Stewart Information Services Corporation

Hello, and thank you for joining the Steward Information Services First Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. Later, you will have the 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 call over to your Brian Glaze, Chief Accounting Officer. Please go ahead.

Thank you for joining us today for Stewart's first quarter 2023 earnings conference call. We will be discussing results that were released yesterday after the close. Joining me today are CEO Fred Eppinger and CFO David Heise. To listen online, please go to the Stewart.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 FEC 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 for Stuart's first quarter 2023 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 Stuart and the current market. Our efforts at Stuart over the last three years have focused on fundamentally improving the company's operating performance to better position ourselves on our journey to becoming the premier title services company. The long-term goal remains to create a strong and resilient business that can thrive through all real estate cycles and economic conditions. We focus on improving margins, growth, and resiliency by improving our scale and attractive markets and enhancing our operational capabilities. In challenging markets like we are currently in, it is often difficult to advance long-term goals. However, I am pleased with our progress towards improving our long-term performance as we balance investments with the need to manage expenses carefully. As we discussed before, we anticipated the first quarter to be our most challenging. To prepare for this, we took significant actions to manage costs during the second half of 22 and again in the first quarter of 23. We have been careful not to take actions that we felt would threaten our competitization and long-term value-creating opportunities. We believe this is a historic cycle low, and the right answer to get us through this period is to continue to invest in our people and remain focused on a long-term improvement plan and manage through a couple of challenging quarters, which is what we are doing. Early in the first quarter, interest rates kicked down fairly significantly, which resulted in an increase in open orders. However, order volumes slowed again when rates quickly reversed again in February, peaking in mid-March. These challenging market dynamics, along with the impact of seasonality, led us to our lowest quarter closed order volumes in over 20 years and resulted in an overall loss to the quarter. As we moved into the second quarter, interest rates moderated slightly but remained elevated. We expect this difficult environment will moderately improve in the second quarter, but the challenging environment will continue into the second half of 23, and we will continue to manage our business with a careful balance of cost discipline and investments you expect will be the best position for the long term. Although interest rates have declined in the early second quarter, interest rates, home inventory, and housing affordability would mean hindrances to any quick return to a normal real estate market. We would be focused on our long-term strategies, enhancing our operating model, investment in technology, and customer experience, and improve efficiency of our operations in building scale and targeted areas. While we took additional expense actions this quarter, we recognize that these strategic investments will cause our cost ratios to remain elevated in this market. We believe that the long-term investments coupled with a thoughtful near-term expense management will improve our structure and financial performance in the long term. In our direct operations, we are making progress on our strategy to scale and attract the markets. Even during this challenging market, we've continued to evaluate a select number of opportunities to increase our scale and footprint. Given the market uncertainty, we will make very thoughtful decisions around deployment of capital. Positioning our commercial operations for growth across all our business lines has been a key focus in our journey, and these operations are an important component of our overall strategy. We've made investment in talent during the past year to aid in achieving these objectives, and we believe our focus will create long-term growth in the commercial markets, although we recognize changing financial markets may create headwinds in the short term. In our agency business, we have made excellent progress on our deployment of technology and services that provide greater connectivity, ease of use, and risk reduction for agent partners. As we move through 23, our platform of services for agents is as strong as it's ever been, and we've begun to see meaningful share growth in our target markets. On the topic of technology, we continue to invest significantly in improving our technology for the title production process automation and centralization to improve operational efficiencies and capabilities. We've already made significant progress in improving customer experience across all channels and rolling out our agency technology platform, which significantly enhances ease of use and connectivity with agents. Additionally, we have made significant progress integrating completed acquisitions into our production of other systems. which improves our customer experience as well as the overall operating efficiencies that we've been building on for the past several years. The remaining integrations will be an important focus for the remainder of 2023. Maintaining our current strong financial position while investing opportunistically during this market remains a top priority. Financially, our long-term goals remain to generate high signal, low double-digit margins over the cycles. However, there will be quarters like the first quarter and