First American Financial Corp Q2 FY2024 Earnings Call

Greetings and welcome to the First American Financial Corporation Second 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. 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 13747727. 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 second quarter of 2024. 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 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 yesterday's earnings release and the risk factors discussed on our Form 10-K and subsequent SEC filings. Our presentation today also 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 yesterday's earnings release, which is available on our website at www.firstam.com. I will now turn the call over to Ken DeGiorgio.

Thank you, Craig. While market conditions remained challenging in the second quarter, we benefited from the seasonal pickup in demand. Total revenue was $1.6 billion, and our adjusted earnings per diluted share were $1.27. Our title segment delivered an adjusted pre-tax margin of 11.9% this quarter compared with 12.6% last year. In the purchase market, despite early positive signs, the spring selling season proved to be disappointing. Our closed orders were up less than 1% compared with last year as affordability issues, high mortgage rates, and elevated home prices suppressed demand. Despite the muted transaction activity, tight inventory conditions led to home price appreciation, resulting in a 4% increase in our direct purchase revenue. Challenging conditions continue into the third quarter, with open purchase orders down 3% through the first three weeks of July. Closed refinance orders were down 5% in the second quarter. Refinance activity picked up as the quarter progressed. The double-digit open order growth we posted in June has so far accelerated in the first three weeks of July with open orders up 19%, but we are coming off a low base, with refinance accounting for less than 5% of direct revenue in the second quarter. Our commercial business is stable in the face of continuing uncertainty in the market. Closed orders were down 2% in the second quarter. For the first three weeks of July, while open orders are up 4%, we expect the ongoing uncertainty to weigh on our commercial business in the third quarter. We remain optimistic, however, that we will see a meaningful rebound in activity in the seasonally strong fourth quarter. Our home warranty segment again delivered strong results with an adjusted pre-tax margin of 15.2%, though our real estate channel is facing the same headwinds we are seeing in our title company's purchase business. We are increasing our emphasis on the direct-to-consumer channel, which we expect to drive increased profitability over the long term. Turning to the progress we have made on our long-term strategic initiatives. First American is the undisputed leader in title data with the most comprehensive, accurate, and timely data assets in the industry. While for years we have leveraged these data assets to automate underwriting of refinance transactions, we have had early success in extending the competitive advantage of these assets to purchase transactions. In April, we successfully launched an ongoing pilot for automated underwriting for purchase transactions, which is much more complex and heavily dependent on title data. This initiative, which we call Sequoia, was launched in Maricopa and Riverside counties with a goal of rendering an insurable title decision for at least 50% of residential properties. At Endpoint, we have successfully built a next-generation settlement platform that is bringing extensive automation to the closing process for residential transactions. Going forward, we will focus on further enhancing this technology and deploying it in a broader organization. Over the long term, we expect that Sequoia, Endpoint, and other initiatives will enable us to service our customers faster and more efficiently than the competition. On our last earnings call, we indicated that we expect modest revenue growth this year, which will enable us to achieve title margins similar to what we posted in 2023. After closing the books on the first half and looking at the order pipeline in July, while we maintain our perspective on our full year performance, our results will ultimately depend on the strength of a currently uncertain commercial market in the second half of the year, and in particular, the fourth quarter. Now, I'd like to turn the call over to Mark for a more detailed discussion of our financial results.

Thank you, Ken. This quarter, we generated earnings of $1.11 per diluted share. Our adjusted earnings, which excludes the impact of net investment losses and purchase-related amortization was $1.27 per diluted share. Turning to our title segment, revenue was $1.5 billion, down 1% compared with the same quarter of 2023. Purchase revenue was up 4% during the quarter, driven by a 4% increase in the average revenue per order. Commercial revenue was $177 million, a 1% decline over last year. Though our closed commercial orders fell 2%, the average revenue per order for commercial transactions increased 1%. Refinance revenue declined 9% relative to last year. With mortgage rates hovering around 7%, they are still at levels materially above what is needed to generate a significant rise in refinance activity. In the Agency business, revenue was $616 million, down 1% from last year. Given the reporting lag in agent revenues of approximately one quarter, these results primarily reflect remittances related to Q1 economic activity. Information and other revenues were $241 million during the quarter, down 1% compared with last year. This decline was primarily due to an increase in the capture rate of title premiums from an affiliated title agent, which caused a decline in information and other revenue, and a comparable increase in direct premium and escrow fees. Investment income was $126 million in the second quarter, down $16 million compared with the same quarter of last year. The decline was primarily driven by lower average interest-bearing escrow and tax-deferred property exchange balances, partly offset by higher interest income from the company's warehouse lending business. The provision for policy losses and other claims was $35 million in the second quarter, or 3.0% of title premiums and escrow fees, down from the 3.5% loss provision rate in the prior year. The second quarter rate reflects an ultimate loss rate of 3.75% for the current policy year, and a net decrease of $9 million in the loss reserve estimate for prior policy years. Pre-tax margin in the title segment was 11.7% or 11.9% on an adjusted basis excluding both net realized gains and purchase-related amortization. Total revenue in our home warranty business totaled $107 million, unchanged compared with last year. Pre-tax income in home warranty was $17 million, up 15% from the prior year. The loss ratio in home warranty was 46%, down from 49% in 2023 due to lower claim severity that was partially offset by higher claim frequency. Adjusted pre-tax margin in the home warranty segment was 15.2%, up from 12.9% in 2023. The effective tax rate for the quarter was 23.2%, in line with our normalized tax rate of 24%. In the second quarter, we repurchased 752,000 shares for a total of $41 million at an average price of $54.14. Our debt to capital ratio as of June 30th was 29.7%. Excluding secured financings payable, our debt-to-capital ratio was 22.5%. Now, I would like to turn the call back over to the operator to take your questions.

