First American Financial Corporation (FAF) Q3 2012 Earnings Report, Transcript and Summary

At this time, all participants are in a listen-only mode. After the presentation, we will conduct a question-and answer session. Today’s conference is being recorded. If you have any objections, you may disconnect at this time. 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 for a short time by dialing 402-220-4725. We will now turn the call over to Craig Barberio, Director of Investor Relations to make an introductory statement. You may begin.

Thank you Jeff. Good morning everyone and thank you for joining us for our Third Quarter 2012 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 may contain forward looking statements such as those described on pages five 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 described on page five of the news release. Management’s commentary contains and responses to your questions may also contain certain financial measures that are not presented according with generally accepted accounting principles including personnel and other expense, operating expense ratio and adjusted corporate net expense. The company is presenting these non-GAAP financial measures because they provide the company’s management and investors with additional insight into the operational efficiency and performance of the company relative to earlier periods and relative to the company’s competitors. The company does not intend for these non-GAAP financial measures to be a substitute for any GAAP financial information. In the news release that we filed today, we is available on our websitewww.firstam.com, the non-GAAP financial measures disclosed in management’s commentary are presented with and reconciled the most directly comparable GAAP financial measures. Investors should use these non-GAAP financial measures only in conjunction with the comparable GAAP financial measures. With that, I will now turn the call over to Dennis Gilmore.

Thanks Craig and good morning and thank you for joining our call. I'll begin with a review of the quarter highlights, followed by a few comments on the outlook for the fourth quarter in 2013. We continue to see strong revenue growth in 2012. Third quarter total revenues were 1.2 billion, up 25% compared to last year primarily driven an increase in refinance transactions and we continue to see a rebound in the resale market with transaction volumes up 8%. In addition, our commercial division delivered strong results with revenues 106 million up 19% compared to last year. Net income was 104 million or $0.95 per share. These results include net realized investment gains of $0.27 per share which were primarily due to the sale of the remaining stake in Core Logic. The title segment generated a pre-tax margin of 12.9% including the impact of net realized investment gains that increased the margin by 160 basis points. We continue to demonstrate significant operating leverage in the quarter even though our expenses were slightly impacted by a strong build in open title orders throughout the third quarter. Turning to the outlook. Third quarter open orders were up 29% and so far in October, open orders per day are running slightly ahead of September driven by strong refinance transaction. The increase in open orders combined with a strong commercial pipeline indicates that closed orders should remain strong throughout the fourth quarter. Our outlook for the fourth quarter and our performance year-to-date puts us firmly on track to deliver at or above the high end of our goal of an 8 to 10% title margin for full year 2012. Our financial performance has improved significantly in 2012 and we are optimistic to continue gradual improvements in the mortgage and real estate markets in 2013. Given our outlook, I am pleased to report that our board of directors approved a 50% increase in our quarterly dividend beginning in the fourth quarter to $0.12 per share. This increases doubles our dividend from the level we established at the spin off back in 2010. Looking ahead we remain committed to becoming the premier title in settlement search company in the US and our key markets abroad. We will maintain our efficient cost structure and continue to deliver strong margins while pursuing profitable growth in our title business. I'd now like to turn the call over to Max for a more detailed review of our financial results.

