Earnings Call Transcript - FNF Q2 2020

Operator, Operator

Good morning, ladies and gentlemen, and welcome to the FNF 2020 Second Quarter Earnings Call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions with instructions to follow at that time. As a reminder, this conference is being recorded. I would now like to turn the conference over to Jamie Lillis, Investor Relations for FNF. Please go ahead, sir.

Jamie Lillis, Investor Relations

Thank you, operator, and good morning. Thank you for joining our second quarter 2020 earnings conference call. Joining me today is our CEO, Randy Quirk; President, Mike Nolan; CFO, Tony Park; and F&G's CEO, Chris Blunt. We'll begin with a brief strategic overview from Randy. Mike will review the title business. Chris will review F&G and Tony will finish with a review of the financial highlights. We'll then open the call for your questions and finish with some concluding remarks from Randy. But before we begin, I would like to remind you that this conference call may contain forward-looking statements that involve a number of risks and uncertainties, in particular the COVID-19 pandemic. There is significant uncertainty about the duration and extent of the impact of this pandemic. Statements that are not historical facts, including statements about our expectations, hopes, intentions, or strategies regarding the future, are forward-looking statements. Forward-looking statements are based on management's beliefs, as well as assumptions made by and information currently available to management at the time of this call. Because such statements are based on expectations as to future financial and operating results and are not statements of fact, actual results may differ materially from those projected. We undertake no obligation to update any forward-looking statements whether as a result of new information, future events, or otherwise. The risks and uncertainties that forward-looking statements are subject to include, but are not limited to, the risks and other factors detailed in our press release dated yesterday and in the statement regarding forward-looking information, risk factors, and other sections of the company's Form 10-K and other filings with the SEC. This conference call will be available for replay via webcast at our website at fnf.com. It will also be available through phone replay beginning at 3:00 P.M. Eastern Time today through August 12. The replay number is 844-512-2921 and the access code is 13706371. Let me now turn the call over to our CEO, Randy.

Randy Quirk, CEO

Thank you, Jamie. I would like to start by thanking our employees for their hard work as they have continued to keep our operations running smoothly even as approximately 70% have continued to work remotely as a result of the COVID-19 pandemic. Our first priority remains the safety and health of our people during these challenging times, and I'm very proud of their efforts. I will let Mike go into more detail on the title business momentarily. Touching on the highlights of our title business, in the second quarter we generated adjusted pre-tax title earnings of $378 million compared with $363 million in the comparable year-ago quarter and an 18.4% adjusted pre-tax title margin compared with 17.7% in the second quarter of 2019. We are also pleased to announce that last week we purchased the remaining 21% interest in ServiceLink for $90 million, which gives us full ownership in the leading provider of centralized, residential refinance title and closing and default management services, as well as the second-largest loan subservicer in the industry. Turning to our acquisition of FGL Holdings. After three years as a minority holder in F&G, we closed our acquisition on June 1, 2020, in a cash and equity deal valued at approximately $2.7 billion at closing. We are excited to welcome the F&G employees and policyholders into the FNF family. F&G had strong sales for the quarter, and as a result of the acquisition, F&G was recently upgraded by multiple rating agencies and achieved a major distribution milestone by successfully expanding into the financial institutions channel. We continue to expect the transaction to be more than 10% accretive on a pro forma basis to FNF's 2020 earnings per share and 20% accretive on a pro forma basis to FNF's 2021 earnings per share. Looking forward, our commitment to creating meaningful long-term value for our shareholders through our capital allocation strategy is unwavering. We announced in late July our quarterly cash dividend of $0.33 per share, which reflects a fourth-quarter dividend increase of 6.5%. Our share buyback was previously suspended due to the F&G acquisition and the uncertain COVID-19 outlook. We continue to watch the economy and the COVID-19 pandemic closely as we evaluate share buybacks. Let me now turn the call over to Mike Nolan to discuss the title insurance business in more detail.

