Earnings Call Transcript - STC Q1 2020

Operator, Operator

Hello and thank you for joining the Stewart Information Services Q1 2020 Earnings Call. At this time, all participants are in a listen-only mode. Later, you'll have an opportunity to ask a question during the question-and-answer session. Please note this call may be recorded. I will be standing by, should you need any assistance. It is now my pleasure to turn today's conference over to Nat Otis, Head of Investor Relations. Please go ahead.

Nat Otis, Head of Investor Relations

Thank you, Brie. Good morning. Thank you for joining us for today's Stewart's first quarter 2020 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. 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 risk 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.

Fred Eppinger, CEO

Thank you, Nat, and thank you everyone for participating in the call today. We are very pleased with the progress we made in the first quarter. However, due to the unique circumstances we’re facing, I'll let David go over the quarter's details in a moment. I want to take a moment to reflect on our company as we navigate these challenging times. First, I want to express my gratitude to all the frontline workers who are tirelessly keeping our communities safe and healthy. We are also thinking of those who have lost loved ones or are dealing with the challenges of COVID-19. At Stewart, I want to thank our employees for their tremendous efforts over the past month during such uncertain times. Our team has worked diligently to ensure the safety of our customers and coworkers while creatively finding ways to close transactions using various tools under very challenging conditions. In the second week of March, we shifted to an operating approach where about 70% of our employees began working from home, introducing new social distancing measures and operational models to ensure safety for everyone involved while managing record demand. In my view, even at the peak of uncertainty, we came together and accomplished our goals. Clearly, this new operating approach requires daily communication among the team to address changes as they arise. I am truly proud of our team's ability to work together and adapt to the changing business environment. Ultimately, while we do not know how things will unfold, our top priority remains the health and safety of our employees and customers as we continue to operate and close transactions. From a business perspective, we are still closing transactions daily as we work through the business pipeline we established in the first quarter as well as the new business that continues to come in, even though it is at a reduced volume. We are witnessing growth in remote online notarization levels, with 95% of our offices now trained in and using RON at some level. Moreover, several temporary state executive orders have permitted personal appearances to be substituted with video verifications known as remote-ink notarizations. Only a few states currently do not permit RON or RIN transactions. For in-person closings, we are doing everything possible to ensure safety, including measures like glass dividers and drive-through or tail-gate closings. Regarding underwriting, due to delays in recording closings caused by county courthouse backlogs or complete closures, Stewart is offering policyholders gap insurance for the delayed period between closing and recording for most transactions. The first quarter was strong for Stewart. We built on a solid market with a renewed sense of focus and alignment with our strategic direction, creating momentum to kick off the year. Nevertheless, the first quarter is becoming less relevant as we look toward the remainder of 2020 and 2021. It is important to understand that we are navigating uncharted waters. While the real estate sector is in a stronger position entering this recession compared to the last, the economic stresses we may face moving forward could be much greater. While peak unemployment rates reached 10% in the late 2000s, recent data from various economists suggest we will exceed that level. Additionally, tighter lending standards and capital constraints for lenders due to extended forbearance periods could worsen the situation. It is essential to note that the previous recession did not involve a global pandemic, and there is currently no timeline for a vaccine. Given this context, we anticipate the next two quarters to be very challenging for both our residential and commercial segments. However, I believe we are well-positioned, both operationally and financially, to navigate this tough period. Stewart is in a strong financial position with a 14% debt-to-equity ratio and over $400 million in cash and liquid assets, exceeding our regulatory requirements, plus an additional $50 million available on our revolving credit facility. To conclude, I want to emphasize three key points. First, we will prioritize the safety of our employees, customers, and communities. Second, we will maintain transparency regarding the challenges we face now and in the future. Lastly, when this situation ends, Stewart will be positioned as a leader in our industry, ready to support the ongoing continuity of real estate. Thank you for your time, and now David will discuss this quarter's financials.

