Stewart Information Services Corp Q3 FY2023 Earnings Call

Hello, and thank you for joining the Stewart Information Services Third Quarter 2023 Earnings Call. Please note today's call is being recorded. It is now my pleasure to turn today's conference over to Brian Glaze, Chief Accounting Officer. Please go ahead, sir.

Thank you for joining us today for Stewart's Third Quarter 2023 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 2023 Earnings Conference Call. Yesterday, we released financial results for the quarter and David will review these in a minute. Before doing so, I'd like to update you on our view of the market and our continued progress on important initiatives that we believe will set Stewart up for long-term success. This quarter, we are proud to celebrate 130 years of business as a pioneer in the title industry and also coming up on our 30 years as a listed company on the New York Stock Exchange. These milestones caused me to reflect on the last 4 years. Looking back, I see that we have made great strides in fundamentally improving Stewart's operating and financial performance to better position ourselves for an even more prosperous future. Although the current economic environment continues to pose significant short-term challenges, we have materially improved our business, creating a strong and more resilient enterprise that will thrive over a full real estate cycle. Even in light of the current economic environment, we continue to intensely focus on our journey to become the premier title service company. We are managing through a challenging environment where we believe mortgage rates will remain elevated into 2024, with rates increasing throughout the third quarter to around 7.5%, having been previously in the high 6% range at the close of the second quarter. Higher mortgage rates continue to impact transaction volumes, and we find ourselves at historic lows for the sale of existing homes. At an industry level, we are experiencing historically low purchase volumes combined with low existing home listing inventory, which has kept pricing strong. As we look forward, we see 2024 as a transition year to a more normal market in 2025, and we believe the next 6 months will continue to be very challenging given the macroeconomics layered on top of the typical seasonal impacts. While we have significantly improved the underlying financial and operational performance of the company, there is more we can and will do. It is critical that we remain focused on improving margins, growth, and resiliency through improved scale in attractive markets and enhancing our operational capabilities. In this challenging environment, it is easy to lose focus on achieving long-term goals. However, I am extremely pleased with the dedication we have shown in making progress on our enterprise initiatives during the third quarter and in our progress towards improving our long-term performance. Maintaining our strong financial position, even in this current environment, gives us the flexibility to continue to pursue these investments and take advantage of opportunities as they arise. We have continued to manage costs thoughtfully and have taken targeted cost actions where appropriate. We have been careful not to take actions that we felt would threaten our competitive position and long-term value-creating opportunities. We believe that the real estate cycle will get to normalize later in 2024. The best path forward for Stewart to get through this period is to continue investing in our people and remaining focused on our long-term improvement plan. I believe we have done a good job of balancing strong financial discipline with targeted investments, and we will continue to be very diligent with our expense management during this difficult moment in the cycle. We remain focused on enhancing our operating model, investments in technology to enhance the customer experience, improve the efficiency of our operations, and build scale in targeted areas. These strategic investments will cause our cost ratios to remain elevated in a market with low transaction volumes but will set us up for better overall performance in the future. We believe that these long-term investments, coupled with thoughtful near-term expense management, will improve our structure and financial performance in the long term. We routinely reevaluate markets in our direct operations where we have the opportunity to increase share and enhance our leadership strength. Given the market uncertainty, we have been more selective in our investment decisions to ensure that our deployment of capital provides long-term returns, and I believe we will maintain this conservative approach through the first half of 2024. We remain positive on the commercial market, even though we believe certain sectors remain challenged in the near term due to changing financial markets; for example, energy remains strong for us while we see ongoing challenges in sectors like office and multifamily properties. Growth in all sectors of our commercial operations is an important component of our overall strategy, and positioning our commercial operations for growth across all business lines has been a key focus of our journey. We are making investments in talent so that we have the leadership in place to achieve these objectives. We are investing in technology to support our commercial operations to allow us to better serve our customers, and we believe our strategies will create long-term growth in the commercial markets for us. In our Agency business, we are leveraging our technology to drive market share gains. In both this quarter and throughout the year, we have made excellent progress on our deployment of technology and services that provide a significantly improved customer experience for our agents. This enhanced experience includes greater connectivity, ease of use, and risk reduction for our agent partners. We are pleased that our platform of services for agencies is as strong as it has ever been, and we have begun to see meaningful progress in our target markets, such as Florida and Pennsylvania, as well as the overall commercial market. In Real Estate Solutions, we are seeing share gains as we leverage our improved portfolio of services to serve our lender clients more effectively. Although we are not immune to the market downturn in these businesses, we've been able to offset some of this with our share gains. A significant point of our investments is focused on improving our technology for title production process automation and centralization to improve operational efficiencies and capabilities. Our investments have already resulted in significant progress in improving our customer experience across all channels. An example of this is the one I just mentioned regarding our agency technology platform, which significantly enhances ease of use and connectivity with agents. Another area of priority as we work to improve our operating efficiency is the centralization and digitization of our title data. We are pleased with the significant progress we have made this year in production levels, and we anticipate considerable improvement in our delivery costs. We continue to integrate our acquired entities into production and other systems. This integration helps us improve our overall customer experience and offers operating efficiencies that we've been building on for the past several years. Integrating the remaining acquired companies is an important priority, and we expect to complete the majority of our integration efforts by mid-next year. Improving our financial strength by growing margins has been a significant focus of our journey. We have made good progress with this effort, and we are aware that returns remain depressed during this phase of the cycle. The investments I've mentioned, many of which have been materially implemented, should allow us to achieve low double-digit margins as we turn to a normal 5 million unit purchase market. Specifically, the initiatives that we prioritized this year should improve margin by about 200 basis points in a normal market. While we're encouraged by improvements in talent within technology, customer experience, and our financial model, we know that work persists; the journey is not complete. We remain focused on our strategic plan of building an improved competitive position by being more efficient and having a disciplined operating model that functions well throughout all real estate cycles. We have emphasized growing scale in attractive markets across all our lines of business, and we have made great strides in improving the customer experience overall. Retaining key talent is always important. We've been even more focused on retaining talent through this market so that we have the right team in place as the cycle improves. Our efforts are yielding results: increased year-over-year market share gains in each of our direct agency, commercial, and real estate service businesses. Let me conclude by reiterating that we have been managing the balance of our expenses and investments thoughtfully, being mindful of the necessary operating discipline for the current market challenges while remaining dedicated to strengthening Stewart's long-term growth performance. Our solid financial footing should best position us to take advantage of the opportunities that this difficult cycle will provide. Finally, I remain positive on the long-term view of the real estate market and Stewart's ability to become the premier title services company. Our associates have worked diligently throughout these challenging times, and I appreciate all they have accomplished. I also want to thank our customers for their continued loyalty and support. Dave will now update everyone on the results.

