First American Financial Corp quarterly report, Q2 FY2014

First American Financial Corporation — Q2 2014 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2014. Unaudited consolidated results. The company provides title insurance and related services, specialty insurance, and trust and banking services.

Key financial results

Amounts are in millions, except per-share data. Comparisons are with the corresponding 2013 period.

Metric	Q2 2014	Q2 2013	Six months 2014	Six months 2013
Revenue	$1,150.0	$1,288.5	$2,162.8	$2,435.2
Income before taxes	$76.5	$59.2	$111.7	$118.8
Net income attributable to company	$50.6	$34.7	$72.3	$70.9
Diluted EPS	$0.47	$0.31	$0.67	$0.64
Operating cash flow	Not stated for quarter	Not stated for quarter	$44.9	$158.4

• Q2 revenue declined 10.7%; pretax income rose 29.1% and company-attributable net income rose 45.9%. For the first half, revenue fell 11.2% and pretax income fell 6.0%, while attributable net income increased 2.1%.
• Q2 title insurance and services pretax margin was 8.0%, compared with 6.1%; specialty insurance margin was 12.1%, compared with 8.7%. First-half margins were 6.4% and 14.0%, respectively.
• Cash and cash equivalents were $1,041.3 million at June 30, up from $834.8 million at year-end. Total equity was $2,546.7 million. Notes and contracts payable were $454.7 million, versus $310.3 million at year-end; deposits were $1,962.7 million, largely associated with banking operations.
• Operating cash flow for the first half fell to $44.9 million from $158.4 million, including claim payments, net of recoveries, of $240.1 million. Cash increased $206.4 million overall, supported by financing inflows, including higher bank deposits and debt issuance.

Material changes and business drivers

• Lower mortgage activity—especially refinancing—drove the revenue decline. Company direct title operations closed 33.3% fewer orders in Q2; domestic refinance orders closed per day fell 57.5%, while residential purchase orders closed per day declined 3.5%.
• Title insurance and services revenue fell 12.4% in Q2. Higher average revenue per direct order, reflecting a shift toward purchase and commercial transactions, partly offset lower order volume. Segment pretax income nevertheless improved, mainly as the prior-year quarter included substantially greater loss-reserve strengthening.
• Specialty insurance revenue increased 8.5% in Q2, primarily from home warranty renewals and growth in property and casualty policies. Home warranty claims rates improved, while property and casualty claims rates rose; Q2 results included California wildfire losses.
• The company acquired a mortgage-industry loan analytics and review business for $155.0 million and completed three other acquisitions for $10.9 million during the first half. Total acquisition consideration was $165.9 million; goodwill increased by $147.2 million, primarily from acquisitions.

Outlook, risks and unusual items

• Management said resources should be sufficient for anticipated operating requirements and obligations for at least 12 months. It did not provide specific earnings or revenue guidance. Management expected quarterly cash dividends at or above the Q2 level, subject to board discretion.
• The board doubled the quarterly dividend to $0.24 per share, effective with the June 2014 dividend. The $250 million share-repurchase authorization had $182.9 million remaining at quarter-end; no shares were repurchased in the first half.
• The May 2014 amended credit agreement provides a $700 million unsecured revolving facility through May 14, 2019. At June 30, $150 million was drawn at 1.90%, leaving $550 million available; the company reported compliance with financial covenants. The holding company reported $207.3 million cash and access to the facility.
• Title loss reserves totaled $1,013.2 million. Q2 title-loss provision was 8.9% of title premiums and escrow fees, including a $25.1 million net increase in prior-year reserves, primarily for a large 2007 commercial claim net of anticipated recoveries. The comparable 2013 quarter included $89.0 million of prior-year strengthening.
• Management identified class-action litigation and regulatory examinations concerning, among other matters, title rates, competition, customer acquisition and agency relationships. Losses are not estimable for many matters; the company said proceedings could alter business practices and potentially affect results.
• First American Title Insurance Company redomesticated from California to Nebraska effective July 1, 2014. Management was assessing statutory effects and did not expect a material impact on holding-company liquidity or capital resources.
• The defined benefit pension plan was underfunded by $56.4 million at June 30. The company contributed $18.1 million in the first half and expected an additional $23.7 million contribution during the remainder of 2014.
• The filing reports a $4.3 million increase in Q2 other operating expenses to correct prior-period foreign-currency translation and transaction errors, which management considered immaterial. It also describes revisions to 2013 cash flow and year-end 2013 tax-related balance-sheet amounts.
• Risks include sensitivity to real estate and mortgage volumes and interest rates, claims-reserve estimation, investment and mortgage-backed securities losses, regulation and litigation, reliance on agents and large lenders, pension funding, cybersecurity and data protection, and acquisition integration. A 50-basis-point change in expected loss rates for the latest six title policy years could change IBNR reserves by approximately $105.2 million.

Most important facts for investors to verify

• Whether title order volumes and refinance activity stabilize, and how the shift in transaction mix affects revenue and margins.
• Actual recoveries and ultimate exposure on the large 2007 commercial claim, alongside changes in title-loss reserves and claims experience.
• Progress and financial returns from the $165.9 million of acquisitions, including purchase-price allocation and integration.
• Developments in title-industry lawsuits and regulatory inquiries, including any resulting changes to business practices or rate-setting.
• The effects of the Nebraska redomestication on the title insurer’s statutory capital, surplus and dividend capacity.
• Operating cash generation, use of the revolving facility, pension contributions, and the sustainability of dividends amid cyclical market conditions.