STEWART INFORMATION SERVICES CORPORATION MANAGEMENT'S OVERVIEW
Third quarter 2020 overview. We reported net income attributable to Stewart of$55.9 million ($2.21 per diluted share) for the third quarter 2020, compared to net income attributable to Stewart of$66.1 million ($2.78 per diluted share) for the third quarter 2019. On an adjusted basis, Stewart's third quarter 2020 net income of$55.9 million ($2.21 per diluted share) increased 84% from$30.4 million ($1.28 per diluted share) in the third quarter 2019. Third quarter 2020 pretax income before noncontrolling interests was$76.3 million compared to pretax income before noncontrolling interests of$91.1 million for the third quarter 2019. Third quarter 2019 results included pretax items of: •$46.9 million of net realized and unrealized gains, primarily composed of a$50.0 million gain recorded in the ancillary services and corporate segment related to the merger termination fee paid by Fidelity National Financial (FNF), and a$2.7 million impairment charge on an equity method investment recorded in the title segment, and •$1.0 million of third-party advisory expenses related to the terminated FNF merger transaction recorded in other operating expenses within the ancillary services and corporate segment. Summary results of the title segment are as follows ($ in millions, except pretax margin): For the Three Months Ended September 30, 2020 2019 % Change Operating revenues 562.7 499.2 13 % Investment income 5.0 4.8 6 % Net realized and unrealized gains (losses) - (2.8) 100 % Pretax income 82.4 49.5 66 % Pretax margin 14.5 % 9.9 % Title segment pretax income grew$32.9 million , or 66%, while pretax margin also improved 460 basis points to 14.5% in the third quarter 2020 compared to the prior year quarter. Title operating revenues increased$63.5 million , or 13%, resulting from increases in direct title revenues of$35.0 million , or 14%, and gross independent agency revenues of$28.5 million , or 11%. The effect of changes in the fair value of equity securities investments was minimal during the third quarters of 2020 and 2019; however, during the third quarter 2019, the segment recorded a$2.7 million impairment charge on an equity method investment. Excluding the impairment charge, pretax income for the third quarter 2019 would have been$52.3 million (10.4% margin). Consistent with the increased title revenues in the third quarter 2020, the segment's overall operating expenses increased$33.6 million , or 7%, as agency retention expenses and combined title employee costs and other operating expenses increased 11% and 3%, respectively, from the third quarter 2019. Our average independent agency remittance rate for the third quarter 2020 improved to 18.2% compared to 17.8% in the prior year quarter; while combined title employee costs and other operating expenses, as percentage of title revenues, was 39.5% in the third quarter 2020 compared to 43.4% in the prior year quarter. Title loss expense increased in the third quarter 2020 primarily due to increased title revenues, higher domestic loss provisioning rates due to the current economic environment, and unfavorable loss development in our Canadian business. As percentage of title revenues, the title loss expense in the third quarter 2020 was 5.1% compared to 4.2% from the prior year quarter. Direct title revenues (refer to schedule in Results of Operations - Title Revenues section ) in the third quarter 2020 increased from the prior year quarter as a result of improved domestic non-commercial revenues, primarily driven by increased purchase and refinancing residential orders from both existing and newly acquired title offices. This increase was partially offset by decreased commercial revenues resulting from reduced transaction sizes and volumes. Domestic commercial fee per file in the third quarter 2020 was approximately$9,700 , which was 23% lower than the third quarter 2019; while domestic residential fee per file was approximately$1,900 , or 11% lower than the third quarter 2019, primarily due to a higher mix of refinancing compared to purchase transactions. 18 -------------------------------------------------------------------------------- Summary results of the ancillary services and corporate segment are as follows ($ in millions): For the Three Months Ended September 30, 2020 2019 % Change Operating revenues 28.0 8.6 224 % Net realized gains - 49.7 (100) % Pretax loss (6.0) 41.6 (115) % The segment's results for the third quarter 2019 included a$50.0 million realized gain related to the FNF merger termination fee and$1.0 million of merger expenses. Excluding net realized gains and merger expenses, the segment's pretax results for the third quarter 2020 improved$1.1 million , or 15%, compared to the prior year quarter. Third quarter segment operating revenues improved, primarily driven by$24.2 million of revenues generated byU.S. Appraisals, which were partially offset by a$4.8 million decline in search and valuation services' revenues