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spk01: Greetings and welcome to the First American Financial Corporation second quarter 2022 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 the First Americans website at www.firstam.com forward slash investor. Please note that the call is being recorded and will be available for replay for the company's investor website and for a short time by dialing 877-660-6853 or 201-612-7415 and enter the conference ID 137-31471. We will now turn the call over to Craig Barbario, Vice President, Investor Relations, to make an introductory statement.
spk00: Good morning, everyone, and welcome to First American's earnings conference call for the second quarter of 2022. Joining us today on the call will be our Chief Executive Officer, Ken DiGiorgio, 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 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. Risk and uncertainties exist that may cause results to differ materially from those set forth in these forward-looking statements. For more information on these risk and uncertainties, please refer to this morning's earnings release and the risk factors discussed in our Form 10-K and subsequent SEC filings. 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 details 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 I'd now like to turn the call over to Ken DiGiorgio.
spk03: Thank you, Craig. The company delivered strong results in the second quarter with revenue of $2.1 billion and earnings of $1.01 per share or $1.97 per share excluding net investment losses. Our title segment margin was 11.7% or 13.9% excluding net investment losses. While we operate in a cyclical business, we have a strong presence in all market segments, including resale, refinance, commercial, new home, and default, which can provide a level of diversification. So while rising interest rates have slowed our residential business, our commercial business, for example, has grown an impressive 30% this quarter and is on track to achieve another record year. We are also beginning to realize the benefit of higher interest rates at our bank and on other escrow and tax deferred exchange balances. Investment income increased by $23 million in our title segment this quarter, and we now expect to add $200 million to annualized investment income by year end, up from the $150 million that we discussed with you on our last call. As I suggested earlier, our residential purchase business declined this quarter. open orders were down 12% with June down 18% compared with last year. So far in July, this trend is continuing with open purchase orders down approximately 20% compared with last year. Given the decline in residential real estate activity and the uncertain economic outlook, we continue our focus on expense management. As you would expect, We are acting most aggressively in the business units with the greatest exposure to the declining residential market. We will see much of the benefit from these reductions beginning in the third quarter. Additional expense reductions are underway in July, and we are closely monitoring order levels to further balance expense levels as needed going forward. While we continue to manage our cost structure, we also remain steadfastly committed to investing in strategic initiatives that support our company's long-term growth and operational efficiency, despite their impact on near-term profitability. Significant among these is Endpoint, our digital title and settlement company that we built from the ground up. Endpoint has attracted leading talent that has developed technology to streamline the closing process and empower prop tech companies and investors looking to scale their operations. After demonstrating strong customer acceptance in early test markets, Endpoint is rapidly building a national footprint and is currently operating in 27 states and by year end expects to be licensed in 43 states. Another of these initiatives is ServiceMAC, the mortgage subservicing business we acquired last year. Since its founding in 2018, ServiceMAC rapidly achieved the sixth largest market share position. While ServiceMac has high potential as a standalone business, significant synergies exist with our other operations, in particular our bank, which can hold deposits administered by ServiceMac. Lastly, while we have successfully automated the title production process for certain refinance transactions, we are now focused on solving instant title decisioning for purchase transactions, which is more complex. Our industry-leading property record and title plant assets put us in a unique position to solve this problem, which, when solved, promises to improve the customer experience and increase our efficiency. We expect to test this instant decisioning initiative with customers in two large markets by year end. This quarter, we continue to prioritize share repurchases, acquiring 3.9 million shares and through July 27th, an additional 963,000 shares. Since the beginning of this year, we have repurchased approximately 6% of our shares outstanding as of the end of last year. Reflecting its confidence in the long-term prospects of our company, our board recently approved a new $400 million share repurchase authorization, which enhances our capital deployment flexibility going forward. Now I'd like to turn the call over to Mark for a more detailed discussion of our financial results.
