First American Financial Corp (FAF) 2011 Q1 法說會逐字稿

Welcome and thank you for standing by. 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 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 203-369-1842. We will now turn the call over to Craig Barberio, Director of Investor Relations, to make an introductory statement.

Good morning, everyone, and thank you for joining us for our first-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 may contain forward-looking statements such as those described on pages 4 and 5 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 take 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 pages 4 and 5 of the news release.

Management's commentary contains, and responses to your questions may also contain, certain financial measures that are not presented in accordance with Generally Accepted Accounting Principles, and including an adjusted loss provision rate. The companies presenting these non-GAAP financial measures because they provide the company's management and investors with additional insight into the operational 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 Form 8K that we filed today, which is available on our website, www.firstAM.com, the non-GAAP financial measures disclosed in management's commentary are presented with and reconciled to the most directly comparable GAAP financial measures. Investors should use these non-GAAP financial measures only in conjunction with the comparable GAAP financial measures.

I will now turn the call over to Dennis Gilmore.

Thank you, Craig.

First American posted a net loss of $15 million or $0.15 per diluted share this quarter. Our results reflect the $45 million reserve strengthening charge for our Canadian operations, which reduced our EPS by $0.26. This charge is in connection with a guaranteed valuation product that we sell exclusively in Canada. This product, which is small from a revenue perspective, guarantees the accuracy of the valuation of a property as of the date the loan was made. Again, we only guarantee the value of the collateral and only as of the date the loan was made. It is sold only on loans with LTVs of 80% or less, and it is underwritten using the preeminent property risk assessment tool.

While the product appeared to perform well for years, during 2010, we began to see an increase in claim activity. At the end of the first quarter of 2011, we observed a meaningful increase in claim activity, which led our internal actuary to determine that a reserve strengthening was necessary. We are disappointed with the product, and we are canceling it in its current form, and we're looking to reinsure a modified version. If we can't reinsure all or most of the risk, we will terminate it completely.

In addition to the reserve strengthening in Canada, we also strengthened our US reserves by $15 million due to increased claim activity for prior policy year.

Our open order accounts were down 17% relative to the fourth quarter, primarily due to lower refinance volumes. The impact of the decline was offset by a reduction in personnel and other operating expenses totaling $50 million. Our commercial title business continues to perform well with revenues up 35% over last year. In the first quarter, we had our highest open order counts since 2008.

First American Mortgage Service, which includes our national lender and default businesses, had a very good quarter. Our national lender operations are focused on large lender refinance channels, and we believe this business is gaining market share with revenues up 11% compared to last year.

In default, our revenues were down 18% from the first quarter of 2010, but on a sequential basis, revenues were up 11% in the first quarter of 2011.

Our Specialty Insurance segment generated pretax earnings of $12 million this quarter for an 18% margin. Both our home warranty and our property and casualty businesses performed well.

Regarding capital management, there were two noteworthy developments in the quarter. In March, our board authorized $150 million share repurchase program. And in April, we sold 4 million shares of our investment in CoreLogic, which represents approximately a third of our position. Given the conditions we see in the market, we will continue to maintain a conservative balance sheet.

Specific to current market conditions, March open orders were up 4% from February, and April orders are trending slightly down from March. While resale orders are up slightly in April, overall, the spring selling activity has been off to a slow start.

Looking forward, we will continue to manage our expenses and drive efficiencies across our business. The majority of our future expense reductions will be market driven, as we believe that the mortgage and real estate markets are nearing a bottom and we are positioning the company for future growth.

I would now like to turn the call over to Max Valdes, who will provide a more detailed review of our financial results.

Thank you, Dennis. The company generated total revenues of $932 million for the quarter, up 3% from the same quarter the prior year. Net loss for the quarter was $15.3 million or $0.15 per share compared with net income of $13.8 million or $0.13 per share for the same quarter of the prior year. As Dennis mentioned, the results for the current quarter included a $45 million reserve strengthening charge in our Canadian operations, which totaled $27 million on an after-tax basis or $0.26 per share.

In the Title Insurance and Services segment, total revenues for the quarter were $861 million, up 3% compared with the same quarter of the prior year.

