Stewart Information Services Corp Q3 FY2021 Earnings Call

Hello and thank you for joining the Stewart Information Services Third Quarter 2021 Earnings Call. At this time, all participants are in a listen-only mode. Later, you will have the opportunity to ask a question during the question-and-answer session. Instructions will be given at that time. Please note, this call is being recorded. It is now my pleasure to turn today's conference over to Nat Otis, Head of Investor Relations. Please go ahead.

Thanks Leo. Good morning. Thank you for joining us today for Stewart’s third quarter 2021 earnings conference call. We will be discussing results that were released yesterday after the close. Joining me today are CEO Fred Eppinger and CFO David Hisey. To listen online, please go to the stewart.com website to access the link for this conference call. I will remind participants that this conference call may contain forward-looking statements that involve a number of risks and uncertainties. Because such statements are based on an expectation of future financial operating results and are not statements of fact, actual results may differ materially from those projected. The risks and uncertainties with forward-looking statements include but are not limited to the risks and other factors detailed in our press release published yesterday evening 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. Let me now turn the call over to Fred.

Thanks Nat. And thank you all for joining us for today's third quarter earnings call and for your interest in Stewart. In a minute, David will take you through the details of this quarter's financial results, but before then I'd like to discuss Stewart's operational evolution to date and the continued execution of our long-term strategy. Two years ago, we started a journey here at Stewart, a journey to become the premier title services company. We knew it would take some time, but we also knew we had a valued brand, strong balance sheet and associates that were ready and willing to make an impact. Between then and now we have navigated the dramatic impacts of the COVID-19 pandemic, as well as a historic real estate market that continues to have momentum. So where are we on the journey and what have been the main areas of focus and progress. We've made significant improvement on our operational capabilities by adding greater scale and priority markets, augmenting our core business with essential real estate technology and services and injecting new talent and energy into a 125 year old company. As I like to say, we are a 125-year-old startup. Initial goals of achieving double-digit margin have been met and exceeded albeit with the help of a very robust market. As David will discuss Stewart's operating revenues are up almost $240 million or 40% from last year. And operating income was up over $30 million or 55% in a quarter in which the Mortgage Bankers Association forecasted purchase originations down 12% year-over-year and overall mortgage originations down 25%. So we feel we are comfortably outperforming the market and creating some real value. At this stage of our journey, we can safely say much has structurally changed and improved, but we have more work to be done. Through acquisitions, we have grown scale and many critical markets where our size once hindered profitability and prevented the efficient managing of daily operations; scale and flexibility are critical in a business that is both seasonal and cyclical. We accelerated our restructuring in the midst of heavy transaction volume. We closed offices where we forecast challenges going forward and we added to markets we believe would be the centers of real estate activity in the future. On the topic of talent, we are becoming a destination for some very special talent. On the top people at Stewart, what we call our senior leadership team, 50% are new or have been promoted. Our aggressive entrepreneurial actions have attracted great talent, not just from title operations, but across the real estate services spectrum and in real estate technology. Given our investment, our commitment and nimbleness, many talented leaders have joined us. This investment and improvement in talent will support our journey for years to come. Most importantly, we have become more valuable to our customers by building ease into the customer experience. For our larger lender partners, we have technology and services that bring greater efficiency and usefulness both in the current market as well as in the more digitally transformed marketplace. Our smaller customers see the value in our ability to make their daily lives easier through tools, technology, service and security. The last component being of vital importance is wire fraud has become a critical issue for agents and the very reason we have partnered with Certified. I will leave you with a couple of thoughts. First, while our operational performance has benefited from the historic real estate market we are in, here at Stewart, we are focused on building a business that will thrive through the full real estate cycles, and also be able to take advantage when technology and digitization further transforms the closing process. We are intensely focused on driving the digital innovation required to deliver a superior closing process today and into the future. And I am confident our investments have positioned us for the current and future success. Second, while it is critical to build toward a vision of a fully automated and digitized closing process in the future, for now at its core, title insurance remains a technology-enabled but execution-driven business in which the clearing of title removes risk from customers who are ultimately making the largest purchase of their lifetime. This is a very important reality. As always, I want to thank our associates for all their hard work and congratulate them on their results. Our journey continues, and we are a quarter closer to our goal. Thank you and now David will update everyone on the results of the quarter.

