First American Financial Corp quarterly report, Q2 FY2015

First American Financial Corporation — Q2 2015 Form 10-Q

Reporting period: Three and six months ended June 30, 2015. Unaudited consolidated financial statements. The company’s principal business is title insurance and related real estate services, supplemented by specialty insurance, including home warranty and property and casualty coverage.

Financial performance

Metric	Q2 2015	Q2 2014	Six months 2015	Six months 2014
Revenue	$1.324 billion	$1.150 billion	$2.435 billion	$2.163 billion
Income before taxes	$141.6 million	$76.5 million	$200.6 million	$111.7 million
Net income attributable to company	$93.3 million	$50.6 million	$131.0 million	$72.3 million
Diluted EPS	$0.85	$0.47	$1.19	$0.67
Cash from operations	Not presented separately for quarter	Not presented separately for quarter	$166.9 million	$44.9 million

Q2 revenue rose 15.1%; pretax income rose 85.2%. Q2 pretax margin was 10.7%, versus 6.6% a year earlier.
Title Insurance and Services Q2 revenue increased 16.3% to $1.227 billion; pretax income increased to $154.7 million from $84.8 million, and margin expanded to 12.6% from 8.0%.
Specialty Insurance Q2 revenue grew 7.1% to $97.7 million, while pretax income edged down to $10.6 million from $11.0 million; margin was 10.8% versus 12.1%.
At June 30, cash and cash equivalents were $1.270 billion, investments $4.628 billion, notes and contracts payable $584.5 million, and total equity $2.659 billion. Debt was 18.0% of total capitalization, down from 18.6% at year-end 2014.
Operating cash flow improved year over year. Investing activities used $663.5 million, including $1.207 billion of security purchases and $61.8 million of capital expenditures; financing activities provided $579.2 million, including a $632.6 million increase in deposits. Cash rose $79.6 million to $1.270 billion.

Changes, outlook and notable items

Revenue and title earnings benefited from higher commercial, refinance and residential purchase activity. Direct title orders closed increased 15.1% in Q2; direct premiums and escrow fees increased 20.5%. Higher average revenue per order also contributed.
Title loss provision was 6.5% of title premiums and escrow fees in Q2, compared with 8.9% in Q2 2014. The prior-year quarter included a larger reserve increase for prior policy years. The current quarter included a $5.1 million net increase in prior-year reserve estimates.
Specialty Insurance claims costs rose; home warranty claims rates were affected by higher June temperatures and air-conditioning claims. Corporate results included a $4.0 million noncash charge in the first quarter related to deferred-compensation-plan investments. Six-month investment gains also included office-building sale gains, partly offset by a $6.6 million impairment of internally developed software.
Management said resources should cover anticipated operating requirements and obligations for at least 12 months. It expected quarterly dividends at or above the current level, but future declarations remain at the board’s discretion. The Q2 dividend was $0.25 per share. No specific earnings or revenue guidance was provided.
The company had no borrowings on its $700 million revolving credit facility at quarter-end. Holding-company liquidity included $238.5 million of cash and $700 million available under the facility. Insurance-subsidiary distributions are regulated; $512 million was available for the remainder of 2015 without prior regulatory approval.
The CFPB’s integrated mortgage disclosure rules were expected to take effect October 3, 2015. Management warned implementation could delay mortgage processing or reduce volumes, particularly initially, and said the company was preparing.

Risks and contingencies

Results are exposed to real estate transaction volumes, mortgage rates and credit availability, title pricing regulation, and changes in relationships with major lenders and government-sponsored enterprises.
Title claims reserves totaled $956.8 million at June 30, down from $1.012 billion at year-end, primarily reflecting settlement payments on large claims. Management noted that a 50-basis-point change in expected loss rates for the six most recent policy years could change IBNR reserves by approximately $101.1 million.
The company disclosed numerous lawsuits and regulatory examinations, many involving title rates, referral practices, fees, consumer protection, and employee classification. For many matters, loss probability or range could not be estimated. Management did not expect the proceedings to materially affect overall financial condition or liquidity, but acknowledged possible material effects in an individual period and potential business-practice changes.
A Canadian excise-tax matter could result in an assessment; the amount cannot currently be estimated. Management believes it is reasonably likely to prevail but stated a loss is possible.
Other significant risks include investment-market and interest-rate exposure, pension funding, cyber and systems disruptions, agent-related claims or defalcations, and dependence on subsidiaries for holding-company cash. The pension plan was underfunded by $98.3 million at June 30.

Important facts for investors to verify

Whether higher real estate transaction volumes and improved title margins persist, particularly as mortgage rates and market conditions change.
Subsequent development of title claims reserves, including the large-claim settlements and sensitivity of recent-year IBNR estimates.
Actual effects of the CFPB disclosure-rule implementation on closing volumes, processing times and costs.
Developments in material lawsuits, regulatory examinations and the Canadian excise-tax matter, including any assessments or changes in business practices.
Cash availability and liquidity quality: customer escrow and trust balances are substantial, and some are not company assets but may entail contingent obligations. Verify the distinction between these balances and unrestricted corporate liquidity.
Investment portfolio performance, pension contributions and the company’s ability to maintain dividends amid changing operating conditions.