Business context and reporting period
First American Financial Corporation filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2018. Its principal businesses are title insurance and related real estate services, and specialty insurance, including home warranties and property and casualty coverage. Results are seasonal and sensitive to real estate activity, mortgage availability, and interest rates.
Financial performance and condition
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $1.491 billion | $1.454 billion | $2.789 billion | $2.771 billion |
| Net income | $155.1 million | $121.9 million | $231.3 million | $180.0 million |
| Net income attributable to company | $155.1 million | $122.3 million | $231.4 million | $180.5 million |
| Diluted EPS | $1.37 | $1.09 | $2.05 | $1.61 |
| Income before taxes | $202.0 million | $184.2 million | $295.0 million | $268.0 million |
Q2 revenue rose 2.5% year over year and net income attributable to the company rose about 27%; six-month revenue increased about 0.6% and attributable net income about 28%. Q2 pretax margin was approximately 13.5%, versus 12.7% a year earlier. Title Insurance and Services pretax margin increased to 15.3% from 14.8%; Specialty Insurance margin was 8.4% versus 8.3%.
Q2 growth reflected higher direct premiums and escrow fees (+3.2%) and net investment income (+42.2%). Investment income benefited from higher short-term rates. Title direct premiums and escrow fees increased with higher average revenue per closed order, despite fewer orders; residential refinance activity weakened. The effective tax rate fell to 23.2% from 33.8%, primarily reflecting the federal rate reduction under the Tax Cuts and Jobs Act.
For the six months, operating cash flow was $254.1 million, compared with $234.6 million in 2017. Investing activities used $567.9 million, including acquisitions, securities purchases, and secured-financing activity; financing activities provided $154.4 million. Cash and cash equivalents declined $160.7 million to $1.227 billion.
At June 30, total assets were $9.959 billion and total equity was $3.571 billion. Notes and contracts payable were $736.4 million and secured financings payable were $96.2 million. The $700 million revolving credit facility had $160 million outstanding and $540 million available; it matures May 2019. The company reported compliance with its financial covenants. Cash dividends declared were $0.38 per share in Q2.
Material changes, outlook and risks
- Title Insurance and Services revenue grew 2.4% in Q2, while segment pretax income rose 6.3%. Direct title orders closed fell 8.3%; average revenue per order increased 13.3%. Six-month agent premiums declined 3.7%.
- Specialty Insurance revenue increased 4.4% in Q2, primarily from growth in home warranty contracts. Segment pretax income increased 5.9% for the quarter; claims rates varied between home warranty and property and casualty lines.
- Management gave no specific earnings or revenue guidance. It expects the tax law to continue to benefit the effective tax rate and expects quarterly dividends to continue at or above the current level, subject to board discretion. Management said available cash, operating cash generation, and credit availability should meet anticipated obligations for at least 12 months.
- Management cited real estate and mortgage-market cyclicality, rising interest rates, reduced refinancing, and regulatory changes as factors that could affect transaction volumes and results. Other disclosed risks include investment losses, changes in claims experience and reserves, title-agent conduct, cyber and funds-transfer fraud, data access, and dependence on large lenders and government-sponsored enterprises.
- Non-ordinary-course lawsuits and regulatory inquiries include claims concerning fees, settlement practices, agent relationships, and other matters. For many cases, the company could not assess the probability or estimate a loss; it did not believe the matters would materially harm overall financial condition or liquidity, though an adverse outcome could affect a particular period. A Canadian excise-tax matter also has an unestimable potential loss.
- Notable accounting and portfolio items: adoption of fair-value-through-earnings accounting for equity securities resulted in a $40.6 million cumulative adjustment to retained earnings; Q2 included $3.6 million of net realized investment gains. Six-month other comprehensive loss was $73.3 million, largely reflecting debt-security valuation and foreign-currency changes. The company acquired a warehouse lender; related secured financings payable were $96.2 million at quarter-end.
Important facts for investors to verify
- Whether title order volumes and average revenue per order continue to offset lower refinance activity, and how mortgage rates affect purchase and refinance demand.
- Investment portfolio performance, including unrealized debt-security losses and equity fair-value gains recognized in earnings.
- Claims trends and reserve assumptions; management estimates a 50-basis-point change in recent title-policy loss rates could change IBNR reserves by approximately $120.5 million.
- Available holding-company liquidity, subsidiary distribution constraints, the May 2019 revolving facility maturity, and the warehouse lender’s funding exposure.
- Developments in pending litigation, regulatory investigations, and the Canadian excise-tax issue, for which potential exposure is not clearly quantifiable in the filing.