Stewart Information Services Corp (STC) 2023 Q2 法說會逐字稿

Thank you for joining us today for Stewart's Second Quarter 2023 Earnings Conference Call. We will be discussing results that were released yesterday after the close. Joining me today are CEO, Fred Eppinger; and CFO, David Hisey. To listen online, please go to the stewart.com website to access the link for this conference call. This conference call may contain forward-looking statements that involve a number of risks and uncertainties. Please refer to the company's press release and other filings with the SEC for a discussion of the risks and uncertainties that could cause our actual results to differ materially. During our call, we will discuss some non-GAAP measures. For reconciliation of these non-GAAP measures, please refer to the appendix of today's earnings release, which is available on our website at stewart.com. Let me now turn the call over to Fred.

Thank you for joining us today for Stewart's Second Quarter 2023 Earnings Conference Call. David will review the quarterly financial results in a minute. But before we get into the financial results that we released yesterday, I want to update you on our view of the market and our continued progress on important initiatives that we believe will set Stuart up for success in the long term. During the last 3 to 4 years, we have focused on fundamentally improving Stuart's operating performance and launching out on a journey to become the premier title services company. While the current economic environment poses significant challenges, we have materially improved our business, creating a strong and more resilient business that will thrive over a full real estate cycle. But we also know there is more that we can do, and it is critical for us to remain focused on improving margins, growth and resiliency to improve scale in attractive markets and enhancing our operational capabilities. In difficult markets, such as the current one, it is often indies focused on achieving these long-term goals.

However, I'm very pleased with our progress on these enterprise initiatives during the second quarter and are on progress towards improving our long-term performance. Given the continued volatility in the market, we have balanced investments in these initiatives, we would need to manage expenses very thoughtfully. As we've discussed before, we are not surprised that the challenging economic environment continued into the second quarter. Although interest rates declined early in the second quarter, they increased throughout the remainder of the quarter and the 30-year mortgage interest rate now hovers around 7%. As would be expected, the increase in rates has offset some of the typical seasonal increases in residential or volumes that are expected during the summer months. Fortunately, we have seen modest increases in the transaction volumes during the second quarter after experiencing a historic low in the first quarter. Demand for new homes is strong, although listing for existing loans remains very low.

We expect the challenges of this environment to continue throughout 2023. We have managed costs carefully throughout this market while focusing on our long-term strategy, which requires a careful balance between investing in initiatives and managing expenses. We've been careful not to take actions that we felt would threaten our competitive position and long-term value-creating opportunities. We believe that the real estate cycle will be found in 2024 and the best past Board for Stuart to get through this period is to invest in our people and remain focused on our long-term improvement plan while managing through a few challenging quarters.

We remain focused on our long-term strategy, enhancing our operating model, investments in technology to enhance customer experience and improve efficiency of our operations and building scale in targeted areas. We recognize that these strategic investments will cause our cost ratios to remain elevated in the market with exception of low transaction votes. We these long-term investments, coupled with thoughtful near-term expense management will improve our structure and financial performance in the long term. In our direct operations, going scale in attractive markets remains a priority.

We are routinely reevaluating markets where we have the opportunity to pre-share and enhance our leadership strength. Given the market uncertainty, we have been more selective in our decisions in order to ensure our deployment of capital makes sense for the long term. Positioning our commercial operations for growth across all our business lines has been a key focus of our journey as those operations are an important component of our overall strategy. We are making investments in talent so that we have the leadership in place to achieve these objectives.

We are investing in technology to support the commercial operations to allow us to better serve our customers, and we remain optimistic about commercial. But as we discussed last quarter, the commercial environment remains uncertain in the short term due to changing financial markets. Certain commercial sectors, such as energy remain very strong for us, but we see ongoing challenges in sectors like office and multifamily. However, we believe our focus will create long-term growth in the commercial markets. In our Agency business, we are leveraging our technology to drive market share gains. We have made excellent progress on our deployment of technology and services to provide a significantly improved agent experience for Stewart.

This experience includes greater connectivity, ease of use for risk reduction for our agent partners. We are pleased that our platform of services for agents is as strong as it's ever been, and we've begun to see meaningful progress in target markets such as Florida and agency commercial and others. A significant component of our investments is focused on improving our technology for the total production process automation and centralization to improve operational efficiencies and capabilities. We have already made significant progress in proving the customer experience across all channels and are rolling out our agency technology platform, which significantly enhances user use of connectivity with agents.