Mike Nolan, President

Thank you, Randy. We generated strong adjusted pre-tax title earnings of $378 million, a 4% increase over the second quarter of 2019. Our adjusted pre-tax title margin was 18.4%, a 70 basis point increase over the prior year. We had a 36% increase in direct orders closed, driven by a 158% increase in daily refinance orders closed, offset by a 24% decrease in daily purchase orders closed and a 24% decrease in total commercial orders closed. Total commercial revenue was $184 million compared with the year-ago quarter of $286 million due to the 24% decrease in closed orders and a 14% decline in total commercial fee per file. For the second quarter, total orders opened averaged 10,800 per day with April at 9,500, May at 10,900, and June at 12,000. For July, total orders opened were over 13,200 per day, as we continue to see a strong recovery in purchase activity and continued strength in the refinance market. Daily purchase orders opened in April were down by 43% versus the prior year period, while May was down 16%, and June was down less than 1% versus the prior period. For July, daily purchase orders opened were up 10% versus the prior year. Refinance orders opened increased by 111% on a daily basis versus the second quarter of 2019. For July, daily refinance orders opened were up 116% versus the prior year. Lastly, total commercial orders opened decreased by 25% over the second quarter of 2019. On a positive note, we experienced steady improvement in commercial opened orders per day during the quarter from April's low, with total commercial opened orders per day up 10% from April to May and up 12% from May to June. For July, total commercial opened orders per day were up 16% over June and up 10% over July of 2019. While we are very encouraged by our second quarter volumes, it remains difficult to forecast the rise of COVID-19 cases and the resultant impact on the residential and commercial real estate markets. Fortunately, our team has significant experience operating through challenging times, and through our investments in technology, we have been able to tactically keep our business operating as usual for our clients and partners while maintaining a tight grasp on our expense structure. To that end, we made the difficult decision to reduce staffing by approximately 3,100 employees at the end of the first quarter and the early part of April. We continue to monitor the market and have since added approximately 1,100 employees in June and July as order volumes increased. We will continue to aggressively manage our expenses through the second half of 2020, given the uncertain market backdrop, and will remain focused on order volumes looking forward as we maintain our culture of expense discipline. Let me now turn the call over to Chris Blunt to review F&G's second quarter highlights.

Chris Blunt, CEO of F&G

Great. Thanks, Mike. F&G had a record level of fixed index annuity sales of $866 million in the second quarter in a period when industry annuity sales declined materially, and several of our direct competitors chose to reduce volume. Our solid capital position and investment management capabilities through our partnership with Blackstone allowed us to outpace industry sales trends and continue to take market share while maintaining our pricing discipline. We successfully expanded into the financial institutions channel in late June by partnering with one of the largest independent broker-dealers in the country. We are off to a strong start and are excited about the prospects for this new channel. For the quarter, total product net investment spread was 350 basis points, up 124 basis points over the prior year and net investment spread for fixed indexed annuities or FIA was up 347 basis points, up 63 basis points over the prior year. Each was boosted by merger impacts on adjusted investment yield. The adjusted investment yield of 5.42% reflects merger and purchase accounting effects, primarily from changes to average assets under management or AAUM. Adjusted yield, excluding these effects, was 4.55%, roughly in line with F&G's full-year 2019 historical yield of approximately 4.50%. AAUM was reduced by $2.3 billion for discontinued operations and the recognition of a $500 million unrealized loss on the investment portfolio that was marked to market at the time of the merger. As of June 30, the portfolio was in a net unrealized gain position of $600 million. Finally, as it relates to capital, F&G finished the second quarter with an estimated risk-based capital or RBC ratio of about 400% for our primary operating subsidiary compared to 425% at the end of the first quarter of 2020. The RBC decline in the current quarter reflects a planned return of capital to the holding company for normal course liquidity needs as well as investment-related mark-to-market and credit drift. Let me now turn the call over to Tony Park to review FNF's second quarter financial highlights.

