Feb 21, 2013
Executives
Craig Barberio - Director, IR Dennis Gilmore - CEO Max Valdes - EVP & CFO Mark Seaton - SVP, Finance
Analysts
Mark DeVries - Barclays Brett Huff - Stephens, Inc. Geoff Dunn - Dowling & Partners Jim Ryan - Morningstar Jim Fowler - Harvest Capital Bose George - KBW
Operator
Good morning and thank you for standing by. At this time, all parties are in a listen-only mode until the question-and-answer portion of today’s call.
(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 203-369-0799.
We will now turn the call over to Craig Barberio, Director of Investor Relations to make an introductory statement.
Craig Barberio
Good morning everyone and thank you for joining us for our fourth quarter and year-end 2012 earnings conference call. Joining us on today’s call will be our Chief Executive Officer, Dennis Gilmore; Max Valdes, Executive Vice President and Chief Financial Officer and Mark Seaton, Senior Vice President of Finance.
At this time, we would like to remind listeners that management’s commentary and responses to your questions may contain forward-looking statements such as those described on pages four and five of today’s news release and other statements that do not relate strictly to historical or current fact. The 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. Factors that could cause the anticipated results to differ from those described in these forward-looking statements are also described on pages four and five of today's news release.
Management’s commentary contains and responses to your questions may also contain certain financial measures that are not presented in accordance with Generally Accepted Accounting Principles including a personnel and other operating expense ratio. The company is presenting these non-GAAP financial measures because they provide the company’s management and investors with additional insight into the operational efficiency and performance of the company relative to earlier periods and relative to the company’s competitors.
The company does not intend for these non-GAAP financial measures to be a substitute for any GAAP financial information. In the news release that we filed today, which is available on our website, www.firstam.com, the non-GAAP financial measures disclosed in management’s commentary are presented with and reconciled to the most directly comparable GAAP financial measures.
Investors should use these non-GAAP financial measures only in conjunction with the comparable GAAP financial measures. I will now turn the call over to our Chief Executive Officer, Dennis Gilmore.
Dennis Gilmore
Thanks, Craig. Good morning and thank you for joining our call.
I will begin with a brief overview of our 2012 results, followed by fourth quarter highlights and conclude with a few comments on the outlook for 2013. 2012 was a successful year for the company.
Total revenues were $4.5 billion, up 19% compared to 2011. Given the efficiencies we built into our cost structure, we realized strong operating leverage during the year.
The company’s full-year net income was $2.77 per share. Apart of the spin-off in 2010, the company set financial adjectives for a pretax title margin of 8% to 10% and a return on equity of 10% to 12% by year-end 2012.
I am pleased to report that we exceeded both of these objectives, achieving a pretax title margin of 11.3%, a return of equity of 13.7% for the total company. Importantly, 2012 provide a clear demonstration for the earnings potential of the company.
Turning to the fourth quarter results; total revenues for the company were $1.3 billion, up 28% compared to last year. The increase was driven by the strength of our title segment.
Net income was $0.85 per share. Title revenues for the quarter were $1.2 billion, up 30% compared to last year, with a pretax margin of 12.7%.
Closed orders in the fourth quarter were the highest level of the year up 34% compared to 2011, driven by strong refinance activity. Our commercial division also delivered strong results with revenues of $146 million, up 36%.
To a limited extent, we experienced an acceleration of commercial closing in anticipation of higher tax rates. During the fourth quarter, we continue to see a recovery in the resale market with closed transactions up 18% compared to last year and our average revenue for resale order was up 12%.
In our specialty insurance segment, total revenues in our property and casualty and home warranty businesses were up 11% combined with a favorable claim experience the segment achieved a pretax margin of 16.6%. With new and existing home purchases in the early stages of recovery, we are optimistic that housing market will continue to improve.
Open orders in January and so far in February are relatively flat compared to the same period last year, but the order mix is shifting towards higher premium purchase transactions. While there is uncertainty concerning the impact and timing of the expected decline in refinance activity and the magnitude of growth in the purchase market, we believe the company is well positioned going into 2013.
Our capital management strategy will remain consistent. We will invest in value creating projects in our core business; where possible we will make strategic acquisitions that complement our existing businesses.
In 2012, we doubled our dividend and we will continue to evaluate for opportunities to return capital back to shareholders. We believe the company has a strong balance sheet with good financial flexibility which will support the execution of our strategic objectives.