due to significantly lower customer orders. The segment's results for the third quarter 2020 and 2019 included approximately$6.3 million and$7.3 million , respectively, of net expenses attributable to parent company and corporate operations, with the higher expenses in the third quarter 2019 being primarily driven by the FNF merger expenses mentioned above. Consistent with our investment and growth strategy of focusing on attractive businesses and geographies where we can have sustained success and where additional scale can efficiently and effectively improve profitability and margins, we acquired a number of title offices in the states ofAlaska ,Arizona ,Colorado andNevada during the late third quarter 2020. These acquisitions realign Stewart to strongly compete in several strategic markets where we have traditionally been underrepresented. As expected, these acquisitions, along with our second quarter acquisition ofU.S. Appraisals, were immediately accretive to Stewart, evidenced by positive contributions to our third quarter 2020 pretax results. Subsequent toSeptember 30, 2020 , we acquired a national provider of appraisal management and residential real estate valuation services. Along withU.S. Appraisals, we expect this acquisition to further leverage our position in the evolving real estate closing experience and improve scale and synergies within our ancillary services business. We believe our solid operating results and liquidity position will allow us to continue investing and growing to maximize our operational potential. COVID-19 pandemic. InMarch 2020 , a global pandemic escalated relating to a novel strain of coronavirus (COVID-19), which resulted in a slowdown in the global economy and aU.S. declaration of a national emergency. In response to the pandemic, health and governmental bodies, including the state ofTexas where we are headquartered, issued travel restrictions, quarantine orders, temporary closures of non-essential businesses and other restrictive measures. In response to the pandemic, we deployed our business continuity plan in March and continue to take appropriate measures to protect the safety of all our employees and customers, while monitoring the evolving effects of the COVID-19 pandemic on the national and international fronts. Within theU.S. , our business has been deemed an essential business which allows us to continue underwriting and closing real estate transactions for our residential and commercial customers on a daily basis. When possible, we utilize our digital capabilities, including remote online notarization (RON), remote ink notarization (RIN), electronic signature platforms, virtual underwriting, and mobile earnest money transfer tools to aid our employees in facilitating real estate transactions during this challenging environment. To date, various levels of restrictions to address the spread of COVID-19 are still in place across theU.S. and the rest of the world, with some economies gradually opening up and efforts to develop vaccines continue. We continue to proactively manage our business through this crisis with the help of our exceptional employees and support of our customers. While the pandemic continues to persist, Stewart is committed to helping people safely navigate the real estate closing process. We believe our strong liquidity position will allow us to facilitate our customers' purchase and refinance of real estate should macro-economic conditions become more challenging. 19 --------------------------------------------------------------------------------
CRITICAL ACCOUNTING ESTIMATES
The preparation of the Company's condensed consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of certain assets, liabilities, revenues, expenses and related disclosures surrounding contingencies and commitments. Actual results can differ from our accounting estimates. While we do not anticipate significant changes in our estimates, there is a risk that such changes could have a material impact on our consolidated financial condition or results of operations for future periods. During the nine months endedSeptember 30, 2020 , we made no material changes to our critical accounting estimates as previously disclosed in Management's Discussion and Analysis in the 2019 Form 10-K. Operations. Our primary business is title insurance and settlement-related services. We close transactions and issue title policies on homes, commercial and other real properties located in all 50 states, theDistrict of Columbia and international markets through policy-issuing offices, agencies and centralized title services centers. Our ancillary services and corporate segment includes our parent holding company expenses and certain enterprise-wide overhead costs, along with our ancillary services operations, principally appraisal, and search and valuation services. Factors affecting revenues. The principal factors that contribute to changes in operating revenues for our title and ancillary services and corporate segments