Greetings, and welcome to the First Quarter 2023 First American Financial Corporation Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation.

[Operator Instructions] A copy of today's press release is available on First American's website at www.firstam.com/investor. Please note that the call is being recorded and will be available for replay from the company's investor website and for a short time by dialing 877-660-6853 or 201-612-7415 and entering the conference ID 13738122.

We will now turn the call over to Craig Barberio, Vice President, Investor Relations to make an introductory statement. Please go ahead sir. .

Thank you. Good morning, everyone, and welcome to First American's earnings conference call for the first quarter of 2023. Joining us today on the call will be our Chief Executive Officer, Ken DeGiorgio; and Mark Seaton, Executive Vice President and Chief Financial Officer.

Some of the statements made today may contain forward-looking statements that do not relate strictly to historical or current fact.

These forward-looking statements speak only as of the date they are made and the company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made.

Risks and uncertainties exist that may cause results to differ materially from those set forth in these forward-looking statements. For more information on these risks and uncertainties, please refer to this morning's earnings release and the risk factors discussed in our Form 10-K and subsequent SEC filings.

Our presentation today contains certain non-GAAP financial measures that we believe provide additional insight into the operational efficiency and performance of the company, relative to earlier periods and relative to the company's competitors.

For more details on these non-GAAP financial measures, including presentation with and reconciliation to the most directly comparable GAAP financials, please refer to this morning's earnings release, which is available on our website at www.firstam.com. I would now like to turn the call over to Ken DeGiorgio..

Thank you, Craig. Ongoing challenges and market conditions in the first quarter continued to weigh on our results, although 136% increase in net investment income along with our expense management efforts enabled us to deliver a pre-tax title margin of 6.5%. Our home warranty segment had a strong quarter with a pre-tax margin of 15.3%.

On a consolidated basis we earned $0.44 per share or $0.49 before net investment losses. A sharp decline in affordability driven by mortgage rates above 6% along with low inventory and elevated home prices adversely impacted the housing market and as a result our residential purchase business.

Currently however the purchase market appears to have stabilized. For the first three weeks of April, we are seeing typical seasonal improvement in the purchase order trend with open orders up over 5% compared with March. Refinance open orders remained at trough levels in the first quarter, averaging 350 per day.

The current pool of mortgage loans would need to see rates drop well below 5% to incentivize a significant uplift in refinance activity, which is highly unlikely in the near future. The weakness in the commercial market, which began in the back half of 2022 also impacted our results this quarter with our commercial revenue down 39%.

The decline in activity was seen across all regions and asset classes including industrial and multifamily and large deals were down 50% from last year. Commercial open orders were down 28% in the first quarter and that order trend has continued into the first three weeks of April with orders down 30%.

While there is a high degree of uncertainty concerning the commercial market outlook based on feedback we are getting from customers, we remain optimistic that transaction activity will improve in the second half of the year given the progress made on price discovery during the first quarter and ample capital availability, notwithstanding, the potential impact of the baking crisis on available credit.

Our financial strength allows for continued investment in our innovation and other strategic initiatives, which are imperative to our long-term growth strategy. We continue to make progress at Endpoint, our digital title and settlement company, which now has a national presence.

This month, Endpoint announced the launch of its mobile notary platform, which streamlines the process of signing documents in real estate transactions. Our title company has begun to use the platform, the first time that the broader company has leveraged Endpoint's proprietary technology.

As Endpoint continues to reengineer the closing process, it will drive efficiency and improve the customer experience not only for itself but for other divisions of First American as well.

During the last few quarters, we have discussed our initiative to develop instant title decisioning for purchase transactions, which also promises to improve our operational efficiency and expand our competitive advantage. Given the success of our early testing, we expect to deploy it in two markets within the next year.

This next-generation technology is made possible by a number of factors unique to First American, including our talented technology data sciences and underwriting teams and the most comprehensive title and real property database in the industry which is fueled by our proprietary data-extraction technology.

We also continue to make progress at ServiceMac which turned cash flow positive last quarter and is now the fifth largest subservicer in the market, after experiencing 62% revenue growth this quarter. In closing, I want to thank our employees, who have shown resiliency through difficult market conditions.

They've remained steadfast and committed to our company and our customers, enabling us to grow our market share by over two percentage points in 2022 which will pay dividends when the current cycle turns.

