Stewart Information Services Corp Q4 FY2021 Earnings Call

Hello, and thank you for joining the Stewart Information Services Fourth Quarter and Full Year 2021 Earnings Call. Please note, this call is being recorded. It is now my pleasure to turn today's program over to Nat Otis, Head of Investor Relations. Please go ahead.

Thanks, Emma. Morning. Thank you for joining us today for Stewart's Fourth Quarter 2021 Earnings Conference Call. We will be discussing results of our release 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 are subject to 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.

Thank you for joining us today for Stewart's fourth quarter 2021 earnings conference call. David will take you through the quarter's financial results in a minute. But before then, I would like to touch on Stewart's 2021 results and what we see in front of us for 2022 and beyond. We are now two full years into what we call the journey to become the premier title services company. '20 and '21 were two of the best as well as the most challenging years in the title industry as a whole, given tremendous changes in the market, historically low rates and an ongoing impact and uncertainty caused by COVID. For Stewart specifically, it has been a period filled with significant change and increased focus, a focus on significant structural improvement with enhanced operating discipline and a renewed commitment to the customer experience. More remains to be done in our journey, but we are encouraged by our progress as we have materially improved from 2019 to '21. We have significantly improved in every aspect of our business and have demonstrated our ability to materially improve our margins while significantly growing our business. We are pleased with the results in all our lines this quarter across residential and commercial, where we are building a strategy to take advantage of what looks like a very positive commercial market that lies ahead. We have enhanced our core business by leveraging added scale in targeted geographies while also placing a greater focus on managing more effectively and efficiently. We have built scale in targeted services, and we continue to benefit from an influx of industry talent that see Stewart as a destination for forward-thinking leaders, offering a significant long-term opportunity. In the area of technology, we understand that the real estate transaction will continue to evolve, becoming less paper-intensive, more remote and more digital. As we have done with many of our recent transactions, we will continue to invest, when appropriate, in technologies and services that help facilitate this change, and therefore, improving the customer ease of use and experience. Though we are proud of our accomplishments to date, we recognize there is more to be done in the face of a higher interest rate environment and a further evolution of the market. The long-term outlook for the residential real estate market remains encouraging as purchase segment trends are projected to continue to be strong and demographic realities such as first-time millennial home buying add to the opportunity of an increasingly favorable mix shift. That said, our industry and our company will likely need to navigate a near-term horizon of greater interest rate uncertainty as the Fed acts more aggressively to cure inflation by taking actions that may lead to a further pullback of refinancing activity. At Stewart, we have been preparing for this market transition by reconstructing a title company that is better able to sustain the ups and downs of a full real estate cycle. A key part of building the resilient foundation is the work we continue to do to gain adequate local scale in priority markets. As part of this process, we continue to opportunistically add new title agencies and teams for our Stewart family, increasing talent and leadership in those market segments along the way. Historically, Stewart has been less weighted to refinancing volumes. And as we have grown, we have looked to acquire companies and talent that align with our view of future mix. We continue to reconstruct Stewart to be resilient under all conditions by focusing on our business mix, deeper agency relationships, additional commercial opportunities and investing in technology and operating model improvements to deliver the enhanced customer experience. Let me finish by thanking our associates for all their hard work and customers for their continued support. We are on a journey together to make the company more successful and resilient. David will now update everyone on our results.