include: •mortgage interest rates; •availability of mortgage loans; •number and average value of mortgage loan originations; •ability of potential purchasers to qualify for loans; •inventory of existing homes available for sale; •ratio of purchase transactions compared with refinance transactions; •ratio of closed orders to open orders; •home prices; •consumer confidence, including employment trends; •demand by buyers; •number of households; •premium rates; •foreign currency exchange rates; •market share; •ability to attract and retain highly productive sales associates; •departure of revenue-attached employees; •independent agency remittance rates; •opening of new offices and acquisitions; •office closures; •number and value of commercial transactions, which typically yield higher premiums; •government or regulatory initiatives, including tax incentives and the implementation of the new integrated disclosure requirements; •acquisitions or divestitures of businesses; •volume of distressed property transactions; •seasonality and/or weather; and •outbreaks of disease, including the COVID-19 pandemic, and related quarantine orders and restrictions on travel, trade and business operations. Premiums are determined in part by the values of the transactions we handle. To the extent inflation or market conditions cause increases in the prices of homes and other real estate, premium revenues are also increased. Conversely, falling home prices cause premium revenues to decline. As an overall guideline, a 5% change in median home prices results in an approximately 3.7% change in title premiums. Home price changes may override the seasonal nature of the title insurance business. Historically, our first quarter is the least active in terms of title insurance revenues as home buying is generally depressed during winter months. Our second and third quarters are the most active as the summer is the traditional home buying season, and while commercial transaction closings are skewed to the end of the year, individually large commercial transactions can occur any time of year. On average, refinance title premium rates are 60% of the premium rates for a similarly priced sale transaction. 20 --------------------------------------------------------------------------------
RESULTS OF OPERATIONS
Comparisons of our results of operations for the three and nine months endedSeptember 30, 2020 with the three and nine months endedSeptember 30, 2019 are set forth below. Factors contributing to fluctuations in the results of operations are presented in the order of their monetary significance, and we have quantified, when necessary, significant changes. Segment results are included in the discussions and, when relevant, are discussed separately.
Our statements on home sales and loan activity are based on published
Operating environment. Existing home sales grew for the fourth consecutive month in September, according to NAR, and is attributed to the currently record-low interest rates and an abundance of buyers in the marketplace, despite lower housing inventory levels compared to last year. Actual existing home sales in the third quarter 2020 grew approximately 13% from the third quarter 2019. On a seasonally-adjusted basis,September 2020 existing home sales increased 21% and 9% from a year ago andAugust 2020 , respectively.September 2020 median and average home prices increased approximately 15% and 12%, respectively, compared toSeptember 2019 prices.September 2020 housing starts improved 2% and 11% fromAugust 2020 and a year ago, respectively. Newly issued building permits inSeptember 2020 also improved, up 5% and 8% fromAugust 2020 andSeptember 2019 , respectively. As reported by Fannie Mae and MBA (averaged), one-to-four family mortgage originations improved 51% to approximately$1.1 trillion in the third quarter 2020 from$702 billion in the third quarter 2019, primarily driven by an approximately 91% increase in refinancing originations resulting from the current lower mortgage interest rate environment. While purchase originations decreased in the second quarter 2020 on a year-on-year basis, third quarter 2020 purchase originations improved 23% sequentially from the second quarter 2020 and also increased 15% compared the third quarter 2019, as the real estate market continues to recover from the effects of the COVID-19 pandemic. For the fourth quarter 2020, Fannie Mae and MBA are forecasting that existing and new home sales will improve 10% and 35%, respectively, compared to last year's fourth quarter, but consistent with the seasonality of the market, will sequentially decline 1% and 5%, respectively, compared to the third quarter 2020. Total mortgage originations for the fourth quarter 2020 are expected to improve 17% from last year's fourth quarter, driven by 23% and 13% higher purchase and refinancing lending, respectively. The 30-year mortgage interest rate is expected to average approximately 3.1% for the year 2020, compared to the 2019 average of 3.8%.