Thank you. We will now be conducting a question-and-answer session. And our first question comes from the line of Mark Hughes with Truist Securities. Please proceed with your question.

Yes, thank you very much. You talked about in the warranty business, maybe a focus on the direct-to-consumer channel. What motivated that? What kind of impact could that have on profitability? Is that going to be kind of an upfront expense load? Curious about that.

Thank you for the question, Mark. A significant reason for this is our desire to diversify the business, especially considering the challenges I mentioned earlier regarding the real estate channel. The real estate channel, which involves selling home warranties linked to purchase transactions, is facing similar difficulties as our title business. There has been an ongoing opportunity to explore the direct-to-consumer channel, which is partially driven by the untapped potential in the home warranty market. Many homes currently lack coverage by home warranties, and a key strategy to address this is to engage directly with consumers. I believe your implication is accurate; there is an initial investment needed for the direct-to-consumer approach, and it takes time to see profitability from this channel as we move into renewals.

And then on the Sequoia initiative, what are the implications in terms of revenue per order, if you're successful there with instant decisioning? What does that mean in terms of the kind of the revenue opportunity going forward?

Well, Mark, I'll point out that, as I mentioned in my comments, this is at the pilot stage, very, very early. We just rolled out the pilot in April. So it's very early to tell. But we think there will ultimately be real revenue opportunities associated with Sequoia because the feedback we get from customers is they want things done, they want to know if there's a title issue faster, and we can tell them at Sequoia instantly. And we've proven that out so far, with the pilot in Maricopa and Riverside counties. And there will obviously also be efficiency gains if the pilot ultimately proves successful.

And then the commercial, you expressed optimism about the fourth quarter, but maybe hedged a little bit on Q3. Did I hear that right? And what motivates that maybe a little more tempered view on Q3?

Well, I mean, I look at Q3 as coming off of Q2. As I mentioned, closed orders were down 2% and Q2 revenue was down. Yes, we did see open orders tick up in July in the first three weeks, up 4%. But just based on what we're hearing and the trend we saw in Q2, I think that you analysts may be more optimistic than we are on Q3, but we are very optimistic on Q4. We saw in Q2, for example, a shift to refinance, which tells me that they are starting to work out some of the issues, particularly in office on loans that have been coming due. So that's a sign that things are starting to move a little bit. We also saw increases in Q2, both year-over-year and sequentially in our average revenue per order, which we think is an indicator that price discovery is further along.

Thank you. Our next question comes from the line of Mark DeVries with Deutsche Bank. Please proceed with your question.

Yes, thanks. My first question is a follow-up on your last comments, Ken. On the optimism for the fourth quarter, are those last two factors the main reason? Are there the conversations you're having that kind of make you optimistic about how with clients on how the end of the year is shaping up in terms of transaction size and velocity?

Yes, I mean it's a little bit of both. It's conversations and the factors I just described. I think it's an expectation that we might get some interest rate reductions, which I think are big. I think the forward curve is anticipating three rate reductions before the end of the year. But of course, as I've said in the past, the forward curve is never accurate. So it's a little bit of all of those things, and then obviously talking to our own people about what they're seeing in the pipeline and what their expectations are. But I'm getting weary of trying to predict what the commercial market is going to do because there is a lot of volatility and uncertainty, but we are optimistic.

Okay, fair enough. And then, Mark, I was hoping to get an update from you on the efforts you talked about on the last call to defend your deposits, some of the migration that you're going away, whether that was through offering a little rate. Could you just give us an update on what happened over the last quarter?

