First American Financial Corporation — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; unaudited. First American provides title insurance and settlement services, property and casualty insurance, and home warranty products.
Financial performance
| Metric | Q1 2014 | Q1 2013 / comparison |
|---|---|---|
| Revenue | $1,012.8 million | $1,146.8 million; down 11.7% |
| Income before taxes | $35.3 million | $59.6 million |
| Net income attributable to First American | $21.7 million | $36.2 million |
| Diluted earnings per share | $0.20 | $0.33 |
| Operating cash flow | $(104.6) million | $(50.9) million |
| Cash and cash equivalents | $770.4 million at March 31 | $834.8 million at December 31, 2013 |
| Notes and contracts payable | $457.0 million | $310.3 million at December 31, 2013 |
| Title Insurance and Services pretax margin | 4.6% | 6.0% |
| Specialty Insurance pretax margin | 16.0% | 19.5% |
Operating cash outflow included $123.0 million of claim payments, net of recoveries. Investing cash outflow was $166.1 million, including $165.9 million for acquisitions; financing cash inflow was $206.2 million, including $150.0 million of new borrowings. Total cash decreased $64.4 million during the quarter.
At March 31, the company had $150.0 million drawn on its $600.0 million revolving facility, with $450.0 million available and a 2.16% interest rate. It reported compliance with facility covenants. The holding company had $243.0 million of cash and management said resources were sufficient for anticipated obligations for at least 12 months. Total assets were $6.63 billion and total equity was $2.46 billion.
Changes and drivers
- Lower refinance activity was the primary pressure on results. Domestic refinance orders closed per day fell 63.7%, and total domestic title orders opened per day fell 28.0% year over year. Residential purchase and commercial activity partly offset the decline.
- Title Insurance and Services revenue fell 12.9% to $925.3 million and pretax income fell 33.7% to $42.6 million. Direct title orders closed fell 38.2%, although average revenue per order increased 39.0% to $1,723, reflecting a shift toward higher-premium purchase and commercial transactions and higher property values.
- Specialty Insurance revenue rose 6.9% to $87.1 million, but pretax income declined 12.6% to $13.9 million. Property and casualty claims increased, which the company attributed mainly to more severe winter weather and higher claim frequency and severity.
- Title loss provision fell to 6.0% of title premiums and escrow fees from 8.7%. The prior-year rate included a $28.6 million reserve increase for older policy years; the current-quarter rate reflected the ultimate loss rate for the current policy year.
- Investment income and realized investment gains declined year over year. The company also recorded $0.5 million of credit-related impairment losses on non-agency mortgage-backed securities.
Outlook, risks and unusual items
- Management cited ongoing cost adjustments in response to weaker refinance volumes, including lower employee headcount and temporary labor; Q1 severance expense was $3.7 million.
- The board increased the quarterly dividend from $0.12 to $0.24 per share, effective with the June 2014 dividend. Management expected future quarterly dividends at or above that level, subject to board discretion. The company also expanded its repurchase authorization from $150 million to $250 million; $182.9 million remained, and no shares were repurchased in Q1.
- Four acquisitions were completed for $165.9 million in aggregate, including a $155.0 million purchase of a mortgage-industry loan-quality analytics and review-services company. Purchase accounting remained preliminary. The company drew $150.0 million on its credit facility to help fund acquisitions.
- Key exposures include real estate and mortgage-market cycles, interest rates, investment and mortgage-backed-security losses, title-claim reserve estimates, pension funding, agent conduct, and regulatory scrutiny. The filing says a 50-basis-point change in expected loss rates for the six most recent title policy years could change IBNR reserves by approximately $105.4 million.
- The company disclosed pending class actions and government examinations involving, among other matters, title rates, competition, customer acquisition and retention, and agency relationships. It could not estimate loss or a loss range for many cases; it did not believe the matters would materially harm overall financial condition or liquidity, but acknowledged possible changes to business practices could have a material effect.
- Escrow deposits were $5.1 billion and like-kind exchange funds were $1.9 billion at quarter-end; much of these customer funds are not company assets, but the company may be contingently liable for their disposition or transfer. It also guaranteed $14.5 million of affiliate and third-party indebtedness without recording a liability.
- The filing reports an underfunded pension plan ($62.2 million at March 31) and expects an additional $32.3 million of pension and supplemental-plan contributions during the remainder of 2014. It also reports $53.5 million of liabilities for uncertain tax positions, before $32.6 million of potential offsetting tax benefits.
Important facts for investors to verify
- Whether purchase and commercial activity, order volumes, and the shift away from refinancing can offset continued weakness in refinance transactions.
- Whether the lower current-period title loss rate persists and how actual claims development changes the substantial IBNR reserve.
- Acquisition integration, final purchase-price allocations, acquired-business performance, and the resulting increase in debt and goodwill.
- Cash generation after claims, acquisitions, dividends, pension contributions, and other capital needs; confirm liquidity available to the holding company versus regulated subsidiaries.
- Developments in title-industry litigation and regulatory investigations, including any resulting fines, settlements, or business-practice changes.
- Investment-portfolio credit and interest-rate exposure, pension funding assumptions, and resolution of uncertain tax positions.