First American Financial Corp quarterly report, Q3 FY2020

First American Financial Corporation — Q3 2020 Form 10-Q

Business context and period. Unaudited results for the three and nine months ended September 30, 2020, compared with the same 2019 periods. First American provides title insurance and related real estate services, specialty insurance, and trust and banking services. Results are highly influenced by real estate and mortgage transaction volumes, interest rates, and claims experience.

Financial results and key metrics

Metric	Q3 2020	Q3 2019	Nine months 2020	Nine months 2019
Revenue	$1,913.7 million	$1,671.2 million	$4,935.4 million	$4,473.4 million
Income before taxes	$243.4 million	$245.3 million	$541.0 million	$616.5 million
Net income attributable to First American	$182.3 million	$187.2 million	$416.1 million	$483.4 million
Diluted earnings per share	$1.62	$1.65	$3.68	$4.26
Cash provided by operating activities	Not separately reported for the quarter	Not separately reported for the quarter	$681.0 million	$611.7 million

Q3 revenue increased 14.5%, while pretax income declined 0.8% and attributable net income declined 2.6% year over year. Approximate consolidated pretax margin was 12.7%, versus 14.7% in Q3 2019.
Nine-month revenue rose 10.3%, but pretax income fell 12.2% and attributable net income fell 13.9%. Approximate pretax margin was 11.0%, compared with 13.8%.
Q3 Title Insurance and Services revenue increased 15.0% to $1.772 billion; segment pretax income rose 33.1% to $337.5 million, with a 19.0% pretax margin versus 16.5%. Specialty Insurance recorded a $72.1 million pretax loss, including a $73.3 million impairment charge.
Cash and cash equivalents were $1.512 billion at September 30, 2020, compared with $1.486 billion at year-end 2019. Total equity was $4.735 billion.
Notes and contracts payable were $1.012 billion and secured financings payable were $526.5 million. The company had issued $450 million of 4.00% senior unsecured notes due 2030; no borrowings were outstanding on its $700 million revolving credit facility. Debt-to-capitalization was 24.5%; adjusted ratio excluding secured financings was 17.6%.
Operating cash flow for the first nine months increased year over year despite lower net income. Investing activities used $1.096 billion and financing activities provided $465.7 million; cash increased by $48.0 million over the period.

Material changes versus the prior comparable period

Residential refinance activity and title orders accelerated: Q3 direct domestic refinance and purchase premiums and escrow fees increased 91.9% and 19.7%, respectively. Domestic commercial direct premiums and escrow fees declined 28.6%.
Lower short-term interest rates reduced net investment income by 37.9% in Q3, to $52.5 million. Q3 net realized investment gains increased to $45.0 million from $1.5 million, partly offsetting that decline.
The company recorded $73.3 million of pretax impairment losses after committing to sell its property and casualty insurance business. The business was classified as held for sale; completion was expected within one year.
Incurred title claims were lower year over year, but the company raised its calendar-year title loss rate from 4.0% to 5.0% in response to economic uncertainty. The Q3 title provision rate was 5.0%, versus 4.0% in Q3 2019.
Specialty Insurance claims costs rose: the Q3 home warranty claims rate was 64.5%, versus 59.9%; the property and casualty claims rate was 82.7%, versus 63.8%, with large losses and West Coast wildfires contributing.
Acquisitions totaled $391.9 million in the first nine months, including a $350 million mortgage document and e-closing technology acquisition. Goodwill increased to $1.355 billion from $1.151 billion at year-end.

Outlook, commentary, risks and unusual items

The filing provides no formal earnings or revenue guidance. Management said the residential purchase pipeline was strong entering Q4; purchase orders opened were up 14.1% in Q3 and that trend continued into October. Management expected refinancing activity to remain elevated for the rest of 2020.
Refinance orders opened averaged 3,200 per day in Q3 and 2,800 per day during the first three weeks of October. Management did not expect Q4 2020 commercial revenue to match Q4 2019, despite an improving commercial pipeline.
Management said the pandemic’s ultimate effect was difficult to predict. Most of the global workforce was working remotely, and the company expected that situation to continue through year-end. It believed available cash flows, liquid assets and credit capacity were sufficient for anticipated needs over at least the next 12 months.
The company expects to continue quarterly dividends at or above the current level, subject to board discretion and other factors. Q3 dividend declared was $0.44 per share. No shares were repurchased in Q3; $92.7 million remained under the repurchase authorization at quarter-end.
Title IBNR reserves are sensitive to loss assumptions: management estimated that a 50-basis-point change in loss rates for the six most recent policy years could change reserves by $131.1 million; a 100-basis-point change could affect them by $262.2 million.
Cybersecurity-related litigation and regulatory matters remain unresolved. In September, the company received an SEC Wells Notice indicating staff’s preliminary recommendation of an enforcement action related to the 2019 information-security incident and disclosures. The New York Department of Financial Services filed charges and scheduled a hearing. The company disputed the SEC staff’s position; outcomes and potential losses were not estimable in the filing.
Other risks include pandemic and real estate-market uncertainty, investment and interest-rate risk, wildfire and other catastrophe exposure, regulatory changes, cyberattacks and fraud, and the effects of LIBOR’s expected discontinuance. A Canadian tax assessment of $14.9 million was being appealed; the company said a loss was not probable and recorded no liability.

Important facts for investors to verify

Progress, terms and expected timing of the property and casualty business sale, and any further impairment or separation costs.
Whether refinance and purchase volumes remain strong, and whether commercial real estate activity continues to recover.
Future title and specialty insurance claims, reserve assumptions and the potential reserve sensitivity disclosed by management.
Developments and potential financial consequences of the SEC, New York DFS and other investigations, cybersecurity lawsuits, and the Canadian tax appeal.
How recurring operating performance compares with reported earnings given lower investment income and the quarter’s significant realized investment gains and impairment charge.
Debt, credit-facility capacity, subsidiary distributions and the sustainability of dividends and share repurchases under changing business conditions.