First American Financial Corp
NYSE:FAF
Earnings Call Analysis
Q3-2023 Analysis
First American Financial Corp
In an environment where interest rates are at historic highs, leading to reduced home sales reminiscent of levels seen during the financial crisis, the company has shown resilience by maintaining expense management and bolstering net investment income. They achieved a pre-tax title margin of 12% (adjusted), resulting in adjusted earnings of $1.22 per diluted share. While the refinance market remains stagnant, the company has observed a slight uptick in residential purchase business, offering a glimmer of hope that the market has reached a stable point. However, commercial revenue suffered a 39% decline, posing ongoing uncertainty despite expectations of a seasonal fourth-quarter uptick.
Despite registering a loss of $0.02 per diluted share mainly due to unrealized losses in the venture portfolio and equity securities, the company's adjusted earnings stood resilient at $1.22 per diluted share. Revenue in their title segment dropped 19% year-over-year, with commercial and refinance revenues facing significant declines due to market readjustments. On a positive note, investment income saw a 35% increase, thanks to rising interest rates benefiting the company's cash and investment portfolio. While they maintain a cautious stance on expense management, they also highlighted a lower provision for policy losses and claims, adjusting their loss provision rate to 3%. Furthermore, strategic initiatives focused on long-term growth, though currently loss-making, have started showing improved margins. A robust home warranty business also contributed to their financial strength, demonstrating enhanced control over claims and seizing opportunities within the direct-to-consumer channel.
The company prides itself on an outsized market share in the New Home segment and is exploring efficiencies through technology such as Endpoint, which could transform the role of escrow officers and customer service. They anticipate a moderate decrease in investment income for the fourth quarter due to the loss of Home Point loans, but expect this to be partially offset by lower interest expenses. Moreover, they plan to continue investing in innovative solutions, with a reduction in the loss provision rate signaling a conservative but adaptable approach to reserving. The company remains cautious yet optimistic about the commercial market, identifying potential in asset classes where price resets have already occurred, such as multifamily and suburban office locations.
The management conveys confidence in their current debt leverage position, with a debt-to-capital ratio of 23.5%, slightly above their long-term target of 18-20%. This comfort is backed by their strong balance sheet, including $1 billion of AOCI, which is expected to bolster their debt-to-capital situation over time. Even in a challenging market, the company hasn't noticed any significant disruption in residential purchase orders, thanks in part to the normal seasonal patterns. As they prepare to enter new markets with their instant decisioning technology, the future looks cautiously optimistic. The company aims to navigate towards 2024 with prudent financial management and a focus on strategic growth areas, despite the cautious outlook and the unpredictable macroeconomic climate.
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Greetings, and welcome to the First American Financial Corporation third quarter earnings conference call. [Operator Instructions] A copy of today's press release is available on First American's website at www.firstam.com/investor. Please note that the call is being recorded and will be available for replay from the company's investor website and for a short time by dialing (877) 660-6853 or (201) 612-7415 and enter the conference ID 13741673. We will now turn the call over to Craig Barberio, Vice President, Investor Relations, to make an introductory statement.
Good morning, everyone, and welcome to First American's Earnings Conference Call for the Third Quarter of 2023. Joining us today on the call will be our Chief Executive Officer, Ken DeGiorgio; and Mark Seaton, Executive Vice President and Chief Financial Officer.
Some of the statements made today may contain forward-looking statements that do not reflect -- or relate to strictly to historical or current fact. 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 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 with and reconciliation to the most directly comparable GAAP financials, please refer to this morning's earnings release which is available on our website at www.firstam.com.
I would now like to turn the call over to Ken DeGiorgio.
Thank you, Craig. The rapid increase in interest rates to levels not seen in many years, continues to produce challenging market conditions. With housing affordability currently at its lowest point in over 3 decades, existing home sales this year have declined to the slowest annual pace since the global financial crisis. Moreover, sales volumes in the commercial market have reverted to pandemic load levels and are down approximately 50% from each year of 2021.
Despite these historically difficult conditions, our continued focus on expense management and strong growth in net investment income enabled us to deliver a pretax title margin of 12% on an adjusted basis. On a consolidated basis, we generated adjusted earnings of $1.22 per diluted share. our residential purchase business
[Audio Gap] 3 weeks in October, open purchase orders are down 7% compared with September, which is consistent with normal seasonality, but are up slightly compared with the prior year. While this performance is mostly driven by a historically low comparison period, it also reflects the results of our industry-leading homebuilder division and is further indication that the market has stabilized.
