Stewart Information Services Corp Q3 FY2022 Earnings Call

Hello and thank you for joining the Stewart Information Services Third 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. Instructions will be given at that time. Please note today's call is being recorded. It is now my pleasure to turn the conference over to Mr. Brian Glaze, the Chief Accounting Officer. Please go ahead, sir.

Thank you for joining us today for Stewart's third quarter 2022 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. This conference call may contain forward-looking statements that involve a number of risks and uncertainties. Please refer to the company's press release and other filings with the SEC for a discussion of the risks and uncertainties that could cause our actual results to differ materially. During our call, we will discuss some non-GAAP measures. For reconciliation of these non-GAAP measures, please refer to the appendix in today's earnings release, which is available on our website at stewart.com. Let me now turn the call over to Fred.

Thank you for joining us today for Stewart's third quarter 2022 earnings conference call. David will go over the quarterly financial results in a minute, but before that, I'd like to cover our overall view of Stewart in the current market. As I discussed before, much of the efforts over the last 2.5 years have focused on fundamentally restructuring the company's operating approach to better position ourselves on our journey to becoming the premier title services company. The long-term goal has been to create a stronger and more resilient business that can perform better through all real estate cycles and economic conditions. We have focused on improving margins, growth, and resiliency by improving our scale, our operating capabilities, and our financial discipline. While the third quarter was very challenging, I am pleased with how we are managing in this rapidly changing environment. We saw our economic headwinds coming early in the year, and it is now clear that the back half of '22, likely the first half of '23 will be a very difficult environment for our industry. While we will be taking additional actions as needed to improve our structural resource allocation, we remain focused on our long-term goals in building an improved competitive position in a more efficient and effective operating model that functions well throughout the real estate cycle. We've made significant progress in improving our talent, our technology, our customer experience, and our financial models, but more work is needed to be done. The market has transitioned, as you know, to a higher interest rate environment, with rates rising at an unprecedented speed. We are currently over 7% compared to a 3% or 4% early in the year, putting significant pressure during the third quarter on housing affordability and driving a significant reduction in purchase orders as inventories remained low and home prices continued to decline. We have been preparing for this work and continue to adjust to these market changes. Consolidated adjusted margins came in just under 8% for the quarter and adjusted title margins declined to just about 10%. I am pleased with the improvements we have made to our operating structure that allowed us to remain relatively strong. Margins in our real estate services businesses remained in the mid-single digits, and our adjusted margin excluding amortization is positively above 10%. As a comparison, Stewart's pretax operating margins prior to beginning our non-restructuring journey were in the low to mid-single digits in a normal market and in low-volume quarters during difficult years. Like the first quarter, we consistently lost money. Our efforts to improve scale in our direct operations, improve our portfolio through acquisitions in real estate services, and improvements to our operating model have allowed us to strengthen our margins, particularly in challenging markets. Obviously, there will be continued pressure in this market, but we are better positioned to manage this challenge while maintaining strong customer service. I'd like to reiterate that even though the market has transitioned, our journey continues. We remain focused on investing to make structural improvements, maintaining critical scale in high-demand markets, and investing in operational improvements to improve customer service as well as reducing the cost of delivery. Our efforts to enhance the customer experience through technology investments that meaningfully change the ease of use and expand our product offerings in our agency, lender, and direct businesses made significant progress this quarter, and our efforts will continue. We are also balancing financial discipline with maintaining a high level of customer service, which Stewart is recognized for in the industry. To achieve our goal of becoming the premier title services company, we recognize that we must make thoughtful investments even in the current environment. We continue to evaluate opportunities to improve scale and target direct markets and add additional services that perform well in our existing lender services. We currently have significant capital resources available to deploy as these opportunities arise. Our recently announced acquisition of FNC Title Services is a nationally recognized provider of title services for reverse mortgage transactions and is the most recent example of our commitment to investing in the long-term growth of Stewart. I'd like to welcome the employees of FNC to our Stewart family. Regarding our direct operations, market share growth in target MSA markets remains a key strategic objective. As I have mentioned before, we closed on more than 20 regional title companies during the past two years and continue to evaluate opportunities to deploy available capital. We made significant progress this quarter integrating these acquisitions into our production and other systems, which improves the customer experience as well as the overall