Good morning, everyone, and thank you, Fred. I would also like to thank our associates for their outstanding service and our customers for their continued support. During the third quarter and through today, the real estate market continues to experience low housing inventory, high mortgage rates, and lower commercial and residential real estate activity, contributing to lower third quarter operating results compared to the third quarter last year. Yesterday, Stewart reported third quarter net income of $14 million or $0.51 per diluted share on revenues of $602 million. Starting this quarter, we revised our presentation of consolidated non-GAAP measures relating to adjusted net income and adjusted EPS by excluding acquired intangible asset amortization from the calculation. This revised presentation allows us to be consistent with how we present non-GAAP measures related to our title and Real Estate Solutions segments. We don't believe this amortization is indicative of our operating performance. After adjusting for net realized and unrealized gains and losses, acquired intangible asset amortization, and other items detailed in the Appendix A of our press release, adjusted net income for the third quarter was $24 million, or $0.86 per diluted share compared to net income of $43 million or $1.58 per diluted share in the third quarter of 2022. Regarding the Title segment, total revenues in the third quarter decreased by $126 million or 19%, while pretax income decreased by $16 million or 32% compared to the prior year quarter. After adjustments for purchase intangible amortization and other items, the segment's pretax income was $42 million or 8% margin compared to $65 million or 10% margin for the same quarter last year. In our direct title business, total opened and closed orders in the third quarter declined by 7% and 10%, respectively, compared to last year, primarily due to the current real estate environment. Domestic commercial revenues decreased by $9 million or 15%, primarily due to lower transaction volume, while average commercial fee per file was approximately $14,200 compared to $13,700 from the prior year quarter. Domestic residential revenues declined by $37 million or 18%, primarily due to lower purchase and refinancing volumes. Average residential fee per file in the third quarter was $3,000 or 10% lower than last year's quarter due to lower purchase mix. Total international operating revenues decreased by $5 million or 12%, primarily as a result of lower transaction volumes at our Canadian operations. Given the lower commercial and residential activity in the market, third quarter revenues from our agency operations decreased by $75 million or 22% compared to the third quarter last year, while the average remittance rate was roughly comparable. Regarding title losses, total title loss expense in the quarter declined by $3 million or 13%, primarily due to lower title revenues. As a percentage of title revenues, third quarter title loss expense was 4.3% compared to 3.9% in last year's quarter, which benefited from favorable claims experience. For the full year 2023, we still expect title losses to average in the low 4% of title revenues. Related to the Real Estate Solutions segment, third quarter pretax income was $2.6 million compared to $3.4 million last year, primarily driven by a slight dip in revenues, while strength in our credit-related data businesses helped offset other transactional businesses. Pretax margin was 3.8% compared to 4.8% in the third quarter of 2022. After adjusting for purchase intangible amortization, adjusted pretax margin was 13%, similar to the prior year quarter. On our consolidated operating expenses, our employee cost ratio was 31% in the third quarter compared to 27% last year, primarily as a result of lower operating revenues. Lower operating revenues also resulted in a slightly higher other operating expense ratio of 22% compared to 21% last year. On taxes, our third quarter income tax expense was higher than our normal tax rate of 24% primarily due to additional tax expense resulting from lower utilization of foreign tax credits as we completed and filed our federal tax return. The impact of this true-up on EPS was roughly $0.13 per share. We do expect our tax rate to return to historical levels. On other matters, we continue to have a solid financial position to support our customers and associates in the real estate market. At the end of the third quarter, our total cash and investments were approximately $380 million over statutory premium reserve requirements, and we also have a fully available $200 million line of credit facility. Total stockholders' equity attributable to Stewart at September 30, 2023, was approximately $1.35 billion with a book value of approximately $49 per share. Lastly, net cash provided by operations in the third quarter was $60 million compared to $49 million during the prior year quarter, primarily due to lower claims and accounts payable payments, partially offset by lower net income. We appreciate our customers and associates and remain confident in our support of the real estate markets. I'll now turn it back over to the operator for questions.

