Earnings Call Transcript - FAF Q3 2025

Operator, Operator

Greetings, and welcome to the First American Financial Corporation's Third 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 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 13756641. We will now turn the call over to Craig Barberio, Vice President of Investor Relations, to make an introductory statement. Craig, please go ahead.

Craig J. Barberio, Vice President of Investor Relations

Thank you. Good morning, everyone, and welcome to First American's earnings conference call for the third quarter of 2025. Joining us today on the call will be our Chief Executive Officer, Mark Seaton; and Matt Wagner, 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 Mark Seaton.

Mark Seaton, CEO

Thank you, Craig, and thank you to everyone joining our call. Today, I will provide a brief review of our earnings and share our outlook on the market. Today, we announced adjusted earnings per share of $1.70 for the third quarter, another strong result that highlights the resilience of our business. We continue to see two distinct market dynamics. Our commercial business delivered outstanding performance, while the residential market remains in a period of transition. Even so, our adjusted consolidated revenue grew 14% and adjusted EPS increased 27%. Commercial revenue increased 29%, and we set a record for average revenue per order at just over $16,000 per closing. The rebound in the commercial market began in the third quarter of 2024, which means the year-over-year comparisons are becoming more challenging. Nonetheless, even against tougher comps, we delivered another strong quarter with a 29% growth rate. We continue to see broad-based strength in commercial, led by the industrial sector, which includes data center transactions, a consistently high-performing sub-asset class. Even excluding data centers, the industrial market remains robust, driven by sustained e-commerce demand for logistics and warehouse space. Multifamily was our second strongest asset class, with solid performance across a wide range of geographies. Investment income grew 12% this quarter. Our investment portfolio, particularly our bank, continues to serve as a countercyclical earnings driver. The residential side of our business continues to navigate challenging market conditions. Purchase revenue declined 2%, primarily due to reduced demand for new homes. The purchase market has remained soft over the last three years, largely driven by affordability challenges and elevated mortgage rates. However, when purchase volumes begin to normalize and return to long-term trends, we are well positioned to capture growth, thanks to our operating leverage and strong relationships with local real estate professionals who play a critical role in driving purchase activity. Refinance revenue was up 28% this quarter. Although we've seen an uptick in volumes, the refinance market remains at historically low levels. Our home warranty business continues to post very strong earnings. Our pretax income was up 80%, driven by a lower loss rate, and we continue to grow our direct-to-consumer channel, which is offsetting the ongoing weakness in real estate. I'm optimistic about our long-term outlook. We're at the early stages of the next real estate cycle, and our industry-leading investments in data, technology, and AI position us to outperform as the market strengthens. By modernizing our platforms and integrating AI across our operations, we expect to drive significant productivity gains, reduce risk, and unlock new revenue opportunities, further extending First American's leadership in the industry. Now I would like to turn the call over to Matt for a more detailed review of our financial results.

