First American Financial Corporation (NYSE:FAF) Q3 2024 Earnings Call Transcript October 24, 2024 11:00 AM ET

Company Participants

Craig Barberio - Vice President, Investor Relations
Ken DeGiorgio - Chief Executive Officer
Mark Seaton - Executive Vice President & Chief Financial Officer

Conference Call Participants

Bose George - KBW
John Campbell - Stephens Inc
Terry Ma - Barclays
Mark DeVries - Deutsche Bank
Mark Hughes - Truist Securities
Geoffrey Dunn - Dowling & Partners

Operator

Greetings, and welcome to First American Financial Corporation Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]

A copy of today's press release is available on First American's website at www.firstam.com/investors. Please note that this call is being recorded, and we will available for replay from the company's investor website and for a short time by dialing 877-660-6853 or 201-612-7415 and enter the conference ID 13749447.

We will now turn the call over to Craig Barberio, Vice President, Investor Relations, to make an introductory statement. Please go ahead.

Craig Barberio

Good morning, everyone, and welcome to First American's earnings conference call for the third quarter of 2024. Joining us today on the call will be our Chief Executive Officer, Ken 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 facts. These forward-looking statements speak only as of the date they are made, and the company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made.

Risks and uncertainties exist that may cause results to differ materially from those set forth in these forward-looking statements. For more information on these risks and uncertainties, please refer to yesterday's earnings release and the risk factors discussed on our Form 10-K and subsequent SEC filings.

Our presentation today also contains certain non-GAAP financial measures that we believe provide additional insight into the operational efficiency and performance of the company relative to earlier periods and relative to the company's competitors. For more details on these non-GAAP financial measures, including presentation 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.

Ken DeGiorgio

Thank you, Craig. In the third quarter, we benefited from measured improvement in market conditions. Our adjusted revenue was up 4%, the first year-over-year growth we've experienced since the second quarter of 2022. And our adjusted earnings per diluted share were $1.34, an increase of 10%.

Title premiums and escrow revenues were up across all key business lines, but most notably in our commercial division where revenues were up 19%, also the first increase since the second quarter of 2022. Growth in commercial revenue was driven by a sharp increase in the fee per file to which an 80% increase in large transactions contributed.

In the purchase market, demand started to pick up late in the quarter with a decline in mortgage rates to around 6% ahead of the Fed's 50 basis point cut in mid-September. Demand, however, softened as mortgage rates backed up 50 basis points soon after the Fed meeting and other factors impacting affordability persisted.

As a result, our closed purchase orders per day this quarter declined 2% compared with last year. While continued, albeit moderating, home price appreciation was one of the factors that negatively impacted affordability. It did drive an increase in our average revenue per order and a resulting 3% increase in our purchase revenue.

Closed refinance orders were up 12% in the third quarter with transaction activity increasing as the quarter progressed. The improved order flow combined with a higher fee per file resulted in a 20% increase in our refinance revenue.

Although our title segment investment income declined this quarter compared with last year, it grew sequentially as we began to realize the benefit of our investment portfolio rebalancing project. Mark will discuss that in greater detail in his remarks.

Our Home Warranty segment delivered an adjusted pre-tax margin of 7.7%, down from 9.3% last year. Though a slight improvement in the claims rate helped the margin, we deliberately increased marketing spend in our direct-to-consumer channel. This direct-to-consumer investment is expected to drive increased profitability as the lifetime value of new contracts is realized over time.

As we've discussed on prior calls, we are committed to developing innovative proprietary technologies that promise to boost our productivity and enhance the customer experience in ways that will create a sustainable competitive advantage. We believe however that an opportunity exists to reduce our technology spend without compromising on this commitment by centralizing, standardizing and simplifying our technology operations. We have already implemented certain changes that have reduced costs and we expect to realize additional benefits as we make further progress in this effort.

