Earnings Call Transcript - STC Q3 2020

Operator, Operator

Hello and thank you for joining the Stewart Information Services Third Quarter 2020 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, and instructions will be provided at that time. Please note that this call may be recorded. It is now my pleasure to turn the conference over to Nat Otis, Head of Investor Relations. Please go ahead.

Nat Otis, Head of Investor Relations

Thank you, Catherine. Good morning. Thank you for joining us today for Stewart’s third 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 risks and uncertainties with forward-looking statements are subject to include, but are not limited to the risks and other factors detailed in our press release published yesterday evening and in the statement regarding forward-looking information, risk factors and other sections of the company’s Form 10-K and other filings with the SEC. Let me now turn the call over to Fred.

Fred Eppinger, CEO

Thanks, Nat. And thank you all for joining us today and your interest in Stewart. In a minute, Dave will go through this quarter’s financial results in more detail, but before I would like to touch on a few other things about our performance this quarter. Well, it feels like much longer given everything that has happened in 2020. This quarter represents the completion of a full year of financial results for Stewart since I took over as CEO in September 2019. For that reason, I’d like to take a moment to reflect on a few things. First and foremost, I am proud of how this company and its employees have handled the change and turbulence of the past year. The terminated merger with Fidelity National in September feels like a minor speed bump when compared to the upheaval experienced by our country, our communities, our customers, employees and their families because of COVID-19, as well as a very real and active real estate market. Through it all, our employees maintained their focus on delivering superior service in challenging conditions, while above all, ensuring the safety of their customers and coworkers. I constantly refer to what is taking place here at Stewart as a journey, because it highlights that the work to achieve our mission will take time. That said, our results this quarter and year-to-date show that real progress has been made on the journey to become the premier title services company. Our growth is not simply the result of macro tailwinds of low rates and a positive real estate market, but it’s equally about those former customers being reintroduced to the value of the Stewart brand. New hires joining forces with our existing employees are actively working to ensure everyone here at Stewart goes the extra mile to deliver added value and a better experience for our customers. Along with a focus on target growth, the foundation of greater operating discipline with this quarter’s record operational profitability reflects our hard work in this area thus far. I believe that much more progress can be and will be made as we move into 2021 and beyond. In many ways, we remain structurally disadvantaged versus our peers with respect to business mix, scale and geography. That said, I am pleased with our first steps in addressing these differences. Acquisitions in core title and ancillary services have brought significant scale and a better mix to Stewart, with more to come on the horizon. New hires have reminded us that Stewart is now an attractive destination for talent both from our industry and adjacent industries. We have made good progress so far, but there’s much more to be done. David will now go through our financials for this quarter in more detail.