Thank you Dennis. The company generated total revenues of 1.2 billion in the third quarter, up 25% compared with the same period of last year. net income was 103.5 million or $0.95 per share compared with net income of 21 million or $0.20 per share last year. Net income in the quarter benefited from 47.3 million and net realized investment gains were $0.27 per share which was primarily due to the sale of our remaining position in Core Logic common stock. In the title insurance and services segment, total revenues were 1.1 billion, up 23% compared with the same quarter of last year. Direct, premium and escrow fees were up 29% this quarter, driven by a 35% increase in close orders which was partially offset by a 4% decline in the average revenue per order closed. Average revenue per order closed was $1,502 compared to $1,569 for the same quarter of last year. Agent premiums were up 21% which is comparable to the increase in direct premiums we experienced in the second quarter reflecting the normal reporting lag in agent revenues of approximately one quarter. Agent retention was unchanged at 80.2% of agent premiums. Information and other revenues totaled 158.8 million flat compared to the same quarter of last year. while US revenues increased 6%, they were offset by lower revenues in Canada due to a decline in mortgage transactions resulting primarily from the recent tightening of lending requirements. Total investment income for the title segment was 39.3 million, an increase of 21.1 million for the third quarter of 2011 reflecting higher net realized investment gains from the sale of Core Logic common stock that was held at our primary insurance underwriter. Personnel costs were 317.2 million up 16% compared with the same quarter of last year. this increase was primarily due to higher incentive based compensation driven by improved revenues and profitability and to a lesser extent higher staffing levels required to support the increased order volume compared to the prior year. Other operating expenses were 197 million, up 12% from the same quarter of last year. this increase was primarily due to higher production related expenses and temporary labor costs in response to higher order activity. The ratio of personnel, another operating expenses to net operating revenue declined to 73% from 77% last year reflecting significant operating leverage. In the third quarter, the provision for title losses was 6.6% or premium and escrow revenue reflecting an ultimate loss rate of 5.6% for the current policy year and a net increase in the loss reserve estimates for prior policy years. Year-to-date incurred plans were down $26 million and paid claims were down $18 million compared to last year. we expect this positive trend to continue as a high loss policy years of 2005 through 2008 become more seasoned. We’re also encouraged by the positive results we continue to see from our most recent policy ears, 2009 through 2012. Pre-tax income for the title insurance and services segment was 141.9 million generating a pre-tax margin of 12.9% compared to 52.8 million and 5.9% last year. The current quarter includes net realized investment gains that increased the pre-tax margin by 160 basis points while the third quarter of 2011 includes net realized losses that reduced the pre-tax margin by 20 basis points. Turning to the specialty insurance segment, total revenues was 81.4 million up 10% compared with the same quarter of the prior year. the loss ratio was 61% compared to 60% last year. Net realized investment gains increased by $2 million and as a result, the third quarter pre-tax margin was 10% up from 9.2% last year. pre-tax income for corporate was 5.9 primarily a result of a $25.4 million gain from the sale of Core Logic stock held at the holding company. Excluding the sale of the stock, corporate net expense was 19.5 million in line with our expectation of 20 million per quarter. Our tax rate in the third quarter was 33.3% reflecting adjustments related to the company’s ability to claim foreign tax credits. Year-to-date, the company’s tax rate is 34.8%. going forward, we expect our normalized tax rate to be approximately 38%. With that, I will turn the call over to Mark.

Thank you Max. I will provide a few comments on our capital and liquidity. Cash provided by operations in the third quarter was $147 million, an increase of 82 million relative to the third quarter of last year. the increase in operating cash flow was driven by improved earnings, reduced working capital and a 11% drop in paid title claims. Capital expenses during the quarter were $21 million, up from 19 million in the same quarter last year, primarily due to an increase in IT related initiative. Our cash and investment portfolio totaled 3.7 billion as of September 30th, which includes 1.4 billion of fiduciary funds. The portfolio is comprised of debt securities of 2.5 billion, cash and short term deposits of 833 million, equity securities of 178 million and a 193 million in less liquid long term investments. Overall, we continue to have a high quality portfolio. Debt on our balance sheet totaled 272 million as of September 30th. Our debt consists of 200 million funded on our current facility, 42 million of trustee notes, and 30 million of other notes. Our debt to capital ratio as of September 30th was 10.7%. During the third quarter, we sold our remaining stake in Core Logic at an average price of $23.28 per share. This sale generated proceeds of $208 million of which 70 million was received by our primary insurance subsidiary and a 138 million was received by the holding company. The fund that the regulated insurance companies have been reinvested into our portfolio as they contribute towards the capitalization of our underwriter. The fund that the holding companies have been used to pay down $140 million on our credit facilities subsequent to the end of the quarter. Although we intend to increase our debt to capital ratio over time, paying down the credit facilities generated the best immediate return. I would now like to turn the call back over to the operator to take your questions.

(Operator Instructions). Our first question of the day comes from Mark DeVries with Barclays Capital.

Why was the information other revenue line down 5% Q over Q? is there some seasonality to that that we should be aware of?

Actually what's happening up there, it’s really being at the back of our Canadian operation? They’ve tied down credits down as pretty aggressively in Canada which has driven down the transaction volumes and so that's what caused our revenue to be down and or flat in that category. We’re going to watch it very closely and we’ll adjust our cost if we need to.

Okay and do you view that as more of a kind of a recurring impact on that business with the volumes or might that snap back or what do you expect there/

We’re just going to watch it. At this point I think it’s going to be more recurring. But again, we’re going to watch the market very closely.

Sorry if you gave this, but did you provide the purchase refinance of your closed orders in the quarter?

Yes, the mix in the quarter, well in terms of the close, I'll just give you the monthlies in July was 64%, in August it was 65, September it was 67 and October it was 66%. That's the mix of closed orders that were refund. For the quarter it was 65%.

And how did that compare that mix remind us to second quarter? It was a little heavy at refi?

Yes it’s a little bit heavy at refi. In the second quarter, in terms of closed orders it was about 60% refi. So closed orders, the mix has gone up in the third quarter.

Okay so follow up to that, to what do you guys attribute I guess the feed profile was actually up a little bit in the Q for Q basis even though I guess refi was a higher percentage of mix. Do you have an explanation for that?

