First American Financial Corp
NYSE:FAF
Earnings Call Analysis
Q4-2023 Analysis
First American Financial Corp
The company showcased its commitment to returning value to shareholders by repurchasing 329,000 shares in the fourth quarter, a total investment of $18 million, which reflects confidence in the perceived value of the company with shares bought at an average price of $53.85.
Financial health is indicated by a relatively modest debt-to-capital ratio of 28.6%, and an even more conservative figure of 22.3% when excluding secured financings payable. This suggests the company is not overly reliant on debt to finance its operations, which can be a positive sign for future stability.
The company anticipates modest growth in its core business for the upcoming year. It's predicted that the booked loss rate of 3% is sustainable and margins are expected to remain robust, with double-digit figures in line with the previous year. This projection, however, takes into account potential challenges such as reduced investment income in the event of interest rate cuts by the Federal Reserve, estimated to lower annualized investment income by $15 million each time rates are reduced.
Escrow balances, which tend to track the commercial business trajectory, are projected to see a modest uptick in 2024.
The company is facing margin pressures, specifically a 130 basis point drag, due to investments in Endpoint and instant decision-making solutions. Improvements are expected throughout the year, but the impact on margins is projected to decline, though it will still be present by year-end.
Capital expenditures are slated to decrease by 10-15% from the previous year's $263 million, signaling efficiency improvements and the completion of certain projects. The company is hiring more in-house engineers, reducing the reliance on third-party services, and thereby achieving cost savings.
In a hopeful sign of progress, the company reports that deposits for agent banking grew from $110 million at the start of the year to $271 million by year-end. Although these figures represent a small fraction of the overall $6 billion deposit base, the strong growth trajectory highlights potential in the agent banking sector.
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Greetings, and welcome to the First American Financial Corporation Fourth Quarter and Full Year 2023 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 13743995. 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 Fourth Quarter and Year-End Earnings Conference Call for the year 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 relate 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 and 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 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 with 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 DeGiorgio.
Thank you, Craig. We were performing well in a challenging market ahead of the cybersecurity incident that occurred in late December.
As previously disclosed, we elected to take systems off-line while we assessed and remediated the situation. The incidents materially impacted the company's operations and consequently, our fourth quarter financial results. Our title orders and related product demand appear to have returned to normal levels, however, and we do not expect any significant ongoing impact from the incident.
Looking to 2024, we expect challenging market conditions to persist. Housing affordability and lack of inventory will remain headwinds for our purchase business. Refinance activity will also remain subdued given that most existing mortgages carry interest rates under 5%. Transactions in the commercial market should increase albeit at lower prices as price discovery continues. While we expect to see modest revenue growth in both our residential and commercial businesses this year, this could change depending on the path of mortgage rates.
Turning to order trends in our key markets. Purchase open orders in January are up 6% compared with last year. Refinance open orders in January averaged over 300 per day, consistent with trough levels experienced throughout 2023. Commercial open orders for January are up 7% compared with last year. While some of these orders spilled over from December, these trends support our assessment that the cybersecurity incident will not have a significant ongoing impact on our business.
Despite the uncertainty of the timing of a sustained recovery in our key 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. We remain active in our share repurchase program, repurchasing $18 million of our shares in the fourth quarter for a total of $73 million for the full year at an average price of $55.18 per share.
In closing, I want to acknowledge the significant support provided by our agents and customers, and other industry participants during our cybersecurity incident. I also appreciate the patience our customers demonstrated as we work through the process of returning to normal operations. In addition, we have consistently highlighted the importance of our people to the success of our business. The incredible dedication and resilience they demonstrated in response to the cybersecurity incident underscores this principle. I gradually appreciate their tireless efforts to serve our customers and restore our systems. 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 earnings of $0.33 per diluted share. Our adjusted earnings per share, which excludes the impact of net investment losses and purchase-related amortization was $0.69. These results include tax benefits of $5 million or $0.05 per share, primarily due to research and development tax credits we claimed.
