so on, do you have a specific amount of cash allocated for the VC initiative? Or is it more opportunistic, where one year it could be $0 and the next year it could be $100 million?

I would say it's truly opportunistic. I mean that's something that we've always talked about in terms of whether it's acquisitions, buybacks, or venture. We really are opportunistic depending on what the opportunities are. We saw a lot of opportunities in venture in the last couple of years, and we decided to go big there. So there's nothing earmarked. It could be $0 1 year, it could be $200 million one year; it just depends on the opportunities.

Okay. And has the Board or management put a limit on how much funding you're willing to put into the VC efforts?

No.

Mark, how much did Docutech contribute in the first quarter of last year? And if you could say how much this first quarter as well.

Give me 1 second here, Mark. You're talking about revenue or EBITDA?

If you'd like to share both, well. And consumer, I was thinking revenue.

Hold on just a second.

I have just one more question. A new high-profile competitor has recently emerged in the title sector. Have you noticed any impact from this competitor, or do you have any general thoughts on the situation?

I'm not going to comment directly on, not really on the market impact, but something I did mention in my script, which is probably, again, poorly understood or not well understood with our company is, for example, just in our data businesses, we have 11 patents on OCR and extraction, not alone. So we've got a very, very active IP campaign going on. So we'll probably give more insight on that in the future, too, and the number of patents we have across the whole enterprise, not only data extraction, but title automation. So more to come on that, okay?

Understood.

Yes. So Mark, in terms of Docutech, so the first quarter this year, we had revenue of $23 million. And that's all, again, all in info and other, and we had EBITDA of $8 million. And then the first quarter of last year, we owned it not the entire quarter, but we had $6 million of revenue and about $3 million EBITDA.

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 by entering the conference ID 13718763. The company would like to thank you for your participation. Again, this does conclude today's teleconference. You may now disconnect. Have a great day.