FIRST AMERICAN FINANCIAL CORPORATION THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. THESE FORWARD-LOOKING STATEMENTS CAN BE IDENTIFIED BY THE FACT THAT THEY DO NOT RELATE STRICTLY TO HISTORICAL OR CURRENT FACTS AND MAY CONTAIN THE WORDS "BELIEVE," "ANTICIPATE," "EXPECT," "INTEND," "PLAN," "PREDICT," "ESTIMATE," "PROJECT," "WILL BE," "WILL CONTINUE," "WILL LIKELY RESULT," OR OTHER SIMILAR WORDS AND PHRASES OR FUTURE OR CONDITIONAL VERBS SUCH AS "WILL," "MAY," "MIGHT," "SHOULD," "WOULD," OR "COULD." THESE FORWARD-LOOKING STATEMENTS INCLUDE, WITHOUT LIMITATION, STATEMENTS REGARDING FUTURE OPERATIONS, PERFORMANCE, FINANCIAL CONDITION, PROSPECTS, PLANS AND STRATEGIES. THESE FORWARD-LOOKING STATEMENTS ARE BASED ON CURRENT EXPECTATIONS AND ASSUMPTIONS THAT MAY PROVE TO BE INCORRECT. RISKS AND UNCERTAINTIES EXIST THAT MAY CAUSE RESULTS TO DIFFER MATERIALLY FROM THOSE SET FORTH IN THESE FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD CAUSE THE ANTICIPATED RESULTS TO DIFFER FROM THOSE DESCRIBED IN THE FORWARD-LOOKING STATEMENTS INCLUDE THE FACTORS SET FORTH ON PAGES 3-4 OF THIS QUARTERLY REPORT. THE FORWARD-LOOKING STATEMENTS SPEAK ONLY AS OF THE DATE THEY ARE MADE. THE COMPANY DOES NOT UNDERTAKE TO UPDATE FORWARD-LOOKING STATEMENTS TO REFLECT CIRCUMSTANCES OR EVENTS THAT OCCUR AFTER THE DATE THE FORWARD-LOOKING STATEMENTS ARE MADE. CRITICAL ACCOUNTING ESTIMATES A summary of the Company's significant accounting policies that it considers to be the most dependent on the application of estimates and assumptions can be found in the Management's Discussion and Analysis section of the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 . Changes in 2020 to the Company's significant accounting policies, which are dependent upon estimates and assumptions, include the adoption of new accounting guidance for the recognition of credit losses. For discussion of the new guidance and the related changes to the Company's accounting policy, see Recently Adopted Accounting Pronouncements, Note 3 Debt and Equity Securities and Note 4 Credit Losses - Financial Assets and Off-Balance Sheet Credit Exposures to the condensed consolidated financial statements.
Recently Adopted Accounting Pronouncements
InAugust 2018 , theFinancial Accounting Standards Board ("FASB") issued updated guidance that is intended to reduce potential diversity in practice in accounting for the costs of implementing cloud computing arrangements (i.e., hosting arrangements) that are service contracts. The updated guidance aligns the requirements for capitalizing implementation costs for these arrangements with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software and hosting arrangements that include an internal-use software license. The updated guidance is effective for interim and annual reporting periods beginning afterDecember 15, 2019 . The adoption of this guidance, effectiveJanuary 1, 2020 , did not have a material impact on the Company's condensed consolidated financial statements. InAugust 2018 , the FASB issued updated guidance as part of its disclosure framework project intended to improve the effectiveness of disclosures in the notes to the financial statements. The updated guidance eliminates, adds and modifies certain disclosure requirements related to fair value measurements. The updated guidance is effective for interim and annual reporting periods beginning afterDecember 15, 2019 . The adoption of this guidance, effectiveJanuary 1, 2020 , did not have a material impact on the Company's condensed consolidated financial statements. InJanuary 2017 , the FASB issued updated guidance intended to simplify how an entity tests goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Under the updated guidance, an entity will perform its goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and will recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value, with the loss recognized limited to the total amount of goodwill allocated to that reporting unit. The updated guidance is effective for interim and annual reporting periods beginning afterDecember 15, 2019 . The adoption of this guidance, effectiveJanuary 1, 2020 , did not have a material impact on the Company's condensed consolidated financial statements. 35 -------------------------------------------------------------------------------- InJune 2016 , the FASB issued updated guidance intended to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The updated guidance replaces the current incurred loss impairment methodology with a methodology that reflects expected credit losses and requires the consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The updated guidance is effective for interim and annual reporting periods beginning afterDecember 15, 2019 . The adoption of this guidance, effectiveJanuary 1, 2020 and applied prospectively, did not have a material impact, except for the disclosure requirements, on the Company's condensed consolidated financial statements. See Note 3 Debt and Equity Securities and Note 4 Credit Losses - Financial Assets and Off-Balance Sheet Credit Exposures to the condensed consolidated financial statements for further information on the Company's credit losses.
