Stewart Information Services Corporation — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Financial statements are unaudited. Stewart provides title insurance and settlement-related services, with ancillary search and valuation operations.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Operating revenues | $485.2 million | $481.2 million | $919.4 million | $919.3 million |
| Total revenues, including investment income and gains/losses | $492.9 million | $485.5 million | $930.1 million | $928.5 million |
| Income before taxes and noncontrolling interests | $31.3 million | $33.1 million | $28.1 million | $39.0 million |
| Net income attributable to Stewart | $22.4 million | $18.6 million | $18.6 million | $22.7 million |
| Diluted EPS attributable to Stewart | $0.95 | $0.79 | $0.79 | $0.96 |
- Q2 consolidated pretax margin was approximately 6.4% of total revenues, versus 6.8% a year earlier. The title segment’s reported pretax margin was 7.9%, down from 8.4%.
- Q2 title-segment revenues rose to $479.1 million from $470.4 million, while pretax income declined to $37.7 million from $39.5 million. Ancillary services and corporate reported a $6.4 million pretax loss, versus a $6.3 million loss.
- For the first half, title-segment pretax income fell to $42.9 million from $51.7 million. Ancillary services and corporate’s pretax loss widened to $14.8 million from $12.7 million.
- Title loss provisions were 4.0% of title revenues in Q2 and 4.2% for the first half, compared with 5.2% and 5.1%, respectively, in 2017. The company cited lower loss experience and a $3.7 million favorable prior-year reserve development for the first half.
Cash flow, balance sheet and liquidity
- First-half cash from operations was $7.4 million, down from $16.5 million. Investing activities used $7.1 million, compared with $43.1 million; financing activities used $27.6 million, compared with $13.7 million. Cash declined $29.0 million to $121.1 million.
- At June 30, cash and investments totaled $818.1 million, including statutory reserves; management reported $322.2 million net of statutory reserves. Statutory reserves of approximately $482.4 million, plus $13.6 million of statutory cash, are not available for general use.
- Notes payable were $107.7 million; stockholders’ equity was $666.2 million. The line of credit balance was $98.9 million, with $23.6 million remaining available, net of an unused letter of credit. Debt-to-equity excluding Section 1031 notes was approximately 16.1%, below the company’s stated 20% internal limit.
- Estimated title losses were $475.5 million, including $406.9 million of IBNR reserves. The filing says ultimate claims may differ materially from current estimates.
- First-half common dividends were $0.60 per share, totaling approximately $14.1 million. The company repurchased about 16,600 shares for $0.7 million for tax withholding on vested awards.
Changes and management commentary
- Q2 operating revenues increased 0.8%, but pretax income fell 5.5%; Stewart-attributable net income increased 20.5%, aided in part by lower income tax expense. First-half operating revenues were essentially flat, while Stewart-attributable net income declined about 18%.
- Agency title revenues grew, but direct title revenues declined. Q2 direct revenues decreased 3%; closed orders fell 10%, including declines in purchase, refinance and commercial orders. Management attributed weakness particularly to refinancing and lower centralized title activity. Commercial direct revenues grew 8% in Q2.
- Higher commissions and acquisition-related employee costs weighed on results; lower title losses and other operating expenses partly offset those costs. Ancillary valuation-services revenue weakened.
- Management expects the 2018 title loss provisioning rate to range from 4.0% to 4.5%. It cited ongoing cost management, automation and systems consolidation efforts. The filing gives no broader earnings or revenue guidance.
Merger, risks and unusual items
- Stewart agreed to be acquired by Fidelity National Financial (FNF). The stated consideration is generally $25 cash plus 0.6425 FNF shares per Stewart share, with elections for $50 cash, 1.2850 FNF shares, or the mixed consideration, subject to proration and possible regulatory divestiture adjustments. Divestitures above $75 million in 2017 revenue could reduce value, up to a maximum $4.50 per share adjustment if divestitures reach $225 million in revenue.
- Closing was expected in Q1 or Q2 2019, subject to shareholder, antitrust and insurance regulatory approvals and other conditions. Stewart had received an FTC second request for information and was responding; it reported approvals from a majority of states where Form E filings were made.
- Q2 included $4.0 million of prior-policy-year reserve reductions, partly offset by $3.9 million of charges related to two ongoing escrow litigation matters, and $1.8 million of unrealized equity-security gains. The first half also included $2.3 million of strategic-alternatives advisory expenses in Q1.
- Reported effective tax rates were 20% for Q2 and 19% for the first half; excluding approximately $1.5 million of discrete tax benefits, management reported rates of 25% and 26%, respectively.
- Key risks include merger approval, delay or failure; possible transaction costs and a $33 million termination fee in specified circumstances; regulatory divestitures; fluctuation in FNF share value and consideration proration; real-estate and mortgage-market weakness; reserve uncertainty, litigation, and limits on access to regulated-subsidiary cash. Ordinary-course legal and regulatory matters were not expected by management to materially affect results.
Important facts for investors to verify
- Progress and conditions for the FNF transaction, including regulatory approvals, potential divestitures, proration and the final value and form of consideration.
- Whether title-loss experience supports the 4.0%–4.5% full-year provisioning expectation, and how escrow litigation and IBNR reserves develop.
- Operating trends in closed purchase and refinance orders, commercial business, and agency revenues and retention rates.
- Cash available to the parent and underwriters after statutory restrictions, along with operating cash generation, debt availability and claims-payment capacity.
- Effects of investment-market changes, currency movements, and the expected 2019 lease-accounting adoption, which management anticipated would materially increase reported assets and liabilities.