First American Financial Corporation — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; unaudited. First American provides title insurance and real-estate-related services, as well as property and casualty insurance and home warranties. Comparisons are with Q1 2015 unless otherwise noted. Dollar amounts below are in millions, except per-share data.
Financial performance
| Metric | Q1 2016 | Q1 2015 / comparison |
|---|---|---|
| Revenue | $1,201.7 | $1,111.1; up 8.2% |
| Income before taxes | $75.6 | $58.9; up 28.2% |
| Net income attributable to First American | $52.5 | $37.6; up 39.5% |
| Diluted earnings per share | $0.47 | $0.34 |
| Cash dividends declared per share | $0.26 | $0.25 |
| Cash used for operating activities | $56.4 | $66.3 |
| Cash and cash equivalents at quarter-end | $975.9 | $1,027.3 at Dec. 31, 2015 |
| Notes and contracts payable | $580.5 | $581.1 at Dec. 31, 2015 |
Consolidated pretax margin was approximately 6.3%, compared with 5.3% in Q1 2015. Title Insurance and Services revenue was $1,098.5, up 7.7%, and pretax income was $87.7, up 26.1%; its pretax margin rose to 8.0% from 6.8%. Specialty Insurance revenue was $103.0, up 9.0%, but pretax income fell 28.7% to $12.2 and its margin declined to 11.9% from 18.2%.
Title-segment growth was led by agent premiums, up 18.3% to $512.2. Direct premiums and escrow fees decreased 1.8% to $404.0 as lower order volumes offset higher average revenue per closed order. Specialty Insurance premiums increased, particularly in home warranty, but claim costs rose: home warranty claims were 53.1% of premiums versus 46.9%, and property and casualty claims were 67.8% versus 59.1%. The effective tax rate declined to 30.3% from 35.9%, including benefits from resolved tax examinations and tax credits.
Cash, debt and liquidity
Operating cash outflow improved year over year, though remained negative; claim payments, net of recoveries, were $114.0 versus $135.7. Cash decreased $51.4 during the quarter. The company reported $700.0 of undrawn revolving credit capacity, no borrowings under the facility, and compliance with its financial covenants. The revolver terminates May 14, 2019. Notes and contracts payable were 16.9% of total capitalization, down from 17.5% at year-end 2015. Management said resources were sufficient for anticipated obligations for at least the next 12 months.
Cash balances should be considered alongside customer-related balances: the company reported $2.759 billion of deposits as liabilities and administered $7.0 billion of escrow deposits and $2.1 billion of like-kind exchange funds. Certain customer escrow and trust assets are off balance sheet; the company may be contingently liable for their disposition. The company also reported $7.4 million of maximum contingent guarantees of affiliate and third-party indebtedness, with no related liability recorded.
Changes, outlook and key risks
- Real-estate activity was mixed: MBA data cited by management showed Q1 mortgage originations up 3.6%, with purchase originations up 23.3% and refinancings down 12.2%. Company direct title orders opened per day declined 11.6%; refinance orders fell 17.1% and purchase orders 1.8%.
- Management reported that direct residential closings had returned to typical timeframes after initial delays related to the TILA-RESPA integrated disclosure rule (TRID). The rule’s longer-term effects remain uncertain.
- Title claims provision was 5.5% of title premiums and escrow fees, versus 6.6% a year earlier. The quarter included a $4.7 million net increase in prior-policy-year reserve estimates. The total claims reserve was $983.7 million.
- Other comprehensive income was $47.5 million, chiefly reflecting after-tax unrealized investment gains and favorable foreign currency translation; this raised stockholders’ equity to $2.843 billion from $2.759 billion at year-end.
- The investment portfolio was 91% fixed income; 95% was rated or classified as investment grade. Management identified interest-rate, credit and liquidity exposure. No material changes in market risk were reported.
- The defined-benefit pension plan was underfunded by $82.0 million at March 31. The filing estimates that a 50-basis-point change in expected loss rates for each of the six most recent title policy years could change IBNR reserves by $104.5 million.
- Legal and regulatory matters include title-rate, referral-practice, employment-classification and consumer-protection lawsuits, as well as regulatory examinations of pricing, competition, customer acquisition and agency relationships. For many cases the company could not estimate the likelihood or amount of loss; it said these matters were not expected to materially affect overall financial condition or liquidity, while acknowledging possible period-specific effects and potential business-practice changes.
- A Canadian tax authority position could result in an excise-tax assessment; the amount is unknown and not reasonably estimable. The company believes it is likely to prevail but says a loss is possible.
- Management expects to continue quarterly dividends at or above the current $0.26 per-share level, subject to board discretion. The $250 million repurchase authorization had $182.4 million remaining; 14,200 shares were repurchased in Q1 for approximately $0.45 million.
The filing gives no specific earnings or revenue guidance. Principal stated risks include real-estate and mortgage-market cyclicality, interest rates, title claims and agent conduct, regulation and litigation, investment losses, pension funding, cyber and funds-transfer fraud, and reliance on subsidiary distributions. Management reported effective disclosure controls and no material change in internal control over financial reporting. The 2015 comparative presentation includes immaterial reclassifications and revisions described in the filing.
Important facts for investors to verify
- Whether title order volumes, particularly refinance activity, stabilize and whether agent-premium growth is sustained.
- Whether the increased Specialty Insurance claims ratios persist and how they affect segment margins.
- How title-loss assumptions and the $983.7 million claims reserve develop; assess the disclosed reserve sensitivity.
- Updates on material lawsuits, regulatory examinations and the unquantified Canadian excise-tax exposure.
- Holding-company liquidity and access to subsidiary distributions, while accounting for customer deposits and other custodial balances.
- Investment portfolio performance, pension funding requirements, and any subsequent changes to dividends or repurchases.