Turning to the outlook for the remainder of the year. We expect challenging conditions in the purchase market to persist. For the first three weeks of October, our open purchase orders are down 3% though our open resale orders are up 1.4%.

The refinance market should continue to improve though off a low base. Our refinance business accelerated in the first three weeks of October with open orders up 76%. And we remain optimistic that the commercial business will perform well in the fourth quarter given higher term refinancing demand, continued progress on price discovery and our own robust pipeline of large transactions.

As we indicated last quarter, we expect that modest revenue growth for the full year of 2024 will enable us to achieve title margins similar to what we posted in 2023. We now have stronger conviction in that outcome given the recent performance of our commercial business and the increase in interest income resulting from our portfolio rebalancing project.

The first year-over-year growth in revenue in nine quarters that I mentioned earlier coupled with our expectation that affordability challenges will gradually abate also make us cautiously optimistic that we are in the beginning stage of a new cycle that will drive further improvement in 2025.

While we have been operating through a cyclical downturn since the Fed began its historic interest rate hike cycle in early 2022. Our operating strength and strong balance sheet has enabled us to make meaningful investments in our business while maintaining our commitment to return capital to shareholders.

Since the beginning of 2022 we have repurchased 10 million shares for a total of $574 million at an average price of $57.74 per share. During the same period we have also increased the common stock dividend by 6% to an annual rate of $2.16 per share.

In closing, I would like to comment on the widespread damage and devastation that the recent hurricanes inflicted across several Southeastern states. Many of our employees and the communities in which they live have endured profound hardships. While we are grateful that all of our people are safe. We know that many now face the difficult task of recovery. I want to thank our people for all they have done to lend a hand to those impacted and to reiterate our company's commitment to support our people and their communities.

Now I'd like to turn the call over to Mark for a more detailed discussion of our financial results.

Mark Seaton

Thank you, Ken. This quarter we generated a GAAP loss of $1 per diluted share. Our adjusted earnings, which excludes the impact of net investment losses and purchase related amortization was $1.34 per diluted share.

During the third quarter we rebalanced our investment portfolio by selling certain debt securities in an unrealized loss position. Our net realized investment losses of $312 million this quarter were primarily due to this rebalancing.

As a result, we expect to save $90 million of cash taxes in the near term and we expect to increase investment income by approximately $67 million per year beginning in Q4 by reinvesting the proceeds in higher-yielding securities. The average duration and credit quality of the portfolio is unchanged as a result of this rebalancing.

Turning to our title segment. Revenue was $1.3 billion down 15% compared with the same quarter of 2023. Excluding net investment losses revenue increased 4% from last year. Purchase revenue was up 3% during the quarter all driven by an improvement in our fee per file.

Commercial revenue was $190 million a 19% improvement over last year. Though our closed commercial orders fell 5% the average revenue per order for commercial transactions surged 23%. Refinance revenue climbed 20% relative to last year. Despite growth in order activity, refinance still accounts for just 5% of our direct revenue. In the agency business, revenue was $684 million up 3% from last year. Given the reporting lag in agent revenues of approximately one quarter these results primarily reflect remittances related to Q2 economic activity.

Information and other revenues were $242 million during the quarter, up 1% compared with last year due to an uptick in the demand for the company's information products. Investment income was $136 million in the third quarter, down $5 million compared with the same quarter last year due to lower average interest-bearing escrow and tax-deferred property exchange balances. However, our investment income was up $11 million on a sequential basis.

As I mentioned earlier we expect our investment portfolio rebalancing to generate approximately $67 million of additional interest income per year beginning in the fourth quarter. We estimate that the third quarter benefited by $8 million related to this initiative as we ramped up fixed income security purchases throughout the quarter.

We'd like to provide a little more visibility into our investment income line item going forward. In Q4, we now expect between $140 million and $145 million of investment income in the title segment. This includes the full run rate of our portfolio rebalancing projects. It also assumes a 25 basis point Fed cut in November and a second 25 basis point cut in December. Based on current average cash and escrow balances, we estimate that each 25 basis point cut in the Fed funds rate will reduce annual investment income in the title segment by $15 million.

