First American Financial Corporation (FAF) Q4 2009 Earnings Report, Transcript and Summary

Welcome and thank you for standing by. All participants will be in a listen-only mode until the question-and-answer session. (Operator Instructions). Copies of today's discussion materials are available on First American's website at www.firstam.com/investor. Please note that the call is being recorded and will be available for replay from the company's investor website and for a short time, by calling 203-369-3594. We will now turn the call over to Jo Etta Bandy, Senior Vice President of Corporate Communications to make an introductory statement.

Thank you. Good morning everyone and thank you for joining us for our fourth quarter and 2009 year-end earnings conference call. At this time, we would like to remind listeners that management's commentary and responses to your questions may contain forward-looking statements such as those described on page two of the accompanying slides and other statements that do not relate strictly to historical or current facts. The forward-looking statements speak only as of the date they are made and the company does not undertake to update forward looking statements to reflect circumstances or events that occur after the date the forward looking statements were made. Risk and uncertainties exist that may cause results to differ materially from those set forth in these forward looking statements. Factors that could cause the anticipated results to differ from those described in the forward looking statements are described on slide two. As indicated on slide three, management's commentary and responses to your questions also contain certain financial measures that are not presented in accordance with general accepted accounting principles. The company does not intend for these non-GAAP financial measures be a substitute for any GAAP financial information. In the slide presentation these non-GAAP financial measures has been presented with and reconcile to the most directly comparable GAAP financial measures. Investors should use these non-GAAP financial measures only in conjunction with comparable GAAP financial measures. Joining us today on the call will be our Chairman and Chief Executive Officer, Parker Kennedy; Anand Nallathambi, President and Chief Operating Officer of First American Information Solutions Group; Dennis Gilmore, Chief Executive Officer of the company's Financial Services Group and Buddy Piszel, First American Chief Financial Officer. During the call, we will be referring to a slide presentation which is currently available on First American's website at firstam.com/investor. At this time, it is my pleasure to turn the call over to Park Kennedy.

Thank you, Jo. I would like to welcome everyone to First American's fourth quarter call. Please refer to page four of the earnings presentation for a summary of our consolidated earnings. First American reported earnings per diluted share of $0.38 for the fourth quarter compared with a net loss of $0.72 in the fourth quarter of 2008. This quarter had several one time charges that we will cover throughout the presentation. In total, these one time charges reduce net income by $24.9 million or $0.25 per diluted share. Adjusting our earnings to reflect these changes results in earnings per diluted share of $0.63 in the fourth quarter. We are pleased with these results. For the full year 2009, First American earned $2.09 per diluted share on revenues of $6 billion as compared to a loss of $0.28 on revenues of $6.2 billion for the full year of 2008. On previous calls, we provided you with one time adjustments to our earnings for prior quarters. For the full year, these adjustments totaled on an after tax basis $49.9 million or $0.52 per diluted share. So on an adjusted basis, full year 2009 earnings per share were $2.61 which I believe reflects strong performance in a tough market. In the fourth quarter, we made considerable progress on our commitment to separate information solutions and financial services businesses. In November, we completed an exchange offer to acquire the publically held shares in First Advantage and in December, we amended our agreement with Experian to facilitate the purchase in 2010 of their remaining interest in our joint venture with them. We're also making great progress on the regulatory and financing trends and Buddy will cover these points later in the call. To wrap up, 2009 was a good year and we are pleased with the progress we made to improve financial results. Our strong performance in the fourth quarter demonstrates those efforts. During the year, the company and its employees worked hard to execute on many initiatives that enabled the financial services business to return to sustainable profitability and enabled our information solutions business to continue to show strong results. We accomplished this despite a challenging environment in the mortgage and real estate markets. We are expecting a challenging market in 2010 but we are prepared to execute on our strategic plans in both business segments and continue to make the necessary changes to further improve our financial performance. We are looking forward to completing this event and seeing our financial and information businesses thrive as independent public companies. Now I would like to introduce Anand Nallathambi, President and Chief Operating Officer of the Information Solutions Group.