Pending Accounting Pronouncements
InDecember 2019 , the FASB issued updated guidance intended to simplify and improve the accounting for income taxes. The updated guidance eliminates certain exceptions and clarifies and amends certain areas of the guidance. The updated guidance is effective for interim and annual reporting periods beginning afterDecember 15, 2020 , with early adoption permitted. The Company does not expect the adoption of this guidance to have a material impact on its condensed consolidated financial statements. 36 --------------------------------------------------------------------------------
Results of Operations Summary of First Quarter A substantial portion of the revenues for the Company's title insurance and services segment results from the sale and refinancing of residential and commercial real estate. In the Company's specialty insurance segment, revenues associated with the initial year of coverage in both the home warranty and property and casualty operations are impacted by volatility in residential purchase transactions. Traditionally, the greatest volume of real estate activity, particularly residential purchase activity, has occurred in the spring and summer months. However, changes in interest rates, as well as other changes in general economic conditions inthe United States and abroad, can cause fluctuations in the traditional pattern of real estate activity. The Company's total revenues increased$109.4 million , or 8.4%, in the first quarter of 2020 when compared with the first quarter of 2019. This increase was primarily attributable to increases in direct premiums and escrow fees of$106.4 million , or 20.7%, and agent premiums of$98.1 million , or 19.6%, partially offset by a decrease in net realized investment gains and losses of$97.4 million . Direct premiums and escrow fees in the title insurance and services segment from domestic residential refinance, purchase and commercial transactions increased$63.5 million ,$21.3 million and$11.2 million , or 153.8%, 11.9% and 7.5%, respectively. According to theMortgage Bankers Association's April 2, 2020 Mortgage Finance Forecast (the "MBA Forecast"), residential mortgage originations inthe United States (based on the total dollar value of the transactions) increased 73.2% in the first quarter of 2020 when compared with the first quarter of 2019. According to the MBA Forecast, the dollar amount of purchase originations increased 12.7% and refinance originations increased 215.5%. This volume of domestic residential mortgage origination activity contributed to increases in direct premiums and escrow fees for the Company's direct title operations of 11.9% from domestic residential purchase transactions and 153.8% from domestic refinance transactions in the first quarter of 2020 when compared with the first quarter of 2019. During the first quarter of 2020, the level of domestic title orders opened per day by the Company's direct title operations increased 53.1% when compared with the first quarter of 2019. Residential refinance, residential purchase and commercial opened orders per day increased 188.0%, 3.7% and 3.8%, respectively, when compared to the first quarter of 2019. The Company is increasingly utilizing innovative technologies, processes and techniques to speed the delivery of its products, increase efficiency, improve quality, improve the customer experience and decrease risk. These efforts include streamlining the closing process by converting certain manual processes into automated ones, in an endeavor to improve the customer experience by simplifying and reducing the time it takes to close a transaction, reducing risk and improving communication. The Company increasingly is employing advanced technologies to automate various processes, including various processes related to the building, maintaining and updating of title plants and other data assets, as well as the search and examination of information in connection with the issuance of title insurance policies. As a result of the recent reduction in interest rates in connection with the coronavirus pandemic, the Company has experienced a significant increase in refinance orders. To facilitate the processing of these orders, the Company has expanded the use of certain of these advanced technologies. While many of these initiatives are also designed to decrease risk, they present risks of their own. The degree to which these innovative efforts will be successful, and their ultimate impact on the Company's results of operations, is uncertain. In addition to the Company's innovative activities, other participants in the real estate industry are seeking to innovate in ways that could impact the Company's businesses. These participants include certain of the Company's sources of business, competitors and ultimate customers. Innovations by these participants may change the demand for the Company's products and services, the manner in which the Company's products and services are ordered or fulfilled and the revenue or profitability derived from the products and services. The Company has made and will likely continue to make high-risk, illiquid investments in some of these participants, typically during their early- and growth-stages. If any of these companies do not succeed, the Company could lose and/or be required to impair all or part of its investment in the unsuccessful company. The risk of failure or impairment for these investments is greater in the current economic environment. These investments could also facilitate efforts that ultimately disrupt the Company's business or enable competitors. Accordingly, the Company's efforts to anticipate and participate in these transformations could require significant additional investment and management attention and may not succeed, resulting in a reduction in market share, reduced profitability and/or a loss of invested funds. The ultimate degree to which these and other innovations in the real estate industry will impact the Company's business and results of operations is uncertain. 