Stewart Information Services Corp (STC) 2015 Q4 法說會逐字稿

Welcome to the Stewart Information Services Fourth Quarter and Full Year 2015 Earnings Conference Call and Webcast. 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, sir.

Thank you, Tenisha. Good morning. Thank you for joining us for our fourth 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. To listen online, please go to the stewart.com website to access the link for this conference call. I will remind participants this conference call may contain forward-looking statements that involve a number of risks and uncertainties. Because such statements are based on an expectation of future financial operating results and are 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 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.

Thanks, Nat. Again, we appreciate everyone joining us today. This morning we reported fourth quarter 2015 earnings with our title segment delivering another quarter of solid results. Our mortgage services segment remained challenged by the delinquent loan servicing operations that we are exiting. Alan is going to provide the specifics of our financial results in a moment. But let me first offer my thoughts on 2015 and the outlook for 2016 at a more macro level. 2015 will be remembered as the year trade for the title industry, bringing more process and technology changes than we have seen in decades. We are seeing a return to business as usual as any lingering questions are resolved and processes and technologies are fined. In addition to this industry change, 2015 was an eventful year for Stewart. We accomplished much that laid the foundation for a continued prosperous future. We launched a major brand refresh and committed resources to disciplined targeted sales growth. We've rigorously evaluated the performance of our network of direct offices and consequently exited several underperforming states. We instituted new processes and technology that improve operational efficiencies and initiated an enterprise-wide effort that will revamp our title and escrow production over the next 24 months, enabling further efficiencies and expense reductions.

We accomplished significant outsourcing pursuant to our cost management program, resulting in our enhanced year-over-year pretax margin and we expect to leverage the lessons learned to further reduce costs, improving margins in 2016 and beyond. Restoring our mortgage services operations to profitability has been more difficult than anticipated. We responded to rapidly shifting market conditions and announced the exit from our delinquent loan servicing operations in the second quarter of 2015. Unfortunately, those operations have and continued to negatively impact results for the first quarter of this year. Market conditions change continuously and we are acting aggressively to create a more cost effective operating platform including systems rationalization, offshoring, reevaluating our geographic footprint. In November 2015, we announced a 20% increase in the Company's cash dividend payable to common shareholders to $1.20 per share, responding to our ability to deliver improved operating performance and cash flow. The first quarterly payment of the increased dividend began in December, 2015. We remain committed to allocating capital to maximize shareholder value including how and when we invest in growth and operational capabilities.

Of course, capital allocation and operational decisions always take into consideration, our expectations of market conditions. Our current view is for total title industry revenues in 2016 to be in line with 2015. We expect home sales and home prices will experience low single-digit increases, which will be offset by declines in refinanced volumes. We do believe that strong commercial real estate market combined with a greater than normal commercial refinance volume, should result in a low double-digit percent increase in industry-wide commercial revenues. With respect to Texas, specifically Houston, each continued to gain job, while the Houston's housing market has seen a recent decline in home sales, particularly in homes priced over $750,000. While home sales in Houston declined 2.5% last year, I want to remind you that 2015 was the second highest sales volume ever recorded in the city. We anticipate 10% decline in total Houston existing home sales in 2016, partially offset by a small increase in median price. The Houston economy is far more diversified now, than in past slow down. And in fact, we are seeing offsetting job growth and increased housing demand related to the downstream energy construction boom along the Gulf Coast. Texas overall existing home sales are expected to grow in 2016, albeit at a lower rate than the 3.4% seen in 2015. But whatever the global market conditions present, we continue to pursue smart revenue growth. In late 2014, we established a chief revenue office and during 2015, expanded our revenue growth and sales management capabilities.

Today we have specific revenue targets for 2016 that should yield above market growth in these areas we target through specific plans for the accountable executives to achieve them. We also recognize that the changing regulatory environment and its impact on customer requirements may enable highly accretive acquisitions in our core title business. Coupled with our successful cost management programs, including further centralization, offshoring and technology rationalization over the next two years, we are committed to 10% pretax margin in a normalized origination market.

