Earnings Call Transcript - STC Q2 2023

Operator, Operator

Hello and thank you for joining the Stewart Information Services' Second Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. Later, you will have the opportunity to ask questions during the question-and-answer session. Instructions will be provided at that time. Please note today's call is being recorded. It is now my pleasure to turn the conference over to Brian Glaze, Chief Accounting Officer. Please go ahead.

Brian Glaze, Chief Accounting Officer

Thank you for joining us today for Stewart's second 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 a 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.

Fred Eppinger, CEO

Thank you for joining us today for Stewart's second quarter 2023 earnings conference call. David will review the quarterly financial results in a minute, but before we get into the financial results that we released yesterday, I want to update you on our view of the market and our continued progress on important initiatives that we believe will set Stewart up for success in the long term. During the last three to four years, we have focused on fundamentally improving Stewart's operating performance and embarking on a journey to become a premier title services company. While the current economic environment poses significant challenges, we have materially improved our business, creating a strong and resilient company that will thrive over the full real estate cycle. But we also know there is more that we can do. It is critical for us to remain focused on improving margins, growth, and resiliency to improve scale in attractive markets and enhance our operational capabilities. In difficult markets such as the current one, it is indeed a focus on achieving these long-term goals. However, I am very pleased with our progress on these enterprise initiatives during the second quarter and our commitment to improving our long-term performance. Given the continued volatility in the market, we have carefully balanced investments in these initiatives, managing expenses very thoughtfully. As we've discussed before, we are not surprised that the challenging economic environment continued into the second quarter. Although interest rates declined early in the second quarter, they increased throughout the remainder of the quarter, and the 30-year mortgage interest rate now offers around 7%. As expected, the increase in rates has offset some of the typical seasonal increases in residential volumes that are expected during the summer months. Fortunately, we have seen modest increases in transaction volumes during the second quarter after experiencing a historic level in the first quarter. The new home market is strong, although listings for existing homes remain very low. We expect the challenges of this environment to continue throughout 2023. We are managing costs carefully throughout this market, while upholding our long-term strategy, which requires a careful balance between investing in initiatives and managing expenses. We've been cautious not to take actions that might threaten our competitive position and long-term value-creating opportunities. We believe that the real estate cycle will rebound in 2024, and the best path forward for Stewart to navigate these periods is to invest in our people and remain focused on our long-term improvement plan while managing through a few challenging quarters. We remain dedicated to our long-term strategy, enhancing our operating model, investing in technology to enhance customer experience and improve operational efficiency, and building scale in targeted areas. We recognize that these strategic investments will cause the cost ratios to remain elevated in a market with exceptionally low transaction volumes. We believe that these long-term investments, coupled with thoughtful near-term expense management, will enhance our structure and financial performance in the long run. In our direct operations, growing scale in attractive markets remains a priority. We are routinely reevaluating markets where we have the opportunity to increase our market share and enhance our leadership strength. Given the market uncertainty, we have been more selective in our decisions to ensure that our capital deployment makes sense for the long-term. Positioning our commercial operations for growth across all our business lines has been a key focus, as those operations are an important component of our overall strategy. 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 the commercial operations to better serve our customers, and we remain optimistic about the commercial sector. However, as we discussed last quarter, the commercial environment remains uncertain in the short term due to changing financial markets. Certain commercial sectors such as energy are performing very well for us, but we continue to see ongoing challenges in sectors like office and multifamily. Nevertheless, we believe our focus will create long-term growth in the commercial markets. In our agency business, we are leveraging technology to drive market share gains. We have made excellent progress in deploying technology and services to provide a significantly improved agent experience for Stewart. This experience includes greater connectivity, ease of use, and risk reduction for our agent partners. We are pleased that our platform of services for agents is the strongest it's ever been, and we've begun to see meaningful progress in target markets such as Florida in the agency sector, commercial, and others. A significant part of our investments is focused on improving our technology for production process automation and centralization to enhance operational efficiency and capabilities. We have already made significant progress in improving the customer experience across all channels and are rolling out our agency technology platform, which significantly enhances ease of use and connectivity with agents. Improving our operating efficiencies, particularly through the centralization of our digital title plans, is another priority. During the quarter, we made significant progress on our roadmap to integrate completed acquisitions into our production and other systems, improving the customer experience as well as the overall operating efficiencies that we have been building over the past several years. Integrating the remaining required companies is a top priority for the balance of 2023. Maintaining a strong financial position is always important, but even more so during a market like this. Our current strong financial position allows us to capitalize on opportunities. Financially, our long-term goal remains to generate high single-digit to low double-digit margins over the cycle. The margins will be higher in some quarters as evidenced by the first quarter. However, as indicated by our second quarter results, modest increases in transaction volumes and improved margins have contributed positively to our performance. Additionally, the investments we have been discussing, once fully implemented, should allow us to achieve low double-digit margins throughout the cycle. While we are encouraged by the improvements in talent, technology, customer experience, and our financial model, there is still work to be done, and the journey is not complete. We have been focused on a strategic plan to build our competitive position by creating a more efficient and disciplined operating model that functions well throughout all real estate cycles. We have emphasized growing scale and attractive markets across all lines of our business, and we have made significant progress in improving customer experience in all our channels. Retaining key talent is always important, and we have been even more focused on this during the market challenges so that we have the right team in place as the cycle improves. Our efforts should result in increased year-over-year market share gains in each of our direct, agency, and commercial businesses. Let me conclude by reinforcing that we have been managing our expenses and investments with a sensible balance between operating discipline and the current short-term market challenges, thus strengthening Stewart for long-term growth performance. Our strong financial position should best position us to take advantage of the opportunities that this cycle provides. Finally, my positive long-term view of the real estate market and Stewart's ability to accomplish its objectives as a title service company is unwavering. Our associates have worked hard throughout these challenging times, and they appreciate all they have accomplished. I also want to thank our customers for their continued loyalty and support. Dave, we will now update everyone on the results.

