First American Financial Corporation — Q1 2019 Form 10-Q
Business context and period. First American provides title insurance and real-estate transaction services, specialty insurance, and related financial services. This unaudited report covers the three months ended March 31, 2019; comparisons are with Q1 2018 unless stated otherwise. Amounts below are in U.S. dollars.
Key financial results
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Total revenue | $1.304 billion | $1.297 billion | +0.5% |
| Income before income taxes | $141.7 million | $93.1 million | +52.2% |
| Net income attributable to the company | $109.6 million | $76.2 million | +43.7% |
| Diluted earnings per share | $0.97 | $0.67 | Up $0.30 |
| Cash provided by operating activities | $34.5 million | $43.2 million | Down $8.7 million |
| Cash and cash equivalents, March 31 | $1.337 billion | $1.467 billion at Dec. 31, 2018 | Down $130.1 million |
- Revenue mix and earnings quality: Net investment income rose to $82.3 million from $42.8 million, while net realized investment gains were $32.7 million versus a $5.7 million loss. These investment items more than offset declines in core transaction-related revenue: direct premiums and escrow fees fell 5.5%, agent premiums fell 5.0%, and information and other revenue fell 8.4%.
- Expenses and margins: Total expenses were $1.162 billion versus $1.204 billion. The effective tax rate increased to 22.5% from 18.2%. Title Insurance and Services reported pretax income of $142.0 million and a 12.1% pretax margin, compared with $102.4 million and 8.6%. Specialty Insurance reported pretax income of $17.8 million and a 14.6% margin, compared with $9.9 million and 8.7%.
- Balance sheet and debt: Total assets were $11.160 billion and total equity was $3.881 billion at March 31. Notes and contracts payable were $731.0 million; secured financings payable were $127.6 million. The company reported a debt-to-capitalization ratio of 18.1%, compared with 17.8% at year-end 2018. The $160 million drawn on the revolving credit facility is included in the company’s financing disclosures; the filing reports $540 million of facility availability.
- Liquidity and cash flow: Investing activities used $290.6 million and financing activities provided $124.0 million. Cash declined by $130.1 million during the quarter. Management said operating cash generation, liquid assets, and revolving-credit availability were sufficient for anticipated requirements for at least twelve months. The holding company had $187.1 million of cash and $540 million available under its revolving facility.
- Investment portfolio: Debt and equity securities totaled $6.304 billion at fair value. Management reported that 97% of the portfolio was rated or classified as investment grade. Unrealized debt-security losses were attributed primarily to interest-rate changes and were considered temporary; the company said it did not expect or intend to sell the affected securities before recovery.
Material changes and management commentary
- Management attributed improved earnings mainly to increased investment income and investment gains, lower personnel and operating costs in title services, and a lower home-warranty claims rate. Core title activity weakened: direct operations’ domestic title orders opened per day fell 8.7%, and domestic orders closed fell 13.1%.
- Title Insurance and Services revenue declined 1.1%, but pretax income rose 38.7%; the segment benefited from higher investment income and gains as well as lower expenses. Specialty Insurance revenue rose 7.8% and pretax income rose 79.7%, with a lower home-warranty claims rate partly offset by a higher property-and-casualty claims rate.
- On January 1, 2019, the company adopted lease accounting guidance and recognized operating lease assets of $309.9 million and liabilities of $334.0 million. It recorded a $1.3 million cumulative-effect increase to opening retained earnings.
- The company declared and paid a quarterly dividend of $0.42 per share, up from $0.38 a year earlier. Management expected quarterly dividends to continue at or above the current level, subject to board discretion. The company repurchased 47,000 shares for $2.1 million; $161.6 million remained under its $250 million authorization.
Outlook, risks, and contingencies
- The filing provides no specific earnings or revenue forecast. Management emphasized that real-estate and mortgage activity is seasonal and cyclical; higher interest rates or reduced mortgage availability can weaken residential transactions. Future investment income may also be reduced by lower short-term rates or lower average balances.
- The $700 million revolving credit agreement was scheduled to terminate on May 14, 2019, with $160 million outstanding at March 31. Management anticipated a successor agreement before termination and said available holding-company liquidity could repay the balance if necessary. The company was in compliance with the facility’s financial covenants at quarter-end.
- Several putative class actions, principally concerning title-insurance and settlement practices, had not been certified. The company said it could not yet assess the probability or estimate a possible loss range; it did not believe the cases would materially adversely affect overall financial condition or liquidity, although an unfavorable outcome could affect results in a period.
- The company expected a Canadian excise-tax assessment of approximately $12.0 million to $12.8 million, plus interest, during the first half of 2019. It disputed the tax’s applicability, intended to appeal, considered it reasonably likely to prevail, and had recorded no liability because it did not consider a loss probable.
- Other material risk areas include real-estate market conditions, claims-reserve estimation, title-agent conduct, investment-market and interest-rate exposure, regulation and litigation, data privacy, cybersecurity, funds-transfer fraud, and industry technology disruption. Management estimated that a 50-basis-point change in loss rates for each of the six most recent title policy years could change the incurred-but-not-reported reserve by about $122.5 million.
Important facts for investors to verify
- How much of the earnings increase is sustainable operating improvement versus investment income and equity-security gains?
- Whether title-order volumes, residential purchase and refinance activity, and core premiums recover or weaken further.
- Progress and final terms of the successor revolving credit agreement, including refinancing of the $160 million outstanding balance.
- Developments in the Canadian tax assessment and the unresolved class-action and regulatory matters.
- Changes in title claims experience and reserve assumptions, including the potential sensitivity disclosed by management.
- Whether lease adoption, dividends, repurchases, and investment-portfolio changes alter liquidity or capital allocation.