First American Financial Corporation (FAF) Q4 2015 Earnings Report, Transcript and Summary

Greetings and welcome to the First American Financial Corporation Fourth Quarter Earnings Conference Call. [Operator Instructions] A copy of today’s press release is available on First American’s website at www.firstam.com. Please note that this call is being recorded and will be available for replay from the company’s investor website for a short time by dialing 877-660-6853 or 201-612-7415 and entering the conference ID 13628414. I will now turn the call over to Mr. Craig Barberio, Director of Investor Relations to make introductory statements. Thank you. You may begin.

Good morning, everyone and thank you for joining us for our 2015 fourth quarter and year end earnings conference call. Joining us on today’s call will be our Chief Executive Officer, Dennis Gilmore and Mark Seaton, Executive Vice President and Chief Financial Officer. 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 4 of today’s news release 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 are made. Risks 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 these forward-looking statements are also described in Pages 4 and 5 of today’s news release. Management’s commentary contains and responses to your questions may also contain certain financial measures that are not presented in accordance with generally accepted accounting principles, including personnel and other operating expense ratios and success ratios. The company is presenting these non-GAAP financial measures, because they provide the company’s management and investors with additional insight into the operational efficiency and performance of the company relative to earlier periods and relative to the company’s competitors. The company does not intend for these non-GAAP financial measures to be a substitute for any GAAP financial information. In the news release that we filed today, which is available on our website, www.firstam.com, the non-GAAP financial measures disclosed in management’s commentary are presented with and reconciled 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. With that, I will now turn the call over to Dennis Gilmore.

Thanks, Craig. Good morning and thanks for joining our call. I will begin with a review of 2015 followed by our fourth quarter highlights and conclude with a few comments regarding our outlook for 2016. The company had a strong year in 2015, with EPS rising 22% to $2.62, each of our key title market showed strong revenue growth. Purchase revenue was up 11% as the housing market recovery continues. The finance revenue surged 29% due to a decline in mortgage rates early in the year. Our commercial business had a record year with revenues up 17%. Throughout 2015, we continue to manage our expenses effectively achieving a success ratio of 56% for the title segment. Our title business posted a 10.2% pre-tax margin for the year. And the company’s return on equity improved to nearly 11% both in line with our stated objectives. In 2015, we gained market share on our direct title business and expanded our property record database to be the largest in the industry. We increased the utilization of our data assets throughout the company and pursue the opportunities to use our data to lower our risk profile and our title business. 2015 was a good year for First American. Turning to the fourth quarter, EPS was $0.74 per year – EPS was $0.74. The quarter’s results include $6 million of net realized investment losses, which reduced EPS by $0.04. Our commercial business had an all-time record quarter generating $206 million of revenue, up 4% compared to last year. For the quarter, pre-tax margin on our title business exceeded 10%. We are encouraged by these strong results given that we implemented the new mortgage disclosure rules, TRID, which wouldn’t affect in October. The extensive effort we devoted to TRID, including upgrading our systems and training both our people and our customers, paid off as we were able to successfully manage through the sweeping process changes that were required. After experiencing some initial delays in closings, by the end of the quarter, our direct residential business returned to its typical closing timeframes. Looking forward, we believe that TRID will not have immaterial impact on our closings and we have a high degree of confidence, we are well-positioned for the upcoming spring selling season. In 2015, we spent $20 million in capital expenditures related to TRID, which will impact our amortization expense in 2016, but we do not expect any significant reductions in operating expenses now that TRID has been implemented. Revenues in our Specialty Insurance segment grew by 5% during the quarter. However, we experienced higher claim losses in both home warranty and our property and casualty business combined with a non-favorable swing in net realized gains and losses, the segment’s pre-tax margin declined to 10%. Turning to market outlook, despite uncertainties in the economy, we remain optimistic that the housing market will continue to strengthen in 2016. We are well positioned to capitalize on anticipated growth on the purchase market. We are benefited from the recent decline in mortgage rates. Our refinance orders per day were 1,700 in January and are now running at approximately 2,100 per day so far in February. While the increase in refinance orders will provide short-term benefit, it is uncertain how long this level of elevated refinance activity will continue. We believe the commercial market is poised for another strong year in 2016. However, we expect our growth rates to moderate relative to what we experienced last year. Based on the positive long-term outlook, our Board of Directors recently approved a 4% increase in our common stock dividend to $1.04 per share annually. In closing, we are proud of what we accomplished in 2015. We believe the company is well-positioned to capitalize on the ongoing housing recovery and to achieve our vision at the end of premier title, insurance and settlement service provider. I would now like to turn the call over to Mark for a more detailed review of our financial results.