Matthew Wajner, CFO

Thank you, Mark. This quarter, we generated GAAP earnings of $1.84 per diluted share. Our adjusted earnings, which exclude the impact of net investment gains and purchase-related intangible amortization, was $1.70 per diluted share. Adjusted revenue in our Title segment was $1.8 billion, up 14% compared with the same quarter of 2024. Commercial revenue was $246 million, a 29% increase over last year. Our closed orders increased 6% from the prior year, and our average revenue per order was up 22%. Purchase revenue was down 2% during the quarter, driven by a 5% decline in closed orders, partially offset by a 3% improvement in the average revenue per order. While refinance revenue was up 28% compared with last year, it accounted for just 6% of our direct revenue this quarter and highlights how challenged this market continues to be. In the Agency business, revenue was $799 million, up 17% from last year. Given the reporting lag in agent revenues of approximately one quarter, these results primarily reflect remittances related to second quarter economic activity. Information and other revenues were $276 million during the quarter, up 14% compared with last year, primarily due to refinance activity in the company's Canadian operations, revenue growth in the company's subservicing business, and higher demand for non-insured information products and services. Investment income was $153 million in the third quarter, up 12% compared with the same quarter of last year, primarily due to higher interest income from the company's investment portfolio, partly offset by a decline in interest income from operating cash due to lower balances and lower short-term interest rates. Net investment gains were $6 million in the current quarter, compared with net investment losses of $308 million in the third quarter of 2024, which were primarily due to losses realized from the company's investment portfolio rebalancing project. Personnel costs were $543 million in the third quarter, up 10% compared with the same quarter of 2024. The increase was primarily due to incentive compensation expense resulting from higher revenue and profitability, higher salary expense, and employee benefit costs. Other operating expenses were $276 million in the quarter, up 9% compared with last year, primarily due to higher production expense driven by higher volumes and increased software expense. Our success ratio for the quarter was 62%, which is in line with our historic target of 60%. The provision for policy losses and other claims was $42 million in the third quarter or 3.0% of title premiums and escrow fees, unchanged from the prior year. The third quarter rate reflects an ultimate loss rate of 3.75% for the current policy year and a net decrease of $11 million in the loss reserve estimate for prior policy years. Pretax margin in the title segment was 12.9% on both a GAAP and adjusted basis. Looking at October, we are seeing a similar pattern in opened orders to what we have experienced so far this year, with a strong commercial market and sluggish residential market continuing. For the first three weeks of October, commercial orders are up 14%, while purchase orders are down 6%. The strength in commercial order activity is positioning us well for the remainder of the year and into 2026. Turning to the Home Warranty segment, total revenue was $115 million this quarter, up 3% compared with last year. The loss ratio was 47%, down from 54% in the third quarter of 2024. The improvement in the loss ratio was primarily due to lower claim frequency, largely driven by favorable weather conditions. Pretax margin in the Home Warranty segment was 14.1% or 13.5% on an adjusted basis. The effective tax rate in the quarter was 23.1%, which is slightly below the company's normalized tax rate of 24%. Our debt-to-capital ratio was 33.0%. Excluding secured financings payable, our debt-to-capital ratio was 22.5%. This quarter, we raised our common stock dividend by 2% to an annual rate of $2.20 per share. We also repurchased 598,000 shares in the third quarter for a total of $34 million at an average price of $56.24. Now I would like to turn the call back over to the operator to take your questions.

Operator, Operator

And our first question comes from the line of Mark Hughes with Truist Securities.

Mark Hughes, Analyst

On the commercial ARPO revenue per order, obviously, 3Q is very strong. Could you talk about that, the sustainability, perhaps what you're seeing so far in 4Q?

Mark Seaton, CEO

Thanks for the question, Mark. Yes, I would say it's sustainable. I mean, typically, in commercial, there is some seasonality to ARPO, right? It usually builds throughout the year. And we think it will continue to build in Q4. We're just seeing a lot of momentum in commercial. There are a lot of big transactions. We track 11 asset classes. Ten of our asset classes were up in the third quarter year-over-year. The only one that wasn't up was energy, which has historically been a really good asset class for us, but Q4 is typically a big energy quarter. We've got some big deals in the pipeline. So just in terms of Q3, it exceeded our expectations. And we're really optimistic about what we see in Q4. So it's been a really good story for us.

Mark Hughes, Analyst

Yes. How about the outlook currently for investment income? I know you've talked about some historically some sensitivities, but kind of what should we anticipate in Q4?

Matthew Wajner, CFO

This is Matt. Thanks for the question, Mark. For Q4, we expect it to be slightly down from the previous quarter due to some challenges from rate cuts. However, the decrease should be modest. That's the current expectation.

Mark Hughes, Analyst

Okay. And then when we think about the refi orders, what's the kind of recent trend in refi per day?

Matthew Wajner, CFO

For the first three weeks of October, we're opening about 875 open orders per day in refi.

Operator, Operator

The next question comes from the line of Terry Ma with Barclays.

Terry Ma, Analyst

I was hoping you could give an update on maybe just Sequoia and Endpoint in terms of the timeline for the pilots. I think last quarter, you said Endpoint pilot was going to roll out in December. Is that still on track? And then for Sequoia in the markets that you're piloting currently, any kind of early results?

