First American Financial Corp quarterly report, Q1 FY2017

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First American Financial Corporation — Q1 2017 10-Q

Reporting period: Three months ended March 31, 2017; unaudited. First American provides title insurance and related real estate services, along with specialty insurance products.

Financial results and liquidity

  • Revenue: $1.317 billion, up 9.6% from $1.202 billion in Q1 2016. Growth included agent premiums (+12.2%), direct premiums and escrow fees (+4.4%), and information and other revenue (+17%). Acquisitions contributed substantially to the information and other increase.
  • Profit: Income before taxes was $83.9 million, up from $75.6 million. Net income attributable to the Company was $58.3 million, versus $52.5 million; diluted EPS was $0.52 versus $0.47. The 2017 effective tax rate was 30.8%, including a $2.4 million reduction in tax expense from new share-based compensation accounting guidance.
  • Segment performance: Title Insurance and Services pretax income rose 12.1% to $98.2 million, with an 8.2% pretax margin versus 8.0%. Specialty Insurance pretax income fell 18.0% to $10.0 million, and its margin declined to 9.1% from 11.9%, including higher property and casualty claims related partly to West Coast winter storms.
  • Cash flow: Operating activities provided $6.1 million, compared with $56.4 million used in Q1 2016. Investing activities used $23.7 million and financing activities provided $57.7 million. Cash and cash equivalents increased $41.3 million to $1.047 billion.
  • Balance sheet and debt: Total assets were $8.874 billion and total equity was $3.078 billion at March 31. Notes and contracts payable were $735.5 million. The company had $160 million outstanding on its $700 million unsecured revolving facility at 2.73%, with $540 million available, and reported compliance with its financial covenants.
  • Dividends: The company paid $0.34 per share in Q1, up from $0.26 a year earlier. Management expects quarterly dividends to continue at or above the current level, subject to board discretion and other factors.

Changes, outlook and notable items

  • Domestic residential purchase activity strengthened while refinancing weakened: direct premiums and escrow fees from purchase transactions increased 12.6%, while refinance fees fell 11.3%. Direct-operation refinance orders opened per day declined 37.3%; purchase orders opened per day increased 0.5%.
  • Management identifies real estate and mortgage activity as cyclical and seasonal, and notes that rising interest rates can reduce refinancing and residential transaction volumes. No specific revenue or earnings guidance is provided.
  • The company contributed $34.0 million in March to fully fund its terminated defined-benefit pension plans. It expects to complete the transfer of remaining liabilities in Q2 2017 and recognize approximately $159 million of pension expense upon completion. After termination, it estimates annual personnel-cost reductions of approximately $22 million, based on 2016 expenses.
  • Title claims provision was 4.0% of title premiums and escrow fees, compared with 5.5% in Q1 2016; management reported no change in prior-year loss-reserve estimates this quarter. The total claims reserve was $1.013 billion. Management notes that a 50-basis-point change in expected loss rates for the last six policy years could change the IBNR reserve by $111.7 million.
  • Regulators are examining or investigating matters including title insurance pricing and rates, industry competition, customer acquisition and retention, and agency relationships. The company does not currently expect these inquiries to materially harm its overall financial condition, results or cash flows, but says resulting practice changes could have a material effect.
  • Numerous lawsuits, including putative class actions involving title rates, fees, business practices and employment classification, remain pending. For many, the company cannot assess the likelihood or estimate a possible loss. A Canadian excise-tax matter also remains unresolved, with no loss estimate available.
  • Customer funds are significant: escrow deposits totaled $6.8 billion and like-kind exchange funds $2.3 billion at quarter-end. Certain funds and trust assets are not company assets, but the company may be contingently liable for their disposition or transfer.

Most important facts for investors to verify

  • Whether purchase activity and agent premiums can offset falling refinance volumes as interest rates and housing conditions change.
  • The timing and full earnings impact of the expected $159 million pension expense, and whether the anticipated $22 million annual cost reduction follows completion.
  • Claims development and reserve adequacy, particularly given the disclosed sensitivity of IBNR estimates.
  • Developments in regulatory investigations, class actions and the Canadian excise-tax matter, including any new estimable exposures or business-practice changes.
  • Liquidity at the holding company and subsidiary dividend capacity: management reported $269.1 million of holding-company cash and $540 million of undrawn revolver availability; insurance-subsidiary dividends, loans and advances are regulated.
  • Investment portfolio exposure to interest rates, credit and liquidity: 94% was investment grade, while 6.2% of the portfolio was non-investment grade.