Thank you, Fred, and good morning. Let me also thank our associates for their amazing service and our customers for their steadfast support. Although we are in a seasonally slower residential period and the market is adjusting to Fed commentary and rising rates, the residential purchase market remains active, driven by demand. Commercial real estate continues to recover, particularly in the industrial and multifamily segments. Office is increasingly active and energy is poised to benefit from continued economic recovery and environmental focus. There are several watch items that could impact future business performance, including Fed and government policy in action, improving yet historically high mortgage delinquency and forbearance, consumer pullback, a lingering virus and uncertain jobs environment, rising inflation and slow supply chains. Consistent with our strategy, we are focused 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 our agency and commercial operations, broadening our lender services offerings and, throughout our business, improving service and digital capabilities to provide seamless end-to-end user experience. During the quarter, we added Great American, Greater Illinois Devon, Homeland, Las Cruces and Rainier to key direct operations markets. Our lender services and data businesses added Informative Research and Provider Credit Data and PropStream will provide real estate data. Informative Research and PropStream provide business generation and improvement information so critical to our customers in a transitioning market. We are excited about these businesses, their possibilities and their teams and welcome them to Stewart. For the fourth quarter of 2021, Stewart yesterday reported net income of $85.5 million and diluted earnings per share of $3.12 on operating revenues of $951 million. On an adjusted basis, fourth quarter net income was $80.5 million, an improvement of $24 million or 43% compared to last year's quarter. The adjustments to our quarter net income were primarily due to net unrealized gains on equity securities investments. Compared to last year's quarter, total title revenues increased $178 million or 26% due to strong results from our residential agency and commercial operations. The Title segment generated pretax income of $118 million, which is $23 million or 25% higher as a result of increased revenues and continued management focus. Pretax margin for the segment was comparable to last year. With respect to our direct title business, domestic residential revenues increased $43 million or 18% due to higher purchase transactions and improving scale. Residential fee per file for the fourth quarter was approximately $2,700, which was 38% better than last year's quarter due to higher purchase mix. Domestic commercial revenues improved $35 million, driven by increased volume and average fee per file of $19,400. Total international revenues improved $4 million or 10% compared to last year's quarter due to increased transaction volumes in our Canadian operation. Total open and closed orders in the fourth quarter decreased 22% and 14%, respectively, primarily due to lower refinancing transactions as expected with the market trend. Our commercial and purchase closed orders increased 7% and 3%, respectively, compared to last year's quarter. Similar to our direct title operations, our agency operations generated a solid quarter with revenues of $445 million or 27% higher than last year. The average agency remittance rate during the quarter was 18%, roughly in line with last year's quarter. On title losses, total title loss expense decreased $13 million or 28% due to favorable claims experience. As a percentage of title revenues, title loss expense in the fourth quarter was 4% compared to 7% in last year's quarter, while for the year, it was 4% in 2021 compared to 5% in 2020. In regard to operating expenses, which consist of employee and other operating costs, total operating expenses increased primarily due to higher employee count, increased variable costs tied to higher revenues, state sales tax assessments and office consolidation costs. Employee costs as a percentage of operating revenues improved to 23% versus 25% last year, while other operating expenses increased to 22% from 18% last year, primarily due to the increased size of our ancillary and other real estate services operations. On other matters, we completed our $450 million senior notes offering and used the proceeds to repay outstanding credit facility borrowings and for acquisitions. To maintain liquidity flexibility, we obtained a $200 million unsecured revolving line of credit, which is fully available for future drawings. Our financial position remains on a solid foundation to support our customers and employees in the real estate market. Our total cash and investments on the balance sheet are approximately $620 million over regulatory requirements, and we have the new available line of credit facility. Stockholders' equity attributable to Stewart increased to $1.3 billion. Our book value per share was approximately $48, an increase of 27% from last year. Lastly, net cash provided by operations for 2021 was $390 million compared to net cash provided by operations of $276 million last year. We are grateful for and inspired by our customers and associates, advocates for everyone's improved safety and property, confident in our support of real estate markets. And now I'll turn it back to the operator for questions.

And our first question is coming from Bose George with KBW.

Good morning, Bose.

Just on the PropStream acquisition, I wanted to ask how we should think about accretion to earnings this quarter after the deal closed and how we should think about the increase next year.

Yes, Bose, it's David here. So, on PropStream, yes we've been thinking about that. It's about a $40 million run-rate revenue business at 40% pretax margins.

Okay, perfect. That's helpful, thanks. And then actually switching over to commercial — obviously there was a big jump in the commercial premium this quarter — anything unusual to call out there or just reflecting a very strong commercial market?

Yes, that's covered in my remarks and I think we've seen strength on the product side: multifamily and industrial, and office is coming back a little. Also a number of geographies, particularly in the Northeast — Boston and New York — really started to pick up. So yes, it's sort of across the board in product and geographies; we have a much better performance.

We have a bullish outlook on commercial, as I think others do as well. It's always lumpy for us if you have a few big ones, but we are very confident — this is a strong commercial market right now. We have also been making some investments internationally and we've got some opportunity there too. We look forward to that.

Okay, great, thanks a lot.

Our next question comes from John Campbell with Stephens Incorporated.

Congrats on a great quarter and a great year. I wanted to see if we could maybe dive into the M&A side of things for just a second. So David, if you could talk to the M&A capital deployed last year, and roughly how much of that was tied to ancillary services versus the platform build-out or against the title business. And then, Fred, maybe if you could talk to the broader strategy around the platform and as you step back from what was obviously a busy year, how much of the heavy lifting do you feel is left on that platform build-out?

