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spk00: Greetings and welcome to the First American Financial Corporation's 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. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. A copy of today's press release is available on First American's website at www.firstam.com. firstam.com forward slash 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, 137-11297. We will now turn the call over to Craig Barberio, Vice President, Investor Relations, to make an introductory statement.
spk03: Good morning, everyone, and welcome to First American's earnings conference call for the third quarter of 2020. Joining us today will be our Chief Executive Officer, Dennis Gilmore, and Mark Seaton, Executive Vice President and Chief Financial Officer. Some of the statements made today may contain forward-looking statements that do not relate strictly to historical or current facts. These forward-looking statements speak only as to 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. For more information on these risks and uncertainties, please refer to this morning's earnings release and the risk factors discussed in our Form 10-K and subsequent SEC filing. Our presentation today 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 information on these non-GAAP financial measures, including presentation width and reconciliation to the most directly comparable GAAP financials, 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. Good morning, and thank you for joining our call. I'll start with a review of our third quarter results, provide perspective on the actions we are taking with our property and casualty business, and discuss our outlook for the remainder of 2020. Mark will discuss our earnings in greater detail and provide an update on our company's capital position. We delivered strong financial results in the third quarter. Revenues were $1.9 billion, up 15%, and earnings per share of $1.62. Our pre-tax margin in our title segment hit a record 19%. As volumes increased, we also kept our focus on cost efficiency, achieving a 40% success ratio, well ahead of our 60% target. Purchase revenues were up 20% in the third quarter, driven by closed order growth and higher fee profile. Low mortgage rates are driving substantial demand And given the limited inventory of houses for sale, price depreciation has been robust. Our pipeline is strong heading into the fourth quarter. As purchase open orders were up 14% in the third quarter, and this trend continues in October. Refinance revenues were up 92% in the third quarter, driven by strong growth in closed orders. Low rates continue to support elevated open orders, which were averaging 3,200 per day in the third quarter. So far in October, we are opening 2,800 orders per day. Our commercial business revenues in the third quarter declined 29%, improving from the 39% decline of the second quarter. The overall commercial market continues its recovery with improvements varying by asset class. This quarter, we started to see a return of large transactions. We are encouraged that our open orders improve throughout the third quarter. with orders down only 7% year over year. Commercial orders over the last six weeks are flat to last year. Turning to our special insurance segment, we've initiated a process to sell the property casualty business. While this business has performed well over the years, based on recent financial results, we've decided to focus on our core business and redeploy our capital to areas with higher expected returns. Our home warranty business delivered strong growth, improved retention rates, and effective expense management throughout the quarter. The business continues to experience an increase in claim frequency, particularly in the appliance and plumbing trades, which we believe are attributable to the pandemic. Due in part to this trend, we are in the process of making policy changes and adjusting our pricing to offset cost pressure in the business. We expect the home warranty business to continue to generate strong margin performance this year. Going into the fourth quarter, we are optimistic that low rates and demographic tailwinds will continue to drive strong purchase and refinance activity. And as we have indicated throughout the year, we expect refinance volumes to remain elevated well into next year. While our improving commercial pipeline increases our optimism going forward, We do not anticipate the business will meet last year's record performance. Throughout the third quarter, we experienced elevated order volumes and the vast majority of our workforce continues to work remotely. Our performance has demonstrated the strength and flexibility of our business. And while the pandemic has greatly slowed major sectors of the economy, it has accelerated the digital innovation in our markets, validating our strategy, and the investments we've made over the past few years to secure our leadership position in data, title automation, and digital closings. I'd now like to turn the call over to Mark.