the fourth quarter of 2022 where margins will be challenged. We remain focused on our strategic plan of building an improved competitive position by being more efficient and having a disciplined operating model that functions well through all real estate cycles. We have emphasized growing scale in attractive markets across all businesses and we have made significant progress in improving the customer experience in all channels. While we are encouraged by our improvements in all our four critical funds, talent, technology, customer experience, and our financial model, we recognize work remains and our journey is not complete. However, we have seen the results of our efforts to increase year-over-year market share gains in each of our direct, agency, and commercial businesses. Let me finish by reiterating that we will both manage our expenses and investments with a practical balance between an operating discipline for the current short-term market challenges and strengthening Stewart for the long-term growth and performance. Strong Financial Footage should best position us to take advantage of the opportunities that this cycle will provide. I also would like to restate my positive long-term view on the real estate market and the ability of Stewart to become the premier title services company. A tremendous thank you to our associates and all their hard work and to our customers for their continued loyalty and support. David will now update everyone on our results. Good morning, everyone, and thank you, Fred. First, I would also like to thank our associates for their amazing service and our customers for their support. As Fred noted, the first quarter saw a continuation of a difficult real estate market and poor consumer sentiment. Low residential inventory, high mortgage rates, lower commercial real estate activity, and tough economic conditions all contributed to the situation. Yesterday, Stewart reported a net loss of $8 million or $0.30 per diluted share on total revenues of $524 million. After adjusting for net realized and unrealized gains and losses, he adjusted first quarter net loss was $7 million or $0.25 per diluted share, compared to a net income of $56 million in the first quarter of 2022. The lower results for the first quarter were primarily driven by significantly lower revenues caused by volume declines on lower home sales and refinances. Total title revenues in the first quarter decreased $265 million, or 37%, resulting in the title segment's pre-tax loss of approximately $1 million compared to pre-tax income of $83 million during the prior year quarter. After adjustments for purchase intangible amortization and other items listed in Appendix A of our press release, the segment's free tax income was $4 million, or 1% margin, compared to $81 million, or 11% margin, in 2022. In our direct title business, domestic commercial revenues decreased $24 million, or 42%, primarily due to lower transaction volume and size. Average commercial fee per file was approximately $8,300 for the first quarter, compared to $12,700 for the prior year quarter. Domestic residential revenues were down $70 million, or 32%, as a result of significantly lower purchasing and refinancing transactions. However, residential fee per file was approximately $3,400, which was 30% higher from last year due to a higher purchase mix. Total international revenues decreased 16 million, or 40%, primarily due to lower transaction volumes in our Canadian operations. Total open and closed orders declined by 37% and 45% respectively in the first quarter compared to last year. In line with our direct title revenues, first quarter revenues from our agency operations decreased 155 million, or 38 percent compared to last year. The average agency remittance rate decreased to 17.4 percent compared to 18.1 percent, primarily as a result of geographic mix. In regard to title losses, total title loss expense in the first quarter decreased 12 million, or 40 percent, primarily driven by lower title revenues. As a percentage of title revenues, the title loss expense was 3.9% compared to 4% last year. For the four-year 2023, we expect title losses to average from 4% to 4.2% of title revenues. For the real estate solution segment, pre-tax income decreased to $1.4 million for the first quarter from $7 million last year. primarily as a result of 30% lower revenues driven by lower transaction volume. First quarter pre-tax margin was 2.2% compared to 7.6% last year. After adjusting for purchasing tangible amortization, the adjusted pre-tax margin was 11.5% compared to 14.8% last year. The segment's total operating expenses in the quarter decreased 26 percent, primarily due to lower costs related to revenues and lower incentive compensation. Consolidated employee costs as a percentage of operating revenues increased to 33 percent compared to 24 percent in last year's quarter, primarily due to lower operating revenues in 23. Other operating expenses as a percent of operating revenues were 23%, which was comparable to last year. On other matters, our financial position remains strong to support our customers, employees, and the real estate market. At March 31, 2023, our total cash and investments were approximately $340 million over statutory premium requirements, and we also have a fully available $200 million line of credit facilities. Total stockholders' equity attributable to Stewart at the end of the quarter was approximately $1.35 billion, and our book value per share was approximately $50. Lastly, cash used in operations was $51 million compared to net cash provided by operations of $35 million last year, primarily driven by the first quarter's net loss. We are always grateful for our customers and associates. We advocate for everybody's safety and prosperity, remain confident in our support of real estate markets. I'll now turn the call back over to the operator for questions.

