Q3 2023 First American Financial Corp Earnings Call
Participants
Craig Barberio; VP of IR; First American Financial Corporation
Kenneth David DeGiorgio; CEO & Director; First American Financial Corporation
Mark Edward Seaton; Executive VP & CFO; First American Financial Corporation
Bose Thomas George; MD; Keefe, Bruyette, & Woods, Inc., Research Division
Geoffrey Murray Dunn; Partner; Dowling & Partners Securities, LLC
John Robert Campbell; MD & Research Analyst; Stephens Inc., Research Division
Mark Douglas Hughes; MD; Truist Securities, Inc., Research Division
Soham Jairaj Bhonsle; VP & Residential Housing Services Analyst; BTIG, LLC, Research Division
Presentation
Operator
Greetings, and welcome to the First American Financial Corporation third quarter earnings conference call. (Operator Instructions) A copy of today's press release is available on First American's website at www.firstam.com/investor.
Please note that the call is being recorded and will be available for replay from the company's investor website and for a short time by dialing (877) 660-6853 or (201) 612-7415 and enter the conference ID 13741673.
We will now turn the call over to Craig Barberio, Vice President, Investor Relations, to make an introductory statement.
Craig Barberio
Good morning, everyone, and welcome to First American's Earnings Conference Call for the Third Quarter of 2023. Joining us today on the call will be our Chief Executive Officer, Ken DeGiorgio; and Mark Seaton, Executive Vice President and Chief Financial Officer.
Some of the statements made today may contain forward-looking statements that do not reflect -- or relate to strictly to historical or current fact. These forward-looking statements speak only as of the date they are made, and the company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made.
Risks and uncertainties exist that may cause results to differ materially from those set forth in these forward-looking statements. For more information on these risks and uncertainties, please refer to this morning's earnings release and the risk factors discussed in our Form 10-K and subsequent SEC filings.
Our presentation today contains certain non-GAAP financial measures that we believe provide additional insight into the operational efficiency and performance of the company relative to earlier periods and relative to the company's competitors. For more details on these non-GAAP financial measures, including presentation with and reconciliation to the most directly comparable GAAP financials, please refer to this morning's earnings release which is available on our website at www.firstam.com.
I would now like to turn the call over to Ken DeGiorgio.
Kenneth David DeGiorgio
Thank you, Craig. The rapid increase in interest rates to levels not seen in many years, continues to produce challenging market conditions. With housing affordability currently at its lowest point in over 3 decades, existing home sales this year have declined to the slowest annual pace since the global financial crisis. Moreover, sales volumes in the commercial market have reverted to pandemic low levels and are down approximately 50% from the peak year of 2021.
Despite these historically difficult conditions, our continued focus on expense management and strong growth in net investment income enabled us to deliver a pretax title margin of 12% on an adjusted basis. On a consolidated basis, we generated adjusted earnings of $1.22 per diluted share. Our residential purchase business continues to reflect these market headwinds, but appears to have stabilized at trough levels. For the first 3 weeks in October, open purchase orders are down 7% compared with September, which is consistent with normal seasonality, but are up slightly compared with the prior year. While this performance is mostly driven by a historically low comparison period, it also reflects the results of our industry-leading homebuilder division and is further indication that the market has stabilized.
Refinance open orders remained at trough levels in the third quarter, averaging 350 per day, a level they have held all year. Given the current pool of mortgage loans outstanding and the outlook for interest rates, it remains unlikely we will see a significant uplift in refinance in the foreseeable future.
Our commercial business revenue declined 39% compared with last year, consistent with the first half of the year. Average revenue per order also declined again this quarter for the fifth consecutive quarter, which suggests that price discovery is well underway as the market corrects. Commercial open orders for the first 3 weeks of October are down 5% compared with last year and are down 3% sequentially. There is still a high degree of uncertainty concerning the commercial market. However, based on our market intelligence, we continue to expect higher commercial revenues in the fourth quarter, which is consistent with the normal seasonal pattern.
While our key purchase commercial and refinance markets appear to have troughed, we expect the difficult market conditions to persist well into next year. Despite the uncertainty of the timing of a recovery in these markets, the strength of our business, along with our financial discipline and strong balance sheet allow us to continue to invest for long-term growth while returning capital to our shareholders. This quarter, we raised our common stock dividend by 2% to an annual rate of $2.12 per share. We also repurchased $9 million of our shares in the third quarter and have accelerated our purchases in October, already purchasing an additional $9 million of our common shares.