spk04: Thank you, Dennis. In the third quarter, we earned $1.62 per diluted share. This includes net realized investment gains totaling $45 million or $0.30 per diluted share and impairment on assets held for sale of $73 million or $0.49 per diluted share. Excluding these two items, we are at $1.80 per share. In the title insurance and services segment, direct premium and escrow fees were up 12% compared with last year. This growth reflects a 30% increase in the number of closed orders, partially offset by a 13% decline in the average revenue per order. The average revenue per order decreased to $2,193 due to a shift in the mix of direct title orders to lower premium refinance transactions. At a product level, we continue to see higher average revenue per order for purchase transactions, which increased 8% this quarter, as well as for refinance transactions, which increased 4%. The average revenue per order for commercial transactions declined 17% as the number of large transactions lagged the prior year. Agent premiums, which are recorded on approximately a one-quarter lag relative to direct premiums, were up 10%. The agent split was 79.3% of agent premiums. Information and other revenues totaled $283 million, up 38% compared with last year. A number of factors contributed to this growth, including the growth in mortgage origination that led to higher demand for the company's title information products, and our acquisition of DocuTech, which isn't included in the prior year results. Additionally, we benefited from services provided to support a temporary pandemic-related government program in Canada. Investment income within the title insurance and services segment was $45 million, down 38%, primarily due to the impact of the decline in short-term interest rates on the investment portfolio and cash balances. Personnel costs were $481 million, up 8% from the prior year. This increase was primarily due to higher incentive compensation expense and salary expense and higher costs as a result of recent acquisitions, partially offset by lower employee benefit expense. Other operating expenses were $251 million, up 15% from last year. The increase was primarily due to higher production-related costs as a result of the growth in order volumes. The provision for title policy losses and other claims was $70 million, or 5.0% of title premiums and escrow fees, an increase from the 4.0% loss provision rate in the prior year. Claims experience continues to be favorable relative to our expectations. Incurred title claims totaled $33 million in the third quarter, a 21% decline relative to 2019. To date, we have not seen enough safety claims. Our intent is to maintain a 5% loss rate until we have more visibility into how the current environment will affect our claims experience. Depreciation and amortization expense was $36 million in the third quarter, up $6 million or 21% compared with the same period last year, primarily due to higher amortization of intangibles related to recent acquisitions. Pre-tax income for the title insurance and services segment was $337 million in the third compared with $254 million in the prior year. Pre-tax margin was a record 19.0% compared with 16.5% last year. Excluding the impact of net realized investment gains, pre-tax margin was 17.1% this quarter compared with 16.4% last year. As Dennis mentioned, we have initiated a plan to sell our property and casualty insurance business. For the first nine months of 2020, our property and casualty business recorded a pre-tax loss of 91.5 million. This amount includes two items. First, an impairment on assets held for sale of 73.3 million, which was recorded this quarter. And second, a 5.6 million reserve strengthening recorded in the first half of 2020. The results of the property and casualty business will continue to be recorded in the specialty insurance segment until a sale is completed. Net expenses in the corporate segment were $22 million, up $3 million compared with last year, largely due to higher interest expense associated with our $450 million senior notes transaction, which closed in May. The effective tax rate for the quarter was 24.6%, in line with our normalized tax rate. Notes and contracts payable on our balance sheet total just over $1 billion as of September 30th, which consists of $992 million of senior notes, $13 million of trustee notes, and $6 million of other notes and obligations. I would now like to turn the call back over to the operator to take your questions.
spk00: Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. One moment, please, while we poll for questions. Thank you. Our first question is from John Campbell with Stevens Incorporated.
spk02: Hey guys, good morning.
spk00: Please proceed with your question.
spk02: Hey guys, good morning. Good morning. Hey, I just want to clarify a couple of things on the PNC business. So you guys are just selling, I guess just PNC and not home warranty, that's right?
spk03: That is correct, yes.
spk02: Okay. And then Mark, thanks for the earnings breakdown, but if you could maybe provide what the PNC revenue was over the last nine months,
spk04: Yeah, John. So year-to-date, it's $101 million in revenue.
spk02: Okay. And I think you also said you're going to hold that in the specialty segment. You're not moving that to discontinued ops. Is that right?
spk04: Yeah, we looked at that, and it's not material enough to move it to discontinue it out, so it's just going to be recorded in specialty insurance just like it always has been until we consummate a transaction.
spk03: Yeah, John, I'll just give you some additional detail. I mean, the results will stay on the specialty segment, and we're looking to get the transaction completed by the first half of next year, so we'll get further update at that point.
spk02: Okay. And then on the higher home warranty claims, you guys highlighted the pandemic as maybe kind of influencing trends. How did you guys get to that conclusion? And I guess what is it about the pandemic? Is it just people at home more and it's just kind of more wear and tear on the home?
spk03: Exactly. We mentioned it in the second quarter, if I'm not mistaken, and the business is doing really well. It's interesting. Our sales are really strong, both consumer direct and our real estate channels. And I think, John, as you know, our seemingly worst quarter, our toughest quarter is always the third quarter. So no surprise there. But inside the quarter, we saw an uptick of our appliance trade, our appliance claims, and our plumbing claims. And we can't draw a straight line back to the pandemic, but it's just logical the way you laid it out. People are at home more. They're putting more stresses on their housing systems. So we're going to take a look at some of our policies right there and do some price adjustments to make sure that our returns are appropriate for that business. But all in all, that business is doing well. We'll think we'll have a very strong fourth quarter in 2021.
