First American Financial Corporation (FAF) Q3 2017 Earnings Report, Transcript and Summary

Greetings and welcome to the First American Financial Corporation Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [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 877-660-6853 or 201-612-7415 and enter the conference ID of 13672053. We will now turn the call over to Craig Barberio, Vice President of Investor Relations, to make an introductory statement.

Good morning, everyone and welcome to our 2017 Third Quarter Earnings Conference Call. Joining us on today’s will be our Chief Executive Officer, Dennis Gilmore; and Mark Seaton, Executive Vice President and Chief Financial Officer. As always some of the statements made today may contain forward-looking statements that do not relate strictly to historical or current fact. These forward-looking statements speak only as of the date they are made and the Company does not undertake to update these 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. For more information on these risks and uncertainties, please refer to today's earnings release and the risks factors discussed in our Form 10-K and subsequent SEC filings. Our presentation today also contains certain non-GAAP financial measures that we believe provide additional insight into the operational efficiency and performance of the Company relative to earlier periods and relative to the Company's competitors. For more details on these non-GAAP financial measures, including presentation with and reconciliation to the most directly comparable GAAP financial measures, please refer to this morning’s earnings release which is available on our website at www.firstam.com. I will now turn the call over to Dennis Gilmore.

Thanks, Craig. Good morning and thank you for joining our call. I will review our third quarter results and provide a few comments regarding our outlook for the remainder of 2017. In the third quarter, our GAAP earnings were $0.19 per share, which include an expense for the pension termination of $0.89 and net realized investment losses of $0.04. Our purchase and commercial businesses performed well in the third quarter. Purchase revenues were up 10% driven by a 7% increase in the average fee per order. Our purchase business continues to benefit from growth and transaction activity and from higher real estate values. Our commercial business had a strong quarter with revenues up 6% over the last year. We have a healthy commercial pipeline heading into the fourth quarter and we expect 2017 to be another year for this business. Turning to our Specialty Insurance segment. Revenue grew by 8%, with a pre-tax margin of 5.2% and our overall loss ratio and improve to 65%. Home Warranty had another strong quarter in which it significantly reduced claim losses through improvements in its contractor now that can service operations. And to a lesser degree the business also benefited from favorable weather conditions. During the third quarter, our Property and Casualty business experienced elevated claim losses due to higher severity and frequency. We also expect the wildfires in California to negative impact the P&C business in the fourth quarter. We anticipate losses from these products to continue to develop and we will hit our reinsurance retention limit of $5 million. Turning to capital management, we spent $87 million on acquisition during the quarter. We acquired a leading title agency in Nevada that complements our direct operations. In addition we bought out our majority of joint venture partner and a title information company, broadening our geographic footprint to further strengthen our leadership position and title information. The recent hurricanes and wildfires have caused extreme hardship for many people across the country including a number of First American employees and customers. Our immediate focus was helping our impacted employees and providing them with the resources they needed. Throughout these events, I'm proud of how hard our people worked to get our operations back up in running and allowing us to quickly resume service to our customer. As a result, we expect that Company's financial performance will not be significantly impacted. We remain optimistic about our title segment as we head into the fourth quarter, our purchase business continues to grow with open orders up 5% in October. Our commercial pipeline is strong, our refinance business is right sized and title claims continue to shrink favorably. We believe these conditions will enable the Company to deliver financial results in 2017 and will position us well going into 2018. I will now turn the call over to Mark for more detailed review of the financial results.

