Stewart Information Services Corp (STC) 2015 Q3 法說會逐字稿

Good day everyone and welcome to the Stewart Information Services third-quarter 2015 earnings conference call and webcast. As a reminder, today's call is being recorded. At this time all participants have been placed in a listen-only mode and the floor will be open for your questions following the presentation.

I would now like to turn the call over to Nat Otis, Director of Investor Relations. Please go ahead.

Thank you, Keith. Good morning. Thank you for joining us for our third-quarter 2015 earnings conference call. We will be discussing results that were released earlier this morning. Joining me today are CEO, Matt Morris, and CFO, Allen Berryman. (Operator Instructions).

I will remind participants that the conference call may contain forward-looking statements that involve a number of risks and uncertainties. Because of such statements are based on expectations of future financial operating results and not statements of fact, actual results may differ materially from those projected. The risks and uncertainties with forward-looking statements are subject to include but are not limited to the risks and other factors detailed in our press release published this morning 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.

Let me now turn the call over to Matt.

Thank you, Nat. I appreciate everyone joining us this morning.

Today we reported third-quarter 2015 earnings with our title segment producing another quarter of solid results and our mortgage services segment remaining challenged by the delinquent loan servicing operations which we are exiting. As a consequence of our decision last quarter to exit this business line, we took a non-cash impairment charge of $35.9 million associated with goodwill and certain intangibles in the mortgage services segment.

As to overall revenues, we are pleased to report continued growth with total operating revenue increasing 9.9% over last year's third quarter. A portion of that growth stems from 2014 acquisitions which were finalized in August of last year. We did see strong growth in residential retail and refinancing orders closed as well with closings up 17.8% over the prior-year quarter.

Looking ahead although the industry has seen a decline in mortgage applications since the October 3 implementation of the new integrated disclosure requirements, we are encouraged that our efforts to prepare our people, processes and technology will minimize any disruption.

Our title segment continued to deliver solid results generating revenue growth of 14.3% and a pretax margin of 15.6%. This is a 200 basis point improvement over last year's adjusted pretax margin of 13.6%. Our title operations benefited from increases in transaction volume, good domestic commercial growth which is up 16.5% over prior year and the cost management program.

While our mortgage services segment results are overshadowed by delinquent loan servicing operations, we are seeing continued improving revenues and opportunities in other mortgage service offerings supporting our shift towards mortgage originations.

As announced during the second quarter, we are exiting the delinquent loan servicing operations and anticipate the wind down and final exit of these operations will occur by the end of the first quarter 2016. This phased exit process will continue to negatively impact profitability through the first quarter of 2016.

As of quarter end, we have essentially completed the cost management program we announced in 2014 where we have achieved our revised target of $30 million of annualized savings which exceeds our original goal of $25 million. As in our second-quarter earnings report, we have included a table in the press release setting forth adjusted income before taxes and adjusted EBITDA. We provide this information as we feel these are important measures of our operational improvement.

As you see from that table, our adjusted income before taxes is approximately $38 million as compared to the prior year quarter's $34.6 million. This represents a growth of 10.1% on total revenue growth of 9.5% and represents an adjusted pretax margin of 6.8%. This represents continued progress toward our goal of an overall pretax margin of 10% and a normalized mortgage origination environment.

Cash from operations also improved during the quarter growing from $49.3 million to $56.7 million, an improvement of 15%. Finally, we declared and paid a quarterly cash dividend of $0.25 per share returning $5.6 million to shareholders.

From a macro standpoint, we remain bullish on housing expecting growth in home purchase volume and home values over the next several years while gradual increases in interest rates will slow refinance volumes.

So now I am going to turn it over to Allen who will outline more details of our financial results.

Thank you, Matt, and good morning everyone. In addition to the impairment charge Matt mentioned a moment ago, we recorded several charges during the quarter and while I will provide more detail as to the underlying drivers of these items as I discuss individual business unit results, I want to summarize them here to provide some context for the quarter's overall results.