Lastly, in continuing our transformation, we announced on January 26 of this year, a plan to reclassify the Company's stock to eliminate its dual class structure. We believe the proposal will strengthen Stewart's corporate governance by aligning voting rights with the economic interest of our stockholders. Our simplified capital structure provides solid foundation for us to drive value creation and future growth. The company will be seeking stockholder approval of the reclassification at its annual meeting of shareholders on April 27, 2016.

So now, I'm going to turn it over to Alan to discuss the financial results.

Thank you, Matt, and good morning everyone. Total operating revenues decreased 3.3% in the fourth quarter 2015, compared to the year-ago quarter. With title revenue is essentially the same as last year and mortgage services revenue is declining by 40.2% as we exit the default servicing business. Although overall closed title orders declined by 1.5% from fourth quarter 2014, a shift in mix offset the revenue decline that would have otherwise had been experienced. We closed 2.6% fewer residential orders in the fourth quarter, 2015, which was offset by growth in refinancing and commercial orders closed at 5% and 1.5% respectively. We believe that our residential closings in the quarter were somewhat negatively impacted by the new integrated disclosure requirements, known as Know Before You Owe, which became effective October 3, 2015. Commercial revenues continued to show strength with worldwide growth of 9.1% over the prior year. Notwithstanding the modest growth in overall title segment revenue, the segment generated solid pretax results with pretax margin growing approximately 200 basis points, to 12.1%. In addition to the growth in higher margin commercial revenues, our cost management program positively influenced pretax margin. With an expected sharp decline in refinancing originations in 2016, as well as an ongoing reduction in the number of delinquent and defaulted loans, we anticipate title revenues associated with these transactions to decline primarily affecting our centralized title operations within the mortgage services segment.

While we have seen new customer growth in mortgage services, our operational focus will be on continuing to rationalize our cost structure to return to segment profitability in the second quarter with margin growth on track for further improvement in the back half of the year. As in previous quarters, we've 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 operational profitability.

We recorded several non-recurring and non-operating charges during the quarter and I want to summarize them here to provide some context to quarter's overall with results. We incurred approximately $3.7 million of cost in mortgage services segment relating to the exit of the delinquent loan servicing operations consisting principally of several, early lease termination charges, asset impairments and accelerated amortization. Our estimate of the total charge to be incurred related to exiting these operations remains in the previously stated $5 million to $7 million range to be incurred through the first quarter of 2016.

The title segment incurred approximately $1.8 million of non-operating charges associated with severance and asset impairment. The corporate segment reported approximately $4.4 million of charges related to severance, residual consulting costs of the cost management program and asset impairment. So with that background, I'll look at our business unit results. With respect to direct title operations, revenues increased by about 1% from the fourth quarter of 2014. Total title orders opened in the fourth quarter declined 8.6% from the prior year quarter, while total title in quarter closed decreased 1.5%.

Residential fee profile in the quarter was $1,943, up slightly from $1,901 in the third quarter 2015. US-only commercial revenues increased 8.7%, to $48.7 million compared to fourth quarter of 2014. Total worldwide commercial revenues for the quarter were $55.2 million, an increase of 9.1% from the fourth quarter of 2014. International commercial revenues, though unfavorably impacted by strengthening US dollar still grew 12.1% to $6.5 million, compared to fourth quarter of 2014. Looking at commercial revenues on a full year basis, which helps to smooth out some of the quarterly volatility. US-only commercial revenues grew a strong 14.7% and total worldwide commercial revenues grew 9.3%. For the fourth quarter of 2015, total international revenues were $27.8 million, down 2.1% from $28.4 million in the fourth quarter of 2014. The revenue decline was due solely to the change in foreign currency exchange rates as a result of continued strengthening of the US dollar. Our independent agency operations also generated positive result, as the fourth quarter of 2015 revenue is comparable to fourth quarter of 2014. Net of agency retention, independent agency revenues increased 1.5%. The full year 2015 and 2014 remittance ratios were 18.3% and 18.5% respectively. And our anticipated ongoing remittance ratio will be in the mid-18% range, since we consider our full year remittance ratios to be more predictive than any single quarter.