David Hisey, CFO

Thank you, Fred, and good morning. Let me also thank healthcare, other frontline professionals, and our associates for their tireless and inspirational service during these challenging times. The quarter started strong due to low rates and high real estate demand. As the quarter progressed, rates dropped due to unprecedented government stimulus actions causing an increase in refinance activity, while purchase activity began to decline as national stay-at-home orders were implemented. These conditions continue at this stage of the second quarter, with normally strong spring real estate activity reduced as we await the reopening of our country. Moving to the Q1 results. Yesterday, Stewart reported total operating revenues of $446 million and net income of $5 million for the first quarter of 2020, which was the strongest first quarter in Stewart history. As laid out in Appendix A of the press release, adjusted net income was $13 million with adjusted diluted earnings per share of $0.56 compared to an adjusted net loss of $7 million and adjusted diluted loss per share of $0.28 in last year's quarter. The $11 million mark-to-market losses on equity securities in the first quarter of 2020 accounted for the difference in diluted and adjusted diluted earnings per share. Our total title revenues for the quarter improved to $440 million, or 17% from last year on solid performance in all areas of our title business. The title segment generated pretax income of $15 million or a 3.4% pre-tax margin. Excluding the mark-to-market adjustments, the segment's first quarter pre-tax income would have been $26 million or a 5.8% pre-tax margin. With respect to our direct title business, direct residential revenues improved $25 million or 24% on increased orders. Residential fee per file was approximately $2,000, or approximately 11% lower than last year primarily due to a higher refinance-to-purchase transaction mix. Domestic commercial revenues also increased $8 million or 23% resulting from more transactions and an 18% higher commercial fee per file of approximately $11,400. Total international revenues improved $4 million or 20%, primarily driven by increased volumes from our Canada and U.K. operations. Total open and closed orders for the quarter grew 49% and 36%, respectively, compared to the prior year quarter. Our agency business increased revenue due to market trends and the continued return of agents post-merger termination. Regarding title losses, total title loss expense increased 19% consistent with increased title revenues. As a percentage of title revenues, our title loss expense was 4.2%, which was comparable to the prior year quarter. Our ancillary services and corporate segment continued to see lower volumes in our capital market search business as that business tends to move counter to loan originations. Turning to operating expenses, which consist of employee and other operating costs. Total operating expenses were relatively flat to the prior year quarter, as employee costs rose modestly with higher revenues, and other operating expenses declined due to continued management focus. The combination of these items caused employee costs as a percentage of revenue to decline from 33% to 30% and other operating expenses to decline from 20% to 16%. On other matters, as Fred noted earlier, our financial position remained strong. Our total cash and investments on the balance sheet are $400 million over regulatory requirements, which along with our $50 million available line of credit provide a solid foundation to support our customers, employees, and real estate markets. Stockholders' equity attributable to Stewart was $732 million at the end of the first quarter with a book value per share of $30.90. I'll now turn the call back over to the operator to take questions.

Operator, Operator

And we will now go to Bose George with KBW. Please proceed.

Bose George, Analyst

Yes. Good morning.

Fred Eppinger, CEO

Good morning.

David Hisey, CFO

Yes, good morning.

Bose George, Analyst

Thanks. So I just wanted to first ask about your ability to control costs as we enter what is likely to be a pretty challenging environment in all the channels. Can you just talk about how much of your expenses are sort of more variable both on the residential side and then on the commercial as well?

Fred Eppinger, CEO

Thank you. Our goal has been to enhance our margins, and we will continue to focus on that to position the company for long-term profitable growth. In the fourth quarter, we implemented several targeted actions, and we took further steps in the first quarter. I anticipate that we will keep taking specific actions to strengthen our position as we move forward. These are exceptional circumstances, and my responsibility is to create value for our shareholders. Our aim is to navigate through these challenges while maintaining a cohesive and motivated team dedicated to improvement and growth. We will manage ourselves effectively during this time to emerge stronger. I believe we are a more agile company that is prepared to adapt, and that will be our primary focus.

Bose George, Analyst

Okay. That's helpful. Thanks. Now, switching to the commercial market, which had its best quarter, can you discuss the pipeline and what you are observing there? Additionally, considering your concentration in Texas, is your commercial sector predominantly focused there, or is it fairly spread out across the nation?

