Stewart Information Services Corporation — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. Unaudited results; dollar amounts below are USD millions unless noted.
Business context
Stewart provides title insurance and related real estate transaction services, mortgage services, and corporate support. The title business remains its largest segment. Results reflect a weaker refinance market, acquisition-driven growth in mortgage services, and a significant reduction in title-loss expense that included recovery on a prior-year claim.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $508.1 | $536.8 | $1,348.5 | $1,477.8 |
| Pretax earnings | $42.8 | $29.6 | $35.8 | $85.6 |
| Net earnings attributable to Stewart | $23.7 | $15.4 | $17.9 | $45.5 |
| Diluted EPS | $0.97 | $0.63 | $0.76 | $1.88 |
| Cash from operating activities | — | $15.1 | $70.8 |
- Q3 revenue fell 5.4% year over year, while Stewart-attributable earnings rose 54%. Q3 pretax margin was approximately 8.4%, versus 5.5% a year earlier. Nine-month pretax margin was approximately 2.7%, versus 5.8%.
- Q3 title-segment revenue was $440.5, down 12.6%; pretax earnings increased 24.2% to $74.9, a 17.0% margin versus 12.0%. Results included a prior-claim recovery, partly offset by $3.8 of litigation accruals.
- Q3 mortgage-services revenue increased 125.3% to $63.1, supported by acquisitions and new contracts. The segment earned $3.4 pretax, compared with a $0.02 loss in Q3 2013. For the first nine months, it recorded a $0.4 pretax loss, compared with $16.3 earnings in 2013.
- Q3 title-loss expense was $9.1 versus $32.6; the reported loss provision rate was 2.0% of title operating revenue versus 6.4%. Excluding the large-claim recovery and related adjustments, the company reported Q3 rates of 5.2% and 6.4%, respectively.
- Operating cash flow dropped to $15.1 from $70.8 for the first nine months, primarily due to lower operating results and greater claim payments in excess of provisions. Cash and equivalents were $168.4 at September 30, down from $194.3 at year-end 2013.
Balance sheet, debt and liquidity
At September 30, total assets were $1,381.4, liabilities $714.5 and total equity $666.9. Notes payable were $64.1 and convertible senior notes $27.2, for total debt of approximately $91.3. Notes payable had increased from $5.8 at December 31, 2013, primarily reflecting acquisition and other borrowing needs.
Cash and investments totaled $771.1, including approximately $437.1 of statutory reserve investments and $30.9 of cash designated for statutory reserves; the company reported $334.0 net of statutory reserves. Parent-company cash was $14.0. Management reported statutory liquidity of 0.95:1 for its principal underwriter as of June 30, below its internal 1:1 objective. Access to insurance-subsidiary funds and dividends is subject to regulatory limits.
In October, $27.2 of convertible notes matured and were exchanged for approximately 2.1 million common shares. The company also replaced its $75.0 million credit line with a $125.0 million facility expiring in October 2019; $60.0 was outstanding at September 30 and transferred to the new facility.
Material changes, outlook and commentary
- Three 2014 acquisitions, including DataQuick’s collateral valuation business, cost $39.4 net of liabilities assumed and were primarily funded by the unsecured credit line. Preliminary acquired goodwill was $16.1; purchase-price allocation remained in progress.
- Management said the original estimate of approximately $5.0 in annual acquisition synergies had been achieved, with integration continuing and further mortgage-services margin improvement expected in 2015.
- Management expects a title-loss provisioning rate of 5.0%–5.5% in Q4 and into 2015. It reaffirmed a goal of $25 million in annualized cost savings, excluding market conditions, by the end of 2015; actions implemented in Q3 were expected to produce approximately $2.0 in annual savings.
- The company remained committed to a $70 million share-repurchase program through the end of 2015, funded from operating cash generation. It repurchased approximately 422,000 shares for $13.4 in Q3; cumulative purchases were approximately 0.5 million shares for $16.3.
- No formal earnings or revenue guidance was provided. Management cited potential support for Q4 transaction volume from lower interest rates and announced mortgage-rule changes, while noting the housing and refinance markets remain key drivers.
- Notable items included $4.2 of Q3 litigation-related accruals and approximately $2.4 of acquisition integration costs. A California title-related matter was settled with approximately 500 plaintiffs for $10.53; a small number did not settle, with trials expected in 2015. A separate Great American Insurance dispute was settled confidentially in Q3 after a jury verdict for Stewart; settlement terms were not disclosed.
Risks and contingencies
Title-loss reserves totaled $491.5, including $116.9 for known claims and $374.6 for incurred-but-not-reported claims. Management emphasized that reserve estimates require judgment and may differ materially from ultimate losses; a 100-basis-point change in the loss provision rate would have affected nine-month provision and pretax results by approximately $12.4. Other risks include mortgage and real estate market conditions, agency fraud or defalcations, acquisition integration, litigation and regulatory matters, foreign currency movements, and restrictions on moving insurer cash to the parent. Management said it believed existing liquidity was sufficient for ongoing operations, subject to regulatory constraints.
Key facts for investors to verify
- How much of Q3 earnings improvement came from the prior-claim recovery, and when were recovery proceeds received? The filing says proceeds arrived after quarter-end but does not disclose the settlement amount.
- Whether title-loss reserves and the stated 5.0%–5.5% provisioning range remain appropriate as claims develop, particularly large claims and escrow-fraud losses.
- Whether operating cash flow improves and the underwriter’s statutory liquidity ratio reaches management’s 1:1 objective; verify the new credit facility’s utilization and covenant headroom.
- Whether acquisitions deliver the stated synergies and improve mortgage-services margins in 2015, while managing integration costs and increased debt.
- How the remaining California plaintiffs’ claims and other litigation or regulatory matters resolve, including any material financial consequences.