First American Financial Corporation — Q3 2010 Form 10-Q
Reporting period: Three and nine months ended September 30, 2010. Amounts below are in millions, except per-share data. The company became a separate public company on June 1, 2010; 2010 results include both pre- and post-separation periods, so comparisons with 2009 may not reflect stand-alone costs or financing.
Business context and financial performance
First American provides title insurance and related services, plus specialty insurance products including home warranty and property and casualty coverage. Its results remain closely tied to real estate and mortgage activity.
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Operating revenues | $976.7 | $1,069.6 | $2,805.6 | $2,941.8 |
| Total revenues, net of reported investment impairment items | $1,003.5 | $1,100.6 | $2,881.9 | $3,014.0 |
| Income before taxes | $56.0 | $68.5 | $137.5 | $143.2 |
| Net income attributable to the Company | $33.1 | $38.8 | $80.7 | $72.3 |
| Diluted earnings per share | $0.31 | $0.37 | $0.76 | $0.70 |
| Cash provided by operating activities | Not presented by quarter | $25.4 | $128.9 |
Q3 title insurance and services pre-tax margin was 6.5%, versus 6.8%; excluding net realized investment results and impairment losses, management reported an adjusted margin of 6.7%, versus 6.3%. Specialty Insurance pre-tax margin improved to 16.5% from 11.4%. The effective tax rate was 40.4% in Q3 and 40.9% for the nine-month period.
Liquidity, debt and balance sheet
- Cash and cash equivalents were $742.8 at September 30, up from $631.3 at December 31, 2009. Total assets were $5.686 billion and total equity was $1.942 billion.
- Operating cash flow for the first nine months fell to $25.4 from $128.9. Investing activities used $100.2; financing activities provided $186.4, including a $286.3 increase in demand deposits and $210.3 of debt issuance, partly offset by debt repayments and a $130.0 cash distribution to TFAC upon separation.
- Notes and contracts payable were $296.7, compared with $119.3 at year-end 2009; the company also had a $400 million revolving credit facility, with $200 million borrowed at September 30 at a 3.06% rate. The facility matures June 1, 2013.
- Demand deposits, $1.440 billion, are liabilities associated largely with customer and bank deposits; they should not be treated as unrestricted cash. The company said its resources were sufficient for anticipated operational cash needs for at least 12 months and expected annual cash dividends of approximately $25 million.
Material changes and management commentary
- US mortgage origination volume declined 22.1% in Q3 year over year, according to the cited Mortgage Bankers Association forecast; purchase originations fell 47.5%. Title revenues excluding investment gains and impairment losses declined 9.4%.
- Direct title orders closed declined 13.0% in Q3 and 23.9% year to date. Higher average revenue per order, market-share gains, commercial activity and filed rate increases partly offset lower volumes.
- Management attributed lower expenses to cost containment and operating efficiencies. It expected weak economic conditions and tight mortgage credit to continue affecting demand and said it would continue cost-control measures, including workforce reductions and efficiency improvements.
- Title claims provision included $15.5 million for worse-than-estimated experience in prior policy years, principally 2006 and 2007; a $4.2 million benefit from lowering the expected ultimate loss rate for 2010 partly offset this. Total loss reserves were $1.133 billion, down from $1.228 billion at year-end.
- Foreclosure suspensions and potential lender process deficiencies could reduce foreclosure-related revenue and create defense costs. Management said the effects were uncertain and did not then expect a material adverse effect.
- The separation increased certain stand-alone corporate expenses. The company also held 12.9 million CoreLogic shares, valued at $247.8 million at quarter-end, subject to contractual disposal provisions.
Risks, contingencies and unusual items
- Investment impairments recognized in earnings were $2.7 million for Q3 and $7.2 million for the nine months. Almost all of the $68.7 million amortized cost of non-agency mortgage-backed and asset-backed securities was rated below investment grade; five securities with $31.0 million amortized cost were on negative credit watch.
- The company disclosed a Bank of America lawsuit alleging mishandling of certain title-policy claims. It said the outcome could materially affect results in the period of disposition, although the amount of exposure was not clear in the filing.
- Regulatory audits and investigations include title insurance pricing, competition, customer acquisition and retention, and agency relationships. Management did not expect these matters, individually or collectively, to have a material adverse effect, but noted that business-practice changes could have material effects.
- The defined-benefit pension plan was underfunded by approximately $89.6 million. The company contributed $20.7 million during the first nine months and expected to contribute another $7.3 million in 2010.
- Other risks include real estate weakness, mortgage-credit constraints, title claims reserve uncertainty, investment and interest-rate exposure, customer concentration, regulation of title rates, and the potential for goodwill impairment. Goodwill and other intangible assets totaled approximately $0.9 billion.
Key facts for investors to verify
- Whether title order volumes, mortgage activity and the mix of purchase, refinance and commercial transactions improve or deteriorate.
- Whether title loss development—especially for recent policy years—and foreclosure-related claims alter reserve needs or costs.
- How operating cash flow develops relative to earnings, capital spending, dividends and debt service.
- The performance and disposition timing of the CoreLogic shareholding, and any further impairment in the investment portfolio.
- Updates on the Bank of America litigation, regulatory inquiries, pension funding and the company’s ability to sustain its expected dividend.