First American Financial Corporation — FY 2011 Form 10-K
Reporting period: Fiscal year ended December 31, 2011. This is an annual report, not a standalone fourth-quarter filing. The company provides title insurance and related services, specialty insurance, and trust and banking services; title insurance and services generated 92.6% of consolidated revenue. Comparisons below are primarily with FY 2010.
Financial performance and position
- Revenue: $3.821 billion, down 2.2% from $3.907 billion. The decline reflected weaker real estate and mortgage activity; U.S. residential mortgage originations fell 19.7% during 2011, according to the cited MBA forecast.
- Profit: Pretax income was $130.3 million, down 38.6%. Net income was $78.6 million versus $129.0 million; net income attributable to the company was $78.3 million, or $0.73 diluted EPS, versus $127.8 million, or $1.20. The effective tax rate was 39.7%.
- Margins: Title insurance and services pretax margin fell to 4.5% from 6.4%; specialty insurance margin eased to 13.6% from 14.9%. Consolidated pretax margin was approximately 3.4%.
- Cash flow: Operating cash flow was $133.8 million, down from $155.5 million. Claims paid, net of recoveries, were $503.4 million. Cash and cash equivalents declined $310.4 million to $418.3 million, principally reflecting financing outflows including lower deposits, as well as investment and other cash uses. Cash capital expenditures were $69.8 million.
- Debt and liquidity: Notes and contracts payable totaled $300.0 million, including $200.0 million drawn on a $400.0 million revolving facility maturing June 2013; the company reported covenant compliance. Holding-company cash was $147.3 million, with $200.0 million of undrawn revolver capacity. Management said resources were sufficient for anticipated operating needs and obligations for at least 12 months. Regulated subsidiaries could provide up to $181.1 million in dividends, loans and advances in 2012, subject to restrictions.
- Balance sheet and reserves: Total assets were $5.370 billion and total equity was $2.035 billion. Claims reserves were $1.015 billion, down from $1.108 billion; IBNR reserves were $816.6 million. The principal title underwriter reported statutory surplus of $817.6 million.
- Investments and retirement obligations: Debt securities were $2.202 billion, with approximately 98% of fixed-income holdings rated or classified investment grade. The 8.9 million CoreLogic shares had a $167.6 million cost basis and $115.5 million fair value; the $52.1 million unrealized loss remained in accumulated other comprehensive loss. The defined-benefit pension plan was underfunded by $128.7 million.
Material changes versus FY 2010
- Direct domestic title orders closed fell to 917,500 from 1,079,000, while orders opened fell 14.6%. Title revenue declined 2.1%; segment pretax income fell 30.9%, largely reflecting higher claim provisions.
- Title policy-loss provisions rose to $270.7 million from $180.8 million. The provision rate increased to 9.5% from 6.2%, incorporating reserve strengthening for a Canadian guaranteed-valuation product, unfavorable prior-year development, and a Bank of America settlement.
- Specialty insurance revenue was nearly flat at $287.0 million; segment pretax income declined 8.3% to $39.1 million. Home warranty claims costs increased as a share of premiums, partly reflecting greater direct-to-consumer business.
- Expense actions reduced personnel and other operating expenses by 3.9% overall. The company reduced its domestic employee count by 6.3% and office footprint by 9.1%.
Outlook, commentary, risks and unusual items
- Management gave no specific FY 2012 revenue or earnings guidance in the provided filing text. It reported an expense-reduction program expected to generate approximately $40 million in annualized savings, with savings beginning to be realized in the third quarter of 2011. Staffing and costs would continue to be adjusted to order volumes.
- Management described mortgage credit as tight and economic conditions as uncertain. It noted that foreclosure-related revenue had declined amid scrutiny of foreclosure practices and could decline further; costs to defend insured title to foreclosed properties were also a risk.
- Claims estimates are a significant uncertainty: management said a 50-basis-point change in loss rates for each of the six most recent policy years would change IBNR reserves by approximately $120.4 million. Claims development remained exposed to housing prices, defaults, foreclosures, and older high-loss policy years.
- Unusual 2011 items included $45.3 million of reserve strengthening for the Canadian product and a $32.2 million total charge for settlement of Bank of America litigation. The settlement was court-approved and dismissed with prejudice. The filing also reported $34.2 million of unfavorable prior-policy-year development, primarily for 2007.
- Numerous class-action lawsuits and regulatory audits or investigations remained outstanding, including matters concerning title rates, referrals, competition, settlement practices and agency relationships. For many cases, the company said it could not estimate the likelihood or amount of loss; it did not believe the matters then known would materially harm overall financial condition or liquidity, but acknowledged possible material effects on results in a period of resolution or from required practice changes.
- Other key risks include dependence on real estate transactions and a small number of large lenders, title-rate regulation, reinsurance and agent-related exposures, investment and CoreLogic share-price risk, pension funding, goodwill impairment, cybersecurity and handling of escrow funds. The industrial bank began a multiyear wind-down in 2011 and stopped originating or purchasing new loans.
- The independent auditor issued an unqualified opinion on the consolidated financial statements and concluded internal control over financial reporting was effective as of year-end.
Important facts for investors to verify
- Whether title order volumes and real estate market activity improve, and whether planned cost savings are achieved without impairing service.
- Subsequent claims emergence, especially for 2005–2007 policies and the Canadian guaranteed-valuation product; assess the assumptions underlying the $816.6 million IBNR reserve.
- Whether specialty insurance claim ratios and segment margins stabilize.
- Liquidity and refinancing plans ahead of the June 2013 revolver maturity, including cash needs, debt covenants and regulatory limits on subsidiary distributions.
- Changes in CoreLogic’s share value and any impairment decision, as well as pension plan funding needs and investment performance.
- Developments in pending litigation, regulatory investigations, foreclosure practices and government-sponsored mortgage-enterprise reform.