Tony Park, CFO

Thank you, Chris. We generated $2.4 billion in total revenue in the second quarter, with the title segment producing $2.2 billion, F&G producing $124 million, and the corporate segment generating $72 million. Second quarter net earnings were $309 million, which include net realized gains of $162 million versus net realized gains of $41 million in the second quarter of 2019, primarily due to mark-to-market accounting treatment of equity and preferred stock securities, whether those securities were disposed of in the quarter or continued to be held in our investment portfolio. Excluding net realized gains, our total revenue was $2.3 billion as compared with $2.1 billion in the second quarter of 2019. Adjusted net earnings from continuing operations were $305 million or $1.09 per diluted share. The title segment contributed $276 million, F&G contributed $37 million, and the corporate and other segment had an adjusted net loss of $8 million. Excluding net realized gains of $169 million, our title segment generated $2.1 billion in total revenue for the second quarter, a slight increase from the second quarter of 2019. Direct premiums decreased by 8% versus the second quarter of 2019. Agency revenue grew by 4% and escrow, title-related and other fees increased by 7% versus the prior year. Personnel costs decreased by 4% and other operating expenses were relatively flat. All in, the title business generated an 18.4% adjusted pre-tax title margin, a 70 basis point increase versus the very strong second quarter of 2019. Interest income in the title and corporate segments of $41 million declined $18 million as compared with the prior year quarter, due to the reduction of short-term interest rates and the use of cash to fund the F&G acquisition. In late April, we signed a credit agreement for a $1 billion, 364-day delayed draw term loan. This term loan allowed us to secure financing to close the acquisition of F&G in a challenging capital markets environment brought on by COVID-19. In June, when the capital markets improved, we closed on an issuance of $650 million of 3.4% senior notes due June 15, 2030. The net proceeds of the issuance of the notes have been used to repay approximately $640 million of principal amount borrowed under the term loan credit agreement. Total FNF debt outstanding was $2.4 billion on June 30, for a debt-to-capital ratio of 27%. Our title claims paid $51 million were $10 million lower than our provision of $61 million for the second quarter. Carried title reserve for claim losses is currently $52 million or 3.5% above the actuary's central estimate. We continue to provide for title claims at 4.5% of total title premiums. Finally, our title investment portfolio totaled $4.4 billion at June 30. Included in the $4.4 billion are fixed maturity and preferred securities of $2.4 billion with an average duration of 3.5 years and an average rating of A2, equity securities of $700 million, short-term and other investments of $300 million, and cash of $1 billion. We ended the quarter with over $500 million in cash and short-term liquid investments at the holding company level. Let me now turn the call back to our operator to allow for any questions.

Operator, Operator

Our first question today is from Mark DeVries of Barclays. Please proceed with your question.

Mark DeVries, Analyst

Yes, thank you. Mike, could you repeat what the commercial trends were year-over-year in July? And also just talk about what you're seeing in terms of closing rate on open orders in commercial and the mix whether it's kind of local or national and larger transactions versus smaller?

Mike Nolan, President

Yes. Sure, Mark. Great question. So the July number was 10% up over July of 2019. And also in the opening remarks, just really referenced the sequential improvement that we've seen off of April lows with July being up 16% from June and really just that sequential growth has gotten better May over April June over May July over June. In terms of the mix, when it fell – and we talked about this before, the falloff was stronger in national fell and local but less. And then as sequential improvement was coming back in May and June it was kind of stronger in local and a little bit less in national. But that really turned around in July, and one of the most encouraging things I think that we can report is the July opens were up 27% on the national side over June and local was up 11%. So we just saw a really big comeback, if you will, in our national opens in July. And for both national orders and our overall orders in July we're now back to pre-pandemic levels. And that's very positive because remember that pre-pandemic levels were really record levels in this now six-year enhanced commercial performance. You also asked about the mix. The other thing we've seen when the pandemic hit, we saw a pretty shift on the open side from re-sales at about 68%, 69% of the opens falling down to about 59%. And as we've gotten into June and July, it's really reverted back to where we were. We're opening 67%, 68% on the resale side versus refi.