We incurred $5.7 million of expense related to the cost management program and CFPB integrated disclosure readiness recorded primarily as other operating expense in the corporate segment. While there may be some modest trailing costs in the fourth quarter we have essentially completed the cost management program and the related implementation expenses.

As a recap, approximately half of the $30 million in annualized cost savings is due to outsourcing as well as other process changes yielding headcount reductions which will be visible in the corporate segment fourth-quarter numbers especially when compared to the second-quarter corporate numbers. Another approximately $12 million relates to various actions in the title segment which are visible improving margins as we saw in both second and third quarter 2015 versus the prior year.

The remaining component is from various procurement initiatives where we achieved lower unit pricing. Although we have concluded the cost management program originally unannounced in the first quarter 2014 in conjunction with our value creation strategies, we continue to implement projects to improve our cost-effectiveness.

We expect to further leverage the work already done in areas such as outsourcing and other technology enhancements and we expect those to further support our ongoing efforts to improve margins in 2016 and beyond. We also accrued $1.5 million of litigation costs in the title segment relating to a previously disclosed matter dating back to 2005 which fully resolves this matter.

Lastly, we incurred approximately $600,000 of costs in the mortgage services segment relating to the exit of the delinquent loan servicing operations. We continue to anticipate that the total charge we incurred relating to exiting these operations will be $5 million to $7 million during the fourth quarter of 2015 and first quarter of 2016.

With that background, I will turn to our business unit results.

With respect to our direct title operations, revenues increased 4.7% from the third quarter of 2014. Following the usual seasonal pattern, total title orders opened in the third quarter declined 3.4% from the prior year quarter while total titles orders closed increased 11.8%.

Residential fee for file in the quarter was $1,896 essentially unchanged from the $1,894 in the second quarter. US-only commercial revenues increased 16.5% to $45.2 million compared to third-quarter 2014. Total worldwide commercial revenues for the quarter were $49.4 million, an increase of 10.7% from the third quarter of 2014. International commercial revenues were unfavorably impacted by strength in the US dollar.

For the third quarter 2015, total international revenues were $31.1 million down 9.2% from $34.2 million in the third quarter of 2014. The entire revenue decline was due to changing foreign currency exchange rates as a result of the strengthening US dollar.

Overall, our direct operations had a solid quarter from a revenue perspective. Our direct offices reported strong revenue growth, our commercial business continues to show gains and our international business remained solid when reviewed on a local currency basis.

Our independent agency operations also saw strong growth with revenues increasing 22% in the third quarter 2015 compared to the third quarter 2014. Net of agency retention, independent agency revenues increased 28.3% as our agency remittance ratio improved from 18.4% in the year-ago quarter to 19.4% this third quarter. The improvement in remittance ratio was driven by increased business from our agencies in the higher remitting state of Florida combined with declines from the lower remitting states of California and Texas.

I will note that the year-to-date remittance ratio which we view as more representative than any single quarter was 18.8% and 18.4% in 2015 and 2014 respectively.

With respect to title losses, title losses were $25.9 million in the third quarter of 2015 or 5.0% of title revenues. Although we reported title policy loss expense of $9.1 million in the third quarter of 2014, the prior year quarter included a credit relating to the recovery of a portion of a previously recognized large loss. Excluding this credit, title losses were 5.2% of title revenues in the prior year quarter.

On a year-to-date basis and excluding the prior year recovery, our core accrual rate for title losses was 5.5% and 5.2% in 2015 and 2014 respectively. We anticipate maintaining our core accrual rate in that range going forward.

As we saw in both first and second quarters, quarter-to-quarter fluctuations in the overall title loss ratio are not unusual due to any new large claims incurred as well as adjustments to reserves for existing large claims or escrow losses. Our total balance sheet policy loss reserves were $478.6 million at quarter end and remained above the actuarial midpoint of total estimated policy loss reserves.

