First American Financial's CEO Discusses Q3 2011 Results - Earnings Call Transcript

| About: First American (FAF)

First American Financial Corporation (NYSE:FAF)

Q3 2011 Earnings Call

October 27, 2011 11:00 am ET


Craig Barberio – Director, Investor Relations

Dennis J. Gilmore – Chief Executive Officer

Max O. Valdes – Executive Vice President and Chief Financial Officer

Mark E. Seaton – Senior Vice President, Finance


Mark DeVries – Barclays Capital

John Campbell – Stephens Inc.


Welcome to the First American Third Quarter 2011 Earnings Call. At this time, all participants are in a listen-only mode. (Operator Instructions) A copy of today's press release is available on First American's website at 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 203-369-1399.

We will now turn the call over to Craig Barberio, Director of Investor Relations to make an introductory statement.

Craig Barberio

Good morning, everyone. And thank you for joining us for our third quarter 2011 earnings conference call. Joining us on today's call will be our Chief Executive Officer, Dennis Gilmore; Max Valdes, Executive Vice President and Chief Financial Officer; and Mark Seaton, Senior Vice President of Finance. At this time, we would like to remind listeners that management's commentary and responses to your questions today may contain forward-looking statements, such as those described on page four of today's news release. And other statements that do not relate strictly to historical or current fact.

The 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. Factors that could cause the anticipated results to differ from those described in the forward-looking statements are also described on page four of the news release.

With that, I will now turn the call over to Dennis Gilmore.

Dennis J. Gilmore

Thanks, Craig. Good morning and thank you for joining the call. I'll begin by going over our third quarter operational highlights of the company. Total revenue in the third quarter was $965 million, down 4% from the third quarter of 2010, with net income of $21 million, or $0.20 per share. The results of the quarter include a reserve charge of $27.7 million and net realized investment losses of $3.3 million, which, combined, reduced our earnings per share by $0.17.

The Title segment generated a pretax margin of 5.4% on revenues of $898 million. Our Commercial division continued its strong performance, with revenues up 22% compared to last year. And our International division had a strong rebound, with revenues up 24%, driven by the strength of our Canadian operations. The quarter also benefited from lower costs, as we hit our target for the $40 million annualized expense reduction program that we implemented last quarter.

In August, as mortgage interest rates dropped, we saw an increase in open orders. For the quarter, orders were up 14% sequentially, with refinance transactions accounting for 62% of all residential orders. Open title orders held steady in September, and we're seeing a slight downward trend in October, given this trend and our expectation for continued strong commercial activity. The fourth quarter pipeline looks favorable.

Turning to our Specialty Insurance segment, we achieved pretax earnings of $7 million, for a 9% margin. The overall loss ratio was 60%, compared to 53% in the third quarter of last year. During the quarter, we experienced adverse development for title claim losses, primarily related to policy year 2007, resulting in a $14.7 million reserve charge.

In addition, as mentioned on last quarter's call, we've been engaged in a multi-stage mediation process with Bank of America and FiServ that was scheduled to conclude at the end of August. The parties agreed to delay the final stage until the fourth quarter. As part of that process, we’ve engaged the services of statisticians and other experts to help us analyze the claims involved in the lawsuit. As a result of that analysis, we’ve estimated our financial exposure to be between $13 million and $42 million, with $13 million being our best estimate of the Company's financial exposure. We've booked a reserve and offered to settle the case for that amount.

Let me briefly comment on recent developments concerning CoreLogic. On August 29, CoreLogic announced that its Board was exploring options aimed at enhancing shareholder value, including a potential sale of the entire Company. We own over 8% of CoreLogic and are the Company's largest shareholder. Therefore we have a strong interest in the outcome of that process.

Since their announcement and in a series of SEC filings and communication with CoreLogic, we’ve made our interest known. Last week, we delivered a letter to their Board indicating that in the current environment, we do not believe the Company could be sold at a price that is in the best interest of long-term shareholders. We also advised their Board that a better solution is for CoreLogic to focus on its core business.

In the event, they decide to pursue a sale anyway. We submitted a non-binding offer for the Company. We've also made a non-binding offer to purchase certain of their assets that we believe to be non-core to them. While we are not certain as to the timing or ultimate outcome of the CoreLogic process, we are monitoring the situation closely.

Looking forward to 2012, we expect that the market environment will remain difficult, but we believe we have positioned the Company well. With a conservative balance sheet, good liquidity, we are in a strong position to pursue opportunities for organic growth and strategic investments in our core business, all with the goal of improving our financial performance and delivering superior shareholder value.

I'd now like to turn the call over to Max for a more detailed review of our financial results.

Max O. Valdes

Thank you, Dennis. The Company generated total revenues of $965 million for the quarter down 4% from the same period of the prior year. Net income was $21 million or $0.20 per share, compared with net income of $33.1 million or $0.31 per share for the same quarter of the prior year. The results for the current quarter include $3.3 million in net realized investment losses, $14.7 million in title claim reserve additions for prior policy years and a $13 million reserve in connection with Bank of America's pending lawsuit. On a combined basis, these items reduced earnings per share by $0.17.

