Fidelity National Financial, Inc. Q3 FY2023 Earnings Call

Ladies and gentlemen, good morning, and welcome to the Fidelity National Financial, Inc. Third Quarter 2023 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. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Lisa Foxworthy-Parker, SVP, Investor and External Relations. Please go ahead.

Great. Thanks, operator, and welcome, everyone. Joining me today are Mike Nolan, Chief Executive Officer; and Tony Park, Chief Financial Officer. We look forward to addressing your questions following our prepared remarks. Chris Blunt, F&G's CEO; and Wendy Young, F&G's CFO, will join us for the Q&A portion of today's call. Today's earnings call may include forward-looking statements and projections under the Private Securities Litigation Reform Act which do not guarantee future events or performance. We do not undertake any duty to revise or update such statements to reflect new information, subsequent events, or changes in strategy. Please refer to our most recent quarterly and annual reports and other SEC filings for a discussion of the factors that could cause actual results to differ materially from those expressed or implied. This morning's discussion also includes non-GAAP financial measures that we believe may be meaningful to investors. Non-GAAP measures have been reconciled to GAAP where required in accordance with SEC rules within our earnings materials available on the Company's website. Yesterday, we issued a press release, which is also available on our website. Today's call is being recorded and will be available for webcast replay at fnf.com. It will also be available through telephone replay beginning today at 3:00 p.m. Eastern Time through November 15, 2023. And now, I'll turn the call over to our CEO, Mike Nolan.

Thank you, Lisa, and good morning. Overall, we've had a strong quarter despite the tough market. Starting with our title business, we delivered adjusted pretax earnings of $311 million in an industry-leading adjusted pretax title margin of 16.2%. This is an outstanding result, especially given that U.S. mortgage rates have advanced to multi-decade highs recently peaking at over 8% in October, which is the highest level since November of 2000. In turn, this is keeping a lid on residential purchase applications, which have decreased to their lowest level since 1995, almost three decades ago. As a result, we continue to be focused on managing expenses and have reduced staffing and operating expenses this year. As of September 30, our total field operations employee count has been reduced by about 13% over the past 12 months. This has generated about $70 million in run rate personnel cost savings in the third quarter as compared to the third quarter of 2022. We have also reduced our direct title office locations from approximately 1,400 to below 1,300, generating about $1 million per month in expense savings. Commercial volumes are trending in line with our expectations. We have generated commercial revenue of $263 million in the third quarter and $767 million in the first nine months, putting us on track for $1 billion for the full year and in line with levels seen in more normal years like 2015 to 2019. Looking at sequential volumes more closely, daily purchase orders opened were down 7% from the second quarter of 2023 and down 8% for the month of October versus September, in line with seasonal expectations and down 2% for the month of October versus the prior year and refinance orders opened per day were down 8% from the second quarter of 2023, up 2% for the month of October versus September and down 13% for the month of October versus the prior year. Our total commercial orders opened were 779 per day, flat for the third quarter versus the second quarter of 2023, down 7% for the month of October versus September and down 4% for the month of October versus the prior year. Overall, total orders opened averaged 5,000 per day in the third quarter with 5,300 in July and 4,900 in both August and September. For the month of October, total orders opened were 4,600 per day, down 6% versus September. While we are pleased with our continued strong performance in profitability, we remain cautious as we anticipate order volumes at or near historic lows as we close out the year and enter the first quarter, which in turn is expected to pressure industry margins much like last year. As always, we will manage our business to the trend in open orders to protect our profitability. Beyond the near-term pressures, we remain bullish on the mid- to long-term fundamentals of the real estate market. A clear benefit of our financial strength, scale, and profitability is our ability to continue to strategically build and expand our title business by investing in technology, recruiting talent, and making acquisitions, which we have continued to do while maintaining industry-leading margins. Turning to our F&G business, we are pleased to see investor recognition of F&G's success as its market capitalization has increased from $2.4 billion at the time of the partial spinoff last December to approximately $4 billion. F&G recently held an Investor Day on October 3, which provided a deep dive into the Company's proven track record of growth and highlighted strategic levers that the team is employing to create value for stakeholders and which will benefit F&G as its majority shareholder. To recap, F&G's future potential upside is from three areas; first, sustainable asset growth from its retail and pension risk transfer growth strategies; next, margin expansion from investment opportunities, effectively managing operating expenses for operational scale benefit and incremental fee-based earnings from flow reinsurance and owned distribution. And finally, we believe there is potential for F&G's share price to more fully reflect its core business performance and the accretive nature of its flow reinsurance and owned distribution strategies as they scale over time. For the current quarter, F&G has profitably grown its assets under management for flow reinsurance to a record $53 billion at September 30 and now comprises 31% of FNF's adjusted net earnings. I'd like to wrap up by thanking all our employees for delivering another industry-leading performance this quarter despite the market headwinds. This is a seasoned team that knows how to prudently manage through tough cycles while continuing to invest in the business to take advantage of opportunities for longer-term growth. With that, let me now turn the call over to Tony Park to review FNF's third quarter financial highlights.