Yes, sure. So, first of all, our investment income came in line with our expectations. We talked on the last call about how we expected $120 million to $125 million of investment income in the title segment for the rest of the year, and we came in at the high end of that range, which is right in line with where we saw it. At last quarter, we talked about how 30% of our escrow deposits, we don't capture any economics from for different reasons. And it's stabilized this quarter. In Q1, that number was 30%. In Q2, it was 29%. So, it's stabilized, and our initiatives haven't really kicked in yet. We just started to kick them in July. The benefit that we got was really just market-driven this quarter, and the initiatives we have to defend these deposits and deploy more incentive for customers to use our own banker are just now starting to kick in. We feel good that things have stabilized on that front.

Okay, great. Thank you.

Thanks, Mark.

Thank you. Our next question comes from the line of Soham Bhonsle with BTIG. Please proceed with your question.

Hey everyone. I wanted to follow up on your last question, Mark, regarding net interest income. It seems like you've implemented some strategies in July. Should we anticipate that interest income or any costs will increase as you work to retain these deposits? Also, what is the outlook for net interest income in the second half of the year?

Soham, there are a few things to consider. For the second half of the year, we currently anticipate that it will be at the lower end of our projected range, roughly around $120 million per quarter for Q3 and Q4. One reason for this is that we lost our last remaining home point loans on July 1st. Those loans were associated with $300 million in deposits, which we were utilizing at the Fed funds rate. With the departure of these loans as of July 1st, we're experiencing a slight drag on investment income for the third quarter, although this will be offset by a reduction in interest expense. Overall, it won’t impact pre-tax results significantly. Looking ahead to the fourth quarter, if we do see three rate cuts in September, November, and December, we might face some additional pressure on investment income, but we still believe we'll maintain that $120 million per quarter for Q3 and Q4 due to these factors.

Okay. And then just back to title margins, I was hoping to maybe understand the cadence of margin progression from here in the back half. Last year, you had the cybersecurity issue, and so we can't really use that as the base for the fourth quarter. But if I look back to the fourth quarter of 2022, you did a 10.9% on margin. Any thoughts on cadence for margins in the back half would be helpful as well.

A lot of it is going to depend on what Ken talked about with how strong the commercial market is. I would just say that in a typical year where we don't have significant refi activity, Q2 is the peak of our pre-tax margins, and we think that's going to be the case this year, too. We expect our normal seasonal decline in title margins as we progress through the year. We think Q2 kind of hit the high water mark because there's not much refi activity out there. Ultimately, it will depend on how strong the commercial market is, but we feel like margins have peaked in Q2 this year.

Okay. And then, Ken, just last one on Endpoint. I was hoping you could share whether there are recent wins or any anecdotes from customers that would help illustrate the appetite for what you're building here. Should we think of Endpoint more as like one plus one equals two, or is there going to be any cannibalization in the regular way of doing title longer-term?

Yes, I mean I'll say sort of generally that the customers who have experienced Endpoint have liked the platform and the approach that Endpoint is taking. Keep in mind that it's a pretty small direct revenue base with Endpoint. The focus on Endpoint going forward, in addition to operating as a stand-alone business, as I mentioned, is further enhancing the capabilities of Endpoint and then deploying it in the broader organization. We think that's where the real opportunity lies in making our broader organization more efficient. This is not just in the area we have talked about in the past, mainly what we call Jot, which is mobile notary management, but in the production side, the operations side of the broader title company. I see it as a one plus one equals three opportunity.

All right. 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. I don't know if you gave this already, but what was the margin impact from Instant Titling and Endpoint, and then from Sequoia? Should we think of any margin drag from that as that builds out?

Thank you for the question, Bose. Yes, the margin impact this quarter was a 140 basis points drag for Endpoint and Sequoia combined, which is an improvement from a 150 basis points drag last quarter. I believe that over time, this will continue to decrease.

Okay. And the 140 basis points, that was Endpoint and Instant Titling or is that with Sequoia in there or is that for Sequoia going forward?

So, Sequoia is our instant decisioning for purchase transactions, so yes.

Okay, perfect. Just switching over to investment income. When I look at your call report, it looks like the bank's contribution to investment income is about a quarter of it is coming from the bank versus the rest on your own balance sheet. Is there a way to think about how much of the investment income is from the bank versus not from the bank?

This quarter, we had $126 million of investment income and $44 million of that came from the bank. The rest is primarily our investment portfolio from our insurance companies, both onshore and offshore. That's our fixed income portfolio, and we also have investment income from our escrow deposits that are third-party banks.

Okay, great. Thank you.

Thanks, Bose.

Thank you. Our next question comes from the line of Terry Ma with Barclays. Please proceed with your question.

Hi thanks. Good morning. You guided to a similar margin for full year 2024 as full year 2023. As we look at revenue performance in the first half, it was down 1%, 2%. Do you need to see a reacceleration in revenue growth in the back half to hit that margin guide? It sounds like you're a little less optimistic on Q3 but a little bit more optimistic on Q4. Just wondering how to think about that?