Our first question will come from Bose George with KBW.

Can you give us an update on your margin expectations for the next 12 to 18 months? Given your comments on 2024 being a transition year, should we think about 2025 as when we should expect a more normalized double-digit margin?

Yes, Bose, thanks for the question. That’s exactly right. At the beginning, when I first got here, we talked about targeting high single digits to double digits. I think in about 2020 to 2021, we achieved that. Obviously, 2021 outperformed because it was excess volume. But in a 5 million unit purchase market, I think we were in that 9.5%, 10% margin range. The issue is that while we have done good work, the volume is so depressed right now that we are unable to extract all the margin. I think 2025 is when we will get back to that 5 million range and therefore see margins improve. I consider the next two quarters to be quite difficult given where we are and the volumes, although that should stabilize a bit in the first quarter as the market corrects after last year's downturn. We have good insights into this transition.

That's helpful. And then on investment income, that was up nicely this quarter. Can you just talk about the trajectory for that? Is this quarter a reasonable run rate? Or could that continue to trend up with rates?

Yes, Bose, as we discussed in the last quarter, we were really putting the escrows to work. I think we had indicated that’s about $2 million a month, which is what it remains. So you saw the full impact of that in the third quarter, along with a little uptick in general investment income due to the more favorable rate environment. I would say this is a pretty good run rate where we stand now, although obviously, it’s also affected by the float. If volumes were to continue to decrease significantly, it could impact balances, but overall, I’d suggest this is a decent run rate.