With respect to title losses, title losses were $27.7 million in the fourth quarter of 2015 or 5.9% of title revenues compared to $31.3 million or 6.6% of title revenues in the prior year quarter. On a year-to-date basis, which helps to smooth out some of the quarterly volatility in loss ratios and excluding the $14.8 million recovery recorded in the third quarter of 2014, our core accrual rate for title losses was 5.6% for both 2015 and 2014. We anticipate maintaining our core accrual rate around 5.5% going forward. Our total balance sheet policy loss reserves were $462.6 million at quarter-end and remained above the actuarial midpoint of total estimated policy loss reserves. We closed out 2015 on a strongly positive note in our title operations, notwithstanding the effects of the integrated disclosure requirements. Although total title segment revenues grew approximately 1% from last year's fourth quarter, the segment generated pretax income of $54.9 million representing 12.1% margin, increasing 20.4% from fourth quarter 2014, to $45.6 million, which was a pretax margin of 10.2%.

Looking at mortgage services segment, revenues decreased 39.8% to $42.2 million compared to the year ago quarter. Fourth quarter 2014 revenues include net realized gains of $7.4 million. Relative to fourth quarter 2014, the revenue decline is primarily attributable to expected declines within our delinquent loan servicing operations following demand for certain centralized title products including refinancing transactions in default related title and the sale of small subsidiary in fourth quarter of 2014. Excluding the impairment and non-operating charges, the segment generated an adjusted pretax loss of $8.8 million in fourth quarter 2015 versus pretax income of $1.7 million for fourth quarter 2014. This represents a pretax decline of $10.5 million on an operating revenue decline of $19.9 million. The delinquent loan servicing operations will continue to operate unprofitably during the first quarter of 2016, as we wind its business down in accordance with the schedule agreed to with our customers. After finalization of the wind down of the delinquent servicing operation, the revenues for the mortgage services segment will be predominantly aligned with the mortgage origination cycle, especially as it relates to centralized title and valuation service.

While we will retain our capabilities in providing services to assist in the management of troubled loans, we expect the residual revenues associated with the service offerings continue to shrink. Therefore, as we mentioned earlier, our operational focus in 2016 will be on implementing cost reductions and other efficiencies to return the segment to profitability in the second quarter of 2016. With respect to operating expenses, op employee cost for the fourth quarter 2015 decreased 4.2% from fourth quarter of 2014 and decreased sequentially 3.2% from third quarter 2015.

Average head count decreased approximately 6% and 3.2% from fourth quarter of 2014 and third quarter of 2015 respectively. Excluding severance charges, employee cost as a percentage of operating revenues were 31.8% and 32.4% for the fourth quarters 2015 and 2014 respectively. Other operating expenses for fourth quarters 2015 and 2014 were comparable. Fourth quarters 2015 and 2014, include $1.3 million and $7.7 million respectively of the charges described earlier. Excluding the impact of these costs, other operating expenses as a percentage of total operating revenues were 19% and 17% in the fourth quarters 2015 and 2014 respectively with the fourth quarter 2015 ratio being unfavorably influenced by lower operating revenues.

Depreciation and amortization expense was $8.3 million in the fourth quarter of 2015, as compared to $8.2 million in the fourth quarter of 2014. Included in the fourth quarter 2015 is $1.1 million of accelerated depreciation charges related to exiting the delinquent loan servicing operations. Lastly, a few comments on other matters. Fourth quarter 2015 results include net realized losses of $4.6 million, driven primarily by $3.6 million in impairment charges whereas fourth quarter of 2014 included net realized gains (technical difficulty) non-investment portfolio realized gains totaling $9.1 million, partially offset by impairment charges of $2.7 million.

