Stewart Information Services Corp Q1 FY2022 Earnings Call

Hello, and thank you for joining the Stewart Information Services First Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. Later, you will have an opportunity to ask questions during the question-and-answer session. Please note, this call is being recorded. It is now my pleasure to turn today's program over to Mr. Nat Otis, Head of Investor Relations. Sir, please go ahead.

Great. Thank you. Thank you for joining us today for Stewart's First Quarter 2022 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 First Quarter 2022 Earnings Conference Call. David will go over the quarterly financial results in a minute. But before that, I'd like to touch on a little bit of the big picture. Over the past two years, much of the work here at Stewart has centered around initiating and carrying out a structural retooling of the company's operations to position ourselves better on our journey to what we call becoming the premier title service company. The goal has always been to create a sustainable business that would succeed through all types of real estate cycles and economic conditions. We focused on improving margins, growth and our resiliency. We did this by improving our scale, our operational capabilities and our financial discipline. I would add that, during this time, we also focused on enhancing the customer experience through technology investments that have meaningfully changed our ease of use in our agency, lender and direct businesses. I believe the first quarter demonstrates that we have made significant progress on our journey. It was not long ago that Stewart consistently lost money in the first quarter. In 2022, even as the market normalized, we delivered record results. The backdrop of rising interest rates, normal seasonality and uncertainty of the spring selling season is weighing on the start of '22. But this is the market environment we've been preparing for. The expectation has always been that today's market would be different than 2021 and '23 will be different than '22. And we will be prepared for each of these, as we continue our efforts to build a better and more resilient Stewart. I say this for two important reasons. First and foremost, we are confident in our ability to manage in this transitional period and remain bullish on the long-term prospects for the markets we operate in. Second, it is important to understand that just because the market has transitioned, our journey continues. We remain laser-focused on strengthening the foundational tenet of our structural improvement, attaining meaningful scale in priority markets aided by leading technology support and innovation to help drive superior and consistent service delivery to our customers. We have taken great strides in addressing a lack of scale in various markets over the last couple of years. On the direct side, we have executed more than 20 regional title transactions and added significant bench strength and talent. We have changed market presence in Arizona, Illinois, Michigan, Texas, California, Colorado and Washington to our advantage, just to name a few. In addition, in markets that we determined adequate scale could not be accomplished without excess investment, we simply closed or sold operations often to an agent partner. On the agency side, we've invested in technology and services that provide greater connectivity, ease of use and risk reduction for our agent partners. As the industry accelerates, the implementation of online and paperless transactions we are there to help support our agents as they undergo this critical transition. We believe our opportunity to grow scale in our growth markets and improve our shelf space with winning independent agents is just beginning. Why is this so important? Why does how the scale of one MSA translate into Stewart becoming the winning title services company and increasing shareholder value? Let me briefly explain. As in all industries, customers are the lifeblood of success and growth, maybe more so in title insurance, as we make our money on each real estate transaction with no recurring revenue stream. Industry volumes vary by quarter given all of the reasons we have just discussed. So delivering great consistent service, while matching resources to revenues in a disciplined way, is the special sauce in our industry. Historically, Stewart has been subscale in many of the key markets, both in direct and from an agency standpoint. “An inch deep and a mile wide” is a phrase I often use. This places significant pressure on our local people and operations as order activity fluctuates. An office of four people acting by themselves can't ramp up quickly enough to take advantage as volumes increase, negatively impacting customer service. Conversely, when order activity wanes, business goes elsewhere because of inconsistent customer service through the cycle, while profitability also dips due to the lack of operational levers to pull. This is why scale in our priority MSAs is the building block of our success and why we will continue to opportunistically look for core title acquisitions that match our profile as well as work to add technologies and services that help deepen our agency partnerships and increase share with winning agents in our target markets. We have made great progress over the past few years as we used our MSA market assessments to help guide us and bolster our operations. Clearly, more work needs to be done, but we will continue to grow and enhance our competitive position in each market. Even with the changing market conditions we believe opportunities will continue to arise to build share in our target markets allowing us to profitably grow throughout the cycle. Let me just finish by reiterating my positive long-term view of the real estate market and ability at Stewart to become the premier title services company. I would also like to thank our associates for all their hard work and our customers for their continued support. David, will now update everyone on the results.