Thank you, Mike. Starting with our consolidated results, we generated $2.8 billion in total revenue in the third quarter. Third quarter net earnings were $426 million, including net recognized losses of $356 million versus net earnings of $362 million including $230 million of net recognized losses in the third quarter of 2022. The Title segment contributed net earnings of $185 million, the F&G segment contributed $259 million, and the Corporate segment had a net loss of $18 million. The net recognized gains and losses in each period are primarily due to mark-to-market accounting treatment of equity and preferred stock securities, whether the securities were disposed of in the quarter will continue to be held in our investment portfolio. Excluding net recognized gains and losses, our total revenue was $3.1 billion as compared with $3.4 billion in the third quarter of 2022. Adjusted net earnings from continuing operations was $333 million or $1.23 per diluted share compared with $272 million or $0.99 per share for the third quarter of 2022. The Title segment contributed $245 million. The F&G segment contributed $102 million and the Corporate segment had an adjusted net loss of $14 million. Turning to Q3 financial highlights specific to the Title segment, our Title segment generated $1.9 billion in total revenue in the third quarter, excluding net recognized losses of $46 million, compared with $2.3 billion in the third quarter of 2022. Direct premiums decreased by 24% versus the third quarter of 2022. Agency premiums decreased by 25% and escrow title-related and other fees decreased by 7% versus the prior year. Personnel costs decreased by 10% and other operating expenses decreased by 16%. All in, the title business generated adjusted pretax title earnings of $311 million and a 16.2% adjusted pretax title margin for the quarter versus 17.1% in the prior year quarter. Our title and corporate investment portfolio totaled $5 billion at September 30. Interest and investment income in the title and corporate segments of $108 million increased $37 million as compared with the prior year quarter, primarily due to higher income from our 1031 exchange business and cash and short-term investments. Looking ahead to 2024, we expect interest and investment income to moderate in the $95 million to $100 million quarterly range with gradually declining 1031 exchange balances and spreads and assuming level cash and short-term investment balances. Our title claims paid of $69 million were $12 million higher than our provision of $57 million for the third quarter. The carried reserve for title claim losses is approximately $81 million or 4.8% above the actuary central estimate. We continue to provide for title claims at 4.5% of total title premiums. Next, turning to Q3 financial highlights specific to the F&G segment. F&G hosted its earnings call earlier this morning and provided a thorough update, so I will focus on the key highlights of its quarterly performance. F&G reported gross sales of $2.8 billion in the third quarter, down 3% from the prior year quarter. This reflects lower retail channel sales, offset by higher institutional market sales. Coming off record sales in the first half of the year, retail sales were intentionally lower in the quarter as F&G finalized its reinsurance agreements and enhanced product features to position for a strong finish to 2023 and create momentum for 2024. Within this market environment, F&G has seen a sharp increase in submitted annuity premium in September and October, which is expected to provide a strong growth trajectory for annuity sales in the fourth quarter. F&G's net sales retained were $2.3 billion in the third quarter, in line with the prior year quarter. In addition, and as expected, F&G has increased flow reinsurance to 90% of MYGA sales in September of 2023. As a reminder, F&G utilizes flow reinsurance, which provides a lower capital requirement on ceded new business while allocating capital to the highest returning retained business. This enhances cash flow, provides fee-based earnings and is accretive to F&G's returns. F&G has profitably grown its retained assets under management to a record $47 billion at September 30. Assets under management before flow reinsurance were $53 billion adjusting for the approximately $6 billion of cumulative net business ceded. Adjusted net earnings for the F&G segment were $102 million in the third quarter. This includes alternative investment returns below our long-term expectations by $24 million or $0.09 per share. Let me wrap up with a few thoughts on capital and liquidity. We remain focused on ensuring a balanced capital allocation strategy as we navigate the current environment. We ended the quarter with $949 million in cash and short-term liquid investments at the holding company level, which has remained relatively steady since year-end despite the effect of market headwinds and historical low volumes in the title business. FNF's consolidated debt-to-capitalization ratio, excluding AOCI, was 27.7% as of September 30. This is in line with our long-term target range of 20% to 30%, and we expect that our balance sheet will naturally delever as a result of growth in shareholders' equity, excluding AOCI. Going forward, our consolidated annual interest expense on debt outstanding is approximately $175 million, comprised of approximately $80 million for FNF's holding company debt and $95 million for F&G segment debt. Following a record level of share repurchases in 2021 and 2022 at a total combined cost of $1 billion. We have prudently moderated our repurchase volume in the first nine months of this year to preserve financial flexibility through the multi-decade low volumes of this market cycle. Therefore, there were no share repurchases in the third quarter and only $4 million of share repurchases in the first nine months of the year. During the third quarter, we paid common dividends of $0.45 per share for a total of $123 million. We continue to view our current annual common dividend of approximately $500 million as sustainable. This concludes our prepared remarks, and let me now turn the call back to our operator for questions.