The title segment generated pretax income in the third quarter 2015 of $78.7 million representing a 15.6% margin. Third quarter of 2014 generated pretax income of $74.9 million but the prior quarter was favorably influenced by the title loss recovery mentioned above. Excluding this recovery, the title segment's adjusted pretax margin was 13.6%.

Looking at our mortgage services segment and given the significance of the acquisitions to the current quarter results, my comments here will focus mainly on the total segment results rather than mortgage services revenues as reported in our consolidated statement of operations.

Revenues generated by our mortgage services segment were $49.9 million for the third quarter, decreasing 20.6% compared to the year-ago quarter. While we are seeing growth in origination-related services, those sales successes are overshadowed by the delinquent loan servicing operations.

As announced during the second quarter, we are exiting the delinquent loan servicing business. We now anticipate the orderly wind down and final exit of these operations will occur by the end of the first-quarter 2016. We continue to anticipate that the total charge to be incurred relating to exiting these operations will be $5 million to $7 million of which $600,000 was incurred during the third quarter and the remainder will take place in the fourth quarter 2015 and first quarter of 2016.

We also accelerated amortization of assets used in these operations as the useful lives of those assets will reset to coincide with the expected final shutdown date of March 31, 2016.

As of quarter end, we have notified approximately 250 employees in the mortgage services segment of their expected termination date. These employees will be released on a staggered schedule throughout fourth quarter of 2015 and first quarter of 2016. The severance expense associated with these employees will be recognized over the remaining service period.

Also as discussed in the second quarter, the decision to exit the delinquent loan servicing operations was an indication of potential impairment of goodwill in the mortgage services segment. So we performed a preliminary evaluation of the recoverability of such goodwill and other intangibles in accordance with generally accepted accounting principles.

As a result of this evaluation, we recorded a non-cash charge of $35.9 million in the quarter which is $30.5 million after tax consisting of $35 million of goodwill impairment and $900,000 of intangible asset impairment. The goodwill impairment charge essentially eliminates all goodwill associated with the legacy mortgage services operations as well as the goodwill associated with the 2013 acquisition.

This non-cash accounting charge will not impact the Company's liquidity, its cash flows, compliance with its debt covenants or any future operations. Excluding the impairment and costs associated with the exit activity, the segment reported a $0.9 million pretax loss versus pretax income of $3.3 million for the third quarter of 2014.

Sequentially from second quarter 2015, revenues for the segment fell by $8.1 million while pretax earnings declined $3.6 million excluding the impairment charge. The delinquent loan servicing operations will continue to operate profitably during the fourth quarter of 2015 and first quarter of 2016 as we wind this business down in accordance with the schedule agreed to with our customers.

Due to the significance of the impact of the delinquent loan servicing operations on overall segment results, we expect the segment to report a pretax loss in both fourth-quarter 2015 as well as first-quarter 2016.

Looking at operating expenses, employee costs for the third quarter were essentially unchanged from the third quarter of 2014 despite the strong revenue growth. While the average overall headcount decreased approximately 2.5% from the third-quarter 2014, the lower salaries and benefit costs associated with this decline was offset by higher variable compensation earned due to increased revenues. As a percentage of total operating revenues, employee costs in the third quarter 2015 improved 280 basis points from 32.7% to 29.9% compared to the prior year quarter.

Other operating expenses as a percentage of total operating revenues were 18.1% and 19.0% in the third quarter's 2015 and 2014 respectively. These expenses increased 4.4% in the third quarter of 2015 compared to the year-ago quarter. During the quarter, we incurred other operating expenses associated with the cost management program and CFPB readiness aggregating $5.7 million and a $1.5 million litigation charge as noted above.

During the third-quarter 2014, we incurred approximately $2 million of other operating expenses relating to acquisition integration and the cost management program as well as $4.2 million of litigation-related expense. Excluding the impact of these incremental expenses in both quarters, other operating costs would have increased approximately 4% due to fees aid to the third-party outsourcing firm as well as higher variable costs associated with the increased title revenues.

