Fidelity National Financial Inc (FNF) 2010 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the FNS 2010 third-quarter earnings conference call.

At this time, our participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. (Operator Instructions). As a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, Mr. Dan Murphy. Please go ahead.

Tanks and good morning everyone. Thanks for joining us for our third-quarter 2010 earnings conference call. Joining me today are George Scanlon, our new CEO, Tony Park, our CFO, Randy Quirk, President, and Al Stinson, Executive Vice President. We'll begin with a brief strategic overview from George, as well as an update on the Title business and our operating copies. Tony will finish with a review of the financial highlights. We'll then open it up for your questions and finish with some concluding remarks from George.

This conference call may contain forward looking statements that involve a number of risks and uncertainties. Statements that are not historical facts, including statements about our beliefs and expectations, are forward-looking statements. Forward-looking statements are based on management's beliefs, as well as assumptions made by and information currently available to management. Because such statements are based on expectations as to future economic performance and are not statements of fact, actual results may differ materially from those projected. We undertake no obligation to update any forward-looking statements whether as a result of new information, future event or otherwise. The risks and uncertainties which forward-looking statements are subject to include, but are not limited to, the risks and other factors detailed in our press release dated yesterday and in the statement regarding forward-looking information, risk factors, and other sections of the Company's Form 10-K and other filings with the SEC.

This conference call will be available for replay via webcast at our website at FNF.com. It will also be available through phone replay beginning at 11 AM Eastern time today through October 28. The replay number is 800-475-6701 with an access code of 173222.

Let me now turn the call over to our CEO, George Scanlon.

Thank you Dan. Good morning everybody. This was another strong quarter for our Title Insurance business, as refinance volumes began to increase in June and showed continued strength throughout the entire third quarter. With many of those orders opening late in the quarter, we expect to see a significant amount of the benefit of those increased order counts in our fourth-quarter results.

We completed the acquisition of Commerce Velocity during the third quarter. Commerce Velocity provides technology solutions to mortgage lenders, loan servicing organizations, and investment banks that enable users to mitigate risk and optimize outcomes for their mortgage loan portfolios. Commerce Velocity has been strategically aligned with ServiceLink, our national lender platform and a leading provider of origination and default related solutions to the mortgage industry. The strategic integration of our new and existing competencies creates a complete workflow management solution from loan origination through loss mitigation, default and asset disposition.

We sold approximately half of our investment in FIS stock through that company's August tender offer, selling 1.6 million shares at the tender of $29. This resulted in total proceeds of nearly $47 million, a pretax gain of approximately $22 million. We continue to own another 1.6 million shares of FIS with a current value of approximately $45 million.

There has been significant discussion and speculation concerning our involvement with foreclosures and potential risks we face from those transactions. Many lenders have announced that they have halted foreclosures and the sale of REO properties due to possible flaws in documentation used in the foreclosure process. We do not believe that this situation will have a material adverse effect on our Title business.

FNS Title Insurance underwriters issue title policies on REO properties to new purchasers and lenders to those purchasers. FNF believes those policies will not result in additional claims exposure to FNF because the new owners and their lenders would have the rights of good faith purchasers, which should not be affected by potential effects in documentation. Even if a court sets aside a foreclosure due to a defect in documentation, the foreclosing lender would be required to return to our insureds all funds obtained from them, resulting in no loss under the title insurance policy.

Additionally, we recently reached an agreement with Bank of America under which they will provide a representation that all documentation procedures and/or notices related to the foreclosure of a property comply with state law and local practice. They will indemnify FNF against any losses incurred directly by their failure to comply with state law or local practice on transactions in which foreclosure has already occurred or been initiated and those to be initiated in the future. We believe that this agreement reflects current law in every state and is consistent with the rights that we have under the policies that we issue. We will also require similar representation and indemnification on future REO transactions from all other lenders.

Yesterday, our Board of Directors set a dividend payout target of 30% of 2010 net earnings for 2011 common stock dividends. This decision provides additional financial ability throughout 2011. The additional uses of cash flow are expected to include stock repurchase, acquisitions, and debt repayment.