Thank you, Fred and good morning. Let me also thank our associates for their amazing service and our customers for their loyal support. Although we are entering a seasonally slower real estate period, real estate markets remain strong, driven by demand and favorable interest rates. Commercial is showing good recovery, particularly in industrial, energy and multifamily. There continue to be several watch items that could impact future business performance, including federal and government policy and action, improving yet historically high mortgage delinquency and forbearance, lingering virus effects, rising inflation and slower supply chains. Consistent with our strategy in Fred’s comments, we continue to focus on the areas that will have the most meaningful and durable impact on our long-term operating performance: gaining scale in attractive direct markets, improving scale and geographic focus in agency and commercial operations, broadening and scaling lender services offerings, and throughout our business, improving service and digital capabilities to provide ease of use and better user experience. For the third quarter of 2021, Stewart yesterday reported net income of $89 million and diluted earnings per share of $3.26 and total operating revenues of $830 million. On an adjusted basis, third quarter net income was $86 million, an increase of $31 million or 55% compared to last year’s quarter as disclosed in Appendix A of the press release. The adjustments to our third quarter net income were primarily driven by a gain relating to an acquisition contingent liability adjustment. Compared to last year, total title revenues for the quarter increased $205 million or 37% due to solid results from residential agency and commercial operations. The Title segment generated pre-tax income of $119 million, which is $37 million higher than last year’s quarter as a result of this revenue growth and continued management focus. Pre-tax margin for the segment also improved 90 basis points to 15% compared to last year. With respect to our direct title business, residential revenues increased $55 million or 23% driven by higher purchase transactions and improving scale. Residential fee per file was approximately $2,400, a 24% improvement compared to last year's average fee per file due to a higher purchase mix. Domestic commercial revenues improved $28 million or 76% due to increased transaction volume and higher average fee per file, which was $15,400 versus $9,700 in last year's quarter. Total international revenues increased $17 million or 49% primarily due to improved volumes in our Canadian operations. Total open and closed orders in the third quarter decreased 13% and 3% respectively due to lower refinancing transactions consistent with the market trend. However, commercial and purchase closed orders increased 11% and 8% respectively compared to the third quarter of 2020. In line with our direct title business, agency operations generated a strong quarter with revenues improving 42% to $402 million versus $283 million last year. The agency remittance rate for the third quarter was 17.9% compared to 18.2% last year. On a year-to-date basis, it was 17.8% for both 2021 and 2020. On title losses, total title loss expense increased $2 million or 7%, primarily as a result of higher title revenues, partially offset by favorable claims experience. As a percentage of title revenues, the title loss expense in the third quarter was 4% compared to 5% in the prior year quarter. In regard to operating expenses, which consist of employee and other operating costs, total operating expenses increased primarily in relation to higher revenues. Employee costs as a percentage of operating revenues improved to 24% from 26% last year, while other operating expenses increased to 18% from 17% last year, primarily due to increased pass-through appraisal and service costs. Excluding these costs, our overall other operating expense ratio would have been similar to last year. On other matters regarding Informative Research, the transaction closed at the end of September. At that point, the company had $85 million in run-rate revenues and a 15-plus percent pre-tax margin with new customers to be onboarded and a good pipeline of future business that should grow both the top and bottom line going forward. Our financial position remains very strong to support our customers, employees and the real estate market. Our total cash and investments on the balance sheet were approximately $585 million. We had about $74 million available on our existing line of credit facility. Shareholders' equity attributable to Stewart increased to $1.2 billion at September 30, 2021 with a book value of approximately $45 a share. Lastly, net cash provided by operations for the third quarter increased to $107 million compared to $91 million from last year's quarter. We remain grateful for and inspired by our customers and associates, advocates for everyone's improved safety and prosperity, and confident in our supportive real estate markets. I'll now turn the call back over to the operator for questions.

Thank you. We'll take our first question from Bose George of KBW.

Good morning, Bose.

Good morning. Great quarter. A couple of things: first on the commercial, obviously that premium number was really high. Just curious if there's anything lumpy in there that we should think about in terms of run-rate perspective?

Hi Bose. David here. Thanks for the question. No, I think it was a strong rebound across the board with the benefit of some of the segments that I mentioned in industrial, multifamily and energy. Yes, so it was good — it's bounced back. It's starting to show stronger growth breadth-wise.

Our next question is from John Campbell with Stephens, Inc.

Hi, good morning.

Hey John. Good morning.

Hey, this is AJ Hawley stepping in for John Campbell.

Okay. Hey, AJ.

I had a quick question on Informative Research. First, is this going to be captured in the ancillary services segment? And second, what's the expected accretion potential? If you can maybe help frame up the overall revenue and potential income impact?

Yes. It will be in the ancillary segment. I think we gave some of that in my comments — $85 million run-rate revenue, 15% pre-tax margin. So you should be able to infer from that.

Yes. Okay. And then one follow-up if I may. What's your M&A appetite from here and how does that rank relative to dividends and buybacks?

So we still see significant opportunity for us. As we've said from the beginning, our assessment of the various MSAs indicates there are structural opportunities for us to enhance our economics in a number of markets. We also think there are additional capabilities and services that make sense for us to enhance our offering to the lender market. And frankly in the data area, we think there's some ability for us to continue to think about opportunities to deliver greater value to our various segments. So we are still thinking that our growth opportunity is in front of us. As far as the other capital options, you saw us a couple of quarters back increase our dividend. We think that's an appropriate thing to consider, particularly since our stock price has risen. So we will assess and consider that as well, because I do think it's important for us to continue to maintain a good yield for our shareholders. But it's growth first; right now capital for us is growth first and then the others.