I am also pleased to announce that First American has been named one of the 100 best companies to work for, by Great Place to Work and Fortune Magazine for the eighth consecutive year.

This accomplishment is a tribute to our unique culture and our people, who in addition to delivering best-in-class service, continuously find new and innovative ways to meet our customers' needs. Now I'd like to turn the call over to Mark, for a more detailed discussion of our financial results..

ServiceMac, Endpoint and instant decisioning for purchase transactions, which together generated a pre-tax loss of $18 million this quarter, impacting our pre-tax title margin by 150 basis points. Pre-tax margin in the Title segment was 6.5% or 6.1% excluding net investment gains.

Included in this result were $10 million of intangible asset amortization related to acquisitions and $4 million of severance incurred during the quarter. Beginning this quarter we moved our Property and Casualty results to our Corporate segment and are disclosing our Home Warranty result as a stand-alone reporting segment.

Total revenue in our Home Warranty business totaled $104 million slightly ahead of last year. Pre-tax income in Home Warranty was $16 million, unchanged from the prior year. The loss ratio in Home Warranty was 47% up from 46% in 2022 driven by a higher severity of claims partially offset by lower frequency.

The effective tax rate for the quarter was 22.8%, lower than our normalized rate of 24% due primarily to the mix of income between our insurance and non-insurance businesses since our insurance business generally paid state premium tax in lieu of income taxes.

In the first quarter we repurchased 556,000 shares for a total of $30 million at an average price of $54.75. Our debt-to-capital ratio as of March 31 was 28.4%. This ratio was impacted by both our accumulated other companies of loss and our secured financings payable.

Excluding these two items which is more in line with our bank fee ratio our debt-to-capital ratio was 20.1%. As we discussed last quarter on February 1, we repaid $250 million of senior unsecured notes that matured using cash on hand at the holding company. Later in the year we expect to draw on our line to partially replace this debt.

Now I would like to turn the call back over to the operator to take your questions. .

Thank you. We will now be conducting a question-and-answer session [Operator Instructions] Our first question comes from Bose George with KBW. Please proceed with your question..

Hey, guys. Good morning. I wanted to ask about margins. Is there – just given the weakness in sort of the broader markets, can you just talk about margin expectations for the year.

And if this persists is there more you can do on the expense side to kind of address it?.

Thanks for the question, Bose. So the challenge we have is obviously the market. When you look at purchase and commercial refinance, which really drives our business, I mean all those are going to be headwinds going into this year certainly relative to last year.

The good news is that we've seen evidence of the purchase and the refi, markets have really bottomed out and commercial is really close to getting there. But yet we'll still face year-over-year headwinds. I think on the positive side for margins this year, investment income obviously is going to be a tailwind for us, looking at a year-over-year basis.

We've got the full year of a few acquisitions we did last year that will be incorporated this year. It's not material but it will be a little bit of a help for us. We still are going to get a lot of efficiencies based off of some of the expense measures we took last year.

And we've talked about these strategic investments and we think that the loss will continue to narrow this year. You saw that we lowered the loss rate to 3.5%. Obviously, that's going to help our margins. And then lastly I'll just say that our P&C business lost $18 million last year and obviously that loss is going to narrow this year.

So when you mix that all together, I mean even though we're in a – what we think is going to be a trough year, we're still looking at double-digit margins this year. And in terms of – can we do more? I mean there's always more that we can do with the market is sort of worse than our expectations.

But we're looking at at least double-digit margins in 2023 based on what we see today..

Okay. Great. That's helpful. And then actually on interest income you noted that it remains a tailwind.

Any change to the guidance you gave in the past, obviously forward rate expectations have changed a little bit?.

Well, what I'd say for that is going back to Q3, we said that we could hit $600 million of investment income in 2023, assuming two things happen. One is that the forward curve for Fed funds rate played out like the market thought it was going to and the second thing was that balances were even with Q3 levels, that they didn't change.

And what's happened now is the Fed funds rate has really played out like the market has thought but balances have fallen. And certainly our commercial business was down 40% sequentially from Q4 to Q1. And so our investment income was down sequentially just because the balances fell.

