Earnings Call Transcript - STC Q2 2022

Operator, Operator

Hello and thank you for joining the Stewart Information Services Second Quarter 2022 Earnings Call. At this time all participants are in a listen-only mode. Later you will have an opportunity to ask a question during the question-and-answer session. Instructions will be given at that time. Please note today's call is being recorded. And it is now my pleasure to turn today's conference over to Brian Glaze, Chief Accounting Officer. Please go ahead.

Brian Glaze, Chief Accounting Officer

Thank you, Shelby. Thank you for joining us today for Stewart's second quarter 2022 earnings conference call. We will be discussing results that were released yesterday evening. Joining me today are our CEO, Fred Eppinger, and CFO, David Hisey. To listen online, please go to the Stewart 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 for 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 statements 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 for joining us today for Stewart's second quarter 2022 earnings conference call. David will go over the quarterly financial results in a minute, but before that, I'd like to cover our overall view of Stewart and our position in the current market. Much of the work here at Stewart over the last few years has focused on restructuring, refocusing, and rebuilding the company's operations to better position ourselves to be a more successful resilient company, ultimately to become what we refer to as the premier title services company. The goal is to create a sustainable business that performs through all types of real estate cycles and economic conditions. We are focused on improving margins, generating growth, and creating a stronger competitive position by improving our scale, enhancing our operational capabilities, and maintaining our financial discipline. As part of our journey, we are focused on enhancing the customer experience through technology investments that have meaningfully changed our ease of use and expanded our product offerings in our agency, lender, and direct business. I am pleased with the progress we made and demonstrated in the second quarter as we maintained strong margins and continued to make progress on our operating priorities in a more challenging market. We've seen the market transition to a high-interest rate environment. The interest rate increases have put significant pressure on refinance transactions, which we have been historically less dependent on, and to a lesser extent on purchase transactions. So we expect that the current environment will continue throughout the second half of 2022. While it is a more challenging environment, Steward, because of our significant improvements, is well prepared to successfully manage through these market changes. I'd like to emphasize that even though the market has transitioned, our journey continues. We remain focused on our structural improvement, attaining critical scale in priority markets aided by leading technology support and innovation to drive superior and consistent service delivery to our customers. To achieve our goal of becoming the premier title services company, we recognize that we must continue to make thoughtful investments even in this environment. In our direct operations, share growth remains our important goal in our overall strategy in targeted MSA markets. Over the last couple of years, we have focused on the acquisition of more than 20 regional title companies and we are constantly evaluating opportunities to deploy available capital. We are hard at work integrating these acquisitions into our production and other systems to improve the customer experience and overall operating efficiencies built over the last few years. Above all, we are managing our business in a disciplined way given the current environment, and that never stops. In our agency business, we have made significant progress on our deployment of technology and services that provide greater connectivity, ease of use, and risk reduction for our agent partners. As the industry accelerates the implementation of online and paperless transactions, we are identifying ways to better support our agents as they undergo the critical transition. We believe our opportunity to grow scale in our target markets and improve our share with winning independent agents is on a very solid path forward. We are seeing revenue growth in our commercial operations and we are investing in these operations for the future as they are an important component of our overall strategy. We are optimistic regarding the commercial markets overall, although the tougher capital markets create some temporary headwinds in certain parts of the country. To be clear, there is more work to be done as we maintain our focus on growing and enhancing our competitive position, improving scale, and operational capabilities. We recognize that maintaining customer service levels is a fundamental part of who Stewart is, while also managing expenses is more important than ever. Even in the changing market conditions, we still see opportunities to invest and grow share in our target market, allowing us to profitably grow throughout the cycle. Let me just finish by reiterating my positive long-term view of the real estate market and our ability to continue to grow and become the premier title services company. I would also like to thank our associates for all their hard work and our customers for their continued support. David will now update everyone on the results.