Another area of priority as we work to improve our operating efficiency is the centralization and digitization of our title plants. During the quarter, we have made significant progress on our road map of integrated completed acquisitions into our production and other systems, which improves the customer experience as well as the overall operating efficiencies that we have building on for the past several years, integrating the remaining required companies is a top priority for the balance of 23.

Maintaining strong financial position is always important, but even more during a market like this. Our strong financial position, like we currently have, allows us to make opportunistic investments. Financially, our long-term goal remains to generate high single, low double-digit margins over the cycle. Over the cycle, there will be high and low quarters as evidenced in the first quarter. However, the modest increases in transaction volumes, margins improved significantly as indicated by our second quarter results. In addition, the investments we have been discussing once fully implemented, should allow us to achieve low double-digit margins over the cycle.

While we're encouraged by improvements in talent, technology and customer experience and our financial model, the work remains them done and the journey is not complete. We may focus on our strategic plan of building an improved competitive position by building more efficient and having a disciplined operating model that functions well throughout all the real estate cycles. We have emphasized growing scale in attractive markets of cause all lines of our business, and we have made significant progress in improving customer experience in all our channels.

Retaining key talent is always important, and we have been even more focused on retaining talent to this market so that we have the right team in place as the cycle improves. Our efforts are yielded results increased year-over-year market share gains in each of our direct agency and commercial businesses. Let me conclude by reinforcing that we have been managing our expenses and investments with sensible balance between operating discipline and current short-term market challenges and strengthening store for long-term growth performance.

The strong financial footage should best position us to take advantage of the opportunities that this cycle will provide. Finally, my positive long-term view of the real estate market, the ability of store to become the PREM entitled service company has not waivered. Our associates have worked hard throughout these challenges times, and I appreciate all they have accomplished. And I also want to thank our customers for their continued loyalty and support. Dave will now update anyone on the results.

Good morning, everyone, and thank you, Fred. Before anything else, I would also like to thank our associates for their wonderful service and our customers for their support. Our second quarter improved sequentially to the first quarter. However, low housing inventory, high mortgage rates, lower commercial and residential real estate activity and economic conditions continue to exist in the market, contributing to lower second quarter operating results as compared to last year's quarter. Yesterday, student reported net income of $16 million or $0.58 per diluted share on total revenues of $549 million. After adjusting for net realized and unrealized gains and losses and other items detailed in Appendix A of the press release, the second quarter adjusted net income was $19 million or $0.69 per diluted share compared to $70 million in the second quarter, net income of $70 million in second quarter 2022.

Regarding the second quarter title segment, total revenues decreased $278 million or 37%, while pretax income decreased to $35 million compared to $94 million last year. After adjustments for purchase intangible amortization and other items, the segment's pretax income was $37 million or 8% margin compared to $105 million or 14% margin in last year's quarter. On our direct title business, total open and closed orders declined by 18% and 29%, respectively, compared to last year, primarily due to the current real estate market. Domestic commercial revenues decreased $26 million or 38% due to lower transaction volume and size. Average commercial fee per file was approximately 11,600 compared to 13,100 in last year's quarter. Domestic residential revenues declined $50 million or 21% due to lower purchase and refinancing transactions. However, average residential fee per file was up 11% and to 3,300 versus 2,900 due to higher purchase mix.

Total international operating revenues declined $18 million or 35%, primarily due to lower transaction volumes in our Canadian operations. As a result of lower commercial and residential activity in the market, second quarter revenues from our agency operations decreased $201 million or 49%. The average agency remittance rate slightly improved to 17.7% versus 17.1% last year, primarily as a result of geographic mix. Investment income increased due to higher rates and due to our working with our bank partners to better utilize escrow balances where appropriate. In regard to title losses, total title loss expense in the second quarter decreased $7 million or 25%, primarily due to lower title revenues. As a percent of title revenues, title loss expense was 4.2% compared to 3.5% in last year's quarter, which benefited from last year's favorable claims experience.