Thank you, Dennis. Total revenue in the fourth quarter was $1.4 billion, up 8% compared with the fourth quarter of 2014. Net income was $82 million or $0.74 per diluted share. The current quarter results include net realized investment losses of $6 million or $0.04 per diluted share. In addition, investment income in the current quarter includes impairment of investments and affiliates of $2 million, which reduced earnings per diluted share by $0.01. In the Title Insurance and Services segment, direct premium and escrow fees were up 4% compared with last year. This growth was driven by a 5% increase in the average revenue per order. The average revenue per order increased to $2,236 due to an increase in the average revenue per order for purchase transactions as well as the shift of the mix towards commercial transaction. Agent premiums were up 14%, reflecting the normal reporting lag in agent revenues of approximately one quarter. The agent split was 79.0% of agent premiums. This quarter, to confirm with the industry practices, we have reclassified certain revenues from direct premium and escrow fees into agent premiums. This reclassification caused our reported agent split to decline by 120 basis points and had no impact to total revenue, net income or earnings per share. Information and other revenues totaled $161 million, down 2% compared with last year driven by a lower demand for the company default information products and unfavorable currency translation. Personnel costs were $381 million, up 10% from the prior year. This increase was primarily due to higher incentive-based compensation relative to last year. Other operating expenses were $180 million, down 3% from last year. This decline was primarily due to higher earnings credits and reduction in professional services and production-related costs. The ratio of personnel and other operating expenses to net operating revenue was 72.1%. The provision for title policy losses and other claims was $70 million, or 6.5% of title premiums and escrow fees compared with a loss provision rate of 6.6% in the same quarter of the prior year. We expect our loss provision rate in 2016 to decline to between 5% and 6% of title premiums and escrow fees. However, this estimate may change depending on actual claims experience. During the fourth quarter, our paid claims fell 27% and we expect continued reductions in paid claims this year as older, high loss rate policy years become more seasoned. Pre-tax income for the Title Insurance and Services segment was $129 million in the fourth quarter compared with $125 million in the fourth quarter of 2014. Pre-tax margin was 10.3% compared with 10.8% last year. Turning to the Specialty Insurance segment, total revenues were $100 million, up 5% compared to last year. The loss ratio for the segment was 59%, up from 52% in the prior year with higher losses experienced in both home warranty and property and casualty. The increase in the loss ratio and home warranty was primarily due to a return to a more typical seasonal loss rate as compared with an unusually low loss rate last year. In the property and casualty business, the loss ratio increase was primarily due to hailstorm events in New Mexico. Pre-tax margin for this segment was 10.0%. Net expenses in the corporate segment were $22 million in the fourth quarter, up 14% relative to the prior year, driven by higher costs related to company benefit plans. The effective tax rate for the quarter was 30%. The tax rate benefited from $5.6 million or $0.05 per diluted share of non-recurring items, largely due to the release of valuation allowances against foreign deferred tax assets. In terms of cash flow, cash provided by operations was $199 million, a 2% increase from 2014. One of the drivers to our improved cash flow was the decline in paid title claims, which declined $18 million this quarter. Capital expenditures were $33 million, unchanged from the fourth quarter of last year. Debt on our balance sheet totaled $585 million as of December 31. Our debt consists of $549 million of senior notes, $30 million of trustee notes and $6 million of other notes and obligations. Our debt to capital ratio as of December 31 was 17.5%. We have the entire amount available under our $700 million revolving credit facility. In January, we repurchased 14,200 shares for $450,000 at an average price of $31.97. These shares were purchased in accordance with the 10b5-1 trading plan. Lastly, as Dennis mentioned, our Board of Directors recently approved a 4% increase to our common stock dividend to $1.04 per share annually. I would now like to turn the call back over to the operator to take your questions.

Thank you. At this time we will be conducting question-and-answer session. [Operator Instructions] Our first question is from John Campbell from Stephens. Please go ahead.

Hey, guys. This is Hayden sitting in for John. So just a quick question on commercial activity, where do you guys thinks we are at in kind of the commercial cycle here and you did mention that you expect those growth rates to slow moderately in 2016, but just as far as your overall market share, I mean do you kind of expect that to remain flat in a growing environment or do you expect to take share kind of walk through the moving pieces there?

Sure. A couple of points to that question, the first is what’s our outlook in the market? We think we are going to have another very good year in 2016 and our pipelines are very strong. The momentum in the business is strong right now. But as I have said, I think the growth rate will start to moderate over what we have experienced over the last few years. With regards to the share, we are very intent to continue to grow our share and gain share in the marketplace.