David Hisey, CFO

Thank you, Fred, and good morning. Let me also thank our associates for their amazing and inspirational service and our customers for their support during these unique times. The third quarter saw a continuation of the trends that unfolded in the second quarter. Our financial activity was strongly driven by refinancing demand, with the 30-year mortgage rates in the 3% area as the Fed continues to be accommodative. The commercial segment remains challenged by economic events. We continue to be mindful of the economic stress caused by the virus, as well as mortgage forbearance, which will result in increased foreclosures that may lead to title losses. Moving to Q3 results, yesterday, Stewart reported total operating revenues of $591 million, net income of $56 million and diluted earnings per share of $2.21. This is a significant improvement from last year’s quarter, which had an adjusted net income of $30 million and adjusted diluted earnings per share of $1.28, as disclosed in Appendix A of the press release. Remember that last year’s quarter results included the $50 million FNF merger termination fee, along with some impairment charges and merger expenses. Our title revenues for the quarter improved to $563 million, up 13% from last year, driven by another strong performance from residential and agency operations, partially offset by lower revenues from commercial services. Pretax income for the title segment was $82 million, a 66% improvement from the third quarter of last year. Pretax title margin also improved to 14.5% as a result of this revenue growth and the continued discipline in running our business that Fred mentioned earlier. With respect to our direct residential title business, revenues increased by $48 million, or 30%, primarily due to increased purchase and refinance transactions from existing and newly acquired title offices. The residential fee per file is approximately $1,900, which is lower than last year also due to a higher refinance mix. Domestic commercial revenues decreased by $13 million, or 26%, as a result of fewer commercial transactions and a lower average fee per file of $9,700. Total opened and closed orders improved 48% and 44%, respectively, compared to the prior year quarter, primarily due to the affirmation of refinancing and driven by purchase demand. Our recent acquisitions contributed about 7% to both open and closed orders. Our agency business increased revenue by $29 million, or 9%, on increased business activity, while agency remittance improved to 18.3% versus 17.8% from last year. Regarding title losses, total title loss expense increased by $7 million, or 35%, primarily due to increased title revenues, as well as increased provisions in our domestic business due to the current economic environment and unfavorable loss development in certain coverages within our Canadian operations. As a percentage of title revenues, our title loss expense was 5.1% versus 4.2% in the prior year quarter. As previously announced, we acquired some higher losses in early September. We welcome these new associates to the Stewart family and are very excited about the early results, which generated $10 million of revenue in the month. These acquisitions are consistent with our strategy of improving our scale and competitive position in priority markets and have proven industry talent to strengthen our customer and business relationships. In regard to operating expenses, which consist of employee and other operating costs, total operating expenses increased primarily due to higher employee incentive compensation, consistent with our improved operating results, partially offset by lower operating costs as we continued our management focus, as well as reduced marketing and travel spending due to the current COVID-19 environment. Employee costs as a percent of operating revenues improved to 26% from 28% last year, while other operating expenses declined to 16.7% from 17.3% last year. On other matters, our financial position remains very strong. Our total cash and investments on the balance sheet are approximately $500 million, fulfilling regulatory requirements, along with a $100 million available line of credit, providing a solid foundation to support our customers, employees, and real estate markets. Stockholders’ equity attributable to Stewart was $944 million, with a book value of approximately $35 a share as of September 30, 2020. Lastly, excluding the $50 million FNF merger fee in the prior year quarter, net cash provided by operations improved from $66 million to $91 million in the third quarter of this year. I’ll now turn it back over to the Operator for questions.

Operator, Operator

We’ll go first to John Campbell with Stephens, Inc. Your line is open.

John Campbell, Analyst

Hey, guys.

Fred Eppinger, CEO

Good morning, John.

John Campbell, Analyst

Good morning and congrats. Hi. Good morning. Congrats on the great results. But I think from my math here from a justice standpoint, it looks like you guys almost put up enough EPS to match in this quarter to almost match what you did in 2018. So really, really nice results. Congrats.

Fred Eppinger, CEO

Thank you, John.

John Campbell, Analyst

Yeah. So I would have asked a little bit about the newly acquired Western State Offices. David, I think you said that helped lift orders like 7%. Was that for the full quarter or just for the September orders?

David Hisey, CFO

It was for the full quarter, John, and I also noted $10 million in revenue for the month. Keep in mind that we close around the first of the month and then there was a smaller one a little later.

John Campbell, Analyst

That's helpful. Regarding the acquired offices, to what extent were they contributing to agency revenue previously? Will there be a negative impact as the agency undergoes some mix shifts?

David Hisey, CFO

Yeah. I would say we were not one of the bigger participants in that. So it shouldn’t be a big negative.

John Campbell, Analyst

Okay. Regarding the reserves, can you elaborate on the strengthening and provide insights into the developments in Canada versus the conservative approach following the moratorium and how foreclosures might impact next year?

David Hisey, CFO

I would say the majority of our focus has been on the latter point, being aware of potential economic changes. As we have done in recent quarters, we have continued to analyze product differences and make necessary adjustments. Overall, our primary concern has been to stay informed about ongoing developments.

Fred Eppinger, CEO

I believe it's wise to adopt a conservative stance right now, considering the current trends. The focus is really on IBNR.

John Campbell, Analyst

And then, I guess, last one here, I’ll just tack on to that. What do you estimate for how much you’ll hire at this stage based on the actuary estimate?

Fred Eppinger, CEO

I am hiring naturally investment.

David Hisey, CFO

Over the midpoint as we’ve typically been.

John Campbell, Analyst

Okay. Great. Thanks, guys.

Fred Eppinger, CEO

Thank you. Appreciate it.

Operator, Operator

Our next question comes from Bose George with KBW. Your line is open.

Bose George, Analyst

Good morning and it was a strong quarter. I have a couple of questions. First, Fred, you mentioned that there will be more on the acquisition front. Can you elaborate on that? Additionally, regarding the balance sheet, your debt to capital is below 10% and you have a significant amount of cash. How should we view the cash available to support growth?

