First American Financial Corporation (NYSE:FAF)
Q1 2016 Earnings Conference Call
April 21, 2016 11:00 AM ET
Craig Barberio - Director, Investor Relations
Dennis Gilmore - Chief Executive Officer
Mark Seaton - Executive Vice President and Chief Financial Officer
Kevin Kaczmarek - Zelman and Associates
Jeff Harwood - Barclays
Bose George - KBW
Mark Hughes - SunTrust
Eric Beardsley – Goldman Sachs
Hayden Blair - Stephens
Ryan Byrnes - Janney Montgomery Scott
Geoffrey Dunn - Dowling & Partners
Eric Robinson - Jason Deleeuw with Piper Jaffray
Greetings and welcome to the First American Financial Corporation First 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 entering the conference ID 13634408.
We will now turn the call over to Craig Barberio, Vice President of Investor Relations to make introductory statements. Thank you. You may begin.
Good morning everyone and welcome to our first quarter 2015 earnings conference call. Joining us on today’s call will be our Chief Executive Officer, Dennis Gilmore and Mark Seaton, Executive Vice President and Chief Financial Officer.
Some of the statements make today may contain forward looking statements that do not relate strictly to historical or current facts. These forward looking statements to be growing as of the days they have made and the company does not undertake to update these 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 the today’s earnings release and the risk factors discussed in our form 10K and other SEC filings.
Our presentation today contain certain non-GAAP financial measures which we believe provide additional insides and the operational efficiency and the performance of the company relative to the earlier period and relative to the company’s competitors. For more details on these non-GAAP financial measures including presentation work and reconciliation to the most directly comparable to GAAP financial measures, please refer to today’s earnings release which is available on our website at www.firstam.com.
With that, I will now turn the call over to Dennis Gilmore.
Thanks Craig. Good morning and thanks for joining our call. I will begin with a review of our first quarter highlights and conclude with a few comments regarding our outlook for 2016.
2016 was out to the good start, first quarter EPS was $0.47, up from $0.34 last year. The strong result was driven primarily by title segment which delivered a pre-tax margin of 8%. Overall, I am pleased with the company’s first quarter performance. We maintained our focus on cost efficiency, we benefited from our improved titles claims experience and we were able to take advantage of an improving housing market.
Within our core title segment, we were up 8% driven by our agency business which experienced a very strong quarter with revenues up 18. Our agency channel continues to benefit from the additional key commercial and national agents.
Our direct purchase business grew by 9% in the first quarter compared with last year driven primarily by higher fees profile. Quarter’s purchase orders per day were flat and the average fee per transaction grew 7% during the quarter.
Our close refinance orders were down 18% compared with the last year. However, we experienced a strong increase in refinance orders beginning in January in response to lower mortgage rates. Our open refinance orders averaged 2000 per day in the quarter up 22% from the fourth quarter.
Our commercial revenue declined 4% in the first quarter due to fewer large deals closed however the business remain strong and we continue to see broad based strength across most segments in markets.
As previously discussed, the new mortgage disclosure rules TRID, took effect in October of last year. Overall First Americans extensive preparation served us well and I am proud of our title operation successful response to this change.
During the quarter, we continue to refine our processes and believe the new settlement practices have become a normal part of our direct title operations. Furthermore, we do not expect any material impact on our financial results going forward.
Revenue in our special insurance segment grew by 9% during the quarter. However, we experienced higher claim losses in both home warranty and our property and casualty businesses which caused the segments pretax margin to decline to 12%.
Regarding acquisitions, we have recently announced the closing of foresight appraisal like a leading independent appraisal company. The company offers comprehensive real estate evaluation solutions with nationwide coverage. We've been looking to add a residential appraisal company for some time to augment our valuation offerings. This acquisition accelerates our efforts to help our customers deliver a defect free mortgage while providing a superior consumer experience.
Turning to the outlook for 2016, I am optimistic that we will see continued improvement in the housing market. Regarding the purchase market, all orders remain flat relative to last year but we continue to see strength in our fee’s profile. We continue to benefit from elevator refinance activity which we finance orders, running at approximately 2000 per day and a commercial business is closed for a good year.
I believe the company is well positioned for 2016 and beyond and we remained focused on driving operating efficiencies, gaining profitable market share in our core title business, to help maximize long term profitability.
On a final note, I am pleased that during the quarter First Americans recognized by Fortune Magazine as one of the 100 best companies to work for America given the importance of our people to the business this prestigious distinction reflects the success of our ongoing commitment to the premier title insurance and settlement service provider. I'd now like to turn the call over to Mark for more detail review of our financial results.