As previously disclosed, our earnings this quarter were materially impacted by the cybersecurity incident. However, the exact impact the incident had on our results is unknowable. In our title segment, revenue from certain transactions were transitioned to other providers, while others were delayed into 2024.
On December 18, prior to our systems being taken offline, we produced an internal forecast estimating our adjusted EPS to be $1 per share. This forecast includes our actual results for October and November are forecast for December and a tax rate of 24%. Our actual adjusted EPS was $0.69, including the $0.05 tax benefit implying a $0.36 shortfall relative to our internal estimate. Although we believe most of this difference is related to the cyber incident. As I mentioned, the exact impact the incident had on our fourth quarter results is unknowable. Included in this $0.36 shortfall was $11 million of direct expenses related to the incident in our corporate segment. It is too early to tell how much of this shortfall will be recouped in the first quarter or how much will ultimately be covered by our insurance program. We do not believe the incident will have a significant impact on the company's outlook for 2024 Turning to our title segment. Revenue was $1.3 billion, down 18% compared with the same quarter of 2022. Commercial revenue was $172 million, a 32% decline over last year. Our average revenue per order for commercial transactions declined 20% this quarter to $11,000 due to a combination of fewer large transactions and lower valuations as prices in the commercial markets soften. Purchase revenue was down 11% during the quarter, driven by a 14% decrease in the number of orders closed, partially offset by a 4% increase in the average revenue per order. Refinance revenue declined 32% relative to last year. Although mortgage rates have fallen 100 basis points from the recent highs, there are still levels materially above what is needed to generate a significant rise in refinancing activity.
In the Agency business, revenue was $570 million, down 24% from last year. Given the reporting lag in agent revenues of approximately 1 quarter, these results reflect remittances related to Q3 economic activity. Our information and other revenues were $211 million, down 12% relative to last year. This decline was primarily due to reduced demand for the company data and property information products in our direct title business.
Investment income within the Title Insurance and Services segment was $132 million, unchanged relative to the prior year as higher interest rates were offset by lower escrow balances. For the full year of 2023, we saw our investment income surged 50% as the Fed raised rates 4 times. Now as the Fed prepares to lower rates, we estimate that for each 25 basis point decline in the Fed funds rate, our annualized investment income will decline $15 million but the ultimate amount will fluctuate depending on the level of cash and escrow balances.
The provision for policy losses and other claims was $30 million in the fourth quarter or 3.0% of title premiums and escrow fees, down from the 4.0% loss provision rate in the prior year. The 3.0% loss rate reflects an ultimate loss rate of 3.75% for the current year with an $8 million release for prior policy years. Over the last several quarters, we have highlighted the margin drag in the title segment related to three strategic initiatives: ServiceMac, Endpoint and instant decisioning for purchase transactions. We have seen significant earnings improvement in ServiceMac since we acquired the company in October of 2021. And this quarter, the pretax margin of ServiceMac was in line with our overall Title segment results and no longer margin drag. Therefore, we are removing ServiceMac from our commentary and only including Endpoint and instant decision for purchase transactions. Together, these two strategic initiatives reduced our pretax margin in the title segment by 130 basis points.
Pretax margin in the title segment was 4.5% or 7.5% on an adjusted basis. Total revenue in our home warranty business totaled $99 million, a 9% decline compared with last year. In 2022, we recognized a favorable deferred revenue adjustment of $8 million. Excluding this adjustment, revenue in our home warranty business will be flat relative to last year. Pretax income in home warranty was $15 million, down 6% from the prior year. The loss ratio in home warranty was 44%, down from 47% in 2022, driven by lower frequency and severity of claims. Adjusted pretax margins in the home warranty segment was 19.9%, up from 18.8% in 2022. The effective tax rate for the quarter was 10.7%. Lower than our normalized tax rate of 24% due primarily to research and development tax credits we recognized during the quarter.
