First American Financial Corporation — Q1 2013 10-Q
Business context and reporting period. The filing covers the unaudited three months ended March 31, 2013, compared with Q1 2012. First American provides title insurance and related services, as well as property and casualty insurance and home warranties. Results are closely tied to real estate and mortgage activity and are seasonal.
Financial performance and position
| Metric | Q1 2013 | Q1 2012 / prior date |
|---|---|---|
| Total revenue | $1,146.8 million | $966.8 million |
| Income before taxes | $59.6 million | $51.6 million |
| Net income attributable to First American | $36.2 million | $31.3 million |
| Diluted earnings per share | $0.33 | $0.29 |
| Operating cash flow | $(50.9) million | $(7.8) million |
| Cash and cash equivalents | $814.5 million | $627.2 million at Dec. 31, 2012 |
| Notes and contracts payable | $317.4 million | $229.8 million at Dec. 31, 2012 |
| Total stockholders’ equity | $2,379.9 million | $2,348.1 million at Dec. 31, 2012 |
Total revenue rose 18.6%; pretax income increased 15.6%, and attributable net income increased 15.6%. The approximate consolidated pretax margin was 5.2%, down slightly from approximately 5.3% a year earlier. The effective tax rate was 39.2%, versus 39.7%.
Segment results: Title Insurance and Services revenue increased 19.2% to $1,062.6 million, while pretax income rose 5.7% to $64.3 million and its pretax margin fell to 6.0% from 6.8%. Specialty Insurance revenue increased 9.9% to $81.5 million; pretax income grew 24.0% to $15.9 million, and its margin improved to 19.5% from 17.3%.
Operating cash outflow widened to $50.9 million, including $111.2 million of claim payments, net of recoveries. Investing activities provided $16.1 million and financing activities provided $224.3 million; cash increased $187.3 million during the quarter. The quarter’s cash increase was supported by $249.1 million of debt issuance and higher bank deposits, among other items.
On January 29, 2013, the company issued $250 million of 4.30% senior unsecured notes due 2023 and used part of the proceeds to repay credit-facility borrowings. At quarter-end, no amounts were drawn on the $600 million revolving facility. Management reported $262.2 million of cash at the holding company and said resources were sufficient for anticipated needs for at least 12 months. Notes and contracts payable rose to 11.8% of total capitalization from 8.9% at year-end.
Material changes and management commentary
- Management attributed stronger title results to increased U.S. mortgage originations. The company reported 291,400 direct title orders closed, up 11.5%, and average revenue per closed order of $1,373, up 4.4%.
- Agent premiums increased 28.5%; the filing notes that recognized agent premiums generally lag policy issuance. Information and other revenue declined 2.3%, mainly reflecting weaker Canadian title-related demand.
- Title loss provision increased to 8.7% of title premiums and escrow fees from 7.2%. The quarter included a $28.6 million net increase in estimates for prior policy years, mainly 2006 and 2007, reflecting higher-than-expected claims, including several large commercial claims. Total claims reserves were $977.3 million at quarter-end.
- Specialty Insurance’s direct premiums rose 11.0%, largely on home warranty contract growth. Its property and casualty claims ratio increased to 52.5% from 51.3%, which the company attributed primarily to higher weather-related claims.
- Net realized investment gains were $9.3 million versus $1.7 million, primarily from security sales and an office-building sale in the title segment. No credit-related impairment losses were recognized in Q1 2013, compared with $2.6 million in Q1 2012.
- The investment portfolio totaled $2.84 billion in debt and equity securities. Management reported approximately 99% of fixed-income investments as investment grade; all six non-agency mortgage-backed securities were below investment grade and classified as Level 3.
- The defined-benefit pension plan was underfunded by approximately $125.3 million. The company contributed $7.9 million in Q1 and expected to contribute another $35.1 million during the rest of 2013.
Outlook, risks and contingencies
The company gave no quantified earnings or revenue guidance. Management described improving real estate and mortgage activity, while emphasizing sensitivity to interest rates, mortgage-credit availability, transaction mix and seasonal patterns. Management expected to continue quarterly dividends at or above the current level, subject to board discretion and other factors.
Key risks include real estate and economic downturns; interest-rate and investment-market changes; claim-reserve estimation; title-agent conduct; regulated title rates and increased regulatory scrutiny; lender concentration; data access, cybersecurity and wire-transfer risks; pension funding; and restrictions on subsidiary distributions. The company cited multiple class-action lawsuits and ongoing regulatory examinations involving, among other matters, title pricing, competition, customer-acquisition practices and agency relationships. It said it could not estimate loss or range of loss for many matters, did not expect the identified examinations to materially harm overall results, but warned that changes to business practices could have a material impact.
Customer funds and other administered assets are significant but generally are not company assets: escrow deposits were $4.0 billion, trust assets $2.9 billion and like-kind exchange funds $1.2 billion at March 31, 2013. The company may be contingently liable for their disposition. It also disclosed $19.9 million of maximum potential payments under guarantees of affiliate and third-party indebtedness, with no related liability recorded.
Most important facts for investors to verify
- Whether increased transaction volumes and the favorable order mix persist, particularly as refinance activity and interest rates change.
- Whether claims development—especially the $28.6 million prior-year reserve increase and the 8.7% title loss provision rate—continues or requires further reserve strengthening.
- How much of reported earnings growth is repeatable versus attributable to realized investment gains and other unusual items.
- Cash-flow conversion, including the causes of negative operating cash flow and the effect of deposit movements and customer funds on reported liquidity.
- Debt-service and capital-allocation implications of the 2023 notes, planned pension contributions, dividends and subsidiary dividend restrictions.
- Developments in material litigation, regulatory investigations, investment valuations and the pension plan’s funded status.