First American Financial Corporation: Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015; unaudited, compared with Q1 2014. The company provides title insurance and related real estate services, specialty insurance, and corporate services.
Financial performance
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Revenue | $1,111.1 million | $1,012.8 million | +9.7% |
| Income before taxes | $58.9 million | $35.3 million | +67.2% |
| Net income attributable to the company | $37.6 million | $21.7 million | +73.2% |
| Diluted earnings per share | $0.34 | $0.20 | +$0.14 |
| Operating cash flow | $(66.3) million | $(104.6) million | Less cash used |
| Cash and cash equivalents, quarter-end | $878.4 million | $770.4 million | Q1 2014 comparative |
Consolidated pretax margin was approximately 5.3%, compared with 3.5% in Q1 2014, calculated from reported revenue and pretax income. Title Insurance and Services pretax margin improved to 6.8% from 4.6%; Specialty Insurance margin increased to 18.2% from 16.0%. Net investment income rose to $20.6 million from $17.8 million, while realized investment results shifted to a $1.0 million loss from a $2.6 million gain. Interest expense increased to $7.2 million from $3.9 million.
Liquidity, debt and cash flow
- Cash declined by $311.7 million during the quarter, from $1.190 billion at year-end to $878.4 million. Investing used $495.2 million, including $806.5 million of security purchases, partly offset by financing cash flow of $254.4 million.
- Operating cash use was $66.3 million, including $135.7 million of claim payments net of recoveries. It was lower than the $104.6 million used in Q1 2014.
- Notes and contracts payable were $585.6 million at March 31, 2015, versus $587.3 million at December 31, 2014. Deposits were $2.612 billion, up from $2.333 billion; these include customer-related deposit liabilities and should not be read as conventional funded debt. Notes and contracts payable were 18.3% of total capitalization.
- The company reported no borrowings on its $700 million revolving facility, available through May 2019, and said it was compliant with its covenants. Holding-company cash was $207.4 million. Management said resources were sufficient for anticipated operational cash needs and obligations for at least 12 months.
- Quarterly cash dividends were $0.25 per share. Management expected quarterly dividends to continue at or above that level, subject to board discretion and other factors. $182.9 million remained under the $250 million repurchase authorization; no shares were repurchased in the quarter.
Changes and management commentary
- Management attributed revenue growth principally to higher refinance and commercial activity, and also to increased residential purchase activity. Direct refinance revenue increased 75.6%; commercial revenue increased 28.3%; residential purchase revenue increased 9.4%.
- Direct title operations closed 207,600 orders, up 15.3%. Refinance orders closed per day rose 62.2%, and purchase orders closed per day rose 2.4%.
- Title Insurance and Services pretax income rose to $69.5 million from $42.6 million. Higher order volumes and revenue contributed to higher personnel, production and temporary labor costs. Specialty Insurance pretax income rose to $17.2 million from $13.9 million, with increased home warranty premiums and improved home warranty claims experience.
- The title loss provision was 6.5% of title premiums and escrow fees, versus 6.0%; the 2015 rate included a $4.3 million net increase in estimates for prior policy years. The known-title-claims reserve fell $66.1 million, primarily following settlements of large claims. The company paid $35 million net of $21 million recovered through reinsurance on specified claims.
- Goodwill increased to $983.7 million, including $28.7 million from acquisitions; management reported no impairment-triggering events during the quarter. Capital expenditures were $32.1 million, versus $21.2 million.
Outlook, risks and contingencies
- No quantified earnings or revenue guidance was provided. Real estate and mortgage activity is seasonal and sensitive to interest rates, credit availability, and economic conditions.
- CFPB integrated mortgage-disclosure rules were scheduled to apply to relevant applications beginning August 1, 2015. The company was preparing for implementation but warned of potential processing delays or lower mortgage volumes, particularly during initial implementation.
- Pending lawsuits and regulatory examinations include matters involving title rates, referral practices, fees, home warranty claims and other business practices. For many cases, the company could not assess the likelihood of loss or estimate a loss range. It said the matters were not expected to materially harm overall financial condition or liquidity, but adverse outcomes could affect results in a particular period or prompt business-practice changes.
- A Canadian tax authority’s guidance could lead to an excise-tax assessment concerning services to lenders. The amount was not estimable; the company believed it was reasonably likely to prevail but acknowledged a possible loss.
- Key risks include real estate downturns, interest-rate and investment-market movements, title-claim reserve estimation, agent conduct, regulation and litigation, cyber and systems incidents, pension funding, and dependence on distributions from regulated subsidiaries. A 50-basis-point change in expected loss rates for the six most recent title policy years could change the incurred-but-not-reported reserve by approximately $99.8 million.
- The defined benefit pension plan was underfunded by $105.0 million at March 31, 2015. The company contributed $8.7 million in Q1 and expected to contribute a further $27.1 million in 2015.
Most important facts to verify
- Whether the elevated refinance and commercial transaction activity persists, and how CFPB rule implementation affects order volumes and processing.
- Whether title-loss assumptions and reserves remain adequate, especially given the disclosed $99.8 million sensitivity to a 50-basis-point change.
- Developments in class actions, regulatory investigations and the Canadian excise-tax matter, for which potential exposure was not clearly quantifiable.
- Cash generation and liquidity in subsequent quarters, considering Q1 operating cash outflow, security purchases, claims payments and acquisition spending.
- The sustainability of dividends and the availability of subsidiary distributions, given holding-company cash needs and regulatory limits.