Fred, go ahead.

Yes, sure, John. A lot of the activity was in the fourth quarter and throughout the year. It's probably a few hundred million in services-driven deals between PropStream and Informative Research and then, yes, I think we did about $600+ million total; the rest was on the core platform, the title agency-type activity.

Yes, I think as you look at our business, it's been a pretty interesting couple of years. We went from a $1.8 billion company to $3.3 billion, right, growing over $1.5 billion and obviously the market is good, but we've repositioned ourselves and as we've talked, we looked at all the MSAs. I would say there are still 15 or 20 MSAs where I'd like to see a material change in our share position. But it's a lot less volatile than it was, and you saw we took some additional action this quarter on some consolidations, leasing, elimination and closing some offices. There's not a lot of that left to do. But I think there is opportunity in a material way in some of our MSAs. The other point I would make is that if you look at our top 90 markets, our leadership is so much better and well positioned that we will be able to do tuck-ins in micro-geographies if it makes sense. So I think opportunities continue to be in front of us. If I use the word platform a little more broadly, we still have work on our data management, technology investments, systems work and our operating model. As far as workflows go, we're making good progress, but we still have improvements to focus on. I like the combination for us that there are opportunities to grow as well as continue to improve. In our view of the market — it's now seasonal again and it's not as good as last year — but it's going to be a very good market and our outlook for the next couple of years is that we think it could be two of the better years in history in the industry if the purchase segment holds up. There's some uncertainty coming into the first quarter, but we feel pretty good about where we are. So we have more work to be done, but I feel in a good place as we continue to move forward.

Yes, makes sense. That's helpful. I saw the office consolidation cost that you guys called out in the press release — it didn't look like you backed that out of your adjusted numbers. Is there a way to frame up, was that a meaningful cost, any kind of color there?

Yes, it was in the $5 million range. We try to improve the business when we can, so that's an example to get it ready for the longer term in the cycle.

We started—I've described it as inch deep and mile wide—and we have presence in a lot of places. Our view is that until we see clarity to winning at a local market level, we should be able to keep investing there. Most of that work is behind us, but we still have some work to do in a number of markets to gain a level of share. We feel comfortable we can deliver good service and strong margins through the cycle. So a little bit of work to do.

And last one, just if I can squeeze in one more on the reserves — it looks like they came down maybe 3.9% or so this quarter, and obviously they were down last quarter as well. Are you seeing better trends in the back half? Are you feeling better about that? Just give us an idea of how we should be thinking about that for 2022.

Yes, we've guided mid-4s. I would read that guidance the same; maybe it will be a couple of ticks higher or a couple of ticks below that mid-4s number, but I think it's a solid number. If you remember what happened during some of the turmoil, we were very thoughtful about reserves. If you look at where we are in the range, we're kind of at the most conservative point. So if things happen well, it can flow into earnings because we have been reserving quite strongly, which I think is appropriate given the uncertainty. But the mid-4s range is the right number. There's nothing material that we see that would make us take that down.

Our next question comes from Geoffrey Dunn, Dowling and Partners.

I got a few questions here. As you noted, the outlook is strong for 2022 and 2023 but you are facing seasonality for the first time in a year or two with this Q1 and you also have some rate headwinds. Can you give us an idea of how January trended for opening and closed orders and just remind us how you think about a Q1 in a typical year, since it seems like maybe it's back to the normal pattern?

Yes, we saw a continued decline a little bit in January relative to December. Since the December Fed meeting through the January Fed meeting, there was a tremendous increase in the 10-year and the mortgage rate itself. So we saw a month of negative activity and we've seen that a little bit in orders. But purchases remain strong. We probably have similar levels to last year, if not a little up, but refinances are getting hit.

You can see from the revision of our December open orders the drop, and what's interesting is that last year there was no seasonality — that was unique. To your point, I think it is back to normal. It will be a little choppy, probably in the first quarter, as we return to the normal cycle. Last year, weather was great across the country, so you didn't have to pick up anything there. I think it's going to be fine, but it's going to be less than last year. I look at the whole year and I feel really good; I think it will be a fine year but not as strong as the prior year.

All right. And on that outlook, if you erase the last two years, the MBA forecast for 2022 and 2023 seems almost ideal for title given a strong purchase market. So is success in 2022 and 2023 based on the existing forecast a double-digit margin for title?