Thank you, Park. Good morning everyone. The Information Solutions Group delivered improved results for the fourth quarter of 2009. Relative to the fourth quarter of 2008, revenues were up 2.9%. Our results for the quarter were impacted by the $13.4 million of cost related to the buy in of the publicly held shares of FADV, $2.2 million in severance costs and $6.2 million in net realized investment losses. When we adjust for these items, EBITDA was $111.5 million and pretax income was $77.9 million for the quarter. On a same basis comparison to the fourth quarter of 2008, EBITDA was up 5.6% and the pretax income was up 5.8%. For the full year 2009, all results were equally positive. Total revenue of $2.1 billion was up 4.2% over the prior year with strong growth from mortgage origination and loss mitigation related businesses. The overall macro economic conditions provided significant headwinds for the risk mitigation and business solutions segment. Our adjusted EBITDA and pretax income for the year were $512.1 million and $382.6 million respectively up 6.7% and 11.9% relative to 2008. Getting back to focus on the fourth quarter relative to the same period in 2008, we experienced revenue growth in credit, tax, flood, property valuation and default products while our lead generation employment services and litigation support businesses suffered revenue declines. From a product development perspective, the fourth quarter had many positive highlights. On a new product front, we announced the launch of a new Appraiser-Validated Price Opinion, a product that is designed to enhance the accuracy and application of traditional broker price opinions. In addition, our geospatial solutions group, an extension of our flood services operation rolled out several new products for the property and casualty insurance industry. This is a clear example of the crossover potential of our product capabilities into new business verticals. New product innovation and expansion into related and new verticals is a key part of our organic growth strategy. From a sales and marketing perspective, we added new sales commitments representing $94 million in annualized revenue on a gross basis in the fourth quarter of 2009. These aggressive sales efforts have helped us maintain positive momentum despite the challenging environment. Fourth quarter sales wins included a $20 million contract to provide appraisals on short sales for a major financial institution, a $20 million contract to provide broker price opinions for one of the GSEs and a $5 million contract to deploy Fraud Manager and the LoanSafe product and Willcap [ph] for a large national bank. From an organizational perspective, there are many projects underway as we get ready for the spinoff at the standalone public company. We are pleased to report the significant milestones that were accomplished during the quarter. Park mentioned the closing of the FADV transaction and the completion of a amendment to the Experian joint venture agreement. These agreements not only allow us to streamline our corporate structure and financial reporting, but also will provide us with increased flexibility to leverage and develop the strength of our data and business services assets. In addition to corporate structure and operational readiness related projects, we're also looking forward to launching our new name and branding strategy soon. The economic indicators and the market reports point to 2010 being another challenging year with an expected 40% drop in mortgage originations, and continued high levels of unemployment. However, I believe we are prepared to demonstrate resilience in the face of stiff economic headwinds. As we prepare for the spin-off, our corporate teams are focused on the structure related activity and our operational teams are continuing their disciplined focus and executing on client needs and market opportunities. 2010 will be an exciting year in our company history. With that, I'd like to turn it over to Dennis to discuss the fourth quarter results for the financial services group.

Thank you, Anand, and welcome. Fourth quarter pretax income for the Title Insurance segment was $45 million resulting in a 4.7 pretax margin. These results include $10 million of net realized investment losses on a combined $5 million of employee separation and lease termination cost, offset by a $5 million claim recovery. Excluding these items, our adjusted pretax income was $54 million or a pretax margin of 5.7. In 2009 our primary focus was on centralizing, standardizing and simplifying our business model and these efforts translated into a $290 million improvement in our pretax earnings despite a $310 million decline in revenue. We'll continue these efforts throughout 2010 and beyond. Additionally we will take advantage of opportunities to grow our market share in select markets. In the fourth quarter, we closed 334,000 loans, an 8% sequential decline and closed orders due to normal seasonality. The mix of refinance orders remained relatively constant throughout the quarter at 35%. Our direct revenues declined 6% sequentially due to a decrease in the number of closed title orders. This was offset by an increase in our average revenue per order which was 14.53, an increase of 2% relative to the third quarter. Our agency revenues decreased 2% sequentially but was up 23% over the prior year. Our salary and personnel costs were up 1% from the prior quarter. During the fourth quarter, the title segment reduced its employees by 340. Further reductions have been made in 2010 and we will continue to make adjustments as we realize the ongoing benefits of our reorganization efforts and as we continue to adjust to current market conditions. Our other operating expenses declined 14% from the prior quarter. The decline was primarily due to lower production costs as a result of the decline in open orders. In addition the company closed 45 offices in our ongoing effort to rationalize our foot print resulting in annual savings of $2 million. The loss ratio in the Title Insurance segment was 5.3% for the fourth quarter. This rate includes the $5 million claim recovery. The ultimate loss ratio for policy year 2009 remains at 6% and we expect in 2010 the loss ratio to be between 5% and 5.5%. Total revenues in our commercial division were $65 million, a 25% increase relative to the prior quarter. We saw an increase in the number of closed deals in the fourth quarter which is the typical seasonal pattern. The commercial outlook for 2010 remains challenging, but we are encouraged by an uptick in transaction volumes, primarily driven by an increase in workout related transactions. Total revenues in our international division were $74 million down 9% on a sequential basis and we are seeing an increase in transaction volume in our Canadian market. Transaction levels were strong in November and December and we expect this trend to continue. In 2010, we will continue to invest and grow our international operations. Total revenues at our special insurance segment were $72 million, relatively flat from the prior quarter. Pretax income for the segment was $12 million for a pretax margin of 17%. And our home warranty experience has a strong turnaround from 2009 driven by aggressive expense management and improvement in our management of our service delivery network. As we move into 2010, we continue to operate in a challenging business environment. Open orders averaged 6,600 per day in the fourth quarter. And in January, we opened 5,800 per day and in February we are opening 6,600 orders per day. Severe wind or weather in many parts of the country have impacted open orders which will put pressure on our first quarter earnings. The most recent MBA forecast is calling for a 40% decline in mortgage origination levels from 2009. Anticipating this decline, we will continue to focus on preserving and improving our margins by enhancing our agency profitability, increasing our market share in select markets, continue to leverage our offshore capacity, optimizing our investment portfolio and capitalizing our gradual recovery on our commercial and international markets. To summarize, we made significant progress in 2009 and we are proud of our operational and financial achievements. We expect this trend to continue in 2010 and beyond as we prepare to become a standalone company. I'd now like to introduce Buddy Piszel our Chief Financial Officer.