Title premiums and escrow fees were $697 million for the quarter, up 4% compared with the same quarter of last year.

Direct revenues were flat, driven by an 8% decline in closed orders, offset by higher average revenues per order closed.

Average revenues per order closed increased 8% to $1,337 compared to the same quarter of last year. This increase primarily reflected the strength of our higher premium commercial title business, partially offset by the increase in lower premium refinance transactions.

Agent premiums were up 7% in the quarter, primarily due to the normal reporting lag of approximately one quarter. As a result, higher agent remittances this quarter were consistent with the increase in the company's direct premiums and escrow fees in the fourth quarter of 2010 relative to 2009.

Information and other revenues totaled $149 million for the quarter, up 3% compared to the same quarter of last year. This line item includes title plan information, search products, appraisal, and other related revenue.

The increase in the quarter was driven by increased demand for title plan information, partially offset by reduced demand for the company's default and international information products.

Investment income totaled $17 million for the quarter, down 11% compared with the same quarter of last year.

This decrease was primarily due to lower interest earned on the investment portfolio. We incurred net realized investment losses of $1.4 million for the quarter compared with net realized investment gains of $2.7 million for the same quarter of last year.

Personnel costs were $264 million for the quarter, up $2.3 million or 1% compared with the same quarter of last year. This increase primarily reflects the higher commissions paid as a result of improved commercial activity that was largely offset by a reduction in US headcount and lower health care-related expenses in the current quarter.

Other operating expenses were $173 million in the quarter, down 4% from the same quarter of last year. Lower office-related costs and a decline in bad debt expense in our default business were the primary drivers. These declines were partially offset by increased production-related expenses as a result of improved commercial activity and a shift to lower-margin products in the company's default business.

Agent retention was 80.0% of agent premiums compared with 80.6% in the first quarter 2010.

The improvement in agent retention was largely due to a large commercial transaction with a favorable agent split that closed in the current quarter. Nonetheless, we continued our efforts and progress on improving agent splits across a number of markets.

The provision for title losses was $96 million in the first quarter or 13.8% of premium and escrow revenue compared with 5.9% in the same quarter of 2010.

The $45 million reserve strengthening charge for the company's Canadian operations was, by itself, 6.5% of premium and escrow revenues for the quarter. The reserve strengthening charge was primarily driven by policy years 2007 and 2008. We base the reserve strengthening adjustment on our internal actuary's best point estimate, which was well above a third-party actuary's estimate.

Excluding the reserve strengthening charge in Canada, the loss provision rate in the current quarter was 7.3% of premium and escrow revenue, reflecting an expected ultimate loss rate of 5.2% for the 2011 policy year, and a net increase in the loss reserve estimates for certain prior policy years, primarily 2007. We continue to book to our actuary's best point estimate.

The company's title insurance segment generated a negative pretax margin of 2.2% in the quarter compared to a positive 3.2% for the same quarter of last year.

Switching gears, our Specialty Insurance segment continued to perform well. Total revenues were $69 million, essentially flat, compared with the same quarter of last year. Total expenses were down 4%, primarily driven by higher costs in 2010 related to the home warranty's move to a new call center.

The Specialty Insurance segment pretax margin was 17.8% for the current quarter, up from 14.0% for the same quarter of the prior year.

Finally, corporate expenses were $17.5 million in the first quarter. We anticipate that corporate expenses will be at a quarterly run rate of $15 million for the remainder of 2011.

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

Thank you, Max. I will provide a few comments on the capital and liquidity.

Cash used for operations in the first quarter was $50 million. It is typical in our business to have a drain on cash in the first quarter due to the seasonality of our operations and the timing of certain cash payments. Capital expenditures during the quarter were $13 million, which is less than the $15 million we've targeted to spend on a quarterly basis.

I would like to take a moment to explain our thinking around our investment in CoreLogic. At the time of the spinoff, we owned 12.9 million shares of CoreLogic. $5.2 million of these shares were held at our holding company, and the remaining 7.7 million shares were held at a regulated insurance company. We consider the shares at our holding company to be excess capital as we do not need them to operate our business. However, we do not consider the shares at the insurance company to be excess capital as they are admitted assets for statutory surplus purposes.

