First American Financial Corporation
Q1 2014 Earnings Call Transcript

Published: 11 Sep 2014

[Jeremy E. Campbell:]

Hey, good morning. All right, so we have First American Financial and CFO, Mark Seaton has the honor to be at the Mariano Rivera to the Global Financial Service Conference here and close it out. He’s has been the CFOs now with the Company for quite a while and with that we also have Craig Barberio up here from Investor Relations. With that, we’ll just turn it over to Mark.

[Mark E. Seaton:]

Thank you, Jeremy. Yes, I want to thank Jeremy for inviting us to the conference here. This is I don’t how many years it’s really been here, but we've had a long history with Barclays and so we’re happy to be here again this year. Again, we have the distinction of being the last company to present in the last day here. So thank for taking the interest in First American. Before I started, I want to alert you to our Safe Harbor Statements as well as our statement around the use of non-GAAP financial measures. First American, we’ve got a history of growth. We’ve really started the Company back in 1889 in Orange County and for many decades we grew the Company, in 1982 we completely build out our footprint in the U.S. and that’s the year that we reached all 50 states. In the mid-80s we began expanding our products outside of Taiwan in escrow to other complementary businesses and in 2010 we spun-off a lot of those businesses into a separate public company. And our Company as we know it has been in its current legal structure since June of 2010. We are an industry leader, we’ve got the second most market share in the U.S. of 27%, we’re the largest provider of title plan information in the U.S., we’re number one internationally and we’re also the second largest home warranty company behind the company called American Home Shield. We’ve got a very strong financial position $5 billion of revenue about $300 million free cash flow last year and we’ve got relatively low debt at a 15% debt-to-capital ratio. Our total shareholder returns since the spin-off has been favorable, you can see on the bottom line there. Our stock has been up on average 19% annualized since the spin-off and that’s up versus 17% for the S&P and 16% for Russell 2000. Year-to-date the returns haven’t been as good relative to the benchmark, but certainly when you look at the one-year and the three-year we’ve outperformed the benchmarks fairly significantly. In terms of investment consideration, we’re a pure play in the title and mortgage markets. We have – all of our eggs are in the title and the settlement services basket. We’re not diversified in the sense that we don’t own manufacturing businesses and other types of business, but we are diversified within title and mortgage. We've got a very strong commercial business, strong refi, strong purchase, strong default. So we are diversified within the tile and the mortgage markets, but we’re a pure play. We’ve got a very strong competitive position and we are pursuing growth opportunities both domestically and internationally. We have made a lot of changes to our cost structures over the last five-year, six-years. That really has enhanced our long-term’s earnings power. Today our title company is running at roughly a 10% pretax margin and historically that has been the peak margins for First American. Back when we were in a $3 trillion mortgage market First American used to hit 10% margins. Now we’re in $1 trillion mortgage market and we are hitting 10% margin. So we are hitting as high of margins we've ever hit in the past, despite the fact of the market as low as it’s ever been in the past. And we’ve taken out a lot of structural costs which I’ll get into a little bit later in the presentation. And we also have a meaningful opportunity to return capital to shareholders. We doubled our dividend earlier this year; we’re paying $0.96 per year which is about 3.4% yield. Historically First American has paid about 20% of our earnings in dividends and now we’re paying roughly 40% of our earnings in dividends. So that’s a strategic move that we've made that says that we want to return significant amount of our capital back to our shareholders and we are going to continue to do that over time. And then we also repurchase shares opportunistically, last year we purchased 3 million shares at an average price of $21.90 and that’s been a good investment for us. So we are very opportunistic and we buyback our stock when we feel like it’s undervalued. This slides shows our strategy, our vision is to the premier title insurance and settlement services company. We are not saying we want to be number one in every market, we want to be the best, we want to have the best returns to our shareholders, we want to have the best service to our customers and we want to be the best place to work for our employees and we’re tracking metrics along all three of those mentions. In terms of where we are going to compete, those are the three pillars you can see here on the left, we want to gain profitable market share in our core title and closing business. So we are always going to compete in title insurance, it’s our core business, its what we do, its what we've done since 1899 and that’s always going to be a key part of our strategy. The middle pillar is something that we’re going to talk a lot more about today and in the future, but we have a [burgeoning] (ph) data in mortgage solutions business, we’re providing solutions to lenders to help them either mitigate risk or increase share or improve their margins. And so we’ll talk more about that later in the presentation. And then the third pillar is really our complementary businesses. We have businesses in First American that aren’t our core title insurance business, but it’s providing other software and services to our customers that make a lot of sense for them to be underneath the First American umbrella. So those are the three areas that we’re going to compete in, we’re not going to get outside of this; we've got a very focused strategy. And on the bottom pertains to capital management, we’re going to focus M&A on enhancing the core and we want to optimize our capital management strategy as well. And so we’ll talk more about that in a few minutes. This slide shows the mortgage origination trends, on the upper left is the residential mortgage originations for the MBA and the bad news on this slide as you can see the residential originations have really been decline since 2006. This slide we show since 2012. And 2014 originations are expected to hit trough of about a $1 trillion most of that coming from purchase about 40% of it or so coming from refinance. The good news here is that we feel like 2014 will be a trough in terms of the market. We feel like there is going to be growth in 2015 and beyond. And the other good news on this slide is we get paid twice as much for purchase transactions than we do for refinance transaction. And so the purchase market is going to be growing next year and beyond and that’s really our core business. We have 800 offices in the direct channel and most of those are there to service the purchase market. On the commercial revenue on the bottom left, there is not as great projections for the commercial market, but we show our commercial revenue here since 2009 and its been growing at 31% a year for the last four-years to five-years really since 2009. So last year we did $546 million of commercial, we’ve got 45 national commercial offices scattered throughout the major capital market centers in the U.S. especially here in New York. And we do very well in commercial, we've got very good people, we've got a very good system, very good platform, we've got good financial strength, good balance sheet and we play very well in commercial and has relatively higher margins than the rest of our operations. We’re also seeing a lot of broad-based strength in commercial in terms of the types of assets that we’re seeing, its coming from multifamily, its coming from industrial, it’s coming from office. So we’re seeing a broad-based strength and we think that the strength in the commercial market will continue for the next couple of years and that plays very well for us. In terms of market share, we basically have two channels that we sell our products. So our direct channel where we have a direct relationship with the customer, whether it’s the lender or mortgage broker or real estate agent and we do the search and the examination, we issue the policy and we pay the claims and we keep 100% of premium. That’s the direct channel. The agency channel is where we have agents that are completely unaffiliated with First American and they have the relationship with the customer and they do the search and the exam, but they are not underwriter so they issue our policy and for that we typically on average get about 20% of the premium some state its higher, some state its lower but on average its about 20%. We’ve got 800 offices across the U.S. and we've got 7,650 agents that we support in our agency channel. You can on the direct graph that our market share in direct has really been up since the spin-off, its up to 1.3% and most of those gains have come really in the last two years, we've been very focused on gaining profitable share in our direct business and its starting to pay dividends and we are very focused on the top four states