In the Title Insurance and Services segment, total revenues for the quarter were $898 million, down 3% compared with the same period of the prior year. Direct premium and escrow fees were down 1% driven by an 18% decline in closed orders, largely offset by higher average revenues per order closed.

Average revenues per order closed increased 21% to $1,561, compared to the same quarter of last year. This increase primarily reflected strength in higher premium resale and commercial transactions. Agent premiums were down 8% in the quarter, compared to the 1% decline in our direct premiums. The weaker relative performance in agent premiums reflects weaker title order activity in the second quarter of 2011, as compared to 2010, due to the normal reporting lag in agent revenues of approximately one quarter.

Information and other revenues totaled $160 million for the quarter, up 5% compared to the same period of last year. The increase was driven by our Canadian operations.

Investment income totaled $20 million for the quarter, almost equal to the same quarter of last year. We incurred net realized investment losses of $1.9 million, compared with net realized investment losses of $2.5 million for the same period of last year.

Personnel costs were $279 million for the quarter, down $6.1 million, or 2%, compared with the same period of last year. This decline primarily reflects a reduction in US headcount and reduced costs related to employee benefit plans. Other operating expenses were $174 million for the quarter, down 5% from the same quarter of last year. Lower office-related costs and a reduction in consulting expenses were partially offset by increased production-related expenses in the Company's commercial, default, and international businesses.

Agent retention was 80.2% of agent premiums, compared with 80.7% in the third quarter 2010. The improvement in agent retention was due to the geographic mix of agent revenues, and our continued progress on improving agent splits on both new and existing agency relationships across a number of markets. The provision for title losses in the current quarter was 9.7% of premium and escrow revenue, compared with 6.6% in the same period of last year.

The third quarter rate of 9.7% reflects an ultimate loss rate of 5.8% for the current 2011-policy year, a $13 million reserve in connection with Bank of America's pending lawsuit, and $14.7 million in adverse development for prior policy years, primarily 2007. During the quarter, incurred claims were higher than expected, and our actuary determined that, given the near-term economic outlook, it was prudent to further develop the higher incurred claims, resulting in a net reserve adjustment of $14.7 million. We continue to book to our actuary's best point estimate.

Pretax income for the Title Insurance and Services segment was $48.9 million in the third quarter, a decline of 19%. The segment generated a pretax margin of 5.4% in the quarter, compared to 6.5% for the same period of the prior year. This quarter's 5.4% pretax margin was negatively impacted by the adverse claims development charge, which lowered the margin by 1.7 percentage points, and the reserve in connection with Bank of America's pending lawsuit, which lowered the margin by an additional 1.5 percentage points.

Turning to the Specialty Insurance segment, total revenues were $74 million, essentially flat compared to the same quarter of the prior year, despite a $2 million decrease in net realized investment gains. Total expenses were up 9%, primarily driven by higher claim losses in both business lines. Home warranty claims were up, due to one of the hottest summers on record, while the property and casualty business experienced a relatively high number of large losses on stand-alone claims.

The Specialty Insurance segment pretax margin was 9.0% for the current quarter, down from 16.4% for the same quarter of last year. Finally, corporate expenses were $17.2 million in the third quarter, including a $1.6 million asset impairment.

With that, I will turn the call over to Mark.

Mark E. Seaton

Thank you, Max. I will provide a few comments on our liquidity and capital. Cash provided by operations in the third quarter was $53 million, up from $23 million in the second quarter. Capital expenditures during the quarter were $17 million, which included investments in technology, software development, and title plan expansion.

In terms of liquidity, we currently have $57 million of operating cash at our holding company. Our cash balance recently benefitted from CoreLogic's early payment on their $17 million note payable to us, that was created at the time of the spinoff. In addition to our operating cash, we also have 6 million of our 8.9 million shares of CoreLogic at the holding company. Based on yesterday's closing price, our stake in CoreLogic was valued at $105 million, $71 million of which is held at the holding company. In addition, we also have $200 million available on our $400 million line of credit.

Our cash and investment portfolio totaled $3.2 billion, as of September 30, which includes $1.4 billion of fiduciary funds. The portfolio is comprised of debt securities of $2.1 billion, cash and short-term deposits of $695 million, equity securities of $170 million, and $201 million is less-liquid, long-term investments.

Overall, we have a high-quality portfolio, with just 1% of our debt securities rated below investment grade. Debt on our balance sheet totaled $279 million, as of September 30. Our debt consists of $200 million funded on our credit facility; $45 million of trust deed notes, and $34 million of other notes. Our debt-to-capital ratio as of September 30 was 12.3%.

I would now like to turn the call back over to the Operator to take your questions.



Thank you. We are now ready to begin the question-and-answer session. (Operator Instructions) Our first question comes from Mark DeVries of Barclays Capital.