Fred Eppinger, CEO

Dave, why don’t you take the balance sheet then I’ll come back to the…

David Hisey, CFO

Yeah. So, Bose, I think we’ve touched on the capital thought process in the past. I think, obviously, the money on the line of credit is available and there’s probably a good couple hundred million on top of that, like to leave a little bit above regulatory cushion and just to have operating buffers and alike. But I think that’s sort of how we think about capital for investment. And I think we’ve talked about where we’re looking to use that for, right? I think growth core title and ancillary and things of that nature. And you’ve seen that activity really for the last few months.

Fred Eppinger, CEO

Yes, regarding the previous question, if you look at our situation, we have often found ourselves spread too thin. Our focus now is on investing in our strengths and being strategic in each local market. Achieving a certain market share can significantly enhance our capabilities and margins, leading to more stability. We are committed to improving our operations and managing expenses thoughtfully. Increasing revenue where we have strong leadership positions will enhance our resilience in earnings and margins. We are targeting specific markets and have already made progress, with more opportunities ahead. Additionally, we are looking to build scale in certain areas and are approaching that effectively. Overall, we believe we are executing the basics well while concentrating on managing our business thoughtfully and strategically shifting our investments toward our strengths. I am pleased with our ability to grow despite having redirected over $30 million to more profitable areas and addressing longstanding issues. Although we have more work to do, I am satisfied with our quarterly performance and the progress we’ve made.

Bose George, Analyst

Okay. Great. That makes sense. Thanks. And then actually just wanted to ask the premiums in the quarter, on the direct side, it was up very meaningfully, on the agent side it was up a little more modestly. Can you just talk about the differential? And also just remind me, is there any lag on the agent revenue?

Fred Eppinger, CEO

There is a slight lag in reporting, typically around 40 to 60 days for market trends. However, I am pleased with our targeted approach to reconnect with those who left due to the transaction, and we have made significant progress. We are also investing in our value proposition, connectivity, and ease of use, and we are making solid strides in these areas. In terms of our business strategy, we are being very deliberate about our growth, focusing on specific locations, as splits and profitability vary in the agency business. I am optimistic about our progress, and I expect to see continued improvements over the next couple of quarters. We have several investments rolling out that will strengthen our relationships, so I feel confident about our direction.

Bose George, Analyst

Okay. Great. Actually, let me just ask one more question that I’ve asked in the past before as well. But just I wanted updated thoughts and where you think the margin can end up. I mean, this is the quarter where your titled margin is getting a lot closer to the peers. Just any updated thoughts on how we should think about where that goes?

Fred Eppinger, CEO

Yeah. It’s an unusual year with a lot of things going on, for sure. When we started, I set forth to say, okay, we ran between a 4.5 and 5 for the three years previous margin and I felt very strongly that we could do the right things over the next three years to get to high single digits. I would tell you that I am more confident today in that than I’ve ever been before. But I still believe that’s kind of right. I think we could have accelerated some of our progress here. It’s hard to completely see. But I think that’s kind of still where I am. Could that change at Stewart? We’re trying to get better every day and as we kind of get our structure and our portfolio together, we’ll see. But that’s what we’re shooting for. That’s what we believe will happen. So that allows our shareholders to get what I believe above-average growth for the next three years, as well as a twofer on the margin as we move forward over the next three years.

Bose George, Analyst

That’s great.

Fred Eppinger, CEO

I think we all agree that’s margin.

David Hisey, CFO

Yeah.

Fred Eppinger, CEO

Exactly.

David Hisey, CFO

You were asking about prior.

Fred Eppinger, CEO

I’m sorry, but I’d told you over…

Bose George, Analyst

Yeah.

David Hisey, CFO

Yeah. Exactly.

Bose George, Analyst

So that sort of people can see more.

Fred Eppinger, CEO

Yeah. So the pretax side of margin growth. Okay. Great. Thanks a lot and nice quarter. Thank you. Appreciate it.

Operator, Operator

We’ll go now to Geoffrey Dunn with Dowling & Partners. Your line is open.

Fred Eppinger, CEO

Good morning.

Geoffrey Dunn, Analyst

Yeah. Good morning. Fred, can you talk a bit about the commercial market, the recovery you have seen today, that’s also at the local level and the national-type accounts? But also your outlook, not necessarily through year-end, but into 2021. Obviously, we all see the same reports about title office space, et cetera. Now, what’s that market look like to you?