Refinance open orders remained at trough levels in the third quarter, averaging
[Audio Gap] significant uplift in refinance in the foreseeable future. Our commercial business revenue declined 39% compared with last year, consistent with the first half of the year. Average revenue per order also declined again this quarter for the fifth consecutive quarter, which suggests that price discovery is well underway as the market corrects. Commercial open orders for the first 3 weeks of October are down 5% compared with last year and are down 3% sequentially. There is still a high degree of uncertainty concerning the commercial market. However, based on our market intelligence, we continue to expect higher commercial revenues in the fourth quarter, which is consistent with the normal seasonal pattern.
While our key purchase commercial and refinance markets appear to have troughed, we expect the difficult market conditions to persist well into next year. Despite the uncertainty of the timing of a recovery in these markets, the strength of our business, along with our financial discipline and strong balance sheet allow us to continue to invest for long-term growth while returning capital to our shareholders. This quarter, we raised our common stock dividend by 2% to an annual rate of $2.12 per share
[Audio Gap] already purchasing an additional $9 million of our common shares.
In closing, given the importance of people to our business, I am pleased that First American has been named 1 of the best workplaces for women by Great Place to Work and Fortune Magazine for the eighth consecutive year. This accomplishment is a tribute to our workforce, approximately 2/3 of which are women. I'm proud that First American's commitment
[Audio Gap] Now I'd like to turn the call over to Mark for more detail
[Audio Gap]
[Audio Gap] Our adjusted earnings per share was $1.22. Our adjusted earnings exclude net investment losses of $164 million, primarily due to unrealized losses recognized in the venture portfolio and changes in the fair market value of equity securities as well as purchase related intangible amortization of $10 million. As of September 30, the book value of our venture portfolio totaled $301 million, which equates to approximately 7% of our equity and 2% of our total assets. Revenue in our Title segment was $1.5 billion, down 19% compared with the same quarter of 2022. Commercial revenue was $160 million, a 39% decline over last year. Our average revenue per order for Commercial transactions declined 15% this quarter to $10,763 due to a combination of fewer large transactions and lower valuations as prices in the commercial market reset. Purchase revenue was down 15% during the quarter, driven by an 18% decrease in the number of orders closed, partially offset by a 3% increase in the average revenue per order. Refinance revenue declined 41% relative to last year due to the increase in mortgage rates.
In the Agency business, revenue was $665 million, down 27% from last year. Given the reporting lag in agent revenues of approximately one quarter, these results reflect remittances related to Q2 economic activity. Our information and other revenues were $240 million, down 14% relative to last year. This decline was the result of lower transaction levels across several business units driven by the company's data and property information products and post close and document generation services.
Investment income within the Title Insurance and Services segment was $142 million, a 35% increase relative to the prior year. The increase was primarily due to rising interest rates, which drove higher investment income from the company's cash and investment portfolio, escrow balances and tax-deferred property exchange balances. The impact of higher interest rates was partially offset by lower average balances, primarily in the company's and tax deferred exchange balances.
We continue to manage expenses given the decline in transaction activity. Our success ratio was 50%, meaning that our personnel and other operating expenses declined $127 million, and our net operating revenue declined $253 million. The provision for policy losses and other claims was $35 million in the quarter or 3.0% of Title premiums and escrow fees, down from the 4.0% loss provision rate in the prior year and down from the 3.5% loss provision rate in the first half of this year. The 3.0% loss rate reflects an ultimate loss rate of 3.75% for the current year with a $9 million release for prior policy years.
Over the last several quarters, we have highlighted the margin drag in the Title segment related to 3 strategic initiatives: ServiceMac, endpoint and instant decision for purchase transactions. This quarter, these initiatives together generated a pretax loss of $12 million, impacting our pretax title margin by 110 basis points, an improvement from the 130 basis point drag in Q2, primarily driven by deep boarding fees received by ServiceMac. Pretax margin in the Title segment was 10.5% or 12.6% on an adjusted basis.
Total revenue in our home warranty business totaled $108 million, a 3% increase compared with last year. Pretax income in home warranty was $9.4 million, up 124% from the prior year. The loss ratio in home warranty was 55%, down from 59% in 2022, driven by lower frequency and severity of claims. The effective tax rate for the quarter was 29.4%, higher than our normalized rate of 24%, due primarily to the mix of income between our insurance and noninsurance businesses since our insurance business generally pays state premium tax in lieu of income taxes.
