Stewart Information Services Corporation — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013. Financial statement amounts below are in millions of dollars, except per-share data. Interim financial statements are unaudited.
Business context
Stewart provides title insurance and related services, mortgage services, and corporate services. Title remains the core business. Management cited an improving housing market, including higher home sales and prices, while mortgage refinance activity and demand for distressed-loan services weakened.
Key financial metrics
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Total revenue | $536.8 | $520.7 | $1,477.8 | $1,389.4 |
| Pretax earnings | $29.6 | $39.4 | $85.6 | $62.7 |
| Net earnings attributable to Stewart | $15.4 | $34.7 | $45.5 | $47.4 |
| Diluted EPS attributable to Stewart | $0.63 | $1.45 | $1.88 | $2.04 |
| Operating cash flow | Not separately stated | Not separately stated | $70.8 | $56.8 |
- Q3 revenue increased 3.1%; title segment revenue rose 7.0%, while mortgage services revenue fell 31.3%. For the first nine months, revenue grew 6.4%.
- Title segment pretax earnings were $61.7 in Q3 versus $50.6 a year earlier; its pretax margin was 12.3%, up 1.5 percentage points year over year but down 3.1 points sequentially from Q2.
- Mortgage services reported a Q3 pretax loss of $1.4, compared with pretax income of $12.4 a year earlier. Its first-nine-month pretax income was $13.6, down from $32.6.
- Title-loss expense was $32.6 in Q3 and $80.4 for nine months. The reported title-loss ratio was 6.5% and 5.8%, respectively, compared with 7.3% and 8.3% in the prior-year periods. Q3 included $11.2 of prior-year non-large claim reserve reductions and approximately $11.2 of charges for large claims.
- Cash and cash equivalents were $201.1 at September 30, 2013, versus $208.5 at December 31, 2012. Cash and investments, including statutory-reserve amounts, totaled $770.8. Operating cash flow improved by $14.0 year over year; investing cash use was $66.9 and financing cash use was $9.9.
- Total debt was approximately $32.5, including $27.1 of convertible senior notes, versus $71.2 at year-end 2012. The company exchanged $37.8 principal of notes for 3.1 million common shares and cash for accrued interest. Its $25.0 unsecured credit line had no borrowings outstanding.
- Stockholders’ equity attributable to Stewart was $643.5; total equity including noncontrolling interests was $655.2. Book value per share was $29.12, down from $29.91 at year-end 2012.
Material changes and unusual items
- Q3 net earnings fell substantially despite higher revenue and title-segment earnings. Management attributed the decline in pretax earnings primarily to weaker mortgage services results; the comparison in net earnings was also affected by Q3 2012’s use of net operating loss carryforwards, which reduced that period’s tax expense. Q3 2013 effective tax rate was 42.9%, versus 6.1% in Q3 2012.
- Nine-month 2013 results included a $5.4 noncash charge related to early retirement of convertible notes and a $1.7 gain on non-title insurance proceeds. Investment and other losses were net $2.3 for the period, versus net gains of $5.8 a year earlier.
- In August 2013, Stewart acquired certain assets of Allonhill, a loan due-diligence and risk-management provider, for $15.3 cash during the first nine months. The purchase-price allocation was expected to be finalized in Q4.
- Fitch upgraded Stewart’s Insurer Financial Strength rating from BBB+ with a positive outlook to A- with a stable outlook in August 2013.
Outlook, liquidity, risks and contingencies
- Management expected mortgage-services revenue to remain depressed over the next several quarters as new contracts ramp up and the business transitions away from expired distressed-loan contracts. It expected the Allonhill acquisition to be accretive to earnings in the first half of 2014.
- Management stated that operating cash flow and underwriter cash, subject to regulatory restrictions, should fund operations and claims. A substantial majority of consolidated cash and investments was held by the title insurer and subsidiaries; statutory reserves and restrictions limit transfers to the parent. Parent-company cash was $7.8.
- Management identified housing and mortgage-market conditions, interest rates, title-loss reserve estimates, regulation, agency conduct, litigation, financing access, and dependence on subsidiary cash flows among key risks. It said it had adequate reserves for discussed litigation and regulatory matters and did not expect them to materially affect consolidated results or financial condition.
- Notable legal matters included a favorable October 2013 appellate ruling and plaintiffs’ agreement not to pursue further appeals in the Citigroup/Mexico title-policy dispute; a favorable October 2013 bellwether jury verdict in the California Gearhart-related litigation, with further proceedings possible; and an adverse August 2013 ruling on certain policy defenses in the Credit Suisse/Tamarack case, with Stewart’s motion to reconsider pending. Outcomes remain uncertain.
- The filing reported no material change in risk factors or market-risk disclosures, and management said disclosure controls and internal control over financial reporting were effective as of September 30, 2013.
Important facts for investors to verify
- Whether mortgage-services contracts ramp as anticipated and offset revenue lost from expired distressed-loan contracts.
- How title-loss reserve development, especially large claims and IBNR estimates, affects future earnings and claims cash flows.
- The tax-rate comparison and the effect of the prior-year tax benefit on reported year-over-year earnings.
- Regulatory limits on access to insurer-held cash and the adequacy of statutory reserves and capital.
- Developments and potential exposure in the Credit Suisse/Tamarack litigation and other pending claims and regulatory matters.
- Allonhill’s finalized purchase accounting and whether the acquisition achieves the stated accretion expectation.