Thank you, Dennis. Total revenue in the first quarter was $1.2 billion, up 8% compared with the first quarter of 2015. Net income was $53million or $0.47 per diluted share. The current quarter results include net realized investment going to 5 million or $0.03 per diluted share. In addition, this quarter’s effective tax rate of 30.3% benefited from 3.8 million of non-recurring items or $0.03 per diluted share.
In the Title Insurance and Services segment, direct premium and escrow fees were down 2% compared with last year. This decline was driven by a 7% decrease in the number of direct prior orders closed partially offset by a 5% increase in the average revenue per order. The average revenue per order increased to $1,943 due to the shift of the mix from lower premium recent transactions to higher premium commercial transactions and to a lesser extent the increase in the average revenue per order per purchased transactions.
Agent premiums were up 18% in part driven by the recent addition of key commercial and national agents. The agent split was 79.1% of agent premiums.
Information and other revenues totaled 154 million, down 1% compared with last year driven by a lower demand for the company’s default information products as a result of the decline in loss mitigation activity during the quarter. Personal cost were 355 million up 5% from the prior year, the increase was primarily due to the higher salary expense including the impact of one additional payroll day and higher stock based compensation expense.
Other operating expenses were 165 million, down 8% from last year. The decline is primarily driven by lower production with expenses and the impact of the foreign currency transaction gains. The ratio of personnel and other operating expenses to net operating revenue was 78.2%.
The provision for title policy losses and other claims was $51million, or 5.5% of title premiums and escrow fees compared with a loss provision rate of 6.6% in the same quarter of the prior year. During the first quarter, our paid title claims still 36% from the prior year.
Pre-tax income for the title insurance and services segment was 88 million in the first quarter compared with 70 million in the first quarter 2015. Pre-tax margin was 8.0% compared with 6.1% last year.
Turning to the specialty insurance segment, total revenues were $103 million up 9% compared with last year. The loss ratio for the segment was 58% up from 51% with higher loss experienced in both home warranty and property casualty. The increase in a loss ratio and home warranty was primarily due to higher contract servicing costs. In the property and casualty business, the loss ratio increase was primarily due to higher claim severity. Pre-tax margin for the summer was 12%.
Net expenses in the corporate segment were 24 million, down 12% driven by lower cost relative to the company benefit declines. The effective tax rate for the quarter was 30.3%. The tax rate benefited from 348 million or $0.03 per diluted share of non-recurring items.
In terms of cash flow, cash used for operations was 66 million, an improvement from the 56 million operating cash outflow recorded last year. Capital expenditures were $39, a 6% reduction from 2015.
Debt in our balance sheet totaled $580 million as of March 31. Our debt consists of 546 million of senior notes, 29 million of trustee notes and 5 million of other notes and obligations. Our debt-to-capital ratio as of March 31 was 17%. And we have the entire amount available under our 700 million revolving credit facility.
I would now like to turn the call back over to the operator to take your questions.
[Operator Instructions] Our first question comes from the line of Kevin Kaczmarek with Zelman and Associates. Please proceed with your question.
I noticed you mentioned some strong Asian commercial business drove to Asian revenue, I was wondering if you get some more color on as where these new agents that just started under using as an underwriter or are they just allocating more deal flow to you and kind of, can you give us some color on what types of deal these are bringing in? Whether it be in terms of geography or as the office multifamily energy et cetera?
Kevin, this is Dennis. A couple thing about the agency. We did have some new findings of commercial agents last year which did help increase our revenue in the first quarter and we think that benefit will continue on. We have also continue to increase some of our national residential agents and that's helped us. Also, in the agency business too we saw a strong stronger movement throughout the east coast. And we had a targeted effort there to gain share and I think that's paying some dividends but the last thing on the agency piece from the agency side, once we could have had some delayed impact from the TRID issue to happening in the agency business, so it was kind of a lot of things going on an agency.
Back very specifically to your question again though, we have made a targeted effort to sign commercial agents and we're going to continue that effort and it's paying us dividends.
Ok great and I noticed there have been few premium changes within a few different states by you guys as well as a number of your peers. I was wondering if you had a sense of the net effect of the rate changes assuming the flat volumes over the next year?. What's the expected impact of revenue?