37 -------------------------------------------------------------------------------- Additionally, the Company continues to monitor developments in its regulatory environment. Currently, federal officials are discussing various potential changes to laws and regulations that could impact the Company's businesses, including the reform of government-sponsored enterprises such as the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) and data privacy regulations, among others. Changes in these areas, and more generally in the regulatory environment in which the Company and its customers operate, could impact the volume of mortgage originations inthe United States and the Company's competitive position and results of operations. Coronavirus Pandemic Update The coronavirus pandemic and responses to it have created significant volatility, uncertainty and economic disruption. The extent to which the coronavirus pandemic impacts the Company's business, operations and financial results will depend on numerous factors that the Company may not be able to accurately predict, including: the duration and scope of the pandemic and restrictions and responses to it; governmental, business and individual actions that have been and continue to be taken in response to the pandemic; the ongoing impact of the pandemic on economic activity and actions taken in response, including the efficacy of governmental relief efforts; the effect on participants in real estate transactions and the demand for the Company's products and services, including as a result of higher unemployment, business closures and economic uncertainty; and the Company's ability to sell and provide its services and solutions, including as a result of illness, travel restrictions, people working from home, governmental closure orders and partial or full closures of business and government offices. Because many of the more significant pandemic-related events occurred late in the first quarter and because the Company's businesses are still processing many orders opened before these events, the Company expects that the pandemic will have a greater impact on future periods than the current period. As a result of the coronavirus pandemic and responses to it, the number of residential purchase orders opened by the Company's direct title operations declined sharply in the middle of March. For the first three weeks in April, open purchase orders are down 43.4% compared to the same three weeks of 2019. The 43.4% decline the Company is currently experiencing has been largely consistent since the beginning of April. For the first three weeks in April, residential refinance orders opened by the Company's direct title operations have averaged approximately 3,000 orders per day, up 121% compared to the same three weeks of 2019. Revenue from the Company's commercial business, for the first three weeks in April, has declined 44.1% compared to the same three weeks of 2019. Commercial transactions in industries such as retail, hotels and multifamily have slowed considerably. While the Company is unable to predict with certainty the ultimate impact the coronavirus pandemic and related responses will have on its business, the Company currently expects a 45% year-over-year decline in opened residential purchase orders in the second quarter with gradual improvement in the second half of the year. The Company also expects residential refinance orders to remain elevated throughout 2020. The Company's investment income is expected to decline significantly in the second quarter given the 150-basis point decline in the federal funds rate in March. The Company expects investment income in its title and settlement services segment to be in the range of$40 million to$45 million per quarter. For the Company's commercial business, it expects a 50% year-over-year decline in revenue in the second quarter with a gradual improvement for the remainder of the year. 38 --------------------------------------------------------------------------------
Title Insurance and Services Three Months Ended March 31, (in thousands, except percentages) 2020 2019 $ Change % Change Revenues Direct premiums and escrow fees$ 501,301 $ 402,756 $ 98,545 24.5 % Agent premiums 599,682 501,537 98,145 19.6 Information and other 208,273 170,089 38,184 22.4 Net investment income 59,668 70,053 (10,385 ) (14.8 ) Net realized investment (losses) gains (68,299 ) 27,745 (96,044 ) (346.2 ) 1,300,625 1,172,180 128,445 11.0 Expenses Personnel costs 421,615 381,131 40,484 10.6 Premiums retained by agents 475,381 396,607 78,774 19.9 Other operating expenses 226,595 168,640 57,955 34.4 Provision for policy losses and other claims 55,049 36,172 18,877 52.2 Depreciation and amortization 29,517 31,162 (1,645 ) (5.3 ) Premium taxes 15,519 12,978 2,541 19.6 Interest 3,973 3,483 490 14.1 1,227,649 1,030,173 197,476 19.2 Income before income taxes$ 72,976 $ 142,007 $ (69,031 ) (48.6 )% Margins 5.6 % 12.1 % (6.5 )% (53.7 )% Direct premiums and escrow fees were$501.3 million for the three months endedMarch 31, 2020 , an increase of$98.5 million , or 24.5%, when compared with the same period of the prior year. The increase was primarily due to an increase in the number of domestic title orders closed by the Company's direct title operations, partially offset by a decrease in the average domestic revenues per order closed. The domestic average revenues per order closed was$2,315 for the three months endedMarch 31, 2020 , a decrease of 6.5% when compared with$2,475 for the three months endedMarch 31, 2019 . The quarter over quarter decrease in average revenues per order closed was primarily due to a shift in the mix of direct revenues generated from higher premium commercial products to lower premium residential refinance products, partially offset by higher average revenues per order from commercial transactions and higher residential real estate values. The Company's direct title operations closed 202,700 domestic title orders during the three months endedMarch 31, 2020 , an increase of 34.3% when compared with 150,900 domestic title orders closed during the same