spk06: Thank you, Ken. This quarter we earned $1.01 per diluted share. Included in this quarter's results were $0.96 of net investment losses, primarily related to the change in fair value of marketable equity securities. Excluding these losses, we earned $1.97 per diluted share. Revenue in our title segment was $2.1 billion flat compared with the same quarter of 2021. Commercial revenue was $289 million, a 30% increase over last year. We continue to see strength in the commercial market as closed orders, average revenue per order, and the number of large liability transactions all showed growth over the prior year. Our escrow balances totaled $14 billion at the end of the quarter. up from $11 billion at year end, which indicates a healthy pipeline for commercial activity as we enter the second half of the year. Purchase revenue was up 2% during the quarter, driven by a 15% increase in the average revenue per order, partially offset by an 11% decline in the number of orders closed. Our revenue per order for purchase transactions benefited from recent acquisitions of escrow companies in Southern California. We include escrow revenue from these transactions in the numerator without a corresponding title order in the denominator. Excluding acquisitions, average revenue per order would have been up 6%, which is more in line with what we would expect given home price appreciation. Refinance revenue declined 58% relative to last year due to the increase in mortgage rates. In the agency business, revenue was $937 million, up 4% from last year. Given the reporting lag in agent revenues of approximately one quarter, we are experiencing growth and remittances related to Q1 economic activity. Our information and other revenues were $305 million, up 2% relative to last year. Revenue growth was primarily due to the recently completed acquisitions of ServiceMac and Motorload. Investment income within the title insurance and services segment was $70 million, a 49% increase relative to the prior year. As we've stated previously, we expect to generate 15 to 20 million of annualized investment income in the title segment for each 25 basis point increase in the federal funds rate. We believe this estimate is still appropriate and expect to see the benefit of the Fed's July rate hike beginning in August. Based on the current forward curve for the federal funds rate, we expect our investment income to grow by approximately 200 million. on an annualized basis in 2022. On the expense side, we are reducing expenses in areas of the company that are being impacted by the slowdown in residential activity. Year-to-date through July, we had over 600 staff reductions. However, our overall employee count has increased, primarily related to our acquisition of Muddleode. In the second quarter, we incurred $11 million of severance expense. Pre-tax margin in the title segment was 11.7%, or 13.9% excluding net investment losses. As Ken highlighted, we continue to invest in businesses and innovation initiatives that we believe will positively contribute to our profitability over time, but at this point in our life cycle, detract from our financial results. The three initiatives Ken discussed, Endpoint, Service Mac, and Instant Decisioning for Purchase Transactions, Together generated a pre-tax loss of $28 million this quarter, impacting our pre-tax margin by 150 basis points. We expect ServiceMax to turn profitable by the end of this year, and we expect endpoints losses to bottom out in 2022 with earnings improvement in 2023 and beyond. Turning to the specialty insurance segment, total revenue in our home warranty business totaled $102 million, down 5% compared with last year. Excluding net investment gains and losses, total revenue increased 2% to $106 million. Pre-tax income in home warranty was $9 million, down from $13 million the prior year. Excluding net investment gains and losses, pre-tax income was $13 million, up from $10 million last year. The loss ratio in home warranty was 52.4%, down from 55.5% in 2021, driven by a lower frequency of claims. The wind down of the property and casualty business remains on track for completion in the third quarter. The business had a pre-tax loss of $5 million this quarter. As of June 30th, the company had no active homeowner policies and a small number of renter policies remained in force. The effective tax rate for the quarter of 22.1% is less than our normalized tax rate of 24.5% as a result of fluctuations in forecasted earnings between our insurance and non-insurance businesses. since our insurance businesses generally pay state premium tax in lieu of income tax. In the second quarter, we repurchased 3.9 million shares for a total of $227 million at an average price of $57.93. So far in Q3, we've repurchased an additional 963,000 shares for a total of $52 million at an average price of $54.20. Our debt-to-capital ratio as of June 3 was 29.6%, or 25.0%, excluding secured financing payable. At the end of the quarter, we had $750 million of accumulated other comprehensive loss, primarily due to unrealized losses in our fixed income portfolio related to the rise in interest rates. This loss contributed 250 basis points to our debt-to-capital ratio. Over time, we expect our unrealized loss position to narrow. As our duration is 4.5 years, the average credit quality is AA+, and we don't have a need to liquidate the portfolio to generate cash. Now I would like to turn the call back over to the operator to take your questions.