Fred Eppinger, CEO

Yeah. Great question. David, why don’t you start with it, then I will jump on it.

David Hisey, CFO

Yeah. Geoff, I mean, I guess, we’ll probably as we have been for this year and it was our last quarter, we may not be as optimistic as some of our competition there. I think we’re planning for a longer recovery. We could see some pickup in activity sort of going into next year with workouts and moves into special servicing and that kind of thing and maybe in selected markets. But in general, it doesn’t seem like there’s a big pickup in activity and we’re planning for a longer recovery there.

Fred Eppinger, CEO

Yeah. I would say, if we see activity, there are some of the smaller fields starting to happen in some of the secondary cities. But I would also just say, because I think this is a longer term, for us this is an important opportunity. We are right now very focused again on some targeted markets and we’re looking at what the opportunity is and going to try to be selective in how we really invest and position ourselves as this thing comes out. I would also say that in Canada, we think this is a material opportunity for us long-term. So for me, we’re cautious about what we see, but it’s also an important part of where we’re going to go on our growth. We are trying to position ourselves and work pretty hard at being thoughtful about where we put investment and think about the future. I think you’ll see everybody in the same ballpark, as a result, because it’s kind of the markets driving this reduction, but I do think it’s an important part of what we are and what we’re going to be.

Geoffrey Dunn, Analyst

Do you see that there has been a secular disruption to the commercial market?

David Hisey, CFO

I mean, again…

Fred Eppinger, CEO

It’s probably too early to tell, I mean, you can flip a coin on whether people are going back to work or not. I mean, there are equal studies saying it’s all work-from-home and then everybody wants to get back to the office. I’d say it’s too early to call.

David Hisey, CFO

I think it's important to note that there are mixed opinions on this issue. As we emerge from the current situation, we can expect to see a significantly different mix. I'm curious to understand if, as you mentioned, this change will be permanent or how it may evolve.

Geoffrey Dunn, Analyst

Okay.

Fred Eppinger, CEO

When you bet on things like all day long at some point you want to be able to actually thought like…

Geoffrey Dunn, Analyst

All right. Thank you, guys.

Fred Eppinger, CEO

Thanks, Geoff. Appreciate it.

Operator, Operator

And we do have a follow-up question from John Campbell with Stephens, Inc. Your line is open.

John Campbell, Analyst

Hey, guys.

Fred Eppinger, CEO

Hi, John.

John Campbell, Analyst

Thank you very much for letting me squeeze one more in.

Fred Eppinger, CEO

Yeah.

John Campbell, Analyst

Speaking of working component, I am wondering eventually get back to the office. I’m just curious about on the other operating expense line. David, I don’t know if you can suss out how much or what maybe the run rate savings are from less T&E and less kind of travel activity?

David Hisey, CFO

Yeah. It’s a good question. There’s a lot in that line. I would say we’re probably down a good $10 million for the year run rate there.

Fred Eppinger, CEO

Yeah. I would say that if you think about all discretionary kind of stuff that’s tied to, what’s hard about it, we also have extra costs of setting people up remotely, too. So this is…

John Campbell, Analyst

Yeah.

Fred Eppinger, CEO

But it’s less, I would say, less than $10, but probably that’s the right ballpark of discretionary that we got out because of the situation.

John Campbell, Analyst

Okay. That’s helpful. And then the $60 million of cost savings you guys called out, how much of that was impacting corporate? And if I know, at one point you guys were running corporate about $5 million a quarter. Is that still kind of the same run rate?

David Hisey, CFO

Yeah. It’s about $5 million. Yeah. It’s in the press release, isn’t it? Like $6 million or so.

Fred Eppinger, CEO

Yeah.

John Campbell, Analyst

Yeah.

David Hisey, CFO

Okay.

John Campbell, Analyst

Okay. Thank you, guys.

Fred Eppinger, CEO

Yeah. Thank you.

Operator, Operator

And this will conclude our question-and-answer session. I would now like to hand the call back to our speakers for any closing remarks.

Fred Eppinger, CEO

That concludes this quarter’s conference call. Thank you for joining us today and your interest in Stewart. See you next quarter.

David Hisey, CFO

Thank you.

Operator, Operator

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