First American Financial Corporation — FY2017 Form 10-K
Business context and reporting period. The filing covers the fiscal year ended December 31, 2017; it is an annual report, not a standalone fourth-quarter report. First American provides title insurance and real-estate settlement, data, and related services, plus property-and-casualty insurance and home warranties. Title insurance and services generated 91.7% of consolidated revenue.
Financial performance and position
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Revenue | $5.772 billion | $5.576 billion | +3.5% |
| Income before income taxes | $445.3 million | $477.6 million | -6.8% |
| Net income attributable to the Company | $423.0 million | $343.0 million | +23.3% |
| Diluted EPS | $3.76 | $3.09 | +21.7% |
| Cash from operating activities | $632.1 million | $489.4 million | +$142.7 million |
| Cash and cash equivalents at year-end | $1.387 billion | $1.006 billion | +$381.1 million |
| Total assets | $9.573 billion | $8.832 billion | +8.4% |
| Notes and contracts payable | $732.8 million | $736.7 million | -0.5% |
| Stockholders’ equity | $3.480 billion | $3.008 billion | +15.7% |
- Consolidated pre-tax income margin was approximately 7.7%, down from 8.6% in 2016. Net income attributable to the Company was approximately 7.3% of revenue, versus 6.2% in 2016; the comparison was substantially affected by tax reform.
- Title insurance and services revenue rose 3.1% to $5.293 billion, and pre-tax income rose 7.3% to $642.4 million; segment pre-tax margin improved to 12.1% from 11.7%.
- Specialty insurance revenue increased 6.7% to $465.0 million, but pre-tax income fell 7.9% to $36.9 million; segment pre-tax margin declined to 7.9% from 9.2%.
- Operating cash flow rose to $632.1 million, after $472.0 million of claim payments net of recoveries. Capital expenditures were $136.7 million. Dividends paid were $159.3 million.
- At year-end, the $700 million revolving facility had $160 million drawn at 3.32%, with $540 million available. The Company reported covenant compliance. Notes and contracts payable were 17.4% of total capitalization, versus 19.6% in 2016.
- Management stated that operating cash generation, liquid assets, and revolving-credit availability were sufficient for anticipated needs and obligations for at least the next 12 months.
Material changes versus 2016
- Title activity shifted toward purchases and commercial transactions as refinancing weakened. Domestic direct title orders closed fell 14.1%; direct premiums and escrow fees increased 0.9%, as average revenue per closed order rose 17.2%. Residential refinance direct revenue declined 32.3%, while residential purchase and commercial direct revenue rose 11.4% and 5.3%, respectively.
- The title loss provision rate declined to 4.0% from 5.5%, including no change in prior-year reserve estimates in 2017; 2016 included a $42.6 million net increase in prior-year title loss estimates. Total claims reserves were $1.029 billion, including $875.7 million of title IBNR.
- Specialty insurance claims costs increased. Property-and-casualty claims were 85.0% of premiums, versus 63.3% in 2016, reflecting greater severity and frequency, including California wildfires and western U.S. rainstorms. Home warranty claims improved to 53.5% of premiums from 60.7%.
- Consolidated pre-tax income decreased despite revenue growth, in part because corporate expenses included $152.4 million of pension settlement costs in 2017, compared with $66.3 million in 2016. The pension-plan termination is expected to reduce annual corporate personnel costs by about $22 million based on 2016 expense levels.
- The effective income tax rate fell to 5.3% from 28.1%. The Tax Cuts and Jobs Act generated estimated net tax benefits of $114.1 million in 2017, including a $130.9 million one-time noncash benefit from remeasuring deferred taxes, partly offset by other tax effects. The Company said its tax accounting remained subject to refinement.
Outlook, risks, contingencies, and unusual items
- Management expects the tax law changes to benefit future effective tax rates, earnings per share, and cash taxes, but the effects of the law on real-estate transactions and mortgage originations were uncertain. No specific earnings or revenue guidance was provided.
- Results are highly sensitive to cyclical and seasonal real-estate and mortgage activity, interest rates, credit availability, transaction mix, and property values. Refinancing is particularly rate-sensitive.
- Title claims reserves are a material estimate risk: management said a 50-basis-point change in loss rates for each of the six most recent policy years could change IBNR reserves by $117.8 million. The actuary’s reasonable IBNR range was $716.3 million to $910.9 million, compared with management’s $875.7 million estimate.
- The filing describes putative class actions and governmental examinations involving, among other topics, title fees and rates, competition, settlement services, customer practices, and agent relationships. For most specified lawsuits, the Company could not assess the probability or estimate a loss range; management did not expect the matters to materially affect overall financial condition or liquidity, but adverse outcomes or practice changes could affect individual-period results or future operations.
- A Canadian tax authority inquiry could result in an excise-tax assessment; the amount, if any, was not estimable. The Company believed it was reasonably likely to prevail but stated a loss was possible.
- Two fourth-quarter 2017 out-of-period adjustments were recorded: an $8.5 million increase in other operating expense for previously uncollectible fee balances, and a $4.7 million increase in depreciation and amortization plus a $1.8 million decrease in realized investment gains related to title-plant asset corrections. The Company considered the adjustments not material to previously issued statements.
- Other identified risks include regulatory and rate-setting changes, concentration among large mortgage lenders, agent defalcations and claims, cyber and data-security incidents, fraudulent fund transfers, investment-market losses, and restrictions on subsidiary dividends. Escrow deposits administered totaled $7.5 billion and like-kind exchange funds totaled $2.6 billion; these are generally not Company assets, but the Company may be contingently liable for their disposition.
- The board increased the quarterly dividend to $0.38 per share in 2017. Management expected quarterly dividends at or above that level, subject to board discretion and legal and capital constraints. The share repurchase authorization had $182.4 million remaining; no shares were repurchased in 2017.
Important facts for investors to verify
- How much of 2017 earnings growth persists after excluding the $114.1 million estimated tax-reform benefit, and whether subsequent tax-accounting adjustments alter it.
- Whether title IBNR and large-claim reserves develop within management’s estimate and how the actuary’s wide reasonable range changes over time.
- Whether elevated property-and-casualty losses, including wildfire exposure in California, are adequately addressed by pricing and reinsurance.
- Whether purchase and commercial activity can offset continued weakness in refinancing, and how mortgage volumes affect title orders, margins, and cash generation.
- The outcomes and potential business-practice effects of regulatory inquiries, class actions, and the Canadian excise-tax matter, for which several exposures were not quantifiable.
- The continued availability of holding-company liquidity and subsidiary distributions, including the revolving facility’s May 2019 termination date and regulatory limits on insurance-subsidiary dividends.