spk01: At this time, we will 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 your line is in the question queue. You may press star 2 to remove your question from the queue. For participants using speaker equipment, it may be necessary for you to pick up your hands up before pressing star keys. One moment while we poll for questions. Our first question comes from the line of Mark DeRise with Barclays. You may proceed with your question.
spk07: Yeah, thanks. Just wanted to start on the commercial business. I mean, it sounds like your pipeline is quite strong, which is a bit surprising just based on at least what we're hearing anecdotally from people It's the larger, more institutional end of the market where we're just hearing things are not transacting. So could you just give us a little bit better sense of kind of what the sources of strengths are, whether there are any kind of causes of concern that activities about the decline and any kind of differences across different types of property types and markets?
spk03: This is Ken. I'll take the first crack at that. As we mentioned, we had a great quarter, and we're still seeing a lot of demand in the commercial space. There's a lot of capital chasing deals, and in the quarter, this was across asset classes. It was obviously led by multifamily and industrial, but the demand was across asset classes. Across geographies, though some of the urban core markets like New York, San Francisco, LA were weakest. But again, across the geographies and across deal sizes as well. Though in the quarter, large transactions were probably up significantly. But again, we saw it across deal sizes. And frankly, we looked good going into the second half. As Mark mentioned, escrow balances are up over year end. So we see a strong pipeline. We were anticipating, again, as we mentioned, to have another record-setting year. So maybe we're defying some of what we're reading out there, what you're seeing out there in the marketplace, but we're still seeing strong demand.
spk07: Okay. Yeah, that's helpful. And then just turning to endpoint, just kind of want to better understand what the endgame is there. It sounds like it's... It's going to be a drag on earnings, you know, for the indefinite future. When do you see that becoming profitable or, you know, is the real contribution going to come from lift you get and kind of core title?
spk03: Well, you know, I think, I mean, we don't know exactly when yet it's going to turn profitable. As we mentioned, we think that we think the losses are going to bottom out this year and then we'll start and then the earnings will start growing in 2023 and beyond. But I think, you know, the end game there is, you know, twofold. One is to improve the efficiency in our business. But secondarily, it's to meet the demands of, you know, of a changing customer base. I mean, there are customers that want this digital first experience and Endpoint is, you know, is rapidly expanding to provide it. And that's, Yeah, that's on, I guess, what you'd call the retail side and also with prop tech companies. So, again, the end game with Endpoint really is first and foremost to meet that customer demand. But we do expect it to generate efficiencies for the core business.
spk07: Okay, got it. Thank you.
spk01: Our next question comes from the line of Bose George with KBW. You may proceed with your question.
spk02: Hey, good morning. Actually, just sticking to Endpoint, You know, the $28 million in losses you mentioned, how is that broken out, you know, just between Endpoint, ServiceMac, and that other piece?
spk06: Thanks for the question, Bo. So in the second quarter, we had about $10 million of a pre-tax loss in ServiceMac, which is, as we mentioned, we think that will flip to break even later this year. Endpoint had about a $12 million pre-tax loss this quarter, and our purchase automation initiative was about $6 million.
spk02: Okay, great. Thanks. And then, actually, I wanted to switch and ask about leverage. You know, can you remind us, you know, where you think you want that to, you know, the range to be? And, you know, with it at 25% now, how do you think about, you know, further buybacks or acquisitions?
spk06: Well, 25% is as high as we've been in some time, and we've always talked about our target debt-to-cap being around 20%, but we're real comfortable operating at 25%. Our covenant says we can't go above 35, so we've got plenty of room there. And one of the reasons why our deficit cap has shot up, the bigger reason, is because of the unrealized losses we have in our fixed income portfolio, which were roughly about $900 million at the end of June. So we don't really need to liquidate the portfolio. We feel like those losses will eventually come back over time. And so we're real comfortable with where we are at 25 right now.
spk02: Okay. And actually, did you mention the duration of the portfolio, so the timeline in which that $900 million should come back?
spk06: The duration of our – we think about our portfolio as like our bank portfolio and then our insurance company's portfolio. But on a consolidated basis, the duration is four and a half years, a little bit less in the bank, a little bit higher in the insurance company. Okay.
spk02: And so that should be kind of the rough timeline for it to come back, that loss?
