First American Financial Corporation — Q3 2017 Form 10-Q
Business context and reporting period
Unaudited results cover the three and nine months ended September 30, 2017; comparisons are with the same 2016 periods. The company operates title insurance and services, specialty insurance, and corporate functions. Results are sensitive to real estate and mortgage activity, especially refinancing.
Financial performance and liquidity
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $1,519.6M | $1,508.3M | $4,291.0M | $4,071.6M |
| Income before tax | $18.0M | $166.9M | $286.0M | $396.1M |
| Net income attributable to company | $21.4M | $107.3M | $201.9M | $262.0M |
| Diluted EPS | $0.19 | $0.96 | $1.80 | $2.36 |
Q3 consolidated pretax margin was approximately 1.2%, versus 11.1% a year earlier, largely reflecting a $152.4M pension settlement charge. Title Insurance and Services pretax margin was 13.0% (13.5% prior year); Specialty Insurance margin was 5.2% (1.6%). The nine-month effective tax rate was 29.7%, compared with 33.7%; Q3’s rate was -17.9%, reflecting tax benefits and reserve releases.
- Operating cash flow for the first nine months was $455.5M, up from $252.2M; capital expenditures were $103.1M. Cash and cash equivalents were $1,141.9M at September 30, up from $1,006.1M at year-end 2016.
- Notes and contracts payable were $734.1M, versus $736.7M at year-end; $160.0M was drawn on the $700M revolving facility, with $540M available. Holding-company cash was $259.3M. The company reported compliance with credit-facility financial covenants.
- Stockholders’ equity was $3,293.9M, up from $3,008.2M. The quarterly dividend rose 12%, to $0.38 per share; $117.2M of dividends were paid in the first nine months. No shares were repurchased during that period.
Material changes versus prior period
- Revenue rose 0.7% in Q3 and 5.4% for the first nine months, but attributable net income fell 80.1% and 22.9%, respectively, primarily due to the pension settlement.
- Mortgage originations nationally were down 16.0% in Q3 year over year, according to the cited MBA forecast: purchase originations rose 7.4%, while refinancings fell 42.6%. Company direct title orders closed declined 20.2% in Q3; refinance orders closed per day fell 42.5%, while purchase orders rose 4.8%.
- Title Insurance and Services revenue was nearly flat in Q3 but increased 5.0% for nine months. Specialty Insurance revenue increased 7.9% and 8.4%, respectively, with improved reported pretax results.
- Net investment income increased 30.8% in Q3, primarily from higher short-term rates and higher average investment balances. Q3 net realized investment losses were $7.0M, including a $6.6M loss associated with acquiring the remaining ownership of an affiliate.
Outlook, commentary, risks and unusual items
- Management said cash flows, liquid assets, and revolving-credit availability should meet anticipated needs for at least 12 months. It expected quarterly dividends at or above the then-current level, subject to board discretion; no formal earnings guidance was provided.
- The company completed the transfer of its remaining pension obligations to an insurer in July and recorded $152.4M of settlement expense. It estimated an annual personnel-cost reduction of about $22M versus 2016 levels.
- Management did not expect hurricanes and wildfires to have a significant overall financial-statement impact, but expected California wildfires to affect Specialty Insurance in Q4 and projected losses could reach the $5.0M reinsurance retention limit.
- Third-quarter out-of-period corrections, deemed not material individually or in aggregate, increased depreciation and amortization by $4.7M, reduced realized investment gains by $1.8M, reduced title plants and indexes by $6.5M, and increased personnel costs by $9.0M.
- Pending lawsuits and regulatory inquiries include title pricing, competition, settlement practices, customer acquisition and agent relationships. The company said it could not assess losses for most class actions; certain outcomes or required business-practice changes could be material. A potential Canadian excise-tax assessment was not estimable.
- Key risks include real-estate and interest-rate cycles, title rate regulation, claims-reserve estimation, agent conduct, investment losses, cybersecurity and funds-transfer fraud, regulatory scrutiny, and acquisition integration. A 50-basis-point change in recent title-policy loss rates could change IBNR reserves by approximately $115.9M.
Important facts for investors to verify
- How much of the sharp Q3 earnings decline is attributable to the one-time pension charge, and whether the expected annual $22M cost reduction materializes.
- Whether title order volumes, especially refinancing, stabilize and whether purchase and commercial activity can offset continued refinance weakness.
- Development of Specialty Insurance claims, including California wildfire losses and the reinsurance retention, and trends in home-warranty and property-and-casualty claim rates.
- Title loss-reserve adequacy, including changes in estimates for recent policy years, and the potential exposure from pending litigation, regulatory inquiries, and the Canadian tax matter.
- Acquisition performance and integration, and the effects of investment-market changes, interest rates, and regulatory or tax reform on earnings and liquidity.