First American Financial Corporation (FAF) Q1 2011 Earnings Report, Transcript and Summary

Welcome and thank you for standing by. At this time, all participants are on a listen-only mode. (Operator Instructions) A copy of today’s press release is 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 dialing 203-369-1842. We will now turn the call over to Craig Barberio, Director of Investor Relations to make an introductory statement.

Good morning, everyone, and thank you for joining us for our first quarter 2011 earnings conference call. Joining us on today’s call will be our Chief Executive Officer, Dennis Gilmore, Max Valdes, Executive Vice President and Chief Financial Officer, and Mark Seaton, Senior Vice-President of Finance. 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 pages four and five of today’s news release and other statements that do not relate strictly to historical or current fact. 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 are made. Risks and uncertainties exist that may cause results to differ materially from those set forth in the forward-looking statements. Factors that could cause the anticipated results to differ from those described in the forward-looking statements are also described on pages four and five of the news release. Management commentary contains and responses to your questions may often contain certain financial measures that are not presented in accounting to generally accounting principles, including an adjusted loss provision rates. The company is presenting these non-GAAP financial measures because they provide the company’s management and investors with additional insight with the operational performance to company relative to earlier periods and relative to the company competitors. The company does not intent for these non-GAAP financial measures to be a substitute for any GAAP financial information, in the Form 8-K that we filed today which is available on our website www.firstam.com. The non-GAAP financial measures disclosed in management commentary are presented with and reconcile to the most directly comparable GAAP financial measures. Investors should use these non-GAAP financial measures only in conjunction with the comparable GAAP financial measures. I will now turn the call over to Dennis Gilmore.

Thank you Craig. First American posted a net loss of $15 million or $0.15 per diluted share this quarter. Our results reflect $45 million reserves strengthening charge for our Canadian operations which reduce our EPS by $0.26. This charge is in connection with a guaranteed evaluation product we sell exclusively in Canada. This product which is small from our revenue perspective guarantees the accuracy the valuation of the property as of the date that loan was made. Again, we only guarantee the value of collateral and only as of the date the loan was made. We sold only on loans with LVVs at 80% or less and it is underwritten using the prominent property risk assessment tool. The product appear to perform well for years, during 2010 we begin to see an increase in claim activity. At the end of the first quarter 2011, we observed the meaningful increase in claim activity which let our internal actuary to determine that the reserve strengthening was necessary. We are disappointed with the products and we are cancelling its current form. And we are looking to reinsure a modified version, but we can’t reinsure all or most of the risk, we will terminate it completely. In addition to the reserve strengthening in Canada, we also strengthened our U.S. reserves by $15 million due to increased claim activity for prior policy year. Our open order accounts were down 17% relative to the fourth quarter primarily due to lower refinance volumes. The impact of the decline was offset by a reduction in personal and other operating expenses totaling $50 million. Our commercial title business continues to perform well with revenues up 35% of last year. In the first quarter, we had our highest open order accounts since 2008. First American mortgage service, which includes our…

Thank you, Dennis. The company’s generated total revenues of $932 million for the quarter; up 3% from the same quarter of the prior year. Net loss for the quarter was 15.3 million or $0.15 per share compared with net income of 13.8 million or $0.13 per share for the same quarter of the prior year. As Dennis mentioned, the results for the current quarter included a $45 million reverse strengthening change in our Canadian operations which totaled 27 million on an active after-tax basis or $0.26 per share. In the Title Insurance and Services segment, total revenues for the quarter were $861 million; up 3% compared with the same quarter of the prior year. Title premiums and escrow fees were $697 million for the quarter; up 4% compared with the same quarter of last year. Direct revenues were flat, driven by an 8% decline in closed orders, offset by higher average revenues for orders closed. Average revenues per order closed increased 8%, to $1,337 compared to the same quarter of last year, this increase primarily reflected the strength of our higher premium commercial title business partially offset by the increase of lower premium refinance transactions. Agent premiums were up 7% in the quarter; primarily due to the normal reporting lag of approximately one quarter. As a result, higher agent remittances this quarter were consistent with an increase in the company’s direct premiums and escrow fees in the first quarter of 2010 relative to 2009. Information and other revenues totaled $149 million for the fourth quarter; up 3% compared to the same quarter of last year. This line item includes title plan information, search products, appraisal and other related revenues. The increase in the fourth quarter was driven by increased demand for title plan information, partially offset by reduced demand for…