Thank you, Fred, and good morning. Let me also thank our associates for their amazing service and our customers for their trusted support. As we enter the traditional home buying season and with the recent increases in 30-year mortgage rates to the 5% area, the residential and commercial real estate markets are moving to more traditional, seasonal and economic influences. Residential real estate markets continue to see demand driven by favorable demographics and the importance of home. Commercial real estate is seeing activity across most asset classes: industrial, multifamily, office and retail, with energy poised to benefit from needed supply and environmental focus. There are several watch items that could impact future business performance including Fed and government policy in action, particularly with moderating inflation, an uncertain consumer and jobs environment, and the impact of global conflict on supply chains, particularly food and energy. As Fred noted, we are focused on managing our business in 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 and deepening lender service offerings, and throughout our business improving service and digital capabilities to provide seamless end-to-end user experience. For the first quarter, Stewart reported net income of $58 million and diluted earnings per share of $2.11 on total revenues of $853 million. As disclosed in Appendix A of the press release, adjusted net income for the first quarter was $56 million, which was 8% higher compared to last year's quarter. The adjustments to our first quarter net income were primarily related to net unrealized gains on equity securities investments. As mentioned in our press release, we revised the presentation of our operating segments effective in the first quarter to reflect the total segment. The increased size of our real estate solutions operations, which were previously combined with our corporate operations, warrants disclosure as a separate segment. Our Corporate and Other segment includes primarily corporate operations while Title remained substantially unchanged. Total Title revenues for the quarter increased $97 million or 15% compared to last year's quarter, primarily due to improved results from our agency and commercial operations. The segment's pre-tax income improved to $83 million, which was $6 million or 7% higher than last year's quarter. Title pre-tax margin for the first quarter this year was 11.4% compared to 12.2% last year, primarily due to the effect of significantly lower refinancing volume and investments we are making in the segment to improve Title production and Title data. With respect to our direct operations, domestic commercial revenues improved $27 million, driven by increased transaction volume across most asset classes and a 47% higher average fee per file of $12,700 for the first quarter of 2022. Domestic residential revenues increased $4 million or 2% due to higher purchase transactions and improved scale offsetting the lower refinancing volume. Residential fee per file for the first quarter of 2022 was $2600, which was 37% better than last year's average fee per file due to the higher purchase mix. Total international revenues improved $7 million or 20% compared to last year, primarily due to increased transaction volumes in Canadian operations. Total open and closed orders in the first quarter decreased 26% and 24% respectively, primarily due to the expected lower refinancing transactions consistent with the market trend. This was partially offset by 31% and 4% higher commercial and purchase closed transactions in this year's first quarter versus last year's quarter. Our agency operations had another strong quarter, generating revenues of $404 million, which is 17% higher than last year. The average agency remittance rate slightly improved to 18.1%, compared to 17.1% in last year's quarter. On title losses, total title loss expense for the first quarter was comparable to last year's quarter as the effect of higher title revenues was offset by overall favorable claims experience. As a percent of title revenues, the title loss expense in the first quarter was 4% compared to 4.6% in the first quarter last year. In regard to operating expenses which consist of employee and other operating costs, total operating expenses increased mainly due to the increased variable costs related to revenue and higher employee count. Employee costs as a percentage of operating revenues improved to 24% from 25% last year, while other operating expenses increased to 22% from 18% last year, primarily because of the increased size of our real estate solutions operations which typically have higher other operating expenses. On other matters, our financial position provides a solid foundation to support our customers, employees in the real estate market, our total cash and investments on the balance sheet are approximately $560 million of regulatory requirements. We have a fully available $200 million line of credit facility. At the end of the quarter, stockholders' equity attributable to Stewart was approximately $1.312 billion. Our book value per share was approximately $49, an increase of 2% from December 31, 2021. Lastly, net cash provided by operations for the quarter was $35 million compared to $47 million from last year's quarter, primarily due to higher payment of operating liabilities outstanding at the end of December, partially offset by the higher net income in the quarter. We are always grateful for the support of our customers and associates. We advocate for everyone's improved safety and prosperity and are confident in our support of real estate markets. I'll now turn the call back over to the operator for questions.