Mark Seaton, CEO

Yes, thanks, Terry. First of all, regarding Endpoint, we are still on track with everything we discussed in the third quarter. The product is ready for testing, and we have people on campus this week testing it. The testing is going well, and we still plan to roll it out in our first office in December. We are also planning for a broader rollout in the spring as we expand throughout the country. It will take us about two years to achieve a national presence, but we are very excited. Our current system, called FAST, has been in use since 2002, so we've relied on it for 23 years. It has served us well, but with technological advancements and the arrival of AI, we are eager about Endpoint. It will enhance our productivity, provide a superior user interface for our escrow officers, and minimize mundane tasks, allowing them to spend more time with clients. We are pleased with the progress we've made since last quarter and continue to hit our milestones. Regarding Sequoia, we are also optimistic about its development. We initiated Sequoia with the goal of offering instant title for purchase transactions, which has not been accomplished in the industry, although it exists for refinance transactions. We’ve achieved significant milestones for Sequoia as well; our AI engine is operational, and we are processing live refinance orders, which is a milestone in itself. The product is currently in production in three counties, and our success rates have exceeded expectations. We plan to launch our first purchase transaction in the first quarter, and we are on track with that timeline. A national rollout will take us about two years, but once achieved, we anticipate being able to produce commitments more quickly, accurately, and cost-effectively than current market offerings. We are very excited about the developments with both Endpoint and Sequoia.

Operator, Operator

The next question comes from the line of Bose George with KBW.

Bose George, Analyst

Just sticking to Sequoia and Endpoint, can you remind us just what the margin impact of those programs are of just running the two platforms and just the way to think about the timeline for that kind of rolling off?

Mark Seaton, CEO

Thank you, Bose. Initially, we separated out the margin impact from Endpoint and Sequoia to help investors assess the performance of our core title business without those investments. At that time, we were uncertain about their success due to significant technological challenges. Now we are confident that they will succeed. While there may still be questions about timing, we believe both will work effectively. Therefore, we are integrating them into our core operations, making them part of our title segment. We will no longer disclose the margin impact from Endpoint and Sequoia, as we think it is fairer for investors to evaluate us based on our overall performance, including those programs. Furthermore, since they are now integrated into our core operations, it has become more challenging to track them as standalone entities.

Bose George, Analyst

That makes sense. I'm just trying to think about the benefits that will arise once they are rolled out and the old platforms are shut down. It's difficult to quantify right now, but there will be a benefit at the end of this process.

Mark Seaton, CEO

There's no doubt about it, Bose. Previously, we've discussed the impact, which has been approximately 100 basis points. You don't invest 100 basis points without expecting a return that exceeds that amount. There are several ways to achieve value. Firstly, we are currently supporting two different systems. For both Endpoints and Sequoia, we still have our legacy system in operation while the new systems show a lot of potential but currently handle very little volume. Therefore, we're effectively paying for technology on two fronts right now. Eventually, we'll transition fully to the new systems, which will lead to savings by decommissioning the old systems. Secondly, we're enthusiastic about the fact that the new system will significantly enhance productivity, which we are confident will materialize. Lastly, I truly believe we can capture market share in both of those products. While gaining market share in our industry is challenging, there are compelling reasons to think that more customers will prefer doing business with First American due to our modern platform. I see three distinct avenues for value creation that will develop gradually over time, resulting in observable incremental improvements.

Bose George, Analyst

Okay, that's helpful. Regarding the order count, the default and the other line item has increased significantly again. Are these clients allocating product, or could you clarify what's happening there?

Mark Seaton, CEO

I would just say that among all our order counts, we analyze purchases, commercial transactions, refinances, and what you are referring to as other. We have noticed an uptick in default activity. It exists, but I wouldn't categorize it as significant, and it really doesn’t constitute a major aspect of our business at this time, yet we have observed it. It's not necessarily all about foreclosures; there may be some foreclosures involved, but much of it relates to the loss mitigation work we perform for certain alternative products.