In the fourth quarter, we repurchased 329,000 shares for a total of $18 million at an average price of $53.85. Our debt-to-capital ratio as of December 31 was 28.6%, excluding secured financings payable, our debt-to-capital ratio was 22.3%.
Now I would like to turn the call back over to the operator to take your questions.
We will now be conducting the question-and-answer session. [Operator Instructions] Our first question comes from Bose George with KBW.
In terms of your margin expectation for 2024, if the MBA is right, we have a modest improvement in purchase. And as you noted, commercial gets a little better. NII maybe a little bit worse. Like where do you think everything kind of shakes out in terms of your margin in '24 versus '23?
Thanks for the question, Bose. There's a lot of factors, obviously. I mean the good news is we do feel like there'll be modest growth in our core business, and we talk about commercial and purchase, perhaps maybe not quite as much as the MBA suggesting, but we do feel like we'll have some modest growth. We also feel like our 3% loss rate that we booked this quarter is sustainable from what we can see now. So that should be a little bit of a tailwind.
The downside for next year is if defense starts to lower rates, that's going to have an impact on our investment income. I just talked to my script here, how we're going to lose $15 million of annualized investment and every time the Fed lowers rates. So we'll have to see how that plays out. But that would be a headwind. But right now, as we look at everything, we feel like our margins in '24 are going to be very similar to what they were in 2023, we had double-digit margin this year. We feel like we can hit double-digit margins in '24 as well.
Okay, great. That's helpful. And then actually, I just wanted to ask the cash balance went up a lot in the quarter. What was driving that?
It was really a function of the incidents. We had a lot of cash at our bank. Typically, we wouldn't hold that much cash. We would push it out to third-party banks, but it was incident-related and we just held a lot of cash in our bank because we just didn't quite have the ability to push it out to third-party banks that we typically do with that time of year.
Okay. Great. And then actually one more on NII. Do you think the balances will be -- escrow will be roughly flat year-over-year? And any reason to think it will be different?
Well, I would say we think that balance is -- they really track our commercial business. So I would say that they should be up modestly in 2024 at roughly about 60% of our escrow balances are commercial related. So they're really going to track commercial. So we think commercial is going to have a modest improvement we should have modest improvement in our escrow balances as well.
Our next question comes from Terry Ma with Barclays.
So on the 130 basis point margin drag from Endpoint and instant decision, is there any color you can provide on how that kind of trends throughout the year. I think with ServiceMac, it had kind of been abating by about 20 basis points a quarter.
We think it's going to improve throughout the year. Our endpoint results have improved, and we think they're going to get better and better. We've been talking about instant decisioning for purchase transactions for a few quarters now. And those expenses, we feel like are going to ramp up this year as we roll out that. And so I think it will improve a little bit, but it will still be a drag even as we get to the end of the year, but probably less than 130 basis points we're experiencing that.
Okay. Got it. And then on the investment income. Is there, I guess, any more color you can provide just based on where the forward curve is right now?
Well, when we checked yesterday, the forward curve, I think, had 5 rate decreases. One of those would be in December, which wouldn't really have an effect on us. And so I would just -- I mean, the guidance that we look at internally, again is every time the Fed cuts, we're going to lose $15 million of investment come in our title segment. And so if the Fed is going to cut 5x, more of those again in December, which wouldn't really have an effect on investment income we'd lose $60 million of annualized investment income. That wouldn't all hit, obviously, next year, but you can sort of model that out given the guidance we've provided.
Our next question comes from Soham Bhonsle with BTIG.
Just a follow-up on the margin. I guess you talked through some of the puts and takes here. But, is there any additional CapEx that we should be thinking about to maybe shore up any of your systems with the cyber incident or any sort of investment that you would have to make this year that we should be thinking about?