In closing, given the importance of people to our business, I am pleased that First American has been named one of the best workplaces for women by Great Place to Work and Fortune Magazine for the eighth consecutive year. This accomplishment is a tribute to our workforce, approximately 2/3 of which are women. I'm proud that First American's commitment to advancing the careers of women and our world-class culture enable us to achieve this recognition year after year.
Now I'd like to turn the call over to Mark for more detailed discussion of our financial results.
Mark Edward Seaton
Thank you, Ken. This quarter, we generated a loss of $0.02 per diluted share. Our adjusted earnings per share was $1.22. Our adjusted earnings exclude net investment losses of $164 million, primarily due to unrealized losses recognized in the venture portfolio and changes in the fair market value of equity securities as well as purchase related intangible amortization of $10 million. As of September 30, the book value of our venture portfolio totaled $301 million, which equates to approximately 7% of our equity and 2% of our total assets.
Revenue in our title segment was $1.5 billion, down 19% compared with the same quarter of 2022.
Commercial revenue was $160 million, a 39% decline over last year. Our average revenue per order for Commercial transactions declined 15% this quarter to $10,763 due to a combination of fewer large transactions and lower valuations as prices in the commercial market reset. Purchase revenue was down 15% during the quarter, driven by an 18% decrease in the number of orders closed, partially offset by a 3% increase in the average revenue per order. Refinance revenue declined 41% relative to last year due to the increase in mortgage rates.
In the Agency business, revenue was $665 million, down 27% from last year. Given the reporting lag in agent revenues of approximately one quarter, these results reflect remittances related to Q2 economic activity. Our information and other revenues were $240 million, down 14% relative to last year. This decline was the result of lower transaction levels across several business units driven by the company's data and property information products and post close and document generation services.
Investment income within the Title Insurance and Services segment was $142 million, a 35% increase relative to the prior year. The increase was primarily due to rising interest rates, which drove higher investment income from the company's cash and investment portfolio, escrow balances and tax-deferred property exchange balances. The impact of higher interest rates was partially offset by lower average balances, primarily in the company's escrow and tax deferred exchange balances.
We continue to manage expenses given the decline in transaction activity. Our success ratio was 50%, meaning that our personnel and other operating expenses declined $127 million, and our net operating revenue declined $253 million. The provision for policy losses and other claims was $35 million in the quarter or 3.0% of Title premiums and escrow fees, down from the 4.0% loss provision rate in the prior year and down from the 3.5% loss provision rate in the first half of this year. The 3.0% loss rate reflects an ultimate loss rate of 3.75% for the current year with a $9 million release for prior policy years.
Over the last several quarters, we have highlighted the margin drag in the title segment related to 3 strategic initiatives: ServiceMac, Endpoint and instant decision for purchase transactions. This quarter, these initiatives together generated a pretax loss of $12 million, impacting our pretax title margin by 110 basis points, an improvement from the 130 basis point drag in Q2, primarily driven by deep boarding fees received by ServiceMac. Pretax margin in the title segment was 10.5% or 12.0% on an adjusted basis.
Total revenue in our home warranty business totaled $108 million, a 3% increase compared with last year. Pretax income in home warranty was $9.4 million, up 124% from the prior year. The loss ratio in home warranty was 55%, down from 59% in 2022, driven by lower frequency and severity of claims. The effective tax rate for the quarter was 29.4%, higher than our normalized rate of 24%, due primarily to the mix of income between our insurance and noninsurance businesses since our insurance business generally pays state premium tax in lieu of income taxes.
In the third quarter, we repurchased 161,000 shares for a total of $9 million at an average price of $57.87. So far in October, we have ramped up our purchases buying 162,000 shares for $9 million at an average price of $52.90. Our debt-to-capital ratio as of September 30 was 29.7%. Excluding secured financings payable, our debt-to-capital ratio was 23.5%.
Now I would like to turn the call back over to the operator to take your questions.
Question and Answer Session
Operator
(Operator Instructions) Our first question comes from the line of John Campbell with Stephens.
