First American Corporation (New)

Greetings and welcome to 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. 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. forward slash investor. Please note that this call is being recorded and we will 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 13749447. We will now turn the call over to Craig Barberio, Vice President, Investor Relations, to make an introductory statement. Please go ahead.

Good morning, everyone, and welcome to First American's earnings conference call for the third quarter of 2024. 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. 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 yesterday's earnings release and the risk factors discussed on 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 width and reconciliation to the most directly comparable GAAP financials, please refer to yesterday's earnings release, which is available on our website at www.firstam.com. I would now like to turn the call over to Ken DiGiorgio.

Thank you, Craig. In the third quarter, we benefited from measured improvement in market conditions. Our adjusted revenue was up 4%, the first year-over-year growth we've experienced since the second quarter of 2022. And our adjusted earnings per diluted share were $1.34, an increase of 10%. Title premiums and escrow revenues were up across all key business lines, but most notably in our commercial division, where revenues were up 19%, also the first increase since the second quarter of 2022. Growth in commercial revenue was driven by a sharp increase in the fee profile, to which an 80% increase in large transactions contributed. In the purchase market, demand started to pick up late in the quarter with a decline in mortgage rates to around 6% ahead of the Fed's 50 basis point cut in mid-September. Demand, however, softened as mortgage rates backed up 50 basis points soon after the Fed meeting and other factors impacting affordability persisted. As a result, our closed purchase orders per day this quarter declined 2% compared with last year. While continued, albeit moderating, home price appreciation was one of the factors that negatively impacted affordability. It did drive an increase in our average revenue per order and a resulting 3% increase in our purchase revenue. Closed refinance orders were up 12% in the third quarter, with transaction activity increasing as the quarter progressed. The improved order flow, combined with a higher fee profile, resulted in a 20% increase in our refinance revenue. Although our title segment investment income declined this quarter compared with last year, it grew sequentially as we began to realize the benefit of our investment portfolio rebalancing project. Mark will discuss that in greater detail in his remarks. Our home warranty segment delivered an adjusted pre-tax margin of 7.7%. down from 9.3% last year. Though a slight improvement in the claims rate helped the margin, we deliberately increased marketing spend in our direct-to-consumer channel. This direct-to-consumer investment is expected to drive increased profitability as the lifetime value of new contracts is realized over time. As we've discussed on prior calls, we are committed to developing innovative proprietary technologies that promise to boost our productivity and enhance the customer experience in ways that will create a sustainable competitive advantage. We believe, however, that an opportunity exists to reduce our technology spend without compromising on this commitment by centralizing, standardizing, and simplifying our technology operations. We have already implemented certain changes that have reduced cost, and we expect to realize additional benefits as we make further progress in this effort. Turning to the outlook for the remainder of the year, we expect challenging conditions in the purchase market to persist. For the first three weeks of October, our open purchase orders are down 3%, though our open resale orders are up 1.4%. The refinance market should continue to improve, though off a low base. Our refinance business accelerated in the first three weeks of October with open orders up 76%. And we remain optimistic that the commercial business will perform well in the fourth quarter, given higher term refinancing demand, continued progress on price discovery, and our own robust pipeline of large transactions. As we indicated last quarter, we expect that modest revenue growth for the full year of 2024 will enable us to achieve title margins similar to what we posted in 2023. We now have stronger conviction in that outcome given the recent performance of our commercial business and the increase in interest income resulting from our portfolio rebalancing project. The first year-over-year growth in revenue in nine quarters that I mentioned earlier coupled with our expectation that affordability challenges will gradually abate, also make us cautiously optimistic that we are in the beginning stage of a new cycle that will drive further improvement in 2025. While we have been operating through a cyclical downturn since the Fed began its historic interest rate hike cycle in early 2022, our operating strength and strong balance sheet has enabled us to make meaningful investments in our business while maintaining our commitment to return capital to shareholders. Since the beginning of 2022, we have repurchased 10 million shares for a total of $574 million at an average price of $57.74 per share. During this same period, we have also increased the common stock dividend by 6% to an annual rate of $2.16 per share. In closing, I would like to comment on the widespread damage and devastation that the recent hurricanes inflicted across several southeastern states. Many of our employees and the communities in which they live have endured profound hardships. While we are grateful that all of our people are safe, we know that many now face the difficult task of recovery. I want to thank our people for all they have done to lend a hand to those impacted and to reiterate our company's commitment to support our people and their communities. Now I'd like to turn the call over to Mark for a more detailed discussion of our financial results.