Title revenues. Direct title revenue information is presented below:
Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 Change % Change 2020 2019 Change % Change
($ in millions) ($ in millions)
Non-commercial
Domestic 208.2 160.5 47.7 30 % 503.8 416.8 87.0 21 %
International 30.4 28.8 1.6 6 % 70.4 66.8 3.6 5 %
238.6 189.3 49.3 26 % 574.2 483.6 90.6 19 %
Commercial:
Domestic 36.7 49.7 (13.0) (26) % 108.7 133.7 (25.0) (19) %
International 4.8 6.1 (1.3) (21) % 13.7 16.9 (3.2) (19) %
41.5 55.8 (14.3) (26) % 122.4 150.6 (28.2) (19) %
Total direct title revenues 280.1 245.1 35.0 14 % 696.6 634.2 62.4 10 %
21-------------------------------------------------------------------------------- Direct title revenues improved in the third quarter and first nine months of 2020, compared to the same periods last year, primarily as a result of higher domestic non-commercial revenues driven by increased purchase and refinancing residential orders from existing offices and revenues generated by newly acquired title offices, which were approximately$10.3 million for the third quarter and first nine months of 2020. These increases were partially offset by decreased commercial revenues resulting from reduced transaction sizes and volumes. Total refinancing and purchased closed orders increased 47% and 42% in the third quarter and first nine months of 2020, respectively; while commercial closed orders decreased 4% and 11%, respectively, compared to the same periods in 2019. Domestic residential fee per file for both the third quarter and first nine months of 2020 was approximately$1,900 , lower compared to$2,200 for both the same periods in 2019 primarily as a result of a higher mix of refinancing compared to purchase transactions in 2020. Domestic commercial fee per file in the third quarter and first nine months of 2020 declined to approximately$9,700 and$10,300 , respectively, compared to$12,600 and$11,300 , respectively, in the same periods in 2019, primarily due to the slowdown in the commercial real estate market resulting from the COVID-19 pandemic. Total international revenues in the third quarter and first nine months of 2020 were comparable to the third quarter and first nine months of 2019, primarily as a result of higher volumes generated by ourCanada operations being offset by lower volumes from other international locations. Orders information for the three and nine months endedSeptember 30 is as follows: Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 Change % Change 2020 2019 Change % Change Opened Orders: Commercial 3,703 4,251 (548) (13) % 11,308 13,209 (1,901) (14) % Purchase 73,668 60,579 13,089 22 % 184,240 179,298 4,942 3 % Refinance 86,823 45,387 41,436 91 % 223,322 101,913 121,409 119 % Other 1,067 1,128 (61) (5) % 2,293 3,827 (1,534) (40) % Total 165,261 111,345 53,916 48 % 421,163 298,247 122,916 41 % Closed Orders: Commercial 3,799 3,956 (157) (4) % 10,556 11,809 (1,253) (11) % Purchase 52,407 46,080 6,327 14 % 123,548 124,994 (1,446) (1) % Refinance 56,027 27,834 28,193 101 % 138,909 59,831 79,078 132 % Other 555 604 (49) (8) % 1,316 2,555 (1,239) (48) % Total 112,788 78,474 34,314 44 % 274,329 199,189 75,140 38 % Gross revenues from independent agency operations increased$28.5 million , or 11%, and$102.2 million , or 15%, in the third quarter and first nine months of 2020, respectively, compared to the same periods last year, which was consistent with the improving real estate market trends and the continued return of agents after the FNF merger termination. Agency revenues, net of retention, increased$6.4 million , or 14%, and$19.6 million , or 16%, in the third quarter and first nine months of 2020, respectively, compared to the same periods in 2019, generally in line with the gross agency revenue change. Refer further to the "Retention by agencies" discussion under Expenses below. Ancillary services revenues. Ancillary services operating revenues for the third quarter and first nine months of 2020 increased$19.3 million , or 224%, and$13.9 million , or 45%, compared to the same periods in 2019.U.S. Appraisals, which we acquired during the late second quarter 2020, generated revenues of$24.2 million and$31.3 million in the third quarter and first nine months of 2020, respectively. These revenues were partially offset by lower revenues from our existing search and valuation services of$4.9 million and$17.1 million (both 57%) in the third quarter and first nine months of 2020, respectively, compared to the same periods in 2019, primarily driven by significantly lower orders from several customers. Investment income. Investment income for both the third quarter and first nine months of 2020 was generally comparable to the same periods in 2019, primarily as a result of increased dividend income offsetting the effect of reduced interest income due to the lower interest rates on our investments in 2020. 22 --------------------------------------------------------------------------------
Net realized and unrealized (losses) gains. Refer to Note 5 to the condensed consolidated financial statements.