Cash provided by operations was $14.9 million in the fourth quarter of 2015, compared to $49.6 million for the same period in 2014, a decrease of $34.7 million. The decrease is due to the decline in net income as well as claims payments in excess of our loss provision as we paid a large claim that had previously been accrued. Fourth quarter of 2014 also included a cash receipt related to the partial recovery of a large loss, which had been reflected in title loss expense in the third quarter 2014. With regard to further cost management, our focus is on those actions that will improve pretax margins, and as we have said, our goal is to achieve 10% pretax margin in a normalized origination market. Our plan is to improve margins, include further outsourcing, additional automation and manual processes, and further consolidation of our various systems and production operations. Improving margins also means seeking better pricing from our vendors, aggressively managing our portfolio of office leasing and being disciplined when it comes to keeping existing office open for deciding to open a new one. All of these drive margin improvement. Given the multitude of variables involved, we don't feel comfortable providing an absolute number for cost reduction.

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

The floor is now open for questions. (Operator Instructions) Bose George, KBW.

Hey, this is actually Chas Tyson on for Bose. Had a question on the mortgage services segment. A couple quarters ago, you guys had given guidance on that segment, targets of I think of $120 million to $140 million of revenue with low-teens EBITDA margins, given the commentary you made about lower centralized refi and default production in 2016, are there any updated thoughts on those revenue or margin numbers?

I would say right now that there's -- the revenue numbers in 2016 are probably modestly lower than that. But I would also say that as we mentioned a minute ago, our goal is to get that segment back into profitability beginning in Q2 and then ramping it up from there. I still expect to see us in sort of a pretax margin of about let's call it high single-digits with EBITDA tight margin in low double-digits as we get towards the back half of 2016.

Okay. And should we think if we look at the segment and try to ex-out the delinquent services part of the business, I know you mentioned that you're trying to look at the cost structure to get to profitability in 2Q. But I guess, if we think about the segment going into Q2, we ex-out delinquent services, do you need to rationalize the cost structure or take out some cost to get to profitability, or would it already be profitable even absent finding efficiencies?

Well, we would clearly need to rationalize some of the cost structure to get to the margin targets that I just outlined. But I don't think we get there on just business as usual with those remaining operations.

Okay. Got it. And then I wanted to ask you if you have a viewpoint, just kind of on the industry in general, whether there is a possibility for consolidation among larger players from an antitrust perspective. Do you think that would be a possibility?

It's hard to speculate on that. It's really so many variables involved in potential industry consolidation. You don't want to try to predict what regulatory actions might be taken over or not. So I think at this point, we'd rather not speculate on that.

John Campbell, Stephens Inc.

Hey just back to the mortgage services segment, can you isolate or maybe tell us a little bit more about maybe the origination side of business, kind of what that's doing below the surface. Is that growing outside of the default related services?

Refinance volume is falling I think we've seen as an industry trend. And so most of our refinance business is in that mortgage services segment. And so while it is origination that business line is primarily made up to the default services, which are obviously declining as the economy improves, as well as falling refinance volumes.

Okay. Got it. And then, obviously with some of the severance costs coming out of mortgage services, you guys have already taken a lot of actions. So it's not necessarily as you get in the next few quarters, you guys have to cut additional staff. It sounds like you already maybe have made some cuts and we should see those just naturally some of those costs show up into the next two quarter or three quarters?

I think that's fair. Obviously, we're going to react to volume fluctuations and continue to make cost rationalization as volumes fluctuate. To say that we're completely done with the cost cutting on the side of the business that's unrelated to what we're exiting is probably not completely accurate.

Got it. And then just industry trends, I mean obviously the 30 year has declined, I think every single week to start this year. Are you guys seeing any kind of lift like modest lift out of refi to start the year?

We are. I think that's in line with what we're seeing in the overall market, but yes, we would echo what we're saying in the press on refinance increases as mortgage rates are declining at start of this year.

Got it. And then last one from me, on the reserve. That was a little bit higher than we were expecting this quarter. I know there's some volatility there. Was that anything that you guys can isolate in the past, any particular maybe a commercial claim or anything like that?