And our first question will come from Bose George with KBW.

Hey everyone. Good morning. Actually first, I just wanted to ask in terms of the acquisitions that have closed recently, is the accretion from them all now fully reflected in the numbers this quarter, or is there sort of more that we should think about as we model?

Yeah. Well, we did close a lot as David stated here. We did close a lot in the fourth quarter. So I think we're still seeing the full effect of those come online. And then, we still have our integrations and finishing on the acquisition accounting. So, I think it's fair that there's still some movement coming this year. We obviously did such a big amount in the fourth quarter.

Okay. And regarding the movement, we should still expect some level of accretion in terms of additional revenues and expenses.

Right, I mean we don't have like a number of them closed during the quarter as an example. So we don't have even a full quarter of activity for some of them.

Yeah.

Yeah.

Okay, okay, great. And so then, actually the release mentioned the real estate brokerage acquisition which was subsequently sold. Was that something that you guys had mentioned before? I just don't recall that.

No. So I don't think we mentioned it. I mean, this was just an opportunity to facilitate a transaction for an owner of a title agency and that's what we did. So we haven't really mentioned that before.

Okay, great, that makes sense. Thanks. Can you talk about commercial and purchase trends in the second quarter?

Yeah. I mean, I think we're seeing the effects of what most people are seeing in commercial right as the economy opened over the last year. You've really started to see improvement across all the asset classes. I think some of the industry information Real Capital Analytics put out a report that first quarter sales activity was quite high across the asset classes. And we're seeing that pretty much throughout the assets and the country. You even have New York opening up a bit now as well.

It's been broad-based on the commercial side for us. As we've mentioned in previous calls, we are quite optimistic about commercial moving forward.

Okay. That's great. Thanks a lot.

Great. Thanks.

Thank you. And our next question comes from Geoffrey Dunn with Dowling & Partners.

Good morning.

Good morning. Fred, you've mentioned that you have completed 20 regional acquisitions. Could you provide an example of how increased scale in MSA has impacted profitability in a specific location, such as Illinois where you have made a couple of acquisitions?

Yeah.

How is it that you can provide us with some numbers around this?

Yeah…

…scale building does for you?

In Southern Colorado, specifically Colorado Springs, we started as a small operation with a marginal contribution in the 5% to 6% range. Initially, we struggled during the first quarter due to seasonality and low volume, which limited our ability to adjust resources and caused us to lose talent to competitors. Now, we are the leading player in the purchase market in Colorado Springs, which has greatly increased our stability. This has led to improved employee retention and our margins have risen thanks to better management through seasonal cycles. We've also enhanced our business operations by focusing on centralization and improving operational efficiency. The business has transformed from underperforming to consistently superior, allowing us to pursue strategic acquisitions in smaller areas and gain immediate advantages. Our access to data has become more cost-effective with higher volume, and our market reach has enabled easier access to necessary resources. For context, in retail banking, having a significant share of local deposits changes the margins positively, and the same concept applies in our industry. Achieving around a 10% market share boosts both margin stability and growth potential. We've also ensured consistency in service delivery, which is crucial for managing cycles effectively. With a larger workforce, the ability to mitigate downturns is significantly enhanced. We analyze each market to identify leaders and determine the best competitive strategies, whether through agency or direct channels. Our approach involves strategic positioning within these markets. While some resources may be challenging to acquire, we target them strategically. Overall, we've made substantial improvements through operational efficiencies as well as growth strategies. I'm optimistic about our progress, though I believe there's room for further growth.

Okay. And then just a follow-up on M&A. I think up till even a month or two ago we were hearing that companies were still trying to sell themselves off of 2021 results. Are you seeing more sellers come into the market right now and more rational valuations, or is it still in a transition period and potential sellers hanging on to 2021 type of expectations?