operating efficiency that we have been building on for the past several years. Most importantly, we are managing our businesses in a disciplined manner for both the current environment and the long-term strength of Stewart. In our agency business, we believe our opportunities to improve scale in our growth markets and improve our share with the highest quality independent agents is as strong as it's ever been. I'm pleased with the continued significant progress on our deployment of technology and services that provide better connectivity, ease of use, and risk reduction for our agent partners. As the industry accelerates the implementation of online and paperless transactions, we have identified ways to better support our agents as they undergo this critical transition. We have been investing in our commercial operations to set them up for growth as they are an important part of our overall strategy. We are optimistic regarding the commercial markets overall, although we recognize there may be some headwinds in the short term due to changing financial markets. Overall, we will manage our expenses and investments very carefully in this challenging market to ensure we are financially strong so that we can opportunistically take advantage of any opportunities that arise now or as we return to a more normal real estate market. I'll conclude by reiterating my positive long-term outlook on the real estate market and our ability to position Stewart as the premier title services company. I would also like to thank our associates for 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 trust and support. Through the home buying season, the residential market has been negatively impacted by 30-year mortgage rates now in the 7% area. Consumer sentiment has worsened due to inflation, affordability, and recession concerns. Commercial real estate began to see the impact of rates and volatile capital markets. Yesterday, Stewart reported a net income of $29 million and diluted earnings per share of $1.08 on total revenues of $716 million. After adjustments primarily from net unrealized gains and losses on equity securities and office closure and severance expenses, adjusted net income for the third quarter was $37 million or $1.37 per diluted share compared to $86 million or $3.17 per diluted share in last year's quarter. Compared with last year's quarter, total title revenues for the third quarter decreased to $120 million or 16%, primarily due to lower market activity driven by higher interest rates. The title segment's pretax income for the third quarter was $52 million compared to $119 million in the third quarter of 2021. While on an adjusted basis, the segment's pretax income was $63 million compared to $119 million in the prior year quarter. Adjusted pretax margin for the third quarter was 9.6% compared to 15.4% last year. In regard to our direct title business, domestic commercial revenues were down $4 million or 5% primarily as a result of reduced transaction size. The average fee per file was $13,700 compared to $15,400. Domestic residential revenues decreased $45 million or 18% due to lower purchase and refinance transactions. However, residential fees per file increased 12% to approximately $3,300 compared to $2,900 last year due to a higher purchase mix. Total international revenues decreased to $11 million or 20% compared to last year, primarily due to lower transaction volumes in our Canadian operations and weaker foreign currency exchange rates against the U.S. dollar. Total open and closed orders declined by 40% and 39%, respectively, primarily as a result of the elevated interest rate environment. Consistent with the softer market, the third quarter revenues from our agency operations decreased by $61 million or 15% compared to last year. The average agency remittance rate slightly decreased to 17.6% compared to 17.9% last year due to geographic mix. On title losses, total title loss expense in the quarter decreased by $5 million or 16%, primarily due to lower title revenues. As a percent of title revenues, the title loss expense was 3.9% compared with 4% last year. For the full year 2022, we anticipate our title losses will be approximately 4% of title revenues. Regarding our real estate solutions segment, pretax income increased by 21% compared to last year due to the effect of our acquisitions. Pretax margin for the third quarter was 4.8% or 13.1%, including purchase intangible amortization compared to 4.3% and 10.8%, respectively, in last year's quarter. In regard to operating expenses, which consist of including other operating costs, total operating expenses for the quarter decreased primarily due to lower revenue-related costs partially offset by higher salaries and increased employee count due to acquisitions. We incurred approximately $4 million of office closure costs and severance as we evaluate the resources needed to serve the markets. Employee costs and other operating expenses as a percentage of operating revenues was 27% versus 21% last year. On other matters, our financial position continues to provide strong support for our customers, employees of the real estate market in the current economic environment. Our total cash and investments as of September 30, 2022, approximate $457 million of the regulatory requirements, and we also have a fully available $200 million via credit facility. At the end of the third quarter, total stockholders' equity attributed to Stewart was approximately $1.34 billion, and our book value per share was approximately $50, which is 4% higher than year-end. Lastly, net cash provided by operations for the third quarter was $49 million compared to $107 million from last year's quarter, primarily due to lower net income in the quarter. We are always grateful for and inspired by our customers and associates. We advocate for everybody's improved safety and prosperity and are confident in our support of real estate markets. I'll now turn it back to the operator for questions.