Thank you. And at this time, if you would like to ask a question, please press star 1 on your touch-down phone. We will take our first question from Boze George with KBW. Please go ahead.

Morning, Boze. Hey, guys. Good morning. Actually, I wanted to ask about the margin. It might be a tough question, but just given the challenging backdrop on both residential and commercial and assuming that persists for much of this year, what can we think about in terms of the margins that business can generate?

Yeah, I'm still convinced that if we look at for the next six to eight quarters, we will end up averaging kind of that high single-digit number. I do think the question is kind of how it evolves this year. And I think we all have a view that it's going to improve material into the second half of the year. I think if you think about it now, I would say over the last six weeks, I think it's going to be a more moderate improvement in the second quarter that it will improve. What's interesting for us is that... Closed orders were down 50% in January, 48, I think, in February, and then 40 in March. We made money in March. And so I think we're a much better company. I think we can manage ourselves, and I think the margins will improve dramatically through the year. I just think there'll be one moderate improvement in the second quarter than maybe we thought six weeks ago because of the volumes. But, you know, again, if you look at last year where we had a tough, Fourth quarter, we ended at the eight. I think we'll be a little less than that this year if the back half improves. But I think we have a lot of leverage here. One of the things is we have capacity in the system. And so as the volume comes in, we won't be adding a lot of resource, right? So we have a lot of leverage where we are, and the portfolio is a lot better. And because I look at it historically, at our forecast and kind of where we are, And I think we're bouncing off the bottom now and we're poised to do all that for the rest of the year.

Okay, that's great. That's very helpful. Thanks. And then just on the real estate solution segment, what's a good way to think about the run rate there? Like how much of that is transaction-dependent versus not?

Yeah, as I said, it's pretty transaction-dependent. If you think about the mix of businesses, We've got the proctoring business, which is a subscription business, so that's not as transaction-dependent, although people come in and out of that business, you know, depending on what's happening in the market. So that's less transaction-dependent. But the other businesses, appraisal, credit, you know, those are transaction-dependent. And so that was what you really saw in this quarter in some of those businesses transactions hit pretty hard. You know, we have had some pretty good success in the credit business with differentiating in the market. And I think in general, that business is doing well relative to the market. You know, we're a participant in the Fannie Appraisal Modernization Program, one of the 10 or so folks that were selected for that. So those are the kinds of things that will really help that business sort of be durable and better than some. you know, as the market improves. But that's a way to maybe think about the fits and takes. I'd say a good amount, you know, over half is transaction dependent. And then, you know, you've got some stuff that's less transaction dependent.

Okay, that's helpful. And then just the increase in that segment over last quarter, was that just sort of, you know, some of the acquisitions kicking in?

Well, we did have the small account check acquisition in the first quarter. We had a nominal benefit from that, but we did also have some customer wins, and so I think it was a combination of those. We have some good momentum in a couple of those businesses around products that actually help lenders save money in the mortgage process, and so we're actually getting a little bit of growth happening in a couple of those businesses right now.

Okay, great. Thanks a lot.

And we will take our next question from John Campbell with Stevens Inc. Please go ahead.

Hey, guys. Good morning.

Good morning. Hey, going back to the question, and this is for Fred or maybe David here, but Fred, you talked to the leverage potential in the model where you don't think you need to add much additional expense as the revenue rebuilds. Just trying to get a better grip on those incrementals. It would be helpful if you guys maybe provide the all-in fixed cost level as it stands right now, or if you're not able to provide that, maybe just talk broadly to the mix of fixed first variable costs now and maybe how you expect that to shift from here.

