First American Financial Corporation — FY 2013 Form 10-K
Reporting period: Year ended December 31, 2013. The filing also reports fourth-quarter results. Amounts below are in U.S. dollars; financial amounts are rounded to millions unless otherwise stated.
Business context
First American provides title insurance, closing and escrow, real-estate data and related services, as well as property and casualty insurance and home warranties. Title insurance and services generated 92.9% of consolidated revenue in 2013. The business is substantially exposed to cyclical real-estate and mortgage activity.
Financial and operating metrics
| Metric | 2013 | 2012 | Change |
|---|---|---|---|
| Revenue | $4,956.1 million | $4,541.8 million | +9.1% |
| Income before income taxes | $310.7 million | $467.4 million | -33.5% |
| Net income attributable to First American | $186.4 million | $301.0 million | -38.1% |
| Diluted earnings per share | $1.71 | $2.77 | -38.3% |
| Cash provided by operating activities | $378.5 million | $429.7 million | -11.9% |
| Total assets | $6,520.6 million | $6,050.8 million | +7.8% |
| Stockholders’ equity | $2,453.0 million | $2,348.1 million | +4.5% |
Consolidated pretax margin was approximately 6.3% in 2013 versus 10.3% in 2012. Operating cash flow followed payment of claims, net of recoveries, of $479.3 million, compared with $446.0 million in 2012.
- Title insurance and services: Revenue was $4,606.1 million, up 9.7%; pretax income was $350.2 million, down 26.1%; pretax margin fell to 7.6% from 11.3%. Higher average revenue per direct order and agent premiums supported revenue, while claim-reserve strengthening and higher expenses weighed on earnings.
- Specialty insurance: Revenue was $339.6 million, up 7.8%; pretax income was $42.1 million, down 11.2%; pretax margin declined to 12.4% from 15.1%. Higher home-warranty and property-and-casualty claims contributed to the margin decline.
- Debt and liquidity: Notes and contracts payable were $310.3 million, up from $229.8 million; debt was 11.2% of total capitalization versus 8.9%. The company issued $250 million of 4.30% senior notes due 2023. It had no borrowings on its $600 million revolving credit facility at year-end, and the parent company reported $221.7 million in cash. Management said resources were sufficient for anticipated cash needs for at least 12 months.
- Capital returns: Dividends declared were $0.48 per share, up from $0.36. The company repurchased 3.0 million shares for $64.6 million during 2013.
Material changes versus the prior comparable period
- Mortgage activity shifted substantially: U.S. purchase originations increased 11.0% while refinances fell 24.3%, according to the MBA forecast cited in the filing. First American’s direct domestic closed residential resale orders per day rose 11.2%, while refinance orders per day fell 20.4%; total direct domestic title orders closed declined 7.4%.
- Interest rates rose beginning in May 2013, materially reducing refinance activity in the second half. The order mix shifted toward residential resale and commercial transactions, which generally generate higher premiums than refinances.
- Title claim provisions rose to $343.5 million from $237.4 million. The title loss provision rate increased to 8.8% of title premiums and escrow fees from 6.9%, including a $148.5 million net increase in estimates for prior policy years.
- Operating cash flow declined despite higher revenue. Net realized investment gains also fell sharply, to $9.2 million from $67.7 million; 2012 included gains from sales of CoreLogic stock.
Fourth-quarter results, outlook and risks
Fourth-quarter 2013 revenue was $1,219.9 million, compared with $1,276.8 million in fourth-quarter 2012; pretax income was $84.8 million versus $147.7 million, and net income was $51.8 million versus $93.2 million. Fourth-quarter net income included a $4.4 million net reduction for items that should have been recorded in a prior period, reducing diluted EPS by $0.04. The company also recorded $5.3 million of severance expense in the quarter as it adjusted staffing to lower refinance volumes.
Management expected elevated foreclosure processing to continue in the near term, with potential for further lender-policy claims. It noted that real-estate and financial-market conditions appeared to be improving but that actual claims could vary materially from projections. The title IBNR reserve was $840.1 million; the actuary’s reasonable-estimate range was $729.7 million to $1.0 billion. A 50-basis-point change in expected loss rates for the six most recent policy years could change the IBNR reserve by approximately $105.8 million.
Other significant risks include regulatory scrutiny and rate regulation, dependence on a relatively small number of large mortgage lenders, agent conduct and defalcations, investment and interest-rate exposure, data and cybersecurity incidents, and an underfunded pension plan. The defined-benefit pension plan was underfunded by $68.6 million at year-end. The company reported multiple pending class actions and regulatory inquiries; it said it could not estimate potential losses for many matters, while not expecting them to materially adversely affect overall financial condition or liquidity. Outcomes or business-practice changes could nevertheless affect results.
No specific earnings or revenue guidance was provided. Management expected to continue quarterly dividends at or above the current level, subject to board discretion and legal and capital constraints. On February 5, 2014, the company agreed to acquire a mortgage-industry loan analytics and review business for $155 million, expected to close by March 31, 2014; it planned to draw $150 million on its credit facility to fund the transaction.
Most important facts for investors to verify
- Whether the $148.5 million prior-year reserve strengthening, including lender, commercial and Canadian guaranteed-valuation claims, proves adequate as claims develop.
- Whether falling refinance volumes and the changed transaction mix affect title revenue, staffing costs and margins in subsequent periods.
- The development of foreclosure-related lender claims and the estimated ultimate losses for older policy years.
- The status and potential financial or operational effects of pending litigation, regulatory examinations and investigations.
- Completion, financing and subsequent performance of the announced $155 million acquisition, and the company’s liquidity and capital allocation after closing.