Thank you, Ken. This quarter, we generated a gap loss of $1 per diluted share. Our adjusted earnings, which excludes the impact of net investment losses and purchase-related amortization, was $1.34 per diluted share. During the third quarter, we rebalanced our investment portfolio by selling certain debt securities in an unrealized loss position. Our net realized investment losses of $312 million this quarter were primarily due to this rebalancing. As a result, we expect to save $90 million of cash taxes in the near term, and we expect to increase investment income by approximately $67 million per year beginning in Q4. by reinvesting the proceeds in higher yielding securities. The average duration and credit quality of the portfolio is unchanged as a result of this rebalancing. Turning to our title segment, revenue was $1.3 billion, down 15% compared with the same quarter of 2023. Excluding net investment losses, revenue increased 4% from last year. Purchase revenue was up 3% during the quarter, all driven by an improvement in our fee profile. Commercial revenue was $190 million, a 19% improvement over last year. Though our closed commercial orders fell 5%, the average revenue per order for commercial transactions surged 23%. Refinance revenue climbed 20% relative to last year. Despite growth in order activity, refinance still accounts for just 5% of our direct revenue. In the agency business, revenue was $684 million, up 3% from last year. Given the reporting lag in agent revenues of approximately one quarter, these results primarily reflect remittances related to Q2 economic activity. Information and other revenues were $242 million during the quarter, up 1% compared with last year due to an uptick in the demand for the company's information products. Investment income was $136 million in the third quarter, down $5 million compared with the same quarter last year due to lower average interest bearing escrow and tax deferred property exchange balances. However, our investment income was up $11 million on a sequential basis. As I mentioned earlier, we expect our investment portfolio rebalancing to generate approximately $67 million of additional interest income per year beginning in the fourth quarter. We estimate that the third quarter benefited by $8 million related to this initiative. as we ramped up fixed income security purchases throughout the quarter. We'd like to provide a little more visibility into our investment income line item going forward. In Q4, we now expect between $140 and $145 million of investment income in the title segment. This includes the full run rate of our portfolio rebalancing project. It also assumes a 25 basis point Fed cut in November and a second 25 basis point cut in December. Based on current average cash and escrow balances, we estimate that each 25 basis point cut in the Fed funds rate will reduce annual investment income in the title segment by $15 million. The provision for policy losses and other claims was $37 million in the third quarter, or 3.0% of title premiums and escrow fees unchanged from the prior year. The third quarter rate reflects an ultimate loss rate of 3.75% for the current policy year and a net decrease of $9 million in the loss reserve estimate for prior policy years. Adjusted pre-tax margin in the title segment was 11.6%, excluding both net realized losses and purchase-related amortizations. Total revenue in our home warranty business totaled $111 million, up 2% compared with last year. Pre-tax income in home warranty was $9 million, down 4% from the prior year. The loss ratio in home warranty was 54%, down from 55% in 2023 due to lower claim frequency that was partially offset by higher claim severity. Adjusted pre-tax margin in the home warranty segment was 7.7% compared to 9.3% last year. The effective tax rate for the quarter was 28.4%. Excluding the impact of net realized investment losses and purchase-related amortization, the tax rate was 20.5%, lower than our normalized rate of 24% due to $6 million of research and development and foreign tax credits recognized during the quarter. Our debt-to-capital ratio as of September 30th was 34.8%. Excluding secured financing payable, our debt to capital ratio was 26.6%. In September, we raised $450 million in a public offering of 10-year senior notes. $300 million of the proceeds will go toward paying off notes that mature on November 15th of this year. Now, I would like to turn the call back over to the operator to take your questions.

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your questions from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. The first question comes from the line of Bose George with KBW. Please go ahead.