Fred Eppinger, CEO

It is relatively dispersed. We have a strong presence on both coasts as well. Commercial is going to be a bit challenged given the economy and the freezing up of many industries, such as hospitality and energy. We believe that commercial will be a challenged segment for a while for everybody. I think it's just the way the market is. David, is there something you want to add on that? I want to make sure.

David Hisey, CFO

No, Fred. I think you covered it pretty well. I mean, obviously the commercial markets vary by asset class with retail and energy and hospitality consistent with the declines in those primary businesses. I think being a little more challenged. But I think in general, you covered it — expect it to be maybe a little bit longer turnaround in that business just due to the nature of it.

Bose George, Analyst

Okay. Thanks. Actually, maybe just one little one also on the gap insurance product you mentioned. Can you just explain how that works? And is that going to be a material number? Or is that just a pretty modest piece?

Fred Eppinger, CEO

It's modest. But David, is there anything else you want to add on that one?

David Hisey, CFO

No. And I think just to expand on what you said in your comments, Fred, on the gap insurance, I think it's the way the market has moved generally just because of what's happening with county recorders offices and the like. And so I think our practices are pretty consistent with the way other underwriters are doing it and also working in conjunction with lenders and the GSEs on what they require from a title policy.

Bose George, Analyst

Okay. Great. Thanks.

Fred Eppinger, CEO

Thank you, appreciate it.

Operator, Operator

And we will now hear from Mackenzie Aron with Zelman & Associates. Please proceed.

Fred Eppinger, CEO

Good morning.

Mackenzie Aron, Analyst

Thanks. Good morning. First question on the investment income, can you help us think about the sensitivity to the lower rate environment that we're now in?

Fred Eppinger, CEO

Sure. So David, why don't you take that?

David Hisey, CFO

Thank you for the question, Mackenzie. I believe we are somewhat different from some of our competitors. We have maintained greater liquidity, which means that part of our portfolio will be significantly influenced by the recent drop in short-term rates over the past month. However, besides that liquid portion, the majority of our portfolio has an average duration of over four years in the bond sector, and we don't face many near-term maturities. Therefore, I wouldn't anticipate major changes to the base coupon rate. The variability will primarily come from the shorter-term portion.

Mackenzie Aron, Analyst

Okay. That's helpful. Thank you. And then is there any color that you can give us on just what you've seen so far in April on the order flows?

Fred Eppinger, CEO

Yeah. David, why don't you take that?

David Hisey, CFO

I believe that in March, we observed a slight increase in the refinance percentage, which likely continued on a percentage basis. However, overall open orders have been decreasing due to diminished market activity. We will need to see where that ultimately settles. Considering new home listings and recent data, there may be a decline of over 20 percent for open orders depending on how the month concludes. Closings could remain relatively stable compared to March, thanks to a solid pipeline. Much of this will rely on the mix of refinances since rates are still low, credits are tightening as mentioned, and we need to see how primary real estate activity resumes.

Mackenzie Aron, Analyst

Okay. Great. And then on the loss provision rate, is it realistic to think that that can trend higher? And maybe what should we be thinking about in terms of the potential for higher losses in this type of an environment as well?

Fred Eppinger, CEO

Yeah. It's a great question. And David, why don't you run it – go take it and I can follow-up?

David Hisey, CFO

I would like to provide some general context on the current real estate market compared to 2007 and 2008. It is in a significantly better position now. Lending standards have improved going into this environment, and there is a better supply-demand balance with ongoing excess demand for real estate, which will help support prices. During the Great Recession, substantial declines in home prices led to significant losses. Currently, we are in a much stronger situation. While it is difficult to predict the ultimate losses, it is worth noting that we have better government programs in place to address this situation. Even though we are experiencing a national forbearance, there have been recent announcements from the FHFA about the GSEs buying loans out early from the pools, which will help stabilize the market. The eventual losses will depend on factors such as the potential increase in fraud, the pace of foreclosures, and the employment situation, which will influence how quickly people return to work. Therefore, while it is challenging to anticipate exact figures, this context should provide some insight into the potential losses this time compared to the previous crisis.