Operator, Operator

The next question comes from the line of Geoffrey Dunn with Dowling & Partners.

Geoffrey Dunn, Analyst

Mark, back on Sequoia, it doesn't seem like there's a demand for instantaneous title. So it really sounds like it's more about efficiency gains. But then obviously, you have political pressure picking up every so often according to the cost of title. So as you think about the longer-term profile of the business, is this just naturally where the business is evolving to, and maybe you struggle to keep those gains? Or do you think that there's something more sustainable in those efficiency gains over time?

Mark Seaton, CEO

I believe there are several points to address, Jeff. First, I want to ensure I answer your questions thoroughly; if I miss anything, please feel free to reach out. Regarding Sequoia, I respectfully disagree with the notion that there isn't demand for instant title. From my conversations with customers and our sales team, it's clear that they see instant title for purchase transactions as significant. We're committed to testing this out. Even if it turns out to not be beneficial, we're transforming a labor-intensive product into a data-centric one, providing us with greater flexibility and the ability to innovate new offerings. This should offer us an advantage, especially on the agency side, where a lower production cost can create a competitive edge. When it comes to title waivers and their sustainability, it's important to remember that we operate in the title insurance sector, not the title waiver sector. We have a responsibility to protect consumers and lenders while maintaining affordable pricing. The discussions around the title waiver pilot are notable, but I believe title insurance will remain essential. Our industry must prioritize what is best for consumers by safeguarding their property rights while ensuring affordability. We'll observe how the market evolves, but with Sequoia, we gain significant strategic flexibility moving forward as we gradually roll it out.

Geoffrey Dunn, Analyst

Okay. And then I thought it was interesting, you brought up AI directly in your press release, you mentioned again on the call. Can you give some examples of how you're using AI? And I guess, in particular, how much is AI coming into play with your kind of living title initiatives?

Mark Seaton, CEO

It's a significant development for both Endpoint and Sequoia, which has generated a lot of inquiries during this call. We're dedicating substantial internal discussions to it. Initially, we launched those initiatives without AI, aiming to modernize the title production and settlement processes. However, over the past 6 to 12 months, the emergence of AI models has shifted our approach. Now, both Endpoint and Sequoia are built as AI-native platforms, integrating AI at their core, which will enhance our products beyond what we could have achieved previously. We're employing both a top-down and a bottom-up strategy for utilizing AI. Recently, we rolled out ChatGPT enterprise to all 19,000 employees, which I'm eager to see the results from. We have examples of retaining customers thanks to AI, minimizing risks, and discovering innovative ways to optimize our processes. While we may not see immediate, dramatic improvements in margins due to AI, I believe that over time, we'll gradually enhance our efficiency as our company adapts to these new technologies.

Geoffrey Dunn, Analyst

Okay. And then just specifically to the living title efforts, is AI a big part of that?

Mark Seaton, CEO

It is, yes...

Geoffrey Dunn, Analyst

Or is that still...

Mark Seaton, CEO

No, the living title is AI. I could provide more details on this, but when I think of Sequoia now, it's an AI-driven product that is producing an automated title commitment for refinances today and purchases tomorrow using AI.

Operator, Operator

The next question comes from the line of Mark DeVries with Deutsche Bank.

Mark DeVries, Analyst

Looks like you only purchased about 20,000 shares after you reported 2Q results. Is there any color you can provide on why you pulled back and what you need to see to get more active?

Matthew Wajner, CFO

Mark, thank you for your question. This is Matt. We are still focused on returning excess capital to our shareholders. In the last quarter, we increased our dividend and, as you pointed out, also bought back some shares, totaling $122 million this year. However, we have paused our buyback program for now to assess how things progress and to consider if there are better uses for our capital. We are continuously reviewing this and will buy back shares when the right opportunity arises.

Mark DeVries, Analyst

Okay. It looks like you ended up delevering a little bit in the quarter. Could you just kind of discuss the range of debt-to-capital ratios you'll look to operate in and kind of where you'd expect to get more aggressive on using excess capital?