[Jeremy E. Campbell:]

Yes, I’ll kick it off with that. Mark you mentioned you guys run into about 10% pretax title margin, especially if you’re adjusting for the reserve build in 2Q, can you just comment at all about what 3Q margins could look like and then maybe what margins may look like in a more normalized type of origination environment.

[Mark E. Seaton:]

Well, typically the second quarter and the third quarter margins are very similar, just because it is your seasonally strong quarter. Fourth quarter its typically less in the summer, because you are not getting that the spring summer selling season, but in the fourth quarter you have got a very strong commercial quarter. So I would – you know we don’t give quarterly guidance, but I think generally speaking if you look over history Q2 and Q3 have been somewhere in the range of each other and I don’t think there is any reason to believe that wouldn’t be the case this year. In terms of normalized margins, its difficult to say, because in order to come up with the normalized margin you have to come up with the normalized market and that’s kind of the tough thing, but the only thing I would say is that we’re running at a 10% margin right now and we’re still on a very depressed market, I mean the purchase originations which is our core business are very depressed levels and its going to take years of double-digit growth to get back to a normalized market. And we feel like it’s not a matter of if we have record margins and I'm talking you know low-teens even mid-teens. It’s just a matter of when. And so we are not operating just kind of sitting on our hand waiting for the market to get better, I mean we are constantly thinking strategically and cutting cost where we can and figuring out to grow where we can, but the fact of the matter is when we do hit a more normalized market we’re going to see margins that we haven’t seen before in the history of the company.