Got it. And then on the share repurchase activity, do you guys have the ability or do you intend to maybe take advantage of some of the pullback, maybe beyond the market, kind of opportunistically within that share repurchase?

It’s a possibility. I mean we take it on a day-by-day basis. So I would just say it’s something we are constantly looking at, constantly evaluating. There was one day in January where we did repurchase shares, but it’s just something that we are continually evaluating.

Got it. And then one more real quick, if I may. On the expense reclassification associated with the closing protection letters, what are the states that require the splits on those BPL premiums?

There is only two states that I am aware of that actually require the splits. I know one of them is North Carolina. I am not sure about the other one.

Got it. I appreciate the questions.

Our next question is from Bose George from KBW. Please go ahead.

Hi. This is actually Chas Tyson for Bose. I wanted to ask – I know you said that there – you saw that in the direct channel traded that you had kind of caught back up by the end of the quarter and I am not saying that really having affect at this point, but on the agent side, do you have a sense on how it’s affecting the agents in your businesses and also is that creating any opportunities to possibly go out and acquire some agent operations that aren’t handling it as well?

Sure, a couple of points there. I mean it’s again comment on our own direct business. We are very happy with where we are right now satisfied, up for our preparation, it’s going well for us. We ended the quarter with a little bit of delays in closings, so as the quarter ramped through, we caught up on our closings. I still think on the direct side, there is level – there is room for still increased efficiency for us as we go into the spring buying season. With regards to the agents, it’s probably pre-mature to tell, there are so many agents out there. I am sure many of them have had no trouble. And I am sure some of them had trouble with it. So those opportunities will become more clear probably as we go into the spring buying season. So we will just see how that plays out.

Okay. On the title margin, was there an affect from TRID this quarter that you can quantify and should we see that revert going forward, as the delay has narrowed?

Not really. We did not bring a lot of excess costs in. We used our own resources for preparation of TRID both technology training and operations. So I do not think that we will see a cost reduction associated with TRID going into the spring buying season. What you will see is some residue or some impact from the capital expenditure of TRID that was $20 million, so you will see that impact in ‘16 and beyond.

Okay. And then as you guys look out over the next couple of years and see the mortgage market that some forecasters think to be fairly stagnant, do you have any interest at all, in consolidating some of the other players in the industry and do you think that it would be feasible from a regulatory perspective?

A couple of points, as I have said before on consolidation in the industry, I think it’s feasible that you could get a consolidation of some combination of the top four underwriters. But it will be completely deal specific, it will be a very difficult deal to be done and there will be heightened scrutiny on it. Now, with regards to acquisitions in the title space for us, specifically we are always looking for tuck-in acquisitions in our key states to grow our footprint if they make sense and they get the necessary return for us.

Okay. Is it fair to say that you could be interested in a large acquisition or it just depends on the facts and circumstances of a deal or just not that flame that you are interested right now?

Again, it would simply depend on the situation.

Okay, that makes sense. Thank you.

Our next question is from Mark Hughes from SunTrust Robinson Humphrey. Please go ahead.

Thank you. Good morning.

Good morning.

The incentive compensation this quarter, is there a catch-up or was there fairly high accrual, did that impact the margin more than you might have expected?

Last – fourth quarter of last year in the title segment, we had kind of a reversal 401(K) match. Fourth quarter this year, we are just – we are booking at basically a higher rate just based on the improved margins of company. Net-net, it’s about $7 million swing from Q4 of last year to Q4 of this year. So that’s one of the primary drivers.

And that – am I right in thinking that probably was an over accrual that you are doing some catch-up or was that $7 million or I guess not the $7 million swing, but would this be the run rate that one might normally expect?

I would think the run rate would be a little bit less, I mean our 401(k) match was about $8 million in Q4. I think it will be a $1 million or $2 million less in that going forward.

Okay. And then, the commercial revenue per order was little flatter this quarter, it’s been volatile, what would you expect on that going forward, is that general trend?

It’s hard to say, I mean typically if you look at our closed orders in commercial, they are flat and what really drives the growth in our commercial revenue and premiums is really the growth in our average fees per file. This year, our commercial revenue for the full year grew 17% over last year, almost all of that was driven by higher average fees per file. So it’s just difficult to say, but as Dennis mentioned before, we do think that will moderate in 2016.

Thank you.

Our next question is from Kevin Kaczmarek from Zelman & Associates. Please go ahead.