The year-over-year comparison is also modestly impacted by our collateral valuation business acquired August 1, 2014.

Depreciation and amortization expense of $7.6 million in the third quarter, an increase of 15.3% compared to the third quarter 2014. The increase is due to amortization of acquired intangibles recorded in the fourth quarter of 2014 and to a lesser extent from accelerated amortization on assets used in the delicate loan servicing operations of $363,000.

Lastly, a couple of comments on other matters. Cash provided by operations was $56.7 million in the third-quarter 2015 compared to $49.3 million for the same period in 2014, an improvement of $7.3 million. The improvement is principally due to better results in our core operations and lower title loss payments.

We don't yet have this quarter in the statutory balance sheet for our principal underwriter completed. As of the second quarter 2015, our statutory liquidity ratio was 0.89 to 1. Our internal objective is to achieve a ratio of at least 1 to 1 as we believe that ratio is crucial from both a rating agency and competitive perspective.

So with that, I will turn the call back over to the operator to take questions.

(Operator Instructions). Bose George, KBW.

This is actually Chas Tyson on for Bose. I am curious now that you have finished the $30 million cost-saving program, what other areas you are looking at for efficiencies? If you can give some color there as well as any potential sizing of future cost savings that you think are inherent in the business.

I think what we are doing is looking to leverage some of the things that we have put in place during this original cost management program whether it is using the outsourcing vendor more thoroughly or whether it is additional technology improvements that might be able to lower our headcount going forward. We've got several things that we are trying to scope right now so it is a little early for us to put a number out there but we do think do feel like we can leverage what we have learned in this initial effort to carry that program going forward.

Okay, following on from that, I mean we calculate the operating pretax margin you guys have been doing over the last couple of years, it is kind of like mid-single digits number. You add back the mortgage services from this number and it should be a couple of points above that. Is there like a target margin that you guys look for or a way for us to think about what other cost cuts that could come through?

I think we have said now for some time that we are looking to in the aggregate to achieve a 10% pretax margin in a normalized origination environment. I mean we really haven't altered that position recently nor do we expect to going forward.

And normalized origination market would mean like $1.5 trillion of originations or something like that?

Something like that, right, something like that.

Okay. And then on the mortgage services segment, is there a way for us to think about what the contribution of revenue and pretax earnings from the delinquent business was as opposed to the rest of the segment this quarter?

We are not really breaking that out separately. I can tell you that for the revenue stream from the businesses that are the ongoing businesses were pretty stable in the quarter. We have seen some nice growth in some of the origination products that are part of that ongoing business. But as I said a few moments ago, both the ongoing revenue decline in that delinquent loan servicing operation is sort of swamping the results for now.

Sure. Should we think that the $120 million to $140 million annualized of revenue that you guided to last quarter for next year is you are at the run rate right now this quarter and also are you at the target EBITDA margins for the nondelinquent portion?

Not following the question completely but let me say this, the run rate revenue that we talked about in the last quarter is still a good run rate revenue for the ongoing business operations. We do expect to see continued revenue declines related to the delinquent loan servicing operations in this quarter which is now fourth quarter and first quarter of 2016.

Sure, got it. The question I'm trying to ask is -- is the nondelinquent portion of revenue is that at about the run rate between $30 million and $35 million or so this quarter as well as are you at the target EBITDA margins for that revenue that is going to keep going on next year?

Probably is a little more revenue growth to come in those new business lines or those business lines that are ongoing. I would say there is probably opportunity for us to improve the margins in that area as well.

Okay, got it. Thank you.

Ryan Byrnes, Janney.

Great, thanks, guys. A quick question on -- with the 250 people, the severance costs, is that part of the $5 million to $7 million of one-time costs or is that going to be in addition to that?

No, no. That is part of it. The $5 million to $7 million is intended to be more of an all-in number whether it is severance or the accelerated amortization costs or whatever it makes cost us to ultimately exit that lease that is associated with that facility.