David Hisey, CFO

Good morning, everyone, and thank you, Fred. Before anything else, I would also like to thank our associates for their wonderful service and our customers for their support. Our second quarter improved sequentially to the first quarter. However, low housing inventory, high mortgage rates, lower commercial and residential real estate activity, and economic conditions continue to exist in the market, contributing to lower second quarter operating results compared to last year's quarter. Yesterday, Stewart reported net income of $16 million or $0.58 per diluted share on total revenues of $549 million. After adjusting for net realized and unrealized gains and losses and other items detailed in Appendix A of the press release, the second quarter adjusted net income was $19 million or $0.69 per diluted share compared to $70 million in the second quarter last year. Regarding the second quarter title segment, total revenues decreased $278 million or 37%, while pretax income decreased to $35 million compared to $94 million last year. After adjustments for purchase intangibles, amortization, and other items, the segment's pretax income was $37 million or an 8% margin compared to $105 million or a 14% margin in last year's quarter. In our direct title business, total open and closed orders declined by 18% and 29%, respectively, compared to last year, primarily due to the current real estate market. Domestic commercial revenues decreased $26 million or 38% due to lower transaction volume and size. The average commercial fee per file was approximately $11,600 compared to $13,100 in last year's quarter. Domestic residential revenues declined $50 million or 21% due to lower purchase and refinancing transactions; however, the average residential fee per file was up 11% to $3,300 versus $2,900 due to a higher purchase mix. Total international operating revenues declined $18 million or 35%, primarily due to lower transaction volumes in our Canadian operations. As a result of lower commercial and residential activity in the market, second quarter revenues from our agency operations decreased $201 million or 49%. The average agency remittance rate slightly improved to 17.7% versus 17.1% last year, primarily as a result of geographic mix. Investment income increased due to higher rates and our work with our bank partners to better utilize escrow balances where appropriate. Regarding title losses, total title loss expense in the second quarter decreased $7 million or 25%, primarily due to lower title revenues. As a percent of title revenues, title loss expense was 4.2% compared to 3.5% in last year's quarter, which benefited from last year's favorable claims experience. For the full year 2023, we expect title losses to average in the low 4% of title revenues. For the real estate solutions segment, pretax income was $3 million in the second quarter compared to $6 million last year, primarily due to lower revenues driven by the real estate and economic environment. Pretax margin for the second quarter was 4.6% compared to 7.4% from last year, and after adjusting for purchase intangible amortization and hedge-upstate sales tax expenses related to an acquisition, adjusted pretax margin was 14.4%, which was comparable to the prior year quarter at 14.7%. Related to our consolidated operating expenses, our employee cost ratio increased to 34% versus 25% in last year's quarter, primarily due to lower operating revenues. Lower operating revenues also led to other operating expense ratio of 24% versus 19% last year. On other matters, our financial position remains solid to support our customers and associates in the real estate market. At June 30, 2023, our total cash and investments were approximately $370 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 was approximately $1.36 billion with a book value per share of approximately $50. Lastly, net cash provided by operations was $35 million compared to net cash provided of $83 million in last year's quarter due to lower net income. We appreciate our customers and associates, and we advocate for everybody's safety and prosperity and remain confident in our exploration of real estate markets. I'll now turn it back to the operator for questions.