Our first question is from Soham Bhonsle with BTIG. Please go ahead.

Hope you're doing well. So first one on title margin. The 16.2% this quarter and one of the toughest mortgage environment that's pretty impressive. And I know you've historically talked about 15% to 20% as normalized. But is there a reason that, that can't be higher? Should we be thinking about a range that's different now? And maybe could you just talk through some of the puts and takes there?

Yes. I think right now, we wouldn't talk about a different range. We're still in a very volatile environment with rates at 7.5% and low inventory volumes historically, but certainly very pleased with the margin performance in the third quarter and just the work of our employees in the field to continue to take care of customers, recruit and manage expenses. And I think if you look at the third quarter to the second quarter, it's really that expense discipline and then a little pickup in some of our non-title businesses like subservicing that allowed us to pull a little bit stronger margin from the second quarter. But I think we need to get past this volatile market to really think about talking about an annualized margin greater than 15% to 20%.

Yes. I mean, keep in mind, the 15% to 20% is an annual number. And certainly, the last couple of quarters, we've been in that range. But you recall from last year, the fourth quarter gets more challenging when inventories come down and then the first quarter even more so. So when you talk about the whole year, you're still not there. We're still in a tough environment.

Yes. And I think to add on to that, in the short term, so we remain cautious on margins for the fourth quarter and first quarter. Our open inventory levels are similar to what we saw going into the fourth quarter last year. And you saw how margins were pressured as we got through the fourth and first quarters. But kind of to your point, we're very confident that as the market returns, we're well positioned to drive margins given this cost structure we have and more importantly, the industry-leading scale that we have. So, we think as rates moderate and this market returns, we'll be able to produce very strong margins. But we kind of got to get through these next couple of quarters.

Got it. Okay. That makes sense. The performance of F&G continues to be very strong. However, one of the concerns we hear is the lack of liquidity in the stock. I understand there is an 80% ownership threshold that you may want to maintain. Could you discuss some of the considerations for a potential equity raise? It seems that the business could benefit from additional capital to accelerate its strategy and capitalize on opportunities. This could also be a way to gradually reduce FNF's ownership, potentially helping to unlock the multiple. Any thoughts on this would be appreciated.

Yes, you raise some valid points. Clearly, liquidity is a challenge, and you might notice some volatility in the share price as a result. F&G is performing very well, as you have likely seen from their results. Their margins are strong, and they are generating about $800 million in cash flow from their existing business and reinvesting that into new opportunities, which are abundant. Ultimately, they will need more equity to continue their growth. We'll have to see how that unfolds, and Chris might have additional insights. We do want to ensure that FNF maintains its ownership above 80% so we have the option to utilize F&G's assets tax-free in the future if the Board chooses to go that route. There are ways to raise equity while maintaining that ownership level. We're currently at 85%, so there's some flexibility. Chris, do you have anything else to add?

No, other than it's now about roughly 18 months until the five-year mark. And so yes, just related to your potential tax-free spin comment.

Our next question is from Mark Hughes with Truist Securities. Please go ahead.

When considering the margin, looking at the transition from the third quarter to the fourth quarter, in both 2020 and 2021, the margins remained fairly stable between these quarters. However, last year saw a more significant decline. How do you assess the transition this year from the third quarter to the fourth quarter, especially in light of the orders you're receiving and the headcount changes?