Thank you, Max. I will provide a few comments on our capital and liquidity. Cash used for operations in the first quarter was $50 million, it is typical in our business to have a drain on cash in the first quarter due to seasonality of operations and the timing of certain cash payments. Capital expenditures during the quarter were $13 million which is less than 15 million, we’ve targeted to spend on a quarterly basis. I would like to take a moment to explain our thinking around our investment in CoreLogic. At the time of the spin-off we owned 12.9 million shares at CoreLogic. 5.2 million This year were held at our holding company and the remaining 7.7 million shares were held at a regulated insurance company. We consider the shares that are holding company to be excess capital as we do not need them to operate our business. However we do not consider the shares at the insurance company to be excess capital as their admitted assets were statutory surplus purposes. We wanted to reduce the risk of the insurance company given that we had such a highly concentrated position in one common stock. On April 5 we agreed to sell, 4 million shares at CoreLogic out of the insurance company, two CoreLogic at a spot market price of $18.95, which resulted in proceeds to us of $76 million. We do not have any future tax payments related to the sale. This action enhances the cash – cash position and improves the surplus quality of the insurance company. We will look to unwind the remaining 8.9 million shares stake in CoreLogic within the next four years as required in connection with our sale. In March, our board approved $150 million share repurchase authorization. We believe repurchasing shares can be…

Thank you. We will now begin the question-and-answer session. (Operator Instructions) and our first question comes from Mark (inaudible). Please state your company name.

Yeah, thanks, from Morgan’s Capital. First, could you give us a little more detail on kind of what you observed in the adverse loss of elements in the 2007 year block and what the risk is of future addition to reserves.

Sure Mark, this is Max. Let me just start by saying that we haven’t really seen a significant deterioration in claims. Really what’s going on is our policy is that we pulled to our actually best point estimate and we do that, it is considered best accounting practice and it provides transparency, but it does create volatility. So, really what happened in the quarter and it really mostly happened in March. We’re expecting roughly $57 million in claims and we’ve received 67 million, so that’s what came in. so our actuary takes that and developed that number to $15 million and added that to its best estimate. So, we pulled to its best estimate and upped our overall reserve. It’s very minor; I mean it’s less than a 2% adjustment to our balance and again we don’t think it’s a significant deterioration or anything, it’s just our regular policy. In April we’re back down to claim counts; today April to date we are right back to claim counts we were forecasting.

And what are the risks of future reserve adjustments for the Canadian operations.

Sure Mark, this is Dennis. You know we have taken the situation obviously very seriously and here’s what we have done in Canada. This product performed well for number of years, but then we clearly had deterioration, and that deterioration started in 2010 and we reflected that in IBNR and by the time we got through quarter of 2011, we have seen a material increase in our claims and we took a position just like an access point in the U.S. Internal actuary took a look at it and decided that needed to take a reserve adjustment and we booked to his best point estimate. And I want to make sure everybody is clear that was higher than our external actuary’s range. So we want to make sure we do this appropriately. We think we have taken a conservative approach to this. I can’t be 100% sure that we won’t have to come back here but we want to make sure that we have taken conservative approach and put the problem behind this.

Okay, and Dennis, I just wanted to feel (inaudible) in your comment about how future expense reductions will be market driven? In a scenario in which volumes just kind of bouncer on the bottom here, would you expect any kind of additional incremental process to the plan?

Thanks for the question, we have done a few things in the quarter, we were relatively aggressive actually. We lowered our employee counts in the U.S. by 275, we eliminated a 160 plus temps in the business, and we’re going to continue to size the business for the market we are operating in, and we are pretty comfortable. We are pretty comfortable, we’re down to the size we need to be for this market. And which really what I’m employing here is that we think we’re narrowing a bottom obviously we can’t make the call that we think we are narrowing bottom and we’re going to make market adjustments and also we’re very focused on growth right now. We think there are good opportunities for others to grow when we look at over the year, next few years.

Okay, great. And is there any guidance you can provide on the earnings impact in the sale of the CoreLogic on your second quarter results.