I would just say that we're -- in terms of CapEx specifically, our CapEx is going to come down next year. So in 2023, we had $263 million of CapEx and it will come down somewhere between 10% and 15% next year. Some of that is because we've finished some projects that we no longer need. Other parts of the decline is just because we feel like we can do things more efficiently than we have in the past. We're hiring a lot of engineers to do work for us as opposed to using more third parties, which is saving us on CapEx. So CapEx is going to come down next year, somewhere around 10% to 15%. And that's despite some, I'd say, enhancements we need to make to our information security program, but it's not going to have a material impact on our earnings or CapEx next year.
Got it. Okay. And then can I just get sort of an update on the roll off of your subservicing assets here? How should we think about that impacting the investment income line potentially through the year?
So we've talked about in the past, these home point loans, it's unclear exactly when the home point loans would leave. Right now, our expectation is that they will be somewhere in mid-year. But one thing I would say is that, again, is not going to have a material impact, certainly to our investment income because we generate investment income from those loans. But we also pay out interest expense in those loans. So even if we lost them, it's not going to have -- you'll see fluctuations for interest income and interest expense. But from a pretax perspective, it's not going to be significant at all. But to answer your question, right now, the expectation is we hold on to those midyear, but that could change depending on circumstances.
Got it. And then just last one. I think Mark, you guys have talked about, look, the $15 million is better than the $20 million historically because you're trying to sort of bring folks to the bank and maybe bank with you guys. I guess I was wondering, have you seen any sort of discernible movement in agent behavior in a market like New York, where you're sort of hearing just likes of NYCB and these folks having some issues. Are you seeing some of that business come to you or any sort of other banks in that market specifically?
You're talking about like deposits for our agent banking industry.
Yes.
We haven't seen a big influx in deposits because of the issues you're referring to here. But I would just say that long term, we are real positive on agent banking. When we started in January of '23, we had basically $110 million of deposits for agent banking. At the end of the year, we had $271 million of deposits. So we're growing it really nicely. It's just from a very small base, right? On a bank deposit base of $6 billion, I mean, $270 million is material, but we're very optimistic about the growth. We feel like we've got a good product market fit, we just need a little bit more time to execute. So we're very optimistic, but the growth that we're seeing isn't because of any troubles of any other bank, it's mostly because we can provide a really efficient product and service to our agent banking clients.
[Operator Instructions] Our next question comes from Mark Hughes with Truist Securities.
Any thoughts on the capital management outlook for 2024?
Capital management, there's a couple of different components we think about it. One is M&A. And I would just say that we would have thought the acquisition pipeline would have been a little bit more robust when the market fell. And it really hasn't, as we've talked about on these calls. But we feel like the longer this kind of market malaise lasts, the more M&A opportunities will be. So that will always be something we look at in terms of the buyback, I mean, we've been very active in the buyback the last 2 or 3 years, and that's always something that we'll look at.
At the end of the day, if we've got excess capital, we feel like stock is undervalued and we don't have better uses for the capital, we'll buy it back. And so that's always something we'll continue to evaluate. And then of course, the dividend. We're not committed to raising dividend every year come hell or high water, but we pretty much have raised the dividend, and that's something we want to continue to do. So the fortunate part is that we've got a really good balance sheet at the trough of the cycle here, and we're looking to actively put it to work where we can.
And then not to try to cut it too finely, but you've mentioned that the January purchase up 6%, commercial up 7%. I think you suggested there could be some spillover from December. If you look at the kind of recent trends, maybe late January or early February, do you see any difference relative to those numbers you gave us?
Yes, I think we saw probably a larger uptick in the early weeks, the first week of January and some it tailed off as you went through the month, which suggest, yes, there was some spillover. But I think on the whole, we feel pretty good about where the numbers came out in January.
Yes. Well, I guess they didn't immediately shift the order somewhere else. So spillover has some meaning as well.
Yes.
Our next question comes from John Campbell with Stephens.