Yes. I think it's a mix of all. But people understand the market is different and have adjusted. I mean for the most part it has adjusted. And one of the things that drove the prior market was some of these new entrants that were trying to create revenue that bought a lot of these refi shops that create and it kind of clouded valuations a little bit because they were silly at some level not the big players not the more traditional players, but there were some others. All of that stuff is out of the system, right? And there was some financial buyers because of how attracted the market – and that's out of the system. So what you have there in my view is a more rational conversation. Now the good operations are still – depending on your margin you work different things based on how well you run, etc. And there are some that still have inflated use of value. And so transactions don't happen. But my view is realism of where we are is absolutely started is in the market. And so again for us it's different. This is not something you just do for a quarter. This is – a lot of the transactions that occur now is stuff that we started talking to two years ago. I mean, this is about really building relationships and understanding what the opportunities are and being focused on the right match and the right people. So I'd like to your point, it's a good question. I think the valuations will be appropriate, right?

All right. Thanks, Fred.

Yes. Thank you.

Thank you. Our next question comes from John Campbell with Stephens.

Good morning, John.

Good morning. This is A.J. Hayes stepping in for John today.

Hi, A.J.

Hey, guys. A quick question here. I know you guys are definitely still got an appetite for M&A, but with the stock pullback I think you guys are also getting a pretty good price to buy some of the company here. So how are you thinking about the balance of the two during this current environment here?

Yes. For us the best use of our capital continues to be to build our business in my view and that's kind of what we're focused on. We've obviously been – we did a dividend increase and we'll try to be thoughtful for our shareholders to make sure we're providing that as well. But right now, our focus has been continuing to build our business. And as you know, every transaction we've done essentially in the title space has been accretive and been helpful. And so that's kind of been our focus and will continue to be a focus here in the short to medium term.

Okay. I have a follow-up question. It's been some time since we've discussed this, and things may have changed with recent acquisitions. Can you provide an update on your cost structure, specifically the breakdown between fixed and variable costs for salaries and operating expenses? Additionally, how do you plan to safeguard margins if there is a decline in overall originations?

Yes. Let me address the second point. Over the past 2.5 years, we've taken significant steps. When we began this journey, we were at a 4%. We are careful about how we manage our resources during this cycle and what actions are necessary to run our business effectively. We are confident that we will maintain our improved margins and continue to manage our operations thoughtfully through the cycle. We achieved this in the first quarter and have done so for the past 2.5 years, and we intend to keep it up. Regarding your other questions, I’ll let David share more details, but we are satisfied with how we are managing our overall expenses and investments. However, I want to emphasize that we will keep investing in our business. Our goal is to excel, and we are currently undertaking some interesting initiatives in product enhancements, integrations, and data management that will improve our effectiveness as a company and our cost structure moving forward. We are balancing both current investments and our operations as we always have. It’s important to manage our business and resources as we navigate the changing landscape. I want to highlight that while the current environment is uncertain, our outlook based on demographics, trends, and forecasts indicates that the next two years should still be strong for titles. We discussed the purchase levels, and we believe our market position remains relatively strong for the next few years. However, we recognize the current volatility and need to ensure effective management. David, do you have any comments?

Yes. My overall point is that while we are mindful of fixed and variable costs, we operate each business according to its specific needs, and the balance of fixed versus variable components differs significantly across businesses. For instance, in the real estate services and solution areas, we rely heavily on outside data and information that tends to be quite variable, especially given our small employee base. In contrast, our direct title operations involve more fixed costs due to facilities, scale, and geographic reach. Each business is managed in alignment with its revenue and cost structure to deliver the outcomes we've achieved. Generally, around 30 percent of our costs are fixed, while a significant portion, approximately 50 to 60 percent, is variable due to transactional costs like bonuses, premiums, and taxes, among others. This is our typical perspective on the matter.

Awesome. Thanks so much, guys.

Thank you.

Thank you. Our next question comes from Ryan Gilbert with BTIG.

Hi, good morning, Ryan.

