First American Financial Corporation — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013. Financial statements are unaudited; amounts below are in millions except per-share data.
Business context and results
First American provides title insurance and related real-estate services, as well as home warranty and property-and-casualty insurance. Results are substantially exposed to real-estate transaction volumes, mortgage availability, and interest rates.
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Revenue | $1,301.0 | $1,208.4 | $3,736.2 | $3,265.0 |
| Income before tax | $107.0 | $155.9 | $225.9 | $319.7 |
| Net income attributable to company | $63.9 | $103.5 | $134.7 | $207.8 |
| Diluted EPS | $0.59 | $0.95 | $1.23 | $1.92 |
| Pre-tax margin | 8.2% | 12.9% | 6.0% | 9.8% |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $245.8 | $251.5 |
Material changes and financial position
- Q3 revenue increased 7.7%, while pre-tax income fell 31.3% and diluted EPS declined from $0.95 to $0.59. For the nine-month period, revenue rose 14.4%, but pre-tax income declined 29.4%.
- Real-estate activity shifted sharply: direct title operations closed 21.6% more residential resale orders per day but 33.5% fewer refinance orders per day year over year. Title orders opened per day fell 29.1%.
- The title segment reported Q3 revenue of $1,212.9 million and pre-tax income of $125.0 million, versus $1,100.3 million and $141.9 million a year earlier. Its pre-tax margin fell to 10.3% from 12.9%. Specialty Insurance revenue rose 5.8% to $86.1 million, while pre-tax income fell to $4.0 million from $8.1 million; its margin was 4.7% versus 10.0%.
- At September 30, cash and equivalents were $833.9 million, total assets $6.50 billion, and total equity $2.38 billion. Notes and contracts payable were $320.5 million, up from $229.8 million at year-end 2012; debt was 11.9% of total capitalization versus 8.9%.
- Operating cash flow for nine months was $245.8 million. Cash increased $206.6 million to $833.9 million after investing cash use of $331.6 million and financing cash provided of $294.8 million.
- The company issued $250 million of 4.30% senior unsecured notes due 2023. At quarter-end it had no borrowings under its $600 million revolving facility, which matures in 2016. Management said resources were sufficient for anticipated operational needs and obligations for at least 12 months.
- Cash dividends declared were $0.12 per share in Q3, compared with $0.08 a year earlier. The company repurchased 2.2 million shares for $47.1 million during the quarter; $82.9 million remained under its authorization.
Outlook, risks and unusual items
- Management attributed the reduced refinance activity to the sharp rise in interest rates beginning in May 2013. The company began reducing costs in refinance-related operations, including headcount and temporary labor; Q3 severance expense was $7.8 million.
- A second-quarter $89.0 million net increase in prior-year loss reserves drove the nine-month title loss provision rate to 9.8%, compared with 6.8% in 2012. The increase included $58.7 million for domestic lenders’ policies, primarily policy years 2004–2008, and $12.9 million for a Canadian guaranteed valuation product. Management expected elevated domestic lenders’ claims to continue through the rest of 2013 and for a period thereafter. Q3’s title loss rate was 5.8%, with no prior-year reserve adjustment.
- Specialty Insurance claim costs rose: Q3 home warranty claims were 65.7% of premiums versus 63.6%; property-and-casualty claims were 60.2% versus 55.0%. Management cited higher claim severity, including dwelling-fire, wildfire, and hailstorm losses.
- Q3 net realized investment losses were $7.0 million, compared with gains of $47.3 million a year earlier. The 2012 comparison included $15.0 million from selling CoreLogic shares. Nine-month 2013 net realized gains were $6.8 million, versus $61.5 million.
- Management expected quarterly dividends to continue at or above the current level, subject to board discretion and the company’s financial and capital needs. The filing gives no formal earnings or revenue guidance.
- Risks include real-estate and interest-rate volatility, title-claim reserve uncertainty, investment valuation and credit risks, regulatory scrutiny and rate regulation, class-action litigation, reliance on title agents and large lenders, pension funding, and operational or data-security disruptions. Several lawsuits and government examinations remain unresolved; loss estimates are often not practicable. Management did not expect the described lawsuits or investigations to materially harm overall financial condition or liquidity, but acknowledged possible effects on results or business practices.
Most important facts for investors to verify
- Whether title claims, especially domestic lenders’ policy claims, continue above expectations and require further reserve strengthening.
- Whether declining refinance activity is offset by purchase and commercial transactions, and how the resulting order mix affects revenue and margins.
- Whether cost reductions offset lower volumes, and whether specialty-insurance claim severity moderates.
- Investment-portfolio sensitivity to interest rates and credit conditions, including the downgraded non-agency mortgage-backed securities.
- Developments in material litigation and regulatory examinations, and the potential impact of any resulting business-practice changes.
- Parent-company liquidity and subsidiary dividend capacity; reported consolidated cash includes funds associated with banking and escrow operations and is not all necessarily freely available to the holding company.