Well, obviously, you know, we have the strict fixed costs, right, that are in the 20% or 30% range. Yeah, sort of 20% to 30% fixed. Then you've got, you know, sort of the infamous, you know, 40% to 50% semi-variable. And then, you know, the 30% to 40% of true variable. And the challenge is always managing the semi-variable. Exactly. So what I would say, John, is that personnel-wise, right, If you're down 50% or you can't cut 50% of your resource personnel, right? And so you're going to be really careful about how you're managing your resource and protect the capabilities of the institution. So what I would say is that we've been very thoughtful and we've done a lot of actions, but the way I think about it is we have excess capacity in that semi-variable component that we've retained to take advantage of the market as it comes back. And so therefore what you see is, and it's Notorious in this business, right? On the way up, your marginal margin is higher, right? Because you're managing kind of that semi-variable to Dave's point in a fixed way, and that will increase. And then at some point, you hit an overtime like we did in 21. If you don't have resources, it really gets exaggerated as far as your margin. So, again, the way I look at it is that – You know, we're bouncing off the bottom here. We've done a very good job. I very applaud our team in being creative across the board and being thoughtful about expenses in every dimension. And as I look forward, that incremental revenue helps us tremendously on margins. I just think it's going to be a tad slower than we thought before. I think the second quarter is what you're seeing is, well, the tenure is down. That's spread wide. And the darn inventory has gone a little bit down. hesitant to go up, although I saw the week yesterday was a tad better. It was like October level. But it's kind of unfreezed over time, and I'm still pretty encouraged by the end of the year. The next quarter is a transition period. And again, I'll reiterate what I said. We were going to have 40% in order count in March, and we made some money. This company historically would have never been able to do that. This company, for 100 years, we never made money in the first quarter. So We have been fortunate enough to do that in the last three years, and you look at our portfolio and how we manage ourselves, and I think we have a lot of leverage on the way up here. We just got to keep managing ourselves carefully, right? It's a challenge market.

Makes sense. That's really good, Keller. I appreciate that. And then on commercial, obviously a lot of uncertainty out there. I think investor attention is really shifting towards commercial, obviously. If you guys can maybe talk to the order pipeline, what you guys are seeing.

I saw March, you know, the open orders are down 40%. Kind of what you're seeing if you've got any insights into April. And then if you could just talk broadly to the mix and the fee profile, maybe what you're expecting around fee profile. There's going to be continued pressures there as you close out in QQ. Go ahead, Dave. Yeah, John. I mean, I think what you're seeing in our book is not inconsistent with what you're seeing in the market generally. You've got, you know, offices obviously challenged, although some markets not as challenged as others. I think the major Metro offices tend to, the major metros tend to be a little more challenged, primarily because they have some more work from home. And so we haven't seen, like in New York and places like that, you know, the bigger transactions come back, and you're seeing that in the longer fee profile. I think as you get into some of the smaller markets, it's not as bad of a story on office, although there you have to, you know, see what's going to happen with all the regional banks because they've got a big credit provider to that sector. You know, we saw a lot of energy deals at the end of the year. I think there's still a lot of activity there, and we'll probably see, you know, some of those mature and close here over the coming year. And then, you know, it's sort of a mixed bag. I mean, you're seeing decent stuff in retail. Multifamily had been really strong. It's slipping a little bit, but generally stronger than the rest. And, you know, industrials backed off a little bit, right, because it just isn't as much activity as it was during the pandemic, but still generally strong. So, you know, I think it's the combination of those things and then what's happening in the capital markets and then people trying to adjust to cap rate changes and the like on valuation that's causing that slowing. The one, if there is a slightly positive thing, you know, deals are mainly getting pushed, not canceled. And so we just have to see how that all develops. And so hopefully as there's more clarity on valuation and capital and financing, those will actually close, right? And that will maybe result in a better outcome. But should that situation not change, then it will continue to be challenged. Yeah. So I don't think it's like the res market. Again, we're planning on it being down a little bit. We were fortunate enough to gain share last year in commercial. We've done some good progress. Our energy practice isn't as busy as it's ever been. It's a little bit choppy and lumpy because of when the closings are. So one of the interesting things we have is we have probably a higher portfolio in our centralized commercial of smaller deals And I think the uncertainty around the regional banks is a little bit of pause in some of that markets. And so there is a little bit, I think, kicking out of some of that. So we kind of think we're going to have this downturn is going to be real for a while. And then we'll see, I think, the back half of the year, some better results. But it's interesting to us. We are really busy in a couple of these segments, as busy as we've ever been. And so it's interesting. by the end of the year and toward the end of the year. But it is kind of a very uncertain. All this stuff going on with the banks this week, it makes all that stuff a little bit uncertain right now. But you also, John, have to think about it in the dimensions. It's not only sector-specific, but it's type of activity. So, you know, new developments, sales, and then refinances, right? And you do have that $1.5 trillion maturity ladder mainly this year and next year, that's going to provide some support to commercial. And then it's just a question of what happens with that, right? Do you have a lot of restructuring? Do you have some defaults? As it looks like now with all the REITs and everybody reporting, even though people might be increasing reserves, a lot of those loans are still performance, right, which would which could be positive because it might mean you could actually refinance those and have to restructure the fall. Yeah, that's super helpful.