Yes. For the margin guide we've given in terms of margins similar to last year, we talked about having moderate or low single-digit revenue growth. So we'll need approximately 2% revenue growth to have margins similar to last year. That's our current expectation, which would imply some acceleration in revenue in the second half relative to the first.

Okay, got it. On the investment income of $126 million this quarter, it was a little bit above the high end. Was there anything episodic in there? I think you mentioned some contribution from the warehouse lending business. Do you expect that to continue for the rest of the year?

We were a little higher than we expected due to the warehouse lending business that's growing and doing well, and we think that will continue. There wasn't anything that was really one-time in investment income that caused us to be above the range. It was just stronger performance from warehouse lending than we anticipated.

Got it. Okay. So the $120 million per quarter guide is mainly just an adjustment for home point coming out.

Home point is really the exclusive reason why we expect investment income to be down in Q3, and then in Q4, a little bit because of expected declines in the Fed funds rate.

Hey guys. Good morning. On the purchase orders, the open orders down 3% thus far in July. I'm curious about how that's kind of looked week-to-week. Maybe if you start in mid-June, I'm just curious if it's been a steady deceleration or if you had a notable drop in June and then it's kind of held that level.

Looking week-to-week, the first week in July, our purchase orders were down 7.5%. The second week, we were down 0.5%. And the third week, we were down 1.5%.

Okay, that's helpful. And then back to the investment income, Mark, in your earnings call, I think you called out the metric of about 30% or so of the deposits not earning interest. Any sense for what the investment income upside would be if you're able to get that back to the teens level that you had in the past?

I don't have that on me here, John. But what I'd say is that the investment income forecast we've been discussing of $120 million assumes that 30% number, which, in fact, was 29% in the second quarter. That assumes it stays flat. We don't expect that to change significantly until we have lower Fed funds rates, but any decline in that 29% to 30% number would lead to upside to our guidance on investment income.

Okay. At the risk of oversimplifying, on lower rates, it diminishes that competitive edge that some of your competitors have and the ability to offer a higher rate. Is that fair to say?

That's correct. For those banking on direct deposits, that's right.

Okay. And then last one for me on the home point loans. Mark, I think you mentioned that everything rolled off July 1st. You talked about the investment income impact, but is there another revenue impact? I'm thinking maybe something in info and other. If you can also talk about any offboarding fees, if there was anything sizable in the quarter?

There will be some minimal impact to info and other revenues because of the fees we charge for servicing loans, but you won't really see it because income continues to grow. You won't really see it because it's going to be immaterial. However, there will be about a $3.5 million deboard one-time fee that we collected in July, which will hit Q3.

Okay, very helpful. Thank you.

Thank you, John.

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

Yes, thank you. I wonder if we could just get kind of a regulatory update, the CFPB, the pilot project, and that sort of thing? Any updated view you might have would be great.

Yes, thanks for the question, Mark. There's probably not a lot of update from the last quarter. On the Title Waiver program, the Fannie request for proposal is out. I think there's been a lot of push back from legislators, state attorneys general, and the like. There's a lot of political pressure coming down on Fannie's regulator, in particular. But it remains to be seen. With the CFPB, their request for information on whether to prohibit lenders from passing on the cost of title insurance is out. Our trade group and other trade groups are responding. In our opinion, that could be bad for consumers. There has been a push over the years to increase transparency, and now this could decrease transparency for consumers. I think it will probably increase costs for consumers, but it feels like the CFPB wants to push ahead. However, at the end of the day, it's not necessarily bad for us. In fact, it could be good for us. We have a strong centralized lender program that should enable us to perform well if the CFPB goes in the direction we think they want to go. As always, we're watching these things carefully. And it's still evolving.

Thank you.

Thank you. Our next question comes from the line of Soham Bhonsle with BTIG. Please proceed with your question.

Hey Ken, just quickly on home warranty. It sounds like you're continuing to invest in that business, but I want to understand the strategic rationale for holding it longer term. Earlier this quarter, there was a sizable acquisition in the space that looks like a pretty healthy multiple. I know there are some differences between your business and theirs, but talk to us about what keeps you interested in the home warranty business and the potential to harvest some of that cash in the future, maybe redeploy that into title or capital return if you choose to do so?

Yes. Thanks for the question. Home warranty is probably the furthest from our core title and settlement business, though I know it is a settlement business in connection with purchase transactions. But we like it for a lot of the reasons I mentioned in response to an earlier question. The home warranty market is dramatically under penetrated, so we think there's a real opportunity to seize that market. On the deal you mentioned, it was a sizable multiple for $210 million. However, that company was primarily selling warranties on new home construction and wasn't really even a risk-taking business. So, it's hard to compare our home warranty company and what we would typically think of as home warranty companies with that business.

Thank you. There are no additional questions at this time. This 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 13747727. The company would like to thank you for your participation, and this concludes today's conference call. You may now disconnect.