Our first question comes from John Campbell with Stephens. Your line is open, please go ahead.

Good morning, John.

Hey guys, good morning. On the FNC Title acquisition, David, are the reverse mortgage orders running through other or refinance?

Well, we're going to have to look at that, John. That one was actually on October 1; none of that is reflected in any of our numbers. But they are most likely purchases. So I think we'll have to look at that presentation going forward.

Okay. So I guess picking up at a higher level, could you maybe size up expected earnings contributions and any kind of early thoughts on the accretion potential?

Yes. I mean I think that you might actually come in when we announce it. I think the way to think about that is much like some of the other title acquisitions we do. I mean this one was in the $40 million revenue and probably north of $10 million in pretax contribution.

It seems like you have a strong business. Some of your competitors have reported an adjusted EPS that excludes purchase amortization. Since you have been active in acquisitions and are likely to continue, I wanted to ask about the purchase amortization for this quarter and your expectations for it to increase next quarter with the FNC acquisition.

Yes. Well, we're going through the purchase accounting on FMC. On the title items, we typically have mainly goodwill, and so you don't see as much amortization because this would have some customers; you could see a little bit more than on traditional title deals. I think as a general matter, we're running about $30-plus million in purchase amortization. We are aware of your comment, and that's something that we're taking a hard look at probably in terms of how we might disclose that.

I think, John, it makes a lot of sense, especially in the real estate services business, if we think about it that way because it's a material part of those deals. And it's why I referred to the margin on adjusted amortization in those businesses being significantly above 10%, right? So that's what affects it for us. And we'll really need to consider more explicit disclosure there.

Yes, that would be very helpful. And then one final question. Regarding the office closures and severance costs, I noticed the $4.2 million charge. Can you provide an estimate of what the annual run rate savings will be? It seems like there might be additional access to compensation, so I would appreciate any further insights on that as well.

Yes. I mean it will be similar to that, obviously. I think we continue to reevaluate where we need to serve the markets, both from a footprint perspective on offices and then from a people perspective. And Fred, I don't know if you have any other comments.

Yes, John. For the last couple of years, I've tried to build more scale for the company because we were pretty spread out and subscale. We've been sprinting at that; we've made tremendous progress, as we saw from the numbers and how much money we made in the first quarter now and stuff like that. We're now a much better and stronger company, but there were certain offices that I think are in attractive markets and locations, and we gave it a shot to try to build those scales. I just looked at the outlook for the next couple of years, and we made the decision to say with a few of these, we'll cut back. I think we've done most of the office work. We have a couple of places that we're considering because we have potential transactions to change the profile, but I don't see a lot of office closures ahead of us unless, again, we did some kind of transaction that we have redundancy, etc. But again, as you know, our whole premise is that if we can get our scale at the MSA level and we can get the scale of the real estate services business, we can manage through the cycle more effectively. So that's why we made the call on a couple of those. I didn't see where we could get there as well as we wanted to be.

Okay, all very helpful. Thank you, guys.

Yeah.

We'll go next to Geoffrey Dunn with Dowling & Partners.

Thanks, good morning. I have a few questions. First, I wanted to dig into the title expenses. Whether it's sequential or year-over-year, your personnel costs came down but obviously lagged the revenue decline, which is typical as you adjust to the market, but was a little more surprising was operating expenses, even trying to back out the charge looked like they might have been flat sequentially. So is there something going on in that line that maybe there's a lag effect there? Are the acquisitions a bit of a challenge? And or are you maybe thinking about the longer run and maybe not cutting expenses as aggressively as you might normally if you were in that structural position you wanted to be? So can you just maybe elaborate on what's going on in those lines a little bit more?