We remain committed to be in the premier title and settlement service company in the US and our key markets abroad. I would now like to turn the call over to Max for a more detailed review of our financial results.
Max Valdes
Thank you, Dennis. The company generated total revenues of $1.3 billion in the fourth quarter, up 28% compared with the same quarter of the prior year.
Net income was $93 million or $0.85 per diluted share compared with net income of $40 million or $0.38 per diluted share last year. The current quarter results include net realized investment gains of $6.2 million or $0.03 per diluted share compared with net realized losses of $2.2 million or $0.01 per diluted share in the prior year.
The fourth quarter results for 2011 also include a $19.2 million charge for legal settlement or $0.11 per diluted share. In the title reinsurance and services segment total revenues were $1.2 billion, up 30% compared with the same quarter of last year.
Direct premium and escrow fees were up 38% this quarter due to a 34% increase in the number of direct title orders closed in the quarter and a small increase in average revenue for order. Average revenue for direct title order closed was $1,547, up 3% compared to the same quarter of last year, as the average revenue for order for commercial and purchase transactions increased.
Agent premiums were up 30% reflecting a normal reporting lag in agent revenues of approximately one quarter. Agent retention was unchanged at 80% of agent premiums.
Information and other revenues totaled a $162 million, up 5% as compared to the same quarter of last year, driven by higher demand for the company's title plan information and default information products, partially offset by lower demand for title related services in Canada. Total investment income for the title segment was up $10.7 million in the fourth quarter, primarily reflecting higher net realized investment gains and an increase in income from investment portfolio.
Personnel costs were $339 million, up 20% compared with the same quarter of last year. This increase was primarily due to higher incentive based compensation driven by improved revenues and profitability and to a lesser extent higher staffing levels required to support the increased order volume compared to the prior year.
Other operating expenses were $211 million, up 25% from the same quarter of last year. This increase was primarily due to higher production related expenses and temporary labor costs from higher title order activity.
The ratio of personnel and other operating expenses to net operating revenue declined to 71% from 75% last year reflecting significant operating leverage. In the fourth quarter, the provision for title losses was $71 million or 7% of title premiums and escrow fees up $6.2 million compared with the same quarter of the prior year.
The current rate of 7% reflects an ultimate loss rate of 5.1% for the current policy year and a net increase in the loss reserve estimates for prior policy years. Year-to-date incurred plans were down $66 million and paid claims were down $63 million compared to last year.
We expect this positive trend to continue as a high loss policy years of 2005 through 2008 become more seasoned. We’re also encouraged by the favorable claims experience we continue to see from our most recent policy years, 2009 through 2012.
Pre-tax income for the title insurance and services segment was $153 million in the quarter, compared with $76 million in the fourth quarter of last year or an increase of 101%. Pre-tax margin was 12.7% in the quarter.
Turning to the specialty insurance segment, total revenues were $80 million, up 11% compared with the same quarter of the prior year. The loss ratio was 51% compared with 53% last year.
Higher premiums and favorable loss experience combined to deliver a pre-tax margin of 16.6% up from 14.1% in the fourth quarter of 2011. Corporate expense was $18.1 million for the quarter in line with our expectation of $20 million per quarter.
With that, I will turn the call over to Mark.
Mark Seaton
Thank you Max. I will provide a few comments on our capital and liquidity.
Cash provided by operations in the fourth quarter was $178 million, an increase of $77 million relative to the fourth quarter of last year. The increase in operating cash flow was primarily driven by improved earnings, and a 28% reduction in paid claims.
Capital expenditures during the quarter were $27 million, up from $22 million in the same quarter of last year due to increases in capitalized software development and title plant information. Our cash and investment portfolio totaled $3.7 billion as of December 31 which includes $1.4 billion of fiduciary funds.
The portfolio is comprised of debt securities of $2.7 billion, cash and short-term deposits of $698 million, equity securities of $198 million and a $193 million in less liquid long-term investments. Overall, we continue to have a high quality portfolio.
Debt on our balance sheet totaled $230 million as of December 31. Our debt consists of $160 million funded on our credit facility, $42 million of trustee notes and $28 million of other notes.
Our debt-to-capital ratio as of December 31 was 8.9%. This January, we closed a $250 million public offering of 4.3% senior unsecured notes due 2023.
We have repaid all borrowings outstanding under the revolving credit facility. On a pro forma basis after taking into account the senior notes offering and the repayment of the credit facility, the company had $320 million of debt and a debt-to-capital ratio of 12.0% as of December 31.