That's great insights. I appreciate that, guys. Last one for me, just kind of a housekeeping question, but David, on the other orders, I know M&A is certainly influencing that, but you've had a pretty big step up there. If you could maybe talk to the seasonality of those other orders as well as what that kind of average fee profile is.

A lot of those primarily are reverse basis through FNC. And, yeah, I mean, that's going to approximate more. Not exactly because the transactions are a little bit smaller, but it's going to be closer to a purchase transaction than a refinance transaction. Okay. And that's from a fee-for-file standpoint and seasonality standpoint? Well, it's not as seasonal, right, because you can do that. If you have equity in your home, it's more a function of getting a hold of a customer and closing the loan. So it's not as seasonal. In markets like this where you have a lot of built-in equity, it's actually a good market. It's just that market's been changing a lot with some of the originators being sold, repositioned, that kind of thing. You've also got new originators coming in So I think it's more a function on the volume side of what's happening with the originators than it is the opportunity from an equity and an age perspective.

Okay.

Makes sense. Thanks, guys. Thanks, John.

And just as a reminder, to ask a question, that is star and one on your touchstone phone. We will take our next question from Jeffrey Dunn with Dowling & Partners. Please go ahead.

Good morning, Jeff. Thanks. Good morning. So I'm not sure if I'm going to ask this right, but from a commercial market, obviously, we're going through a big downturn cycle here. But with what's going on with office space, do you have concerns that there's any kind of secular shift happening? And I ask that more because of your mention about investing in commercial talent. Is your commercial talent, for example, focused on certain sectors, and you could have made an investment in somebody who specialized in office, and now that's not necessarily the right investment? Is that something we have to worry about if office doesn't come back, or is your commercial talent more flexible across the various sectors that you cite? It's a good question because it is actually more flexible.

For us, it's very geographical. One of the things that this company was historically is we were very skewed to New York on a commercial side, and we didn't have the breadth geographically. And so it actually is diversifying away from office in some ways or office-like developments. And so I feel really good about it. In fact, we did some energy-focused acquisition because it's kind of one of our underwriting capabilities. It's obviously because of what's happening. There's some opportunity there. But it's been very much geographic. And obviously, there's some obvious places. whether it's industrial or the warehouse or the data center. There's some natural places that we focused on, given what the trends were. And so I feel pretty good about what we've done. I would say the way I think about it, we primarily were very weak in certain geographies in our coverage and growth markets that were important to cover, and that's how we thought about it. So I'm I actually think we're pretty darn well positioned. I mean, the obvious thing since the pandemic, everybody expected it. I mean, again, this isn't something new. And the other thing, the secondary city versus the primary city, in my view, was also something that kind of you kind of knew and you anticipated as you thought about staffing and approach. But one of the interesting things about us is we've always had a great reputation from an underlying point of view. The issue is because of our uncertainty of being for sale, quote, unquote, three years ago and And the notion of our capital, we had a lot less capital back then. We weren't a relevant third player. We were relevant, but we were less relevant, is a better way to say it. We're now very relevant. The question is, do we have the right capabilities and the right markets to attack the business? And by the way, I would also say that's true in the direct offices at the low end of commercial, where we didn't have as many people dedicated to that segment as we need to have and will have going forward, because that's going to be a vibrant segment for most businesses. It's still the most powerful thing. So, again, I think we've been thoughtful about this. I'm not worried about necessarily the office thing. Or even the retail has been held up a little bit more than we expected. Retail was the other one that I think everybody anticipated was, you know, you weren't going to go long into retail. And so we were pretty thoughtful about how we thought about adding these sources.