We wanted to reduce the risk at the insurance company given that we had such a highly concentrated position in one common stock. On April 5, we agreed to sell 4 million shares of CoreLogic out of the insurance company to CoreLogic at a spot market price of $18.95, which resulted in proceeds to us of $76 million. We do not have any future tax payments related to the sale.

This action enhances the cash position and improves the surplus quality of the insurance company. We will look to unwind the remaining 8.9 million share stake in CoreLogic within the next four years as required in connection with our [staff].

In March, our board approved a $150 million share repurchase authorization. We believe repurchasing shares can be an effective way to return capital to our shareholders. However, while we will be opportunistic, we intend to remain conservative with respect to buybacks until we see recovery in the purchase market and operating margins improve.

In terms of liquidity, we had $51 million of cash at our holding company at the end of March. In addition to this cash, we 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 $[162] million, $109 million of which is held at the holding company. We also had $200 million available on our $400 million line of credit, so liquidity remains very strong.

Our cash and investment portfolio totaled $3.5 billion as of March 31, which includes $1.6 billion of fiduciary funds. The portfolio is comprised of debt securities of $2.1 billion; cash and short-term deposits of $829 million; equity securities of $307 million; and $197 million in less-liquid long-term investments. Overall, we have a high-quality portfolio with 72% of our debt securities rated AAA, and only 2% rated below investment grade.

Debt on our balance sheet totaled $291 million as of March 31. Our debt consists of $200 million funded on our credit facility; $47 million of trustee notes; and $43 million of other notes. Our debt-to-capital ratio as of March 31 was 12.8%.

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

(Operator Instructions). Mark DeVries. Please state your company name.

Yes, thanks; from Barclays Capital. First, could you give us a little more detail on kind of what you observed in the adverse loss developments in the 2007 year book, and kind of what the risk is of future additions to reserves?

Sure, Matt. This is Max. Let me just start by saying that we haven't really seen a significant deterioration in claims. Really what's going on is our policy is that we book to our actuary's best point estimate. And we do that because it's considered best accounting practice and it provides transparency, but it does create volatility.

So, really what happened in the quarter, and it really mostly happened in March, we were expecting roughly $57 million in claims, and we received $67 million, so that's what came in. So our actuary takes that, and he developed that number to $15 million, and that is out to his best estimate. So we booked to his best estimate, and upped our overall reserve.

It's fairly minor. I mean it's less than a 2% adjustment to our RBNR balance. And again, we don't think it's a significant deterioration or anything. It's just our regular policy. In April, we're back down to claim counts to date, April to date, we're right back to the claim counts that we were forecasting.

Okay. And what are the risks of future reserve adjustments for the Canadian operations?

Sure, Mark. This is Dennis. You know, we've taken the situation, obviously, very seriously, and here's what we have done up in Canada.

This product performed well for a number of years, but then we clearly had deterioration, and that deterioration started in '10 and we reflected that in our IBNR. And then by the time we got through the first quarter of 2011, we'd seen a material increase in our claims. And we took a position just like Max explained in the US.

Our internal actuary took a look at it, decided that we needed to take a reserve adjustment and we booked to his best point estimate, and I want to make sure everybody is clear that was higher than our external actuary's range. And so we want to make sure we do this appropriately. We think we have taken a conservative approach to this. I can't be 100% sure that we won't have to come back here, but we want to make sure we have taken a conservative approach and put the problem behind us.

Okay. And then, Dennis, I just wanted to get a little clarification on your comment about how future expense reductions will be market-driven. In a scenario in which volumes just kind of bounce around the bottom here, would you expect any kind of additional incremental cost saves to be planned?

Thanks for the question. We've done a few things. In the quarter, we were relatively aggressive, actually. We lowered our employee counts in the US by 275. We only made [it] 160 plus temps in the business, and we're going to continue to size the business to the market we are operating in. And we're pretty comfortable we are down to the size we need to be for this market.

And really what I'm implying here is that we think we are nearing the bottom now. Obviously, we can't make the call, but we think we are nearing a bottom, and we're going to make market adjustments. And also we're very focused on growth right now. We think there are good opportunities for our business to grow when we look out over the year, the next few years.