spk02: Okay, that's helpful. If I could squeeze in maybe one more on the PNC business. Any kind of rough estimate about the capital being released? Any kind of idea about proceeds and maybe what you would do with that?
spk04: Well, the carrying value on the books as of 9-30 was $50 million. So, you know, we're going through a process, and, you know, ultimately we don't know what the proceeds will be, but the carrying value is $50 million right now.
spk03: John, with regards to the process, I mean, the bottom line here is this business has been a good business for some of the years, but it's been very volatile. It's been a drag on earnings over the last couple of years, and we're just going to redeploy back into more of our core business where we have a more consistent higher return profile. Yep, makes sense to me.
spk02: Thank you, guys.
spk03: Thanks.
spk00: Our next question is from both George with KVW. Please proceed with your question.
spk03: Hey, guys. Good morning. Dennis, you made a comment about the performance expectations for next year. Could you just repeat that? I wasn't sure if you're comparing it versus 2020 or 2019. In general or any specific segment? I think your comment was in general. I think it was just overall performance. I just think we're optimistic, actually, going forward right now. It's been, as you well know, a really volatile year. But when you step back and look at things right now, purchase is very strong. And I'll just give a little detail on purchase right now. We'll still come back into some of our seasonal patterns. But, for example, orders right now through October, that's 17% from a year ago. So, you know, we'll still see seasonality in the fourth and first quarter, but I say that at an elevated order volume. So that's on purchases. On refinance, we still think the 3,000-a-day order volumes are good. We've got lenders building capacity. Spreads are still high, so we think that's still a good number looking forward. And then probably the area where we're probably getting more optimistic faster than we may have thought even two quarters ago is the commercial market. It's improving, and a couple things happened in the quarter that are interesting to us. Over the last six weeks or so, our order volumes were flat from a year ago, so that's very encouraging. While our revenue is down 29%, the business is still a very profitable business. It's a very strong business. And inside the market, we saw a return on some large deals, so that's good. We're seeing some little strength in segments right now, as you probably would guess, in commercial, excuse me, in warehouse or office buildings are starting to move. The weakness is still in hotels and some retail segments. But all in all, we're encouraged by commercial starting to heal faster than maybe we thought even two months ago. Okay, great. Thanks a lot for that. And then, actually, just curious what your thoughts are on buyback. Just some of the stock earnings are great. The stock is down quite a bit. It's been lackluster for a little while. So, yeah, just curious if you think that's a good use of capital here.
spk04: Yeah, this is Mark. Yeah, I mean, that's something that we're always looking at. We did feel like our our earnings were strong. And, you know, one thing is, too, you know, our earnings are higher than they were, you know, a year ago, and yet our stock quite hasn't recovered anywhere near what's pre-pandemic. So it's something that we're continually thinking about.
spk03: Yeah. I think we're taking a look at it right now, and it's just really where you're going. Our earnings are very strong, and we're optimistic looking forward right now. Okay. Great. Thanks, guys.
spk00: Our next question is from Jack Mislenko with West Plano Financial Group. Please proceed with your question.
spk01: Jack Mislenko Good morning. I wanted to talk through revenue per order. Normally, you see they step up 4Q from 3Q. A lot of that is commercially driven. So, I'm thinking out loud here, you've got a purchase market that has kind of held in stronger than seasonally. Certainly, you've got the refi, which is Duluth, but you've also got the commercial beginning to come back. And maybe there's sort of a catch-up dynamic at play here, too, as transactions have maybe been postponed through the prior quarters. Is it possible, is it your thinking from what you see today, that the revenue per order, that step-up could be abnormally higher sequentially than it maybe had been in prior years?
spk04: I would say, you know, when you look back historically, you know, we always have had a higher fee profile in Q4 because of the reasons you mentioned. You know, last year it was up about $100 an order, Q3 to Q4. You know, it's hard to say, but based on where we – because a lot of it ultimately comes down to how strong commercial is going to be, and that's something that's a little bit unknown. But where we see now is we do think there's going to be a step up like there always is. So we think fee profile will be higher in Q4. How much higher, it's just going to depend on the strength of the commercial market.
spk01: Okay. And then on the specialty loss ratio, I know obviously the severity and the volatility from the PNC businesses is much, much greater. But if we were to sort of back out, you know, the PNC volatility, you know, conceptually, how should we think about that loss ratio ratio? with just home warranty on a go-forward basis?