Thanks, Dennis. We had a number of adjustment items this quarter. Most of them have been talked about. I will just provide two more that were in corporate. One is employee separation cost of $6.1 million and we recorded all of our spin related costs at corporate which were $5.7 million. When you add all of the one time items up, it was $41.6 million pretax, $24.9 million on an after tax basis or $0.25 per share of negative items that impacted the quarter. On liquidity and the capital side, we ended the year in great shape. Cash at the holding company ended at $150 million, north of our $130 million target, a $100 million of that will go to InfoCo’s holding company and $50 million of that will go to FinCo’s holding company. Our debt to capitalization came in at a conservative 19.7%. Projected statutory surplus came in really strong at about $800 million. We believe that will continue to put us at the lowest premium leverage ratio in the title industry. So, going into the spin, cash and capital are actually better than we anticipated. So, let me move on to the spin. In December, we filed a Form-10 with the SEC, the comments we got back were manageable. We've already responded in an amendment and will be updating the filing for the year end numbers shortly. So, that process is in really good shape. At this point, we've submitted all the regulatory filings that are required to complete the spin-off transaction and have received a number of key approvals. In January, we filed our private letter ruling request with the IRS. Before we filed, we did a lot of pre work to reduce the likelihood of substantive issues, but it's still a very complex filing. The feedback we receive from the IRS is that given their workload, while it would not be impossible, it would be optimistic for them to complete their work by April 1st. Since we have got a lot of things that we need to plan around the spin date, we decided to move our spin date to June 1. Next we've made a lot of progress on our credit facilities. Both companies have seen strong support from our existing and expanded bank group and we received commitments on a $500 million facility for InfoCo and in excess of $350 million for FinCo at terms that are acceptable to us. This is a big milestone for both companies. With our spin date of June 1, we are pleased to announce our investor day on May 11th at the New York Palace. We are working on an exciting introduction to both companies that will be followed by an extended road show right up to the spin date. So mark that date in your calendars and we look forward to seeing you there. That's it for me and now let’s open it up for questions.

Thank you. (Operator Instructions). Carter Malloy with Stephens, you may ask your question.

Can you just comment a little bit on some of the dynamics inside of your risk mitigation and business information segment? I am just wondering about the sequential step down there, if that's around lumpiness in litigation business and employer or there is actually market share shifts in your three-in-one business?

You are right. The difference or the shift was more seen in our litigation support businesses and our employer services business. As you saw on employment levels globally, last year was a tough year and it progressively got worse towards the close of the year. So that really impacted our ability to really stabilize earnings from that segment. In litigation support, we are and we stay involved in a lot of the conservations. Most of the projects that we are in deals, they have just been deferred, so it’s been more of a holding pattern in litigation support and it’s something that we see across our competitors. So if I have to say, I wouldn't say there is any share degradation in any of these businesses, it’s more of a market downturn.

Okay. And then I was actually a little surprised to see the growth in lead generation side of that business. And as I understood, there was a significant piece of low margin business there that creates upside last year in that business and you guys were actually trying to turn that in the other direction. So should we expect to see some year-over-year at least revenue headwinds on that piece of business this year?