Okay, great. And is there any guidance you can provide on the earnings impact from the sale of the CoreLogic on your second-quarter results?

Yes, Mark, this is Mark Seaton. We're going to have about a almost an $800,000 realized gain in the second quarter because of the $4 million, or 4 million shares of commodity that we sold. So I would say it's immaterial.

Okay. Thanks.

Nat Otis.

KBW. Good morning. Just maybe to follow up on Canada, given that you talked about that it was a relatively small revenue component, if you thought you had to exit that business completely once you kind of looked at it, can you tell us what type of impact that would be on say a percentage basis of your overall international revenues?

Oh, sure. It's immaterial. The product in Canada has been -- was introduced in 2003, and through 2010, our revenues were never higher than $15 million, and they averaged between $5 million and $10 million.

Okay. So you have taken a material portion -- you know you've reserved against a material portion of that business itself right now. Would you say like 50% or something like that?

I'm not going to give a percentage, but we have taken I think the right approach, and we followed our actuary's guidance and booked to his midpoint. He's giving his best estimate.

You know, there's one other comment I would like to make, and it's an important comment for us. And that is, we need to learn lessons from the process, number one.

Number two, we're in the risk assumption business and we need to continue to innovate both in the US and internationally. And this is just a case that we mis-priced our risk. And so the lesson we're going to learn from this is that when we innovate across our product offerings, we're going to make sure that we balance the risk we accept versus what we're going to put out to a reinsurer in early years.

All right. I guess then just shifting over to kind of where you are seeing from a volume standpoint, you gave commentary that you are -- possibly hope to be close to a bottom. But, is there any way to gauge that assuming the trends that you are seeing in April where you think originations are going for a full year -- are they trending given what you are seeing April to a $1.1 trillion or a sub $1 trillion market? Or is it this kind of still within the range of what you expected when you started the year?

It's absolutely in the range of what we expected. The MBA just recently re-forecasted and they upped their forecast to $1.07 trillion. And we don't see any reasons to not believe that forecast at this point. But what actually happens is that we are seeing a little higher refinances, a little lower purchases. We would like to see it reverse of that. And what's actually happening is what the MBA has forecasted right now. And so we think that the forecast is accurate. We've started off with a slow spring, buying season, no question. But we have some optimism that it may grow in May or June, but regardless, we have sized the business for the current order count.

All right, fair enough. And then just last question, just on looking forward into May and June, every year is certainly different, but is -- could you argue that May or -- what month is typically the best month that you would have from a seasonal selling standpoint as things would start to trend upward?

It changes by year, but it typically is April or May.

Okay. Fair enough. Thank you very much.

Sure. You're welcome

(Operator Instructions). Brett Huff.

Brett Huff from Stephens. Morning, everybody. Just a couple of follow-up questions. Wanted to -- the $50 million sequential decline in cost was -- it seemed very good. And I want to make sure that we understood all the components of that. I'm guessing that the FTE cuts are part of it, but is there anything else in particular that should be called out that will continue on or might be one time?

This is Mark. Yes, a lot of the expense reductions just between Q4 and Q1 were just variable in nature. We accrue less bonuses; we accrue less 401(k) match.

We did have some real cost cuts, like we closed 30 offices. We have reduced about 275 people as Dennis said. But a lot of it was just because of seasonal accruals because of the first quarter.

Okay, but the office cuts and the people, obviously, are ongoing. The others sound like they are just seasonal.

Correct.

Okay. And then, second question, any update on the Bank of America situation? Anything you can share with us on that?

Brett, yes, there really isn't. The process continues on. I'm going to stay with our policy of not commenting on active litigation, other than the stuff that I've been saying over the last few quarters.

Bank of America continues to be a very good customer of ours. We continue to deal with Bank of America and Fiserv, and the lawsuit is just proceeding at its own pace.

Okay. And then in terms of agent retention, I want to make sure I get that. The agent retention was driven largely just by a mix of a particularly large transaction that swung that to a little bit lower level than is typical and that will go back to sort of the mid-80, 81 level?