period of the prior year, which was generally consistent with the changes in residential mortgage origination activity inthe United States as reported in the MBA Forecast. Domestic residential refinance orders closed per day increased by 139.9% and domestic residential purchase orders closed per day increased by 5.9%. Agent premiums were$599.7 million for the three months endedMarch 31, 2020 , an increase of$98.1 million , or 19.6%, when compared with the same period of the prior year. Agent premiums are recorded when notice of issuance is received from the agent, which is generally when cash payment is received by the Company. As a result, there is generally a delay between the agent's issuance of a title policy and the Company's recognition of agent premiums. Therefore, current quarter agent premiums typically reflect prior quarter mortgage origination activity. The increase in agent premiums for the three months endedMarch 31, 2020 is generally consistent with the 16.5% increase in the Company's direct premiums and escrow fees in the fourth quarter of 2019 as compared with the fourth quarter of 2018. Information and other revenues primarily consist of revenues generated from fees associated with title search and related reports, title and other real property records and images, other non-insured settlement services, and risk mitigation products and services. These revenues generally trend with direct premiums and escrow fees but are typically less volatile since a portion of the revenues are subscription based and do not fluctuate with transaction volumes. Information and other revenues were$208.3 million for the three months endedMarch 31, 2020 , an increase of$38.2 million , or 22.4%, when compared with the same period of the prior year. The increase was primarily attributable to the growth in mortgage origination activity that led to higher demand for the Company's title information products. 39 -------------------------------------------------------------------------------- Net investment income totaled$59.7 million for the three months endedMarch 31, 2020 , a decrease of$10.4 million , or 14.8%, when compared with the same period of the prior year. The decrease was primarily attributable to lower interest income from the Company's variable-rate debt securities driven by the decline in short-term interest rates. The impact of lower short-term interest rates on income from the Company's escrow balances and tax-deferred property exchange business was mostly offset by higher average balances outstanding. Net realized investment losses totaled$68.3 million for the three months endedMarch 31, 2020 and were primarily from the decrease in the fair values of equity securities. Net realized investment gains totaled$27.7 million for the three months endedMarch 31, 2019 and were primarily from the increase in the fair values of equity securities. The title insurance and services segment (primarily direct operations) is labor intensive; accordingly, a major expense component is personnel costs. This expense component is affected by two primary factors: the need to monitor personnel changes to match the level of corresponding or anticipated new orders and the need to provide quality service. Personnel costs were$421.6 million for the three months endedMarch 31, 2020 , an increase of$40.5 million , or 10.6%, when compared with the same period of the prior year. The increase was primarily attributable to higher incentive compensation, salary and share-based compensation expenses. The increase in incentive compensation expense was due to higher revenue and profit. The increase in salary expense was due to higher average salaries and one additional business day in the quarter. The increase in share-based compensation expense was due to a higher dollar value of restricted stock units granted in the first quarter of 2020 related to 2019 performance. Agents retained$475.4 million of title premiums generated by agency operations for the three months endedMarch 31, 2020 , which compares with$396.6 million for the same period of the prior year. The percentage of title premiums retained by agents was 79.3% and 79.1% for the three months endedMarch 31, 2020 and 2019, respectively. Other operating expenses for the title insurance and services segment were$226.6 million for the three months endedMarch 31, 2020 , an increase of$58.0 million , or 34.4%, when compared with the same period of the prior year. The increase was primarily attributable to higher production related costs due to higher transaction volumes, and increases in professional services expense, computer hardware related costs, software expense and foreign currency exchange losses. The provision for policy losses and other claims, expressed as a percentage of title premiums and escrow fees, was 5.0% and 4.0% for the three months endedMarch 31, 2020 and 2019, respectively. The current quarter rate of 5.0% reflects an ultimate loss rate of 4.5% for the current policy year and a net increase in the loss reserve estimates for prior policy years of$5.5 million . The 4.0% rate for the first quarter of 2019 reflected the ultimate loss rate for the 2019 policy year and no change in the loss reserve estimates for prior policy years. To date, the Company has not experienced an increase in title claims as a result of the coronavirus pandemic. For the three months endedMarch 31, 2020 , the Company's incurred title claims were 6.2% lower than the same period of the prior year and significantly below the Company's actuarial expectation. However, title claims generally increase when economic conditions deteriorate. Due to the recent deterioration in economic conditions in connection with the coronavirus pandemic and responses to it, the Company increased its calendar year loss rate from 4.0% in 2019 to 5.0%. The Company will continue to monitor economic conditions and actual claims experience and will consider this information, among other factors, when determining the appropriate loss rate and reserve balance for incurred but not reported claims in future periods. Depreciation