Business context and reporting period
First American Financial Corporation’s 2010 Form 10-K covers the fiscal year ended December 31, 2010; it is an annual report, not a standalone fourth-quarter filing. The company provides title insurance and real-estate settlement services, as well as property and casualty insurance and home warranties. Title insurance and services generated 92.5% of 2010 consolidated revenue.
The company became a standalone public company on June 1, 2010, following its separation from The First American Corporation, now CoreLogic. Results before the separation are carve-out financial statements that include allocated parent-company costs and may not reflect costs or results as a standalone company.
Financial performance and position
Amounts below are in millions of dollars except per-share data. Full-year comparisons are with 2009 unless otherwise noted.
| Metric | 2010 | 2009 | Change |
|---|---|---|---|
| Revenue | $3,906.6 | $4,046.8 | -3.5% |
| Income before income taxes | $212.1 | $204.3 | +3.8% |
| Net income | $129.0 | $134.3 | -4.0% |
| Net income attributable to the company | $127.8 | $122.4 | +4.4% |
| Diluted earnings per share | $1.20 | $1.18 | +$0.02 |
| Operating cash flow | $155.5 | $233.6 | -33.4% |
- Fourth quarter: Revenue was $1,024.7 million versus $1,032.8 million in fourth-quarter 2009. Pretax income was $74.6 million versus $61.1 million; net income attributable to the company was $47.1 million versus $50.1 million.
- Margins: Title insurance and services pretax margin improved to 6.3% from 5.7%; specialty insurance margin rose to 15.0% from 11.3%. Consolidated pretax margin was approximately 5.4%, compared with 5.0% in 2009.
- Cash and investments: Cash and cash equivalents were $728.7 million at year-end; investments totaled $2,647.2 million. Operating cash flow was after $456.2 million of net claim payments. Cash increased $97.4 million during 2010.
- Debt and equity: Notes and contracts payable were $293.8 million, up from $119.3 million; total equity was $1,993.7 million. Debt represented 12.8% of total capitalization, versus 11.3% a year earlier. The increase reflects the separation and related borrowing.
- Claims and liquidity: Known and incurred-but-not-reported claims reserves were $1,108.2 million, down from $1,227.8 million. Deposits, largely associated with banking and customer funds, were $1,482.6 million. Management said resources were sufficient for anticipated operating needs and obligations for at least 12 months.
Material changes versus the prior comparable period
- Residential mortgage originations fell 24.6% in 2010, according to the Mortgage Bankers Association forecast cited in the filing. Direct title orders opened declined 17.6%, and orders closed declined from 1.305 million to 1.067 million.
- Title and services revenue decreased 4.1% to $3,614.4 million; pretax income increased to $229.5 million from $215.1 million. Lower revenue was partly offset by reduced operating expenses and a lower title-loss provision rate.
- Specialty insurance revenue increased 3.0% to $285.7 million, while pretax income increased 35.8% to $42.7 million. Home warranty claims costs improved; property and casualty claims were affected by winter storms and an Arizona hailstorm.
- Title-loss provision was 6.1% of title premiums and escrow fees, versus 6.8% in 2009 and 10.4% in 2008. The 2010 rate included an upward reserve adjustment for prior policy years; 2008 included $78.0 million of reserve strengthening.
- Corporate costs increased after the company became independent. The filing also reports $7.7 million of 2010 net expense for items that should have been recorded in a prior year, including $6.9 million in fourth-quarter expense relating to prior quarters; each reduced diluted EPS by $0.06.
Outlook, commentary, risks and unusual items
- Management expected tight mortgage credit and economic uncertainty to continue affecting demand, and emphasized cost control, staffing adjustments and targeted growth opportunities. The filing provides no quantified earnings or revenue guidance.
- Foreclosure suspensions and questions about lender foreclosure processes were expected to reduce some default-related revenue and could increase costs defending insured titles. Management said these developments had not materially harmed results to date and did not then expect a material future effect.
- Title claims estimates remain sensitive to housing values, mortgage defaults, underwriting quality and claim emergence. Management estimated that a 50-basis-point change in expected loss rates for each of the five most recent policy years could change the IBNR reserve by $105.1 million.
- The defined-benefit pension plan was underfunded by $108.4 million at year-end; the company expected to contribute approximately $36.4 million in 2011. Pension expense and funding needs could rise if asset returns or assumptions deteriorate.
- The company had a $400 million revolving credit facility, with $200 million drawn and due June 2013; it was in compliance with debt covenants at year-end. Insurance-subsidiary dividends, loans and advances available to the parent in 2011 were capped at $194.3 million.
- Investment risks include the $239.5 million fair value of CoreLogic shares received in the separation and non-agency mortgage-backed securities. The company recorded $8.5 million of 2010 impairment on non-agency mortgage-backed securities, including $6.3 million recognized in earnings; most such holdings were rated below investment grade at year-end.
- Numerous class-action lawsuits and regulatory inquiries involve alleged rate, referral, competition, fee and other practices. The company generally could not estimate potential losses for many cases. A Bank of America lawsuit concerning certain title policies could have a material adverse effect if resolved unfavorably; the company’s estimate of any excess loss beyond related reserves was unclear.
- The filing states that the company expected to continue quarterly dividends at or above historical post-separation levels, but future declarations remain at the board’s discretion. The principal title underwriter’s ratings and statutory surplus, along with goodwill, tax benefits and claim reserves, are also subject to change.
Most important facts for investors to verify
- How much of the improved pretax result reflects sustainable expense and claims trends, versus reserve estimates and unusual or prior-period items?
- Whether title order volumes, mortgage activity and default-related revenue recover or continue to weaken.
- Whether title claims development for recent policy years supports the reported reserves, including the $105.1 million sensitivity to loss-rate changes.
- The potential financial and operating impact of the Bank of America litigation, other class actions and regulatory inquiries.
- Whether the company can fund pension obligations, maintain dividends and meet debt obligations while respecting subsidiary distribution limits.
- The current value and disposition plans for CoreLogic shares, and any further credit losses or impairments in the investment portfolio.