First American Financial Corporation — Q1 2011 Form 10-Q
Business context and reporting period. The unaudited quarter ended March 31, 2011. First American, spun off from The First American Corporation in June 2010, provides title insurance and related services, property and casualty insurance, and home warranties. The filing compares Q1 2011 with Q1 2010; pre-spin-off comparisons may reflect allocated parent-company costs rather than standalone costs.
Financial results and position
| Metric | Q1 2011 | Q1 2010 or comparison |
|---|---|---|
| Revenue | $931.7 million | $908.4 million; up 2.6% |
| Income (loss) before taxes | $(23.4) million | $24.5 million |
| Net income (loss) attributable to the Company | $(15.3) million; $(0.15) per share | $13.8 million; $0.13 per share |
| Cash used for operating activities | $49.6 million | $25.5 million |
| Cash and cash equivalents | $755.3 million at March 31 | $728.7 million at December 31, 2010 |
| Notes and contracts payable | $290.8 million | $293.8 million at December 31, 2010 |
| Total assets / total equity | $5.91 billion / $1.99 billion | $5.82 billion / $1.99 billion at December 31, 2010 |
The consolidated pretax margin was approximately negative 2.5%, compared with positive 2.7% a year earlier. Investment income was $20.8 million, down from $24.9 million; realized investment results were a $0.5 million loss versus a $3.6 million gain. Interest expense was $3.8 million versus $2.3 million.
Segments: Title Insurance and Services revenue rose 2.8% to $861.4 million, but the segment recorded a pretax loss of $18.6 million, compared with $27.2 million of pretax income. Specialty Insurance revenue increased 0.4% to $68.8 million and pretax income rose 27.8% to $12.2 million; its pretax margin improved to 17.8% from 14.0%. Corporate pretax loss widened to $17.5 million from $12.2 million, reflecting higher standalone corporate costs and interest expense.
Title insurance loss provision was $96.4 million, or 13.8% of title premiums and escrow fees, versus $39.4 million a year earlier. It included a $45.3 million reserve strengthening for a Canadian guaranteed-valuation product and $14.6 million of adverse development, primarily for 2007 policy year claims. Excluding the Canadian charge, the reported loss provision rate was 7.3%, compared with 5.9%.
Material changes and liquidity
- Revenue growth was led by agent premiums, up 6.9%; direct premiums and escrow fees were nearly flat. Direct title orders closed fell 7.9% to 222,200.
- Claims costs drove the shift from prior-year profit to a quarterly loss. The title segment’s pretax margin moved from 3.2% to negative 2.2%.
- Operating cash use increased to $49.6 million, including $117.4 million of net claim payments. Investing activities used $71.0 million; financing provided $147.1 million, mainly reflecting a $158.0 million increase in deposits. Cash increased $26.5 million during the quarter.
- The Company had a $400 million revolving credit facility maturing June 1, 2013, with $200 million borrowed; the reported rate on that borrowing was 3.06%. Notes and contracts payable were 12.8% of total capitalization.
- Cash and deposits should be read in light of the banking business: certain customer escrow funds are recorded with offsetting deposit liabilities. Additional escrow, trust, and like-kind exchange customer funds are held off balance sheet; the Company says it may be contingently liable for their disposition.
- Title claims reserves totaled $1.12 billion, including $899.8 million of IBNR. Management’s indicated reasonable IBNR range was $806 million to $1.1 billion.
Outlook, risks, and unusual items
Management gave no numerical earnings or revenue guidance. It said tight mortgage credit and uncertain economic conditions continued to constrain demand, and the expected seasonal spring increase in real estate activity had not materialized: March open title orders per day edged up from February, while April orders per day edged down from March. Management expected market conditions to continue affecting the business, planned to keep managing expenses, and considered mortgage and real estate markets likely near a bottom.
Management noted that foreclosure-related revenue had declined and could remain weak in the short term amid lender process reviews and regulatory developments. It said the developments had not materially harmed the Company to date and did not then expect a material future effect, while acknowledging possible defense costs for insured titles. The Company also faces multiple class-action lawsuits and regulatory audits or investigations, many of whose outcomes or potential losses it said could not be estimated. A Bank of America title-policy lawsuit could materially affect financial condition, results, cash flows, or liquidity if resolved unfavorably.
- Other key risks include actual title claims exceeding reserve assumptions, a weak real estate or commercial property market, investment losses and interest-rate changes, regulatory scrutiny and rate controls, and customer or data-system risks.
- The investment portfolio included $46.4 million fair value of non-agency mortgage-backed securities; 99.6% of their amortized cost was rated non-investment grade or not rated. The Company recognized $0.3 million of credit-related impairment in the quarter and said additional impairments were possible.
- The pension plan was underfunded by approximately $101.7 million at March 31. The Company contributed $7.7 million in Q1 and expected another $28.6 million of contributions during the rest of 2011.
- The Company authorized up to $150 million of share repurchases in March; none had occurred by quarter-end. It paid a $0.06 per-share dividend and said it expected to continue quarterly dividends at or above historical levels, subject to board discretion and relevant conditions.
- After quarter-end, on April 11, 2011, the Company completed the sale of 4.0 million CoreLogic shares for $75.8 million. It retained CoreLogic shares, creating continuing single-issuer investment exposure.
Important facts for investors to verify
- Whether the $45.3 million Canadian reserve charge and subsequent claim experience indicate further reserve strengthening, and how actual losses compare with management’s IBNR range.
- Trends in open title orders, mortgage originations, foreclosure-related activity, and the profitability of direct and agency business.
- Liquidity and capital available after claims, pension funding, dividends, any share repurchases, and the post-quarter CoreLogic share sale; distinguish company cash from customer-related deposits.
- Developments in the Bank of America litigation, other class actions, and regulatory investigations, including any change in estimated exposure.
- Credit quality and valuation of non-agency mortgage-backed securities and the remaining CoreLogic stock position.