First American Financial Corporation — Q2 2021 Form 10-Q
Business context and period: Unaudited results for the three and six months ended June 30, 2021. The company provides title insurance and real estate-related services, specialty insurance, and related financial services. Comparisons are with the corresponding 2020 periods.
Financial performance and position
- Q2 revenue: $2.266 billion, up 40.9% year over year. Growth was led by agent premiums (+51.3%) and direct premiums and escrow fees (+40.7%).
- Q2 earnings: Income before taxes was $399.4 million versus $225.3 million; net income attributable to the company was $302.3 million versus $170.7 million. Diluted EPS was $2.72 versus $1.52. Consolidated pretax margin was approximately 17.6%, compared with 14.0%.
- First-half results: Revenue was $4.292 billion versus $3.022 billion; net income attributable to the company was $535.9 million versus $233.9 million. Diluted EPS was $4.81 versus $2.06.
- Segment performance: Title Insurance and Services Q2 revenue was $2.108 billion and pretax income was $402.4 million, up 44.1% and 69.2%, respectively. Specialty Insurance revenue was $151.6 million and pretax income was $19.7 million, up 13.6% and 169.6%.
- Cash flow: First-half operating cash flow was $477.0 million versus $368.0 million. Investing activities used $1.532 billion; financing activities provided $1.999 billion. Cash and cash equivalents increased $947.2 million to $2.223 billion.
- Liquidity and debt: At June 30, cash and cash equivalents were $2.223 billion. Notes and contracts payable were $1.008 billion and secured financings payable were $611.0 million. The $700 million revolving credit facility was undrawn; management said liquidity was adequate for anticipated needs for at least 12 months. Debt-to-capitalization was 23.5%; adjusted debt-to-capitalization, excluding secured financings, was 16.0%.
- Capital returns: The company declared dividends of $0.46 per share for Q2 and paid $101.0 million in dividends in the first half. It repurchased 1.2 million shares for $64.8 million; $177.2 million remained under its $300 million authorization.
- Margins and claims: Title segment pretax margin was 19.1% for Q2 versus 16.3% a year earlier. Title loss provision was 4.0% of title premiums and escrow fees, down from 5.0%. Home warranty claims rates rose, reflecting higher severity and frequency; property and casualty claims rates declined.
Material changes and unusual items
- Real estate transaction volumes and higher average revenue per order drove strong title results. Domestic residential purchase and commercial activity strengthened, while refinance activity weakened in Q2.
- Net realized investment gains were $86.5 million in Q2 and $153.3 million in the first half, versus $69.3 million and $4.5 million in 2020. Q2 included a $43.7 million unrealized gain from an observable price change in a private-company investment. These investment marks can make earnings volatile.
- The specialty segment’s Q2 investment gains included a $12.2 million gain from selling property and casualty agency operations. The company is exiting its property and casualty insurance business; policies in force had declined approximately 22% by June 30, and management expected a roughly 70% reduction by year-end 2021. Transfers are expected to be completed by the end of Q3 2022, with revenues expected to decline over time.
- Management described potential gains of approximately $237 million related to Offerpad, $55 million from another expected transaction, and about $80 million from other venture investments. These depend on transactions closing at expected valuations and timelines and are not assured.
- First-half other comprehensive loss was $51.4 million, principally reflecting unrealized losses on debt securities; accumulated other comprehensive income turned to a loss of $11.8 million at June 30.
Outlook, risks, and contingencies
- Management expected quarterly dividends to continue at or above the current level, subject to board discretion and business, legal, and capital requirements. No specific earnings or revenue guidance was provided.
- Results are exposed to real estate and mortgage cycles, interest rates, home prices, transaction mix, claims experience, and regulatory or competitive changes. Management noted the seasonal pattern of stronger spring and summer real estate activity.
- The title claims reserve was $1.243 billion, including $1.082 billion for incurred-but-not-reported claims. Management stated that a 50-basis-point change in expected loss rates for the six most recent policy years could change the IBNR reserve by approximately $140.9 million.
- The $351.3 million non-marketable equity portfolio is concentrated in illiquid, high-risk private venture-stage investments. Offerpad’s expected public listing could cause material earnings fluctuations; future gains or losses and the ability to monetize holdings are uncertain.
- Litigation and regulatory matters include class actions and investigations related to title practices and the 2019 data incident. The company stated it could not assess the probability or estimate possible losses for certain cases. It settled with the SEC in June 2021, agreeing to a $487,616 civil penalty and a cease-and-desist order concerning disclosure controls. A separate Canadian excise-tax assessment of $16.4 million is being appealed; no liability was recorded.
- Other notable risks include cybersecurity and funds-transfer fraud, changes in title insurance regulation and rates, investment and interest-rate risk, LIBOR transition, and limits on subsidiary distributions to the holding company. The filing reported effective disclosure controls at quarter-end and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much of reported earnings growth came from real estate operating activity versus volatile investment gains, and whether potential venture-investment gains ultimately close and are monetized.
- Whether purchase and commercial activity can offset weakening refinance volumes, and how transaction mix and staffing costs affect title margins.
- Future title and specialty claims experience, including the adequacy of the $1.243 billion claims reserve and the stated IBNR sensitivity.
- Progress and financial effects of the property and casualty business exit, including policy transfers and expected revenue decline.
- Developments in cybersecurity-related litigation and investigations, the Canadian tax appeal, and other regulatory inquiries.
- Liquidity and capital allocation, including the availability of subsidiary distributions, ongoing dividends and buybacks, and the composition of reported cash given customer escrow balances.