In the third quarter, we repurchased 161,000 shares for a total of $9 million at an average price of $57.87. So far in October, we have ramped up our purchases buying
[Audio Gap] it was 29.7%. Excluding secured financings payable, our debt-to-capital ratio was 23.5%.
Now I would like to turn the call back over to the operator to take your questions.
[Operator Instructions] Our first question comes from the line of John Campbell with Stephens.
I just want to I heard you correctly on the order commentary for October. You said that purchase is trending up year-over-year thus far in October?
Yes. So purchases, it's up slightly for the first 3 weeks in October, very slightly. And a lot of it is driven because included within the purchase transactions is resale, which is most of them. And we also have new homes and new homes is performing pretty well. So when you mix those 2 together, yes, we do have a slight increase in purchase, which is nice to see the lines cross here.
Yes, absolutely. I mean just given the backdrop of continued upward pressure on rates, that's a great outcome. New home sales, I think, maybe a little bit less than 10% of the national mix. What does that look like for you guys a little bit higher?
It's a little bit higher. Historically, the long-term average is about 13% of our purchase orders are home related. So far in October, they're 19%, a little overweight. So that's -- our mix is a little bit higher than the average. [Audio Gap] That's really primarily the interest expense that we pay on our bonds. We also have
[Audio Gap] interest expense, too. So those are the 2 components that make up our the $23.5 million of interest expense we had in the
[Audio Gap]
Our next question comes from the line of Soham Bhonsle with BTIG.
I guess the first one, just on investment -- on the interest income. Can you just, Mark, maybe update us on the year here? And then just maybe help us size what needs to be replaced from sort of the roll-off in ServiceMac? And how quickly you'd be able to sort of do that?
Yes. Thanks for the question, Soham. So in terms of the year, I mean, we're -- obviously, we're 3 quarters done. When we look at Q4, we think based on what we're seeing now, investment income should dip a little bit in Q4, a few million -- $5 million-ish, let's say, plus or minus. And most of that is just driven by the fact that we did lose these Home Point loans, which we've talked about for a couple of quarters. And in the last 30 days or so, we've lost about $300 million of deposits related to that, which was really earning, let's call it, Fed funds. So that's kind of the headwind that we're going to see in the fourth quarter in terms of our investment income. I will say that about 75% of that, though, is going to be a reduction in interest expense in the Title segment too. So it's not all fall to the bottom line, but about 25% of it will.
You could potentially get some efficiency gains, but then there's also sort of this enabling of better customer service. I was hoping you could maybe dig a little bit deeper on the efficiency piece of the value proposition. What sort of efficiencies do you sort of envision? And how does that maybe translate to margins versus, call it, the legacy title business?
Yes. Thanks for the question. I mean I think it's early days to exactly measure the efficiencies. But we anticipate sort of increasing the efficiency of an escrow officer fairly substantially. Again, it's hard to put a number on that at this point. But we know there will be efficiency gains as we automate some of the more mundane and tasks that an escrow officer does and freeze them up to do the more intensive and people-intensive task. And there's also other sort of efficiencies that we'll gain -- and we have already started gaining from endpoint just by deploying some of their technology in other parts of our company. We've mentioned in the past about JOT, which is our mobile notary management systems. We relied on third parties for that in the past.
[Audio Gap] it will probably be fully rolled out in the direct division sometime next year.
Okay. And just one more, Mark. I think on the loss provision rate, I guess, you lowered 25 basis points. But as we sort of go into next year and we potentially are in a more sort of uneven macro environment, right, . [Audio Gap]
I'll start on that. And yes, we did lower the loss rate. And one thing I'll point out, as you recall during the pandemic, we actually took the rate up which I think reflects our pretty conservative approach when it comes to building our reserves. The concerns we had when we did that in the pandemic didn't come to fruition. Some of the
[Audio Gap] And I want to emphasize the upper bounds of reasonableness. I think more directly to your question, I think you could probably expect this rate
[Audio Gap]
[Operator Instructions] Our next question comes from the line of Bose George with KBW.
To your first question, just on the deboarding fees from ServiceMac, how much was that this quarter? And is there more of that to come before that fully rolls off?