and amortization expense was$29.5 million for the three months endedMarch 31, 2020 , a decrease of$1.6 million , or 5.3%, when compared with the same period of the prior year. The decrease was primarily attributable to lower amortization expense for software licenses. Premium taxes were$15.5 million and$13.0 million for the three months endedMarch 31, 2020 and 2019, respectively. Premium taxes as a percentage of title insurance premiums and escrow fees was 1.4% for the three months endedMarch 31, 2020 and 2019. Interest expense was$4.0 million for the three months endedMarch 31, 2020 , an increase of$0.5 million , or 14.1%, when compared with the same period of the prior year. The increase was primarily attributable to higher interest paid on secured financings payable due to higher average balances outstanding, partially offset by lower interest paid related to customer deposits at the Company's banking subsidiary,First American Trust , FSB due to lower interest rates. 40 -------------------------------------------------------------------------------- The profit margins for the title insurance business reflect the high cost of performing the essential services required before insuring title, whereas the corresponding revenues are subject to regulatory and competitive pricing restraints. Due to the relatively high proportion of fixed costs, title insurance profit margins generally improve as closed order volumes increase. Title insurance profit margins are also impacted by the segment's net investment income and net realized investment gains or losses, which may not move in the same direction as closed order volumes. Title insurance profit margins are affected by the composition (residential or commercial) and type (resale, refinancing or new construction) of real estate activity. Title insurance profit margins are also affected by the percentage of title insurance premiums generated by agency operations. Profit margins from direct operations are generally higher than from agency operations due primarily to the large portion of the premium that is retained by the agent. The pre-tax margins for the three months endedMarch 31, 2020 and 2019 were 5.6% and 12.1%, respectively. Specialty Insurance Three Months Ended March 31, (in thousands, except percentages) 2020 2019 $ Change % Change Revenues Direct premiums$ 119,336 $ 111,446 $ 7,890 7.1 % Information and other 3,439 3,067 372 12.1 Net investment income 2,584 2,732 (148 ) (5.4 ) Net realized investment (losses) gains (3,390 ) 4,937 (8,327 ) (168.7 ) 121,969 122,182 (213 ) (0.2 ) Expenses Personnel costs 21,446 19,620 1,826 9.3 Other operating expenses 21,548 19,818 1,730 8.7 Provision for policy losses and other claims 62,428 61,540 888 1.4 Depreciation and amortization 1,894 1,734 160 9.2 Premium taxes 1,796 1,685 111 6.6 109,112 104,397 4,715 4.5 Income before income taxes$ 12,857 $ 17,785 $ (4,928 ) (27.7 )% Margins 10.5 % 14.6 % (4.1 )% (28.1 )% Direct premiums were$119.3 million for the three months endedMarch 31, 2020 , an increase of$7.9 million , or 7.1%, when compared with the same period of the prior year. The increase was primarily attributable to higher premiums earned in the home warranty business driven by an increase in the number of home warranty residential service contracts issued. The increase was also attributable to higher premiums earned in the property and casualty business driven by lower reinsurance costs. Net realized investment losses for the specialty insurance segment totaled$3.4 million for the three months endedMarch 31, 2020 and were primarily from the decrease in the fair values of equity securities, partially offset by a gain from the sale of real estate. Net realized investment gains for the specialty insurance segment totaled$4.9 million for the three months endedMarch 31, 2019 and were primarily from the increase in the fair values of equity securities. Personnel costs and other operating expenses were$43.0 million and$39.4 million for the three months endedMarch 31, 2020 and 2019, respectively, an increase of$3.6 million , or 9.0%. The increase was primarily attributable to higher advertising expense related to the home warranty business and other small increases across several expense categories. The provision for home warranty claims, expressed as a percentage of home warranty premiums, was 42.3% and 43.8% for the three months endedMarch 31, 2020 and 2019, respectively. The decrease in the claims rate was primarily attributable to lower claims frequency, partially offset by higher cost per claim. The provision for property and casualty claims, expressed as a percentage of property and casualty insurance premiums, was 81.0% and 88.7% for the three months endedMarch 31, 2020 and 2019, respectively. The decrease in the claims rate was primarily attributable to lower reinsurance costs in the first quarter of 2020, which had the effect of increasing direct premiums and lowering the claims rate. Additionally, the claims rate benefitted from the release of certain prior year reserves and recoveries received related to wildfires that occurred in 2018 and 2017.
Premium taxes were
41
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A large part of the revenues for the specialty insurance businesses are
generated by renewals and are not dependent on the level of real estate activity
in the year of renewal. With the exception of loss expense, the majority of the
expenses for this segment are variable in nature and therefore generally
fluctuate consistent with revenue fluctuations. Accordingly, profit margins for
this segment (before loss expense) are relatively constant, although as a result
of some fixed expenses, profit margins (before loss expense) should nominally
improve as premium revenues increase. Specialty insurance profit margins are
also impacted by the segment's net investment income and net realized investment
gains or losses, which may not move in the same direction as premium
revenues. The pre-tax margins for the three months ended March 31, 2020 and 2019
were 10.5% and 14.6%, respectively.