Our next question comes from Soham Bhonsle with BTIG.

To start, with the moving rates recently, I was just wondering where orders are trending through October. September was down about 8% year-over-year. What is the current trend?

Yes, the rates have affected order counts. I would describe it as a little bit of a shock to the system. What you saw at the tail end of this quarter has continued into this quarter. Last year, around this time, the shock started, leading to a significant drop toward the end of the year. So we are continuing to see decreases and we remain below last year’s numbers in the fourth quarter.

So does that mean we're trending above or below that 8% decline? Given that the comps are going to get easier, should we think of it as more flattish?

I'm afraid I can't provide an exact figure, Soham. I'm indicating that we are continuing to trend downward as we've experienced both seasonal impacts and the effect of recent rates. The fourth quarter will likely see a decline in orders once again.

Understood. Regarding market share, it looks like refi share picked up quite a bit, and there was also a bit on purchase. Can you walk through what you’re seeing on the ground and possibly from whom you think you're taking market share?

Sure. Each of our businesses has been positioned for growth. In Agency, we were significantly behind on ease of use and integrations until about 15 months ago. We've caught up, and we are starting to gain traction in a number of states as we reintroduce ourselves to agents with a better value proposition. We've increased share from about 5% to 10% in several states. We have less refi as a percentage than some competitors, so that helped us as we grew our purchase market share. In Direct, our talent has improved significantly over the past two years, and while the market is challenging, we are holding our ground and even winning some share. I'm optimistic about our organic growth as we continue to enhance our offerings and deepen relationships with lenders.

That's great to hear. One more question about commercial. Regarding the fee per file side, it was stronger than what your peer reported this morning. Can you just describe the drivers? Is it the energy aspect you mentioned? How do you see the fourth quarter developing?

That’s correct. We are not huge, but we can be quite lumpy based on what mixes close. Your insight is indeed accurate; the larger energy deals drove some of the strength. The commercial market is down significantly overall, potentially 40% to 50%, but we’ve been holding up relatively well. We tend to close significantly in December; in fact, it always is our largest month. We have substantial business in the pipeline, but market uncertainty may affect how many actually close. That’s something we are monitoring closely.

Our next question will come from John Campbell with Stephens, Inc.

I wanted to check on the other orders. There was a significant sequential increase. Could you help with the modeling there? In the past, David, you've mentioned this won't mirror the purchase seasonality, but how should we think about that going forward? Also, could you shed some light on the average fee per file with these orders?

Yes, John. That increase came from the home equity and institutional real estate business that we acquired at the end of last year. Particularly, the institutional real estate part is a bit lumpy—dependent on vault purchases and securitizations. In terms of average fee per file, reverse transactions tend to resemble purchase transactions, while the institutional side will look more like refi transactions driven by the timing of securitizations. So, it can be quite variable. Overall, expect incremental improvement over time, but with variability.

Understood. Regarding the tax rate, the 33% seems primarily due to the lower foreign tax credits. From a GAAP standpoint, it seems like that was about a $0.09 or $0.10 EPS drag, but I noticed this wasn’t added back to your reported adjusted EPS metric. Is that correct?

Yes, we did not add that back. We tend not to put as much focus on tax adjustments. However, if normalized, it would indeed have a significant impact on EPS.

Thanks, that's helpful. Can you reiterate that expectation regarding the lower foreign tax credit being a one-time issue and that it's going to normalize moving forward?

Yes, I did mention that we expect the tax rate to return to what we historically have experienced. We have had lumpy periods, leading to significant adjustments based on our income base, but moving forward, it should normalize.

This does conclude today's Q&A. I'll now turn the call back over to our presenters for any additional or closing remarks.

Well, I want to thank everybody for the interest in joining our call. Thank you very much. Appreciate it.

Thank you, ladies and gentlemen. This concludes today's event. You may now disconnect.