First American Financial Corporation — FY2014 Form 10-K
Reporting period: Fiscal year ended December 31, 2014; filed February 23, 2015. The filing is an annual report, not a standalone fourth-quarter filing. First American provides title insurance and related real-estate services, plus property-and-casualty insurance and home warranties. Title insurance and services generated 92.0% of consolidated revenue.
Financial performance and position
| Metric | FY2014 | FY2013 | Change |
|---|---|---|---|
| Revenue | $4.678 billion | $4.956 billion | Down 5.6% |
| Income before taxes | $350.6 million | $310.7 million | Up 12.8% |
| Net income attributable to First American | $233.5 million | $186.4 million | Up 25.3% |
| Diluted EPS | $2.15 | $1.71 | Up 25.7% |
| Cash from operating activities | $360.6 million | $378.5 million | Down 4.7% |
| Total assets | $7.666 billion | $6.559 billion | Up 16.9% |
| Notes and contracts payable | $587.3 million | $310.3 million | Up $277.1 million |
Title Insurance and Services revenue was $4.304 billion, down 6.5%; pretax income rose 6.5% to $373.0 million and its pretax margin improved to 8.7% from 7.6%. Specialty Insurance revenue grew 8.6% to $368.7 million; pretax income increased 25.7% to $53.0 million and margin improved to 14.4% from 12.4%. Corporate reported a $75.4 million pretax loss, compared with an $81.6 million loss.
Consolidated pretax margin was approximately 7.5% versus 6.3% in 2013; net margin was approximately 5.0% versus 3.8%. Cash and cash equivalents were $1.190 billion at year-end. The company had no borrowings outstanding on its $700 million revolving facility, with all capacity available. It issued $300 million of 4.60% senior unsecured notes due 2024. Notes and contracts payable were 18.6% of total capitalization, versus 11.2% a year earlier. Operating cash flow followed $469.8 million of net claim payments; capital expenditures were $99.4 million.
Material changes and drivers
- Refinance activity weakened sharply: refinance revenue fell 43.2%; residential purchase revenue rose 4.5% and commercial revenue rose 9.0%. Direct domestic orders closed fell 26.0%, while average revenue per closed order rose to $1,918 from $1,513, partly offsetting lower volume.
- Title segment expense for policy losses and other claims declined 26.3% to $253.1 million. The title loss provision rate was 7.0% of premiums and escrow fees, down from 8.8% in 2013, which had included larger prior-year reserve strengthening.
- Specialty Insurance benefited from higher home warranty and property-and-casualty premiums. Home warranty claims improved, while property-and-casualty claims worsened amid severe winter weather and California wildfires.
- Net realized investment gains increased to $31.8 million from $9.2 million. Equity-method investment impairment losses rose to $22.5 million from $7.8 million.
- The company completed acquisitions for $162.5 million, including a $151.2 million mortgage-industry loan-quality analytics business. It completed the wind-down and sale of its industrial bank’s loan portfolio and transfer of its deposits.
Outlook, risks, and unusual items
- Management expected modest growth in 2015 home-purchase originations, some improvement in transaction levels and home prices, and continued commercial-market strength at slower growth rates. January 2015 direct title orders opened per day were 27.0% above the prior-year month, driven by a refinancing rebound; management cautioned that its duration was uncertain.
- Management expected about $9 million of additional 2015 pension and supplemental-benefit expense and about $10 million of additional interest expense from the November 2014 notes. It expected to continue quarterly dividends at or above the current level, subject to board discretion and legal and financial constraints.
- The CFPB’s integrated mortgage-disclosure rules were scheduled to apply to covered applications beginning August 1, 2015. Implementation could increase costs or cause processing delays and lower mortgage volumes; readiness also depends on agents, lenders, and other market participants.
- Title claims reserves were $1.012 billion, including $802.1 million of IBNR. The actuary’s reasonable IBNR range was $726.1 million to $990.5 million; a 50-basis-point change in recent policy-year loss rates could change IBNR by $98.7 million. 2014 reserve strengthening included $41.4 million associated with domestic commercial claims, net of anticipated recoveries.
- The defined-benefit pension plan was underfunded by $111.3 million; low interest rates and revised mortality assumptions affected obligations and contributed to a $56.5 million pension-related other-comprehensive loss in 2014. Expected 2015 contributions were $21.7 million to the pension plan and $14.1 million to supplemental plans.
- Ongoing class actions and regulatory investigations concern, among other issues, title rates, referral practices, fees, and home-warranty claims. The company said it could not assess or estimate losses for many matters. A Canadian excise-tax inquiry could result in an assessment, but the amount was not estimable. Management did not expect the disclosed matters to materially harm overall financial condition or liquidity, while acknowledging possible period-level effects and potential changes to business practices.
- Escrow and like-kind exchange funds are substantial, largely customer funds not recorded as company assets, and can expose the company to contingent liability. The company also cited cyber, data-security, real-estate-cycle, interest-rate, regulatory, major-customer, investment, and agent-related risks.
Most important facts for investors to verify
- Whether purchase and refinance order volumes, including the January 2015 rebound, translated into sustained revenue and operating cash flow.
- Subsequent title-claims development, particularly commercial claims and recoveries, versus the recorded reserves and actuarial range.
- Actual CFPB-rule implementation effects on transaction timing, volumes, compliance costs, and agent and lender readiness.
- Outcomes or new estimates for material litigation, regulatory reviews, and the Canadian excise-tax issue.
- Progress integrating 2014 acquisitions and their contribution to earnings, alongside the higher debt balance, pension funding needs, and dividend commitments.
Reporting note: The filing states that the financial statements were audited by PricewaterhouseCoopers LLP, which gave an unqualified opinion; management and the auditor reported effective internal control over financial reporting as of December 31, 2014.