Okay. Thanks for that. And again with the goodwill impairment, I think I heard you note that this will take care of all of the delinquent books. I think you also mentioned that it took away some goodwill from a 2013 acquisition. Just wanted to see if I heard that right or maybe if you have a little more color there? And then also maybe if you could possibly break down the goodwill behind the title segment and also the mortgage services segment of what you are manning?

I don't have that breakdown here in front of me but I can tell you there is no goodwill impairment in the title segment. I mean we view that as well and there is no goodwill impairment there. As respect to the mortgage services goodwill, yes, I did say that that write-off included the goodwill of a 2013 acquisition that had not performed up to expectations and so that goodwill was written off as well.

I would say that what is left on the mortgage services segment right, now we feel is completely recoverable and should have no further issue with that.

You are not giving us a breakdown of the go forward piece of the mortgage segment but should that business be a positive earnings driver in the second quarter of 2016 I guess once all of the delinquent stuff is flushed through?

Yes.

Just kind of switching up completely, kind of want to get your thoughts on kind of capital management now that again the $70 million kind of commitment or pledge is nearly over. Just want to get your thoughts as to what we should expect heading into 2016 be it increased dividends or buybacks?

No, really haven't made a decision yet on increasing the dividend. At this point we would expect that we at least maintain the dividend that we are paying now and we haven't really discussed with the Board a next level of share repurchase. What I would say is that we will always be mindful of opportunities and if those opportunities present themselves, then we would act on them.

I did mention a moment ago too our liquidity ratio so that is also one of the capital management considerations that we always keep in the front of our minds is getting that liquidity ratio back to a 1 to 1 perspective we think is really important for our commercial business.

And I don't have the third-quarter statutory balance sheet completed yet so it is a little early for me to say what that liquidity ratio might look like but that is also a factor in any decisioning that we do in 2016 on capital management.

Great. Thanks for the color there, guys.

Kevin Kaczmarek, Zelman & Associates.

I guess looking at the delinquent servicing operations another way, I saw a layoff announcement of 200 to 300 people in Virginia I guess about a month ago. How many people are left in the delinquent servicing and how many of those employees will be laid off in 4Q and 1Q?

I think that is pretty much all of them. I know there is a staggered schedule for executing the terminations that stretches out over third quarter and fourth quarter. I honestly don't know right now exactly how that breaks out between the quarters but I know there is a staggered schedule. Or I'm sorry, first quarter this year -- fourth quarter this year and first quarter next year. But I know there is a staggered schedule that they are going to be released over.

And on the restructuring program, can you give us a sense -- I know that the cost saves came out of 3Q gradually I guess there was something on August 1 that happened and something in July. On a run rate basis, how much more of expenses should we expect 4Q go down by right because I think some came out in 3Q and some would come out in 4Q as well?

Yes, I think the way to look at it is in 4Q you should have one full quarter's worth of benefit of the entire $30 million. So as I mentioned a little bit earlier, the way that cost management program broke down is that half of it really sort of took place in the third quarter so you are going to get the full benefit of that $15 million in the fourth quarter whereas the other parts of it related to the direct operations and some of the procurement initiatives that have been coming in over the last 12 months. I would say that going into fourth quarter what you will see is more of the full impact of that $15 million that I mentioned at the outset was related to outsourcing and other technology type things that are going to enable us to lower headcount.

So $15 million of run rate came out in 3Q. Do you know how much the absolute amount was in 3Q? Was that gradually throughout the quarter so maybe half that?

I would say it was probably gradually through the quarter so if you just wanted to take an average of that and call it 8, then that would be fine.

And then I realize it is early on trend and I saw your commentary in the release and I also realize the average order closing time is a bit longer than the 20 or so are days since October 3. But can you give us some color on the closings that have occurred on the new forms and how those have been progressing and whether there are any software bugs or anything else that either your agents or your direct operations are dealing with?

