First American Financial Corp quarterly report, Q2 FY2020

First American Financial Corporation — Q2 2020 Form 10-Q

Business context and period. Unaudited results for the quarter and six months ended June 30, 2020, compared with 2019. First American provides title insurance and real-estate transaction services, alongside specialty insurance, home warranty, banking, trust and related services. Results were shaped by the coronavirus pandemic, low interest rates and a sharp increase in mortgage refinancing.

Key financial results

Metric	Q2 2020	Q2 2019	Six months 2020	Six months 2019
Revenue	$1,608.7m	$1,498.6m	$3,021.7m	$2,802.2m
Income before taxes	$225.3m	$229.5m	$297.6m	$371.2m
Net income attributable to First American	$170.7m	$186.7m	$233.9m	$296.2m
Diluted EPS	$1.52	$1.64	$2.06	$2.61
Operating cash flow	Not separately stated for quarter	Not separately stated for quarter	$368.0m	$301.1m

Q2 revenue grew 7.3%, while attributable net income declined 8.6% and diluted EPS declined 7.3%. Six-month revenue increased 7.8%, but attributable net income fell 21.1%.
Q2 revenue growth included a $60.9m year-over-year increase in net realized investment gains; agent premiums increased $54.0m. Net investment income fell $19.3m, to $58.4m.
Q2 title insurance and services pretax income was $237.8m, with a 16.3% margin versus 17.0%. Specialty Insurance pretax income was $7.3m, with a 5.5% margin versus 12.8%. For the first half, segment margins were 11.2% and 7.9%, respectively, down from 14.7% and 13.7%.
Cash and cash equivalents were $1.523bn at June 30, versus $1.486bn at year-end. Six-month operating cash flow was $368.0m; investing activities used $705.5m and financing activities provided $382.4m.
Total debt-to-capitalization was 24.6%, up from 18.5% at year-end; the company’s adjusted ratio, excluding secured financing payables, was 18.1% versus 14.1%. Notes and contracts payable were $1.011bn and secured financing payables $478.6m.
In May, the company issued $450m of 4.00% senior notes due 2030 and repaid credit-facility borrowings. At quarter-end, its $700m revolving facility was undrawn. The holding company reported $264.7m cash and $700m of facility availability.
The quarterly dividend was $0.44 per share, versus $0.42 a year earlier. The company repurchased $68.9m of shares in the first half; $92.7m remained under its $250m authorization.

Material changes and management commentary

Refinancing drove a sharp mix shift: Q2 domestic residential refinance direct premiums and escrow fees rose 175.6%, while purchase and commercial direct premiums declined 18.8% and 39.3%. Direct title refinance orders opened per day rose 105.8%; purchase and commercial orders fell 14.8% and 29.6%.
Management reported a recovery in purchase orders after April’s 38.2% year-over-year decline: orders were down 10.3% in May and up 4.9% in June. For the first three weeks of July, purchase orders were up 6.5% year over year; refinance orders averaged 3,100 per day. Management expected refinancing to remain elevated for the rest of 2020, while commercial activity was expected to remain under pressure.
Management said about 80% of its global workforce was working remotely and expected this to continue through year-end. It said the pandemic’s ultimate effects remained uncertain and could affect real-estate demand, operations, investment values and claims.
The title loss-rate assumption was raised from 4.0% in 2019 to 5.0% for 2020 amid economic uncertainty. Title claims were below prior-year levels through June, but management cautioned that claims can rise as economic conditions deteriorate. The total claims reserve was $1.095bn.
Specialty Insurance profitability weakened: Q2 claims provisions increased 26.0% year over year. Management attributed higher home-warranty claims to frequency and higher property-and-casualty claims to large losses and prior-period reserve adjustments.
The company completed $391.9m of acquisitions during the first half, including a $350m mortgage-industry document, e-close and fulfillment technology provider. Acquisitions contributed to higher goodwill and intangible assets.

Risks, contingencies and unusual items

The pandemic and economic downturn could reduce purchase and commercial real-estate activity, weaken investment returns, increase credit exposure and claims, and pressure earnings and liquidity. Management nevertheless believed available resources were sufficient for anticipated obligations over at least the next 12 months.
The company disclosed class-action lawsuits, including matters related to a 2019 information-security incident; classes had not been certified, and the company said it could not estimate possible losses. SEC enforcement staff was examining incident disclosures and disclosure controls; the New York Department of Financial Services alleged cybersecurity violations and filed charges. New York and Massachusetts attorneys general were also inquiring into title-industry competition.
A Canadian tax assessment of $14.4m, including interest through June 30, was under appeal. The company said it believed it was reasonably likely to prevail and recorded no liability.
Potentially material risks include reserve-estimate changes, cybersecurity and wire-transfer fraud, regulatory and privacy requirements, title-agent conduct, interest-rate and investment-market movements, LIBOR transition, and possible goodwill impairment. No goodwill impairment trigger was identified in the first half.
Q2’s investment gains were unusually strong: net realized investment gains were $69.3m, primarily reflecting higher equity-security fair values. For the first half, net realized investment results were a $4.5m gain, versus $41.1m in 2019; equity-security fair-value changes contributed to volatility.

No quantified full-year earnings or revenue guidance was provided in the filing. Management expected quarterly dividends to continue at or above the current level, subject to board discretion and business, regulatory and capital factors.

Important facts for investors to verify

Whether refinancing strength and the July purchase-order recovery persisted, and how the mix shift affected revenue per order and margins.
Whether commercial weakness continued and how pandemic-related economic conditions affected title claims, reserves and specialty insurance loss experience.
How much reported earnings depended on equity-market gains, and the effect of lower interest rates on recurring investment income.
Progress and financial contribution from the 2020 acquisitions, including integration costs and the carrying value of acquired goodwill and intangibles.
Developments in the cybersecurity investigations, related lawsuits and Canadian tax appeal, including any potential financial or operational consequences.
Debt, liquidity and capital allocation, including the 2030 notes, the undrawn revolver, dividends and remaining share-repurchase authorization.