Fred Eppinger, CEO

Yes. I would agree with David. And we're in a much better place going in. And I think our risk profile is a lot better going in. So I agree with what all of David said.

Mackenzie Aron, Analyst

Okay. That's helpful. Thank you and best wishes and hope you all stay healthy.

Fred Eppinger, CEO

Yes. Thank you so much.

Operator, Operator

And we will go next to John Campbell with Stephens Inc. Please go ahead.

David Hisey, CFO

Good morning.

Fred Eppinger, CEO

Good morning, John.

John Campbell, Analyst

Hey, guys. Good morning. Congrats on a fantastic quarter. Very, very good results.

Fred Eppinger, CEO

Thank you.

John Campbell, Analyst

I’d like to revisit the order situation for April, particularly with regard to commercial. I was under the impression there might be a slowdown around late March. Your open orders for commercial were down 8% in March, so I’m interested in how that progressed throughout the month. Additionally, could you provide any insights into commercial orders so far in April?

Fred Eppinger, CEO

Yeah. David, why don't you take that?

David Hisey, CFO

Yeah. John, thanks for the question. Yes, the commentary I was giving was sort of more general with a direction more to the residential stuff. I think with respect to commercial, I think it is fair to assume that that activity has dropped off a bit more. We still are seeing orders, but for some of the reasons I mentioned in terms of certain other segments of commercial being more stressed than others. And then also thinking about the parts of the country that have been hit the hardest, right with New York being in the lead there, where there is a lot of commercial activity, yes, the orders have definitely been off a little bit more in commercial than they have in residential.

John Campbell, Analyst

Okay. That's helpful. And then back on the foreclosures. Obviously, the forbearance issues who knows where we go from here, but it does seem like that wherever we're sitting now it's going to be maybe a little bit higher coming out of this. But you kind of talked to the title reserves and why that might not be so adversely impacted relative to the last go around. But could you talk about maybe the ancillary services segment? I know at one point you guys had I think one large contract with a large lender in that business. At one point during the default period was materially higher than where it is today. So I'm just curious in assuming a step-up in foreclosures how the ancillary services business is impacted? And then maybe also on the title side, if you could talk to the default orders? And how that could pick up as well?

Fred Eppinger, CEO

David, go ahead. I'll follow on.

David Hisey, CFO

Yes, that's a great question. Our ancillary services business has three main components. It includes some default services, although that has been negligible lately. The primary focus is on capital markets transactions and valuation services, both of which benefit from the current market situation. The capital markets segment typically involves large transactions, like delinquent loans being packaged and resold, especially with the non-QM market currently inactive. This creates opportunities for selling delinquent loan pools, which would positively impact our business. We also maintain our foreclosure search capability, and if that market returns, we can allocate resources from our centralized search to support it. Valuations are also essential when loans enter foreclosure, making this segment somewhat countercyclical to origination and potentially beneficial if we enter that type of market environment.

John Campbell, Analyst

Okay. That's helpful. And then one other thing kind of related to that broader segment. On the corporate side, what is the run rate now? Is it $5 million maybe $6 million a quarter? Is that right?

David Hisey, CFO

That's correct.

John Campbell, Analyst

Okay. Excellent. Thank you guys.

Fred Eppinger, CEO

Thank you.

Operator, Operator

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

Geoffrey Dunn, Analyst

Thanks.

David Hisey, CFO

Good morning, Geoff.

Fred Eppinger, CEO

Good morning.

Geoffrey Dunn, Analyst

Fred, I wanted to start off by following up on your comment that your focus isn't necessarily on expense management but creating shareholder value. Periods of disruption can also be periods of opportunity. So with the company in solid financial position, how are you thinking about this disruption as an opportunity to maybe look for additional talent? Additional product offerings or platforms? Or weakened agency acquisitions? Are those considerations over the next couple of months? Or is it too uncertain to try to pursue that type of thing?

