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. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. 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 a 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. 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 banking 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 re-engineer 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 2 percentage points in 2022, which will pay dividends when the current cycle turns.
I'm 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. I'd like to turn the call over to Mark for a more detailed discussion of our financial results.
Thank you, Ken. This quarter, we earned $0.44 per diluted share. Included in this quarter's result were $0.05 of net investment losses. Excluding these losses, we earned $0.49 per diluted share. Revenue in our title segment was $1.3 billion, down 32% compared with the same quarter of 2022. Commercial revenue was $148 million, a 39% decline over last year. Our average revenue per order for commercial transactions declined 25% this quarter to $9,900 due to a combination of lower valuations as prices in the commercial market reset and fewer large transactions. Purchase revenue was down 32% during the quarter, driven by a 33% decrease in the number of orders closed, partially offset by a 2% increase in the average revenue per order.
Refinance revenue declined 75% relative to last year due to the increase in mortgage rates. In the agency business, revenue was $590 million, down 38% from last year. Given the reporting lag in agent revenues of approximately one quarter, these results reflect remittances related to Q4 economic activity. Our information and other revenues were $222 million, down 26% relative to last year. This decline was the result of lower transaction levels across several business units, including the company's data and property information products and post-close and document generation services. Investment income within the title insurance and services segment was $125 million, a 136% increase relative to the prior year. Rising short-term interest rates are benefiting the interest income we receive on our cash and investment portfolio, escrow balances, and tax-deferred property exchange balances.
As short-term rates have risen, we expect investment income to continue to be a tailwind for earnings in 2023. On the expense side, we continue to manage expenses given the decline in transaction activity. Our success ratio was 50%, meaning that our personnel and other operating expenses declined $206 million and our net operating revenue declined $409 million. Though below our long-term target of 60%, we believe our success ratio was a good outcome given the sharp decline in transaction activity and our commitment to continue to fund strategic initiatives. The provision for policy losses and other claims was $35 million in the first quarter, or 3.5% of title premiums and escrow fees, down from the 4.0% loss provision rate in the prior year.
The 3.5% loss rate reflects an ultimate loss rate of 3.8% for the current year, with a $3 million release for prior policy years. Of now, we expect to book at 3.5% for the remainder of 2023, that may change depending on claims activity. Ken highlighted, we continue to invest in businesses and innovation initiatives that we believe will positively contribute to our profitability in the long term, at this point in their life cycle adversely impact our financial results. We have discussed three initiatives, 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 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 pays 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 31st was 28.4%. This ratio is impacted by both our accumulated other comprehensive loss and our secured financings payable.
Excluding these two items, which is more in line with our bank fee to ratio, our debt-to-capital ratio was 20.1%. As we discussed last quarter, on February 1st, 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. 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. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before asking questions. One moment please while we poll for questions. Our first question comes from Bose George with KBW. Please proceed with your question.
Yes, good morning. actually, I wanted to ask about margins. Just given the weakness, you know, in sort of the broader markets, can you just talk about margin expectations for the year? You know, if this persists, is there more you can do on the expense side to, kind of address it?
Thanks for the question, Bose. 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, you know, we've seen evidence of the purchase in the refi markets have really bottomed out and commercial is really close to getting there. 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'll 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. 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. Lastly, I'll just say that, you know, our PNC business lost $18 million last year, and obviously that loss is going to narrow this year. 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. You know, in terms of, you know, can we do more?
I mean, there's always more that we can do if the market is sort of worse than our expectations. We're looking at at least double-digit margins in 2023 based on, based on what we see today.
Okay, great. That's helpful. Thanks. Actually on interest income, you noted that, you know, it remains a tailwind. Any change to the guidance you gave in the past? Obviously, forward, you know, rate expectations have changed a little bit.
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, you know, the forward curve for federal funds rate played out like the market thought it was going to. The second thing was that balances were even with Q3 levels, that they didn't change. What's happened now is, you know, the federal funds rate has really played out like the market has thought, but balances have fallen. Certainly, our commercial business was down 40% sequentially from Q4 to Q1, and so our investment income was down sequentially just because balances fell.
When we look at kind of the outlook for investment income this year, we feel like Q1 of $125 million of investment income entitled to trough. We don't see it getting any lower than that. We sort of You know, if we were going to update our sort of guidance that we gave, and we just took March balances and kept them flat and, you know, assume the forward curve. We look at somewhere around $535 million of investment income this year. Again, that's based off of March balances. March balances are typically lower than the average balances. As commercial sort of picks up throughout the year, we think we'll hit higher than that.
We're still positive on investment income, but it was just down this quarter just because of balances.
Great. That's helpful. Thank you.
Our next question comes from Mark Hughes with Truist. Please proceed with your question.
Yeah. Thank you. Just, Mark, to your last point there about how balances ought to build as the year progresses. Is there decent visibility for that? I think you gave the commercial orders down, was it 30% in the first three weeks of April? Is there reason to think the balances will progress from here?