In terms of holding company liquidity, we currently have $174 million of operating cash and $600 million of available on our credit facility. I would now like to turn the call back over to the operator to take your questions.
Operator
(Operator Instructions) The first question comes from Mark DeVries of Barclays. Your line is open.
Mark DeVries - Barclays
Can you talk about the incremental expense and title in the quarter, how much of that you would consider to be fixed and how much would be variable?
Mark Seaton
This is Mark Seaton. Well, it's tough to say you know, what's fixed and what's variable, because it changes all the time.
I think generally speaking, when you look at our personnel expenses, about 25% of our personnel expenses are variable and that’s really commissions and different times we pay, profit sharing and other things like that. When you look at our operating expense line item, about 50% is variable and that’s really our cost of sales.
You know, just different data and information that we have to buy to process the transaction and then of loss provision premium cash and agent retention is 100% variable. So that’s kind of how we look at it.
Mark DeVries - Barclays
Okay, and would you say the operating leverage that you saw this quarter, I know it's kind of the relationship between growth and revenues and expenses is indicative of what we should expect in the near-term as revenues flex up and down, was there anything kind of unusual amount and have to store that?
Mark Seaton
I don't think there was anything unusual in the operating leverage that we saw. We definitely did have a strong commercial quarter and commercial has relatively high margins, this to be the best to our business, but generally speaking, I think the margins that we had were certainly in line with the revenue that we expected, so anything there is anything unusual to happen this quarter.
Mark DeVries - Barclays
Okay, where any additions to headcount in the quarter?
Mark Seaton
Yeah, headcount was up about 141 people from Q3 to Q4. So, we did increase them somewhat in fourth quarter and just to service the additional transactions we have.
Mark DeVries - Barclays
I got it, and I know, Dennis mentioned that the January open orders were flat year-over-year, could you just give us those numbers what they were in kind of a daily basis?
Dennis Gilmore
Yeah, in January our open orders were about beyond somewhat 6,000 a day, our refi orders were down about 9% year-over-year, our purchase orders were up about 9% year-over-year and so far in February the month is over, we are looking at something around 5,900 orders per day, we are seeing the trend continue where refi is continue to soften and purchase is continue to strengthen.
Operator
The next question comes from Brett Huff of Stephens, Inc. Your line is open.
Brett Huff - Stephens, Inc.
A couple of big picture question, Dennis, you mentioned at the beginning of your comments that you guys were able to meet the goal set out when spun the two companies and I was wondering are you thinking about new goals or how are you thinking from a strategic plan or long-term plan or how do you and the board the management team think about the next step?
Dennis Gilmore
Thanks for the question, I think as you know we don't guidance but we were really encouraged by 2012 performance, we got the operating leverage we were looking for the business. We actually came in at 116 and the title margin at the high end of our range that we set.
Now, how we are thinking about it is simply we are going to continue to strive to improve our performance regardless of any market or in that just how we run the business. Specifically in ‘13, it’s really going to depend on the origination market and here so how we are thinking about it.
If and when we move to more a traditional market which I am going to define as two-thirds purchase, one-third refinance, we think there is meaningful opportunity for margin expansion in the business. So we are going to continue to look to improve our performance and wait for the market that move more towards the purchase market.
Brett Huff - Stephens, Inc.
Okay, that is helpful, and then the commercial mix profile, can you give us a sense, I thought it might be higher, can you give us a sense where the deal, are there any big deals in there or was it mostly just many small deals sort of put together?
Dennis Gilmore
Yeah, probably little above, the first we were really proud of our commercial group. They did a great job in the quarter and the franchise itself is doing a great job for commercial customers.
We had revenues of $146 million which actually is a all-time record for us and the group. And specific to the ARPU of commercial, it came in at 99 and we did have some big deals, we just had lot of deals and we also just so it's thought clear to people, we had about $5 million or $7 million probably business from the first quarter for the tax changes, so a little impact, we are not used to it, kind of going forward that I probably use more of ARPU more to be year end, excuse me the ‘12 average of about 8,200 going forward.
Brett Huff - Stephens, Inc.
That's helpful. Can you talk a little bit about the provision.
I know that yours bounces around a little bit and I think the underlying looks really good, I think you said 5.1%. But was there a specific reason in a particular book that we are still backfilling that got worse that drove maybe a little bit higher lease than I expected or is that conservatism.
Give us a sense of how and why that moved up and then also what you are thinking for ’13 and then how that might trend for ’14.