Matthew Wajner, CFO

Yes. Over the long term, we aim for a debt-to-capital ratio of 20%. Currently, we're slightly above that at 22.5%. We're comfortable with this level because we're in the lower part of the market cycle. Having a higher debt-to-capital ratio is acceptable for us right now. As we generated earnings, our capital naturally increased, moving from about 23% to 22.5%. We're satisfied with our current position. As the market improves and the cycle turns, we plan to return to the 20% target over time.

Mark DeVries, Analyst

Okay. And are you guys seeing more of potential interest on the M&A front that could be a use of some of that excess?

Mark Seaton, CEO

Yes, we are. We are seeing it. When the market initially fell in the first half of 2022, I think we were really hopeful that there would be acquisitions and deals to do. And we just really didn't see much. And over the last couple of years, we've really kind of leaned into the buyback, and we felt really good about that. But now there are more things that are coming across our desk. And so we'll see if those deals close or what happens, but they're both on the title side and the non-title side. And there's just more opportunities today than there have been in the last couple of years.

Mark DeVries, Analyst

Yes, it makes sense. I mean, is it fair to say that some of the weakness in the residential side is creating more and more pressure from potential sellers at this point?

Mark Seaton, CEO

Yes, we're seeing that. We're definitely seeing that. So we're disciplined. I mean I would just say just on the M&A side, too, Mark, is we don't feel like we have to do anything. We're not just trying to grow for the sake of growing. The deal has to make sense and it has to be strategic, and we have to make sure we have a good expected outcome in terms of the financials. So if we don't do any deals, we're fine with that. But we do think what we know, there's just more and more opportunities that are rising because the sluggish market has lasted a long time. And I think more and more people are calling us now.

Operator, Operator

The next question will come again from the line of Mark Hughes with Truist Securities.

Mark Hughes, Analyst

Yes. Mark, you'd mentioned the title waiver; you're proposing a title solution. Anything new on the regulatory front, either on the demonstration project or maybe even on the rate front at the various states, anything new?

Mark Seaton, CEO

There's been no update since last quarter. The title waiver pilot is ongoing, and we're just observing to see how that develops. On the state issues, there's also nothing new to report. The most significant topic remains the Texas rate situation, which was mentioned in the last call. The industry anticipates a 6.2% rate cut in Texas in March. While this isn't finalized yet and there is another hearing ahead, that's the expectation we have internally. This is probably the most noteworthy information regarding rates, but again, it's the same update from our previous call.

Mark Hughes, Analyst

Yes. And then when we think about net investment income for 2026, any early thoughts there?

Matthew Wajner, CFO

Yes, Mark. Looking ahead to 2026, the anticipated challenges for investment income include expected interest rate cuts, along with a cut we’ve already experienced this year. To remind you, each 25 basis point rate cut affects us by $15 million annually. Therefore, each rate cut will decrease investment income by around $15 million based on our current balances. For next year, potential offsets that could help include growth in all key markets, especially commercial and moderate growth in purchases. If we see an increase in transaction levels and volumes, we can expect growth in deposit balances, leading to a higher balance rate. Additionally, towards the end of Q3, we implemented operational enhancements at our bank, allowing us to manage 1031 exchange deposits internally rather than relying on third-party banks. This improvement will enhance the economic value of those deposits and should provide a positive influence as we move into next year, potentially offsetting the impact of rate cuts.

Mark Hughes, Analyst

And just a follow-up on that. So is the kind of takeaway message, the balances, the operational enhancements maybe offsetting the rate cuts and so therefore, kind of a more stable outlook for '26?

Matthew Wajner, CFO

I'd say it's too early to say, right? And it's dependent on the level of activity and the level of rate cuts. But right now, where we sit, we would probably see investment income being down year-over-year.

Operator, Operator

Thank you. There are no additional questions at this time, and this will conclude this morning's call. We'd like to remind listeners today 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 13756641. The company would like to thank you for your participation. This concludes today's conference call. You may now disconnect.