Stewart Information Services Corporation — Q3 2012 Form 10-Q
Reporting period: Three and nine months ended September 30, 2012; interim financial statements are unaudited. Unless noted otherwise, dollar amounts below are in millions.
Business context
Stewart provides title insurance and related services through direct and independent-agency operations, and real estate information (REI) services. Its results are sensitive to real estate transaction activity, mortgage rates and availability, home prices, agency mix, and distressed-property programs.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Revenue | $520.7 | $418.5 | $1,389.4 | $1,189.8 |
| Pretax earnings | $39.4 | $7.7 | $62.7 | $7.0 |
| Net earnings attributable to Stewart | $34.7 | $4.5 | $47.4 | $0.2 |
| Diluted earnings per share | $1.45 | $0.22 | $2.04 | $0.01 |
- Q3 revenue grew 24.4% year over year; nine-month revenue grew 16.8%. Q3 pretax margin was about 7.6%, versus 1.8% a year earlier; nine-month pretax margin was about 4.5%, versus 0.6%.
- Q3 title revenue was $477.6 million, up from $396.0 million; REI revenue was $43.1 million, up from $22.5 million. REI pretax earnings were $14.4 million for the quarter, with a pretax margin above 30%.
- Q3 investment income declined 14.4% year over year to $3.7 million, mainly because of lower average yields. Nine-month net investment and other gains were $5.8 million, including gains from investment and property sales.
- Title-loss expense was $34.5 million in Q3; title losses were 7.3% of title revenue, compared with 9.0% in Q3 2011. The estimated title-loss liability was $516.3 million at September 30, including $137.4 million for known claims and $378.9 million for claims expected to be reported later.
Cash, liquidity, and debt
- For the first nine months, operating cash flow was $56.8 million, versus cash used of $4.9 million in 2011. Investing activities used $10.6 million and financing activities used $11.5 million. Cash and cash equivalents, including statutory reserve funds, increased to $177.8 million from $140.8 million at year-end 2011.
- Cash and investments, including statutory reserves, totaled $698.7 million. The company reported $136.4 million of unrestricted cash and investments, excluding equity-method investments; much of the consolidated balance is held by regulated title-insurance subsidiaries and is subject to restrictions.
- Total debt was $71.1 million, including $64.6 million of 6.0% convertible senior notes due October 2014. Notes payable were $6.5 million. A $10 million bank line expiring June 2013 had no borrowings outstanding.
- Stockholders’ equity was $524.7 million, compared with $463.5 million at December 31, 2011. Management said available resources and expected operating cash flows should be sufficient for operations and claims, subject to regulatory limits on subsidiary funds.
Changes, outlook, and management commentary
- Management attributed stronger results to higher closed-order volumes, improving real estate conditions, scalable operations, cost management, improved agency remittance and quality, and lower title claims. Direct orders closed rose 18.1% in Q3, while average revenue per file declined 3.0%, reflecting more refinancing closings.
- Existing-home sales and home prices improved year over year, but management cautioned that broader economic conditions remained weak. It expects agency retention rates to remain around 82%–83% in the near to medium term.
- REI growth reflected lower-margin loss-mitigation projects awarded in late 2011 and early 2012. Management expects revenue from these projects to decline through 2013, and is pursuing more sustainable services; it anticipates REI margins stabilizing in the 20%–25% range.
- The filing provides no specific consolidated earnings or revenue guidance. Management said it expects sufficient liquidity for ongoing needs, while noting possible future borrowing or equity funding if cash is insufficient or strategic needs arise.
- Key risks include housing and mortgage-market changes, title-loss reserve adequacy, regulatory restrictions on insurer cash, litigation outcomes, agency fraud or defalcations, and the uncertain duration of REI government and lender projects. Management reported no material change in risk factors or market-risk disclosures.
Contingencies and unusual items
- Pending litigation included California actions involving loans arranged through Hurst Financial, with a target trial date of May 2013 for an undetermined portion of the cases; a New York-centered title-insurance antitrust class-action series, with numerous claims dismissed; and an appeal of an approximately $4.2 million judgment in the Van Buren matter.
- Management said it was vigorously defending the cases, believed reserves were adequate, and did not expect the disclosed matters to materially affect consolidated results. The ultimate outcomes remain uncertain.
- Guarantees of third-party indebtedness and unused letters of credit totaled $4.1 million, primarily for workers’ compensation. The company reported no material off-balance-sheet liquidity arrangements apart from operating leases and customary customer escrow-related activities.
- Nine-month operating cash flow benefited from improved earnings and lower claim payments, partly offset by increased receivables, which management expected to collect in Q4 2012. The filing also reports a $2.2 million positive cash-flow effect from foreign exchange and a $1.3 million building ownership interest received in exchange for debt forgiveness.
Important facts for investors to verify
- Whether order volumes and housing-market improvement persist, and how refinancing mix affects revenue per file.
- Whether title-loss frequency and severity continue to improve and whether the $516.3 million claims reserve proves adequate.
- Whether REI revenue declines as distressed-property projects retrench, and whether newer services support management’s targeted 20%–25% margins.
- How much cash held by regulated insurance subsidiaries is practically available to the parent, given statutory reserve and dividend restrictions.
- Developments in the California, antitrust, and Van Buren litigation, including potential financial exposure.