Hi. Good morning. and thanks for taking my questions. I wanted to go back to the question on 2Q trends and I guess also your comment around the market being choppy right now. And maybe you could just drill in on how purchase and refi volumes in the residential market has trended in April. I think the big question outstanding right now for investors is the extent to which higher mortgage rates are going to ding homebuyer demand. And it doesn't seem like that's shown up in your numbers yet in 1Q 2022 with purchase volume up 4% year-over-year, but I think any color on how 2Q is trending so far would be really helpful.

Hi, Ryan. It's David here. Recently, the 30-year mortgage rate has risen above 5%, which has definitely impacted the purchase market somewhat. We're still seeing good activity, but it remains somewhat transitional. Additionally, the latest MBA application data indicates that less than 10% of all applications are adjustable-rate mortgages. There is still about a 100 basis point spread in the 4% range on a 7 or 10 one arm, which is a solid purchase product. It's early, and while there has been a slight negative impact, the market is still in transition. It's also important to note that our sensitivity is more to title premium rather than unit volume. The components of title premium include the notional value of the transaction and total transaction volume. Therefore, despite a decrease in units, the total notional balance is holding steady due to rising home prices, creating a favorable title premium environment.

Yeah. That's.

Yeah. Go ahead. I'm sorry.

I wanted to follow up on the revenue per order, which saw a significant increase in the first quarter of 2022. I believe the comparisons will become a bit more challenging as we proceed through the year. How should we evaluate your growth rate in revenue per order? Even when adjusting for mix, it seems to be rising in the mid-20s.

We could potentially see a bit more growth because in the first quarter, the mix shifted significantly towards purchases. As we approach nearly 100 percent purchase transactions, there's still some room to improve our fee per file. However, we likely won't reach the same level as last year, but there may still be some additional space for growth in fee per file.

Okay, great. Last question from me. Generally, we expect to see an improvement in pre-tax margin as we move from the first quarter to the second quarter. Do you believe that will continue to be the case this year? Also, how do you feel about achieving your goal of a double-digit pre-tax margin in 2022 considering the increased volatility we’ve observed in the market?

I believe the objective remains unchanged. We're aiming to achieve that double-digit goal throughout the year. It's still early in the quarter to determine exactly how things will develop. However, the trends that David mentioned are what we're experiencing, and we are optimistic about our ability to navigate through this.

Okay. Thanks very much.

Thank you.

Thank you. Our last question will come from Geoffrey Dunn with Dowling & Partners.

Thanks. I just wanted to follow-up with respect to again building scale and M&A. Your agency commission ratio about 82% stands out versus some of the other peers. And I'm curious, if that comes into the thought process in terms of improving overall agency profitability? And is there M&A opportunity to reduce that, or is that not the right way to be judging kind of the overall agency platforms profitability?

We are very satisfied with our net margins in the agency sector, which reflects a well-run business. However, our geographic distribution is quite distinct. Unlike our major competitors who hold significant market shares in states like Florida where the splits are more favorable, we have minimal presence there. The scale we are building is aimed at state-specific growth and increasing our share. You will often hear me mention Georgia, Florida, and Pennsylvania because of our share percentages and overall profitability in those areas. The split figures are influenced by our competitors' large positions in Florida. That said, we manage our agency business effectively, and I'm pleased with our margins. We are actively seeking growth in our state mix as there are opportunities available. Our seasonality is more pronounced compared to larger players, which is why I feel confident about our management in the first quarter. Since we don’t have a substantial presence in states like California or Florida, our primary markets are in the Northeast and Midwest, where the weather impacts our performance. Thus, there is significant potential for us to increase our share in the metropolitan areas of California and Florida. Overall, we've managed our mix effectively, and the differences in our numbers are a result of our geographic spread.

All right. That's helpful. Thank you.

Thank you.

Thank you. At this time, I would like to turn the floor back over to Mr. Otis and the presenters for any additional or closing remarks.

I'd like to thank everyone for their attention and for joining us on this quarter's earnings call. Thank you.

Thank you, ladies and gentlemen. This concludes today's conference and we appreciate your participation. You may disconnect at any time.