spk04: You know, the loss ratio for home warranty is very seasonal, right? So we get a lot of claims in the summertime when air conditioners go out. We don't get many claims, you know, in the wintertime. So, you know, through the cycle and, you know, on an annualized basis, typically we're somewhere in the, you know, 52% to 54% range, somewhere in there. But obviously that's going to be a higher, lower thing on the core. But annually it's about 52% to 54%.
spk01: Sure. And then you said you're putting in some changes, policy changes. Besides price, what would that look like? Maybe like a, I don't know, like a, a freeze period up front or something before you can make a claim? I'm just curious to come up with some of the changes you're making to address the higher claims.
spk03: Sure, yeah. It's a multiple thing. You look at price, you look at coverage, you look at service fees. So you'll get a lot of different issues to make sure you're priced appropriate for the returns.
spk01: Okay. All right, thank you.
spk03: Thank you.
spk00: Our next question is from Chad Key with Intrinsic Edge. Please proceed with your question. Okay. Moving on to Mark Hughes with SunTrust. Please proceed with your question.
spk05: Yeah, thank you. Good morning. The percent appreciation in residential ARCO and the Percos ARCO, was that a mixed shift or how much of that might have been just home price appreciation?
spk04: You know, it was really, you know, the vast majority that was home price appreciation. So, yeah. You know, as you know, Mark, you know, our fee profile that we report is really on our direct orders, and it's really our direct operations, which are on the west, you know, mainly the western states. But, like, when you look at it per state, California was our biggest state. We had a fee profile increase in California of 8%. You know, I can go along the list. Oregon, Washington, Arizona, they were all, you know, plus or minus that range. So it's really just home price appreciation and not really a big shift in the next.
spk05: Your agent premium was up 10%, a pretty strong number, but it was reported on a one-quarter lag. Your direct was down 4% last quarter. Is that a mixed shift? It seems pretty strong if I'm thinking about it properly.
spk04: Yeah, you know, I would just say that, like, most of the time, the one-quarter lag is a good proxy. Four out of five quarters or so this quarter, it really won. So you're right. You know, we would have expected kind of a lower agency growth based on what happened in Q2. But remittances came in. You know, refis are really strong. Commercials are really strong for agencies. So it's not really a mixed shift. I think it's just timing and remittances more than anything else.
spk05: It seemed like you closed more of the orders than you have historically. It's hard to judge precisely. Any comment other than the obvious, which is people are pretty committed to their refi and purchase at this time, but anything on top of that?
spk04: Are you talking about the direct business or the agency business?
spk05: I'm talking about the direct business, just that you seem to close – a higher proportion of the open orders.
spk03: I would say we're very busy and we're very efficient right now. So I wouldn't go any deeper than that. We're just doing a very good job and the operation is running very efficiently. Thank you. Thank you.
spk00: As a reminder, if you would like to ask a question, please press star 1 on your telephone keypad. Our next question is from Mark Devery with Barclays. Please proceed with your question.
spk06: Yeah, thanks. I had a clarifying question around commercial. You know, I think as you alluded to, obviously, you know, you're already seeing a return of big deals, and I think that's reflected in the ARPA being up pretty materially in commercial. Are you continuing to see an increase in larger deal sizes in your pipeline, and should we expect that commercial ARPA to continue to drift higher in the fourth quarter?
spk03: Yeah, make sure the question, yes, we are. So kind of like I mentioned, we're starting to see the return of the large deals. You'll see the impact in the fourth quarter. I do want to caution that we're not going to match fourth quarter 2019. That was a record quarter. But the market started to improve faster than we thought it would even two quarters ago. So we're encouraged right now with what we're seeing in commercial.
spk06: Okay. Remind me what the normal lag is between opening and closing a commercial order. Is there anything in this environment that's like pushing that out at all?
spk04: No, I mean, I would say the normal lag is, you know, it's similar to a purchase transaction, roughly 55 to 60 days. The one thing with commercial, though, is it's a lot more, there's a lot more dispersion around the mean, right? We can open an order, we might not close it for a year. We can open an order, we can close it two weeks later. So, It really is – it doesn't follow the same, you know, open to close. In purchase or refi, we've got a lot of certainty. Commercials, a lot more dispersion around the name. Okay.