Thank you, Dennis. I will begin by discussing a few unusual items that impacted our earnings this quarter. We incurred an $0.89 per share expense related to the completion of our pension termination. This quarter we begin realizing an annual benefit of $22 million before tax in our corporate segment as a result of this termination. We also incurred $0.04 of net realized investment losses. In addition, we had three items that essentially offset each other. These items included $0.07 tax benefit which was offset by another period of personal expense of $0.05 and write off of a title plan asset for $0.03. In the Title Insurance and Services segment, direct premium and escrow fees were down 1% compared with last year. This decrease was driven by a 20% decrease in a number of orders closed offset by a 24% increase in the average revenue per order. The average revenue per order increased to $2,298 due to a shift in the mix, the higher premium purchase and commercial transactions. The average revenue per order for purchase transactions increased 7%, while the average revenue per order for commercial transactions, increased 11%. Agent premiums were up 1%, reflecting the normal reporting lag of agent revenues of approximately one quarter. The agent split was 79.1% of agent premiums. Information and other revenues totaled $199 million, up 6% compared with last year. The increase was driven by recent acquisitions which contributed $24 million to revenue this quarter. Investment income within the Title Insurance and Services segment was $38 million, up $9 million from the third quarter of last year. As we discussed on our call last quarter, our investment income has benefited from higher short-term interest rates. Including in our tax differed property exchange business, our floating rate agency mortgage backed securities portfolio, as well as interest on our escrow balances. Personnel costs were $422 million, up 3% from the prior year. This increase was driven by the impact of recent acquisitions, as well as an out-of-period personnel expenses. Other operating expenses were $196 million, down 1% from last year. An increase of $11 million from recent acquisitions was offset by $12 million in expense reductions, primarily due to lower production-related expense from the decline in order volume and lower software, legal and bad debt expense compared with last year. The provision for title policy losses and other claims is $47 million or 4.0% of title premiums and escrow fees, compared with a loss provision rate of 5.5% in the same quarter with prior year. The current quarter rate reflects an ultimate loss rate of 4.0% for the current policy year with no change in the loss reserve estimates for prior policy years. Pre-tax income for the Title Insurance and Services segment was $181 million in the third quarter, compared with $189 million in the third quarter of 2016. Pre-tax margin was 13.0% compared with 13.5% last year. Turning to the Specialty Insurance segment, total revenues were $118 million, up 8% compared with last year. The loss ratio of the Specialty Insurance segment this quarter was 65% down from 69% in the prior year. Claims improved notably in our Home Warranty business, primarily due to operational improvement, particularly with our contracts in networking service operations. The loss ratio for the Home Warranty business improved 970 basis points to 50% this quarter. Partially offsetting this favorable claims experienced higher claims from our Property and Casualty business. Pre-tax margins for this segment was 5.2% compared with 1.6% in the third quarter of last year. Net expenses in the Corporate segment were $159 million, included in this amount is $152 million related to the pension termination. Moving forward, we expect net expenses in the Corporate segment to be approximately $75 million on an annual basis after taking into account the pension payment. The effective tax rate for the quarter was negative 17.9%. As I noted earlier, we posted an $8 million benefit relating to certain tax items this quarter. This benefit coupled with low pre-tax earnings due to the pension termination, caused a negative tax rate this quarter. On a normalized basis, we expect our tax rate to be closer to 34%. Debt on our balance sheet totaled $734 million as of September 30th. Our debt consisted $546 million of senior notes, $160 million on our credit facility, $24 million of trustee notes and $4 million of other notes and obligations. Our debt-to-capital ratio as of September 30th was 18.2%. We have $540 million remaining on our $700 million revolving credit facility. In terms of cash flow, cash provided by operations was $221 million, a 109% increase relative to last year, primarily due to the $52 million pension contribution we made last year. I would now like to turn the call back over to the operator to take your questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from the line of Mark DeVries from Barclays. Please proceed with your question.

Thank you. If we back out these non-operating items in the quarter, we have got a pre-tax margin closer to 14.5%, first of all does that sound right to you Mark?

Yes, I think that sound right, if you are backing out the personnel expense and the [indiscernible].

Okay, I believe at a recent conference, you commented that the 10% to 12% pre-tax margin target could be more for and have some upside and you have had a couple of quarters now, albeit the seasonally strong ones, the ones well above that kind of target. Interested to get your updated thoughts on that given these results.

Mark, this is Dennis, we had a very good quarter. Again like I said before, the Company is very, very positioned, our approach to this business is strong, commercial is stronger than we thought going into the year. And the pre-tax margin of the 10% to 12% objective, I think is still appropriate. Running right now year-to-date about 12.1 right in that range. But going forward, if the market continues to improve, we will continue to drive our margin higher through increased operating efficiency. So we are happy where we are right now, we look to continue to drive that up as the market continues to improve and we continue to drive greater efficiency in the business.

Okay. I think in your comments Mark, you indicated that the ARPU was particular strong because of I guess some larger commercial transactions, is that right and if so are you seeing kind of a similar mix in your pipeline right now or should we expect a little bit of volatility around that ARPU in the coming quarters.