I mean you’d think the average revenue quarter would be lower as you mentioned because of the higher refinance but we really saw a significant increase in the average revenue per commercial order which was up 15%. So that was really what drove the increase in ARPUs. We’re just closing figure commercial deals that we did last quarter.

Okay and then finally, could you just elaborate on your decision to sell all of the Core Logic stock this quarter, what was the thinking behind that?

Sure, if you recall, this was part of our capital strategy when we spun the company. We had five years to sell that investment and it was our assessment that Core Logic had performed well and it was an appropriate time to sell the remaining holdings.

Our next question comes from Jim Ryan with Morningstar. Your line is open.

I have a question regarding HAMP mortgages. Can you track or give any information as to what percentage of the third quarter refis were due to HAMP. And then as a follow up to that, from what I have read, there is still quite a few HAMP eligible loans out there. What's your thoughts on that?

Firstly, first part of your question. We’re running right now in the 15 to 20% range on the HARP refinance program right now. And your second part of your question, we've read the same thing that there could be a million loans potential still left that are eligible for refinancing under HARP. At this point we’re optimistic, we’re optimistic the program will run a little longer than we initially thought. So we think it will go all the way through the of and into 2013.

And then one longer term question. Once the refi boom starts trailing down, how do you think in terms of managing your cost? I mean there has been so much automation, is there that much staffing that can be reduced to reflect the huge fall-off in refis or anything like that?

Really what will happen there is it depends on the speed of the transition from a refinance to purchase market, but irregardless, we intend to adjust our cost structure depending on whatever market we’re operating in. but let me probably comment on how we look at ’13 right now. We envision ’13 to have a better refinance mix than we initially anticipated and we envision ’13 to have an improved actual resale market. so at this point, we’re becoming progressively more optimistic on our prospects for ’13.

Our next question comes from Bose George with KBW. Your line is open.

Just given your comment on the margin impact of higher open orders, I mean is it fair to assume that the margins could trend up a bit as gap between and close and open orders converge, assuming the mix between purchase and refi is stable?

Yes we saw that dynamic actually hit us this quarter. We thought it was a good quarter with good operating leverage in the business but the good news was, we were building inventory throughout the quarter which really in our business that means your expenses are front loaded to penning the order and we’ll see the benefit of those expenses in our closed orders in the fourth quarter, probably impacted us about half a point in margin in the third quarter.

And then as you just for the Canadian business, can you just remind us what percentage of the premiums are coming from that business?

It’s a very small number but it shows up in the information line, that's why you’re seeing the impact. It’s not a significant number for us in the overall business. Less than 10%.

Our next question comes from Brett Huff with Stevens Incorporated. Your line is open.

Just quick follow ups, on the (inaudible) I think somebody asked you sort of the details of this quarter. What is your sense for next quarter given what you know now and maybe even any commentary you might have on next year on the (inaudible).

Well typically I would say, in the fourth quarter we expect it to inch up slightly from where it is in the third quarter. Just given the fact that fourth quarter is typically a strong commercial quarter and as you know those have higher fees profile. So we would expect it to be slightly higher but not significantly higher in the fourth quarter.

And then on the backlog question, Denis I think you mentioned that you guys are kind of building an open inventory and expect that to close. When you talk to your bank partners or your bank customers, are they also in a position where they have some open inventory and they are going to see some loans close. I mean are the banks mirroring what your inventory is I guess?

Just as a broad sense I would say yes. Everybody is very busy right now. Everybody’s inventory is at high levels and so we think that the build that we’re seeing from October even into September will continue and we think that we’ll see and our closing ratios by the way are very similar to what we've been seeing. So business is closing. It’s just full pipelines right now.

And then on the incremental margins you mentioned that you were pleased with those, when I do the math it looks like they were about 35 or 40%. I think in the past you felt comfortable with that range. How long is that sustainable as you think through what your demand curve, what you guys think the demand curve looks like next year?

We’re going to continue to run in those kind of ranges, if not, we’re going to try to improve upon them. So that's how we’re running the business right now. They’ll probably come back down to soon, when we transition more from a refinance or purchase markets, so we’ll just have to watch it as we go through that process but we’re comfortable with those kind of leverage ranges.

And then in terms of staff you mentioned that, it sounds like there was some temp folks you had to hire and even maybe permanent staff, you staffed up. Can you give us a sense of I guess maybe sequentially or whatever metric you might want to use in terms of production staff as a result of the higher refi volumes, what you guys had to do?

Yes just in the last, since the second quarter, we have had to staff up a little bit the service to orders. We fired about 200 employees and about 110. And the 10 show up in other operating expenses, so it will be split between the two line items.

This concludes today’s question and answer session. and 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 402-220-4725. The company would like to thank you for your participation. This concludes today's conference call. you may now disconnect.