So Mark, in your prepared remarks, you highlighted that it's impossible to fully size the exact impact of the cyber incident. I think that's definitely understandable. Obviously, a lot of moving parts there, but I'm going to see if we can get a little bit more color at least on what was visible for you guys. So you called out the $11 million expense, but as far as maybe what else is visible, you guys, maybe it's orders that got pushed into 1Q like you just mentioned or maybe it's orders you had the mix that pulled out and went to competitors. Do you have any rough sense for what just -- broadly what the degree of the impact was from that standpoint?
Yes. It's really impossible to tell. It's extremely difficult. I mean certainly, some orders that might have been open with us in the last couple of weeks of December might have opened somewhere else, though, again, we saw some of the spillover, which maybe they were holding the orders and send them to us as soon as our systems got back online. I think where the real issue is our orders that would have closed with us at the end of December and either the customer moved them or in many instances, we move to those orders. But keep in mind, that's behind us now. Those things are behind us now. So we're focused on the orders we got. And again, I think a lot of them, if not all of them are not of them spilled over into January and we'll realize the benefit of those orders in the ordinary course, and of the ordinary time frames, be they a purchase refi or a commercial order.
Okay. That makes sense. And then, Mark, on the investment income, you mentioned the $15 million sensitivity to every 25 basis point cut. I wanted to see if you could give us your latest sensitivity or I guess, maybe a rule of thumb on the interest expense offset. So for every $15 million, how much you would be able to offset in interest expense?
That's something we can tighten up. But I would say -- first of all, it's a good point because if we lose investment income, we are going to lose interest expense the high-level rule of thumb is. If we lose the dollar of investment income, we'll lose about $0.50 of interest expense. I mean a lot -- that's kind of what I would use for maybe modeling purposes. A lot of it depends on the mix of where our investment income is coming from, how much that's the bank versus the nonbank. But that's the high level rule some might use.
Okay. Okay. And then if I could squeeze in one more here. On the success ratio. I think you guys had talked to maybe kind of similar 50% or so in 2024. Obviously, you will be lapping this weaker quarter. For next year, you're going to have maybe appear a little bit of losses out of the investments. You've obviously got some impact from investment income, but maybe if you could talk to whether you feel like that's still kind of a target that you will manage to?
John, I mean, we're definitely managing to the 50%, 60% success ratio. Keep in mind though, when we talk about modest revenue growth, the success ratio is less meaningful. But no, we're absolutely still managing to that level.
And John, I just want to follow up on your first question. So when I said for every dollar of investment income, we lose $0.50 of interest expense. That's in the title segment only. I mean obviously, the corporate segment, we have our the interest expense from our bonds that are outstanding. So my commentary was for title segment only.
Our next question comes from Geoffrey Dunn with Dowling & Partners.
My first question is with respect to the automated title and end point how much insight do you have into the time line of that remaining -- or both those initiatives remaining a drag on your margin? .
Well, I mean, I don't think I mean it's not going to last forever. I think Endpoint -- 2023 was probably a peak year in the losses of Endpoint. And I think those are going to gradually come down over the next couple of years. On instant decisioning for purchase transactions, as Mark mentioned, the expenses are probably going to ramp up, but it's early days on that initiative, very early days. And while I think the expense on the whole scope of thing is fairly modest, it will increase modestly over time until we start to realize the benefits of that. That was much harder to predict, but I would anticipate, again, with endpoint that those -- the drag is starting to decrease, and it will decrease over time over the next couple of years.
And then sorry, a more macro question. I think you -- it sounded like maybe you thought the MBA was a bit aggressive on their forecast. As you go into '24, are you positioning the company more for -- like somewhere in the range of the Fannie and MBA forecast? Or are you maybe more cautious? And I'm particularly interested in your thoughts of the scenario where maybe we see 1 to 3 cuts, but late in the year and '23 or '24 looks like -- looking more like '23 than it does '25.
Well, I think '25 is going to look a lot better than '24 and '23. So I guess I view '24 as a transition year. So yes, we think the MBA is pretty optimistic. We think the GSEs are probably a little optimistic as well. We're probably coming in a little light of them. And again, we see -- as we mentioned earlier, we see modest revenue growth. But I do see '24 as a transition year. And if we get the rate cuts that the forward curve expects or even if we get 1 or 2 less, I think it's setting us up for a great 2025.