[Jeremy E. Campbell:]

And then you touched on this in your prepared remarks, but you know clearly the commercial market showed significant strength over the past few years and it looks like when we look ahead we have kind of a wall of CMBS maturities. Do you expect continued strength to kind of persist for the next few years and maybe just some comments around that?

[Mark E. Seaton:]

Yes, we think that the commercial market is definitely on a stronger side right now, its stronger than the normalized commercial market, but that being said we feel like we've got at least another two-years, three-years of stronger than normal market based on the CMBS maturities. And just based on the fact that you know when we talk to our customers there is a lot of capital in the side lines, people are looking for yield and real estate is a very attractive investment opportunity. So we have good reason to believe that the next couple of years are going to be – continue to be strong in commercial. We don’t expect 30% growth rate like we've had before, but if we get mid-single digit growth rate that would be very good for us, because we have very good earnings on the commercial side and again we've got very good people on a good platform and a very good comparative position. So it’s very difficult to break into on the commercial market and we haven’t seen a new national commercial player in many years. So we’re very well very positioned strategically there.

[Jeremy E. Campbell:]

And then you also touched on use of capital and potential pursuing acquisitions other products that you don’t currently operate now like appraisal. What are some examples of some other type of products that you may be looking to extend into?

[Mark E. Seaton:]

Well, the appraisal product is one, its high on our list and when I say that we've been really talking about that for at least a year now, we still haven’t purchased anything, because we don’t need it. I mean if we never bought an appraisal business we would be just fine strategically, but the fact is that a lot of lenders they like to buy title and appraisal together. Now a lot of our lenders – customers are asking us to provide them a valuation solution. So when I mentioned appraisal, it’s not just traditional appraisal where you send the appraiser out the house and like an appraisal management company type business, its everything from that to automotive appraisals, to broker priced opinion, its valuation through the whole spectrum and so I think that whether its appraisal or BPO or AVM that’s a solution that we need to strengthen over time. Outside of that there is not a whole lot of product that we look at and say that we really need this to strengthen our position. We like where we sit in that right now.

[Jeremy E. Campbell:]

And what does the market look like to appraisal or BPO type companies?

[Mark E. Seaton:]

Fairly fragmented, there is no real public companies out there that do that but there is a host of private companies that do BPOs, they do traditional appraisal and I would say its more fragmented than a lot of the other markets that are out there. So again, we’re going to be very disciplined about it and we will only do it if it make sense and the right fit and we can get it for the right price.

[Jeremy E. Campbell:]

And then just finally here, certainly you guys have used book value as a bit of buyback threshold. I know you have big authorization and you are going to be having all this extra capital come through your free cash flow, but is there an appetite to buyback shares above book value going forward?

[Mark E. Seaton:]

Well what we look at for buybacks is we don’t really – we look at DCF in terms of like what prices we’re going to buy it back, so the first thing we look at is discount cash flows. The second thing we look at is sort of a normalized earnings approach evaluation and those are the two methods primarily the DCF that we really use to evaluate whether or not we should be buying back our stock. Now we also look at book value and we look at PE, and we look at tangible book value as sort of check, but we don’t have a formula that says as soon as stock gets under book value we will buy it back. There might be times when the stock is above book value that we would buy it back. There might be times when it’s below book value that we wouldn’t buy it back. And it also depends on other investment opportunities that we have and the returns of those investment opportunities. So I wish it was as simple to say if its 0.99 we buy it back it just – it’s not the case. Now last year we bought $65 million of stock and it just happen to be slightly below book, but it was a more of a coincidence than anything else, but again we like buybacks and we've done over the past, we have capacity to do that both financially and with our buyback authorization, but we really look at kind of the DCF approach more than anything else.

[Jeremy E. Campbell:]

Well with that I would just like everybody to join me in thanking First American for coming out.

[Mark E. Seaton:]

Thanks for having us.