Operator, Operator

And we will take our first question from Bose George with KBW. Your line is open.

Bose George, Analyst

Hey. Good morning.

Fred Eppinger, CEO

Good morning.

Bose George, Analyst

Good morning. I just wanted to ask first about investment income. Is that new level of investment income something we can run rate or, if not, how should we think about that number going forward?

David Hisey, CFO

Yes Bose, this is David here. So, think of the increase in this quarter versus last year's quarter. Probably about 70% of that is coming from these escrow activities that we just initiated. And so that would be ongoing. The rest is really the difference in better rates, particularly on short-term balances. I think that's probably relatively stable and will vary with balances, but the escrow component is definitely incremental.

Bose George, Analyst

Okay, great. And then in terms of the agent premiums, can you just remind us if there is a lag in that number? So, given the magnitude of the decline versus what happened with direct, does that just reflect the lag and there's a bit of a catch up after?

Fred Eppinger, CEO

There is a little bit of lag in our agency revenues, and we’ve looked at a number of factors regarding it. This same kind of gap occurred in the second quarter of 2021 as well, and we caught up over that. So, we don't see any share shift or anything like that when we look at the agency-level activities. So, I'm pretty comfortable that we'll even out here over the next few months.

Bose George, Analyst

Okay. Okay, great. Thanks very much.

Fred Eppinger, CEO

Thanks.

Operator, Operator

We'll take our next question from Soham Bhonsle with BTIG. Your line is open.

Soham Bhonsle, Analyst

Hey, good morning, guys. First one is just on the purchase orders. It looks like your declines were a little bit better than your peers that announced results today as well. Is there something specific going on there? Is there market share gains we should be considering or is this just your acquisition strategies kicking in now?

Fred Eppinger, CEO

Yes. So, over the last five quarters, each of our businesses has gained share. We don't know this quarter yet until the files come in, but we've had nice momentum in share growth. It's important to note that we haven't had any acquisitions during this comparative time period that affected it. Commercial can be lumpy, but both agency and direct have seen really consistent share gain, which is promising.

Soham Bhonsle, Analyst

Got it. And then on the expenses, I'm trying to tie this in with margins. Fred, the performance this quarter was strong. But if we assume flattish volumes next quarter, is there any reason margins can at least stay flat or higher? Are there any expense items we should be thinking about? I'm just trying to figure out if this is peak for margins this year or if we could see higher margins as we go into next quarter.

Fred Eppinger, CEO

So, there are only usual expenses to consider. The incremental $20 million we're spending for improvement initiatives is kind of spread out, and there are no extraneous expenses to think of that would spike in the next two quarters. So, it’s all going to be driven by revenue volume. Again, we've made improvements in our operations on margin, but many of the improvements won’t be seen unless volume goes up, due to excess capacity in the system as it becomes more efficient. I think it will remain stable, and volume will be the primary driver. The pattern of something like commercial is heavily skewed toward the fourth quarter, which drives changes in that business. But everything else is primarily determined by the general market conditions affecting revenue.

