FAF

First American Financial Corp. 10-Q Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2010. The filing represents the financial services businesses of The First American Corporation prior to its planned spin-off. The Company is preparing to become an independent publicly traded entity (ticker: FAF) following a separation from its parent, which will be renamed CoreLogic, Inc. (ticker: CLGX). The separation is anticipated to occur on June 1, 2010. The Company operates primarily through two segments: Title Insurance and Services, and Specialty Insurance.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 2.3% year-over-year. This was driven by a 26.1% increase in agent operating revenues, which offset a 10.1% decline in direct operating revenues due to lower mortgage origination volumes.
• Profitability: Net income attributable to the Company more than doubled, rising from $4.9 million to $13.8 million. Pre-tax income increased from $10.1 million to $24.5 million.
• Segment Performance:
  • Title Insurance and Services: Pre-tax income surged 94.3% to $28.6 million, aided by cost reductions and improved margins (3.4% vs 1.8%).
  • Specialty Insurance: Pre-tax income increased 9.0% to $9.6 million despite a 2.5% revenue decline, due to lower loss ratios in the home warranty division.
• Cash Flow: Operating cash flow turned negative ($26.0 million used) compared to positive ($7.8 million provided) in the prior year, primarily due to higher claims payments and changes in working capital.
• Investment Portfolio: The Company recognized $1.4 million in other-than-temporary impairment (OTTI) losses on debt securities in earnings, a significant decrease from $40.8 million in Q1 2009.

Guidance, Outlook, and Risks

• Spin-Off Execution: The primary focus is the consummation of the separation on June 1, 2010. The Company has entered into a $400 million revolving credit facility to fund the separation and repay allocated parent debt.
• Market Outlook: Management notes that tightening mortgage credit and economic uncertainty continue to impact demand. Mortgage originations decreased 4.1% in Q1 2010. The Company is focusing on cost control, including headcount reduction and office consolidation.
• Dividends: Post-separation, the Company expects to pay an annual cash dividend of $25.0 million.
• Key Risks:
  • Real Estate Market: Continued weakness in commercial and residential real estate could reduce transaction volumes and increase claim severity.
  • Investment Portfolio: Significant exposure to non-agency mortgage-backed securities, many of which are downgraded below investment grade. Further OTTI losses are possible.
  • Regulatory/Litigation: Ongoing scrutiny of title insurance practices and a significant lawsuit filed by Bank of America regarding title insurance policies issued without full title searches.
  • Pension Obligations: The Company's pension plan is underfunded by approximately $97.6 million, creating potential future funding obligations.

Investor Verification Checklist

• Verify the final terms and closing date of the spin-off transaction and the $400 million credit facility.
• Monitor the status of the Bank of America litigation and potential indemnification claims against Fiserv.
• Review the composition and credit quality of the non-agency mortgage-backed securities portfolio for further impairment risks.
• Assess the impact of the 44.1% effective tax rate and the realizability of deferred tax assets.
• Track the Company's ability to maintain statutory surplus requirements for its title insurance underwriters post-separation.