Yes, Geoff, it's David. On the personnel side, I think your later comment is likely correct. We're trying to balance our service capabilities with a rapidly changing market, so there may be a slight lag in response. Regarding other operating expenses, we plan to thoroughly review all aspects similar to our approach when entering the pandemic. We have travel and promotional costs, where there might be opportunities for savings. However, most of that figure is due to third-party expenses, particularly for data and other services in our real estate business. With ongoing acquisitions, expenses are not decreasing significantly, as there are year-over-year revenue increases in some areas. Nonetheless, we will certainly assess all those expenses comprehensively.

That's a great question. My perspective on this issue is twofold. Regarding the lag, we are intentionally trying to catch up. In the centralized title sector, when the market contracts, lenders often reduce their panel. It's crucial for us to maintain our service metrics, and we believe we have a competitive edge with all our major customers, which is vital for us now and in the future as the market rebounds. We've made some deliberate choices to delay certain actions, and this applies to various offices as well. For instance, one noteworthy aspect of this quarter was that in August, we experienced a slight decrease in rates, and our orders spiked a bit, followed by a rapid decline from five to seven, which was a significant drop. This fast change impacted our order volume quickly. Additionally, our close rate for orders was also significantly affected in that same timeframe, with some offices seeing their workload shrink from 70 to 50 rapidly. We're trying to keep up with that shrinkage and need to be mindful of how we respond to these changes. On other matters, I want to reiterate that we have invested around $20 million this year into significant enhancements such as data management and various integrations. We are also centralizing some processes to help reduce delivery costs. We acquired a company in India to realign our service offerings. We have several ongoing investments that will benefit us in the long term, though these may initially seem incremental since we were slightly behind in some areas. I'm confident in how we are managing costs, though we are indeed lagging behind. We've implemented numerous actions, and more will be needed. Regarding margins, I want to emphasize that we are experiencing a once-in-a-generation event. The decline has been quite significant, so we must be thoughtful in our actions to ensure we are prepared for when the market rebounds. Based on our experience, we need to navigate through this period effectively, and I believe we will. Overall, I see strength in our position; I can analyze our profits and losses office by office, including how we manage our cost categories, and we simply need to ensure we stay vigilant.

Okay. And then to follow up on I want to ask about commercial. You did note that you're starting to see some impact from the increase in rates and obviously, I think we saw the average deal size come down year-over-year. Can you elaborate a little bit more on what you're seeing today in the commercial market and the implications for the pipeline, not only into Q4 but into '23? I think we're still on track for potentially a record year, but it's more about what's coming down the pipe here. Can you talk about what you're seeing today and what the implications you think at this point are for next year?

We are optimistic about the commercial sector overall. However, there has been some pause and revaluation in the financial aspects, which affects the economics of many commercial projects. As a result, there could be some retrading, delays, or hold-ups in certain projects. Despite this, we are seeing a strong order flow. We believe that the commercial segment will remain robust over the next few years, although it may experience some fluctuations as companies restructure. We are also actively making strategic investments; for instance, we've recently added a team and expanded into the Northwest. This situation creates opportunities for us amid some disruptions faced by our competitors. Given our strong position, we are well-prepared to capitalize on this if we maintain our focus. Overall, we have a positive outlook on the market, and as you noted, our performance this year has been strong. We are in a solid position moving forward.

Yes. Just to drill on that a little bit more, Geoff, I mean it's performing obviously relatively better than it was just down just out a little bit. So I think that's what Fred's comment on it being strong. I think where we're seeing activity is in the energy space, in industrial, and apartments are also classified in commercial. So there's a lot of activity in those different segments, less so in the office. Every now and then there's a retail deal, things like that, but there's still good activity across the asset classes. We will focus on a few things more than others, but some of these deals are in the capital markets, right? Because of that volatility, it's been a little choppier, as Fred said.

So maybe there’s a paraphrase: softening in the near term, but no red flag downturn sides?

Yes. And again, I would say exactly. And I would say for us, it's still a major focus for growth. I mean, for us, it’s a place where we're investing in capability because again, it’s – people will run to strength during this kind of cycle. The bigger players who have more skills will have advantages here.

Okay, all right, thank you.

And with no other questions holding, I'd like to turn the conference back to management for any additional or closing comments.

I just want to thank everybody for their attention today and for giving us your time as we went through the quarter. So thank you so much. I appreciate it.

And that will conclude today's program. We thank you for your participation. You may disconnect at this time.