Fred Eppinger, CEO

That's a great question. What’s interesting about situations like this is that if you remain focused and maintain a strong brand, you can leverage certain circumstances to enhance your capabilities. We have been concentrating on that recently and will continue to do so in the future. It feels a bit early in this current situation to get a clear picture of what's happening. My daily objective is to improve our operations, whether by better managing our resources or finding ways to enhance our position. We'll keep working on that. One reason to carefully manage resources is to ensure we have the flexibility to act on opportunities when they arise. Right now, our primary focus is on the safety of our employees and maintaining business operations. Looking ahead, as things become clearer and more stable, I anticipate our continued commitment to becoming the premier company in the industry. The first quarter showed that we've come together effectively, are working well, and can be agile and focused to create further opportunities. There’s still much for us to accomplish. The next couple of quarters may bring challenges in fully understanding our position, but we’re committed to improvement. Ultimately, the aim is to grow the company appropriately, and I believe we can achieve that. We remain dedicated to building the best Stewart with our eyes wide open to the opportunities ahead.

Geoffrey Dunn, Analyst

Okay. And then before the disruption started impacting the business in, I guess, the second week of March for you, can you talk about some of the more material actions you took during the first quarter? I mean it's by far the best margin Stewart's put up in a long time for Q1. Obviously, you did benefit from an inflated resi refi market. But what are some of the more material actions you can point to that have maybe kind of improved your Q1 prospects going forward? And margins in general?

Fred Eppinger, CEO

If you recall, it's a mix of actions taken in both the fourth and first quarters. A major challenge we faced was our lack of a strategic approach in resource allocation, leading us to spread ourselves too thin. Consequently, we were more vulnerable to volume fluctuations because adjusting was tougher without a solid scale. We've started consolidating locations, reallocating capital across different businesses, and increasing our investments in certain markets while being more disciplined in our overall spending. We aim to ensure our investments are not only beneficial in the short term but also cater to future growth. We're working on various technology initiatives that are starting to yield results. This involves reallocating our resources effectively. As I mentioned in the last quarter, we closed around 25 locations and wrote off leases to sharpen our focus. Our goal is to invest in our strengths and build scale in multiple areas, and we've seen progress reflected in our improved resource utilization as we start gaining momentum. We're not completely there yet, but we’re on the right track and will continue to improve as we grow. The next couple of quarters might present challenges, as the journey to where we aim to be is rarely a straight path. However, the actions we've taken position us to maintain flexibility for continued improvement. We're committed to making the right moves to enhance our performance, and I believe we're well-positioned for strength moving forward. Our focus will remain steadfast.

Geoffrey Dunn, Analyst

And then last question is on commercial, highest margin product typically. No slide on the resi side, but I'm assuming the talent there tends to be more specialized and valuable. So, can you talk about the ability to manage expenses on the commercial business? I assume there's more of a variable component on commissions, but maybe not as much flexibility on headcount. How do you think about managing the expense base of that business specifically?

Fred Eppinger, CEO

Yes. We have a fantastic group of talented individuals in our commercial division. It's crucial for us to keep this core team focused and cohesive. Given the current challenges, we need to ensure that our investments target the resources that truly matter. We want to have a precise focus in our commercial area, supporting our talent effectively. This is a business we aim to expand over time, but careful management is necessary as we anticipate some strain due to the number of leases. I agree that we need to be very thoughtful in this area. I have considerable confidence in my leadership team, and we will ensure that we remain focused on the future while taking appropriate actions to align our resources effectively.

Geoffrey Dunn, Analyst

Okay. Thank you.

Operator, Operator

And there appear to be no further questions at this time. I'll turn it back to speakers for any closing remarks.

Nat Otis, Head of Investor Relations

Thank you, Brie. And that concludes this quarter's conference call. I want to appreciate everyone for joining us today and your interest in Stewart. Goodbye.

Operator, Operator

This does conclude today's program. We appreciate your participation and you may now disconnect.