For the full year '23, we expect title losses to average in the low 4% of title revenues. For the Real Estate Solutions segment, pretax income was $3 million in the second quarter compared to $6 million last year, primarily due to lower revenues driven by the real estate and economic environment. Pretax margin from the second quarter was 4.6% compared to 7.4%. And then after adjusting for purchase intangible amortization and catch-up state sales tax expenses related to an acquisition, adjusted pretax margin was 14.4%, which was comparable to the 14.7% in the prior year quarter. Related to our consolidated operating expenses, our employee cost ratio increased 34% versus 25% in last year's quarter, primarily due to lower operating revenues. Lower operating revenues also led to other operating expense ratio of 24% versus 19% last year. On other matters, our financial position remains solid to support our customers' associates in the real estate market.

At June 30, 2023, our total cash and investments were approximately $370 million over statutory premium reserve requirements, and we also have fully available $200 million line of credit facility. Total stockholders' equity attributable to Stewart was approximately $1.36 billion, with a book value per share of approximately $50. Lastly, net cash provided by operations was $35 million compared to net cash provided of $83 million in last year's quarter due to lower net income. We greatly appreciate our customers and associates. We advocate for everybody's safety and prosperity and remain confident that our real estate markets. I'll now turn it back to the operator for questions.

(Operator Instructions) We will take our first question from Bose George with KBW.

I just wanted to ask first about investment income. Is that a new level of investment income, something we can run rate? Or if not, like how should we think about that number going forward?

Yes, Bose, this is David here. So I think the way to think about if you're looking at like the increase of this quarter versus last year's quarter, probably about 70% of that is coming from these escrow activities that we just initiated, and so that would be ongoing, and then the rest is really the difference in better rates, particularly on short-term balances. I think that's probably relatively stable and will vary with balances. But the escrow component is definitely incremental.

Okay. Great, and then in terms of the agent premiums, can you just remind us, is there a lag in that number? So given the magnitude of the decline versus what happened to direct, does that just reflect the lag and there's a bit of a catch-up after.

There is a little bit of lag in our agency revenues growth and we looked at a number of things about it, this same kind of difference, this gap occurred in the second quarter of '21 as well and be caught up over that. So we don't see any share shift or anything like that. When we look at the agency level activity. So I'm pretty comfortable that we'll kind of even out here over the next few months.

We will take our next question from Soham Bhonsle with BTIG.

First one is just on the purchase orders. It looks like your declines were a little bit better than your peer that announced results today as well. Is there something specific going on there? Is there a share take that we should be thinking about? Or is this sort of your acquisition sort of kicking in now and you're getting a benefit of that?

Yes. So we look over the last 5 quarters. Each of our businesses has gained share. We don't know this quarter yet until the files come in, but we've had nice momentum and share growth. It's really irrelevant. We haven't had any acquisitions kind of the comparative time that has affected it. Commercials were lumpy, but both agency and direct, we see really consistent quarters of share gain, which is good. So it's not huge, but it's a step in the right direction.

Got it, and then on the expenses and sort of tying this in with margins, Fred. The performance this quarter was strong. But if we sort of assume flattish volumes, let's say, next quarter on a sequential basis, is there any reason that margins can at least stay flat to higher next quarter? Are there any expense items we should be thinking about? I'm just trying to figure out if this is sort of the peak for margins this year? Or we sort of sought to see some higher as we go in the next quarter?

Unusual expenses. So like the incremental $20 million we're spending, as I talked about for the improvement initiatives were kind of evenly spread. There's no extraneous kind of thing I can think of that would spike in the next 2 quarters. So it's going to be exclusively driven by volume, the revenue volume, and again, we have made improvements in our operations on the margin, but a lot of the improvements, you don't really see unless the volume goes up, you think, because it's kind of, you have excess capacity in the system as you get more efficient.

And so it's going to be pretty steady, I think, driven mostly by the volume. And the only -- all I think about volume, as you know, the pattern is something like commercial is heavily skewed to like the fourth quarter and the end of the year in December in particular, which drives a change in that particular business. But everything else is pretty driven on the general market framework of how revenue unfolds here.

Got it. And then I guess just on commercial, we're hearing sort of mixed things, right, in the market. I guess I just want to get your views on how you're seeing the back half year.

