First American Financial Corporation — FY 2015 Form 10-K
Business context and reporting period. This annual report covers the year ended December 31, 2015; quarterly figures below identify the fourth quarter. First American provides title insurance and real-estate transaction services, alongside property and casualty insurance and home warranties. Title insurance and services generated 92.5% of consolidated revenue.
Financial performance and liquidity
| Metric | 2015 | 2014 |
|---|---|---|
| Revenue | $5.175 billion | $4.678 billion |
| Income before income taxes | $432.8 million | $350.6 million |
| Net income attributable to First American | $288.1 million | $233.5 million |
| Diluted EPS | $2.62 | $2.15 |
| Cash provided by operating activities | $551.3 million | $360.6 million |
| Cash and cash equivalents at year-end | $1.027 billion | $1.190 billion |
| Notes and contracts payable at year-end | $585.1 million | $587.3 million |
Revenue increased 10.6%; attributable net income rose 23.4%. Fourth-quarter revenue was $1.357 billion versus $1.255 billion, and attributable net income was $81.6 million versus $80.5 million. Total assets were $8.254 billion and stockholders’ equity was $2.759 billion at year-end. Operating cash flow increased despite claim payments, net of recoveries, of $476.5 million. Cash declined $162.8 million during 2015, primarily amid investment purchases and capital spending.
The $700 million revolving credit facility was undrawn at year-end and matures in May 2019; the company reported compliance with its financial covenants. The parent company held $289.8 million in cash and reported $700 million available under the facility. Debt was 17.5% of total capitalization, versus 18.6% in 2014. The filing does not provide a current ratio or other conventional consolidated liquidity ratio.
Material changes and notable items
- Title insurance and services: Revenue was $4.788 billion, up 11.2%; pretax income was $490.0 million, up 31.3%, and the pretax margin increased to 10.2% from 8.7%. Higher commercial, residential purchase, and refinance activity contributed. Direct title orders closed rose 8.1% from 2014.
- Specialty insurance: Revenue was $393.8 million, up 6.8%, but pretax income fell 25.4% to $39.5 million and margin declined to 10.0% from 14.4%. Higher home-warranty claim costs and weather-related property and casualty losses contributed; the property and casualty loss ratio rose to 66.4% from 60.1%.
- Title loss provision was 6.6% of title premiums and escrow fees, versus 7.1% in 2014. The company changed its actuarial method to separately model large claims and increased prior-year reserves by a net $93.1 million. Title IBNR reserves were $844.4 million; the actuary’s reasonable range was $719.5 million to $922.0 million. A 50-basis-point change in loss assumptions for the six most recent policy years could change the reserve by about $103.2 million.
- Net realized investment losses were $6.5 million, compared with gains of $30.1 million in 2014. The 2015 results included a $10.9 million software impairment; corporate investment results also included a $4.0 million noncash deferred-compensation-related charge.
- Capital expenditures were $127.6 million, versus $99.4 million, with increased software, data, and title-plant spending, including work to comply with the TRID mortgage disclosure rule. Acquisitions totaled $32.3 million, down from $162.5 million in 2014.
- Cash dividends declared were $1.00 per share for 2015, versus $0.84 in 2014. The board declared a $0.26-per-share dividend in January 2016; future dividends remain subject to board discretion.
Outlook, risks, and contingencies
Management was optimistic that housing would strengthen in 2016, anticipated residential purchase growth, and expected commercial-market growth to moderate from 2015. Lower mortgage rates had lifted refinance orders in early 2016, but management cautioned that the elevated activity might not persist. Management expected the title loss provision rate to decline to 5%–6% in 2016, subject to actual claims experience.
Key risks include real-estate and mortgage-market cyclicality, interest-rate and credit conditions, concentrated lender relationships, regulated title-insurance pricing, and uncertain effects of CFPB rules, including TRID. The company said direct residential closings had returned to typical timeframes by late 2015 after initial delays; the full effect on agency closings and the broader mortgage market remained unclear. Other material exposures include reserve-estimation uncertainty, cyber and wire-transfer risks, investment-market risk, and an underfunded defined-benefit pension plan ($86.4 million underfunded at year-end).
The company disclosed class-action litigation and governmental examinations involving, among other matters, title rates, referral practices, fees, and agency relationships. It said it could not estimate loss probability or range for many cases, but did not expect the disclosed matters to materially adversely affect overall financial condition or liquidity. A possible Canadian excise-tax assessment was also unquantifiable; management believed it was reasonably likely to prevail but acknowledged a possible loss. Escrow deposits totaled $6.6 billion and like-kind exchange funds $2.8 billion; these customer funds are generally not company assets, but the company could be contingently liable for their disposition.
PwC issued an unqualified opinion on the financial statements and concluded internal control over financial reporting was effective as of December 31, 2015.
Important facts for investors to verify
- Whether title claims develop consistently with the assumptions underlying the $844.4 million IBNR reserve, particularly the revised treatment of large claims.
- Whether the forecast 2016 title loss provision rate of 5%–6% is achieved and whether specialty-insurance claim trends improve.
- How purchase and refinance volumes, commercial activity, and TRID implementation affect order closings, revenue, and margins.
- Developments in the unquantified litigation, regulatory investigations, and potential Canadian excise-tax matter.
- Liquidity and capital needs after dividends, capital expenditures, pension contributions, and any acquisitions; also monitor investment valuation and interest-rate sensitivity.