Now, back to the operations. Refinance order volume showed strength throughout the third quarter, moving from 10,500 open orders per day in July to more than 11,400 open orders per day in both August and September with the trend continuing into October. For the quarter, refinance orders comprised approximately 67% of total open orders and 63% of closed orders, with closed refinance orders increasing to 67% of total closed orders during the month of September. While we started to see an increase in closing activity later in the quarter, a large number of the third-quarter open orders will actually close during the fourth quarter, providing additional earnings momentum as we close out 2010.

We had another strong revenue quarter in the Commercial Title business. Commercial revenue accounted for approximately 19% of total direct title premiums in the third quarter, compared with 16% in the third quarter of 2009 and 19% in the second quarter of this year. We opened approximately 18,000 commercial orders in our National Commercial divisions and closed approximately 10,300 commercial orders, generating $68 million in revenue with a fee per file of $6600. This represented a 47% increase in fee per file and an 18% increase in total Commercial revenue versus the third quarter of 2009. We are encouraged by a second consecutive quarter of stronger Commercial title activity and are hopeful that this trend may be an indication of an improving commercial market.

Specialty Insurance revenue was $114 million for the third quarter, an increase of approximately $11 million from the third quarter of 2009. Flood insurance generated $51 million and revenue. Personal Lines insurance contributed $41 million in revenue, and Home Warranty produced $19 million in revenue. Pretax earnings were $11 million and the margin improved to 9.6%. Personal Lines business produced a loss ratio of 70% for the quarter.

Finally, an update on the performance of our portfolio companies -- while we do not consolidate the results Ceridian, they produced revenue of $363 million and EBITDA of $73 million, reflecting an EBITDA margin of 20%. Our 33% share of Ceridian's quarterly loss was $8 million.

We also do not consolidate the results of Remy, but they produced revenue of $283 million, a 42% increase over the same period in 2009. EBITDA of $38 million was strong and grew 77% over the prior year. Our share of Remy's quarterly net income was $7 million. Overall, we recognized $1 million in earnings from our equity investments.

I'd like to now turn the call over to Tony Park, our CFO, to review the financial highlights. Tony?

Thank you George.

FNF generated $1.4 billion in revenue for the third quarter with pretax earnings of $128 million and cash flow from operations of $21 million. Cash flow from operations was negatively impacted by claims paid in our Title and Homeowners business being $67 million higher than the total provision for losses. Book value was $15.25 per share at September 30.

The Title segment generated $1.3 billion in total revenue for the third quarter, a 5% decline versus the third quarter of 2009, as closed orders fell by 7% and fee for file increased by 3%. The price increases of 2009 and the more robust Commercial business allows for the increased fee for file despite a larger mix of closed refinance orders in the third quarter of 2010.

Pretax earnings were $136 million, including $22 million from the sale of the FIS shares, and the pretax title margin was 10.5%. That pretax title margin was 8.9%, excluding the FIS gain.

Title segment personnel costs decreased by $9 million, or 2%, versus the third quarter of 2009, and other operating expenses declined by approximately $23 million or 8%. Overall, total title premiums fell by 8% versus the third quarter of 2009 while personnel and other operating costs combined declined by 5%. Additionally, personnel and other operating costs were a combined 53% of gross Title operating revenue for the quarter, versus 52% in the third quarter of 2009.

Debt on our balance sheet primarily consists of the $701 million in senior notes due in 2011, 2013 and 2017, and the $100 million drawn under our credit facility. Our debt to total capital ratio was 19% at September 30. Total Title claims paid were $132 million during the third quarter, continuing somewhat above expectations, primarily associated with claims incurred during 2005 through 2007 and partially mitigated by more favorable experience in recent years.

Overall, our reserve position is still within a reasonable range of our actuary's point estimate. Additionally, we maintained our 7% provision level and expect to do so again in the fourth quarter.

