Stewart Information Services Corporation

Hello, and thank you for joining the Stewart Information Services fourth quarter and full year 2022 earnings call. At this time, all participants are in a listen-only mode. Later, you'll have an opportunity to ask questions during the question and answer session. Instructions will be given at that time. Please note today's call is being recorded. Lastly, if you should require operator assistance, please press star zero. It is now my pleasure to turn today's conference over to Brian Glaze, Chief Accounting Officer. Please go ahead.

Thank you for joining us today for Stuart's fourth quarter 2022 earnings conference call. We will be discussing the results that were released yesterday after the close. Joining me today are CEO Fred Eppinger and CFO David Heisey. To listen online, please go to the Stuart.com website to access the link for this conference call. This conference call may contain forward-looking statements that involve a number of risks and uncertainties. please refer to the company's press release and other filings with the SEC for a discussion of the risks and uncertainties that could cause our actual results to differ materially. During our call, we will discuss some non-GAAP measures. For reconciliation of these non-GAAP measures, please refer to the appendix in today's earnings release, which is available on our website at Stewart.com. Let me now turn the call over to Fred.

Thank you for joining us today and for Stewart's fourth quarter earnings conference call. David will review the quarterly financial results in a minute, but before that, I would like to cover our overall view of Stewart and the current market. As I discussed before, much of our efforts over the last few years have focused on fundamentally improving the company's operating approach to better position ourselves in our journey to become the premier title service company. The long-term goal remains to create a stronger and more resilient business that can thrive through the real estate cycles and economic conditions. We have focused on improving margins, growth, resiliency by improving our scale and attractive markets and enhancing our operational capabilities and our financial discipline. We have significantly improved our performance and our ability to manage challenging markets, but we were impacted by the significant downturn in the purchase market we saw in the fourth quarter. The challenges associated with higher interest rate environment increased materially during the fourth quarter as interest rates topped out over just 7%, and we are planning for this difficult market to continue into 23, and are managing our business with a balance of cost discipline and investment in skills and capabilities that will best position us for the long term. Although interest rates have declined in early 23 by 100 basis points, and we've seen improving trends in January quarters, interest rates, home inventory, and housing affordability are all tendencies to any quick return to a normal real estate market. Through 22, we have been managing in a declining market, starting with a significant decreased repo market and moving to a rapidly declining purchase market. As a result, we have been taking material but thoughtful and targeted expense actions throughout the year to ensure we maintain financial strength, service our business well, and position us for a more normal market. In the fourth quarter, we saw an additional material decrease in the purchase market ending the year at a 46% decrease in closed orders and a 44% decrease in open orders year-over-year for December, our lowest point of the year. This trend led us to take additional significant but targeted expense actions in the quarter to ensure we maintain our financial flexibility. We continue to manage our business with a long-term view, however. one that maintains and strengthens the investments and improvements we have made over the last few years, ultimately improving our structure and long-term financial performance. We remain focused on a strategic plan of building an improved competitive position by being more efficient and having a disciplined operating model that functions well throughout the cycles. We have emphasized growing scale of attractive markets across our lines of business, and we have made significant progress in improving the customer experience in all our channels. While we are encouraged with our improvements on all four critical fronts, talent, technology, customer experience, and our financial model, we recognize work remains and the journey is not complete. We will continue to invest opportunistically during this market, but we'll be mindful of maintaining our current strong financial positions. Financially, a long-term goal remains to generate high-single, low-double-digit margins over the cycle. However, there will be quarters like the fourth quarter and the first quarter of 2023 where margins will be challenged. Our adjusted margins for the quarter reflect the levels of investment and talent in systems necessary to compete in the long term. Difficult management and seizing on growth opportunities as they arise are keys to improving Stewart's financial position. On the margin front, prior to beginning the journey, pre-tax margins were below single digits in the normal market, and in lower volume markets, we consistently lost money. Our efforts to improve scale in our direct operations, improve our portfolio of acquisitions and real estate services, and strengthen our operating model have allowed us to better weather the margin pressure, particularly in challenging markets. At the outset of the journey, we identified areas that we needed to improve in order to achieve our goal. Since then, we have been significantly improving our technology for title production, process automation, and centralization to improve operational efficiencies and capabilities. We have already made significant progress improving the customer experience across all channels and rolling out our agency technology platform, which significantly enhances ease of use and connectivity with agents. We continue to make excellent progress on these and other investments, but we know that more work needs to be done. We believe the current market will present opportunities to improve scale, targeted, and attractive direct markets, and to add additional services that complement our existing lender services. Share growth and direct target MSA markets remains a key strategic objective. During the fourth quarter, we added FNC title services, which specializes in providing title services for reverse mortgage transactions. and BCHA, which is the national provider of title services to international institutional investors and lenders. Both companies are leaders in their respective fields and are important to our strategy as we increase our service offerings and scale. The year ahead should see additional