The provision for policy losses and other claims was $37 million in the third quarter or 3.0% of title premiums and escrow fees unchanged from the prior year. The third quarter rate reflects an ultimate loss rate of 3.75% for the current policy year and a net decrease of $9 million in the loss reserve estimate for prior policy years.

Adjusted pre-tax margin in the title segment was 11.6% excluding both net realized losses and purchase-related amortization. Total revenue in our Home Warranty business totaled $111 million, up 2% compared with last year. Pre-tax income in Home Warranty was $9 million down 4% from the prior year. The loss ratio in Home Warranty was 54% down from 55% in 2023 due to lower claim frequency that was partially offset by higher claim severity.

Adjusted pre-tax margin in the Home Warranty segment was 7.7% compared to 9.3% last year. The effective tax rate for the quarter was 28.4%. Excluding the impact of net realized investment losses and purchase related amortization, the tax rate was 20.5% lower than our normalized rate of 24% due to $6 million of research and development and foreign tax credits recognized during the quarter.

Our debt-to-capital ratio as of September 30th was 34.8%. Excluding secured financings payable our debt-to-capital ratio was 26.6%. In September, we raised $450 million in a public offering of 10-year senior notes. $300 million of the proceeds will go toward paying off notes that mature on November 15th of this year.

Now I would like to turn the call back over to the operator to take your questions.

Question-and-Answer Session

Operator

Thank you. We’ll now be conducting question-and-answer session. [Operator Instructions] The first question comes from the line of Bose George with KBW. Please go ahead.

Bose George

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

Ken DeGiorgio

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

Bose George

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

Ken DeGiorgio

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

Bose George

Okay. Great. Thanks.

Operator

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

John Campbell

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

Mark Seaton

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

John Campbell

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

Mark Seaton

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

John Campbell

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

Ken DeGiorgio

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

John Campbell

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

Ken DeGiorgio

Are you talking about in the direct-to-consumer channel in Home Warranty?

John Campbell

Right.

Ken DeGiorgio

We think that's where the opportunity is particularly given that the purchase market is under such pressure. So in our real estate channel where we're selling through real estate agents in connection with home transactions given the pressure in that market, we think there's real opportunity in the direct-to-consumer channel.

Keeping in mind, there's a lot of open space in the Home Warranty business. Not many homes have home warranties on them. So, there's a we don't have to go chase down customers from our competitors in order to realize a competitive advantage in that business because there's a lot of open space.

John Campbell

Okay, great. Thanks guys.

Operator

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

Terry Ma

Sorry, I was on mute. Thank you. Good morning. So, it seems like the reinvestment of the repositioning of the investment portfolio the $67 million benefit will mostly just kind of offset the first 50 basis point rate cut and then the two more anticipated ones. Is that a fair way to kind of think about it?

And then as we kind of look forward to 2025 are there any other actions that you can kind of take to optimize or get more out of your investment portfolio to maybe offset any additional rate cuts?

Mark Seaton

First of all, Terry, yes, that's the right way to think about it. I mean for every 25 basis points in the Fed funds rate, right now given where our current balances are, we expect a $15 million reduction in investment income. So, really the $67 million benefit we're going to get will basically fund at least 4-plus Fed cuts.

Now, there's a lot of other factors too. I mean one thing that could offset that is if we have rising commercial volumes next year and purchase volumes that will generate additional investment income and that could insulate some of these Fed cuts that might come our way next year. So, that's kind of how we think about our investment income.

Terry Ma

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

Ken DeGiorgio

Yes. Well, I think the -- thanks for the question Terry. I think -- really I think the results we saw in the third quarter are one of the biggest indicators. I mean to have the first year-over-year increase in revenue in our commercial business is a real positive indicator.