No, nothing really stuck out in the quarter. I mean, in any given quarter, we're going to obviously have a little bit of volatility whether just depending on whether we've got some adjustments positive or negative to our overall reserve position. But no one large thing stuck out in the quarter. I still feel really comfortable about us reserving in about 5.5% range going forward, recognizing that there's always going to be a little up or down in any given quarter.

Patrick Healy, FBR.

Good morning, thanks for taking my questions. First off on the title business, you saw nice year-over-year growth in the pretax margin and kind of outlined some cost-saving initiatives 2016. So it being at 12% now, what would you say is your long-term goal given the initiatives you have now and not asking for a timeline, but say a couple years out, where would you expect that to be in normal origination environment?

Well, in a normal origination environment, you're probably pushing it closer to 15% just assuming all other things being equal. But as we said, we're continuing to work on some production efficiencies that we think help us get there. So they were setup for that sort of margin achievement in that environment.

Okay, great. And then on the capital management side of things, given kind of the market volatility and your new share repurchase authorization you guys put out toward the end of last year, how are you thinking about that maybe near-term and a little bit longer-term between further dividend increases versus kind of looking at your own stock at today's levels?

Well, I would first point out that part of capital management equation is also managing our underwriters' balance sheet. And we don't really know yet what our statutory balance sheet looks like. So, probably not looking to do stock repurchase until we have a better sense of what our overall statutory balance sheet looks like as well as just some other variables that we take into account in any scenario. So it's something that's obviously we evaluate on an ongoing basis and try to make the smartest decision possible given the circumstances at the time.

Just to highlight that again. I think we talked about the prioritization would obviously be the stability of the underwriter first and foremost, secondarily would be dividends in the range, which we are looking at right now, and then subsequent to that just looking at growth opportunities and then stock repurchase would be in there. Board would continue to look at ongoing capital opportunities to see how best to return long-term value to shareholders.

Great and then, if I can sneak one more in. On you talked about a number of cost rationalizations you guys are looking at. So if I think about that on a timeline, is there any you can highlight maybe is a little bit more near-term or low-hanging fruit versus the others you mentioned, or is it really just everything is kind of on an ongoing basis and it will blend in here over the next couple of quarters as we move through 2016 and maybe into 2017.

Yes, I think it should blend in. We've taken really the low-hanging fruit and that's why, as Alan commented, we haven't pushed a number out there. We feel like the cost management program itself took the big buckets and now we have some longer term initiatives that over the next couple of years, we'll continue to improve margins going forward.

If you think about sort of production efficiencies that imply lower unit cost of production, and obviously you get the savings of lower unit cost of production. It's just a little hard to trace it in a straight line, because of volume fluctuations. But that's why we try to focus more on just lowering unit cost, because that's savings that you get in up or down transaction environment.

Kevin Kaczmarek, Zelman & Associates.

Thanks. I guess given trend related issues in the fourth quarter on the title side, I know you gave some margin guidance on the mortgage services segment. But on title, can you give us a sense of whether the expenses were abnormally elevated at the end of 4Q and how they should maybe trend into the first part of 2016?

Yes, we did see some increased over time in our title segment in the fourth quarter. It was about $2.5 million more in overtime in this fourth quarter versus the year-ago fourth quarter. Obviously it's hard to say that of every dollar of that was due to trend but the working assumption, which I think is a valid one is that the lion's share of that increased overtime was due to trend. So as you move into the seasonal slower time of the year, you're naturally not going to incur a lot of overtime to begin with and then you also do other things like adjusting hours or what have you to respond to changes in volume in the first part of the year.

Okay. And on the orders side, would you guys -- I guess is there a kind of an extra backlog of orders that didn't get processed or do you expect to catch up in 1Q or how is that trending in terms of your closing times?

It's interesting, we saw a lot of that take place in Q4 and I think there's some hold over, but honestly a lot of that picked up, toward the end of the year and I would say close a little bit sooner than we may have anticipated.

Okay. And I guess on the commercial side. Have you seen any upticks and claims related to energy or do you have any sense of your exposure here?