Brett, this is Mark again. Yes, so the split this quarter was 80.0. We did have a large commercial transaction. We had about $4 million of premium that swung it.

If you exclude that, our split would have been about 80.5, but we are really pushing hard to reduce that over time. And so we think that it's going to trend down more toward the 80.0 and hopefully less than 80.0 by the end of the year.

We've done a lot to change our splits. New York, which we have talked about in the past, we just announced that we are going from 85/15 to 83/17. So as of today, as of April 1, we are -- the split is 83/17 in New York. And we want to get that down to 80/20 within a year. So that's really going to help us.

We've moved the split materially in a lot of smaller states. Oregon, we've moved it 400 basis points. Montana, we've moved it 400 basis points. Colorado we moved it 100 basis points. And there's also some larger states like California. Typically, our company has always been 90/10. Today it is 88.5, and we want to move that down a little bit more. So we're really focusing hard on the splits and we think we will see some movement there going forward.

Okay. That's what I needed. Thanks for your time.

Jason Deleeuw.

Piper Jaffray. Thanks and good morning. Going back to the Canada product, you guys said you started seeing an increase in the claim activity in 2010. Can you just give us a little bit of color of what was driving that? And then just an idea of what customers were using this product?

Sure. Again, we introduced the product in 2003. It had very good performance in the early years. And in 2009, 2010, we started to see a slight uptick in the Canadian default rate, and that is where we started to identify some deficiencies in our product. And those deficiencies really fall into three categories. Number one, at the highest level, at the highest level we just took too high of an underwriting risk and we weren't adequately compensated for it and we have dealt with that or are dealing with that issue.

Second issue is, the model we used to make our determinations on the share-ability, which is, we think, the best model available, had some weaknesses that we accepted, not the model's fault -- we accepted. And that is we took risk on, for example, rural properties that probably, in retrospect, we should not have.

And then the last component that drove it is we have one of our key customers up there, one of our best customers, has one specific channel that's performed poorly, and we're taking steps to deal with that channel right now.

Were these big or small mortgage lenders in Canada? Can you just give a little bit of sense of that?

Sure, sure. Our top three customers represent over 95% of the volume.

Okay. Then, in the US business with the claims deterioration that we saw, could you guys -- it sounds like April -- it sort of normalized. We just saw the spike up in March on the claims. Can you give us a sense on the regions -- on the regional level or type of mortgage product, where were you seeing the increased claims?

Jason, it's Max. It's really across the board. It's really -- you know, it's across the residential, commercial. It's across direct and agent channels. There's really not one type of claim that's causing the higher claims. It was just like I said, across the board.

Okay. And then just getting back to your -- the margins and managing the expenses for the volumes, but also being positioned for turnaround or near bottom in the volumes, I guess with the current -- it seems like you guys are somewhat comfortable with the expenses right now given the volumes that you are seeing. Can you still hit your margin targets that you guys are looking internally to hit? Can you still hit those with the current expense levels, with the volumes that we are seeing? Or are we going to have to see an increase in volumes?

Well, we have set an objective for this year. For the first quarter -- let me answer it this way.

For the first quarter when I take the reserve strengthening and put it off to the side and I don't mean to not mean it counts, but when I put it off to the side, we actually had a strong operating performance in our business. We hit or exceeded all of our expense ratios and our key operating ratios, number one.

Number two, we set an objective for the business to try to match our performance of 2010, and that will be very difficult, by the way, in the current revenue environment we're in. But we are comfortable we are right sized right now.

Now, towards a longer-term margin, we are not backing off on our commitment at all of an 8% to 10% margin. Now we're going to need some help in the market. We're going to need some stability and ultimately some growth, but that is absolutely our long-term objective.

Okay. And then, could you just give us a sense of the purchase/refi mix in April?

Yes, in April, we opened up about 4600 orders per day, and 46% of those were refis.

Thank you very much.

That's really trended down. In January, it was 55% refi. February was 51%. March, it was 50% and April it was 46%. So we're seeing the mix of refi trickle down throughout the year.

Thank you.

And that's all the time we have for questions today. 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 203-369-1842.

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