David Hisey, CFO

Thank you, Fred, and good morning. Let me also thank our associates for their amazing service and our customers for their trust and support. Moving into the middle of the home buying season, the residential market has been negatively impacted by 30-year mortgage rates persistently above 5%, slowing home sales, and housing starts. Consumer sentiment has worsened due to inflation and concerns about affordability and recession; however, employment rates remained steady. Commercial real estate saw good activity in the quarter; however, rising rates and volatile capital markets are beginning to influence transactions. For the second quarter, we reported net income of $62 million and diluted earnings per share of $2.26 on revenues of $844 million. After adjustments primarily for net unrealized gains and losses on equity securities, which is an equity sell-off, our adjusted net income for the second quarter was $70 million or $2.58 per diluted share, compared to $86 million or $3.17 per diluted share in last year's quarter. Total final revenues for the second quarter increased by $17 million, up 2%, compared to last year's quarter primarily due to better results from our agency and commercial operations, which were partially offset by lower residential revenues on reduced transaction value. The title segment's pre-tax income for the second quarter was $94 million, compared to $126 million in the prior-year quarter. The segment's pre-tax margin for the second quarter was 12.3% compared to 16.7% in the second quarter of 2021, primarily due to the effects of fair value changes in equity securities, lower residential volume, and the investments we are making to grow revenue, improve customer service, and reduce title production costs, as Fred mentioned in his opening remarks. In regard to our direct title business, domestic commercial revenues improved by $13 million or 25% as a result of higher transaction volume across most asset classes and a 17% higher than average fee per file of $13,100. Domestic residential revenues increased by $11 million or 5% driven by lower purchases in refinancing transactions in the second quarter of 2022. The residential fee per file for the quarter was approximately $2,900 versus $2,200 last year due to the higher purchase mix. Total international revenues in the second quarter were $4.0 million or 8% lower compared to last year, primarily due to lower transaction volumes in our Canadian operations. Opened and closed orders in the second quarter both declined by 28%, primarily due to the elevated interest rate environment. Our agency operations generated in the only follow-up quarter with revenues of $410 million, 5% higher than last year. The average agency remittance rate slightly decreased to 17.1% from 17.5% primarily due to geographic mix. On title losses, total title loss expense in the second quarter decreased by $7 million or 21% from last year's quarter, primarily due to our overall favorable claims experience, partially offset by higher total title revenue. As a percentage of total revenues, the title loss expense in the second quarter of 2022 was 3.5% compared to 4.5% last year. For the full year of 2022, we anticipate title losses will be approximately 4% of title revenues. Regarding our Real Estate Solutions segment, which we began to break out last quarter, pre-tax income improved by $4 million compared to last year due to the acquisitions completed towards the end of last year. Pre-tax margin was 7.4% for the second quarter of 2022, 14.7% prior to purchase amortization, compared to 3.8% and 6.6%, respectively, in the second quarter of 2021. It's important to note that these businesses are also impacted by mortgage and real estate volumes, each one slightly differently. And so, yes, you should expect to see some of what we see in title also in the real estate solutions business, impacted by the market. In regard to operating expenses, which consist of employee and other operating costs, total operating expenses for the quarter increased, mainly due to increased variable costs related to revenue and higher employee count. Employee cost as a percentage of operating revenues for the second quarter was 25%, compared to 24% last year, while second quarter other operating expenses were higher at 19% of operating revenues, compared to 17% last year due to the increased size of our real estate solutions operations, which typically have higher other operating expenses due to third-party services. Other matters, our financial position provides strong support for our customers and employees in the real estate market. Our total cash and investments on the balance sheet are approximately $557 million over regulatory requirements and then fully available $200 million line of credit facility. As of June 30, 2022, stockholders' equity attributable to Stewart was approximately $1.35 billion and our book value per share was approximately $50, an increase of 5% from December 31, 2021. Lastly, net cash provided by operations for the second quarter was $83 million, compared to $103 million in last year's quarter, primarily due to lower net income in the second quarter of 2022. We always appreciate the performance of our customers and associates. We hope for everyone's improved safety and prosperity and are confident in our support of the real estate markets. I'll now turn it back to the operator for questions.

Operator, Operator

We'll take our first question from Bose George with KBW.

Bose George, Analyst

Hi, good morning. Actually, first I wanted to ask just about investment income, what's a good run rate for that number and the increase this quarter was that just reflecting the increase in market rates?

David Hisey, CFO

Yes, Bose. That's a good question. We have seen a slight increase due to the rise in rates. In the quarter, we receive dividends from different title plans and related activities. So, it's really a combination of some of those dividends in the interest rate environment. For your question on run rate, I would say probably somewhere in the $5 million to $6 million range, it may be closer to that as it depends on what happens with rates from here, but I think $5 million to $6 million is probably a good number.