progress integrated completed acquisitions into our production and other systems, which improves our customer experience as well as the overall operating efficiencies that we've been building over the past several years. In our agency business, 2022 saw developments in key areas that position us now for increased scale in our growth markets and improve our share with the highest quality independent agents. We have made excellent progress in our deployment of technology and services that provide greater connectivity, ease of use, and risk reduction for our agent partners. As we move through 2023, our platform of services for agents is as strong as it's ever been. Conditioning our commercial operations for going across all our business lines has been a key focus this year, as these operations are important components of our overall strategy. We made significant investments in talent during 2022 with aid in achieving these objectives. We are optimistic regarding the commercial markets long-term, although we recognize they were fully suspended in the short-term, given changing financial markets. Let me just finish by reiterating that we will both manage expenses and investments with a practical balance between an operating discipline for the current short-term market challenges and strengthening steward for the long-term growth and performance. A strong financial footing should best be adjusted to taking advantage of the opportunities that this cycle will provide. I will conclude by reiterating my positive long-term view of the real estate market and the ability of Stewart to become the premier title services company. I would also like to thank our associates for all their hard work and our customers for their continued loyalty and support. David will now update everyone on the results. Good morning and thank you, Fred. Let me also thank our associates for their amazing service and our customers for their steadfast support. During the fourth quarter, residential market was negatively impacted by 30-year mortgage rates that peaked over 7%. Consumer sentiment has been forwarded to the rate environment, inflation, affordability, and recession concerns. Commercial real estate is seeing the impact of higher rates and volatile markets as well. Yesterday, Stewart reported fourth quarter inflation. 2022 net income of $13 million and diluted earnings per share of $0.49 on total revenues of $656 million. After adjustments primarily for net unrealized gains and losses on equity securities and office closures, severance, regulatory and litigation expenses, adjusted fourth quarter net income was $16 million or $0.60 per diluted share compared to $84 million or $3.05 per annum each year in the fourth quarter of 2021. Total title revenues for the fourth quarter decreased $255 million, or 30%, primarily due to the volume declines driven by higher interest rates. As a result, the title savings free tax income was $27 million compared to $119 million in the prior year quarter. While on an adjusted basis, the segment's pre-tax income was $35 million compared to $120 million in the prior year quarter. After adjustments for purchasing tangible amortization and other items listed in the appendix A of our press release, adjusted pre-tax margin for the fourth quarter was 5.9% compared to 14.4% in last year's fourth quarter. In our direct title business, Domestic commercial revenues decreased $26 million or 28%, primarily due to lower transaction volume and size. Average commercial fee per file was $15,100 compared to $19,700 for the prior year quarter. Domestic residential revenues decreased $94 million, or 32%, resulting from lower purchase and refinancing transactions. However, residential fee per file increased 45% to approximately $3,500 from $2,400 last year due to the higher purchase mix. Total international revenues were $16 million, or 34% lower, primarily due to lower transaction volumes in our Canadian operations. Total open and closed orders declined by 48% and 51%, respectively, in the fourth quarter compared to last year, primarily to the economic environment. Similar to our direct title revenues, revenues from our agency operations decreased 133 million or 30% compared to last year's quarter. The average agency remittance rate slightly decreased to 17.6% compared to 18% last year, primarily as a result of geographic mix. On title losses, total title loss expense in the fourth quarter decreased 12 million or 36%. primarily driven by lower title revenues. As a percent of title revenues, the title loss expense was 3.7% compared to 4% in the fourth quarter of 2021. For the full year 2022, our title losses were 3.8% of total revenues compared to 4.2% in 2021. Based on the current economic environment, including a possible recession, we expect 2023 title losses to be at least at 2021 levels. Regarding our real estate solution segment, fourth quarter pre-tax income decreased to $400,000 from $5 million last year, primarily due to lower transaction volumes resulting from the economic environment. Pre-tax margin for the fourth quarter was 0.7% compared to 6.1% in the fourth quarter of 2021. After adjusting for purchasing tangible amortization and other items listed in Appendix A, adjusted pre-tax margin for the segment was 12.8% in the fourth quarter, compared to 9.1% in the prior year quarter. Regarding operating expenses, which consist of employee and other operating costs, total operating expenses for the quarter decreased primarily due to lower costs related to revenues and lower incentive compensation based on their results. Employee costs as a percent of operating revenues were 30% in the fourth quarter compared to 23% in the prior year quarter, primarily due to lower operating revenues. Other operating expenses as a percent of operating revenues were 23% and 22% in the fourth quarter, 22 and 21 respectively. Excluding office closures, regulatory litigation expenses, the other operating expense ratio is 21% in the fourth quarter, 22, compared to 22% in the prior year quarter. On other matters, our financial position is strong to support our customers and employees in the real estate market. Our total cash and investments as of December 31, 2022 are approximately $130 million. other regulatory requirements, and we also have a fully available $200 million loan and credit facility. Total stockholders' equity attributable to Stewart was $1.36 billion, and our book value per share was approximately $50, which is 5% higher than December 31, 2021. Lastly, net cash variety of operations for the fourth quarter decreased to $25 million compared to $133 million last year's quarter, primarily due to the lower net income in the fourth quarter of 2022. We're always grateful for and inspired our customers and associates. We advocate for everybody's safety and prosperity and are confident in our support of real estate markets. I'll now turn the call back over to the operator for questions.