So when we look at kind of the outlook for investment income this year, we feel like Q1 of $125 million of investment income in Title in trough. We don't see it getting any lower than that. We sort of update – if we're going to update our sort of guidance that we gave and we just took March balances and kept them flat and assume the forward curve.

Now, we look at somewhere around $535 million of investment income this year. But again that's based off of March balances. And March balances are typically lower than the average balances. So as Commercial sort of picks up throughout the year, we think we'll hit higher than that.

So we're still positive on investment income but it was just down this quarter just because of balances. .

Okay. Great. That’s helpful. Thank you..

Our next question comes from Mark Hughes with Truist. Please proceed with your question..

Yes, thank you. Just Mark to your last point there about how balances ought to billed as the year progresses.

Is there a decent visibility for that? I think you gave the Commercial orders down, was it 30% in the first three weeks of April, but is there reason to think the balances will progress from here?.

Hi, Mark, this is Ken. I'll answer that one. I mean, I think there is cause for optimism that the commercial market is going to rebound in the second half of the year. And obviously, commercial drives those balances. About 70% of our balances are tied to our commercial business.

And a lot of that is based on our -- as I mentioned in my comments our customer feedback they are expecting a stronger second half mostly because price discovery will have concluded or largely concluded and they're still -- at least we're hearing anecdotally there's still adequate capital despite the banking crisis.

Obviously, we're watching that closely watching loan availability particularly in the smaller to medium-sized commercial market. But everything we're hearing so far is that we anticipate that commercial is going to end up fairly strong this year. Though obviously it will be down compared to a record 2022. .

Yes. When we think about the cost structure just looking back to your direct premiums and escrow fees pretty similar this quarter to what you had in 1Q 2019 when you had -- if I'm looking at it properly 10% pretax margin in Title on a lot less investment income.

Is -- could you maybe give some perspective or thoughts on that? Is that the expense structure was built up these last few years as you had very strong volume and there's an amount that could be taken out if you didn't see a rebound coming. I know you've talked about the investments you're making in these growth initiatives.

I just wondered if you could give some reflections on how the cost structure is different now than it might have been four years this is a while ago, but it's a striking comparison. .

Well, I'd just say back in 2019, it was certainly a better market particularly when you look at the number of transactions. So, you look at what really the big three markets that drive our business commercial purchase refi was all much stronger back in 2019.

2023 at least so far in terms of transaction accounts we're seeing lows we haven't seen since the great financial crisis and even before that in some of those markets. So, when you look at like the cost structure of our individual business units whether it's our commercial business or direct it's very similar.

It's just we have been investing more in some of these initiatives that we've been talking about and just technology in general. So, that's what I'd just say relative to 2019. .

I'm sorry. Mark I guess the one thing I would add too is when it comes to the strategic initiatives and as Mark mentioned in his comments the investments are significant. We can obviously slow those down or shut them off. We don't want to do that. We don't think it makes sense from a long-term strategic perspective, but we -- that's a lever we have. .

Yes. And then on the Home Warranty business I wonder if you could maybe give some thoughts about what you think might happen with the topline there..

Yes, I think well our Home Warranty business had a strong quarter as we noted. I think on the topline I mean there's two channels in the Home Warranty business the real estate channel and the direct-to-consumer channel. The real estate channel there's a high degree of correlation with our Purchase business.

So, as we see real estate transactions fall if they continue to fall that will put pressure on their revenue. But they've had a lot of success in the direct-to-consumer business. In the first quarter, for example, it was up 12% whereas the real estate channel was down almost 35%. So there's opportunity there.

The other thing we're seeing is some good performance with respect to renewals in both channels actually the real estate channel the renewals have been up almost 5% in direct-to-consumer just over 14%.

So, we think there's some opportunity there but they're facing certainly in the real estate channel the same headwinds that are in our residential Title businesses. .

Thank you very much. Appreciate it..

[Operator Instructions] Our next question comes from Mark DeVries with Barclays. Please proceed with your question..

Yes, thanks. I wanted to drill down a little more on the commercial outlook for the back half of the year. I appreciate all the color you provided.

I think one question is the price discovery issue is that impacting the larger transactions sizes more? And if so is we find an equilibrium at these higher rates? Does that kind of have an upward impact on the fee per file? And the second question is how much concern is there from you're hearing from your customers that even as they begin to reach that equilibrium and find price discovery that banks tightening in the wake of this regional banking crisis kind of tightened disproportionately on their CRE business.

