First American Financial Corporation — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. This is an annual filing, not a standalone quarterly report; fourth-quarter figures below are from the filing’s unaudited quarterly data. Amounts are U.S. dollars.
Business context
First American provides title insurance, real estate settlement and related data services, alongside property and casualty insurance and home warranties. The title insurance and services segment generated 91.9% of consolidated revenue. The business is highly exposed to cyclical and seasonal real estate and mortgage activity.
Financial performance and position
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Revenue | $5.748 billion | $5.772 billion | Down 0.4% |
| Income before income taxes | $609.5 million | $445.3 million | Up 36.9% |
| Net income attributable to First American | $474.5 million | $423.0 million | Up 12.2% |
| Diluted earnings per share | $4.19 | $3.76 | Up 11.4% |
| Cash provided by operating activities | $793.2 million | $632.1 million | Up 25.5% |
| Total assets | $10.631 billion | $9.573 billion | Up 11.0% |
| Notes and contracts payable | $732.0 million | $732.8 million | Roughly unchanged |
Net margin, calculated as net income attributable to the company divided by revenue, was approximately 8.3%, versus 7.3% in 2017. The title insurance and services segment’s pretax margin improved to 12.4% from 12.1%; specialty insurance’s pretax margin declined to 5.8% from 7.9%.
Operating cash flow was $793.2 million, after $450.8 million of claims payments net of recoveries. Capital expenditures were $125.5 million. Cash and cash equivalents ended the year at $1.467 billion. At the holding company, cash was $327.3 million, with $540.0 million available on the revolving facility. Total notes and contracts payable were $732.0 million, and secured financings payable were $76.3 million. Debt to capitalization was 17.8%, compared with 17.4% in 2017. The company reported compliance with credit-facility financial covenants.
Investment income rose to $230.3 million from $162.4 million, while net realized investment losses were $56.5 million, compared with $11.2 million of gains in 2017. The effective tax rate was 21.9%, versus 5.3% in 2017; the prior-year rate included a substantial tax-reform benefit. Dividends declared were $1.60 per share, up from $1.44. The company repurchased $18.8 million of stock during 2018.
Fourth-quarter snapshot
Fourth-quarter 2018 revenue was $1.417 billion, down about 4.3% from $1.481 billion in fourth-quarter 2017. Pretax income was $118.9 million, versus $159.3 million. Net income attributable to the company was $91.6 million, versus $221.1 million; the comparison is affected by the unusually low 2017 full-year tax rate, which included tax-reform benefits. The filing does not provide a clear quarterly cash-flow value.
Material changes and management outlook
- Title orders processed by direct domestic operations fell: orders opened declined 8.2% and orders closed declined 11.3% from 2017. Domestic refinance premiums and escrow fees fell 21.4%, while purchase and commercial activity were comparatively stronger.
- Direct title premiums and escrow fees increased 1.5%, but agent premiums declined 3.2%. Higher investment income and lower title claims provision partly offset weaker agent premiums and investment losses.
- Specialty insurance revenue rose 0.9%, but pretax income fell 26.8%. Property and casualty claims remained elevated, including wildfire-related losses; the 2018 claims ratio improved from 2017 but remained high.
- Management expected residential purchase-market weakness to continue in 2019, while anticipating higher investment income and continued strong commercial performance. The company adjusted its cost structure in the fourth quarter. No quantified earnings or revenue guidance was provided.
- The company completed acquisitions for $82.9 million, including a specialized warehouse lender. It continued investing in automation, decision science and digital closing processes; management said the eventual impact of these initiatives was uncertain.
Risks, contingencies and unusual items
- Claims estimates: Title IBNR reserves were $877.1 million. A 50-basis-point change in expected loss rates for each of the six most recent policy years could change the reserve by approximately $122.4 million.
- Litigation and regulatory matters: Putative class and collective actions and regulatory inquiries involve title pricing, competition, settlement services, customer acquisition and agency relationships. Many potential losses could not be reasonably estimated; the company did not expect these matters to materially affect overall financial condition or liquidity, but adverse outcomes or required practice changes could affect results.
- Canadian excise-tax matter: The company expected a 2019 assessment of $12.0–$12.8 million plus interest, intends to appeal, and recorded no liability because it did not consider a loss probable.
- Credit-facility maturity: The $700 million revolving credit agreement, with $160 million drawn at year-end, was due to terminate May 14, 2019. Management anticipated a successor agreement and said holding-company liquidity could repay the balance if necessary.
- Customer funds and operations: The company administered $7.6 billion of escrow deposits and held $2.7 billion of like-kind exchange funds, largely off balance sheet; it may be contingently liable for their disposition. Cybersecurity, data privacy, wire fraud, agent conduct and third-party bank exposures are significant risks.
- Accounting and one-time effects: New accounting treatment for equity securities put fair-value changes through earnings in 2018; the company reported $56.5 million of consolidated net realized investment losses. Tax reform materially affected comparative tax rates. The 2017 statements also included pension settlement costs and an $8.5 million out-of-period adjustment for previously uncollectible balances.
Most important facts for investors to verify
- Whether 2019 residential purchase and refinance volumes, title orders and agent premiums followed the expected weaker trend, and whether commercial activity offset it.
- Whether the $877.1 million title IBNR reserve remains adequate as claims develop, particularly for recent policy years and large claims.
- Whether the revolving credit facility was refinanced or repaid before its May 2019 maturity, and how the acquisition-related warehouse financing develops.
- Subsequent outcomes of the Canadian tax assessment, class actions and regulatory inquiries, including any resulting changes in business practices.
- How much of operating cash, deposits and investment assets is available to the parent company, given subsidiary dividend restrictions and obligations relating to customer funds.