spk06: Yeah, roughly, yeah. I mean, it depends on what happens with interest rates. But, yeah, I mean, we feel like definitely by four and a half years, we'll have recouped it.
spk02: Okay, great. Thanks.
spk06: Thanks, both.
spk01: Our next question comes from the line of Mark Hughes with Truist. You may proceed with your question.
spk08: Yeah, thanks. Good morning. Did you give the order a trend in July for commercials?
spk06: We didn't, but so far in July, our open orders are down 10% from prior year in July.
spk08: When we think about your increase in escrow balances, is that consistent with kind of a down 10% trend, or what you're seeing in escrow funds implies a little better than that?
spk06: Well, I... you know, we track our commercial orders. I wouldn't say it's, you know, unlike on the residential side where we've got a very consistent, you know, average fee profile. The commercial, we don't read too into the orders if they're up 10% or down 10% just because, you know, the size of the deals matters so much more in commercial. And so, yeah, orders are down 10%, but that, you know, it doesn't give us too much heartburn. I mean, what we look at is, you know, our balances in terms of what the deal sizes are about to close and we you know, have our conversations with our customers. And as Ken mentioned thoroughly in his remarks, and we feel really good about the second half this year, but yeah, orders are down 10%.
spk08: Very good. And then, uh, the impact of the instant decisioning, assuming, assuming you have a success and that works out as you anticipate, what does that mean in terms of the cost structure?
spk06: Well, you know, the instant decisioning initiative, I mean, the primary reason for it is to improve the customer experience. We've seen that with our instant decisioning for refinance transactions, and we can get that with purchase transactions. It's very complex. We think we're in a unique ability to provide that given the data assets that we have. So it's mostly an improve the customer experience initiative. However, we do think there's going to be cost savings over time. And so we'll have to kind of see how those play out. But if you can provide it instantly through data, it reduces your manual process and there'll be savings there.
spk03: Mark, I would add too, we're in very early days with respect to this particular title automation effort. As I mentioned, we're going to do an MVP in two large markets at the end of the year, but we're in very early days. So we'll probably know better in the you know, in the coming months, if not years, what the exact cost savings will be.
spk08: Understood. And then your point on the end point profitability was that the loss associated with that would bottom this year and then it would be progressively less negative or would that also hit break even in 2023?
spk06: It'd be less negative. So we'll have a pre-tax loss of roughly $50 million this year, and that'll narrow next year and beyond. We won't flip the profitability next year, but the losses will narrow.
spk08: Thank you very much. Thanks, Mark.
spk01: As a reminder, if you would like to ask a question, please press star 1 on your telephone keypad. Our next question comes to the line of Ryan Gilbert with BTIG. You may proceed with your question.
spk04: Hi, thanks. Good morning, everyone. First question is on ARPO and the purchase business. I think you said plus 6% excluding the escrow acquisitions. Can you just talk about how that trended through the quarter and how you expect that to trend over the rest of the year? I think with overall home price appreciation probably more resilient than I expected, but some headwinds from higher interest rates. potentially in the second half of the year?
spk06: Thanks for the question. So when we look at the purchase ARPO and how it trended through the quarter, it's fallen through the quarter. So in April, our purchase ARPO was 17%. In May, it was 16%. In June, it was 12%. And so for the quarter, when you weigh that all together, it was up 15%. And so when we look at Q3, I mean, based on the trend and just based off of cooling, you know, home price appreciation, we think it's going to obviously come down from the 15. So the run rate as of June is about 12. And so we definitely are seeing it come down here.
spk04: Okay, got it. And I apologize if I missed this, but I think last quarter we talked about revenue flat for the year. Do you think that's still on the cards or has... have trends in residential kind of deteriorated more than we were expecting after 1Q?
spk06: I think, you know, things are deteriorating a little bit. I mean, just based off of where our purchase orders are. But overall, I think, you know, revenue will be down, called low single digits. I mean, we're not seeing anywhere the decline that, you know, you're probably seeing in the headlines or in terms of mortgage origination. So, it'll be down a little bit. call it low single digits.
spk04: Okay, great. Thanks very much. Thank you.