Bose George, Analyst

Okay. Great. And then can you just talk about trends you're seeing in July in both the purchase and commercial market?

David Hisey, CFO

Let me see. Yes, this is David again. In commercial, I would say the market is probably transitioning a little bit like what we saw maybe six months ago in residential, not to that degree because there's still a lot of activity. So even though we continue to see increases in opened orders, we hear from customer feedback that transactions are taking a little longer to execute. So I guess I would just describe the market as still good, but we are seeing some transitions being impacted by the capital markets and interest rate environment.

Bose George, Analyst

Okay. Great. Thank you.

Operator, Operator

We'll take our next question from John Campbell with Stephens Inc.

Fred Eppinger, CEO

Good morning, John.

John Campbell, Analyst

Hey, guys. Good morning. Just a big picture question here, maybe for you Fred or David, either one of you. But you guys have talked about the 10% total company pre-tax margin in the past, and I know you've got some more pressure building on the purchase side of the market. And there's obviously a lot of moving parts that lead up to that 10%. But based on what you're seeing today and what you're expecting, do you think you can manage that 10% mark this year and maybe even next?

Fred Eppinger, CEO

Yes. That's a great question. I believe we can manage to the 10% target. If you look at our trend, our margins were about 4.5% in '19, about 6.5% in '20, and obviously in '21, it was about 12.5% for the company. I would say that there may have been an extraordinary bump in that number due to staffing levels and the extraordinary nature of our sales, but now we are settling into a more normal market. I believe we are adequately positioned to sustain a double-digit, low double-digit margin going forward, as we have made structural improvements to our institution. We need to manage ourselves effectively to achieve that, but I feel confident about our position as a company.

John Campbell, Analyst

Okay. That's helpful. And then, David, on the reserve ratio, 3.5% this quarter, I think in the press release you mentioned 4% for the full year, so maybe implying a little bit of a step-up in the back half. Is that out of conservatism or are you seeing something maybe in the back book that leads you to project that up for the back half?

David Hisey, CFO

We are not seeing any pickup in the claims rate or anything like that. I think it's just when we look forward to our projections, we want to be reflective of the likely title losses, and that's why we settled on the 4%.

John Campbell, Analyst

Okay. That's helpful. And then if I could squeeze in just one more here. I know, I think you guys sold the Coldwell Bain and so the non-title revenue stepped down a little bit sequentially. I think that was the driver of that, but I'm curious about what remains in the real estate solutions segment. Can you help us size up the mix between recurring and transactional revenue there that you see today?

David Hisey, CFO

Yes. The businesses in that segment are valuation businesses. As I mentioned in my remarks, those are impacted by what happens in the origination market. We've got Informative Research, which is a credit-related business that has both highly sensitive services and those that aren't as sensitive, but I would say it is predominantly sensitive in terms of its revenue mix. Prop streams, on the other hand, is a subscription real estate service that is not as sensitive. It's important to see how those businesses are performing in the current market, and they are generally guided by entrepreneurial management teams. So, they should perform well even in this market and we're seeing that in the numbers.

John Campbell, Analyst

Okay. Great. Good work on the quarter, guys. Thank you.

David Hisey, CFO

Thank you.

Operator, Operator

We'll take our next question from Geoffrey Dunn with Dowling & Partners.

Geoffrey Dunn, Analyst

Thanks. Good morning.

Fred Eppinger, CEO

Good morning.

David Hisey, CFO

Good morning.

Geoffrey Dunn, Analyst

A couple of questions. I wanted to revisit your comments on commercial. Rewinding six months in residential, things are starting to take a bit longer. You're seeing more purchase deals pop up than refinances. Are there more legs from a mix shift standpoint with respect to the fee per file? Or are you also seeing that at kind of the deal size deal mix stabilize? So maybe if volumes do flow, we don't get as much offset on the fee per file side?

David Hisey, CFO

Yes. It's a great question, Geoffrey, and a great observation. Until now, we've seen pretty good strength across all real estate asset classes. Larger transactions, whether they are energy, multi-use, or large multi-family, these transactions are active and influence a higher fee per file. The activity in local markets has also been quite strong. Looking forward, we may see a little more pressure on larger transactions as they typically finance in the capital markets. Higher financing costs in the capital markets should drive some influence on cap ratios, which may help stabilize valuations. So, we will need to monitor how this market continues to transition, but for now we remain optimistic.