Dennis Gilmore
Sure, I'm going to turn the question over to Max.
Max Valdes
Thanks Dennis. Yeah, Brett what we show during the quarter is those sort of high loss policy is above 5 (inaudible) it continue to come in higher than expected.
So that drove most of the adverse development. But we are encouraged that even with those policy years even though they came in higher than expected they are down.
The claims for those policy years are down about 25% this year versus last year. So that's a good sign.
They are starting to slow down and then we are also obviously encouraged that the total claims were almost $70 million lower, this year versus last year and that recent books are coming in, the recent policies are coming in and they are performing really well. So our expectation for ’13 is we will probably start the year at a rate around 6.5, but we will have to just see how the claims come in February or March and could go up, it could go down, but that's kind of our expectation.
Brett Huff - Stephens, Inc.
And then Mark I think you said the cash you had at the home [co.] was $160 or $170 now.
Mark Seaton
$174 as of today.
Brett Huff - Stephens, Inc.
And that's all pro forma, etcetera. etcetera.
Mark Seaton
Yes.
Brett Huff - Stephens, Inc.
And then last just housekeeping question, what should we think about for taxes sort of in the near and medium term tax rate.
Max Valdes
I think the tax rate we should think about in the 37% to 38% range.
Operator
The next question comes from Geoff Dunn, Dowling & Partners.
Geoff Dunn - Dowling & Partners
Dennis when FAF and Core split, the company assessed an excess capital opportunity of $500 million and acknowledging we've been in a tougher economy longer than probably anybody expected, you moved the dividend but versus that original number, there's still a lot of that original assessment that's still to be determined. Do you still think that that is the number that you have to work with?
And if that is the case, I think a couple of quarters ago you indicated we should start expecting more active capital management from the company. Can you provide a little bit more color beyond kind of opportunistic returns or acquisitions?
Dennis Gilmore
Yeah, let me give you some high level how we are thinking about capital first of all. We did upon the split we did come out, we were indicating that we would stay conservative and we have by and large held true to that.
But just putting into perspective how we are thinking about it Jeff, we are always going to invest in our core business first and we have been and anything we can do to improve our processes or procedures we will do that. Our second alternative would be to do strategic acquisitions that are going to fit in our core.
By the way what we think are value added, so we are always on the hunt for that, and the third is we are going to continue to look for opportunities to return it back to shareholders as we have been and as you mentioned we doubled the dividend in 2012 and we will continue just to look for perfect opportunities to return it back to shareholders.
Geoff Dunn - Dowling & Partners
How long are you willing to operate at a low double digit, that levered on the balance sheet. Is that something that is kind of your dry powder for anything that might come up or is that something that we’d see move to a more fully leveraged position over the course of 13?
Dennis Gilmore
Again, I think there is opportunities for deployment, Jeff, but I think we will stay probably closer to the ranges we are in right now than move it to the higher end of our range.
Operator
The next question comes from Jim Ryan, Morningstar. Your line is open.
Jim Ryan - Morningstar
Got a question on the Agent, kind of a disparity between the Agent premium growth and the direct. I realized there is always a lag and in the fourth quarter I think year-over-year, it was up 38% direct versus 29% in Agent.
But when I look on a year-over-year basis, it was up 28% in direct and 15% in Agent. What's driving the mix on that?
Mark Seaton
Hey Jim, this is Mark Seaton. Just generally speaking I think the growth in our Agent premium should follow the growth in our direct premium.
I mean there is nothing that is really going on core of the business that would change the growth rate between those two line items materially. But as you know, there is about a one quarter lag between our direct and Agents revenue.
And so the 38% direct revenue growth that we saw in the fourth quarter this year, we should see that in the first quarter on the agency side of the business. So the answer to the question, there is nothing that’s really fundamentally going on.
It's just the timing of when we recognize the revenue.
Jim Ryan - Morningstar
Well, in terms of the year-over-year though, it is possibly, partially driven by commercial or anything along those lines, because I realize that you probably do a lot more direct, commercial and direct as suppose to Agent?
Mark Seaton
Yeah, again it's nothing on the commercial side that would really drive it. It's just that there was a big ramp up and refis that really caused the direct to increase faster, and we're going to get that benefit on the Agency side in subsequent months.
Jim Ryan - Morningstar
So, you might you expect then that it would be more than a one quarter lag coming in to a 2013 when you might see a lot of more agents reporting from the third and fourth quarter?