We are not providing a specific margin guidance, Mark, but I would suggest looking at last year's results since the inventory levels are quite similar. We expect fewer resale closings, similar to last year, and possibly a slight decrease in refinancing, with commercial activity being unpredictable for fourth quarter closings. Given the current inventory levels, I anticipate a challenging quarter. Additionally, the agency revenue mix this quarter could negatively impact margins due to generally lower gross margins. Moreover, fluctuations in non-title businesses within the title segment may also affect margins to some extent. Overall, the industry is experiencing very low inventory levels, which will likely contribute to downward pressure on margins in the short term.

Understood. And then I'm sorry if this came up on the F&G call earlier today, but the Department of Labor, proposing maybe some new rules around fixed indexed annuities. Chris, any impact on that?

Yes. Honestly, I don't believe it's going to have any significant effect. It's essentially a slightly different version of the same rule we've been dealing with for years, showing a lot of similarities to the best interest rule from the NAIC. If the margin could introduce a bit more compliance and oversight costs in the independent channel, we're still evaluating it. However, nothing seems particularly concerning for our business, even in the independent agent channel, which accounts for about 20% of our total sales as we have grown and expanded. I think the IMOs through which we conduct most of our business are very well positioned. They are sophisticated firms with many now having their own RIAs and broker-dealers, and they are competing by providing various value-added services. While I won't express my opinion on whether this is needed, I will say that I am not particularly worried about it.

I think you just did editorialize.

We're going to have us doing that.

Our next question is from John Campbell with Stephens Inc. Please go ahead.

Nice work in the quarter. No problem. On the October order count that was a clear positive in RI is just kind of across the board. It seems like things are turning ever so slightly, and that's impressive given you've got obviously, the 8% backdrop with mortgage rates. Two-part question here. First, on the purchase side, I mean both you guys and First American are, I think, showing clearly better trends than what's kind of been implied out there in the market, I mean, both from the industry forecasters and we look at the MBA weekly apps. I mean the thing there is that's based on the number of mortgages, right? I saw this morning the stat that I think cash sales rose to like 34% of the mix. That was up versus 29% last year. So I guess the question is, are you guys seeing maybe a little bit of deviations from what others might be seeing out there in the market due to rising cash flows? And if that's the case, is there any meaningful impact to fee per file on the purchase side?

Yes, that's a great question, John. It's Mike. We don't specifically track cash sales, although I have heard that the field might be experiencing a slight increase in that area. However, our October purchase orders decreased by 7% sequentially, which is quite normal for this season. Looking back at the third quarter, rates increased significantly, possibly by 60 to 80 basis points during that period. I honestly expected a larger decline considering the rate changes. So, I do think there's some outperformance happening, and cash sales may play a role in that, but I'm not certain.

I want to add something about the fee per file. On the purchase side, we've seen an increase of around 3% compared to Q3 of last year, which was a bit unexpected. I thought the trend would be down as we moved into Q4 and the first quarter, but then it started to rise again. This has likely surprised many, considering that home prices have largely kept their value. There may have been a slight decrease from Q2 to Q3, but overall, they have been holding up quite well so far.

It's a great point. For the last one and a half to two years, we've all been faced with unexpected negative developments. So, it's encouraging to see things starting to turn around. As for refinancing, that's no longer a significant factor, and I'm hesitant to focus on it too much. However, the 2% sequential gain is noteworthy, especially given the higher interest rates. Are you feeling that we're at a definitive low point right now? Would you say that even a slight decrease in rates could potentially lead us back to growth in refinancing?

I tend to agree with you, John, when looking at our refinancing open orders. On average, we've seen 1,012 per day this year through October, and we recorded 966 in October. It's been relatively consistent throughout the year, despite significant fluctuations in rates. It seems like we might be at a low point. Regarding your point about lower rates leading to increased volumes, I completely agree. It may take time for rates to decrease enough to create refinancing opportunities. Historically, the last time rates hit 8% was in 2000, leading to a small refinance market of around $250 billion. In 2003, when rates dropped to 6%, the refinance market surged to $2.5 trillion. While I’m not suggesting that this will happen again, it illustrates how the refinancing market can grow over time as rates decline.