Okay, everyone, good morning. I wanted to start with just a question on margin. In the past, you know, you guys did give ranges for, you know, what you thought margins could be. Can you just, you know, give us an update where you think, you know, where that range is and, you know, what you see as kind of a normalized margin if home sales, you know, sort of get back to some normal level?

Yeah, both. Thanks. Thanks for the question. I mean, you know, I'll start by saying, you know, as I indicated in my remarks, we've got a strong conviction on our margin outlook for, you know, for this year, given especially the performance of our commercial of our commercial business. And we expect further improvement in 2025. But I think I'm not I'm not even sure what a normal what a normal market is anymore. I guess what I would say is, you know, we would revisit our we would revisit the margin probably once we see what 2020 2025 shapes up.

So, OK, great. And then actually just the comment I think you mentioned earlier on the on tech spend. So it sounds like there could be some cost saves. Can you sort of discuss that and tie that into, you know, the impact that the endpoint and instant titling, you know, had this quarter? Are those two kind of related in terms of the tech spend?

Yeah, as I mentioned, we think there's a real opportunity to reduce tech spend without compromising on any of the innovative work that we've been doing and we're making great progress on. We do think there's an opportunity, though, to centralize, standardize, and simplify, and that'll bring costs down. In fact, we've already seen some cost reduction in large part at this stage from Shifting from high cost outside third parties to in-house developers. And we're in the process of doing a zero-based budgeting review. We're looking at all of our projects and, again, looking for opportunities to make the process more efficient and assess the return on the investments we're making. But we're not slowing down. We're not slowing down on our escrow efficiency initiative. We're not slowing down on Sequoia. and we're going to continue to press ahead and make progress on those initiatives.

Okay, great. Thanks.

Thank you. Next question comes from the line of John Campbell with Stiefening. Please go ahead.

Hey, guys. Good morning. Good morning. Hey, on the rebalancing efforts, so 67 million annualized impact, that's obviously a really good addition to the P and L. So great work there. I'm thinking that this uptick does not have a corresponding effect to interest expense, but I wanted to check on that first.

Yeah, you got that right, John. No effect.

Okay. And then, you know, it sounds like you guys are, you know, I think you mentioned cautiously optimistic about a turn in the cycle or beginning stages of the turn in the cycle. I think we typically agree with you guys there, but, um, If we assume enough growth next year where the success ratio is going to actually matter, would you guys expect to manage to that historical success ratio, or is it possible you might be able to move a little bit higher than that next year?

I think in general, John, as a general statement, I mean, we stand by the 60% target. Of course, there's a lot of differences, and a lot of it depends on how much our revenue will grow next year. We've got tailwinds in commercial. We've got tailwinds in purchase. We've got tailwinds in refi. We've got tailwinds in investment income. And so in theory, if there's small changes in revenue, then you get some funky outcomes with success ratio. But if revenue grows more than, let's say, 5% or so, then I think the success ratio really comes into play. And so we stand by that, at least heading into next year.

Okay, that's great. If I could squeeze in one more. I'm just curious about the direct-to-consumer efforts within Home Warranty. Maybe you could size up. The higher marketing spend, I don't know if you can maybe talk to the LTV to CAC framework, and then just maybe more broadly, the long-term opportunity you see for home warranty.

Yeah, you know, as I mentioned, you know, we made an investment this quarter. We've made investments in the past on direct-to-consumer spend. And, you know, we are opportunistic about when we make that. Obviously, there's, you know, the cost associated with generating leads and, you know, the conversion rates from those leads factor in. But we think that, you know, fundamentally it's a good investment over the, you know, over the long term. But, you know, it takes a year or so to realize the value of those investments. So it's early days for us to realize the value and comment on the value of the recent investments we've made in DTC. But, you know, we look at it very, very carefully and we think it makes, we think it's, at least at this point, given the current pricing of these leads, it's prudent to continue investing in it.

Okay. And if I could just squeeze in one more on the, you know, I guess how you gauge success in that venture. I mean, is it, do you think it's meaningful enough where it will, you know, kind of turbocharge or supercharge growth over the next couple of years?