Mark Seaton
Yeah, it could be a little bit more than one quarter but generally speaking, it's about a quarter.
Operator
The next question comes from Jim Fowler, Harvest Capital. Your line is open.
Jim Fowler - Harvest Capital
I might have missed your comment, but could you discuss default title trends in the fourth quarter and what are you seeing in the first couple of months of the first quarter please?
Dennis Gilmore
This is Dennis. We're clearly seeing the default market overall heal itself.
So my comments somewhere regarding the overall market. Default rates are coming down, actually negative equities improving.
So overall, the trends in my opinion are positive to the market itself. Inside of our business, we had a strong performance in the fourth quarter, but some of it was project related work.
So, I think the trends will look similar from ‘12 in to ‘13 from our perspective on default revenues.
Jim Fowler - Harvest Capital
Is it declining at a faster pace in the first month and half versus how say the last couple of months in the fourth quarter?
Dennis Gilmore
Our specific business is not, but we clearly think that default revenues will trend down in ‘13 going in to 14.
Jim Fowler - Harvest Capital
And then just last question. Yesterday, one of your competitors reported and pretax operating margin was up quarter-over-quarter, pretty smartly yours is down.
What explains that and should it be acceptable that it’s down?
Dennis Gilmore
It's actually up. We had a non-recurring gain in the third quarter.
Jim Fowler - Harvest Capital
Okay. Alright, so what was the margin last quarter excluding that?
Max Valdes
Last quarter, it was 11.3% excluding the gain and this quarter was 12.4% on an apples-to-apples basis excluding realized gains, so it’s up about 110 basis points.
Jim Fowler - Harvest Capital
And your competitors is up about 160. Is there anything efficiency wide that we should think its different?
Dennis Gilmore
I am not going to comment on the competitor, we know, we felt the operating leverage in the business was good in the fourth quarter.
Operator
The next question comes from Bose George of KBW. Your line is open.
Bose George - KBW
Going back to the margin, is it fair to say if revenues levels are sustainable then the current margin is a reasonable run rate and then the upside from here comes as a mix shift move more towards purchase overtime?
Dennis Gilmore
Again the comments similar to what I made before. We are going to continue to try to drive for better margin regardless the market we operate in and trying to drive for efficiencies and how we run the business.
But really what we are looking for the business to start to make that transition back to a purchase market, and again we think that more normalized healthy market would be 2/3 purchase, 1/3 refinance, and we are not there yet, but we are encouraged by the trends moving in that direction, and if we think we move into that kind of market, we think there is opportunities for margin expansion in this business.
Bose George - KBW
Okay that makes sense and actually on the commercial side, have you guys ever broken out the commercial margins separately for that segment?
Dennis Gilmore
We have not.
Operator
(Operator Instructions) the next question comes from Brett Huff of Stephens, Inc. Your line is open.
Brett Huff - Stephens, Inc.
I have one follow up and I don't think I missed this, but could you give us the refi mix stats for 4Q and maybe January and February too and I'm not sure you wanted to open or close or whatever makes sense.
Mark Seaton
So in the fourth quarter in terms of opens our refi percentage was 71%, and it really came down through the quarter. So October was 72%, November was 71%, December was 69%, and we've seen that trend continue so far in January it was 67% and February we think its going to be in the low 50s.
So we are seeing that refi soften and purchases climb and you are seeing that reflected in the refi numbers.
Brett Huff - Stephens, Inc.
And then kind of related to that and this is a bigger picture question, but thinking about the units of work I don't know whether it’s harder to do a purchase than a refi just from an amount of work within your company. But it seems like that as the total number of orders could come down as refis probably fall faster than purchases grow.
So you could have a lower absolute amount of work to do, presuming the two are kind of interchangeable and you are going to have a richer mix of refis. Is there anything that should disabuse us of seeing that, is that where the margin expansion is going to come from Dennis?
Dennis Gilmore
It could, again I made it in my opening comments, we are not sure of the slope down on the refi and slope up of purchase. So just we have to wait till that develops, but we do generate twice the revenue, rough numbers twice the revenue on the purchase transaction, more work involved but I think there's ultimately more incremental margin associated with the purchase.
Operator
There are no additional questions at this time. That concludes this morning’s call.
We would like to remind listeners that today's call will be available for replay on the company’s website or by dialing 203-369-0799. The company would like to thank you for your participation.
This concludes today's conference call. You may now disconnect.