First American Financial Corporation — FY 2016 Form 10-K
Business context and reporting period. The filing covers the fiscal year ended December 31, 2016; it is an annual report, not a standalone fourth-quarter filing. First American provides title insurance and real-estate settlement, data and related services, alongside property and casualty insurance and home warranties. Title insurance and services generated 92.1% of consolidated revenue.
Financial performance and position
| Metric | 2016 | 2015 |
|---|---|---|
| Revenue | $5.576 billion | $5.175 billion |
| Income before taxes | $477.6 million | $432.8 million |
| Net income attributable to First American | $343.0 million | $288.1 million |
| Diluted EPS | $3.09 | $2.62 |
| Cash provided by operating activities | $489.4 million | $551.3 million |
| Cash and cash equivalents, year-end | $1.006 billion | $1.027 billion |
| Notes and contracts payable, year-end | $736.7 million | $581.1 million |
| Stockholders’ equity, year-end | $3.008 billion | $2.750 billion |
- Revenue rose 7.7%, income attributable to the company rose 19.1%, and diluted EPS increased 17.9%. The effective tax rate fell to 28.1% from 33.3%, contributing to earnings growth.
- Title insurance and services pretax income increased to $598.9 million from $490.0 million; its pretax margin improved to 11.7% from 10.2%. Specialty insurance pretax income was $40.1 million versus $39.5 million, while its margin declined to 9.2% from 10.0%.
- Operating cash flow decreased 11.2%, partly reflecting working-capital changes; claim payments, net of recoveries, were $463.0 million. Capital expenditures were $132.3 million.
- At year-end, $160 million was drawn on the $700 million revolving facility, leaving $540 million available; the company reported compliance with its financial covenants. Debt also included $300 million of 4.60% senior notes due 2024 and $250 million of 4.30% notes due 2023.
- The investment portfolio included $4.553 billion of debt securities and $404.1 million of equity securities. Management reported 94% of fixed-income investments as investment grade. The filing also reports $6.8 billion of customer escrow deposits, including amounts held at third-party institutions; these are not all company assets.
Material changes and unusual items
- Title direct premiums and escrow fees rose 3.9%; agent premiums rose 9.0%. Domestic title orders closed by direct operations increased 8.6% to 958,400. Commercial direct premiums and escrow fees declined 5.1%, while residential purchase and refinance activity increased.
- During 2016, the company completed title-segment acquisitions for an aggregate purchase price of $115.3 million.
- The company terminated its funded defined-benefit pension plans. It recorded $66.3 million of settlement costs in fourth-quarter 2016 and contributed an additional $84.8 million to the plans during 2016. It expected to contribute about $23 million more in the first half of 2017, recognize approximately $154 million of net unrealized losses in that half, and reduce annual personnel costs by about $22 million after termination is complete.
- Fourth-quarter revenue was $1.504 billion versus $1.357 billion a year earlier. Income before taxes was $81.5 million versus $116.8 million, reflecting in part the pension settlement charge; net income attributable to the company was $81.0 million versus $81.6 million.
- The company revised prior-period balance-sheet amounts after identifying title plant assets that should have been written off and other assets misclassified as title plants. The filing reports reductions to retained earnings, title plants and deferred tax liabilities, and an increase to other investments; investors should consult the stated revisions for period-specific amounts.
Outlook, risks and contingencies
- Management expected the purchase market to strengthen in 2017, but anticipated a modest decline in commercial activity. It reported that rising interest rates had reduced refinance activity: open refinance orders fell from a July 2016 peak of about 2,700 per day to about 1,200 per day in January 2017. The company said it would adjust costs to lower volumes.
- Key exposures include real-estate and mortgage-market cycles, interest rates, regulated title-insurance pricing, concentrated lender relationships, claims reserving, investment-market risk, cyberattacks and fraudulent fund transfers, and regulation of settlement practices.
- Title claims reserves totaled $1.026 billion at year-end, including $888.1 million of title incurred-but-not-reported reserves. The actuary’s reasonable IBNR range was $718.5 million to $938.3 million; management’s estimate was $888.1 million. A 50-basis-point change in loss rates for the six most recent policy years could change IBNR reserves by approximately $110.1 million.
- The filing describes class actions and regulatory inquiries concerning, among other matters, title rates, fees, business practices and agency relationships. For many cases, the company could not assess probable loss or estimate a loss range. It also disclosed a possible Canadian excise-tax assessment for which the amount was not estimable. Management did not expect the described matters to materially harm overall financial condition or liquidity, but noted possible effects on results or business practices.
- Management said available operating cash, liquid assets and revolving-credit availability were sufficient for anticipated needs for at least 12 months. Future dividends remain subject to board discretion and legal and regulatory restrictions; the 2016 declared dividend was $1.20 per share.
- The independent auditor issued an unqualified opinion and concluded internal control over financial reporting was effective as of December 31, 2016.
Important facts for investors to verify
- Whether refinance-volume declines and management’s purchase-market outlook translated into subsequent order volumes, revenue and staffing costs.
- Development of title claims, particularly large claims and the IBNR estimate relative to the disclosed actuarial range.
- Completion costs and timing of the pension-plan termination, including the expected 2017 contribution and approximately $154 million of expected losses.
- Debt, revolver usage, covenant headroom, and the availability of cash held in regulated subsidiaries versus cash at the parent company.
- Progress and potential financial or operational effects of the disclosed litigation, regulatory examinations and Canadian tax matter, as well as the implications of the prior-period financial statement revisions.