This is mark, Kevin. I would say it’s very immaterial and where we really focus on the purchase side, the average key profiles and purchase was up 7% this quarter, most of it was really driven by higher housing prices that the biggest drive of that. We also had a kind of a more of a shift into higher price states like California. There was also a third component of the fact that we've been taking rate in some select states where we thought our rates were inadequate but that's really the third piece of why our [indiscernible] is up.
Our next question comes from the line of Jeremy Campbell with the Barclays. Please proceed with your question.
Thanks guys. So you guys said you're calling for a ‘good year for commercial’. Can you just help kind of define what that might look like? Is it revenue growth that may be a little slower in the past couple years? Or still there maybe some mid-to-high single digits or is it something like some more modest softness on a year-over-year revenue basis?
Hi Jeremy, this is Dennis. First of all when you look at a comparison quarter over quarter, we were down 4%. But it’s a tough comparison we had a couple of very big deals in the first quarter of 2015 so that way on the comparison there and big deals for us will always be lumpy. So when we step back we think the commercial have another good year force in 2016. Our current call on the market is similar, we think over the year similar to 2015 from a size perspective. So Our current product probably be more flat, up a few points, down a few points but a good year for us going forward.
Got it. And then I know the activity is kind of choppy and we had a bit of credit market seizing up a little bit in Jan and Feb but have you seen kind of increased optimism in that market versus those months earlier this year?
I would say a little bit. It’s definitely a tough start of the year but again for us it's more of the choppiness of big deals when they come and when we close and we had a couple of big deals in the first quarter of ’15 but we did have in the first quarter of ’16. So again we are optimistic going forward. I think it’s going to be another very good year for commercial. And I can say for a while that the growth rates were slower and definitely I think we will see that this year. And again I think we are looking probably for a flat, up a few points, down a few points, kind of a year for commercial.
Got it and then just one final one. And again kind of eluded to the aging growth had partly was due to commercial, does there any way to kind of the seize what proportion of that year-over-year growth was driven by commercial agent finance?
A difficult to answer that but our stance is that we are running commercial, our agencies in the low teens right now in our agency business.
Our next question comes from the line of Bose George with KBW. Please proceed with your question.
Good morning. Question on the market share, with the agent strength that you have mentioned, do you think your market share is up a little bit this quarter?
It’s difficult to answer because it’s a more of a targeted effort. We are trying to gain share in the specific states where we have necessary returns we are seeking. So it’s probably more of a little bit of mix bag but we definitely think we are gaining share where we got major effort going on to gain it.
Okay great, thanks. And then at your title margin, it was up pretty nicely year over year, could you just discuss some of the puts and takes there because direct was down year over year, commercial was down, agent was up nicely, is the incremental margin on that agent business to stay high?
Well, the agency business is a great business for us but it’s lowest margin business we had, simply because the agent margins were about 5%. Obviously one of the things that impacted the quarter was the loss rate, loss rate in the year were about 6.5% all year and this quarter we have bought it under 5.5%. so that was a big impact on the margin. And in terms of the overall mix, I don’t that had a significant impact in terms of our 8% margins from it.
And then just on the incremental margins, do you think about they are kind of similar to that 5% number or our incremental margins much different from that agency side?
The incremental margins in the agency are somewhere 5%, simply because of the volume, the vast majority of the expenses that variable and so, our revenue was up or down we always try to target 5% in the agency so I think that that’s fair for an incremental margin.
Okay, great and there is just actually one more related question, on the success ratio this quarter, what drove that I mean that was a pretty high number?
We tried to target our 60% success ratio and this quarter was 10% which is obviously a great outcome for us but there was a little bit, it wasn’t a material this quarter just because we had a very low growth in our net operating revenue. So we had operating revenue was up about 8 million and on that low of number the success ratio becomes less meaningful but we haven’t spent 800,000 in controllable expenses. So obviously we felt like we really control our cost this quarter but it was little bit skewed just because of the low revenue growth of this quarter.
Our next question comes from the line of Mark Hughes with SunTrust. Please proceed with your question.
That 79.1 agency split was at the lower end of your recent range, do you think that will continue?
We did re-class last year, we basically brought, we still it was 48% and there was a re-class that was done, the work was done at 79% and we selected a really be in a 79% range for the foreseeable future?
And then any body language on recent trends, weekly, recent months on a purchase and refi orders?
I am pretty optimistic going into ’16 right now. There are two parts of that questions, first our refinancing business is continuing to stay strong, running at 2000 orders per day approximately and like a little better we had anticipated the year and we are running with very well interest rates now. On the purchase side, as Mark has mentioned, we continue to see strong benefit from our fee increasing driving a lot by inventory, as far we think across the country and where we are sourcing our deals. And we are optimistic going forward in the spring buying season, we are going to continue to see some pick up on the transaction volumes, probably about single digits there that’s what we are hoping for but we think that’s going to be an overall good year.