Yes, there really haven't been any closings again. Those are related to mortgage applications as of October 3 and as you stated, most of the time to closing is extended for lenders. So we are taking those orders systems or have little blips here and there due to the rollout but all seems to be progressing well.

Just came back from the Mortgage Bankers Association earlier this week and American Land Title Association two weeks prior to that and that is definitely the topic of conversation. But we are a little bit in the wait and see mode but a lot of integration with different lender systems, communication with the lenders and realtors but to date we really haven't seen those closings occur yet.

All right, thanks. That is all I have.

(Operator Instructions). John Campbell, Stephens Incorporated

Good morning. Congrats on the quarter. Just on the closing ratio, that was about 200 basis points higher sequentially and about 1000 basis points higher from last year. Was that mostly due to you guys and just lenders rushing to close ahead of [tread]? What exactly drove that?

Some of it is just the massive to open order accounts slowing down on the seasonal basis from Q2. But I am not aware of any particular single factor that drove the closing ratio to go up. I mean it could be a combination of all of the things you mentioned whether it is just trying to get deals closed in the third quarter ahead of tread or just serendipitous timing.

Got it, got it. And then nice work on the remittance ratio. I know how hard that is to move those splits but it sounds like that you guys picked up some additional business in Florida and might have lost a little bit in California and Texas which are more states for you guys. What was the main driver there? Is that just taking additional share, is that just those individual real estate markets just picking up?

We have really had a pretty significant focus on some of the higher remitting states, Florida being one of those. So one quarter does not trend a make but we are encouraged by the quarterly results in Florida and of course the slowdown in business in California and our agent base didn't necessarily hurt it -- it helped us from a remittance rate perspective. But as I said earlier, I would be a little reluctant to claim that that is going to be remittance rate on a go forward basis just it is a little early to say that.

Right, right, that makes sense. Then just back on tread, as we think about next year and maybe the years to follow, just give us Matt or Allen, just either one of you guys just give us your thoughts on what that kind of does to the space? Are we going to see any kind of shifts in the M&A environment? Any kind of shifts around retention rates or anything of the sort?

I think there is some uncertainty there. Obviously as it relates to more regulations, there is a question of the two small to comply and whether some of the smaller agencies -- whether it is worth it to be in compliance with not only some of these regulations and changes in technology but also with increasingly stringent vendor requirements. And so there may be some fluctuation there as that goes forward.

We think overall and our mindset even as we've look at our strategies the last couple of years, there is definitely a pursuit of quality which we think benefits us in the long run. There is definitely a move towards tighter relationships between the agencies and underwriters, the underwriters providing more support to be compliant which we think is a positive for us. So there is still a lot of uncertainty there. I think as we look at more regulation, more possibly to comply, needing more services from the underwriter, these are things that we've tried strategically to position ourselves well to take advantage of.

Thanks for that color, Matt. Appreciate it, guys.

It appears we have no further questions at this time. I will return the floor to Mr. Matt Morris for closing remarks.

Thank you very much for joining us. As we said, the third quarter of 2015 demonstrated continued progress toward our goal of enhancing margins, improving return on equity and driving efficiencies throughout our operations. Even though our third-quarter results were impacted by the non-cash impairment charge, the quarter was a productive and positive one for us. Our title segment margin continued to improve. We finalized the cost management program we announced in 2014 when we generated solid cash flow during the quarter.

As we look forward to the fourth quarter, we are mindful as we stated of the potential impact on closings from implementation of the new integrated disclosure requirements. Given the significance of changes all along the mortgage origination to closed cycle, we believe there may be some disruptions in closings which could result in revenue generation shifting to later in the quarter and into first quarter in 2016. So far in October, we have only experienced a modest decline in open orders per workday as compared to September. But it obviously is too early to discern a trend at this point.

During the fourth quarter, we will have a full quarter's benefit of the cost management program to help offset any potential revenue delay to 2016.

Again, thank you for the time this morning and have a great day.

Ladies and gentlemen, this does conclude today's teleconference. We thank you for your participation. You may now disconnect and have a great day.