Yes, I think you would expect to see some revenue headwinds there. We did not like the rapid growth in products that were more of a health and wellness type products where the margins were not what we wanted and so we're looking at verticals that are going to be more stable over an extended period of time.

And any idea what you expected, at least optical headwind will be on, on the top line for that business this year?

We have to get back to you on that. I would say that the first part of the year, there was a heavy growth in health and wellness products and we did not like the margins nor did we like the risk. So, we purposely kind of stayed away from it in the later part of the year. So, we have to adjust for it.

Brett Huff with Stephens, you may ask your question.

This is actually Tyler in for Brett, how is everybody doing? Dennis, I was just wondering may be if you could give us a little bit more color on some of the things you are doing on the tighter operating expenses, showed some nice sequential decline there and just getting some more details on kind of some of the initiatives?

Sure, we'll give you a lot more details at the upcoming investor day. But we’ve followed a pretty consistent pattern here through the last couple of years. We standardized, we centralized and we simplified our business model and then we leveraged our offshore opportunities where we can and that's the pattern that we repeat through into the business. And so we are very focused in anything that’s a shared services across the organization to lever our efficiencies. We are also very focused right now in our agency performance, we want to make sure that we are receiving the expected return on capital for that model. We're very focused on making sure that our footprint’s at the right level of distribution for our footprint. We are very focused on leveraging our investment portfolio appropriately and then we are working very diligently to control our risk from an underwriting prospective. So, it's an ongoing basis, we'll continue with those efforts throughout 2010 and beyond. So just quick recap, we'll continue to do what we've done in '09 as we go into '10 and that is leverage share services, centralize it, simplify it, standardize it, and then repeat it.

Given some of the estimates that are out there for next year's mortgage origination environment, do you have any sort of title margin targets that you are shooting for that you are hopeful to achieve?

No, we are not going to give guidance on that, but what I will say though is in the current origination environment we think we can continue to improve our performance even at a lower origination market.

Okay. And then lastly just on the June 1 date, are we pretty highly confident that that's going to be the date or is there chance of additional push out?

No, I think at this point we are pretty confident. Given the feedback we got from the IRS, the additional two months gives us a high level of confidence and at this point that's the long pull-in attempt. The rest of the regulatory approvals and the interactions with the SEC, we think will be well done and again, we've scheduled the investor day and we are marking to that June 1 day.

Jason Deleeuw with Piper Jaffray, you may ask your question.

My first question here is on the title business. I just want to make sure I'm clear on this. You talked about a $1.3 trillion origination market for this year. Are you preparing the organization market for this year, are you preparing the organization and the expense levels for $1.3 trillion market this year?

We are, we continue to right size our business however the market dictates we need to.

So do you think it’s possible, I mean I know you guys don't want to give out a title margin goal but do you think it’s possible that you could even expand the margins over the course of the year even if we do see a low origination market like $1.3 trillion?

Yes, this is Dennis. Clearly that will be a difficult objective but that's where we're focused on. We set out a plan, our strategic plan allows us to, we think, to do that, and we are going to continue to operate against that plan and then we'll adjust to the market as we need to.

Okay. And then switching over to the Info Solutions Group, can you help us get a handle here on the outlook for 2010. You got some market share gains, here you got some new sales wins that are going to help this year, but we also got lower mortgage origination volumes likely this year. Can you help us with what you think for top line growth? Can the top line even grow this year or can we expect some declines and then also some sort of an EBITDA outlook for the entire group?

Our sense is, the businesses that are more exposed to the mortgage origination market, which are largely in the IOS segment are going to have some strong headwinds to overcome. Now the good news is that a lot of our business comes from the major market makers and they are not going to loose as much share as the overall markets, so we'll get a little help there. So we think that they'll probably be balancing out between the stress that we take on origination side plus the new business generation. So I think our sense is, we would be at least revenue neutral may be better.

Is that just for information outsourcing solution?

No if you put them all together, you put all the businesses together, I think at this point that's how we would describe it.

Okay. And then on the default revenue, it seems like foreclosure activities slowed here over the winter months, loan mods and we had some moratoriums. What are you guys seeing in your pipeline and what do you expect for that revenue line item as we progress through 2010?

Yeah, this is Anand, and I'll answer it first. Our products structure is more towards the loan workout process and software tools and technology solutions that we provide there and we see some exciting opportunities for us. Although, we are cautious in looking at that market to say is it a consistent market that's going to be stable over a period of time or is it something that's more of an opportunistic type play that we take care of it right now. Our focus is being on looking at the enterprise in a longer term basis and we're making plans to make sure to react to the needs of the market and also to put some strong emphasis on sales that's going to look towards the future.