And in terms of revenue, refi as a percentage of our direct revenue is like 5% right now, and that's been pretty consistent. It was 5% last quarter and 6% in Q1 and 6% in the fourth quarter. And 7% in the third quarter of last year and so, it's just flat-lining at very low levels.

Our next question is from Bose George with KBW. Please proceed.

Tony, I wanted to go back to your guidance on investment income. I mean, you noted that the 1031 balances are likely to moderate. I'm just wondering, is that volume-driven? Or are there other factors that caused that to moderate even if volumes are flat or it looks like maybe even starting to head back up.

Yes, it's more of a forecast than anything else. To be cautious, especially when predicting investment income for the next year, we expect that as regular order counts decrease, the 1031 accounts will likely decline as well. The balances have remained consistently around $4.5 billion throughout the year, and that hasn’t changed yet. However, we anticipate a decline. We earn approximately 400 basis points on those balances, so if they decrease, you'll see that reflected in earnings. I would expect a potential decline in quarterly income of around $10 million as we enter 2024.

Okay. That's helpful. Actually, can you remind me, what's the split of the 1031 balances between residential and commercial?

That's a good question. Mike, do you remember that? My recollection is that it was more residential than I thought. In terms of numbers, it was about 70% residential, but regarding balances...

I don't remember. I think we have to get back to you on that one. But we have the number, both, but I don't have it handy.

Yes, I don't either. It's been a while probably been a year that you looked at it.

I would say this it's probably more residential than you think in terms of the order flow.

Okay. No, that's helpful. And then just one broader question. Just with the recent lawsuits against the realtors and potential change in the commission structure there, especially for the buy-side agents. Just curious what your thoughts are about what that could do with the landscape there changes.

Yes, it's Mike. I think it's really hard to predict at this point. Obviously, there was a significant ruling against a couple of the companies involved, and they will be appealing. This process will likely take some time. It could potentially affect buy-side agents, but from our perspective, it probably won't have a major impact on our business. We believe that real estate agents provide immense value in transactions and will continue to play a vital role. They are trusted intermediaries within local communities for people buying and selling homes, and I think that will persist. We also expect to maintain a close working relationship with the real estate community.

Our next question is from John Campbell with Stephens Inc. Please go ahead.

I have a quick follow-up. I want to revisit the title escrow and other line. Over the past few quarters, that segment has performed significantly better than the direct premiums. Recently, the gap has widened further. I understand that this includes subservicing and warranty revenue, which contributes to some recurring subscription revenue. Additionally, TitlePoint appears to be included in that as well. Could you elaborate on that and also provide some insight into how TitlePoint has impacted margins?

Yes, John, this is Tony. Yes, footnote, Jay and revenue recognition footnote in the 10-Q helps to break this out a little bit. But you're right, you named the primary pieces. First of all, escrow fees are in there, and they tend to trend with direct title premiums, but they've held up better than direct title premiums. And I think that's a combination of maybe commercial coming off a little bit more and commercial has a lower percentage of escrow fees. That could be part of it. I think also sometimes you just have a flat escrow fee. And so, if you have a transaction size that's down, then the direct premium will come down accordingly, but there may be a base to that escrow fee because I think escrow fees were only down about 12%, whereas direct premiums were down about 24%. So that's part of it. And then loan care, which is loan subservicing was actually up in Q3, up against last year's third quarter, so that was a positive. Home warranty is in there as well. It was down a little bit, but maybe not the same percentage as what we saw on the title side. And then ServiceLink has some different businesses in there, some default businesses and other, and it was fairly stable versus what we saw on the title side. In terms of TitlePoint, yes, it is in there as well. I don't have off the top of my head what the margins are. I think our revenue increase in property insight, which includes TitlePoint, revenue was up about $5 million as compared with Q3 of last year, but I don't have that margin. My guess is somewhere in the 20% range if I had to guess, but that can be a follow-up.

As there are no further questions, I would now hand the conference over to Mike Nolan, CEO, for closing comments.

Thank you. We are proud of our very strong performance in the first nine months of the year. We remain well positioned to navigate the current tough market cycle and continue to build and expand our title business for the long term. Likewise, F&G's profitable growth demonstrates its strong momentum with many opportunities ahead to drive asset growth, deliver margin expansion and generate accretive returns. Thanks for your time this morning. We appreciate your interest in FNF and look forward to updating you on our fourth quarter earnings call.

Thank you. The conference of Fidelity National Financial, Inc. has now concluded. Thank you for your participation. You may disconnect your lines.