I've said this a couple of times. Last year your same-store business was basically at 100% capacity and then you had refi on top of it. Your marginal margin in this industry is quite high when you count what you had last year. A lot of people were hired for that excess volume and ran overtime — that's getting out of the system. There are a couple of points of margin compression for everybody as that comes down. We believe we are better positioned; we think we've managed and positioned ourselves. So we believe we can maintain double-digit margins as we move forward.

And just two more here. In terms of the MS and corporate segment, can you give us a sense of run rates there? It looks like corporate might be an $8 million to $9 million run rate when you factor in a full quarter of debt expense. Then you have Informative Research around 15% margin and PropStream at 40%. If I assume the core mortgage services business is a negligible margin, is this a double-digit margin on the mortgage services operations once PropStream is integrated?

Yes. Our goal in that area is low double digits, and I think we're right on track to get there. It's a mix issue — we didn't have data-type assets and services, and that mix is enhancing a bit. We're also assembling assets, particularly around appraisal; there was important platform work we needed to do to hit our target returns. We wanted to minimize customer disruption so we carried some of that work into this year. It's going to continue into this year, but it's coming together nicely. I feel confident that business will be in the low double digits and sustain that. We've got a nice established business there and we're right on track for where we want to be.

Okay. And then just two number questions. What was holding company cash at year end? And also, I think there was $5.6 million of purchase price amortization in Q4. What's the full Q1 run rate for PropStream, including PropStream?

On the purchase accounting, Geoff, we're still finalizing all the purchase accounting. So that number is probably in the area but could go up a little once we finish everything. In terms of holdco cash, I think we are probably in the $50 million to $70 million range.

Our next question comes from Ryan Gilbert of BTIG.

First one is on competition in the title business. I'm just wondering if you had any thoughts around competitive dynamics in the fourth quarter and then what your expectations are for 2022?

I don't think there's much of a change. There are a number of competitors that are very skewed towards refi, regionally and nationally, and some actions they take will create opportunities for us around staffing and resource allocation. We're getting back to what I would consider a more normal market. The strong players will have some advantage during this time. There are challenges with this transition, but in my view it's a more normal market where local market share and your position on the purchase side will drive success. I feel pretty good about what's transpiring. Commercial is back from where it was, and that's a really good market. Larger players with capital and underwriting scale have a huge advantage there. Getting back to a more normal mix market is still very attractive and creates opportunities for those with size and scale.

Second question on refinance volume: down 30% in the quarter, and it looked like open orders were maybe closer to down 40%. That's better than what I was expecting, and I think the market may be closer to down 60%. Do you feel like you picked up share in refi in the quarter? Or are there any specific dynamics around refinance that benefited Stewart relative to the market overall?

That's a great question. We have less refi exposure than anyone in the top six or seven competitors. We didn't focus historically on a centralized offering. We don't have a lot of the national agents that drive refi. We have great relationships, but compared to national agents, we've been a weaker player historically because of some ease-of-use questions a couple of years ago. Our mix of refi is more distributed — more in direct offices and part of our overall business — versus the huge national agents dedicated to it. We don't have a big centralized title operation, so there might be a lag here for some reasons. I'm not sure we're immune to the trends in refi; because it is a smaller part of our business, it's a less meaningful change to our revenue stream. It's an interesting observation; I would anticipate the market is down in the 50s and we're planning for declines in that general area.

Look, Ryan, we're not as big on the West Coast or in California. The other guys are a lot bigger in California, and that's a big refi market.

That's very true.

Okay. Got it. That's really helpful. Last one for me, just a point of clarification. I think you mentioned there was some uncertainty in 1Q '22. Is that just a function of the increase in mortgage rates that we've seen year to date or are there any other areas of uncertainty?

I think that's the main question. Everyone uses the same forecasts. We're comfortable this is going to be a pretty good year. But if something happens beyond that because of inflation, that could change things a bit. That's why there's some uncertainty. The rest of it seems to be on track with our views. We feel this could be a very good year for us and for the industry, particularly for those that are purchase-focused.

That does conclude the question and answer session. I'll turn the program back over to Fred for closing remarks.

Again, I want to thank everybody for joining us on our Stewart fourth quarter call. Thank you so much for your interest.

This does conclude today's program. Thank you for your participation. You may disconnect at any time.