Yes. I mean it's down, right? I mean, obviously, and the financial things that are going on and putting a little bit of pressure on new investment, if you will. And there are some, obviously some segments that are very good, like we were seeing some really nice energy and some of the factors, but obviously, it looks like the office is tough. So it's going to be down. We don't see any pattern to that. But as far as you would jump in the next quarter or something we feel like it's -- the orders are kind of steady at a lower level right now. But again, we are, this is another place, as you know, we've invested a lot and we're continuing to, and we believe we can continue to build that business. But we got there's some headwinds here in the short term as far as a...

And Soham, it's David here. I mean if I just look as Fred said, if I just look at our transaction types for the quarter, there's nothing really in the office sector. I mean there's probably some smaller stuff. But the bigger transactions, as Fred said, are really energy dominates, there's some industrial, hospitality, multiuse, that kind of thing. So it's probably fair to characterize that the decline in office has been offset by the other segments.

Will take our next question from John Campbell with Stephens Inc.

Back on the investment income, I mean, it sounds like you guys do expect that 2Q level will be a pretty good run rate. I'm guessing this probably holds for consensus, but just looking at my model, I mean, if I run rate that, that's $0.60 over $0.60 of EPS upside. You guys just reported roughly that same amount in 2Q. So obviously, that's pretty meaningful. I just want to get a better sense for the sustainability of that step up. So David, you talked to, I think, 70% of the lift coming from escrow actions you guys have taken with bank partners. I'm hoping you can provide a little bit of color there. What exactly did you do that drove such a large impact and what allowed you to make that move now versus not doing it in the past?

Yes. I mean I think the -- well, it depends if you're comparing quarter-to-quarter, which is probably the better comparison than that earlier answer I gave, which like 70% is due to the escrow and 30% is due to better rates holes and so we should probably see, call it, a couple of million dollars a month benefit from the escrow activities. And really, what that is, and it's taken a few months, it's not like we started on it yesterday. It's the stuff you've been seeing in one of our competitors, right?

It's just with rates rising, and they didn't really rise to a level where we could make significant earnings as the banks are always a little late in raising rates until towards the end of the year, and so it's really been work from the last few months to get, call it, roughly $900 million or so of escrows deployed in the space that allow it with any of the disclosures that are needed and so that's why it takes a little while. You have to work with the banks, you have to make sure all the regulations are met. In some instances, you have to make sure you have disclosures, right? But that's all essentially been done at the end of the second quarter, and that's why we should get the benefit going forward.

So John, your observations of goodness. So when we first started this 2 years, we looked at should we buy back because we didn't have a bank, we didn't have access to return on the sows and we couldn't -- because of our scale, couldn't make it work. But the value of short money back was so little that banks were not very interested in part with you, and we were smaller, too.

So now that we've grown and the value of money, obviously, the return on short funding was so much better and the deposits were so valuable, our banking partners have done a really great job stepping up with us, and we now can capture some portion of that earnings on our escrow. So in my view, was an important thing for us to do and as money became more valuable, as something we had to go after and the team did a nice job doing it. But again, we try to get at this a couple of ways early on. It just for us, it was really hard to execute against buying a bank or getting then as interested as it was this year. So I'm glad we're able to get it done.

Yes, absolutely. I mean the macro seems a little bit shaky still on the commercial side. let say, It seems like it wants to pick up a little bit, but that's a great addition to the earnings mix. Congrats there. Second question here on the order mix. Since you guys acquired F&C and DCHH, obviously, there's been some moving parts there. I'm hoping to get a little bit more color or clarity on the other order line. So just maybe as a starting point, just roughly the mix of default versus BCH in FMC and also how we should be thinking about that blended fee per file for other...

Yes. John, for us, that's primarily the reverse from FMC. The feeder files there. I mean, those deals aren't quite as big as a typical purchase business that people file is going to be a little less than that 3,300, 3,400 that we report for purchase. We don't have much of a default business and so that's why that's predominantly FMC reverse.

Okay. And is there typically much seasonality in that line? And then also kind of what's a good closing ratio. Is that going to become of sporadic? Or is the last 2 quarters kind of a good average to think about?

Well, yes, I mean, that mark, so there's kind a little bit of dislocation in that market. So it's not as seasonal, right? If you think about why do people typically go get reverse mortgages, well, they have -- they're typically older there's an age requirement, and then they have a lot of equity in their house and it's sort of a pseudo retirement product. The reason there's been a little bit, there hasn't been as much activity maybe as it could be going forward, even though there's a lot of equity that build up equity and the population's aging is because the market has been a little dislocated, right?