Expenses. An analysis of expenses is shown below:
Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 Change % Change 2020 2019 Change % Change
($ in millions) ($ in millions)
Amounts retained by agencies 231.1 209.0 22.1 11 % 659.1 576.6 82.5 15 %
As a % of agency revenues 81.8 % 82.2 % 82.2 % 82.4 %
Employee costs 155.6 143.8 11.8 8 % 428.8 413.0 15.8 5 %
As a % of operating revenues 26.3 % 28.3 % 27.8 % 30.3 %
Other operating expenses 98.5 87.8 10.7 12 % 245.0 251.0 (6.0) (2) %
As a % of operating revenues 16.7 % 17.3 % 15.9 % 18.4 %
Title losses and related claims 28.4 21.1 7.4 35 % 68.6 55.5 13.1 24 %
As a % of title revenues 5.1 % 4.2 % 4.6 % 4.2 %
Retention by agencies. Amounts retained by title agencies are based on
agreements between agencies and our title underwriters. Amounts retained by
independent agencies, as a percentage of revenues generated by them, averaged
81.8% and 82.2% in the third quarter and first nine months of 2020,
respectively, as compared to 82.2% and 82.4% in the same periods in 2019. The
average retention percentage may vary from period to period due to the
geographical mix of agency operations, the volume of title revenues and, in some
states, laws or regulations. Due to the variety of such laws or regulations, as
well as competitive factors, the average retention rate can differ significantly
from state to state. In addition, a high proportion of our independent agencies
are in states with retention rates greater than 80%. We continue to focus on
increasing profit margins in every state, increasing premium revenue in states
where remittance rates are above 20%, and maintaining the quality of our agency
network, which we believe to be the industry's best, in order to mitigate claims
risk and drive consistent future performance. While market share is important in
our agency operations channel, it is not as important as margins, risk
mitigation and profitability.
Employee costs. Consolidated employee costs increased 8% and 5% in the third
quarter and first nine months of 2020, compared to the same periods in 2019,
primarily as a result of acquisitions and higher incentive compensation related
to improved overall operating results, partially offset by lower salaries
expenses resulting from an overall lower average employee count (excluding
acquisitions). Employee costs for the first nine months of 2020 were also
increased by severance expenses related to cost savings initiatives during the
second quarter 2020. Total employee costs for the third quarter and first nine
months of 2020 related to new acquisitions were $6.1 million and $6.6 million ,
respectively.
Excluding acquisitions, employee costs in the title segment in the third quarter
and first nine months of 2020 increased $6.3 million , or 5%, and $11.2 million ,
or 3%, respectively, primarily due to increased incentive compensation on
improved title revenues, partially offset by lower salaries expenses due to a
lower average employee count. Severance expenses related to cost savings
initiatives during the second quarter 2020 also contributed to the employee cost
increase during the first nine months of 2020 for the segment. Excluding U.S.
Appraisals, employee costs in the ancillary services and corporate segment
decreased $0.6 million and $1.9 million (both 11%) in the third quarter and
first nine months of 2020, respectively, compared to the same periods in 2019,
primarily due to lower salaries expenses resulting from a lower average employee
count.
As a percentage of total operating revenues, consolidated employee costs
improved to 26.3% and 27.8% in the third quarter and first nine months of 2020,
respectively, compared to 28.3% and 30.3% in the same periods in 2019, which
were primarily influenced by our continued focus on managing operating costs.
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Other operating expenses. Other operating expenses include costs that are fixed
in nature, costs that follow, to varying degrees, changes in transaction volumes
and revenues and costs that fluctuate independently of revenues. Costs that are
fixed in nature include attorney and professional fees, third-party outsourcing
provider fees, equipment rental, insurance, rent and other occupancy expenses,
repairs and maintenance, technology costs, telecommunications and title plant
expenses. Costs that follow, to varying degrees, changes in transaction volumes
and revenues include outside search and valuation fees, attorney fee splits, bad
debt expenses, copy supplies, delivery fees, postage, premium taxes and title
plant maintenance expenses. Costs that fluctuate independently of revenues
include general supplies, litigation defense, business promotion and marketing
and travel.
Consolidated other operating expenses increased 12% in the third quarter 2020
and decreased 2% in the first nine months of 2020, compared to the same periods
in 2019. Included in other operating expenses were $21.7 million and $27.7
million of expenses related to new acquisitions for the third quarter and first
nine months of 2020, respectively, which primarily consisted of outside
valuation fees by U.S. Appraisals. Also, during the third quarter and first nine
months of 2019, we incurred $1.0 million and $6.7 million , respectively, of
third-party advisory expenses recorded in the ancillary services and corporate
segment related to the terminated FNF merger transaction. Excluding acquisitions
and non-operating expenses, other operating expenses for the third quarter and
first nine months of 2020 decreased $10.0 million , or 12%, and $27.0 million , or
11%, respectively, compared to the same periods in 2019, and as a percentage of
operating revenues, were 13.8% and 14.5% in the third quarter and first nine
months of 2020, respectively, compared to 17.1% and 17.9% in the same prior year
periods.