spk01: Our next question comes from the line of John Campbell with Stevens. You may proceed with your question.
spk05: Hey, guys. Good morning. Thanks for taking our questions. Mark, you briefly touched on the effect of the acquired rev on the revenue per order. I'm trying to understand the mother load impact on your order count. It sounds like If I understand it correctly, that mother load revenue came on, but you're not reflecting that in order count, so that drove the fee profile higher. But maybe if you could provide a little bit more color on that and maybe specifically how mother load is going to impact the order count moving forward.
spk06: There's different ways to cut that. I would say that kind of excluding mother load, when you just look at our purchase orders in July, Excluding mother load, we're about 23% down on a year-over-year basis. When you add mother load in there, we're down about 20%. So it's added about a 3% point difference in our purchase order change year-over-year.
spk05: Okay, that's helpful. And I'm trying to better understand, so how are you receiving the revenue without the orders?
spk06: Well, There are certain orders that we get directly. So when you look in the second quarter, we had about $37 million of revenue from Motherlode. Half of that was booked in direct revenue, where we're getting orders and we take 100% of premium, we book in direct revenue. The other half of that revenue is booked in information and other. where we're really getting 88% of the premium, but the other 12% on average is going to a different underwriter just because we haven't fully captured those underwriting synergies yet. So it's really split 50-50, and over time, that'll migrate more and more toward direct revenue.
spk05: Okay, that makes sense. And then just from a geographic standpoint, it looks like, from what we can tell, the West Coast is falling much sharper than the rest of the region's. Is there a way, I guess, first, you know, the direct business or the title orders you guys report are obviously coming from direct business. What is your weighting towards the West Coast there? And then maybe if there's any kind of anecdotal call outs for kind of what you guys are seeing in the market there?
spk06: Well, you know, I would just say that like when we talk about our direct orders, those are really our direct operations. And we're direct in 27 states, which is mostly the West Coast. I mean, we're in Florida. but mostly it's just the West Coast. And that's one of the reasons why perhaps our agency business is outperforming and growing faster is just because the East Coast is doing a little bit better.
spk05: Okay. That's very helpful. And then the last question for me, this is maybe a silly question, but, you know, in the past you guys called out the $150 million investment endpoint. Was that a one-time investment or is that essentially running through your P&L? You think that will accumulate, you know, $150 million over time?
spk03: Well, I mean, that was a commitment. I mean, we were committed to make that investment, so I wouldn't consider it running through our P&L. I think I'd focus on the numbers that Mark gave you with respect to what's running through the P&L, but we wanted to make it clear we were committed to invest at least that amount.
spk05: Okay, that makes a lot of sense. Thanks, guys. Thanks, Sean.
spk01: Our next question comes from Jeffrey Dunn with Dowling Men Partners. You may proceed with your question.
spk05: Thanks. Good morning. Mark, can you review the company's liquid resources for capital management? What was Holco balance at your end? What's your remaining regulated div capacity this year, non-regulated sources? And are you still targeting a minimum 250 balance at Holco?
spk06: We are targeting roughly 250 minimum. As of the end of June, we had a $349 million of cash at the holding company. When we look at the amount that we can dividend from our insurance companies for the second half of the year, it's $474 million. We plan out in terms of what dividends we expect to get, and we max out the dividends at our insurance companies, then we have non-insurance subs. We expect at this point that we'll dividend roughly about $500 million of cash from both our regulated and non-regulated subs in the second half of this year. And, of course, we have, in terms of liquidity you're asking about, we've got all $700 million on our line, none of it strong. So we're in a good spot in terms of liquidity.
spk05: I assume, though, specifically for share repurchase, I would be surprised if you draw down more debt when you're already at 25%. Is that fair? Yeah, I think that's fair.
spk06: I think that's fair. I mean, in theory, we don't really have an issue with borrowing to buy back stock, but I think when our debt to cap is at 25 and at this point in the cycle, that's not something we would do. Great. Thanks. Thanks, John.
spk01: There are no further questions at this time. That concludes 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 13731471. The company would like to thank you for your participation. This concludes today's conference. You may now disconnect your lines at this time. Thank you for your participation. Enjoy the rest of your day.
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