Geoffrey Dunn, Analyst

Okay. Technical question with respect to your investment income. I've seen this in the past. Is the second quarter typically when you're getting these title plant dividends, so maybe on a recurring annual basis next to $1 million to $1.5 million in NII?

David Hisey, CFO

That's right. It is typically the second quarter. And I would say there's probably a little bit more activity, but the number you mentioned is in the ballpark for sure.

Geoffrey Dunn, Analyst

And then last question. I think you mentioned that staffing was up. I don't know if that was on a year-over-year basis with acquisitions or if you added staffing in the quarter. Can you just talk about what your staffing trends have been and how you are setting the company up for the back half of the year? Particularly, Fred, given all the work you've had getting the right people in the right places, building scale in certain markets. It seems like it might be a bit more challenging to address staffing after the restructuring and how the company approaches certain areas of the market. So could you just elaborate on that?

Fred Eppinger, CEO

Yes, sure. We have built up quite a bit in our service business, and in some title geographies we've experienced year-over-year growth. We need to be very thoughtful about managing our resources and taking targeted actions in various businesses. I feel good about where we are with our talent. We just need to be thoughtful about incremental investment and targeted investments right now given the market uncertainties. But overall, I'm pleased with the quality of our operations and how we are positioned. As I mentioned, it's transitional for the market, and we need to manage our investments effectively to sustain our double-digit margins through the cycle.

Geoffrey Dunn, Analyst

Okay. Thanks, Fred.

Operator, Operator

Our next question comes from Ryan Gilbert with BTIG.

Ryan Gilbert, Analyst

Thanks. Good morning, everyone.

Fred Eppinger, CEO

Good morning.

Ryan Gilbert, Analyst

First question is on the residential purchase market. It looks like June orders were down maybe 11% to 12% year-over-year. So when we think about your comment around the current environment continuing through the second half of 2022, is a low double-digit decline an expectation on how you're framing this or is July tracking down more on a year-over-year basis than 11% or 12%?

David Hisey, CFO

Yes. In July, what we're seeing is that compared to June, it's down a little bit but not at the double-digit level. We're starting to see how the rest of the year plays out. Yes, we saw the rate increase yesterday. We still have high mortgage spreads, well over 200 basis points, which is historically high. However, many people are sitting on the sidelines waiting to see how things play out. So we didn't see the same level, month-over-month, but the rest of the year remains uncertain. As Fred mentioned, we're managing the business with the assumption that conditions could worsen.

Ryan Gilbert, Analyst

Okay. Got it. Thanks. And then how did fee per file trend through the quarter? It seems home price appreciation has been more resilient than expected given the slowdown in housing demand and higher interest rates.

Fred Eppinger, CEO

We are around $2,900 for residential fee per file. We have started to see that slow down. It was up significantly from $2,200 a quarter ago, but with predominantly a purchase mix now, I believe we are nearing the top given the current market effects.

Ryan Gilbert, Analyst

Got it. And then last one for me on agent mix. It's up year-over-year. Given the comments you made about deploying new initiatives to support the agency business, should we expect your agency revenue as a percent of operating revenue to continue to increase throughout the year or do you think the mix will stabilize from here?

Fred Eppinger, CEO

It's a great question. We have seen nice traction in our agency sector driven by two significant initiatives: improving integrations and connectivity, and understanding agent needs for commercial business. We've seen progress in both areas. Although we are not immune to market trends, we are encouraged by the growth we have realized. Therefore, you may see a shift towards agency growth but we are also focused on our direct business, so I don't expect a material shift between the two segments over multiple quarters. However, I do believe agency performance will continue to show progress.

Ryan Gilbert, Analyst

Okay. Great. Thanks very much.

Fred Eppinger, CEO

Thank you.

Operator, Operator

It appears that we have no further questions at this time. I'll return the floor to the presenters for closing remarks.

Fred Eppinger, CEO

Thank you so much for joining us for our second quarter earnings call. Thank you so much.

Operator, Operator

That concludes today's teleconference. Thank you for your participation; you may now disconnect.