Business context and reporting period
First American Financial Corporation filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2018. The company operates primarily in title insurance and related real estate services, with a Specialty Insurance segment covering property and casualty insurance and home warranties.
Financial performance and position
Amounts below are in millions of dollars except per-share data and percentages.
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $1,542.2 | $1,519.6 | $4,330.7 | $4,291.0 |
| Income before taxes | $195.6 | $18.0 | $490.6 | $286.0 |
| Net income attributable to First American | $151.5 | $21.4 | $382.8 | $201.9 |
| Diluted earnings per share | $1.34 | $0.19 | $3.38 | $1.80 |
| Cash provided by operating activities | Not stated separately | Not stated separately | $484.9 | $455.5 |
- Q3 revenue increased 1.5% year over year; nine-month revenue increased 0.9%. Net investment income rose to $67.9 million in Q3 and $167.0 million for the nine months, reflecting higher average balances and short-term rates.
- Title Insurance and Services pretax margin was 14.6% in Q3 versus 13.0%; for nine months it was 13.1% versus 12.1%. Specialty Insurance pretax margin was 5.0% versus 5.2% in Q3 and 7.3% versus 7.5% for nine months.
- At September 30, cash and cash equivalents were $2.205 billion; investments totaled $6.139 billion; total assets were $11.380 billion; total equity was $3.676 billion. These balances include banking-related activity and customer deposits.
- Deposits were $4.549 billion. Notes and contracts payable were $735.3 million and secured financings payable were $86.5 million. The company also reported $160 million outstanding on its $700 million revolving credit facility, with $540 million available.
- Cash increased $818.1 million in the first nine months, mainly reflecting higher deposits and secured-facility financing activity. Investing activities used $1.015 billion and financing activities provided $1.351 billion.
- The reserve for known and incurred-but-not-reported claims was $1.027 billion. Dividends declared were $0.42 per share in Q3; the nine-month total was $1.18 per share.
Material changes versus the prior comparable period
- Reported earnings rose sharply, but comparison with 2017 is affected by a $152.4 million pension settlement charge recorded in Q3 2017. Management attributed much of the reduction in corporate expenses and improvement in consolidated results to the absence of that charge.
- Real estate activity was mixed: Q3 domestic direct title orders opened per day fell 10.5%, with refinance orders down 32.0% and purchase orders down 4.2%; commercial orders increased 2.8%. Direct title orders closed fell 13.9% in Q3.
- Direct premiums and escrow fees decreased 1.0% in Q3, while agent premiums decreased 2.2%. Higher average revenue per closed order partly offset lower order volumes. For the first nine months, direct premiums and escrow fees increased 1.6% but agent premiums declined 3.2%.
- Title insurance loss provision remained 4.0% of title premiums and escrow fees. Specialty Insurance home warranty claims increased as a share of premiums in Q3, primarily due to higher claim severity; property and casualty claims rates declined, primarily due to lower frequency.
- Debt securities had $104.6 million of gross unrealized losses at quarter-end, compared with $32.7 million at December 31, 2017. Management attributed these primarily to interest-rate changes and did not consider them other-than-temporary impairments.
Outlook, management commentary, risks and contingencies
- Management said available operating cash flows, liquid assets and revolving-credit availability should be sufficient for anticipated operating requirements and obligations for at least the next 12 months. The company expects the Tax Cuts and Jobs Act to continue to benefit its effective tax rate.
- The board raised the quarterly dividend to $0.42 per share, an 11% increase, effective with the September 2018 dividend. Future dividends remain subject to board discretion. The company reported $182.4 million remaining under its share repurchase authorization and no repurchases during the first nine months.
- The company’s business is sensitive to real estate and mortgage activity, interest rates, refinancing volumes, credit availability and seasonality. Management noted that rising rates and reduced financing availability generally weigh on residential real estate activity.
- Risks include investment-market and interest-rate exposure, claims-reserve uncertainty, title-agent conduct, regulation of title rates and settlement services, cybersecurity and data protection, funds-transfer fraud, and potential changes in mortgage-market regulation. A 50-basis-point change in expected loss rates for each of the six most recent title policy years could increase or decrease IBNR reserves by $121.7 million.
- Several putative class actions remain uncertified, and the company said it generally cannot estimate the likelihood or range of loss for these matters. Government examinations include title pricing and rate-setting, competition, settlement services, customer acquisition and agency relationships. The company does not believe these matters will materially harm overall financial condition or liquidity, but acknowledges possible effects on business practices and results.
- The company’s Canadian operations face a possible excise-tax assessment; the amount is unknown and management cannot estimate a loss range. The filing also states that adopting the new lease accounting standard is expected to materially increase reported assets and liabilities, with an insignificant income-statement and cash-flow effect.
Most important facts for investors to verify
- How much of the earnings increase reflects the nonrecurrence of the 2017 pension settlement charge versus underlying operating performance.
- Whether declining refinance activity and title order volumes persist, and how purchase, commercial and agent-channel trends affect revenue and margins.
- Whether the rise in unrealized debt-security losses remains interest-rate-driven and temporary, and how market changes affect investment income and equity.
- Developments in title claims reserves, regulatory examinations, class actions and the Canadian excise-tax matter, including any new estimable exposures.
- Availability and cost of liquidity and financing, including the revolving facility’s May 2019 termination date, warehouse-lending balances, deposit growth and regulatory limits on subsidiary distributions.