At this time, we will open the floor for questions. If you would like to ask a question, please press the star key followed by the one key on your touch tone phone. If at any time you would like to remove yourself from the question queue, press star two. Our first question is coming from John Campbell from Stevens.

Morning, John. Hey, guys. Good morning. Hey, so if I strip out the one-timers here, I'm showing that personnel cost is down maybe a little bit less than half the rate of revenue. Other operating expense is down sharper than revenues. I know it's important that you guys retain staff. you know, to avoid that share loss. And I know you've invested to garner share, and so you don't want to lose that on the other side of the market. So my question here is, is the 4Q movement in revenues and expenses by those line items, is that kind of a preview of what's to come? You're basically cutting the other operating expense faster than the salaries?

A little bit, John. So the reality is that we're lagging a little bit. So we've done on both lines, we've done on the share, amount of stuff in those last three quarters. But when I saw the gift, kind of like I mentioned actually a little bit in the last room, it's called the end of the third and end of the fourth. We took about $25 million worth of action, thoughtfully targeted and surgical, but we took about $25 million of action in the fourth quarter. I would say that was probably 20 personnel, five on top. So the balance, you know, changes and shifts kind of during the year, kind of what we did. And so that's what you saw. And obviously you can see in the restructuring the result of some of that stuff with the office closures and some of the seven stuff. So the balance has been kind of that going in. And so what we see, obviously, the first quarter is our toughest quarter always. And the order counts Obviously, we see the open orders to announce it, but we kind of know what the first quarter is going to be like in some ways. And so I thought that was appropriate to your point. Otherwise, we are being thoughtful about this because in my view, there's two or three terrible quarters we've got to get through, but we've built great capabilities. across the organization, and I've got to make sure we can take advantage of the market when it comes back, and we will. And I want to make sure the momentum stays and the skills stay. And so we're trying to be really quite thoughtful about it, and I feel very good about how the team has managed through it. John, just one other thing on the other expense line and why there may be a difference in the percentages here is that a lot of the real estate services has third-party data and other costs in it, and so that varies a lot more closely to revenue than maybe the employee line. Oh, that's true. Yeah.

Okay, that's a great point. And then on the implied direct title kind of fee profile, I'm having a little bit of trouble back into that. If I take just the direct revenue divided by the closed orders, I think it's about a 40% lift year over year. I know there's a mix shift there, but if I look at that sequentially, it's kind of a similar mix shift, and that's able to 10% move sequentially. I'm thinking maybe the recent acquisitions might be skewing that a bit, so maybe if you could talk to that, help explain that.

Yeah, I think for that kind of a difference, John, I mean, you're probably talking the geographic mix and stuff like that. Those acquisitions, you know, the reverse keeper file isn't quite that high. And the other one closed late in the year, so you wouldn't see any impact. So that's just more geographic mix shift.