Corporate
Three Months Ended March 31 ,(in thousands, except percentages) 2020 2019 $ Change
% Change
Revenues
Net investment (losses) income $ (16,238 ) $ 9,559 $ (25,797 ) (269.9 )%
Net realized investment gains 6,927 - 6,927 -
(9,311 ) 9,559 (18,870 ) (197.4 )
Expenses
Personnel costs (13,401 ) 10,861 (24,262 ) (223.4 )
Other operating expenses 9,297 8,253 1,044 12.6
Depreciation and amortization 38 38 - -
Interest 8,264 8,529 (265 ) (3.1 )
4,198 27,681 (23,483 ) (84.8 )
Loss before income taxes $ (13,509 ) $ (18,122 ) $ 4,613 25.5 %
Net investment losses totaled $16.2 million and net investment income totaled
$9.6 million for the three months ended March 31, 2020 and 2019,
respectively. The decrease in net investment income for the three months ended
March 31, 2020 was primarily attributable to lower earnings on investments
associated with the Company's deferred compensation plan when compared to the
same period of 2019.
Net realized investment gains for the corporate segment totaled
Corporate personnel costs and other operating expenses were a credit of
Eliminations
The Company's inter-segment eliminations were not material for the three months
ended
INCOME TAXES
The Company's effective income tax rates (income tax expense as a percentage of income before income taxes) were 11.7% and 22.5% for the three months endedMarch 31, 2020 and 2019, respectively. The difference in the effective tax rates is primarily due to current-year benefits related to foreign tax law changes and the recognition of additional excess tax benefits associated with share-based payment transactions in the current year. The Company evaluates the realizability of its deferred tax assets by assessing the valuation allowance and makes adjustments to the allowance as necessary. The factors used by the Company to assess the likelihood of realization include its forecast of future taxable income and available tax planning strategies that could be implemented to realize its deferred tax assets. The Company's ability or failure to achieve forecasted taxable income in the applicable taxing jurisdictions could affect the ultimate realization of its deferred tax assets. Based on future operating results in certain jurisdictions, it is possible that the current valuation allowance positions of those jurisdictions could be adjusted during the next 12 months. 42 --------------------------------------------------------------------------------
NET INCOME AND NET INCOME ATTRIBUTABLE TO THE COMPANY
Net income for the three months endedMarch 31, 2020 and 2019 was$63.8 million and$109.8 million , respectively. Net income attributable to the Company for the three months endedMarch 31, 2020 and 2019 was$63.2 million and$109.6 million , or$0.55 and$0.97 per diluted share, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Cash requirements. The Company generates cash primarily from the sale of its products and services and investment income. The Company's current cash requirements include operating expenses, taxes, payments of principal and interest on its debt, capital expenditures, dividends on its common stock, and may include business acquisitions, investments in unconsolidated entities and repurchases of its common stock. Management forecasts the cash needs of the holding company and its primary subsidiaries and regularly reviews their short-term and long-term projected sources and uses of funds, as well as the asset, liability, investment and cash flow assumptions underlying such forecasts. Based on the Company's ability to generate cash flows from operations, its liquid-asset position and amounts available on its revolving credit facility, management believes that its resources are sufficient to satisfy its anticipated operational cash requirements and obligations for at least the next twelve months. In making this assessment, management considered the negative impact that the coronavirus pandemic and related responses has had or is expected to have on the Company's liquidity and capital resources, such as decreased cash flows from operations and increased volatility in the Company's investment portfolio, among other factors. The substantial majority of the Company's business is dependent upon activity in the real estate and mortgage markets, which are cyclical and seasonal. Periods of increasing interest rates and reduced mortgage financing availability generally have an adverse effect on residential real estate activity and therefore typically decrease the Company's revenues. In contrast, periods of declining interest rates and increased mortgage financing availability generally have a positive effect on residential real estate activity, which typically increases the Company's revenues. Residential purchase activity is typically slower in the winter months with increased volumes in the spring and summer months. Residential refinance activity is typically more volatile than purchase activity and is highly impacted by changes in interest rates. Commercial real estate volumes are less sensitive to changes in interest rates, but fluctuate based on local supply and demand conditions for space and mortgage financing availability. Cash provided by operating activities totaled$24.2 million and$34.5 million for the three months endedMarch 31, 2020 and 2019, respectively, after claim payments, net of recoveries, of$108.5 million and$100.0 million , respectively. The principal nonoperating uses of cash and cash equivalents for the three months endedMarch 31, 2020 and 2019 were advances and repayments related to secured financing transactions, purchases of debt and equity securities, dividends to common stockholders, investments in unconsolidated entities, and capital expenditures, and for the three months endedMarch 31, 2020 , business acquisitions and repurchases of Company shares. The principal nonoperating sources of cash and cash equivalents for the three months endedMarch 31, 2020 and 2019 were borrowings and collections related to secured financing transactions, proceeds from the sales and maturities of debt and equity securities, increases in the deposit balances at the Company's banking operations, and for the three months endedMarch 31, 2020 , borrowings under the unsecured credit agreement. The net effect of all activities on cash and cash equivalents were decreases of$436.0 million