Mark, this is Ken. I'll, you know, I'll answer that one. I mean, you know, 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. You know, about 70% of our balances are tied to our commercial business. And a lot of that is based on our, you know, as I mentioned in my comments, our customer feedback. They're expecting a stronger second half, mostly because price discovery will have concluded or largely concluded. And there's still, you know, at least we're hearing anecdotally, there's still adequate capital despite the banking crisis.
You know, obviously, we're watching that closely, you know, watching loan availability, particularly to the in the smaller to medium-sized commercial market. You know, everything we're hearing so far is that, you know, we anticipate to have it that commercial is going to end up fairly strong this year, though obviously it'll be down compared to a record 2022.
Yeah. When we think about the cost structure and just looking back, your direct premiums and escrow fees pretty similar this quarter to what you had in 1Q 2019 when you had, as if I'm looking at it properly, a 10% pre-tax title margin on a lot less investment income. Could you maybe give some perspective or thoughts on that? Is that the, you know, 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, but I just wonder if you could, you know, give some reflections on how the cost structure is different now than it might have been.
Four years is a while ago, but it's a striking comparison.
Well, I'll just say back in 2019, you know, it was certainly a better market, particularly when you look at the number of transactions. You look at what really the big three markets that drive our business, commercial, purchase, refi, I mean, it was all much stronger back in 2019. 2023, at least so far, in terms of transaction counts, we're seeing, you know, lows we haven't seen since the Great Financial Crisis and even before that in some of those markets. When you look at, like, the cost structure of our individual business units, whether it's our, you know, 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.
That's what I'd just say relative to 2019.
Yeah.
Mark, the one thing-
Yeah, I'm thinking first quarter revenue.
I'm sorry. Mark, I guess the one thing I would add, too, is when it comes to these strategic initiatives, as Mark mentioned in his comments, the investments are significant. We can obviously slow those down or shut them off. We don't wanna do that. We don't think it makes sense from a long-term strategic perspective, that's a lever we have.
Yeah. On the home warranty business, I wonder if you could, maybe give some thoughts about what you think might happen with the top line there.
Yeah. I think, you know, while our home warranty business had a, you know, had a strong quarter as we noted. I, you know, I think on the top line, 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. As we see real estate transactions fall, if they continue to fall, you know, that'll put pressure on their revenue. They've had a lot of success in the direct-to-consumer business. You know, in the first quarter, for example, it was up 12%, whereas in the real estate channel, it was down almost 35%. There's opportunity there.
The other thing we're seeing is, you know, some good performance with respect to renewals in both channels, actually. The real estate channel, the renewals have been up almost 5%, and direct-to-consumer, just over 14%. We think there's some opportunity there. They're facing, certainly in the real estate channel, the same headwinds that our, you know, our residential title business is.
Thank you very much. Appreciate it.
As a reminder, if you would like to ask a question, please press star one on your telephone keypad. Our next question comes from Mark DeVries with Barclays. Please proceed with your question.
Yeah, thanks. I wanted to drill down a little more on the commercial outlook for the back half of the year. Appreciate all the color you provided. You know, I think one question is the price discovery issue, is that impacting the larger transactions sizes more? If so, as we, you know, find an equilibrium at these higher rates, does that kind of have an upward impact on the fee per file?
The second question is how much concern is there from you're hearing from your customers that, you know, even as they begin to reach that equilibrium and find price discovery that, you know, banks tightening in the wake of this regional banking crisis kind of tighten disproportionately on their CRE business and you see kind of a lack of supply of credit just as commercial investors are looking to transact?
Yeah. You know, Mark, I think, you know... I mean, it's not, it's not clear if the price discovery is impacting large transactions larger, you know, much more substantially than others, though 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, you know, that price discovery is having an impact on them. Now with respect to the, the, you know, the fee per file, you know, I think if we see large transactions come back into the market, [audio distortion] on our average revenue per order. You know, with that said, we're anticipating that on the whole, you know, large transactions are gonna go down in value as well.
I mean, we're seeing, you know, 10%-15% decline in prices in the, you know, in the commercial market. It's 25% in office. prices across the spectrum, I think are gonna come down.
Okay, got it. Any concerns, around the availability of funding from banks?
Yeah, I mean, as I had mentioned, we're hearing anecdotally that there's, you know, adequate capital. No, we have some moderate concern about it. We're, you know, we're keeping an eye on it. You know, you certainly read a lot in the, you know, in the trade media about, you know, particularly mid-tier banks making credit available to, you know, on smaller or medium-sized commercial deals. It is a concern. It's something we're watching. At least what we're hearing from our customer base is it's, you know, they don't see an issue right now. You know, obviously, you know, there's much remains to be seen.
Okay. Got it. Next question. I mean, you know, this environment's gotta 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? If so, are you kind of prepared to be aggressive in acquiring?
Yeah, I mean, you know, it's interesting, Mark. I mean, we haven't seen a lot of attractive opportunities. We've seen some opportunities, you know, particularly like in the PropTech space that are not too compelling. Given where the market is, we, you know, expect to see some opportunities. You know, if the current challenges, you know, ultimately prove to be prolonged, yeah, I think there will be opportunities. The good news is we have the capital to seize on them. You know, as always, we'll be very disciplined about, you know, about our M&A activity. 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.