And you see kind of a lack of supply of credit just as commercial investors are looking to transact..

Mark I think -- I mean it's not clear if the price discovery is impacting large transactions larger much more substantially than others. So, I guess we could probably infer from the fact that our large transaction volume counts were down 50% in the first quarter, probably suggests that price discovery is having an impact on.

Now, with respect to the fee per file, I think if we see large transactions come back into the market, yes, that will have a positive impact on our average revenue per order. But with that said, we're anticipating that on the whole, large transactions are going to go down in value as well.

I mean, we're seeing 10% to 15% decline in prices in the commercial markets, 25% in the office. So prices across the spectrum, I think, are going to come down..

Okay. Got it.

And any concerns around the availability of funding from banks?.

Yes. I mean, as I had mentioned, we're hearing anecdotally that there's adequate capital. But, no, there is -- we have some moderate concern about it. We're keeping an eye on it. You certainly read a lot in the trade media about particularly mid-tier banks making credit available to -- on smaller and medium-sized commercial deals. So it is a concern.

It's something we're watching, but at least what we're hearing from our customer base is, it's -- they don't see an issue right now. But, obviously, there's much remains to be seen..

Okay. Got it. And next question, I mean, this environment has got to be particularly challenging for subscale players in the title business.

Are you seeing improving opportunities to do acquisitions here, just given some of the distress, some of these players may be under? And if so, are you kind of prepared to be aggressive in acquiring?.

Yes. I mean, it's interesting, Mark. I mean, we're not -- we haven't seen a lot of attractive opportunities. We've seen some opportunities, particularly, like, in the proptech space that are not too compelling. But given where the market is, we expect to see some opportunities.

If the current challenges ultimately prove to be prolonged, yes, I think there will be opportunities. And the good news is, we have the capital to seize on them. But as always we'll be -- we’re being very disciplined about our M&A activity, but we think they're coming. .

Okay. Great. Thank you..

Our next question comes from Geoffrey Dunn with Dowling & Partners. Please proceed with your question..

Thanks. Good morning.

Mark, I know you put it in the Q, but can you front run and give the actual balances for escrow deposits in 1031 as of the end of the quarter?.

Yes. Thanks, Jeff. At the end of the quarter we had $2.1 billion of 1031 exchange deposits.

Was that your question, 1031?.

Yes, that's part of it.

Do you have the escrow as well?.

I'm sorry. Yes. So escrow -- total escrow deposits, we had 10 points -- about $10 billion..

So that's flat?.

Sequentially, it was about $11 billion. Yes. So we're going from -- I'm looking at our bank balances, in the Q we report book balance is a slight difference on timing. But at the end of the year, in terms of bank balances, for escrow we had $11.0 billion. And as of March 31 we had $10.3 billion. So they're down sequentially. That's on escrow..

Okay. So, I guess -- I mean -- so sequentially your net investment income was down a decent amount. What type of yield are you getting on 1031? It seems like it's a really big swing for a $700 million decline in 1031 balances, where your balance sheet assets are up and your escrow is flat.

Can you dig into that a little bit more?.

Yes. So the average rate that we're getting on 1031 right now is about -- well, it's -- average for the quarter is 4.5. But as a general statement, we get Fed funds. Obviously, Fed funds change throughout the quarter. So, as a general statement, we're getting Fed funds for our 1031 business. .

And how does that compare to escrow?.

Escrow, we're getting about Fed funds as well, same thing, maybe a little bit less. So we get probably a little bit more on 1031, but it's generally about Fed funds..

Okay. All right. And then, the other question, obviously, you just talked about M&A and having the capital for that. How do you weigh buyback capital return in a tough macro environment? Last year you indicated you were going to increase that activity you did.

How do you think about that in the current macro challenges?.

Yes, Geoff, this is Ken. I mean, listen, our priorities always remain the same. One is to reinvest in the business, which, as we've talked about a couple of times today, we're doing with Endpoint and title decision and other innovations and strategic initiatives and then M&A, which I talked about earlier.

And then, thirdly, returning capital to shareholders. With respect to repurchases, I mean, the current price is certainly attractive. In Q1, we repurchased over 550,000 shares. Last year we repurchased over 7% of our shares outstanding.