and$130.1 million for the three months endedMarch 31, 2020 and 2019, respectively. The Company continually assesses its capital allocation strategy, including decisions relating to dividends, stock repurchases, capital expenditures, acquisitions and investments. InMarch 2020 , the Company paid a first quarter cash dividend of44 cents per common share. Management expects that the Company will continue to pay quarterly cash dividends at or above the current level. The timing, declaration and payment of future dividends, however, falls within the discretion of the Company's board of directors and will depend upon many factors, including the Company's financial condition and earnings, the capital requirements of the Company's businesses, restrictions imposed by applicable law and any other factors the board of directors deems relevant from time to time. The Company maintains a stock repurchase plan with authorization up to$250.0 million , of which$95.8 million remained as ofMarch 31, 2020 . Purchases may be made from time to time by the Company in the open market at prevailing market prices or in privately negotiated transactions. During the three months endedMarch 31, 2020 , the Company repurchased and retired 1.7 million shares of its common stock for a total purchase price of$65.8 million and, as ofMarch 31, 2020 , had repurchased and retired 5.3 million shares of its common stock under the current authorization for a total purchase price of$154.2 million . During the three months endedMarch 31, 2020 , the Company completed acquisitions for an aggregate purchase price of$391.9 million , which were funded through cash on hand and additional borrowings of$120.0 million under the Company's credit facility. 43
-------------------------------------------------------------------------------- Holding Company.First American Financial Corporation is a holding company that conducts all of its operations through its subsidiaries. The holding company's current cash requirements include payments of principal and interest on its debt, taxes, payments in connection with employee benefit plans, dividends on its common stock and other expenses. The holding company is dependent upon dividends and other payments from its operating subsidiaries to meet its cash requirements. The Company's target is to maintain a cash balance at the holding company equal to at least twelve months of estimated cash requirements. At certain points in time, the actual cash balance at the holding company may vary from this target due to, among other factors, the timing and amount of cash payments made and dividend payments received. Pursuant to insurance and other regulations under which the Company's insurance subsidiaries operate, the amount of dividends, loans and advances available to the holding company is limited, principally for the protection of policyholders. As ofMarch 31, 2020 , under such regulations, the maximum amount available to the holding company from its insurance subsidiaries for the remainder of 2020, without prior approval from applicable regulators, was dividends of$355.5 million and loans and advances of$110.3 million . However, the timing and amount of dividends paid by the Company's insurance subsidiaries to the holding company falls within the discretion of each insurance subsidiary's board of directors and will depend upon many factors, including the level of total statutory capital and surplus required to support minimum financial strength ratings by certain rating agencies. Such restrictions have not had, nor are they expected to have, an impact on the holding company's ability to meet its cash obligations. As ofMarch 31, 2020 , the holding company's sources of liquidity included$92.9 million of cash and cash equivalents and$420.0 million available on the Company's revolving credit facility. Management believes that liquidity at the holding company is sufficient to satisfy anticipated cash requirements and obligations for at least the next twelve months. Financing. The Company maintains a credit agreement withJPMorgan Chase Bank, N.A . in its capacity as administrative agent and the lenders party thereto. The credit agreement, which is comprised of a$700.0 million revolving credit facility, includes an expansion option that permits the Company, subject to satisfaction of certain conditions, to increase the revolving commitments and/or add term loan tranches in an aggregate amount not to exceed$350.0 million . Unless terminated earlier, the credit agreement will terminate onApril 30, 2024 . The obligations of the Company under the credit agreement are neither secured nor guaranteed. Proceeds under the credit agreement may be used for general corporate purposes. AtMarch 31, 2020 , outstanding borrowings under the facility totaled$280.0 million at an interest rate of 2.49%. At the Company's election, borrowings of revolving loans under the credit agreement bear interest at (a) the Alternate Base Rate plus the applicable spread or (b) the Adjusted LIBOR rate plus the applicable spread (in each case as defined in the credit agreement). The Company may select interest periods of one, two, three or six months or (if agreed to by all lenders) such other number of months for Eurodollar borrowings of loans. The applicable spread varies depending upon the debt rating assigned byMoody's Investor Service, Inc. ,Standard & Poor's Rating Services and/orFitch Ratings Inc. The minimum applicable spread for Alternate Base Rate borrowings is 0.25% and the maximum is 1.00%. The minimum applicable spread for Adjusted LIBOR rate borrowings is 1.25% and the maximum is 2.00%. The rate of interest on any term loans incurred in connection with the expansion option will be established at or about the time such loans are made and may differ from the rate of interest on revolving loans. The credit agreement includes representations and warranties, reporting covenants, affirmative covenants, negative covenants, financial covenants and events of default customary for financings of this type. Upon the occurrence of an event of default the lenders may accelerate the loans. Upon the occurrence of certain insolvency and bankruptcy events of default the loans will automatically accelerate. As ofMarch 31, 2020 , the Company was in compliance with the financial covenants under the credit agreement.