Yes, Mark, this is Mark Seaton we are going to have abutted almost 800,000 realized gain in the second quarter because of the 4 million shares (inaudible) so, I would say is immaterial.

Okay, thanks.

And our next question comes from Nat Otis. Please state your company name. Nat Otis – KBW: Okay, KBW. Good morning. Just maybe to follow-up on Canada, you’ve given – talked about that it was relatively small revenue component. If you thought you had the exit that business completely once you kind of looked at it, can you tell us what type of impact that would be on say a percentage basis of your overall international revenues.

Sure. It’s a material. The product in Canada has been – that was introduced in 2003, and to 2010, our revenues were never higher than 15 million and the average between 5 and 10. Nat Otis – KBW: So, you’ve taken the material portion, you’ve reserved against the material portion of that business itself right now. Would you say like 50% or something like that?

I’m not going to give a percentage, but we have taken I think the right approach and we follow our actuary’s guidance since book to midpoint, is keeping its best estimate. You know, there is one other comments I would like to make, it’s an important comment for us and that is we need to learn a lessons from the process number one. Number two, we’re in the risk assumption business and we need to continue to innovate, both in the U.S. and international. This is just a case that we mispriced our risk. And so the lesson we’re going to learn from this is that only innovates across our product offerings; we’re going to make sure that we balance that risk with steps that we’re going to put to re-ensure in early years Nat Otis – KBW: All right. I guess then you’re shifting over to kind of what you’re seeing from a volume standpoint. You gave commentary that you – possibly hop to be close to a bottom but on – Is there any way to gauge that assuming the trends that you’re seeing in April, where you think originations are going for full year? I mean are they trending given what you’re seeing April to 11 or sub one trillion market or is it just kind of still within the range of what you expected when you started the year?

Yeah, it’s absolutely in the range of what we expected. The NBA just recently re-forecasted, made their forecast of 107 trillion and we don’t see any reasons and not believe that forecast at this point, but what actually happened is that we are seeing a little higher refinancing, a little lower purchases. We would like to see a reverse of that and what’s actually happened was what the NBA has forecasted right now. And so we think that the forecast is accurate. We started off with a slow spring buying season, no question. We have some optimism that it may grow in May or June, but regardless, which side the business for the turnover count. Nat Otis – KBW: All right, fair enough. And then just last question. Just on looking forward into May and June, every year is certainly different, but is – could you argue that May or what month is typically the best month that you would have from seasonal selling standpoint as things would start to trend upward?

It changes by year, but it’s typically is April or May. Nat Otis – KBW: Okay, fair enough. Thank you very much.

You are welcome.

(Operator Instructions) Our next question comes from Brett Huff. Please state your company name. Brett Huff –: Good morning Brett Huff from Stevens good morning everybody, just a couple of follow-up questions. I wanted to – the $50 million sequential decline in cost was seemed very good and I want to make sure that we understood all the components of that I am guessing that the FTE culture part of it. But, is there anything else in particular that should be called out that will continue on or might be onetime?

Hey, Brett, this is Mark. A lot of the expense reductions between Q4 and Q1 were just variable in nature and we accrue less bonuses, we accrue that 401(k) match. We did have some real cost cut, like we closed 30 offices, we have reduced about 275 people as Dennis said, but a lot of it was because of seasonal accruals because of the first quarter. Brett Huff – Stevens: Okay, but the office cuts in the people obviously are ongoing the others sound like they’re just seasonal?

Correct. Brett Huff – Stevens: Okay. And then second question any update on the Bank of America situation anything you can share with us on that?

Brett, there really is until the process continues on I am going to say with our policy, I’m not commenting on active litigation other than stuff that I’ve been saying over the last few quarter Bank of America continues to be a very good customer barrowers and we continue to deal with Bank of America and by serving (inaudible) space. Brett Huff – Stevens: Okay. And then in terms of the agent retention I want to make sure I get that, the agent retention was driven largely just by a mix of a particular large transaction that’s one met to a little big lower level than it’s typical and that will go back to sort of the mid 80, 81 level?