spk06: Got it. And just finally, as you alluded to in your prepared comments, the success ratio came in, you know, much better than your target. Should we expect a catch-up on that, or is that, you know – Does that reflect some expense discipline which should keep your success ratio below target for the near term?
spk03: There's not going to be a catch-up. We're running very efficiently. The decisions we made by the way earlier this year to not lay off employees in the second quarter was not a smart decision. We didn't have to hire anybody back. And then all the efforts we've been doing on title automation, both in our data strategy and our digital closing strategies are all paying off right now. So We're seeing the benefit in our operations right now.
spk06: Okay. Are you now running it closer to fuller capacity such that if you see more volume, you may need to at least be closer to that 60% target to scale up?
spk03: I can't predict the future, but we're staffed accordingly right now, so we don't have any issues with that. We've augmented our staff slightly with some temps to deal with some of the volume searches, but we're feeling good about the business. We're feeling good about our position right now.
spk06: Got it. Thank you.
spk03: Thank you.
spk00: Our next question is from Mark Hughes with SunTrip. Please proceed with your question.
spk05: Yeah, the Canada revenue you referenced in the release, how much was that, and is that continuing into the fourth quarter here?
spk04: In the third quarter, it was $18 million. We're talking about the temporary revenue that we're getting from this government release program that we're a subcontractor to. So it's $18 million in the third quarter, and it really ends in October. So there will be a little bit in the fourth quarter, but most of it will go away in Q4. Thank you. Mm-hmm.
spk00: Our next question is from John Campbell with Stevenson Corporate. Please proceed to your question.
spk02: Hey, guys. Thanks. Just a quick follow-up. We haven't, obviously, since the crisis, we haven't talked much about the default business. I mean, obviously, for next year, everybody's got a lot of concerns. You guys are raising reserves. I think Stuart's obviously raising reserves as well, kind of anticipation of that. But there's also the positive impact, I guess, of default. But if you can maybe just kind of walk through that, the assets you have there now, what the revenue impact's been with the moratorium, and maybe what that could look like next year if default activity kind of picks up?
spk04: Yeah, thanks, John. So we have a really good default business, and it serves as a great hedge for us, right? As you mentioned before, back in the last financial crisis, the default business was like our – our highest profit center in the company by a huge margin. You know, as things have recovered here these last, you know, 10 years or so, you know, the volumes have really fallen off. But it's great to be there in case things, in foreclosures do spike up. So far this year, you know, our default business is running at about $35 million of revenue or so year-to-date. And it's basically flat versus last year. So we haven't seen a pickup in our really default activity. But, again, we haven't seen a pickup in foreclosures, too. So if we do see that, then our default business will start to come up.
spk03: Yeah, and, John, Stanis, just long-term, you know, we were the first to move our reserve rate up, thinking that we would see an uptick in default. And I still think that's a possibility going into 21 as the moratoriums kind of roll off and the forbearances roll off. But countering that right now is a real strong appreciation going on in the housing market. And I think, as you know, if people have equity in their house, they're typically not going to let it go to foreclosure. So I think the equity situation is going to, I'll say, blunt any significant, you know, real increase in defaults at this stage right now.
spk02: Okay, that's helpful. And I think, Dennis, I think we might have talked about this last quarter, but where are you guys right now as far as where you're running reserves versus the actuary estimate? And I think you said maybe over 10% you have to release. Is that right?
spk03: That is correct. And I'll let Mark give the first part of that answer.
spk04: You know, so as of 930, we're about 5% over the actuary estimate. And again, we're not close to that 10% range, but we're in a very healthy reserve position right now.
spk02: Absolutely. Okay. Thank you, guys.
spk03: Thank you.
spk00: Our next question is with Mark Hughes with SunTrust. Please proceed with your question.
spk05: Yeah, thanks for indulging me. If we think about the impact in the home warranty business from the appliances and the plumbing, would it be fair to say that's kind of the eight points you went from a loss ratio of 61 to 69? Is it fair to say, you know, that that represents the increased frequency that you saw?
spk04: Yeah, no, that's definitely fair, Mark. You know, home working business, as we talked about, is really great. People are staying at home. As Dennis mentioned, we're getting higher claims, and that's really attributable to, you know, people staying at home more. So appliance, plumbing, trade, those are causing higher losses for us.
spk05: Okay. Thank you very much.
spk04: Thank you, Mark.
spk00: There are no additional questions at this time. 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 877-660-6853. or 201-612-7415 and enter the conference ID, 137-11297. The company would like to thank you for your participation. This concludes today's conference call. You may now disconnect.
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