John Robert Campbell
I just want to I heard you correctly on the order commentary for October. You said that purchase is trending up year-over-year thus far in October?
Mark Edward Seaton
Yes. So purchases, it's up slightly for the first 3 weeks in October, very slightly. And a lot of it is driven because included within the purchase transactions is resale, which is most of them. And we also have new homes and new homes is performing pretty well. So when you mix those 2 together, yes, we do have a slight increase in purchase, which is nice to see the lines cross here.
John Robert Campbell
Yes, absolutely. I mean just given the backdrop of continued upward pressure on rates, that's a great outcome. New home sales, I think, maybe a little bit less than 10% of the national mix. What does that look like for you guys a little bit higher?
Mark Edward Seaton
It's a little bit higher. Historically, the long-term average is about 13% of our purchase orders are new home related. So far in October, they're 19%, a little overweight. So that's -- our mix is a little bit higher than the average.
Kenneth David DeGiorgio
I'd add to that, John. I mean one thing to keep in mind, we have an outsized share of the market in new home, which obviously is a good competitive advantage for us.
John Robert Campbell
Yes, absolutely. And then last question here on the interest expense. That's obviously been up a good bit the last 2 quarters. I wanted to get a better grip on that. I know that's influenced by the bank deposits. So maybe if you could unpack that kind of you could decouple those 2 items, just underlying interest expense versus the bank effect? And then how we should be thinking about the run rate of interest expense here, just assuming that rates stay near current levels?
Mark Edward Seaton
As a general statement, when you look at interest expense in our Corporate segment, it runs $12 million, $13 million a quarter, and that's really primarily the interest expense that we pay on our bonds. We also have interest expense in our title segment. And that's really driven by kind of the cost of funds in our banking operations, both at our bank, First American Trust as well as our warehouse lending business pays interest expense too. So those are the 2 components that make up our -- the $23.5 million of interest expense we had in the title segment this quarter.
Operator
Our next question comes from the line of Soham Bhonsle with BTIG.
Soham Jairaj Bhonsle
I guess the first one, just on investment -- on the interest income. Can you just, Mark, maybe update us on the year here? And then just maybe help us size what needs to be replaced from sort of the roll-off in ServiceMac? And how quickly you'd be able to sort of do that?
Mark Edward Seaton
Yes. Thanks for the question, Soham. So in terms of the year, I mean, we're -- obviously, we're 3 quarters done. When we look at Q4, we think based on what we're seeing now, investment income should dip a little bit in Q4, a few million -- $5 million-ish, let's say, plus or minus. And most of that is just driven by the fact that we did lose these Home Point loans, which we've talked about for a couple of quarters. And in the last 30 days or so, we've lost about $300 million of deposits related to that, which was really earning, let's call it, Fed funds. So that's kind of the headwind that we're going to see in the fourth quarter in terms of our investment income. I will say that about 75% of that, though, is going to be a reduction in interest expense in the title segment too. So it's not all fall to the bottom line, but about 25% of it will.
Soham Jairaj Bhonsle
Okay. And then on Endpoint, Ken, I think you've previously talked about the opportunity there sort of being twofold, right? Like where you could potentially get some efficiency gains, but then there's also sort of this enabling of better customer service. I was hoping you could maybe dig a little bit deeper on the efficiency piece of the value proposition there. What sort of efficiencies do you sort of envision? And how does that maybe translate to margins versus, call it, the legacy title business?
Kenneth David DeGiorgio
Yes. Thanks for the question. I mean I think it's early days to exactly measure the efficiencies. But we anticipate sort of increasing the efficiency of an escrow officer fairly substantially. Again, it's hard to put a number on that at this point. But we know there will be efficiency gains as we automate some of the more mundane and tasks that an escrow officer does and freeze them up to do the more people intensive -- and people-intensive task. And there's also other sort of efficiencies that we'll gain. And we have already started gaining from Endpoint just by deploying some of their technology in other parts of our company. We've mentioned in the past about JOT, which is our mobile notary management systems. We relied on third parties for that in the past. We're now able to do it more efficiently in-house and have made a lot of progress rolling that out in the direct division. It will probably be fully rolled out in the direct division sometime next year.