You had AAG, which was the largest originator acquired by Finance of America. You had the capital markets. The primary execution is the FHA Hakam product. And so the capital markets hadn't been as smooth on that. That's, for the most part, stabilizing and you can see that with people are starting to advertise again. You see Tom -- so every now and then on TV, satiety. And so you should expect the gradual improvement there. But I think that market is still a little fragile with all the things that have been going on, but you should expect a gradual improvement.

And we will take our next question from Geoffrey Dunn with Dowling & Partners.

I wanted to follow up on John's question about NII and just make sure I have all the details here. So incrementally to what we already see in your balance sheet, you were effectively able to deploy about $900 million of escrow funds into interest-bearing accounts. Is that the way to think about the math?

Correct. In terms of the notion analysis, the tricky part is what do you multiply that by right? And that has to be worked out with all the individual banks. And so you can't just like go take a money market rate and apply it to it. And it's also offset by things like service charges and that kind of thing and so our rates are typically in the 3.5%, maybe a little better. It just depends on how things are going. And as we get more mature in the program, you would expect that to maybe come up a little and then we decided to a point raised yesterday. So I think that might be a framework to think about.

Okay, and in doing those moves, was there any opportunity cost on the expense side, meaning you gave up expense credits to get the NII?

Well, it's embedded in the transaction, right? So yes, so I mean before we were offsetting wire costs and things like that, to your point, but we weren't getting much more. Now we're getting something incremental, but those costs are still being offset. That's why I say you can't just take money mark and then apply it to the balances.

Right, and then my last question is in terms of sensitivity, obviously, we've got another 25 bps yesterday, who knows if we'll get anything else in the fall. Is it based on the 3.5, is it may be correct to say 60% of a 25 bps change kind of flows into your incremental yields?

It depends on how persuasive we are when we call these guys. Yes, we might need some of your moves on that.

Yes. All right. But in terms of if all else held equal, that $12 million run rate this quarter should react positively to any additional rate actions including yesterday?

Yes. Well, keep in mind from the quarter, and I forgot if we chatted about this or not. But in the quarter, right, that's why the quarter-to-quarter comparison. It's really the delta in the second quarter versus the second quarter to think about because the second quarter happens to have a title plant dividend in it. So you can't just -- you can't just work off the 12, you have to work probably more of the delta. That's why I said it's about a $2 million a month benefit from the escrow.

Okay, and what is the title plan dividend this quarter?

It was about $2 million in each quarter. That's...

Sorry, the title plan dividend?

It was about 2% in the second quarter of '22 and about the same in the second quarter of '23... So it's a onetime -- we are an owner of Tartan we get that once a year what David say and that's just a one in... That really -- that's...

$1 million run rate going into 3Q?

Correct. Yes. That's why you can't just take the $12 million and apply it.

We will take a follow-up question from Soham Bhonsle with BTIG.

Just one follow-up on the Real Estate Solutions business. I look at revenue this quarter on a year-over-year basis, right? It was down about 13% or so, and that's better than the first quarter, which was I don't know about 30%, and it looks like it outpaced orders essentially. So I guess the question is, Fred, you've talked about, hey, there's some sensitivity to volumes obviously, but it sounds like there's some subscription kicking in as well. Is that the right way to think about it just going forward?

So it has a mix exactly. So there's a mix in there of some things like our data business that's more stable and frankly, we have some services businesses that are having some real good share gains. So it's a point. So it's a little bit -- that obviously moves to volume, but it's a little bit dampened because of that.

So you got to like -- just to give a little more color on that. You have the data businesses, as Fred said, so credit, which is in 40 research and real estate, which is Prop-Stream. So those are more stable because they're not as transactionally driven, and then they're actually doing better in the market. So I think that's where you're seeing the improvement. They're being that improvements being offset a bit by the transactional businesses, which are appraisal note that kind of...

Which like the volume decrease it does a very challenged like the rest of the market.

Yes. I mean I just wanted to ask because the step change quarter-over-quarter on a year-over-year basis was pretty significant just in terms of declines, right? yes. So I guess it does sound like some share take there.

We have no further questions on the line at this time. I'll turn the program back over to management for any additional or closing remarks.

Just want to thank everybody for joining us for this second quarter call. Thank you.

This does conclude today's program. Thank you for your participation. You may disconnect.