Soham Bhonsle, Analyst

Got it. And then I guess just on commercial, we're hearing mixed signals in the market. I just want to get your perspective on the outlook for the back half of the year.

Fred Eppinger, CEO

Yes. I mean, it's down, right? The financial factors are putting pressure on new investments, if you will. There are some segments that are performing well, such as energy, but office is tough. So, it's going to be down. We don't see any particular patterns right now, but orders have been fairly steady at a lower level. Nevertheless, we are continuing to invest and believe we can build that business despite the headwinds.

David Hisey, CFO

And Soham, this is David here. If I look at our transaction types for the quarter, there's nothing really in the office sector. Probably some smaller transactions, but the bigger ones, as Fred said, are really in energy or some industrial, hospitality, multi-use transactions, among others. So, it’s fair to say that the decline in office is being offset by activity in those other segments.

Soham Bhonsle, Analyst

Got it. All right. Thanks a lot, guys.

Fred Eppinger, CEO

Thank you.

Operator, Operator

We'll take our next question from John Campbell with Stephens Inc. Your line is open.

Fred Eppinger, CEO

Hey, John. Good morning.

John Campbell, Analyst

Hey guys, good morning. Back on the investment income; it sounds like you expect the 2Q level will be a good run rate. I'm guessing this holds for consensus, but just looking at my model, if I run rate that, that's over $0.60 of EPS upside. You guys just reported roughly that same amount in 2Q, so that’s pretty significant. I want to get a better sense of the sustainability of that increase. David, you mentioned that 70% of the lift comes from escrow actions you've taken with bank partners. Can you provide a little more color there regarding exactly what you did that drove such a large impact, and what allowed this to happen now versus in the past?

David Hisey, CFO

Yes. If you're comparing quarter to quarter, the earlier answer I gave indicates that about 70% is due to the escrow and about 30% is from better rates. We should see a benefit of call it a couple million dollars a month from the escrow activities. It has taken a few months to get this to work. It's not something we started recently. The recent increase in interest rates provided us with the opportunity to earn significant returns because banks become more interested as well. We deployed about $900 million of escrows into interest-bearing accounts, and it takes time to negotiate and ensure compliance with regulations, but we managed to accomplish this by the end of the second quarter, and that’s why we should reap the benefits going forward.

Fred Eppinger, CEO

Your observations are correct. Achieving this has been a journey for us over the last three years. Initially, we considered buying a bank for access to returns on new escrows but faced challenges due to our scale. However, with the current state of interest rates and our growth, we've been able to capitalize on this opportunity and work with our banking partners to capture earnings on our escrow. This is a crucial move for us now that money has greater value compared to when we attempted it in the past.

John Campbell, Analyst

Absolutely. The macro landscape seems a little unstable on the commercial side, while residential appears to be wanting to pick up a bit. This addition to earnings mix is noteworthy, so congrats on that. My second question is regarding the order mix since you acquired FNC and BCHH. There have been some moving parts, and I’d like to hear more clarity on the other order line. Just as a starting point, what’s your mix between default versus BCHH and FNC, and how should we consider that blended fee profile for others?

Fred Eppinger, CEO

For us, that's primarily the reverse from FNC. The fee per file there isn’t quite as significant as the typical purchase business profile, which would be a little less than the $3,300 to $3,400 that we report for purchase. We don’t have much of a default business, so that’s predominantly FNC reverse.

John Campbell, Analyst

Okay. Is there typically much seasonality in that line? And also, what’s a good closing ratio? Is that going to be sporadic, or are the last two quarters a good indicator?

Fred Eppinger, CEO

Yes, the market has seen a bit of dislocation, so it's not as seasonal. Typically, people seek reverse mortgages when they’re older and have significant equity in their homes. Activity has been challenging recently due to market dislocations caused by the AEG acquisition by Finance of America and some issues in capital markets, particularly with the FHA Ekam product. While it's stabilizing and advertising is increasing again, improvements will be gradual due to these conditions.