Total costs that follow, to varying degrees, changes in transaction volumes and
revenues increased $17.5 million , or 43%, and $17.6 million , or 16%, in the
third quarter and first nine months of 2020, respectively, compared to the same
periods in 2019, mainly due to increased outside search and valuation fees
primarily resulting from U.S. Appraisals' revenues and increased premium taxes
consistent with higher direct title revenues. Excluding the non-operating
expenses above, total costs that are fixed in nature in the third quarter and
first nine months of 2020 decreased $2.1 million , or 6%, and $6.6 million , or
7%, respectively, compared to the same periods in 2019, primarily due to lower
rent and occupancy expenses. Total costs that fluctuate independently of
revenues decreased $3.6 million , or 31%, and $10.3 million , or 32%, in the third
quarter and first nine months of 2020, respectively, compared to the same
periods in 2019, primarily due to decreased marketing and travel expenses mainly
as a result of the COVID-19 pandemic.
Title losses. Provisions for title losses, as a percentage of title operating
revenues, were 5.1% and 4.6% for the third quarter and first nine months of
2020, respectively, compared to 4.2% for both the third quarter and first nine
months of 2019. Title loss expense increased $7.4 million and $13.1 million in
the third quarter and first nine months of 2020, respectively, compared to the
same periods in 2019. The title loss ratio in any given quarter can be
significantly influenced by changes in new large claims incurred, escrow losses
and adjustments to reserves for existing large claims.
The composition of title policy loss expense is as follows:
Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 Change % Change 2020 2019 Change % Change
($ in millions) ($ in millions)
Provisions - known claims:
Current year 3.0 4.1 (1.1) (27) % 7.6 8.4 (0.8) (10) %
Prior policy years 16.9 18.0 (1.1) (6) % 45.0 55.7 (10.7) (19) %
19.9 22.1 (2.2) (10) % 52.6 64.1 (11.5) (18) %
Provisions - IBNR
Current year 25.3 16.7 8.6 51 % 60.5 46.2 14.3 31 %
Prior policy years 0.1 0.3 (0.2) (67) % 0.5 0.9 (0.4) (44) %
25.4 17.0 8.4 49 % 61.0 47.1 13.9 30 %
Transferred from IBNR to known claims (16.9) (18.0) 1.1 (6) % (45.0) (55.7) 10.7 (19) %
Total provisions 28.4 21.1 7.4 35 % 68.6 55.5 13.1 24 %
24-------------------------------------------------------------------------------- Provisions for known claims arise primarily from prior policy years as claims are not typically reported until several years after policies are issued. Provisions - Incurred But Not Reported (IBNR) are estimates of claims expected to be incurred over the next 20 years; therefore, it is not unusual or unexpected to experience changes to those estimated provisions in both current and prior policy years as additional loss experience on policy years is obtained. This loss experience may result in changes to our estimate of total ultimate losses expected (i.e., the IBNR policy loss reserve). Current year provisions - IBNR are recorded on policies issued in the current year as a percentage of premiums earned (provisioning rate). As claims become known, provisions are reclassified from IBNR to known claims. Adjustments relating to large losses (those individually in excess of$1.0 million ) may impact provisions either for known claims or for IBNR. Total known claims provisions decreased in the third quarter and first nine months of 2020 compared to the same periods last year, primarily as a result of decreased dollar amounts of claims reported relating to both current and prior policy years. Current year IBNR provisions in the third quarter and first nine months of 2020 increased primarily due to increased title premiums in 2020, higher domestic loss provisioning rates due to the current economic and mortgage forbearance environment which is expected to result in increased defaults and title losses, and unfavorable loss development in certain coverages within our Canadian business. As a percentage of title operating revenues, provisions - IBNR for the current policy year were 4.5% and 4.0% in the third quarter and first nine months of 2020, respectively, compared with 3.3% and 3.5% in the third quarter and first nine months of 2019, respectively. Cash claim payments decreased$1.1 million , or 5%, and$7.8 million , or 12%, in the third quarter and first nine months of 2020, respectively, compared to the same periods in 2019, primarily due to lower payments on large and non-large claims relating to prior policy years. We continue to manage and resolve large claims prudently and in keeping with our commitments to our policyholders. In addition to title policy claims, we incur losses in our direct operations from escrow, closing and disbursement functions. These escrow losses typically relate to errors or other miscalculations of amounts to be paid at closing, including timing or amount of a mortgage payoff, payment of property or other taxes and payment of homeowners' association fees. Escrow losses also arise in cases of fraud, and in those cases, the title insurer incurs the loss under its obligation to ensure that an unencumbered title is conveyed. Escrow losses are recognized as expenses when discovered or when contingencies associated with them (such as litigation) are resolved and are typically paid less than 12 months after the loss is recognized. During both the first nine months of 2020 and 2019, we recorded approximately$1.0 million and$1.6 million , respectively, of policy loss expenses relating to escrow losses arising from fraud.