Our next question comes from Mark DeVries with Deutsche Bank. .
One more question for you about the impact of the cybersecurity incident. Mark, as you pointed out, there's a lag in reporting in the agent channel. Should we not expect to see that kind of flow through to 1Q agent premiums?
We will definitely have some that trickles over in the first quarter. There's no question about that, but it's just -- it's not going to be material. I wouldn't say it's material at all. So there will be remittances that we get because our agents just couldn't like remit the last week or two of the year. And so we're getting those now. But typically, it's a fairly slow time for agent remittances anyways, and it's just -- it won't be material in Q1.
Okay. Fair enough. And then I was just hoping to get a little bit more context about what kind of gives you comfort that there will be a significant ongoing impact from the incident. Is there anything you can kind of share about the nature or frequency of any kind of regulatory conversations or inquiries around it? And also just discuss kind of what efforts you're doing to identify and fixed vulnerabilities in your systems there?
Yes. I mean I think the big thing about kind of getting back to normal or no ongoing impact is just, first of all, the orders we saw, the order counts we saw come in, in January. And then the feedback we've gotten from our customers. I think by and large, our customers have indicated that they put the incident behind them. And unfortunately, in this day and age, these types of things are becoming more and more commonplace as we've seen with competitors and other participants in the industry.
Obviously, when you have an intent like this, there's regulatory inquiries and potential litigation. But because our information security program really was probably best in class. I don't anticipate, but again, you never know with regulators, but I don't anticipate to have fines or the live coming out of regulators. Now obviously, plaintiff lawyers are different. They always come out of the woodwork in instances like this. But I don't anticipate that any of that would be material. And I would layer in as well that we also have a fairly robust cyber insurance program, which would help mitigate the impact of some of those expenses as well.
Okay. That's helpful. And then just one last follow-up on that last point. I think you -- Mark, is there any sense you can give us for -- if you do get insurance recoveries what those might look like?
I'm sorry, Mark, you broke up there. Can you repeat the question?
Yes. Just is there any sense you can give us for the insurance recoveries and what -- if you receive them what those might look like?
Well, we have a $5 million deductible that we booked in Q4. And so we'll have expenses that hit in 2024 related to the incident. But as long as we feel like those are probable in terms of recoveries, then we won't see them hit the P&L. So we don't see any significant impact in terms of the P&L in 2024 because of the incident we feel like it was all kind of booked in Q4.
Our next question comes from Soham Bhonsle with BTIG.
Mark, I just wanted to quickly follow up on your comment on margins for '24. So I think you said something along the lines that it's going to be similar to '23, but then you also said low double digits. I mean low double digits could be a pretty wide range there. So could you maybe just put a little bit of finer point there for this year?
Well, our adjusted margin in '23 in title was 9.9%. So I mean it's -- so our margins in '24, given all the commentary I gave earlier is more like, call it, a 10% margin. Now listen, if the MBA is right and originations are up 15% to 20%. We're going to do a lot better than that. So we've got more kind of scale in our business, and we're running it more efficiently than we ever have. I mean to have a 10% margin here the trough in cycle is pretty good for us given historical standards. So we just -- again, if we see modest improvement in 2024, we'll still be at that 10% range.
So should we think about a 10% sort of like if volumes are up mid-singles right, versus sort of 10% to 15%. Is that the right way to think about it?
Yes. I'd say low to mid-single digits will be a 10%. Now obviously, there's a lot of moving pieces, but that's our expectation this early in the year.
There are no additional questions at this time. That concludes this morning's call. We'd like to remind listeners that today's call will be available for replay on the company's website or by dialing (877) 660-6853 or (201) 612-7415 and enter the conference ID 13743995.
The company would like to thank you for your participation. This concludes today's conference call. You may disconnect now.