No. We really haven't seen any real uptick in our commercial clients. I mean we've had a relatively -- what I'd call anyway a relatively benign year from that perspective, just relatively few -- we had some in the first quarter. You probably remember the discussion back then around some of the claims we approved for in the first quarter, but since then it's been really pretty modest.

And then I guess lastly on the Asian revenue, what were some of the drivers. Were there anything that stood out in the quarter in terms of the regular order flow or whether their revenues were abnormally affected by trend?

Only anecdotal information there. I had said in the couple of meetings with some of our agents back in middle part of the fourth quarter and it was clearly impacting them then, but my expectation is that as they got into December, they started to see some of that closing activity normalize. You can see from a table in the press release, our orders closed November to December jumped up nicely. And I would participate that the agents had a similar experience.

So I guess in the way you guys accrue for, we shouldn't be modeling any sort of --

No. Since (multiple speakers) we don't really know agent order flow. We just know cash receipt flow and that kind of gives us an idea of trends.

(Operator Instructions) Geoffrey Dunn, Dowling & Partners.

A couple accounting questions. First, I'm trying to get a better idea of how your services profitability compares to other real estate services products out there. When we look at that margin, is there any purchase price adjustments that are in there that you typically see other companies extract out?

Yes. That includes the amortization of acquired intangibles.

So when you're talking kind of low double-digit margin, if you adjust for the purchase price amortization, where does that margin shake out?

Well, that would adjust for the purchase price amortization.

Okay, so the guidance is excluding purchase price amortization which was included in the result this quarter?

Yes, it is included in the results. So, on a GAAP basis, obviously it includes it.

Alright. So are you guys going to start breaking that out for us or because I think the implication then as we're looking at probably more of a high single-digit margin?

For GAAP?

High single-digit GAAP.

High single-digit GAAP and low double-digit adjusted for purchase price amortization. We can certainly put that in our 10-K.

And then with respect to your corporate, has management give any additional thought in terms of allocating that to the segments?

Well, obviously we recognize we're a little different in our trading of corporate expenses than a lot of what centralized services operations that end-up in that segment. So that's something we are evaluating. It's a little premature to speculate on how we might change it, but we are thinking about that again.

Ryan Byrnes, Janney.

Great, thanks. Good morning, everybody. Just had a question on the open orders within commercial. The second quarter in a row, they were down double-digits. Just wanted to see if something was going on within the commercial segment there?

Nothing that we've seen, I think that we can point out. Given nature of commercial transactions, we usually are careful on the quarterly comparison, but we continue to see commercial growth and are encouraged by commercial productivity.

And then shifting back to the corporate segment. Again, I realize there are a bunch of kind of a one-timers running through that this year, but again, it was worse year-over-year, the [pretax losses were at $160 million versus $140 million] last year. Just trying to figure out what a decent run rate again, how should we think about that going forward?

Probably a little premature for me to give guidance on that. Obviously, as I said a minute ago, we're kind of re-thinking how we look at that cost pool there, but I would expect certainly in the first quarter, we will normalize the actual operating expenses of that segment. So I think I'll just leave it at that for now.

Okay. And then just my last one would be the agents split continue -- again year-over-year it was some solid improvement, same as the third quarter. Is that just kind of reflective of the geographic, I guess mix shift and is that something you guys should expect to continue?

The improvement in the quarter was largely due to improved mix in terms of getting more revenue from the higher remitting state. Clearly we've targeted -- from a revenue growth perspective, we've targeted growth in the state that are higher remitting. Having said that, we do think that 18.5% remittance rate would be a good outcome for us in 2016.

(Operator Instructions) And it does appear we have no further questions. I will now hand the floor back over to Matt Morris for any additional or closing remarks.

Thank you very much and again appreciate everyone joining us this morning. Just to close, reiterate that we're encouraged by the Company's transformation over the last several of years and we do remain committed to further margin expansion and growth with some defined projects to drive shareholder value.

So we appreciate your time this morning and have a great day.

Thank you. This does conclude today's teleconference. Please disconnect your lines at this time and have a wonderful day.