First American Financial Corporation — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; unaudited. Comparisons are with Q1 2019 unless noted. The company provides title insurance and settlement services, specialty insurance, and related financial and information services.
Key financial results
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Revenue | $1.413 billion | $1.304 billion | Up 8.4% |
| Income before taxes | $72.3 million | $141.7 million | Down 48.9% |
| Net income attributable to company | $63.2 million | $109.6 million | Down 42.3% |
| Diluted earnings per share | $0.55 | $0.97 | Down $0.42 |
| Operating cash flow | $24.2 million | $34.5 million | Down $10.3 million |
| Cash and cash equivalents, March 31 | $1.050 billion | $1.337 billion | Down from year-end cash of $1.486 billion |
Consolidated pretax margin was approximately 5.1%, versus 10.9% in Q1 2019. The effective tax rate fell to 11.7% from 22.5%, reflecting foreign tax law and share-based compensation benefits.
Revenue growth reflected higher direct premiums and escrow fees (+20.7%), agent premiums (+19.6%) and information and other revenue. These gains were partly offset by net realized investment losses of $64.8 million, compared with gains of $32.7 million in the prior-year quarter. The losses were primarily driven by equity-security fair-value declines; the company reported $82.5 million of realized and unrealized equity-security losses.
Title Insurance and Services pretax income declined to $73.0 million from $142.0 million, with margins of 5.6% versus 12.1%. Specialty Insurance pretax income was $12.9 million versus $17.8 million, with margins of 10.5% versus 14.6%. Investment losses, higher operating costs and a higher title loss provision weighed on profitability.
Balance sheet, liquidity and capital
- Total assets were $11.68 billion at March 31, 2020, versus $11.52 billion at December 31, 2019. Total equity was $4.37 billion, versus $4.43 billion.
- Notes and contracts payable were $847.2 million; secured financings payable were $441.7 million; operating lease liabilities were $324.8 million. Debt-to-capitalization was 22.8%, up from 18.5% at year-end.
- The company had a $700 million unsecured revolving credit facility, with $280 million outstanding and $420 million available; outstanding borrowings carried a 2.49% rate. It was in compliance with financial covenants at quarter-end.
- Management said cash, liquid assets, operating cash generation and credit availability were expected to meet anticipated requirements for at least 12 months, taking pandemic-related effects into account. Holding-company liquidity included $92.9 million of cash and $420 million available on the revolver.
- Cash used in investing activities was $692.8 million, including $386.2 million net cash used for acquisitions. Financing activities provided $244.6 million. Cash declined by $436.0 million during the quarter.
- The company paid $49.7 million in cash dividends and repurchased 1.7 million shares for $65.8 million. The declared quarterly dividend was $0.44 per share.
Material changes and unusual items
- First-quarter acquisition spending totaled $391.9 million. A mortgage-industry document, eClose and fulfillment technology company was acquired for $350 million; the purchase was funded with cash and $120 million of additional credit-facility borrowing. Preliminary acquisition accounting added goodwill and intangible assets.
- Goodwill increased to $1.38 billion from $1.15 billion at year-end, primarily from acquisitions. Goodwill and other intangible assets totaled about $1.6 billion.
- Investment-market volatility produced substantial fair-value effects. The company recorded a $7.5 million credit-loss allowance on debt securities, while describing the bulk of unrealized debt-security losses as noncredit-related and stating it did not expect to be forced to sell those securities before recovery.
- Title loss provision rose to 5.0% of title premiums and escrow fees from 4.0%. The company raised its calendar-year loss-rate assumption in response to economic deterioration; prior-year reserve estimates increased by $5.5 million. Incurred title claims were 6.2% lower year over year in Q1, but management cautioned that claims can rise as economic conditions weaken.
- Operating cash flow was affected by claims paid, receivables and lower accounts payable and accrued liabilities. The filing reports $108.5 million of claims paid, net of recoveries, in Q1.
Outlook, management commentary and risks
- Management expected the pandemic to affect future periods more than Q1, as significant disruption occurred late in the quarter and the company was still processing previously opened orders.
- For the first three weeks of April, opened residential purchase orders were down 43.4% year over year, and commercial revenue was down 44.1%. Management expected a 45% year-over-year decline in opened residential purchase orders in Q2, with gradual improvement in the second half; it expected refinance orders to remain elevated during 2020.
- Management expected Q2 commercial revenue to decline 50% year over year, with gradual improvement thereafter. It expected title and settlement-services investment income of $40–$45 million per quarter and a significant Q2 decline in investment income overall following the March federal-funds-rate cuts.
- The company said it expected to continue quarterly dividends at or above the current level, but future declarations remain at the board’s discretion. It would consider terming out revolver borrowings if debt-market conditions were favorable.
- Key risks include pandemic duration and economic effects, real-estate and mortgage-market activity, investment and interest-rate volatility, title-claims uncertainty, regulatory and litigation exposure, cyber and data-security risks, and possible goodwill or intangible-asset impairment.
- Putative class actions and regulatory inquiries relating to title-business practices and the 2019 information-security incident remained unresolved; the company could not estimate possible losses for the specified class actions. The company also disclosed a $13.8 million Canadian excise-tax assessment under appeal and recorded no liability, stating it believed a loss was not probable.
- The company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether purchase and commercial order declines, refinance strength and management’s Q2 and second-half expectations track actual results.
- How investment losses, lower interest income and market volatility affect earnings, statutory capital and liquidity.
- Whether the increased title loss-rate assumption proves adequate as claims develop and economic conditions change.
- Acquisition integration, final purchase-price allocations, related borrowing and the performance of the acquired technology business.
- Developments in cybersecurity-related litigation and investigations, other title-industry proceedings, and the Canadian tax appeal.
- Available holding-company liquidity, debt levels, covenant compliance and the sustainability of dividends and repurchases under stressed conditions.