First American Financial Corporation — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended September 30, 2011; unaudited. First American provides title insurance and related services, specialty insurance, and banking, trust and investment services. Comparisons are with the corresponding 2010 periods unless noted.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $965.0 million | $1,003.5 million | $2,824.0 million | $2,881.9 million |
| Income before tax | $38.4 million | $56.0 million | $64.2 million | $137.5 million |
| Net income attributable to First American | $21.0 million | $33.1 million | $38.0 million | $80.7 million |
| Diluted EPS | $0.20 | $0.31 | $0.36 | $0.76 |
| Cash provided by operating activities | — | — | $26.2 million | $25.4 million |
Revenue declined 3.8% in Q3 and 2.0% year to date; company-attributable net income fell about 36% and 53%, respectively. Q3 pre-tax margin was 4.0%, versus 5.6% a year earlier. The effective tax rate was 44.6% for Q3 and 40.5% year to date.
- Title Insurance and Services: Q3 revenue was $897.8 million, down 2.9%; pre-tax income was $48.9 million, down 18.5%, and margin was 5.4% versus 6.5%. Direct title orders fell 18.1% in Q3, while average revenue per order rose 20.7%. Nine-month segment pre-tax income declined 41.1% to $87.2 million.
- Specialty Insurance: Q3 revenue was $74.3 million, roughly flat, but pre-tax income fell 45.4% to $6.7 million; margin declined to 9.0% from 16.4%. Higher claim severity and frequency affected home warranty results, and higher routine losses affected property and casualty results.
Financial position, cash flow and liquidity
- At September 30, 2011, cash and cash equivalents were $631.0 million, down from $728.7 million at year-end 2010; total assets were $5.56 billion and total equity was $1.98 billion.
- Notes and contracts payable were $278.9 million, compared with $293.8 million at year-end. The company reported $200 million drawn on its $400 million revolving facility, at 3.00% interest, maturing June 2013, and stated it was in covenant compliance. Debt was 12.3% of total capitalization.
- Operating cash flow was $26.2 million after $354.2 million of net claim payments. Investing activities provided $34.3 million and financing activities used $158.2 million; cash declined $97.8 million during the nine months. Cash dividends were $18.9 million.
- Management said resources, including internally generated funds and revolving-credit borrowings if needed, should cover anticipated operating requirements for at least 12 months. Insurance-subsidiary dividends, loans and advances available for the remainder of 2011 were limited by regulation to $144.7 million.
- Title claims reserves totaled $1.06 billion, down from $1.11 billion at year-end. The company reported a $92.2 million pension-plan underfunding and had contributed $28.1 million to benefit plans year to date; it expected another $8.9 million of contributions in 2011.
Material changes and unusual items
- Title loss provision rose to $112.2 million in Q3 from $86.5 million. The Q3 title loss rate was 9.7% of title premiums and escrow fees versus 6.6% a year earlier. The current-quarter provision included $14.7 million of adverse prior-year development, mainly policy year 2007, and a $13.0 million Bank of America lawsuit reserve. Year-to-date provision also included $45.3 million of strengthening for a Canadian guaranteed valuation product and $14.6 million of prior-year adverse development.
- Net other-than-temporary impairment losses on debt securities recognized in earnings were $3.9 million in Q3 and $5.2 million year to date. The company also recorded a $20.9 million valuation allowance against deferred tax assets in other comprehensive income.
- First American held 8.9 million CoreLogic shares at quarter-end, with a $167.6 million cost basis and $95.3 million fair value. It treated the $72.3 million unrealized decline as temporary and recorded it in accumulated other comprehensive loss. Total other comprehensive loss was $61.0 million in Q3; comprehensive loss attributable to the company was $39.8 million.
- The filing reports prior-period items that reduced Q3 net income by $0.9 million and increased nine-month net income by $1.6 million; management said they were not material to prior or expected full-year statements.
Outlook, commentary and risks
- Management cited tight mortgage credit and economic uncertainty and expected these conditions to continue. MBA data cited in the filing showed Q3 U.S. mortgage originations down 22.9% year over year, with purchase originations up 1.0% and refinancings down 31.3%.
- The company substantially completed an expense-reduction program expected to produce about $40 million in annualized savings, with savings beginning in Q3. No specific earnings or revenue guidance was provided.
- Foreclosure-related revenues had declined amid scrutiny of lender foreclosure processes and could continue to decline in the short term. Management said related matters had not materially harmed the company and did not then expect a future material adverse effect, while noting possible costs to defend insured titles.
- In the Bank of America litigation, the company estimated exposure at $13 million to $42 million, recorded its $13 million best estimate, and offered to settle for that amount. The estimate excludes potential recoveries from Fiserv or insurers; an unfavorable resolution could materially affect financial condition, results, cash flow or liquidity.
- Other risks include class-action and regulatory matters whose potential losses often cannot be estimated; real-estate and mortgage-market weakness; claims-reserve uncertainty; investment-market and CoreLogic-share declines; pension funding; title-agent conduct; rate regulation; and restrictions on subsidiary distributions. The company authorized up to $150 million of share repurchases but had made none by September 30.
- First Security Business Bank began winding down during Q3: it stopped accepting third-party deposits and originating or purchasing new loans, while continuing to service its existing loan portfolio.
Important facts for investors to verify
- Whether title claims experience, including the Canadian valuation product and prior-policy-year development, continues to require reserve strengthening.
- The outcome and final cost of the Bank of America–Fiserv mediation and any recoveries from Fiserv or insurers.
- Whether the CoreLogic share-price decline is ultimately judged other-than-temporary, and the implications of CoreLogic’s strategic review and First American’s non-binding offers.
- Realization of the stated $40 million annualized expense savings and the effect of continued weak mortgage and real-estate activity on orders and margins.
- Liquidity and capital needs, including pension contributions, claim payments, subsidiary distribution limits, and the timing or amount of future dividends or repurchases.