And then finally the specialty insurance loss, is there any details on what cause that any trends you can spot and do you think that will calm down?
Yes, it’s really the driver here is our home warranty business and we have got two things going on, we have seek and we have gained some nice growth there over the last couple of years. But that growth has put some pressure on our contractor network and because of that our clients on the little cost exposure than we thought and we don’t expected, we have got some new issues in place to get that back in line and the second piece of that is that our client replacement cost have been increasing, higher energy replacement cost appliances and for that we are trying to do some targeted price increases. So we are working hard to get that back down, a backup performance back to what it was.
Do you have to say on the home warranty, you have more work that was out of network so to speak with that?
Exactly where you had network services.
Our next question comes from the line of Eric Beardsley with Goldman Sachs. Please proceed with your question.
Thank you. Just on the provision, I guess that 5.5, should we expect that decline further this year or is that a stable run right now?
I wouldn't expect it to decline further. I think that’s definitely the possibility but I don't think that the expectation. Obviously, something we look at every, we felt very confident, we not to be bring down this quarter. And when we look at our incurred claims, they have been really coming below our forecast, all of last year and even this quarter. Our incurred claims are nothing but forecast, so we just felt confident to bring it down but we think that’s the appropriate level for now but obviously the really value that’s throughout the year.
Got it and what do you think the incurred coming under your policy, is that close to 5%?
The last, every policy [indiscernible] agreed 2010 has really been less than 5% on the net of the basis. So we are looking 5.5% just because I would say kind of more, conservative vendor of the reasonable estimate but the last several policies have been really outstanding from the underwriting perspective.
Got it and then just back to the agent growth again since there was some of outside this past quarter, I guess if you would have to look at the relationship between the year over year growth in the direct revenue entitled versus the agency revenue, so usually those are track each other reasonably well on the likes basis. I guess this quarter you are up 18% year over year versus the 4% growth in direct in the fourth quarter, I guess how should we think about that relationship moving forward as you go through the year?
We still like it will definitely slow relative to the 18% growth. There are few things happening, I mean you correctly pointed out that the direct growth last quarter was 4%, so everything else being equal but you expect 4% growth in agency this quarter. I probably have rough guideline, the national agency and commercial agency trying to contribute roughly about 5% in addition to the 4 and then you have a rest of 9%. We don’t have the 10th level but we suspect that most of that is because of the TRID delay but obviously 18% is going to be difficult number ahead for the rest of the year.
And then lastly in terms of those commentaries about the 2000 order per day, was that an April trend, is there any data you have through the first couple of weeks of the months in terms of where open orders are coming in, purchase and refi?
The refinance trend is in April trend and it’s holding strong right now about 2,000 per day.
Got it and then purchase, are you starting to see any year over year growth, any open orders there yet?
We are starting to see it. So we are just kind of entering the bulk of the spring buying season. So we are optimistic about trying to see some transaction increase as we go forward here.
Our next question comes from the line of John Campbell with Stephens. Please proceed with your questions.
This is Hayden on for John Campbell. I was just wondering about the share repurchase and I think I saw you guys retired some shares may be early January but how many do you buyback before and what do you have left on that $250 million authorization?
We repurchased, it was just 14,000 shares this quarter and that’s something that we have disclosed in our fourth quarter earnings call. And we have about $182 million remaining on our share repurchase authority.
Got it, thanks and then I guess on the dividend, number of your competitors have been raising dividends over the past years or so, and I was wondering if you guys were still feeling pretty comfortable about targeting kind of 40% payout range and kind of how good you felt that potential dividend raises comes under the pipeline?
We did raises the dividend in the first quarter by a penny so that’s something that we saw just did for the year. Obviously that something that we talk about with the board every quarter, we are very profitable paying out 40% earnings in dividends and that’s kind of roughly where we have gained for the last two years or so. So I feel we are pretty comfortable at that level. And we will always continue to consider giving increases going forward.
Our next question comes from the line of Ryan Byrnes with Janney Montgomery Scott. Please proceed with your question.
Good morning everybody. Now you guys finally done your appraisal deal, from an M&A perspective, are there any other holes that you are looking at right now or should we imagine M&A going forward, we are focused on many agents?