I think a little both, I mean there is always volatility around commercial ARPU because as you know there is lumpiness to transactions, but this is a general statement, we have seen higher commercial real estate prices, which help our ARPU and we are also just seeing higher quality deals, the larger deals that are coming through. So those few things are the reason why our ARPU is up this year and why it was up 11% this quarter.

Okay and just one last question from me, Would be interested in hearings your updated thoughts on just kind of given what current market expectations are for - with that tightening and the forward curve in general kind of, Mark what is your updated thoughts are and what the benefits could be from higher rates on your investment income here over the next year.

Well if you look back, what has happened, I mean over the last year, at least in the [indiscernible] 9 million more of investment income than we did year ago, so that’s 36 million on an annualize basis. So we got 36 million more of annualized investment income, some of its because of higher balances, but a lot of it, I would say [indiscernible] is redriven. And so if the Fed continues to tighten, we are going to continue to see that benefit. So over the last year, every time the Fed raises 25 basis points, just to high level we get about 12 million more of investment income on an annualized basis. So but that’s somewhat servicing the benefit of.

Okay that’s helpful. Thank you.

Thank you.

Our next question comes from the line of John Campbell from Stephens. Please proceed with your question.

Hey guys. Just back to the margin, as I think about next year, if we hold commercial kind of roughly flattish and I know there is a lot of moving parts there, but is there any reason I mean especially considering your comments just then Mark about investment income, may be lifting a little bit more next year. Is there any reason why you wouldn’t see margin expansion at that Title business next year.

Really it’s going to depend on two things right. It depends on how the market performs from commercial and we are optimistic in commercial right now, going to the remaining of 2017 and to 2018 and it will depend on the purchase market, but if those two hold and continue to expand like we think, we think they will continue drive efficiencies and they will continue to drive to seek better margins in the business. But I think we should come back to where we are right now in the year, we are running right at the upper end of our range to 10% to 12%; right at 12% right now. So we are encouraged by where we are on the business and we are encouraged looking forward.

Absolutely. Great job there. And Mark, I think, I heard you say the $75 million, the expected kind of annual expense in corporate. Is there any really seasonality to that line or is it kind of spread evenly throughout the quarters?

It's spread very evenly throughout the quarter. No seasonality.

Okay. And then last for me. Can you talk to some of the acquisitions and maybe give us an idea, try to size up the kind of revenue run rate from those acquisitions?

Yes, it was an active quarter for us. We closed $87 million worth of acquisitions and I guess what I would say is, the deals were - when you average them together, we got about $50 million of annualized revenue and about two-thirds of that will flow through information and other line item and about a third will go through direct premiums. And the margins are at least as high as they are at our overall [indiscernible].

Okay. Got it. To make sure, I understand that you said $87 million is what you are running up to-date and $50 million was a run rate in the quarter?

I’m sorry $87 million was the cash outlaid for [indiscernible] $50 million would be the annualized revenue run rate.

And two-thirds of that is in info and other and then a third is indirect?

That’s right.

Okay, great. Thanks, guys.

Thank you.

Our next question comes from the line of Mark Hughes with SunTrust. Please proceed with your question.

Yes. Thank you. Good morning. The information and other when you think about on an organic basis, what kind of run rate growth should we expect in there?

Well, that one is a little difficult to - there is different drivers in there. So we have default revenue within there, we have refinance revenue, we have purchased revenue, we have a lot of our international operations revenue went through there. So I would say there is multiple different drivers. However, I would think of the info and other line item would increase at least as fast as our direct premium and escrow line items. Particularly in light of the fact, some of these acquisitions we are doing will increase the info and other line item.

And then what is the run rate for refis in October, if you might share that?

We are running right around 1,300 open orders today, we stabilized now over the last few months and also we have adjusted our cost structure to that current level.

And then your M&A, this is a pretty robust quarter. Is that having done some of the capital management, taking some of the steps destocking and I think your prominent on the share repurchase, it doesn’t seem like that’s near-term focus, should we anticipate elevated level of the M&A in coming quarters?