Hey, Brett this is Mark again yeah the this quarter was 80.0. We did have a large commercial transaction, we had about 4 million of premium that swung it, if you exclude that our split would have been about 80.5, but we are really pushing hard to reduce that overtime. And so we think that it’s going to trend down more towards the 80.0 and hopefully less than 80.0 by the end of the year. We have done a lot to change our splits New York, which we have talked about in the past we just announced that we are going from 8515 to 8317 towards as of today as of April 1st were the split of 8317 in New York, we want to get that down to 8020 within an year. So that will again help us. We moved the split materially in a lot of smaller states, Oregon we moved at 400 basis points, Montana we moved at 400 basis points, Colorado we moved at 100 basis points and there is also some larger states like California, it’s typically our company has always been 1910. Today, it’s 88.5 and we want to move that down a little more. So we are really focusing hard on the splits, and we think we’ll see some movement there going forward. Brett Huff – Stevens: Okay, that’s I had. Thanks for your time.

The last question comes from Jason Deleeuw. Please state your company name. Jason Deleeuw – : Yeah Piper Jaffray thank and good morning.

Good morning. Jason Deleeuw – Piper Jaffray: Going back to the Canada product, are you guys started seeing an increase in the claim activity in 2010, can you just give us a little bit of color on what was driving that and just an idea what customers were using this product?

Sure. Again, we introduced the product in 2003 and had very good performance in the early years and in 2009, 2010, we started to see a slight uptick in the Canadian default rate and that is where we started to identify some deficiencies in our product. And those deficiencies really fall under three categories; number one at the highest level we just took too high an underwriting risk and we weren’t adequately compensated for it, and we dealt without or dealing with that issue. Second issue is the model we used to make determinations on assurability, which is we think is the best model available had some weaknesses that we accept and not the model. So, we accepted and that is we took risk on for example rural properties that probably in retrospect we should know. And then the last component that drove that is we have one of our key customers up there, one of our best customers has launched specific channel that has performed poorly and we’re taking steps to deal with that channel right now. Jason Deleeuw – Piper Jaffray: Where these big or small mortgage lenders in Canada? Can you just give a little bit of sense of that?

Sure, sure. Our top three customers represent over 95% of the volume. Jason Deleeuw – Piper Jaffray: Okay. Then in the U.S business with the claims deterioration that we saw, you guys – it sounds like April it sort of normalized. You just saw the spike up in the March and the claims. Can you give us a sense and the regions in this – under regional level or type of mortgage products? Where were you seeing the increased claims?

Jason, it’s Max. It is really across the board. It is really – it is across residential, commercial, it is across direct agent channels and is really not one type of claims of costs – higher claims you will just – like I said across the board. Jason Deleeuw – Piper Jaffray: Okay, and then just getting back to your – the margins and managing expenses for the volumes but also being positioned before turnaround or your near bottom in the volumes. I guess what the current – it seems like you guys are somewhat comfortable with the expenses right now given the volumes that you are seeing. Can you still hit your margin targets that you guys are looking internally to hit, can you still hit those with the current expense levels with the volumes that we are seeing or we are going to have to see an increase in volumes?

Well, we’ve set an objective for this year, let me answer this. In the first quarter when I take the results strengthening and put it off beside, I don’t mean that not – accounts when I put it off beside we actually had a strong operating performance in our business, we hit or exceeded all our expense ratios and our key operating ratios, number one. Number two, we’ve set an objective for the business to try to match our performance of 2010 and that will be very difficult by the way in the current revenue environment or in. We are comfortable with right size right now. Towards the longer term margin we are not back in off in our commitment at all of an eight to 10 margin. Now we are going to need some help in the market. We are going to need some stability and ultimately some growth, that is absolutely our long-term objective. Jason Deleeuw – Piper Jaffray: Okay. And then could you just give us sense of the purchase refi mix in April?

Yeah. In April, we opened up the 4,600 per day and 46% of those re-price. Jason Deleeuw – Piper Jaffray: Thank you very much.

Definitely trend it down in January with 55% refi, February with 51%, March with 50% and April with 46% but we’re seeing the mix of refi circled down throughout the year. Jason Deleeuw – Piper Jaffray: Thank you.

And 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 203-369-1842. The company would like to thank you for your participation and this concludes today’s conference call, you may now disconnect.