First American Financial Corp quarterly report, Q1 FY2021

First American Financial Corporation — Q1 2021 10-Q

Business context and period. Unaudited results cover the three months ended March 31, 2021, compared with Q1 2020. First American provides title insurance and related real-estate services, alongside specialty insurance, including home warranty and property and casualty coverage. Results are seasonal and closely tied to real-estate and mortgage activity.

Financial performance

Metric	Q1 2021	Q1 2020
Revenue	$2,025.7 million	$1,412.9 million
Income before taxes	$306.0 million	$72.3 million
Net income attributable to First American	$233.6 million	$63.2 million
Diluted EPS	$2.10	$0.55
Operating cash flow	$223.9 million	$24.2 million
Cash and cash equivalents at period end	$2,026.0 million	$1,050.0 million

Revenue increased 43.4%; reported consolidated pretax margin was approximately 15.1%, versus 5.1% in Q1 2020.
Title Insurance and Services generated $1,885.1 million of revenue and $321.6 million of pretax income; its pretax margin rose to 17.1% from 5.6%.
Specialty Insurance revenue rose 11.9% to $136.5 million, but pretax income fell 51.3% to $6.3 million; its margin declined to 4.6% from 10.5%.
Net investment income was $49.1 million, up from $45.9 million. Net realized investment gains were $66.8 million, compared with losses of $64.8 million.
Title loss provision was $140.4 million, including $134.8 million for the current year and $5.6 million for prior years. Title claims provision was 4.0% of title premiums and escrow fees, down from 5.0%.
At March 31, total equity was $4,965.7 million. Notes and contracts payable were $1,009.4 million; secured financings payable were $645.5 million. These amounts exclude deposits, which include customer-related balances.

Material changes and drivers

Higher title activity drove much of the growth: direct premiums and escrow fees increased 26.6%, agent premiums 41.0%, and information and other revenue 31.8%. Direct domestic title orders closed increased 41.9% to 287,600.
Residential mortgage activity benefited from strong refinancing and purchase volumes. Direct residential refinance and purchase premiums and escrow fees increased 79.1% and 27.4%, respectively. Management said refinance orders opened per day declined in Q1 as interest rates rose, while purchase orders opened per day increased.
Q1 2021 net realized investment gains included $42.1 million from private-company investments, following observable price changes from fundraising. The company said a proposed Offerpad transaction, if completed at the announced valuation, could produce an additional approximately $237 million gain; that amount was not reported as a realized Q1 gain.
Specialty Insurance claims costs rose: the home warranty claims rate was 53.9%, versus 42.3%, and the property and casualty claims rate was 89.6%, versus 81.0%. The filing attributes increases to higher home-warranty claim frequency and severity and weather-related losses in the Western U.S.
Operating cash flow improved, while investing activities used $779.3 million and financing activities provided $1,305.1 million. Financing inflows included a $1,303.6 million increase in deposits; secured-financing borrowings and repayments were also substantial.

Liquidity, capital and outlook

Management said cash flows, liquid assets and available credit are sufficient for anticipated operational needs and obligations for at least the next 12 months, including after considering pandemic-related uncertainty.
The $700 million revolving credit facility was undrawn at quarter end and matures April 30, 2024. The company reported compliance with its financial covenants. Holding-company liquidity included $388.9 million of cash and the full $700 million facility availability.
Debt to capitalization was 25.0%, versus 23.7% at year-end 2020; the company’s non-GAAP adjusted ratio, excluding secured financings payable, was 16.9%, versus 17.0%.
Management expected quarterly dividends to continue at or above $0.46 per share, subject to board discretion. The company paid a $0.46 dividend and repurchased 1.2 million shares for $64.8 million in Q1; $177.2 million remained under the $300 million repurchase authorization.
Management expected elevated residential purchase activity to continue well into 2021. It also expected property and casualty policies in force to decline approximately 60% by year-end 2021 as the business exits and transfers policies; transfers are expected to finish by the end of Q3 2022.

Risks, contingencies and unusual items

Results remain sensitive to interest rates, real-estate and mortgage volumes, economic conditions, the pandemic, catastrophe losses, title claims estimates and investment-market changes. The company cautioned that gains and losses on private-company investments may create quarterly volatility.
The title IBNR reserve is estimation-sensitive: management noted that a 50-basis-point change in expected loss rates for the six most recent policy years would change the reserve by approximately $137.5 million; a 100-basis-point change would imply approximately $275.1 million.
Cybersecurity-related consumer and securities class actions, a shareholder derivative action, and regulatory inquiries remain unresolved. The SEC staff issued a Wells Notice in 2020 indicating a preliminary recommendation for an enforcement action; the New York Department of Financial Services has filed amended charges and scheduled an administrative hearing. The company said outcomes were not determinable and did not expect a material adverse effect, while acknowledging that investigations could lead to business-practice changes.
A Canadian excise-tax assessment was $16.1 million including interest through March 31, 2021. The company is appealing, believes it is reasonably likely to prevail, and recorded no liability because it did not consider a loss probable.
Escrow deposits were $9.2 billion and like-kind exchange funds were $3.0 billion at quarter end. These are largely customer funds and are not wholly company balance-sheet assets; the company could be contingently liable for their disposition or transfer.
Other noted risks include title-agent conduct, regulation and title-insurance rates, access to data, LIBOR transition, investment losses, and possible impairment of goodwill or intangible assets. The company had $1.6 billion of goodwill and other intangible assets at March 31.

Important facts for investors to verify

How much of reported earnings growth is attributable to core transaction volumes versus investment gains, particularly private-company valuation changes and the potential Offerpad transaction.
Whether title order volumes, refinancing activity and average revenue per order remain favorable as interest rates and transaction mix change.
Whether lower title loss assumptions remain supported by claims experience and economic conditions, and how reserve sensitivity may affect future earnings.
Progress and financial impact of the property and casualty exit, including policy transfers, non-renewals and resulting specialty-segment revenue and claims.
Developments in the SEC and New York cybersecurity proceedings, related litigation, the Canadian tax appeal, and any contingent exposure not estimable in the filing.