Hi guys. On the open purchase order trends, on a monthly basis, it looks like they were I guess negative in December and January, do you have – is there any particular driver there, because it diverts significantly from some mortgage related metrics like purchased applications showing double-digit growth in both of those months. So can you give us some color on where the weakness is?

No, we saw something similar in the winter month last year and when you look at the first seven business days in February, our purchase orders are down 2% versus last February. So our growth rates sort of have moderated here in the winter, but they did the same thing last year, there is nothing that’s explicitly that we can point to geographically, otherwise they would explain it.

And Kevin, I would say that we are optimistic going into the spring buying season and we will see continued momentum in purchase growth like we saw in ‘15.

Okay, thanks. All my other questions have been answered.

Our next question is from Jeremy Campbell from Barclays. Please go ahead.

Hey, guys. This is actually Jeff Harwood in for Jeremy today. If commercial remains strong and we do get a mini refi wave from the recent downward movement in interest rates, what types of margins can we expect for 2016?

Yes, we are pretty happy with where we are right now. We have got a 10.2 for the year right in line with what we expected and that’s based on the current market environment. So again, how we look at it if the market improves from the purchase perspective and commercial continues to grow and we get the benefit from refinance, we are going to look for continued operating leverage on this business. So, we will continue to drive improved operating leverage going forward if the markets continue to improve.

Great, thanks.

Our next question is from the line of Jason Deleeuw from Piper Jaffray. Please go ahead.

Yes, thanks guys. You have got Eric Robinson on for Jason here. Just looking at the agency operations for the quarter and recognizing the quarter lag and recognizing that revenue, would you expect any kind of TRID impact going into the first quarter of 2016 from the agency side?

Typically, the agent business lagged our direct business by about a quarter. I mean, it’s not perfect, but that’s kind of the rule of thumb. The direct business in Q4 and we saw there was going to be an impact. There really wasn’t an impact, because of TRID and sort of caught up by the end of the quarter as we mentioned in our remarks. So, looking in Q1, we wouldn’t expect a material impact because of that lag on our agency revenue in Q1 because of TRID.

Alright, thanks. And then just on commercial activity. Are you guys seeing most of that activity on like purchase activity or is that more refi for commercial?

It’s a combination. I mean refi and commercial, there is a lot more refi and commercial than there is in residential simply because you have got 5-year and 7-year loans, you don’t have 30-year mortgages out there. So, we get paid about the same now for purchasing a refi. So, the nature of the transaction on the commercial side, whether it’s a purchase refi, it’s not as important to us as it is on the residential side where we get paid more than twice as much for purchasing a refi. And so we for a while we used to track purchasing refi commercial orders and then we just stop doing that, because the refi wasn’t a significant really driver. So, I wouldn’t say its material metric for us.

Alright. Got it. And then just one more here, what about – what are you guys seeing as far as residential trends in some of these energy-specific markets. You noticed – noting anymore weakness there or I think it’s still pretty strong?

I think what we are going to see in ‘16 we have started to see it already and that is weakness in the Houston market, both in residential and commercial. And that’s the primary residential market that we think we will see weakness within the energy issues.

Got it. Got it. Alright. That’s all I have for you. Thank you.

Thank you.

Our next question is from Bose George from KBW. Please go ahead.

Hey, this is Chas Tyson again. I just want to ask about the information revenue line in the title segment. I know you guys have called out, but the default information is a drag on that line, but I was wondering if you could give some color around kind of mixing that and talking about how much of a drag that is versus some of the growth aspects in the rest of the business. And also the demand you are seeing on some of the mortgage and database solutions in the pipeline?

Sure. On info and other, yes, there is a few positives and a few negatives that really drove that. On the positive side, we saw lot of search products and uninsured products just in connection with the settlement process. That business was up 11%. Very similar to the growth trend that we saw on our premiums. Our data visitors within info and other were also up 5%. So, those were the positives. On the negative side, we talked about the fact that our default business continue to decline, it was down 21%. And also our international business, we suffered I guess from foreign currency translation adjustments. So, our international business on a constant currency basis was basically flat, but because the U.S. dollar strengthened so much during the period, our international revenue in that line item was actually down 10%. So, those are some things that we are kind of – there is ups and downs, but overall info and other was down 2% for the quarter.

And do you feel pretty comfortable with the product sweep there or do you think about taking some of those products offline as it looks like they might have not come back for a number of years?

Yes, we are comfortable with the product suite. And I think the trends will continue. We will continue to see softness in the offerings. I think we will continue to see opportunities for growth in the information products and some of the data products. And so – and I think the commercial trends will continue. So again, feel comfortable with them and I think the trends will continue into ‘16.

Okay, thank you very much.

Thank you.