Stewart Information Services Corporation — Q2 2013 Form 10-Q
Business context and period: Unaudited results for the quarter and six months ended June 30, 2013. Stewart provides title insurance and related services, mortgage services, and corporate operations. Comparisons are with the corresponding 2012 periods; amounts below are in millions except per-share data.
Financial results and liquidity
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Total revenue | $517.2 | $483.7 | $940.9 | $868.7 |
| Pretax earnings | $48.9 | $31.2 | $56.0 | $23.3 |
| Net earnings attributable to Stewart | $26.9 | $24.9 | $30.1 | $12.8 |
| Diluted EPS attributable to Stewart | $1.09 | $1.05 | $1.25 | $0.59 |
- Revenue mix and segments: Q2 title segment revenue was $475.4, up from $435.5; mortgage services revenue was $37.3, down from $44.3. Direct title revenue rose 12.6% and agency revenue rose 7.5%; mortgage services revenue fell 22.2%.
- Profitability: Q2 pretax margin was approximately 9.4% of total revenue, compared with 6.5% a year earlier. Mortgage services pretax earnings were $5.2, or a 13.9% margin, versus $12.8, or 28.8%. Title-loss provisions were 5.0% of title revenue versus 8.7% in Q2 2012.
- Cash flow: For the first six months, operating cash flow was $43.1 versus $19.4; investing cash flow used $25.0 versus providing $6.7; financing cash flow used $6.9 versus $8.9. Cash and cash equivalents, including statutory reserve funds, were $216.6 at June 30.
- Liquidity and investments: Cash and investments, including statutory reserves, totaled $756.1. Of this, $449.2 funded statutory premium reserves; unrestricted cash and investments were $163.7, excluding equity-method investments. Management stated it believes liquidity is sufficient for ongoing operations, while noting regulatory limits on access to insurer funds.
- Debt and equity: Total debt was $33.7, including $27.8 of convertible senior notes, versus total debt of approximately $71.2 at December 31, 2012. The company exchanged $37.1 of notes for 3.04 million common shares plus accrued interest. A $25.0 unsecured credit line, expiring in June 2016, was undrawn. Stockholders’ equity was $634.5.
- Other comprehensive results: Q2 comprehensive earnings attributable to Stewart were $12.6 versus $23.1. For the six-month period, net other comprehensive loss was $16.8, including investment-value and foreign-currency effects.
Material changes and management commentary
- Total revenue increased 6.9% in Q2 and 8.3% for the first six months. Management attributed title growth primarily to more closed orders, higher home prices, commercial activity, and a Texas premium-rate increase effective May 1, 2013.
- Management described housing conditions as improving: Q2 existing-home sales were higher year over year and median home prices increased 10.0%. It also cited low, though rising late in the quarter, mortgage rates and continuing uncertainty around employment and housing-market conditions.
- Mortgage services revenue and earnings declined as distressed-loan service contracts expired. Management expected additional revenue declines in the second half of 2013; recently signed contracts were expected to begin generating revenue in mid-third quarter and partially offset the loss. Contract timing may cause quarterly fluctuations.
- Six-month results included a $5.4 non-cash charge related to early retirement of $37.1 of convertible notes and a $1.7 gain on non-title-related insurance proceeds. The note retirement and related conversion also increased shares outstanding.
- Title-loss provision expense benefited from a $6.6 reserve reduction for prior policy years in Q2, following improved loss development and a lower provisioning rate. Management cautioned that large claims can cause substantial quarterly variability. Estimated title-loss liabilities were $501.1, including $115.5 for known claims and $385.6 for claims expected to be reported in the future.
- The Q2 effective tax rate was 41.3% versus 11.3% a year earlier; the six-month rates were 41.5% and 32.0%. Management cited a more normalized tax rate after a valuation-allowance release in late 2012, with 2013 rates also affected by non-deductible costs associated with the note conversion.
- Management reported effective disclosure controls and internal control over financial reporting, with no material quarterly change in internal controls. The filing reported no changes to the company’s risk factors during the quarter.
Risks, contingencies, and outlook
- Results remain sensitive to real-estate and mortgage activity, interest rates, home prices, refinancing and purchase volumes, title claims, agency performance, and regulatory changes.
- Pending litigation includes a Mexico title-insurance dispute on appeal and multiple California lawsuits involving alleged losses related to loans. The company said it was defending the cases and did not expect the outcomes to materially affect its consolidated financial condition or results; outcomes remain uncertain. Other title-policy, class-action, premium-tax, and regulatory matters are also discussed.
- Guarantees of certain third-party indebtedness and unused letters of credit totaled $3.6, primarily for workers’ compensation coverage. The filing also describes ordinary-course claims and commitments.
- Most consolidated cash and investments were held by regulated insurance subsidiaries. Dividends to the parent are subject to legal and regulatory limits; the parent had $9.2 of cash at quarter-end. Management noted that adverse operating conditions, reserve charges, or investment losses could require capital contributions or external financing.
- No formal earnings guidance was provided in the supplied filing text. The filing states that interim results are not necessarily indicative of full-year results.
Most important facts for investors to verify
- Whether new mortgage-services contracts begin on schedule and offset expiring distressed-loan work in the second half of 2013.
- Whether title-loss experience remains favorable and whether the $6.6 prior-year reserve reduction or future large claims materially affect results.
- The tax-rate outlook and the effect of the convertible-note exchange on diluted shares and per-share earnings.
- How much reported liquidity is accessible to the parent given statutory reserve requirements and insurer dividend restrictions.
- Developments in the pending litigation and regulatory matters, and any change in the company’s assessment of their potential financial impact.