First American Financial Corp quarterly report, Q3 FY2012

First American Financial Corporation — Q3 2012 Form 10-Q

Reporting period: Three and nine months ended September 30, 2012. First American provides title insurance and related real-estate services, as well as home warranty and property and casualty insurance. Amounts below are in millions unless stated otherwise.

Financial performance

Metric	Q3 2012	Q3 2011	Nine months 2012	Nine months 2011
Revenue	$1,208.4	$965.0	$3,265.0	$2,824.0
Income before taxes	$155.9	$38.4	$319.7	$64.2
Net income attributable to First American	$103.5	$21.0	$207.8	$38.0
Diluted earnings per share	$0.95	$0.20	$1.92	$0.36

Revenue increased 25.2% in Q3 and 15.6% for the first nine months year over year. Improved mortgage activity drove higher title volumes. Direct title operations opened 438,500 orders in Q3, up 27.3%; orders closed were up 34.9%.
Title Insurance and Services reported Q3 revenue of $1,100.3 and pretax income of $141.9, versus $898.3 and $52.8 a year earlier. Its pretax margin rose to 12.9% from 5.9%. For nine months, revenue was $3,003.5 and pretax income $321.2, versus $2,618.1 and $97.8.
Specialty Insurance Q3 revenue was $81.4 and pretax income $8.1, versus $74.3 and $6.8. Its pretax margin was 10.0%, compared with 9.2%. Nine-month pretax income increased to $34.2 from $29.7.
Q3 and nine-month results benefited from $40.4 of gains on the sale of the company’s remaining CoreLogic shares. The 8.9 million shares sold generated $207.9 cash proceeds; First American held no CoreLogic shares at quarter-end.
Title claim provisions were $59.7 in Q3 and $166.7 for nine months, down from $69.5 and $206.2. As a percentage of title premiums and escrow fees, provisions fell to 6.6% and 6.8%, respectively, from 9.6% and 9.8%.

Cash flow, liquidity and capital

Nine-month operating cash flow was $251.5, versus $35.7 in 2011, after claim payments net of recoveries of $338.9 and $354.2, respectively. Investing activities used $199.1; financing activities provided $273.0.
Cash and cash equivalents were $745.4 at September 30, versus $418.3 at December 31, 2011. Total assets were $5,999.3 and total equity was $2,285.8.
Notes and contracts payable were $272.5, down from $300.0 at year-end. The company had $200.0 outstanding on its $600.0 revolving facility, leaving $400.0 available; the stated borrowing rate was 2.22%. It reported compliance with financial covenants. Notes and contracts payable were 10.7% of total capitalization, versus 12.8% at year-end.
Management said available resources were sufficient for anticipated operating needs and obligations for at least 12 months. The holding company reported $231.1 cash and access to the $400.0 undrawn facility. Insurance subsidiaries’ regulated 2012 dividend, loan and advance capacity was $183.0.
The board declared a Q4 dividend of $0.12 per share in October, a 50% increase from $0.08. The existing $150.0 share-repurchase authorization had $147.5 remaining; no shares were repurchased in the first nine months.

Changes, outlook and risks

Management attributed the stronger quarter mainly to historically low interest rates, gradual economic improvement and increased mortgage-credit availability. The MBA forecast cited in the filing showed U.S. mortgage originations up 33.3% year over year in Q3, with refinancing up 51.7% and purchase originations down 0.9%.
Lower title loss provisions partly reflected less prior-year reserve strengthening than in 2011. However, Canada’s guaranteed valuation product generated unfavorable reserve development of approximately $8.0 in Q3 and $12.6 for nine months; management noted substantial uncertainty in ultimate losses because foreclosure experience is hard to predict and historical data is limited.
Specialty Insurance claims costs rose in Q3, including a higher property and casualty claims ratio attributed primarily to more large claims.
The investment portfolio totaled $2,456.3 in debt securities and $177.7 in equity securities. About 99% of fixed-income investments were rated or classified as investment grade, but all nine non-agency mortgage-backed securities had been downgraded below investment grade. These securities had $28.8 fair value and Level 3 valuation inputs. The filing reports $3.6 of credit-related OTTI losses for the first nine months and says further impairment losses remain possible.
The pension plan was underfunded by approximately $122.0 at September 30. First American contributed $30.2 during the first nine months and expected another $4.1 contribution in 2012.
Numerous class-action lawsuits and regulatory examinations remain pending, including matters involving title rates, referral practices, competition, and settlement services. The company often could not estimate the probability or range of loss; it did not believe the matters would materially harm overall financial condition or liquidity, but acknowledged possible material effects on results in a period or from changes to business practices.
Key stated risks include real-estate and mortgage-market cyclicality, interest rates, regulatory scrutiny and title-rate controls, lender concentration, investment and reserve estimates, title-agent conduct, pension funding, and operational, cyber and wire-transfer disruptions. The filing provided no specific earnings or revenue guidance.

Important facts for investors to verify

How much of the earnings improvement persists after excluding the $40.4 CoreLogic-share sale gain and other realized investment gains.
Whether elevated mortgage-refinance volumes and title-order growth continue, and how lower revenue per direct order affects margins.
Future development in title-loss reserves, especially the Canadian guaranteed valuation product, and whether claim trends in Specialty Insurance persist.
Progress and potential exposure from pending lawsuits and regulatory investigations, for which losses are frequently not estimable.
Investment portfolio credit quality and valuation assumptions, pension funding needs, and continued compliance with credit-facility covenants and liquidity requirements.