And on the title side, we clearly have seen a decline in default related activity because of the moratoriums in the fourth quarter. What we're looking at in 2010 is probably a flatting of that revenue curve from what we have seen over the last couple of years and our focus on that business is to continue to grow our market share in that space.

Nath Otis with KBW, you may ask your question.

I guess the first one, just on a higher level, any update on InfoCo CEO search?

Yeah, this is Park. It's been an ongoing process. It still is but we are hopeful that we'll announce a new CEO in March.

And then I guess a couple of questions for Anand. First in info and outsourcing, the market share gains, are those just smaller guys that are having tough time competing in a slowing market or were there any market share gains against the larger competitors?

I would say it's from both sides and I think going back to how Buddy explained it, in this market we see the big mortgage makers, the major players really consolidate share and we are enjoying because we have a bigger share of wallet with those customers and now we have deeper product infringement [ph] with those customers.

Okay. And then just on another segment, probably more importantly for InfoCo, just getting an idea, is there a way to get a minority interest breakdown by segment and sub-segment for the quarter?

We can get you that. I don't have that right in from of me, Nath, but if you just give Dave Bigelow a call, he'll be able to follow up with that.

Okay, great. And then just last question for Dennis. I want to be clear on what you said about margin improvement even in the event that the overall market starts to take a turn downward. You said that even if the market was a little worse than expected, you still might be able to get margin improvement over the longer term, not necessarily in 2010. How do you phrase it exactly?

That's how I'm looking at it. We’ve got to operate in whatever market is dealt here. We think the market's going to be in the 1.3 [ph] trillion origination market and we're going to be focused on that, and that's how we are sizing our business. And then we coupled out with all the strategic initiatives we have here that are ongoing and so our commitment is to continue to try to improve our efficiencies regardless of the market, and clearly it’s going to get difficult if the market starts to deteriorate from where we are right now.

Timothy Mullen with VNB Trust. You may ask you question. Timothy Mullen - VNB Trust: Guys, what was the paid title claims for the quarter? I don't know if I missed that. I don't think I saw it in the disclosures.

The paid was $76 million.

And then also on a obviously a very general basis, could you talk about what you are seeing at California, both for the quarter and then maybe in the year-to-date in 2010? Are you seeing a lot more activity level or how would you characterize it?

We've actually seen an uptick in California. When we look on a year-over-year basis, we're up 9% in California and I am encouraged that the California market is starting to show some early signs of stability and recovery. So key market for us is obviously one of the largest, if not largest in the country. Key market for us and we want to continue to gain share on that market.

Stephen Velgot from Susquehanna you may ask your question.

Yes, just a couple of questions from me. Do I have to wait till the amended Form 10 to get a pro forma book value number for the financial services?

Yeah, we'll be filling the amended Form 10, the 10-K is due on Monday and within a couple of weeks from there we'll be filling the updated Form 10 with the 12/31 numbers. You'll have them shortly. I would also add that at about that time or earlier, we'll be filling in effect a Form 10 type pro forma for the InfoCo company, so you can see both companies, and we'll keep them both updated on a going forward basis right up to the spin date.

Okay, thank you. And just a question putting the $1.3 trillion forecast in some context, can you share with us what you think your market share was in 2009 in the title insurance business. And last I knew you were fairly optimistic about market share gains over the next several years, but if you can give us a sense of that $1.3 trillion origination forecast, what's that down from in 2009 that people [ph] can assess?

Sure, this is Dennis. Just on the origination forecast, we ended the year in 2009 at about $2 trillion market, we are now having MBA forecast coming out at 1.3. It may be better, it may be worse, we'll play it out as we go through the year. On the market share question, we're running right now at around 27.5 and if you break apart on market share we've been very focused on maintaining and growing our direct market share. We’ve actually strategically lowered our agency market share to improve our performance of that segment. As we go forward, we're very focused on key markets that we want to grow our market share both agent and direct. We've got plans in place to try to do that throughout 2010 and beyond.

That's all the time we have for questions today. That concludes this morning's call. We'd like to remind listeners that today's call will be available for replay on the company's website or by dialing 203-369-3594. Copies of the press release announcing First American's first quarter results and the accompanying slide presentation are also available on First American's website at www.firstam.com/investor. The company would like to thank you for your participation. This concludes today's call. You may now disconnect.