John Campbell, Analyst

Great, thank you for taking our questions, guys.

Fred Eppinger, CEO

Thank you.

Operator, Operator

And we'll take our next question from Geoffrey Dunn with Dowling & Partners. Your line is open.

Geoffrey Dunn, Analyst

Thanks. Good morning.

Fred Eppinger, CEO

Good morning.

Geoffrey Dunn, Analyst

I wanted to follow-up on John's question about net interest income and just make sure I have all the details here. So, incrementally to what we already see on your balance sheet, you were effectively able to deploy about $900 million of escrow funds into interest-bearing accounts. Is that the correct way to think about the math?

David Hisey, CFO

Correct. As for the notional balances, the tricky part is determining the amount to multiply that by, which needs to be worked out with all individual banks. Therefore, you can’t just apply a money market rate to that, as it’s adjusted by service charges and fees. Our rates are typically around 3.5% or slightly better, but it depends on how things progress. As the program matures, you might expect that to increase.

Geoffrey Dunn, Analyst

In implementing those moves, was there any opportunity cost on the expense side? Meaning, did you give up expense credits to gain net interest income?

David Hisey, CFO

Well, it's embedded in the transaction. Yes, we were offsetting wire costs before to your point. However, we weren't earning much before, but now we are getting something incremental while those costs are still being mitigated. That’s why I said the calculations aren't straightforward.

Geoffrey Dunn, Analyst

Based on the current average, is it right to say that 60% of a 25 basis point change flows into your incremental yield?

David Hisey, CFO

It depends on how persuasive we are in our discussions with the banks. Yes, that can be a fair estimation.

Geoffrey Dunn, Analyst

Understood. But on the whole, if all else were held equal, the $12 million run rate this quarter should react positively to any future rate actions?

David Hisey, CFO

Yes, but remember, the quarter-to-quarter comparison matters, particularly with the title plan dividend appearing in the quarter. Thus, it's more about the changes from past quarters than simply applying the number from this quarter without further adjustment.

Geoffrey Dunn, Analyst

What was the title plan dividend for this quarter?

David Hisey, CFO

It was about $2 million in each quarter.

Frederick Eppinger, CEO

As we own a title company, we receive that once a year, and that's a one-time factor.

Geoffrey Dunn, Analyst

So, we had a $10 million run rate heading into 3Q?

David Hisey, CFO

Correct. Hence, you shouldn't merely take the $12 million and apply it directly.

Geoffrey Dunn, Analyst

Got it. Thank you.

Operator, Operator

We'll take a follow-up question from Soham Bhonsle with BTIG. Your line is open.

Soham Bhonsle, Analyst

Hey, guys. Just one follow-up on the Real Estate Solutions business. If I look at revenue this quarter on a year-over-year basis, it was down about 13% or so, which is better than the first quarter, which was down about 30%. It seems like it outpaced orders as well. Fred, you've mentioned that there’s sensitivity to volumes, but it seems there’s some subscription revenue kicking in too. Is that the right way to think about it going forward?

Fred Eppinger, CEO

Yes, you’re thinking about it correctly. There’s a mix in revenue sources, including our data business that is more stable. We have seen some services businesses gaining real market share, so it’s a combination. The transactional businesses, such as appraisal and notary services, are indeed challenged like the rest of the market, but the overall performance is improving due to these factors.

David Hisey, CFO

To provide a little more color, you have the data business, such as credit and research in real estate, which tends to be more stable, and they’re actually performing well in the current market. That’s where you’re witnessing the improvement. The transactional businesses, like appraisal and notary, are facing challenges.

Fred Eppinger, CEO

It's crucial to bear in mind that any improvements are offset by the decrease in those transactional activities, so market conditions are certainly a factor in how things develop.

Soham Bhonsle, Analyst

Thank you for clarifying.

Fred Eppinger, CEO

Thank you.

Operator, Operator

And we have no further questions on the line at this time. I'll turn the program back over to management for any additional or closing remarks.

Fred Eppinger, CEO

Just want to thank everybody for joining us for this second quarter call. Thank you.

Operator, Operator

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