Our next question is from Geoffrey Dunn of Dowling and Partners.

Good morning.

Thank you. Good morning. First, a numbers question: the residential fee per file had a pretty big jump sequentially and it doesn't seem necessarily fully supported by the mix shift or HPA, which suggests maybe geography. You've been bulking up in more MSAs, investing in certain MSAs. I'm trying to get an idea if this shift is sustainable, meaning that the geography has shifted enough that you've gotten a bump beyond just the impact of purchase/refi mix and HPA.

I don't think there's anything abnormal in the numbers. David will follow up, but for us, you're absolutely right. Our growth rate, mix and geography has shifted a little bit based on where we've grown significantly. So places like the Arizona market and the Colorado market, we have shifted and increased pretty materially. There's some stability to that geography now, but I would say the mix shift is pretty dramatic for us as far as our purchase growth versus the refi as well as price increases in most of our markets. You've seen that in our international side too, where we had a material impact from pricing increases. So again, I don't see anything abnormal or unsustainable from what we're seeing.

I think sequentially the residential was up a little around 8%, just a little under $200 a file. And I think it's really driven by the mix of everything. There was a slightly higher purchase percentage, HPI has been up, and then I think it is probably a geography thing. So when you put all that together, 8% isn't really that significant unless you're looking at some different numbers than we are.

Just to follow up, Fred, you mentioned price increases, which is not something I would be thinking about in these market conditions. What is driving your ability to increase pricing in various markets?

That's primarily an international phenomenon for us. If you look at the Canadian pricing environment, it was very robust this year — many quarters like 20% — so that has affected our revenue growth and the mix in Canada. That's really where the phenomenon has been most material.

And then I wanted to focus on Informative Research. I appreciate the numbers. I assume those are run-rate annualized numbers, David?

Correct. Those numbers were as of the date of the acquisition, which we closed at the beginning of October right after quarter end. With respect to the platform itself, a few things to consider. First, ordering is one of the first things that's done in the loan process. They also have capabilities on the analytical side, lead generation and the like. As you go into a market where business is harder to come by, those capabilities are significant. It puts you at the beginning of the process, and then when you're at the beginning of the process, it also puts you in position to order all the other services that go with a mortgage. So you're upfront and can be in a position to order appraisal services, title ordering, some of our notary services fit right in. So the numbers I gave are the business as it stands — that's how we underwrite transactions. We want businesses that we buy to stand alone. But there are certainly a number of overall benefits once it’s plugged into the Stewart network.

We believe that for us the efficiency and effectiveness of the closing process will be enhanced because of some of the things they do and the economics will be enhanced by some of the things they do. That's what we liked about them. The data they use, the platform they have, the integrations they’ve done really meet the objectives of what we’re trying to do broadly: both enhancing the process and improving the economics. And to David’s point, there are obviously some synergies between customers and opportunities in our products. So we like them very much and we do think it was an important add for the company.

But to be clear, this is a growth opportunity, not a platform that is expected to simply trend with volumes?

We would hope that it’s a growth opportunity. Yes, absolutely.

Okay. Thanks.

We have a follow-up from Bose George of KBW.

Well, on the title side it’s the same approach that we’ve been taking and we’re trying to be thoughtful by geography. Clearly we had some significant holes when we started; now, there might be more fill-ins as part of that mix. But that is the same kind of thoughtfulness we’re trying to apply. As refis drop back for us it’s easier to find the right kind of economic matches because obviously what we’re going after is more purchase business and that’s the core of the value you see more and more every day. The ancillary side for us is more selective. We don’t necessarily need more in the portfolio. As I said, there are some capabilities we’re continuing to focus on and build. A year ago we had some glaring problems and holes — we didn’t have scale in our services business and some capabilities were lacking; we really needed what we did in notary and what we did in appraisal to solidify that business. So the urgency on that side is much different than it was before. Not to say that we don’t have our eyes open for opportunities that can improve delivery to our lender clients in particular. I think we’re in a good place, but the pipeline for us is still robust. It’s part of what we’re trying to do, because very strongly, this is about consistent execution to the customer and scale allows you to get through cycles and seasonality better in a local market. As you digitize the business and move for more efficiencies in your operating model, scale helps that too. So it makes a lot of sense for us to continue down that road.

Okay. Great. Thanks.

And this does conclude our question-and-answer session. I’d be happy to return the call to our presenters for any concluding remarks.

Just want to say thank you to everybody for joining us and look forward to talking to you next quarter.

This does conclude today’s call. You may now disconnect your lines and everyone have a great day.