First American Financial Corporation — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; unaudited. Comparisons are with Q1 2017 unless otherwise stated. The company provides title insurance and related real-estate services, specialty insurance, and trust and banking services.
Financial results
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Revenue | $1,297.4 million | $1,317.0 million | Down 1.5% |
| Income before taxes | $93.1 million | $83.9 million | Up 11.0% |
| Net income attributable to company | $76.2 million | $58.3 million | Up 30.8% |
| Diluted EPS | $0.67 | $0.52 | Up $0.15 |
| Operating cash flow | $43.2 million | $6.1 million | Up $37.1 million |
Consolidated pretax margin was approximately 7.2%, versus 6.4% in Q1 2017. The effective tax rate declined to 18.2% from 30.8%, primarily reflecting the reduction in the federal corporate tax rate under the Tax Cuts and Jobs Act. Cash dividends declared were $0.38 per share, compared with $0.34.
Segments: Title Insurance and Services reported revenue of $1,185.5 million and pretax income of $102.4 million, with an 8.6% pretax margin (8.2% prior year). Specialty Insurance revenue was $113.4 million and pretax income $9.9 million, with an 8.7% margin (9.1% prior year). Corporate pretax loss improved to $19.2 million from $24.4 million.
Balance sheet, debt and liquidity
- At March 31, cash and cash equivalents were $1,176.6 million, down from $1,387.2 million at year-end 2017. Total assets were $9,546.8 million and total equity was $3,472.4 million.
- Notes and contracts payable were $731.5 million. The revolving facility had $160.0 million drawn at a 3.63% interest rate, with $540.0 million available; the facility matures May 14, 2019. The company reported compliance with its financial covenants.
- Operating cash flow was $43.2 million; investing activities used $288.7 million and financing activities provided $33.9 million. Cash declined by $210.6 million, mainly reflecting investment purchases, capital spending, acquisitions and dividends.
- Management said available resources were sufficient for anticipated operating needs and obligations for at least the next 12 months. Holding-company liquidity included $181.4 million of cash and the available revolving capacity.
Material changes and drivers
- Total revenue fell mainly because agent premiums declined $46.9 million (8.2%), reflecting weaker refinance activity. Direct premiums and escrow fees rose $16.9 million (3.2%): residential purchase and commercial activity improved, while refinance revenue declined.
- Direct title orders closed domestically fell 9.3%; refinance orders closed per day fell 17.4%, while purchase orders closed per day rose 1.2%. Higher average revenue per closed order helped offset lower volume.
- Net investment income increased $9.8 million, primarily due to higher short-term interest rates and greater interest income. Net realized investment losses widened to $5.7 million from $0.1 million, partly reflecting the required recognition of equity-security fair-value changes in earnings.
- The company adopted new equity-investment accounting on January 1, 2018, recording a $40.6 million after-tax cumulative adjustment to retained earnings. Adoption of the revenue-recognition standard had no material financial-statement impact. AOCI declined substantially, including a $46.8 million after-tax securities loss in Q1.
Outlook, risks and contingencies
- No specific earnings or revenue guidance was provided. Management expected tax reform to continue to benefit the effective tax rate; the effect of tax and regulatory changes on real-estate transaction and mortgage volumes remained uncertain. Management expected quarterly dividends to continue at or above the current level, subject to board discretion.
- Results are exposed to real-estate and mortgage activity, interest-rate movements, seasonal transaction patterns, investment-market and credit risks, and variation in claims experience. Management noted that rising rates and reduced mortgage financing availability can reduce residential real-estate activity.
- The company reported ongoing lawsuits, regulatory examinations and investigations, including matters involving title-industry pricing, competition, settlement services, customer acquisition and agency relationships. It said it did not believe these matters would have a material adverse effect overall, but acknowledged that outcomes could affect individual periods or lead to material business-practice changes. A potential Canadian excise-tax assessment could not be estimated.
- Escrow deposits were $7.7 billion and like-kind exchange funds were $2.5 billion at quarter-end; these customer funds are generally not company assets, but the company may be contingently liable for their disposition. Trust assets managed or held totaled $3.8 billion.
- Other stated risks include regulatory scrutiny and title-rate regulation, dependence on major lenders and agents, cybersecurity and funds-transfer fraud, technology and automation changes, and possible adverse claims-reserve development. The filing notes a 50-basis-point change in recent title-policy loss rates could change the IBNR reserve by approximately $119 million.
Important facts for investors to verify
- Whether purchase-market strength can offset continued weakness in refinance volumes and agent premiums.
- Whether the improved earnings trend persists after separating the lower tax rate and investment-related gains or losses from operating performance.
- Investment portfolio sensitivity to rates and credit: debt securities had $75.1 million of gross unrealized losses at quarter-end; management attributed these primarily to interest-rate changes and did not consider them other-than-temporary impairments.
- Claims-reserve estimates, particularly the long-duration title IBNR reserve, and developments in litigation, regulatory inquiries and the Canadian tax matter.
- Cash-flow sustainability, holding-company liquidity, revolver maturity and capacity, and the board’s future dividend decisions.