Finally, our investment portfolio totaled $4.9 billion at September 30. There are approximately $3.1 billion of legal regulatory and liquidity constraints on some of those investments, including secure trust deposits of more than $400 million and statutory premium reserves for underwriters of approximately $2.1 billion. There are also some less liquid ownership interests in Ceridian, Remy, an American Blue Ribbon of more than $500 million. So of the gross $4.9 billion portfolio, approximately $1.8 billion was theoretically available for use with about $1.7 billion held at regulated to underwriters at approximately $100 million in non-regulated entities. With a debt to total capital ratio of 19% and only $100 million drawn on our credit facility, we have significant flexibility at the holding company level and continue to maintain a strong balance sheet.

Let me now turn the call back to our operator to allow for any questions.

(Operator Instructions). Bob Napoli, Piper Jaffray.

Thank you. Good morning. George, congratulations on your new role at FNF. Question I guess on two things -- one, the BofA deal, what brought that about, their indemnification? Given your view of the exposure you had to the market, did they -- how did you get them to sign that? Why were they concerned about the market being steady for -- are title insurers not funding or providing policies on foreclosures? What's going on there?

This is Peter Sadowski. I'll respond to your question. A number of factors, I believe, played into it. The first, BofA wanted to make sure that we will be able to easily insure their sales once their foreclosure process begins again. They did not want the title companies to have any impediment or to give any impediment to their future sales of REO properties.

At the same time, one of our competitors issued a press release that they wouldn't insure another lender at all. I think that caused them concern, so they approached us with an offer of an indemnity, which we of course accepted. So that's the background for it.

As George stated in his earlier comments, that indemnity is basically reflective of what the law already is in all of the states. We do not believe there is any cause for any of these transactions to be set aside. People that have purchased the properties are good faith purchasers, and we feel comfortable that it is highly unlikely we're going to have any issues with it. I think BofA felt the same way, and this was simply something to ease future transactions.

Great, thank you. A follow-up on the dividend cut -- you've held that dividend at -- through some pretty tough times over the last two years. To cut the dividend now, is that an indication that you just expect the visibility of earnings next year, earnings growth and the purchase market returning, or still not clear? Is this an indication of any additional concerns on the claims side? Why now, given that your balance sheet looks like it could handle that level, the level of dividend you had and certainly investors appreciated that dividend?

This is Bill Foley. We had kind of a long Board meeting yesterday, and we started looking at the payout ratio versus earnings of our dividend policy. If we thought we were coming out of this downturn in short order, we would have maintained that payout ratio. It was over 60% of after-tax earnings. The Board just felt, look, let's be a little conservative going forward for the next year or two. Let's see how the economy does, and let's also start reserving some dollars that might have gone to dividend payment -- dividend payout and buy stock back.

So, it's really a combination; it was a combination of factors. It was reviewed by the Board, and it was a pretty long discussion, because we have been consistent with our dividend. We obviously have the financial capability to keep on -- to maintain a $0.72 rate per share going forward. We just thought, after a lot of hand-wringing, that we ought to set a target, and we ought to announce the target right away, pay the current dividend at the current rate, announce the target for 2011. We felt the 30% payout ratio was probably in the ballpark of what insurance companies pay out, and still allows us to be conservative going forward. I can't say that's going to be the policy forever or for six months or nine months, that we start having some -- a pretty good pickup in the market. You'll see the dividend pop back up. But we're just trying to preserve capital -- that's kind of as simple as that -- and have had some funds left to buy stock.

Thanks, thank you.

Mark DeVries, Barclays Capital.

First, I just wanted to clarify one point. Did you indicate, in the scenario where foreclosures are set aside, that you believe it's the law in all states that then the seller has to reimburse the purchaser for all funds?

Sure. If a closure is set aside, which, as I mentioned, is very highly unlikely that could happen, but if a foreclosure is set aside, then the purchaser who bought the property is going to get his or her money back from the lender who sold it to him.

Okay, great. In light of the outlook for the next year, are there any additional expense (inaudible) that you guys are targeting at this point?