Mark DeVries, Analyst

Okay. That's really helpful. And then the second question I think you guys indicated you still expect 10% accretion from F&G in 2020 and 20% in 2021. Maybe Tony could you give us a little more context around that though, in light of probably the stronger outlook for FNF than you had when you first provided that maybe improving outlook at F&G and also just the financing of that term loan at a lower cost than I think you initially assumed?

Tony Park, CFO

Thank you, Mark. The numbers remain consistent. The 10% expectation may have decreased slightly from the teens due to FNF's performance, which has been stronger than we anticipated about 90 days ago. Looking ahead for the rest of the year, we feel confident about FNF's performance across all markets, which is positive but does create some pressure on the accretion number for 2020. Nevertheless, I still feel optimistic about achieving the 10% accretion as F&G's results are stable and we expect this to continue throughout the year. We were pleased to secure a 3.4% 10-year bond, which is lower than the 4% we initially forecasted back in February. As for the outlook for 2021, while we can't predict the future, if FNF performs well in 2020 and then moderates a bit in 2021, that wouldn't be surprising. I would expect the 20% accretion target for 2021 to increase, potentially reaching the mid-20s or higher, assuming F&G maintains consistent performance with asset growth and FNF levels off a bit.

Mark DeVries, Analyst

Great. That's very helpful. Thank you.

Operator, Operator

Next question comes from Jack Micenko of SIG. Please proceed with your question.

Jack Micenko, Analyst

Hi. Thanks for taking my question. I guess to start off, the FNF business is having a monstrous year. Commercial seems to be coming back. Sounds like F&G is outperforming a bit, I guess in that context, what's going to get you guys more constructive on share repurchase going forward? What are you looking for to sort of change your mind and get back into the share repurchase side? Thank you.

Tony Park, CFO

Yeah, Jack, this is Tony. I want to address that. I don’t think we need to change our views on share repurchase. We feel we are undervalued at the moment, but we are somewhat restricted by capital. Looking at the cash levels of the parent company, I can update you on our status today compared to the end of the quarter. We began the quarter with $1.1 billion in cash and upstreamed around $300 million from our subsidiaries. We allocated about $100 million for our common dividend, which was expected. We borrowed a net $1 billion, which was also anticipated, and we used $1.8 billion in cash for the F&G acquisition. So, we finished the quarter with about $500 million left. However, we have other cash commitments. As mentioned earlier in the call, we acquired the 21% minority interest in ServiceLink for $90 million, which we’re pleased about. We’ve always believed that should be part of our portfolio at full ownership, and we finally made that deal last week. We've also got a dissenting shareholder, a significant one, that we have yet to compensate. Assuming we pay them the same as everyone else, we owe them about $100 million in cash and one million shares. This has been accounted for, except for the cash portion, which we haven’t disbursed yet, and that’s $100 million we need to set aside. So, that's a few hundred million already allocated from the $500 million we have at the holding company at the end of the quarter. Additionally, we have $360 million in outstanding debt, some of which we left as pre-payable because we want to reduce our debt levels. We didn’t want to maintain $1 billion in long-term debt, which is why we issued a $650 million bond. As I mentioned, we have $360 million in pre-payable debt, and we would like to pay that down throughout the year or before next April when the one-year term loan matures. These are some of our cash needs, along with share repurchases, and our ability to engage in buybacks will depend on cash flow generation in the latter half of the year. I believe it will be strong, and we hope to have another opportunity to repurchase shares, which we would like to do. I hope this clarifies our cash needs.

Jack Micenko, Analyst

No. Yeah, that was helpful on the sources and uses. I guess, one for Chris. You did a 13% trailing FIA growth number year-to-year, but you are up 4% Q-to-Q and I think you spoke about some share take. So I'm wondering if you could talk about the trajectory for growth particularly in light of this new agreement that you just signed last month or I guess in June now?