Soham Jairaj Bhonsle
Okay. And just one more, Mark. I think on the loss provision rate, I guess, you lowered it 25 basis points. But as we sort of go into next year and we potentially are in a more sort of uneven macro environment, right? I mean, how are you thinking about that on that line, I guess?
Kenneth David DeGiorgio
This is Ken. I'll start on that. And yes, we did lower the loss rate. And one thing I'll point out, as you recall during the pandemic, we actually took the rate up which I think reflects our pretty conservative approach when it comes to building our reserves. The concerns we had when we did that in the pandemic didn't come to fruition. Some of the concerns we had during the current market also haven't come to bear. So we've built an extremely healthy level of reserves. In fact, we're probably pushing the upper bounds. I mean -- and I want to emphasize the upper bounds of reasonableness. And we think it was the right time to decline it. So we obviously continuously monitor our reserving level. The situation could change. But I think more directly to your question, I think you could probably expect this rate to prevail at least through 2024.
Operator
(Operator Instructions) Our next question comes from the line of Bose George with KBW.
Bose Thomas George
So first question, just on the deboarding fees from ServiceMac, how much was that this quarter? And is there more of that to come before that fully rolls off?
Mark Edward Seaton
Yes. Bose, so this quarter, we had a $3 million benefit because of deboarding fees. And roughly about 40% of the loans were deboarded. So we have another, call it, 60% to come at some point next year. We're not exactly sure about the timing.
Bose Thomas George
Okay. Great. And then can you just talk about capital return priorities? Could we see the cadence of the buybacks pick up? And just also from a leverage standpoint, what -- is that a constraint you keep in mind, just curious how you're thinking about it more broadly.
Kenneth David DeGiorgio
Thanks for the question. I'll start, Bose, obviously, as we talked about earlier, we've accelerated the pace of buybacks. We've already in October bought back shares at the same pace we did in the entire third quarter. And right now, I think our stock is attractive. We've accelerated repurchases, and we think it's very attractive. But obviously, we way repurchases against other uses of capital, such as reinvesting in the business and M&A. But we're obviously committed to return capital to our shareholders, and we think buybacks right now are a pretty attractive alternative.
Mark Edward Seaton
And Bose, I'll just comment on the debt leverage part of that question. So our debt to cap, we look at it excluding secured financings payable because there's sort of gross up there. And if you do that, it's 23.5% this quarter. We've talked about like 18% to 20% being our long-term target. But we're very comfortable, especially here at the trough of the market being higher than our target. So 23.5% is a very comfortable place to be. I think particularly since when you look at the balance sheet, we've got $1 billion of AOCI, and we feel really great about the credit there. So we think that's temporary and now I'll just kind of help our debt to cap as we go along. So we're in a very comfortable place in terms of our debt right now.
Bose Thomas George
Okay. Great. Just one more. In terms of investment income, if the investment income is coming from deposits at your bank versus escrow that you send to third parties, does it make a difference on the return or you kind of agnostic in terms of that? Or could you sort of increase one or the other if the returns are better?
Mark Edward Seaton
There is a difference. I mean, typically, when we give our deposits to third-party banks, the general rule of thumb is that we'll typically earn Fed funds. When we invested at the bank, our cash that's at the bank will earn Fed funds. And then the rest of it, most of the escrow deposits we push to the bank, we buy mortgage-backed securities. And so we're really getting kind of a mortgage-backed security rate as opposed to Fed funds. And sometimes that could be higher and sometimes that could be lower. And Fed funds right now is lower just because of the fact that rates have risen.
Operator
Our next question comes from the line of Geoffrey Dunn with Dowling & Partners.
Geoffrey Murray Dunn
I'm hoping you could talk a bit about commercial market. In particular, where are the large deals down the most? I'm assuming it's office, but I'm interested in a little more color. And more importantly, where are the areas that you're seeing opportunity versus drag outside the office market?
Mark Edward Seaton
Well, a couple of things I'd say. First of all, when you just look at the large deals, we had 4 what we call mega deals with premium over $1 million this quarter. And a year ago, it was 7. We're not seeing the same level of large deals. The large deals that we are seeing are really half of them are multifamily. We had another one that was just a development site. But generally speaking, I would say the large deals are -- we're just -- at least, just not there this quarter. In terms of our top asset classes like where we see in business, multifamily is 22% of our commercial revenue. So we're seeing a lot of activity there. Industrial has always been strong even through the pandemic. It's 17% of our revenue. And then development sites, which is for these greenfield sites at 16%. So those are our top 3. Retail is 10%. Office, you mentioned that, Geoff, office is 5%. So that gives you a little bit more flavor in terms of our revenue. Now that doesn't all add up to 100, there's other asset classes we got add. We've got energy, hospitality, but I referenced the big ones.