It’s going to be balanced approach. Like we said in the past, we are going to continue to focusing on building out what we think is necessary terms and key agents and key states, so that will be an ongoing focus for us. On the other side, we will continue to look at some of the data assets where appropriate and we are going to continue build out some of the mortgage solutions offerings. So appraisal was a good step for us, we look to continue build out that quadrant too.
Okay great and then switching up a little bit, obviously the margins entirely were very strong in the quarter, it seems like a good chunk of the margin improvement was kind of coming from the other operating expenses again they were down about 8.5% year over year, while direct was down just under 2%. Is there anything, I know I think the press release noted that, again it was due to lower order count but also foreign exchange gains. Again, I just think that was real far improvement, just want to see if there any kind of one-time was in there if there was two times improvement?
The other one time that we had in other operating that we would point out is we did have a $4 million recovery that was basically a credit to other operating expenses. We also had a $4 million increase to our sort of health and dental that we know hit the personnel. So basically those two kind of lost out when we look at pretax but when we look at the other operating lines specifically, I would say that we did a $4 million benefit [indiscernible]
Our next question comes from the line of Geoffrey Dunn with Dowling & Partners. Please proceed with your questions.
Thanks, I wanted to follow up more specifically on the expenses. You said there was a 4 million benefit in operating and then 4 million in negative in personnel?
Alright. Can you get into little more granular details. You don’t see these kind of big quarterly changes often, you often had a very big one back in first quarter of ’14 I think, so is this largely variable cost on both sides? Are you seeing that much of a drop off in either pro fees and supply and title plants and that kind of stuff on the operating side and commission and bonuses on the personnel side. I am having trouble kind of adding up how big of a swing it is and try to getting an idea of how much is sustainable here?
I think the first quarter expenses are very good, run rate going forward I mean there is no real noise. When you look at between personnel and other operating expense at the bottom and we think it’s a pretty good run rate going forward. Obviously we have higher expenses as the year goes on just because of seasonality but when you look at our personnel line item, roughly 20% of the cost they are variable but other OpEx is much more variable. In the first quarter about 55% of the expenses and the other operating expense item variable. So it is sort of easier manage the expenses when we have a seasonal quarter in Q1.
So can you get color, may be what are some of the biggest movers sequentially within those two personnel and operating line?
On the personnel side, sequentially salaries were down 2% that is obviously the biggest driver of personal cost. So salaries is declining. From the other operating expenses, we have reduced legal fees, we also left commissions incentives just because of lower transaction activity, so those are some of the drivers that are going out.
And then a bigger picture question on kind of the mid to longer term outlook on commercial. The last several years have benefited from these tenure of maturities. How do we think about, how commercial trends into ’18 and ’19. So first part of that what percentage of commercial businesses is refi right now and how do you think about the sustainability of the revenue trend as we followed to a weaker tenure period in ’18 and ’19?
We don’t have great statistics on the purchase versus refi. purchase versus refi. Our sense is about a third of our business refi and commercials, about two-thirds are purchase. We get paid about the same, in terms of the our goal for purchase and refi commercial. We looked at the same stuff that you are probably looking at in terms of the CMBS business really kind of falling off starting of 2011 but CMBS is not a big part of our commercial business. CMBS is less 5% of our commercial business. So yes that’s going to have an impact post ’17 but it’s not going to be material impact to us.
[Operator Instructions]. Our next question comes from the line of Jason Deleeuw with Piper Jaffray. Please proceed with your question.
Just wanted to touch on your data business, you guys have been building out, so how do you guys seen adoptions with that market and then kind of following up with that what’s the leverage the four size acquisition with that data asset or what’s your plan there?
Couple of parts to that question. Continue to see much progress overall in our data business. We continue to believe that our data business is going to help our title insurance company to run efficiently and that help us control our losses, help us run a production line more efficiently. To that end we are happy to announce by the way that we just rolled out on a number of new plants in Texas which we think bring similar competitive advantage to that market for our own company and for our customers. So those efforts will continue.
Now your question on the appraisal side, we do think that we can use a public record data base to help augment the appraisal efforts to run more efficient appraisal so that would be part of our plans going forward.
Got it and then could you give us a sense of what kind of clients out there leveraging the data business and you are seeing any share gains there?
Our target on that is that again to come back and sell it to, integrate into our own company for our own efficiencies. That was the number one, and the number two we continue to try to leverage our title plan data to all of our customers which really are title oriented and then on the public record database as we try and leverage those back into our lender clients.
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 entering the conference ID number 13634408. The company would like to thank you for your participation and this concludes today's conference call. You may now disconnect.
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