Okay. That's helpful. Thank you, guys. Thanks, John.

And once again, that is star and one if you'd like to ask a question. And it looks like we have another question from John Campbell.

Yes, this is my show today, guys. If you could touch on the BCHH business, that's something obviously you guys acquired in late December. If you can maybe talk to how that impacts the P&L. I'm thinking that probably falls in the real estate solution segment, but then also if you could give a little bit of color on the synergy potential and kind of how that complements the strategy.

Yeah, John, that actually is a title operation, so it's going to be in the title segment. I think a way to think about that is their primary customer base is sort of the institutional investor side to think about single-family rental, think about building rent, that kind of thing. And so, you know, I think much like we did with the reverse business with FNC, we're sort of looking for market segments where you can differentiate and that have growth potential. with what's happening, you know, sort of in the economy with demographics and the like. And, you know, some people, and I'm sure you've done some work on it, have sort of sized that to the family-run institutional and maybe 10% to 15% of the total real estate market at some point. And so, you know, this is one of the premier providers there, and it's just an opportunity to go after that market segment.

Okay, and then this is somewhat related to BCHH, but if you go back to FNC, I think you had talked about in the past that was maybe going to hit other orders, and then maybe I think you said last quarter maybe that was purchased. Is it a mix now? If you could talk about the impact to other orders, that picked up a good bit sequentially. And then also on BCHH, if that's going to hit on purchase or other.

Yeah, FNC is in other orders. With BCHH, I think we're going to need to take a hard look at that because some of it could be other and some of it's purchased, and so there's probably going to be a bit of a split there.

Okay. That's helpful.

Thank you, guys. Thanks, Sean.

Yeah, and it looks like that is a lot of time for question and answer session. I will now turn the program back over to Fred.

I think there's some more in the queue. Is anybody in the queue?

Yes, it actually looks like a couple just queued up. And we have Bose George from KBW.

Hey, Bose. Good morning. Hey, good morning. Just wanted to follow up on the question from John on expenses. As the benefit of the cuts that you did this quarter flow through, is there a way for us to kind of think about what the margin range is for 2023, assuming sort of the market remains roughly in line with consensus expectations?

Yeah, I think, again, it's going to be very different by quarter because the first quarter is going to be much more dictated by the poor order intake in the fourth quarter. And I think after that, we believe it's going to improve pretty materially. The personnel stuff we've done, in my view, gives us, you know, obviously at some level we have excess capacity in the system. still given where we are and what we're doing. And so that as the market improves, obviously those ratios improve materially through the year if you have the capacity steady state as the volume increases. So, you know, we feel pretty good about where we are and where we're going to end up. And if you look at this year's year in total, it gives you, like, if you look at kind of how we managed the full 12 months, even though it was a declining business, And you look at the way that ratio is on an annual basis, you get a pretty good sense of how we can manage the business, right? So I feel pretty good about what we've done and where we are. The one disadvantage we have, as you know, is our portfolio is a little different. We don't have a bank or investment income that goes to the revenue line that changes these ratios. So if you look at us on a comparison basis, we've actually managed pretty well. And obviously, you know, the big guys are three times, four times our size, so there's a little bit of overhead at the top. But I would say on a relative basis, the actions we've taken and the level of actions we've taken is very comparable, actually.

Okay, great.

That's helpful. Thanks.

Just one other thing on that. I mean, I think the one thing to think about is even though we have taken all those actions, I think some of the ratio relationships that you saw in the fourth quarter where, you know, maybe you guys were a little bit lower than actual on the employee side, you know, some of that may continue because we don't get quite the dollar for dollar. I think the first quarter will be very challenging just like the fourth because we're at the bottom right here. And what's interesting, though, that I'm sure you've seen it, what's exciting or, you know, Orders are up for us in January, 28% open orders, and commercial orders are up 20% or something. But your first quarter has driven what your fourth quarter intake was, really. So while it's really good, that lags, right? So I feel like we're bouncing off the bottom here, which is excellent. uh but the first quarter and the other thing about us to remember is we're more seasonal than all the other competitors because we have the least in california and florida everybody else has huge positions in california we don't so we have a little bit of a double win we have a bad fourth quarter and you know a weekish first quarter because we're big in northeast we're big in New England, we're big in like Alaska and stuff. So we have a little bit more of a seasonal lag. But again, I would say that I feel like we called it right because we can see the kind of the trends coming and things bouncing a little bit back. So it's good.