We did also at the same Board meeting yesterday review kind of our corporate overhead, corporate expenses. We feel like a very good job has been done relative to the operations. But corporate expenses, we feel there may be some room to take some costs out. So we've established a synergy plan for senior management from the CEO level on down that, based upon obtaining a $50 million synergy save or cost cut target, some fairly decent dollars would be available in a special bonus program. Then that bonus program would go on above $50 million but it would be at a 25% share rate. So our initial target is to save $50 million. The first $25 million is the shareholders' money, so we don't pay on the first $25 million, but the next $25 million we start having the payout ratio. Above $50 million, the payout ratio goes up. So we are underway on that program as we speak right now, and there's a task force being put together and we need to save some money. Simple as that.

Then just one last point. With the mix of refi being about 67% on open versus 64% on close, is it reasonable to assume there won't be too much additional pressure on the average fee for file as we head into the fourth quarter?

I don't believe there's going to be any pressure. We're kind of at the refi peak right now, and we're getting a lot of refi orders, so the fee for file should be pretty stable.

Great, thanks.

Brett Huff, Stephens.

Good morning. George, congrats on the new role. Just a couple of quick follow-up questions -- any thoughts on the timeline for the saves? That's good news for us I think. Any timelines on that?

We're looking at no more than a 12-month total take-out, trying to get $50 million out within the first six months on a run rate basis.

On the closing ratio, the closing ratios were a little bit lower. I presume -- than we expected anyway. I presume that's just a function of things taking longer, including refis to close because of additional due diligence. Is it different from that or more than that?

I think that's the right way to look at it. Everything, as I think we said last quarter, is getting pushed out a bit. We go as fast as we can. The lenders obviously are pretty thorough, and things are pushed out a bit.

You mentioned that you're going to keep the 7% claims expense provision for 4Q. Any thoughts on it going forward, any change in your view? From what I understand before is you didn't think it was going to change from that as we went forward. Any change in that view now?

Brett, no. This is Tony Park. I don't think we anticipate any change going forward. Payments, as you now, for the last couple of quarters have trended a little higher than expectations. But we are seeing encouraging signs from the most recent policy years, those being 2008, 2009 and 2010. We're also paying about 35% to 40% of our current claims are coming from canceled agents. A lot of those agents have been canceled over the last couple of years but a lot of those agent cancellations date back all the way to 2005. So, we expect the tail to be shorter on those and loss ratios a lot greater on canceled agents. So our expectation is that, despite higher claims payments right now, that they would turn lower sometime in the near future, and at 7% would actually be a little heavy for the current policy years.

Then in terms of the lender indemnification, I think you mentioned you expect similar indemnifications from other lenders on REO properties. Could you just give us more color on that? Are you in discussions with other lenders particularly, or is that sort of a policy that you now require regardless or just --?

It's both. We have discussions with other lenders about a form of a global indemnity, and we circulated a bulletin to all of our operations and agents that, as of November 1, we will require an indemnity from the seller, the servicer or lender before we would insure the REO sale.

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

Doug Mewhirter, RBC Capital Markets.

Good morning. The first question is your escrow fees and Other didn't I guess exactly track with your title premiums. They seemed to come in a little bit better. Was it a result of that acquisition, or is it just change in the kind of a mix? Did you have any large fees that rolled in this quarter?

I think part of it is loan care. We've had an increase in loan care revenue. It was an acquisition last year, so you don't have a full quarter of loan care revenue, which runs about $12 million a quarter. So that's part of it. Other than that, I think it mostly tracks with the change in the premium level.

Okay. I'm sorry. What was the timing of the closing of that loan care?

I think it was right around -- I think it was in June or July, but there has been growth in that business. So part of it is the growth we have seen. I can't remember the revenue in the third quarter last year, but it might have been half to three-quarters of what it was this quarter.

Okay. I guess the second question about -- I guess more broadly a capital management question, not necessarily the dividend. Do you still intend to pay down that debt coming due in August of next year rather than refinance it? Was that maybe a factor in your decision to I guess rejigger the dividend formula?