All right. You've mentioned a few times balancing expense management with longer-term investments, but how long can you sustain that balance? You could paint a scenario that maybe mortgage rates start loosening up, but if the consumer starts running into economic pressure, the estimates for reginations this year and next year could still prove optimistic, and it looks like the spring selling season is starting off soft. At what point do you have to start cutting muscle, or do you just kind of bear down and endure it?

Yeah. I feel like, again, I do feel like we're bouncing off the bottom. That's a great question. So a couple things I'll refer to. I have about $18 to $20 million that I identify as discretionary investments in long-term stuff for the year. That's about five quarters. So I could have made a little bit of money this quarter or close, you know. And those are kind of the data management stuff we're doing. We're doing some kind of work on kind of centralization, and we've got some stuff we're doing on balancing where we do our search work and the cost of delivery of search work. And if I look at those initiatives, it would give you probably a couple, you know, I believe a couple hundred basis points of improvement and margin over the next 18 to 24 months. And they're discretionary. But we're well into the right thing to do. In some case, you could characterize them as we're catching up to our competition. And that's what I was referring to, those discretionary. There's another way to think about it, which is we've taken as much weak action as anybody that we compete against. The issue, in my view, is that I don't think there's a lot of great alternatives to go further. So I think there's always good hygiene, yes, and as things shift and it's commercial, it gets weaker than it was. You know, there's some things we could do on a targeted basis. But we've done kind of what I feel is appropriate, and it would be muscle. You know, so I think we went a lot further down. Again, if the market's going to be down 50% continuously, you've got to rethink that. The whole industry's going to have to think that. So I don't – again, we're a little weak because of the seasonality of us, more so than others. But we, I think we manage our expenses well. I think we're in a good place to actually have increasing margin through the rest of the year. So I feel okay with that. The other point I would make is I mentioned in the last call, one place I feel like we just haven't done enough yet is our interest income on escrow. And when we first started the journey, We looked at getting a bank, and as we go, short money was like a quarter of a point, so nobody was interested in deposits. We are working hard at creating partnerships with a couple of banks to make sure that we're extracting on our couple billion dollars in escrow some interest return, which again changes our margin at this level of volume. And so I think we can get that done by the end of the year, and it kind of helps our profile relatively materially. And so there's this That's the one lever kind of I believe we need to aggressively act on that we have. As far as the portfolio stuff, one of the other questions today was our data business has been growing, and that's a more stable learning to the low volume like this. And so I think we're doing some things on the offensive side that will enhance our margins if the market stays at this level. So I actually think in most all scenarios, we're going to enhance margins. So I feel pretty good about where we are. But, again, it's something we work at pretty hard. And I wanted to mention the 20 because it's an explicit decision we made. I think it's the right decision. I think the IRR on that is going to be tremendous because if it's improved, you know, I think somebody asked about a previous call. The problem with that improvement is if you don't have volume, you don't get the full benefit of those improvements in efficiency. But we'll get to a level of volume soon here that those will be more transparent. So I feel that they want to make it.

All right, thanks. That's a really good caller. Thank you.

And it appears that there are no further questions at this time. I'll turn the call back over to the management for closing remarks.

I want to thank everybody for joining us for this quarter's call. Thank you so much for your attention.

Thank you for your participation.