Chris Blunt, CEO of F&G

Great question. To explain the 13%, the market was down significantly, and some of our closest competitors really reduced their operations, which benefitted us directly. We also had strong performance leading into the COVID environment. While sales have slowed down, they are at levels comparable to 2019, not as drastically as we initially anticipated. I mentioned in the last call that we expected our total sales to be flat or down around 8%, but the outlook is looking more positive now. We are likely to be at the higher end of that range. We're seeing a strong start in broker-dealer sales, and it’s encouraging to see our competitive capacity in action. Overall, this has exceeded our expectations for how quickly we could generate new business. I believe there is potential for increased sales for the year. Regarding scaling, we have been achieving $4 billion in sales while serving about 40% of the total market, and we have now opened up the remaining 60%.

Jack Micenko, Analyst

Okay. And then just as a follow on that last one. Is there seasonality? Is there a meaningful seasonality in the business around the sales cycle, or is it just market volatility higher or lower that they drive a quarter versus quarter performance and growth?

Chris Blunt, CEO of F&G

Yeah. There's a little bit of seasonality, but nothing material like you sometimes see a little slowdown in July and August as clients are on vacation and advisors may be taking some time off. But barring that, no, we don't see a lot of variability there.

Jack Micenko, Analyst

Okay. Thanks. Thanks for taking the question, guys.

Operator, Operator

The next question comes from Bose George of KBW. Please proceed with your question.

Bose George, Analyst

Hey guys, good afternoon. I wanted to ask about the margin outlook for the third quarter. It seems like purchase is stronger, commercial is stronger, and refi is at least as strong. Given that you achieved over 18%, do you think the margin in the third quarter could be just as good or potentially even better? Any insights on that would be appreciated.

Mike Nolan, President

Yes, it's Mike. I think you're correct. When considering the various factors, we should see consistent refinance closings in the third quarter compared to the second. Resale closings in commercial are expected to be better, possibly showing moderate growth in revenue. These are all positive signs. While we will incur some additional personnel expenses, overall, we anticipate a very strong margin, equal to or possibly exceeding that of the second quarter.

Bose George, Analyst

Okay, great. Thanks. And then actually just can you remind us what the margin is at ServiceLink in the centralized refi side?

Mike Nolan, President

Yeah. We ran for the second quarter right around 36%, which is just a tremendous margin in a refinance business, really higher than our commercial margins. And I think it's just probably below that year-to-date maybe 35%.

Bose George, Analyst

Got it, okay. Thanks. And then a quick question about F&G. Without oversimplifying, is the operating income generated in this one month indicative of a good run rate, assuming all else remains equal, even if we set aside growth and credit?

Tony Park, CFO

This is Tony. I want to emphasize that we're looking at just one month, which ends a quarter, so the preferred dividends are a bit stronger in the third month of each quarter. Also, I want to point out the $37 million of adjusted after-tax earnings includes $8 million from notable items we've mentioned. There's a detailed supplement available for you to see how this breaks down. The $8 million primarily relates to SPIA mortality and bond prepayment, which we exclude from what we consider core earnings. This brings us down to $29 million. While you might think about multiplying that by three to estimate $87 million, that could be misleading due to the preferred dividends. A more accurate way to view it is that F&G has generated around $65 million in core after-tax earnings quarterly for three or four consecutive quarters. If you add back the $8 million from preferred dividends, which no longer apply since we've retired them, you arrive at $73 million. Additionally, accounting for about $10 million from positive purchase accounting activity, considering the bond accretion and the unrealized loss that will be adjusted over time, might yield a net of around $10 million, resulting in an approximate run rate of low $80 million on a quarterly basis going forward. I hope this provides clarity.

Bose George, Analyst

Yeah. That's great. Very helpful. Thanks very much.

Operator, Operator

The next question comes from John Campbell of Stephens. Please proceed with your question.

John Campbell, Analyst

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

Tony Park, CFO

Thanks, John.

Chris Blunt, CEO of F&G

Hey, John.