Morning.
Mark, I know you put it in the queue, but can you front run and then give the actual balances for escrow deposits in 1031 as of the end of the quarter?
Yeah. Thanks, Geoff. At the end of the quarter, we had $2.1 billion of 1031 exchange deposits. Was that your question, 1031?
Yeah, that's part of it. Do you have the escrow as well?
Oh, I'm sorry. Yeah. Escrow, total escrow deposits, we had about $10 billion.
That's flat?
Sequentially?
Sequentially, it was about $11 billion. Yeah. We're going from, you know, I'm looking at bank balances. In the Q, we report book balances, slight difference on timing. At the end of the year, in terms of bank balances for escrow, we had $11.0 billion. As of March 31st, we had $10.3 billion. They're down sequentially. That's on escrow.
Okay. I guess, I mean, 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.
Yeah.
Can you dig into that a little bit more?
Yeah. The average rate that we're getting on 1031 right now is about average for the quarter 4.55. As a general statement, we get Fed funds. Obviously, Fed funds change throughout the quarter. As a general statement, we're getting Fed funds for our 1031 business.
How does that compare to escrow?
Escrow, we're getting about Fed funds as well. Same thing. Maybe a little bit less. We get probably a little bit more on 1031, but it's generally about Fed funds.
Okay. All right. 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? You know, last year you indicated you were gonna increase that activity. You did. How do you think about that in the current macro challenges?
Yeah. Geoff, this is Ken. I mean, you know, listen, our priorities always remain the same. You know, one is to, you know, reinvest in the business, which, you know, as we've talked about a couple of times today, we're doing with Endpoint and Title Decision and other innovations and strategic initiatives. M&A, you know, which I talked about earlier. You know, thirdly, returning capital to shareholders. You know, with respect to repurchases, I mean, the current price is certainly attractive. You know, in Q1, we repurchased over 550,000 shares. Last year, we repurchased over 7% of our shares outstanding.
You know, we're gonna be opportunistic given all the demands on our capital, you know, including, as I had mentioned, our expectation that there's gonna be some attractive M&A opportunities forthcoming.
Okay. Thank you.
As a reminder, if you would like to ask a question, please press star one on your telephone keypad. Our next question comes from John Campbell with Stephens. Please proceed with your question.
Hey, guys. Good morning.
Morning.
Morning.
Hey, back to the margin for title. I mean, if we back out the investment income impact, and then if you add back, you know, 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 have to go back to 1Q 2009, so during the housing crisis, to see a similar margin. You know, on Mark's question, it. You know, you guys provided a couple 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.
You know, things to improve a bit on the resi side as well as commercial, which we agree with for sure. As a hypothetical, if you looked at next year, next 1Q, if you just hold everything flat, what type of margin lift do 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. For example, our bank, if you just exclude all the, you know, the revenue from the bank, and you have all the personnel costs and all the, you know, other operating expenses associated with the bank, and not just the bank, but our 1031 business, you know, it's not quite, you know, apples and oranges, I would say. You know, the other thing is our bank pays interest expense too, so you sort of have to back that out.
That's, you know, 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. Basically when we think about the margins, I mean, we're, as I said, we're looking at double-digit margins this year, and we feel like that's a good outcome considering, you know, just the tough market conditions. When we look out 2024, 2025 and beyond, we feel like we're gonna get a lot of lifts for a few different areas. Number one, obviously we'll have hopefully market tailwinds.
Number two is a lot of our, you know, just, I'll call it normal operating expense management will continue to pay off, and we've seen that with the success ratio here these last couple of quarters. Three, hopefully some of these strategic initiatives will continue to, you know, pay dividends for us. When you wrap that all together, you know, we've really. The highest margins we've seen, at least our company's 15%, we saw that in 2021. Now we're having a trough market this year, but we will inch closer to 15, you know, in, you know, in the outer years once these things materialize.
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. 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 projection margins this year. I'm curious if that's a hundred percent, you know, contingent on the resi market improving as well as commercial, at least what you saw in 1Q. Do you think you'd still be able to get there, you know, with cost action if the market sags a little bit?
I would say that's assuming a pretty tough environment. I mean, we're sitting here in April, we have visibility into, you know, sort of June revenue based off of the order count. For the first half, we pretty much know what we're gonna do more or less. The second half, there's still uncertainty, particularly on commercial, particularly, you know, how strong is Q4 gonna be. I would say that double-digit margin assumption doesn't assume the market picks up. We're not assuming a, you know, a big recovery on the residential side. It assumes kind of a flat purchase market and no pickup and refis and some normal seasonality with commercial. There's not a. There's no stretch assumptions with that.
Okay. That's helpful. Last one from me, just a housekeeping question. With PNC being moved into corporate, just wanna make sure I get a better grip on that. I saw the $1.7 million claims costs. How much incremental expense is tied to PNC that's falling into commercial now? Or excuse me, into corporate?
For the quarter, we had about $5 million of losses at corporate because of PNC. We think that's really gonna narrow to a couple 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, you know, very minimal operating expense. 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 877-6606853 or.