Mark DeVries – Barclays Capital

Yeah, thanks. In the unlikely event that CoreLogic decides to sell here and you guys hit the bid, can you give us a little sense of how you would have to pay for that kind of what the cash/stock mix would be? You know, capacity to issue debt to fund cash, and where the limits would be there, given where the rating agencies would want you to stay?

Dennis J. Gilmore

Sure, Mark. This is Dennis. It's still premature in the process right now. Remember, CoreLogic's gone through their own strategic review process and, at this stage, it's not clear what the outcome will be.

In our opinion, the best approach for CoreLogic is to focus on their core business and potentially sell non-strategic assets. So, right now, we're letting the process go through. We're not sure ultimately what the outcome of that process will be. And, at the end of the day, we've had significant discussions with our investment bankers, and we think we have alternatives to ultimately handle either scenario.

Mark DeVries – Barclays Capital

Okay. And, can you give us any color on which of those assets, if they're selling some of the non-core stuff, what's attractive to you?

Dennis J. Gilmore

Again, Mark, it's still very early in the process, and it's a competitive process right now. But, when we look at the company, we think that they have certain assets that we've deemed, in our opinion, to be non-strategic for them, and we also think that there are certain assets that they have that would fit us very well strategically.

And remember, we know these businesses very well. We know the people. We know the operations. So, we do think there are opportunities there, and we think we would be a natural purchaser, if they decide to go down that route and sell non-strategic assets.

Mark DeVries – Barclays Capital

Okay. Thanks. And then, could you give us a little more detail on how you sized, or the actuaries helped you size, the exposure on the BAC lawsuit and also kind of a sense of at least what the largest amount that BAC is still seeking out of this?

Dennis J. Gilmore

Sure. Again, this is, Dennis. Well, first, remember we have got active litigation here, so I can't get into a lot of detail, but we've done a tremendous amount of work and analysis on the actual claims. We've engaged experts, statisticians and others, to help us derive that analysis. We're very confident in what we've done. We think that we've established an accurate range of exposure for the lawsuit. We think the actual value of the lawsuit is $13 million, and we've booked a reserve accordingly. And, we've offered to settle it at that price.

Now, with that said though, the ultimate outcome is still uncertain. We've got to go through a process. We're confident that the process will go – move forward. But, we've got to get through it.

Mark DeVries – Barclays Capital

Okay. And just around that, did you say this process is supposed to run its course this quarter, the fourth quarter, that is?

Dennis J. Gilmore

Yes, the last stage of the mediation was actually scheduled originally in the third quarter, and we all agreed to move it in the fourth quarter. And, that's actually going to kick off next week. So, we're looking forward to moving forward with the process.

Mark DeVries – Barclays Capital

Okay. And is this a binding mediation event or if one party's unhappy, could they…?

Dennis J. Gilmore

It is not a binding mediation. But, all parties, I think, are committed to moving the process forward.

Mark DeVries – Barclays Capital

Okay. Great. Thank you.


(Operator Instructions) Our next question comes from Brett Huff of Stephens, Inc.

John Campbell – Stephens Inc.

Hey, good morning guys.

Dennis J. Gilmore

Good morning, Brett.

Max O. Valdes

Hey, Brett.

John Campbell – Stephens Inc.

Hey, this is, I’m sorry, this is, John Campbell in for Brett Huff.

Dennis J. Gilmore

Good morning, John.

John Campbell – Stephens Inc.

Good morning. So, there seemed to be a pretty impactful, or I guess potentially impactful, news from the Massachusetts court case involving title as it kind of relates to the foreclosure. So, what is your read from this ruling, and how does it affect First American and the industry going forward?

Dennis J. Gilmore

Thanks for the question. At this stage, we had anticipated a ruling along these lines, actually, back in 2009, and we modified our underwriting criteria back in 2009. At this stage, we've had some claims, nothing significant, no significant losses. We do think there'll be claims, but the problem primarily be a duty-to-defend type claim. And the last thing I'll say is that we're all working with industry participants to just try to work through a logical solution here. But again, at this stage, no significant losses.

John Campbell – Stephens Inc.

Okay. Thank you. One last question as it relates to the ongoing HARP program, if you guys don't receive a nice boost from new refi orders, would your cost structure be in line?

Dennis J. Gilmore

Two issues, I think, on the question. First, on the HARP, the details that have been released at this stage, we're optimistic. Now, the final details will be released, I think, November 15. But, we're supporters of anything that helps to stabilize the housing market. So, from that perspective, we just don't know what the up tick in orders will be, but we think it's a positive move. We do not anticipate any significant staffing increases. Actually, with the current increase we've seen in open orders in the third quarter, we've actually let our staffing drift downwards. So, we're pretty efficient on doing refinance orders right now.

John Campbell – Stephens Inc.

Okay. Great. Thanks.


There are no more questions. This 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 203-369-1399. The Company would like to thank you for your participation. This concludes today's conference call. You may now disconnect.

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