Kenneth David DeGiorgio
The thing I would add too, Geoff, in terms of sort of the outlook going forward on asset classes, I think probably the more attractive ones are going to be the ones where we've already seen the most price discovery like suburban office and multifamily and energy is also probably going to be a big asset class for us. And then thinking back on multifamily and when I say suburban office, it's going to be anything that's going to be outside of the big CBD areas. You're just not going to -- the central business districts are under strain right now for obvious reasons.
Geoffrey Murray Dunn
Great. So as you look out to '24, your commentary is cautious in your press release. What is your #1 concern? Is it commercial? Is it direct resi? What one is more uncertain at this point in your mind?
Kenneth David DeGiorgio
Well, I mean I'm uncertain and concerned about all of them, except refi, I know that's not going to get better. So I think there's concern in all of them. I think if you have forced me to way the two, I'm probably a little more optimistic about Commercial, just because I feel like we're making our way through this price discovery. And I think we anticipate to see transaction levels tick up a little bit in commercial next year, albeit keep in mind at lower prices.
So we'll see more orders, but they'll be at lower prices given this price discovery. But we're cautious about all of it into 2024. Now we may get some relief if interest rates go down, when I last checked the forward curve, which was yesterday, I don't know where it is today, where they had 3 rate decreases next year, beginning in the middle of next year. Now the forward curve is historically inaccurate. But if that comes to fruition, that will help, but that's middle to end of next year.
Operator
Our next question comes from the line of Mark Hughes with Truist Securities.
Mark Douglas Hughes
I'm not sure if this may be too granular, but I'm curious whether you saw any impact in the purchase market through these weeks of October with the interest rate fluctuations.
Kenneth David DeGiorgio
No, we haven't seen it, Mark. And it's been a little surprising because when you look at the -- when you look at our purchase orders, they've been following the typical long-term seasonality pattern all year long. So we're -- our purchase orders on the residential side, I mean they're at low levels now, but they haven't gotten any worse. They're getting worse now just because of seasonality. But when you look at the normal seasonality curve for the last 9.5 months, it's been right on the normal curve, and that's surprising, especially recently, given the fact that mortgage rates have climbed particularly in the last 90 days here, we're tackling 8%. So -- but to answer your question, no, we haven't seen any falloff in purchase orders because of the recent climate rates.
Mark Douglas Hughes
And then in the warranty business, I think I've heard you say that direct-to-consumer has been a good channel with real estate being weak. How -- is that holding up? Are you seeing success there?
Kenneth David DeGiorgio
Yes. I mean we are, in general, seeing success with DTC. And I think we've demonstrated, if we turn the dial up on our marketing expense, we see the almost -- well, we see the immediate impact on contracts and DTC though it takes some time for profitability to be realized. I think the story with the home warranty is that they've done a really good job of managing claims in an inflationary environment. So that's been helping. Frequency is down because of lower policy counts, but severity is down. And then we're realizing more and more of the time goes on, the benefit of some pricing actions we've taken. So we're pretty -- we're very positive on home warranty, and we're real positive on the strides that, that group has made on the DTC channel. So there's real opportunity there.
Mark Douglas Hughes
Understood. And then finally, any update on instant decisioning either from the rollout potential benefit expense standpoint?
Kenneth David DeGiorgio
Yes. It's still early days there, though we are anticipating rolling out 2 markets on a test basis at the beginning of next year. So they're hitting their milestones and we're real positive about that. And as we've mentioned in the past, the great thing is it's hard to do. It's impossible to do if you don't have the data, and we've got more data than anyone. And so it's -- we're -- it's trending well.
Operator
Thank you. We have reached the end of the allotted time we had for questions. And 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 (281) 612-7415 and enter the conference ID 13741673. The company would like to thank you for your participation. This concludes today's conference call. You may now disconnect.