John Campbell, Analyst

Tony, regarding F&G, you provided an excellent overview of the income run rate. I'm curious if you could simplify the growth discussion for next year, which we've estimated at around 1% from accretion. Is it possible to translate that into a dollar amount? It seems much of that percentage will hinge on your 2021 core forecasts.

Tony Park, CFO

Chris, I may let you talk about what typically the portfolio would grow from one year to the next. Maybe you can help me out with that one.

Chris Blunt, CEO of F&G

Yes. I think for us what we've typically seen is like net asset growth in the 6%, 7% per year range and then spreads fairly consistent. We're usually able to outperform our pricing targets a bit on our spread assumptions. So we've had pretty consistent double-digit earnings growth rate. In terms of growth and accretion or how that translates into dollar-based accretion, I'd have to leave that to Tony.

John Campbell, Analyst

Okay. We can follow back up offline. But just one other question, just a little bit of out of left field for you guys, but any sense for the index inclusions after closing on F&G? I think you guys at one point were S&P 500. Is there a potential to get back – added back to that?

Tony Park, CFO

Yes. It's one of those situations where you won't know until it actually happens, and then it might occur unexpectedly. We've observed a report indicating that we are very close, if not at the top, of the S&P 500 list. When you are in an acquisition mode like we are, it makes sense to wait for things to stabilize. Given our current position and future outlook, I can certainly see them considering us seriously. However, it may depend on whether someone needs to leave before they can make a replacement. Overall, I believe we are certainly under consideration.

John Campbell, Analyst

Okay. If I could squeeze in one more here actually. On ServiceLink nice job picking up the rest of the interest there. Could you guys maybe run us back through just at a high level the ServiceLink capabilities around default and foreclosure, kind of what that revenue looks like today? It seems like with the moratorium and forbearance, like some of that's probably being paused. I think we've seen that on the Black Knight side, but just curious what you guys are seeing today and kind of how that revenue might trend kind of getting out of forbearance and foreclosure?

Mike Nolan, President

Yeah. Maybe I'll start. It's Mike, John, and then Tony can weigh in. I don't have the dollar numbers right in front of me. But with the forbearance – with the foreclosure moratorium, it certainly impacted a couple of our businesses, including our auction business and our pre-foreclosure title business. But we have other default businesses that are still running strong. And we're by far the leader in default title services. So as those moratoriums get lifted eventually, we should see improvement in those business lines. But Tony, I don't have the revenue numbers right in front of me. I don't know if you do.

Tony Park, CFO

I don't. My recollection is that, we're pretty much in trough default markets currently, just because of the strength in the economy and obviously the forbearances. So the number that we have now it might be $150 million in revenue – $150 million annualized revenue or something along those lines.

Mike Nolan, President

Tony, let me jump in, because I actually just found it. And you're kind of right on the number. Through June our default revenue was $87 million. So annualized, that's what Tony just said. And last year, at this point, we were at $104 million.

John Campbell, Analyst

Okay. And any sense on the margin? I mean, obviously it's not going to be as high as centralized refi, but it seems to be pretty accretive to title, is that right?

Mike Nolan, President

Yeah. It's different by business. But overall, we have about five or six different default businesses that we lump together. Margins are running about 14% this year on the $87 million. Last year at this time, we were at 18% on the $104 million.

John Campbell, Analyst

Very good. Thank you, guys.

Operator, Operator

There are no additional questions at this time. I would like to turn the call back to Mr. Quirk for closing comments.

Randy Quirk, CEO

While the quarter was off to a challenging start, we are very pleased with our second quarter results and the execution of our team. Due to the ongoing pandemic, which has impacted us all, we will continue to diligently watch our expense structure as we manage through the second half of the year. We remain optimistic on the recovery of the housing market, as well as F&G's ratings upgrades, which will allow them to further penetrate the bank and broker channels. This is a significant opportunity, which greatly expands their total addressable market. Additionally, we are confident in the capital and liquidity position of F&G, who remains well positioned to execute on its growth strategy. We look forward to updating you on the third quarter call and hope everyone is able to stay healthy and safe.

Operator, Operator

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.