Are you talking about in the direct to consumer channel and high warranty? Yeah, no, we think that's where the, that's where the opportunity is, particularly given that the purchase market is under such pressure. So in our real estate channel where we're selling through, real estate agents in connection with home transactions. Given the pressure in that market, we think there's real opportunity in the direct-to-consumer channel, keeping in mind there's a lot of open space in the home warranty business. Not many homes have home warranties on them, so we don't have to go chase down customers from our competitors in order to realize a competitive advantage in that business, because there's a lot of open space. Okay, great.

Thanks, guys.

Thank you. Next question comes from the line of Terry Ma with Barclays. Please go ahead. Mr. Ma, please go ahead with the question.

Patrick Corbett, Sorry, I was on mute. Thank you. Good morning. So it seems like the reinvestment of the repositioning of the investment portfolio in the $67 million benefit Patrick Corbett, will mostly just kind of offset the first 50 basis point rate cut and then the two more anticipated ones. Is that a fair way to kind of think about it and then kind of look forward to 2025? Are there any other actions that you can kind of take to optimize or get more out of your investment portfolio to maybe offset any additional rate cuts?

First of all, Terry, yeah, that's the right way to think about it. I mean, for every, you know, for every 25 basis point in the Fed's funds rate right now, given where our current balances are, we expect, you know, a $15 million reduction in investment income. you know, the $67 million benefit we're going to get will basically fund at least four-plus, you know, Fed cuts. Now, there's a lot of other factors, too. I mean, one thing that could offset that is if we have, you know, rising commercial volumes next year and purchase volumes, that could, you know, that will generate additional investment income, and that could insulate some of these, you know, these Fed cuts that might come our way next year. So that's kind of how we think about our investment income.

Got it. Okay, that's helpful. And then any other color you can provide on what you're seeing in commercial so far this quarter? Anything that kind of gives you confidence that the momentum you saw in the third quarter will continue?

Yeah, well, I think that, thanks for the question, Terry. I think, really, I think the results we saw in the third quarter are one of the biggest indicators. I mean, to have the first year-over-year increase in revenue in our commercial business is a real positive indicator. You know, we're seeing strong demand in the business. We're seeing a lot of progress on price discovery. And then we have in our own pipeline of deals give us a lot of confidence. And then for the first three weeks of October, we've actually seen an increase in revenue as well. So we feel pretty good. You know, obviously things can change. It's a volatile market, but we feel pretty good about the rest of the year in our commercial business. Got it.

Okay, that's helpful. Thank you.

Thank you. Next question comes from the line of Mark DeVries with Deutsche Bank. Please go ahead.

Yeah, thanks. First question on the securities reposition. Is there more that you might look to do in 2025, or are you kind of positioned now the way you want to be?

I would say the bulk of it is done. There is still some that we could do that we're considering. But, you know, the scope of that at the most would be about $100 million of losses, and we haven't really decided if we're going to do that yet. But that would be the scope of it. Most of it has been done.

Okay. And then, you know, I think you alluded to some potential offsets on investment income from higher commercial and or purchase. Can you help us think through which is more impactful, if either one is, in terms of, like, incremental volume from commercial versus purchase?

in terms of investment income uh commercial is is more is more valuable to us i mean just because the deals are are um are larger in size they typically take longer to close than a residential purchase transaction typically so we hold the deposits longer and you know we estimate that you know it fluctuates but i would say the rule of thumb is that about 60 percent of our our escrow deposits at the company are commercial so commercial is is a big driver in terms of what our escrow deposits are.

Okay, got it. And then just last question, are you seeing any signs that efforts by certain lenders to kind of use AOLs as an alternative to title or is gaining traction in the market?

You know, I think we've seen probably a slight tick up in usage of AOLs, but it's you know, it's pretty small. And I think, you know, fundamentally, I think when, you know, lenders and others realize that AOLs are not, they're not faster, you know, for an attorney to write an opinion, it actually is a lot slower than a title, underwriting a title policy. They're not better because of, you know, coverage limitations, fraud, having to, you know, sue your lawyer for malpractice. And, you know, given the loan level price adjustments, that often accompany an AOL, they're not cheaper. So I think that, you know, we might see some, you know, continue to see some slight take up on AOLs, but you know, so far it hasn't been, hasn't been too meaningful.