Actually, we are intending to pay down the $166 million that's due next August out of available funds, so we may have to draw down a line of credit for some short period of time to aid with that pay down. But that actually went into the thought process as well just to maybe preserve a little capital and be in the position to not refi, but just keep on paying debt down.

Okay. The last question is for George. I noticed that I guess the personnel expenses went up sequentially a little bit compared with last quarter, and revenues went down a touch sequentially. I assume that would be mostly timing, because you staffed to open orders not necessarily closed orders. You're basically -- you're incurring cost for revenues you are actually going to get next quarter. Is that it, or are you seeing something different where maybe you opened another office in a market which looked promising?

I think that's the right analysis. I think we're using temporary labor to get through the refi cycle we are enjoying right now. We'll expect our personnel costs to come down as we get through that order backlog, like we have consistently in the past, to maintain our margins.

Okay. Thanks. That's all my questions.

Nat Otis, KBW.

Good morning. Most of my questions have been asked, answered, so just one quick one. Any color on order volumes thus far in October?

Yes, it's Randy Quirk. The first two weeks of October, we've -- our order volumes have actually ran up over the last few weeks of September, so they are growing. Certainly at a minimum, they are holding very strong refi orders for the full three months of the quarter, and slightly up in the first two weeks.

That's it. Thank you.

Adam Klauber, Macquarie.

A question on the capital management. You mentioned potentially more emphasis on share repurchase. Timing of that share repurchase is it wait to see how the environment evolves, or is it potentially, if the stock becomes more attractive, you may jump in?

We actually have a share repurchase program that's been underway for some time. We target various levels based upon our book value per share. Haven't been in the market over the last month or so, month and a half. But if the share price weakens, we want to be prepared to buy some shares back. We, frankly, feel like we have far too many shares outstanding, 229 million shares, and if we could reduce that share count significantly, it would be good for all shareholders. So that's our goal. It's kind of a capital reallocation from dividend payout to share repurchase.

Thanks. One more follow-up -- with the foreclosure issue you have to date -- and I realize it's early -- but have you received any related claims or any related lawsuits to date?

None.

Okay. Thank you very much.

Bob Napoli, Piper Jaffray.

Just a question on one of your new businesses and the commerce velocity. You guys obviously built a mortgage related financial technology business -- processing businesses, it's called LPS today. I just wondered, first of all, are there any -- do you have any noncompete restrictions? Are you really trying to go back after that market segment and kind of rebuild what you had subsequently sold and spun off?

We have no noncompete issues with regard to LPS and their mortgage servicing platform. We do feel like the mortgage servicing platform that LPS provides, while it's very sticky and has significant client penetration, is that it's a little outdated. Part of it comes from the lawsuit, part of the idea with Commerce Velocity is to give lenders or give servicers an alternative. It's an evolving process; it's an evolving program.

But the original reason for our company move to Jacksonville was based upon acquiring the mortgage servicing platform that is now held by LPS. Somehow, that got away from us. We need to be competitive in that space. We, frankly, have a very strong balance sheet, and we have very deep -- we have deep relationships with every lender. Commerce Velocity is going to help us in terms of penetrating those lenders in a little different way than we have in the past.

What about the default business, kind of some of the businesses that are also now part of LPS?

We don't have the same level of default, foreclosure/default business that LPS has. We built that business from 2001, 2002 through about 2006 or so, or '07, when the business was spun off. But we are in the default business today, and we have a serious default effort underway with our ServiceLink company. It's an area that we need to penetrate more deeply, and it's a very lucrative piece of the business. It's the dark side of the business, but it's very lucrative. So we are on it.

Thank you.

[Dan Steinman], [Yossis].

Thanks for taking the question. I was just wondering. If you look out next year and maybe the year beyond, you guys have historically said you don't really run your business based on the forecast that guys like MBA and Fannie Mae put out there. But clearly they are out with $1 trillion-ish numbers for total originations next year.

I'm wondering how much of your decision on the dividend comes from looking at those numbers and saying going from $1.4 trillion to $1 trillion is going to cause serious problems in the industry. So I'm wondering if that played a role.