If debt market conditions are favorable, the Company will consider terming out the outstanding amount on its credit facility to take advantage of the low interest rate environment.
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In addition to amounts available under its credit facility, certain subsidiaries
of the Company maintain separate financing arrangements. The primary financing
arrangements maintained by subsidiaries of the Company are as follows:
•
mortgage lenders, maintains secured warehouse lending facilities with
several banking institutions. At March 31, 2020 , outstanding borrowings
under these facilities totaled $441.7 million .
• First American Trust , FSB, a federal savings bank, maintains a secured
line of credit with the Federal Home Loan Bank and federal funds lines
of credit with certain correspondent institutions. In addition, First
American Trust , FSB is a party to master repurchase agreements under
which securities may be loaned or sold. At March 31, 2020 , no amounts
were outstanding under any of these facilities.
•
services company, maintains credit facilities with certainCanadian
banking institutions. At March 31, 2020 , no amounts were outstanding
under these facilities.
The Company's debt to capitalization ratios were 22.8% and 18.5% at
Investment Portfolio. The Company maintains a high quality, liquid investment portfolio that is primarily held at its insurance and banking subsidiaries. As ofMarch 31, 2020 , 94% of the Company's investment portfolio consisted of debt securities, of which 69% were eitherUnited States government-backed or ratedAAA and 98% were either rated or classified as investment grade. Percentages are based on the estimated fair values of the securities. Credit ratings reflect published ratings obtained from globally recognized securities rating agencies. If a security was rated differently among the rating agencies, the lowest rating was selected. For further information on the credit quality of the Company's investment portfolio atMarch 31, 2020 , see Note 3 Debt and Equity Securities to the condensed consolidated financial statements.
In addition to its debt and equity securities portfolio, the Company maintains certain money-market and other short-term investments.
Off-balance sheet arrangements. The Company administers escrow deposits and trust assets as a service to its customers. Escrow deposits totaled$7.7 billion and$7.3 billion atMarch 31, 2020 andDecember 31, 2019 , respectively, of which$3.3 billion and$3.2 billion , respectively, were held atFirst American Trust , FSB. The escrow deposits held atFirst American Trust , FSB are temporarily invested in cash and cash equivalents and debt securities, with offsetting liabilities included in deposits in the accompanying condensed consolidated balance sheets. The remaining escrow deposits were held at third-party financial institutions. Trust assets held or managed byFirst American Trust , FSB totaled$4.0 billion and$4.2 billion atMarch 31, 2020 andDecember 31, 2019 , respectively. Escrow deposits held at third-party financial institutions and trust assets are not considered assets of the Company and, therefore, are not included in the accompanying condensed consolidated balance sheets. All such amounts are placed in deposit accounts insured, up to applicable limits, by theFederal Deposit Insurance Corporation . The Company could be held contingently liable for the disposition of these assets. In conducting its operations, the Company often holds customers' assets in escrow, pending completion of real estate transactions and, as a result, the Company has ongoing programs for realizing economic benefits with various financial institutions. The results from these programs are included as income or a reduction in expense, as appropriate, in the condensed consolidated statements of income based on the nature of the arrangement and benefit received. The Company facilitates tax-deferred property exchanges for customers pursuant to Section 1031 of the Internal Revenue Code and tax-deferred reverse exchanges pursuant to Revenue Procedure 2000-37. As a facilitator and intermediary, the Company holds the proceeds from sales transactions and takes temporary title to property identified by the customer to be acquired with such proceeds. Upon the completion of each such exchange, the identified property is transferred to the customer or, if the exchange does not take place, an amount equal to the sales proceeds or, in the case of a reverse exchange, title to the property held by the Company is transferred to the customer. Like-kind exchange funds held by the Company totaled$2.9 billion and$3.0 billion atMarch 31, 2020 andDecember 31, 2019 , respectively. The like-kind exchange deposits are held at third-party financial institutions and, due to the structure utilized to facilitate these transactions, the proceeds and property are not considered assets of the Company and, therefore, are not included in the accompanying condensed consolidated balance sheets. All such amounts are placed in deposit accounts insured, up to applicable limits, by theFederal Deposit Insurance Corporation . The Company could be held contingently liable to the customer for the transfers of property, disbursements of proceeds and the returns on such proceeds. 45
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