It will definitely be the lumpy, but our strategy stays the same. we are continuing to look for title opportunities to primarily agents where we want to build our direct footprints. We are looking to continue build out our information businesses and how it relates to title automation. So a lot of focus there. We continue to look for mortgage products, to expand our mortgage offerings. I guess the only thing we have really seen change over the last couple of months is we have seen quite a few new opportunities that are slightly outside of the core title, but very complementary to core and we are taking a look at some of those, but they are not significant in size.

Thank you.

Our next question comes from the line of Jason Deleeuw with Piper Jaffray. Please proceed with your question.

Thanks guys you have got Erick Robinson on here for Jason. Congrats on the solid quarter. A lot of my questions have been asked, but I guess if I could just touch on - related to the data and technology initiatives you guys have been focusing on recently. Would you mind just going into a little more detail regarding your recent API initiatives and other technology initiatives that are going to be used to support the digital origination process.

Sure, we continue to focus in on building out our respective public record databases and we continue to look for acquisition augment that strategy and that’s one of the deals we did this past quarter. And bottom line, over the long-term, we look to continue to try to drive automation in the titling process and drive efficiency in the digital closing. So a lot of energy there from both organic and from acquisitions prospective and there will be in the future. We think there is a big market opportunity for us.

Got it and then I guess just to touch again on the open purchase here in October, did I hear it right, was it where purchase of 5% thus far in October.

Correct. We are running about 5% above last year.

Great. Alright, that’s it for me. Thanks guys.

Thanks Erick.

[Operator Instructions] Our next question comes from the line of Bose George with KBW. Please proceed with your question.

Good morning. Just a follow-up on the acquisition question, the level of acquisition this quarter is obviously pretty strong. I mean would you characterize by just kind of opportunistic, or you are seeing more out there, so you could just see this as being sort of a bigger use of capital going forward.

Probably a little of both. I think we are opportunistic this quarter and it will always be lumpy, but we are seeing a lot of viable deals now in the spaces I mentioned before. So again I think we will continue to focus on it, but at end of the day nothing is changing for us, we won't deploy unless we get the returns we expect.

Okay great thanks and then just switching to your earlier comments about wildfire impact, just given the reinsurance, so that number is essentially capped at $5 million the potential loss was for your guys.

Yes, so we are going to have losses that are exceeding our $5 million retention, so we will basically capped at $5 million. We will have to pay a restatement fee as well to reinstate our reinsurance, but that’s going to be roughly a million, we don’t know exactly but our losses are capped.

Okay thanks and actually one on the one-time expense you guys had, the things like the out of period, personal expense. Should we think of them as really one-time or do they are they periodic adjustments like that happen.

Well in the case of the personal expense, it is real expense that the Company incurred it just wasn’t in the current quarter. And so when you are looking at the third quarter operating results I would exclude it. But they are going to occur from time-to-time. In the case of the title plan, it was different in the sense that we went through an effort to reconcile all the title plans on our book and we basically effective found that there was $5 million that was booked in title plans that really shouldn’t have been until we broke that off that was truly kind of the one-time thing. So a pleasant mix there.

Okay, great thanks.

Thank you.

Our next question comes from the line of Geoffrey Dunn from Dowling & Partners. Please proceed with your question.

Thanks, good morning guys. Mark I just want to follow-up on that wildfire question, out of my own on this, but as I understand, I sort of declare those as three events. So how does your reinsurance cover works, is it an event based thing where you might have three $5 million max hits, or is it all encompassing somehow. I'm not sure, if I’m asking that correctly, but you address that concept?

Well, at the end of the day, Geoff, the way we have understood is it’s really one event for - the claims that we have, the properties that we have. So we don’t expect this to be more than a $5 million hit [indiscernible] because there were multiple different events, but as long as they are within 240 hours of each other, we can kind of consolidate them into one event.

Got you. Okay. Perfect. Thank you. Actually, one follow-up I got on rate, as you were talking about corporate. What were you saying about where you expect the corporate run rate expense to be going forward?

$75 million.

Okay. Thanks.

Thank you.

There are no further questions at this time. This does conclude this morning's call. We would like to remind listeners that today's call will be available for replay on the Company's website or by dialing 877-660-6853 or 201-612-7415 and enter the conference ID of 1367-2053. The Company would like to thank you for your participation. This concludes today’s conference call. You may now disconnect.