Second, I'm wondering if -- or how much -- just a general concern that there's going to be a slowdown in foreclosure sales due to all the noise going on, obviously not on the claims side for you guys, but just slowing down the actual process of moving these foreclosures through the pipeline.

Then third, I'm wondering if there has been any regulatory pressure on you guys, or not pressure but I'm coming to you and saying husband some capital here, we foresee tough times ahead. We might need you to come in and help rescue some policyholders who are going to be stuck in title companies that maybe aren't going to be able to make it if we have a $1 trillion market. Thanks.

The answer to the last question first is that we haven't had any contact with any regulators with regard to preserving capital or building our statutory balance sheet. We have a debt to cap ratio of 18%, so we are very secure and safe, relative to our overall capital structure and our investment portfolio. Our investment portfolio is short-term in nature, and it's very, very high quality. So from that standpoint, there are really no issues.

On the foreclosure side, we are not -- it's not a significant piece of our business today. We'd like to have it be larger, but it's not a significant piece of our business. The refi business is very significant. And so we don't feel like foreclosure is going to have much of an impact if they get delayed. It just means that whatever fees are going to be earned might be earned in next quarter or the quarter after instead of the current quarter. So that, again, is not really a concern.

I would say that there is just a lot of uncertainty in the real estate industry. Of course, about the time everyone thinks things are uncertain and they're getting worse and getting worse, they suddenly get better. But we're just trying to be conservative in really our capital allocation in the dividend policy. We felt like we wanted to preserve additional cash, take part of that dividend that was being paid out to shareholders and buy stock back, so reduce our shareholder base. When we compare ourselves to title insurance competitors, they frankly have a much lower payout ratio than we have. First American pays $0.24 and Stuart really doesn't pay much of a dividend. So we just felt like we were maybe not getting rewarded for the 5% yield on our dividend. We're trading at the same multiple of book that FAF is trading for, so all that went into the decision process. So conservatism, preserve capital, buy shares back, and maybe not getting rewarded for it.

Given your comments about your capital strength, I'm curious about the thought process of paying down the $166 million next year and further delevering your balance sheet as opposed to perhaps using that money towards buying back your stock, which is trading considerably below book value today.

That's, again, a consideration. It's a consideration to perhaps just draw down the line and use those funds to buy shares back, or to add -- and gauge in an acquisition program that might have earning assets that we would own a large percentage of and we'd consolidate on our balance sheet, but that would actually create unrestricted, unregulated cash flow to the holding company. We've done a little bit of that with American Blue Ribbon Holdings, but our other large investment was Ceridian. We are a minority partner. We really don't -- and it's a highly leveraged company. So we really don't get any cash flow out of that.

So the next transactions we do, we want to make sure that we have an earning asset that would be -- distribute cash up to the holding company. So all of the things we're talking about went into the thought process on the dividend. Usually, our Board meetings are about 2 hours or 2.5 hours, and this was about 6 hours, so it was about twice as long as normal because we were wrestling with some of these issues.

Have you given thought to if the sort of downside scenario comes to fruition, about whether or not you all would be able to participate in any sort of industry consolidation? I would expect, in normal times, you're probably precluded, given any trust concerns, but if we did get a distressed environment, would that allow you guys to pick up further share?

I would say that, if things become stressful as they were a couple of years ago when the Lend America opportunity came to us, and they had filed bankruptcy, that would be the situation that we would be able to execute against a further consolidation of the industry. So we are, by far, the strongest financially, much larger investment portfolio, much stronger loss reserves. Every regulator, if they have a problem with an underwriter, is going to look to the strength in the industry to solve their problem for them. So again, that is also part of the thought process we went through.

(Operator Instructions). I would like to turn the conference back to the CEO, Mr. George Scanlon. Please go ahead.

This was another strong quarter for our Title Insurance business as refinance volumes began to increase in June and showed continued strength throughout the entire third quarter. With many of those orders opening late in the quarter, we expect to see a significant amount of the benefit of those increased order counts in our fourth-quarter results.

Thank you for joining us this morning.

That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.