But we're going to be opportunistic, given all the demands on our capital, including as I had mentioned our expectation that there's going to be some attractive M&A opportunities forthcoming..

Okay. Thank you..

[Operator Instructions] Our next question comes from John Campbell with Stephens. Please proceed with your question..

Hey, guys. Good morning..

Good morning..

Hey. So back to the margin for Title, I mean if we back up the investment income impact and then if you add back the severance charge and then the $18 million in investment headwinds you guys called out, I'm getting to like a negative 2% kind of underlying Title pre-tax margin.

I think you had to go back to 1Q 2009 so during the housing crisis to see a similar margin.

On Mark's question you guys provided a couple of moving parts there, but I'm trying to get a better sense for maybe the excess costs you might be carrying because it does sound like you guys expect things to improve a bit on the resi side as well as commercial, which we agree with for sure.

But as a hypothetical, if you looked at next year, next 1Q, if you just hold everything flat, what type of margin lift you think you might get from just kind of pairing some of these investments and then maybe taking cost actions if this current environment kind of holds?.

Well, there's a few things there, John. I mean one thing I'd say is that, just backing out our investment income like you have and others have and we've done that same thing too, it really discounts all of the like operating costs that we have at businesses that generate the income.

So for example, our bank, if you just exclude all the revenue from the bank and you have all the personnel costs and all the other operating expenses associated with the bank and not just the bank but our 1031 business, it's not quite apples and oranges, I would say. The other thing is our bank pays interest expense too.

So you sort of have to back that out. So that's one thing I'd point to. Again, going back to 2019, it's just tough because, again, it was sort of an Olympic cycle ago. But, basically when we think about the margins, I mean, as I said, we're looking at double-digit margins this year.

And we feel like that's a good outcome considering just the tough market conditions. So when we look out 2024, 2025 and beyond, we feel like we're going to get a lot of lift for a few different areas. Number one, obviously, we'll have hopefully market tailwinds.

Number two is a lot of our -- just I'll call it normal operating expense management will continue to pay off and we've seen that with the success ratio in the last couple of quarters. And three, hopefully, some of these strategic initiatives will continue to pay dividends for us.

And so, when you wrap that all together, we've really -- the highest margins we've seen at least our company is 15%. We saw that in 2021. Now we're having a trough market this year but we will inch closer to 15% in the outer years once these things materialize. .

Okay. That's a great point. I didn't really think about the incremental excess cost that kind of comes with that higher level of investment income. So that's a good point. On the outlook, Mark you mentioned kind of expectations for a baseline or the low point of like at least 10% Title pre-tax margin this year.

I'm curious if that's 100% contingent on the resi market improving as well as commercial at least what you saw in 1Q, or do you think you'd still be able to get there with cost action as the market sags a little bit?.

No, I would say that's assuming a pretty tough environment. I mean we're sitting here in April. So we have visibility into sort of June revenue based off of the order count. So for the first half we pretty much know what we're going to do more or less.

The second half there's still uncertainty, particularly on commercial, particularly how strong is Q4 going to be. But I would say that double-digit margin assumption doesn't assume the market picks up. We don't -- we're not assuming a big recovery on the residential side.

It assumes kind of a flat purchase market and no pickup in refis and some normal seasonality with commercial. So there's not -- there's no stretch assumptions with that..

Okay. That's helpful. And last one for me just a housekeeping question. With P&C being moved into Corporate, I just want to make sure I get a better grip on that. I saw the $1.7 million of claims costs.

How much incremental expenses tied to P&C that's falling into Commercial now -- or excuse me into Corporate?.

So for the quarter, we had about $5 million of losses at Corporate because of P&C. We think that's really going to narrow to a couple of million here in the next quarter or two. We don't have any remaining policies outstanding.

We've got roughly about 300 claims that we're still kind of working through the pipeline and we just have very minimal operating expense. So I would say it's negligible from here on out..

Okay. Thanks guys..

Thanks, John..

There are no additional questions at this time. This concludes this morning's call. We'd like to remind listeners that today's call will be available for replay on the company's website or by dialing 877-660-6853 or 201-612-7415 and then by entering the conference ID 13738122. The company would like to thank you for your participation.

This concludes today's conference call. You may now disconnect..