Okay, great. That's very helpful. Thanks. And then, actually, can you remind us what drives that non-controlling interest line? It's come down very modestly despite the big move down in income.

Yeah. Yeah, that's where we don't have 100% ownership in some of our businesses. And it varies from period to period. So we have done a slight majority purchased like a couple of years ago, and then we've been staging into that. And so that was helping that line. And then we had a couple of new entities in the fourth quarter, so that might have kicked the ratio off a little bit. But in general, we're trying to minimize the partial ownerships, but there's going to be period fluctuation. So a lot of that was historical. At the beginning, I've been trying to... buy and get rid of that and have some ownership. But one of the recent acquisitions for real good strategic reasons, we did a little bit of a minority ownership for aligning incentives. So that's why it bounced a little bit. But I don't see that getting huge or anything. That's not going to jump.

Okay. Great. I'm actually just going to add one more. Just the legal and regulatory settlement, you know, was that kind of just a one-off? Any color on that?

Yeah, it was. It was with New York on anti-poaching, if you will. Everybody in the industry has kind of looked at it that it came out of actually, I believe, our transactional fidelity and some search they did about anti-poaching. And so we settled, I think it was a third player to settle. on that, and we just wanted to get it behind us. But I think it's a one-off. It's not something that's, you know, temporary.

Okay. Great. Thanks a lot.

Our next question comes from Jeffrey Dunn from Dunning and Partners.

Hey, Jeff. Good morning. Thank you. Good morning. So just first, with respect to the near term, it sounds like activity is picking up. You don't necessarily get those revenues completely in the first quarter, but you certainly have the expenses in processing those orders. So as it shapes up, it sounds like directionally, we're looking at maybe a more compressed margin sequentially. And I guess my main question is, do you think you can make money in the first quarter?

Great question. I think it's going to be a challenging quarter. It's going to be our most challenging quarter. I think we've done a pretty aggressive job managing all our expenses. But, again, I think first quarter is going to be the most challenging.

Okay. And then investment income, it looks like you had a pretty good uptick this quarter after I've seen much movement beforehand. David, did you reposition the portfolio differently, or is this just a lagged impact from last year?

Yeah, Jeff, it's David here.

I mean, a lot of that's just the benefit we're getting in the money markets right now. I mean, you can get the 4% plus in money markets where you weren't getting that, and so it's just the earnings on the excess cash. I think we're keeping the investment portfolio relatively short on the duration side and over-indexing on ways to grow the business, but that's mainly the effect of money market rates. Yeah, and as you know, the short money is so good right now, right? It's a very unique situation how quickly it moved and how good short money is. And, again, it shows a little bit of our gap in that we don't have a depository for our escrow. So our investments are going to come mostly from our investment portfolio and a little bit from the 1031 business. but we don't get the benefit of our $2 billion in escrow. But it is a very unique time, right? It's kind of the best time. It's a little counter cyclical in a tough market right now with investments.

My last question is on commercial. You know, I think a lot of people think of it as like a normalization year for commercial, but the problem is that can be very painful when you're coming up with the results. But can you talk to, beyond maybe what you think as normalization, what remain the hot spots? What are the areas that seem like they're actually starting to get impacted on an economic basis? You know, what are the pluses and minuses relative to the normalized levels?

Yeah, again, for us, what's interesting is that, you know, I think the first one is going to be interesting because I think it's going to be slow in some places, but the orders are up, so the tail, you know, I think the year is going to shape up pretty pretty good. I think there's some geography stuff going on right now. So I think New York is a little bit slower. But for us, it's interesting to get in our mix. Energy is very strong. And so for us, we have some advantages in that. What we're seeing is really nice kind of pickup and growth in the energy sector. And obviously, there's the obvious sectors that are going to struggle a little bit more than others. But in general, we think it's going to be a pretty good market in commercial. I do think the comparison last year's first quarter was really good. So I think there's going to be a comparison in the first quarter. But I think overall for the year, it's going to be solid. It's going to be a solid commercial year. But there is tips and tricks to your point. There's no question right now.

Okay. Thank you. Thank you.

And it appears we have no further questions. I'll now turn the program back over to Fred for any closing remarks.

Well, I want to thank everybody for joining us on this call. Thank you.

And this does conclude today's conference. You may now disconnect. Have a great day.