First American Financial Corporation — Q2 2017 Form 10-Q
Business context and reporting period. Unaudited results for the quarter and six months ended June 30, 2017, compared with the corresponding 2016 periods. First American provides title insurance and real-estate-related services, alongside home warranty and property-and-casualty insurance. Results are sensitive to real-estate transaction volumes, mortgage rates and seasonal activity.
Financial performance and position
- Second-quarter revenue: $1.454 billion, up 6.8% year over year. Income before taxes was $184.2 million versus $153.6 million; net income attributable to the Company was $122.3 million versus $102.1 million. Diluted EPS was $1.09 versus $0.92.
- Six-month revenue: $2.771 billion, up 8.1%. Income before taxes was $268.0 million versus $229.2 million; net income attributable to the Company was $180.5 million versus $154.7 million. Diluted EPS was $1.61 versus $1.40.
- Revenue drivers: Q2 agent premiums rose 7.4%, information and other revenue rose 10.4%, and direct premiums and escrow fees rose 2.7%. Higher purchase and commercial activity was partly offset by weaker refinancing. Information-revenue growth included acquired businesses.
- Segment results: Title Insurance and Services Q2 pretax income was $197.3 million, with a 14.8% margin, versus $172.4 million and 13.7%. Specialty Insurance pretax income was $9.6 million, with an 8.3% margin, versus $4.7 million and 4.5%.
- Claims: Title loss provision was 4.0% of title premiums and escrow fees, versus 5.5% a year earlier; management said the current-period rate reflected the expected ultimate rate for the current policy year and no change in prior-year reserve estimates. Home-warranty claims rates improved, while property-and-casualty claims rates increased.
- Cash flow: Operating cash flow for the first half was $234.6 million versus $146.4 million. Investing activities used $315.8 million; financing activities provided $237.5 million. Cash and cash equivalents increased $160.6 million during the half to $1.167 billion.
- Balance sheet and debt: At June 30, cash was $1.167 billion, investments were $5.459 billion, total assets were $9.314 billion and total equity was $3.198 billion. Notes and contracts payable were $734.5 million; $160 million was outstanding under the $700 million revolving facility at 2.98%, with $540 million available. The company reported compliance with credit-facility covenants.
- Liquidity and capital returns: Parent-company cash was $255 million. Management said available liquidity and operating cash generation were sufficient for anticipated needs for at least 12 months. The Q2 dividend was $0.34 per share, compared with $0.26 a year earlier; management expected quarterly dividends to continue at or above the current level, subject to board discretion. No shares were repurchased in the first half.
Material changes, outlook and risks
- Q2 direct title premiums from domestic residential purchase and commercial transactions increased 11.8% and 6.8%, respectively, while residential refinance premiums declined 34.2%. Direct-operation title orders closed fell 12.4%; refinance orders closed per day declined 36.3%, while purchase orders rose 3.1%.
- Net investment income increased, partly reflecting higher short-term rates, higher average investment balances and a greater allocation to higher-yielding municipal bonds. Q2 net realized investment gains were $17.9 million versus $8.1 million a year earlier.
- Pension transaction after quarter-end: In July 2017, the company transferred remaining pension obligations to an insurer. It expected to record approximately $153 million of pension expense in Q3 2017 and estimated annual personnel-cost reductions of approximately $22 million based on 2016 expense levels.
- Management provided no specific revenue or earnings forecast in the supplied filing text. It noted that rising mortgage rates and weaker refinancing activity can reduce real-estate transactions and revenues; purchase activity is seasonal. Potential regulatory and tax changes—including changes involving Dodd-Frank, government-sponsored enterprises, mortgage-interest deductions and tax-deferred exchanges—could affect transaction volumes or competition.
- Legal and regulatory matters include putative class actions and government inquiries involving title-insurance pricing, competition, settlement services, customer practices and agent relationships. For many matters, the company could not assess the probability or estimate a loss range. Management did not expect the identified matters to materially harm overall financial condition or liquidity, but acknowledged that an adverse outcome or required business-practice changes could materially affect a particular period or future results.
- A potential Canadian excise-tax assessment remained unresolved; the amount was unknown and a loss was possible. The company also identified risks from real-estate and interest-rate changes, title-claim estimates, investment losses, agent conduct, regulation, acquisitions, cyber incidents and fraud involving fund transfers.
Important facts for investors to verify
- Whether purchase and commercial growth can offset continued weakness in refinancing, and whether title-order volumes and per-order revenue support segment margins.
- The sustainability of lower title-loss provisions and improved home-warranty claims experience, alongside the increase in property-and-casualty claims rates and uncertainty in long-duration title reserves.
- The timing and full income-statement impact of the approximately $153 million Q3 pension expense, and whether estimated annual personnel savings materialize.
- Developments in class actions, regulatory investigations and the Canadian tax matter, including any change in the company’s ability to estimate or reserve for potential losses.
- Liquidity, debt and capital-return capacity, including subsidiary dividend restrictions, the $160 million revolver borrowing and the board’s future dividend decisions.