Yes. Bose, so this quarter, we had a $3 million benefit because of deboarding fees. And roughly about 40% of the loans were deordered. So we have another, call it, 60% to come at some point next year. We're not exactly . [Audio Gap] Could we see the cadence of the buybacks pick up? And just also from a leverage standpoint, what is that. [Audio Gap] Bose, obviously, as we talked about earlier, we've accelerated the pace of buybacks. We've already in October bought back shares at the same pace we did in the entire third quarter. And right now, I think our stock is attractive. We've accelerated repurchases, and we think it's very attractive. But obviously, we repurchase against other uses of capital, such as reinvesting in the business and M&A. But we're obviously [Audio Gap]
buybacks right now are pretty attractive alternative. And Bose, I'll just comment on the debt leverage part of that question. [Audio Gap] 25% this quarter. We've talked about like 18% to 20% being our long-term target. But we're very comfortable
[Audio Gap] million of AOCI and we feel really great about the
[Audio Gap] third parties. Does it make a difference on the return? Or are you kind of agnostic in terms of that? Or could you sort of increase one of the. [Audio Gap] is that we'll typically earn Fed funds. When we invested at the bank, our cash that's at the bank will earn Fed funds. And then the rest of it, most of the escrow deposits we push on the bank, we buy mortgage-backed securities. And so we're really getting kind of a mortgage-backed security rate as opposed to Fed funds. And sometimes that could be higher and some times that could be lower. And Fed funds right now is lower just because of the fact that rates have risen.
Our next question comes from the line of Geoffrey Dunn with Dowling & Partners.
I'm hoping you could talk a bit about commercial market. In particular, where are the large deals down the most? I'm assuming it's office, but I'm interested in a little more color. And more importantly, where are the areas that you're seeing opportunity versus drag outside the office market?
Well, a couple of things I'd say. First of all, when you just look at the large deals, we had 4 what we call mega deals with premium over $1 million this quarter. And a year ago, it was 7. We're not seeing the same level of large deals. The large deals that we are seeing are really half of them are multifamily. We had another one that was just a development site. But generally speaking, I would say the large deals are -- we're just -- at least, just not there this quarter. In terms of our top asset classes like where we see in business, multifamily is 22% of our commercial revenue. So we're seeing a lot of activity there. Industrial has always been strong even through the pandemic. It's 17% of our revenue. And then development sites, which is for these greenfield sites at 16%. So those are our top 3. Retail is 10%. Office, you mentioned that, Geoff, office is 5%. So that gives you a little bit more flavor in terms of our revenue. Now that doesn't all add up to 100, there's other asset classes we got add. We've got energy, hospitality, but I referenced the big ones.
The thing I would add too, Geoff, in terms of sort of the outlook going forward on asset classes, I think probably the more attractive ones are going to be the ones where we've already seen the most price discovery like suburban office and multifamily and energy is also probably going to be a big asset class for us. And then thinking back on multifamily and when I say suburban office, it's going to be anything that's going to be outside of the big CBD areas. You're just not going to -- the central business districts are under strain right now for obvious reasons.
Great. So as you look out to '24, your commentary is cautious in your press release. What is your #1 concern? Is it commercial? Is it direct resi? What one is more uncertain at this point in your mind?
Well, I mean I'm uncertain and concerned about all of them, except refi, I know that's not going to get better. So I think there's concern in all of them. I think if you have forced me to way the two, I'm probably a little more optimistic about Commercial, just because I feel like we're making our way through this price discovery. And I think we anticipate [Audio Gap]
we'll see more orders, but they'll be at lower prices given the price discovery.
[Audio Gap] beginning the middle of next year. Now the forward curve is historically inaccurate. But if that comes to fruition, that will help.
[Audio Gap]
Our next question comes from the line of Mark Hughes with Truist Securities.
[Audio Gap]
Impact in the purchase market [Audio Gap]
No, we haven't seen it, Mark. And it's been a little surprising because when you look at the -- when you look at our purchase orders,
[Audio Gap] almost. Well, we see the immediate impact on or on contracts and DTC, though it takes some time for profitability to be realized. I think the story with the home warranty is that they've done a really good job of managing claims in [Audio Gap] And then we're realizing more and more of the time goes on
[Audio Gap] market on a test basis at the beginning of next year. So they're hitting their milestones and we're real positive about that
[Audio Gap] anyone. And so it's
[Audio Gap]