Got it. And it also obviously is making quite an effort in DC to, to kind of educate policymakers around the value of title versus versus AOLs. And Ken, any sense on, on how much traction they're getting and how effective they are in kind of moving perceptions?

Well, you know, I think the telltale sign will be, you know, what happens after the election. But I think there's been a lot of, you know, they've gotten some traction with, you know, AOLs and title waivers and other alternatives in the administration. But there's been a lot of pushback from regulators and legislators, including members of Congress. You know, I think our trade group has done a good job, and I think that, you know, frankly, legislators and regulators themselves have already appreciated, already had appreciated the value of title insurance relative to these alternatives. So, you know, we've got to remain ever vigilant and continue to get out the message on the value of title insurance. And I think, frankly, that we're, the industry's winning that battle.

Got it. Thank you.

Thank you. Next question comes from the line of Mark Hughes with True Securities. Please go ahead.

Thank you. Good morning. On the commercial side, any particular end markets or property types where you're seeing the price discovery proceed or you talk about a healthy pipeline of larger transactions anymore on the mix of that?

Yeah, I think we're seeing price discovery. A lot of this is anecdotal, but we're seeing it across the board. Obviously, the one asset class that continues to struggle, as you'd expect, is office, particularly CBD office. Suburban office is probably doing a little better. But the one thing I'll point out, the nice thing about our commercial business markets, we're pretty diversified. uh you know we have a strong presence in all asset classes so we're not buffeted for better or for worse by any one asset class we're uh we're in the mall and we're in the mall pretty deep yeah um when you see kind of an uptick in the size of transactions like this it's just the normal variability or where these deals are hanging on the sidelines waiting for

a little better interest rate environment? What do we make of that?

It's just a hard thing to determine in terms of what our future fee profile is. I mean, year to date through June, our commercial revenue was down 2%, and we just saw a surge here at 19% in Q3. And so, you know, sometimes those things are difficult to forecast, but we're seeing broad-based strength. And as Kent said, we're really optimistic heading into Q4. But we don't really know what our fee profile is until we get the deals in the door on the open side, and then we can somehow predict. But predicting anything further than a quarter is tough to do in commercial, in terms of the fee profile.

Anything on the CFPB front from a regulatory perspective? Anything there?

We haven't heard much on the CFPB front. I don't think they've forgotten. And I think we'll probably, as I mentioned in response to the earlier question, I think after the election, we may see a tick up in activity with the CFPB. But the RFI is still out there. Our industry responded to it. But we've I think for now they're focused on other areas, but I don't think for a minute that they've forgotten.

Yeah. Okay.

Thank you very much.

Thanks, Mark.

Thank you. Next question comes from the line of Jeffrey Dunn with Dowling and Partners. Please go ahead.

Thanks. Good morning. Good morning. Given the change in the sales approach in home warranty, can you talk a bit about how you think about the strategic value of the platform to the company?

Yeah, and I wouldn't say it's a change in the sales platform. I think it's an evolution. And, you know, one competitor in particular I think has been pretty aggressive with it. It's done a good job with DTC. But we've been working on it. We've been working on it too. And I think we're just ramping up the investment. So I call it more of an evolution than a change. But we like the business. I mean, it's clearly furthest from our core title and settlement business, but we like it. We think there's a lot of opportunity in it, particularly given what, as I mentioned earlier, how under-penetrated the market is. And then even though the real estate channel of that business is suffering right now alongside the purchase business and the title company, for example, I think once the purchase market turns around, and it will turn around, I think that our expertise and deep penetration in the real estate market and the real estate channel is going to be helpful for that business as well.

All right. Thank you.

Thank you. A reminder to all the participants that you may press star and one to ask a question. There are no additional questions at this time. That concludes this morning 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 201-612-7000. and enter the conference ID 13749447. The company would like to thank you for your participation. This concludes today's conference. You may now disconnect.