We're seeing strong demand in the business. We're seeing a lot of progress on price discovery. And then we have and our own pipeline of deals give us a lot of confidence. And then for the first three weeks of October we've actually seen an increase in revenue as well. So, we feel pretty good. Obviously, things can change it's a volatile market, but we feel pretty good about the rest of the year in our commercial business.

Terry Ma

Got it. Okay, that’s helpful. Thank you.

Operator

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

Mark DeVries

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

Mark Seaton

We -- I would say the bulk of it is done. There is still some that we could do that we're considering. But the scope of that the most would be about $100 million of losses. And we haven't really decided if we're going to do that yet. But that would be the scope of it; most of it has been done.

Mark DeVries

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

Mark Seaton

In terms of investment income, commercial is more valuable to us. I mean just because the deals are larger in size, they typically take longer to close than a residential purchase transaction typically, so we hold the deposits longer. And we estimate that -- it fluctuates, but I would say the rule of thumb is that about 60% of our escrow deposits at the company are commercial real estate, but commercial is a big driver in terms of what our escrow deposits are.

Mark DeVries

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

Ken DeGiorgio

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

Mark DeVries

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

Ken DeGiorgio

Well, I think the telltale sign will be what happens the election. But I think there's been a lot of -- they've gotten some traction with AOLs and title waivers and other alternatives in the administration. But there's been a lot of pushback with -- from regulators and legislators, including members of Congress. I think our trade group has done a good job.

And I think that, frankly, legislators and regulators themselves have already appreciated -- already had appreciated the value of title insurance relative to these alternatives. So we've got to remain ever vigilant and continue to get out the message on the value of title insurance. And I think, frankly, that we're -- the industry is winning that battle.

Mark DeVries

Thank you.

Operator

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

Mark Hughes

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

Ken DeGiorgio

Yes. We're seeing price discovery, and a lot of this is anecdotal, but we're seeing it across the board. Obviously, the one asset class that continues to struggle, as you'd expect, is office, particularly CBD office. Suburban office is probably doing a little better.

But the one thing I'll point out, that the nice thing about our commercial business markets, we're pretty diversified. We have a strong presence in all asset classes. So we're not buffeted for better or for worse by any one asset class. We're in the mall and we're in the mall pretty deep.

Mark Hughes

Yeah. When you see kind of an uptick in the size of transactions like this, is it just the normal variability, or were these deals that are hanging on the sidelines waiting for a little better interest rate environment? What do we make of that?

Mark Seaton

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

Mark Hughes

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

Ken DeGiorgio

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

Mark Hughes

Yeah. Okay. Thank you very much.

Ken DeGiorgio

Thanks, Mark.

Operator

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

Geoffrey Dunn

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

Ken DeGiorgio

Yeah. And I wouldn't say it's a change in the sales platform. I think it's an evolution. And some of -- one competitor, in particular, I think, has been pretty aggressive with it, has done a good job with DTC. But we've working on it -- we've been working on it too. And I think we're just ramping up the investment. So I call it more of an evolution than a change. We like the business. I mean, it's furthest -- it's clearly furthest from our core title and settlement business, but we like it. We think there's a lot of opportunity in it, particularly given what I, as I mentioned earlier, how under penetrated the market is.

And then even though the real estate channel of that business is suffering right now alongside the purchase business and the title company, for example, I think once the purchase market turns around, and it will turn around, I think that our expertise and deep penetration in the real estate market and the real estate channel is going to be helpful for that business as well.

Geoffrey Dunn

All right. Thank you.

Operator

Thank you. [Operator Instructions] There are no additional questions at this time. That concludes this morning's call. We would like to remind listeners that today's call will be available for replay on the company's website or by dialing 877-660-6853 or 201-612-7415 and enter the conference ID 13749447.

The company would like to thank you for your participation. This concludes today's conference call. You may now disconnect.