Total title policy loss reserve balances are as follows:
December 31,
September 30, 2020 2019
($ in millions)
Known claims 61.4 67.8
IBNR 405.4 391.3
Total estimated title losses 466.8 459.1
Title claims are generally incurred within the first nine years after policy
issuance and the timing of payments on these claims can significantly impact the
balance of known claims, since claims, in many cases, may be open for several
years before resolution and payment occur. As a result, the estimate of the
ultimate amount to be paid on any claim may be modified over that time period.
Due to the inherent uncertainty in predicting future title policy losses,
significant judgment is required by both our management and our third party
actuaries in estimating reserves. As a consequence, our ultimate liability may
be materially greater or less than current reserves and/or our third party
actuary's calculated estimates.
Depreciation and amortization. Depreciation and amortization expenses during the
third quarter and first nine months of 2020 decreased $0.6 million , or 10%, and
$4.0 million , or 23%, respectively, compared to the same periods in 2019. These
decreases were primarily due to certain information technology assets and fixed
assets, which became fully depreciated or were impaired during 2019, partially
offset by incremental intangible asset amortization expenses related to our U.S.
Appraisals acquisition which approximated $1.1 million for both the third
quarter and first nine months of 2020.
25
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Income taxes. Our effective tax rates for the third quarter and first nine
months of 2020 were 22% and 24%, respectively, based on income before taxes and
after deducting income attributable to noncontrolling interests, in comparison
with effective tax rates of 24% and 25% for the third quarter and first nine
months of 2019, respectively. The lower effective tax rates for the third
quarter and first nine months of 2020 primarily resulted from increased year
over year annualized pretax income and reductions in expected nondeductible
expenses in 2020.
LIQUIDITY AND CAPITAL RESOURCES
Our liquidity and capital resources reflect our ability to generate cash flow to meet our obligations to shareholders, customers (payments to satisfy claims on title policies), vendors, employees, lenders and others. As ofSeptember 30, 2020 , our cash and investments, including amounts reserved pursuant to statutory requirements, aggregated$1.1 billion ($496.7 million , net of statutory reserves on cash and investments). Of our total cash and investments atSeptember 30, 2020 ,$747.2 million ($411.5 million , net of statutory reserves) was held inthe United States and the rest internationally, principally inCanada . Cash held at the parent company totaled$31.3 million atSeptember 30, 2020 . As a holding company, the parent company is funded principally by cash from its subsidiaries in the form of dividends, operating and other administrative expense reimbursements and pursuant to intercompany tax sharing agreements. The expense reimbursements are paid in accordance with management agreements, approved by theTexas Department of Insurance (TDI), among us and our subsidiaries. In addition to funding operating expenses, cash held at the parent company is used for dividend payments to common stockholders and for stock repurchases, if any. To the extent such uses exceed cash available, the parent company is dependent on distributions from its regulated title insurance underwriter,Stewart Title Guaranty Company (Guaranty). A substantial majority of our consolidated cash and investments as ofSeptember 30, 2020 was held by Guaranty and its subsidiaries. The use and investment of these funds, dividends to the parent company, and cash transfers between Guaranty and its subsidiaries and the parent company are subject to certain legal and regulatory restrictions. In general, Guaranty may use its cash and investments in excess of its legally-mandated statutory premium reserve (established in accordance with requirements underTexas law) to fund its insurance operations, including claim payments. Guaranty may also, subject to certain limitations, provide funds to its subsidiaries (whose operations consist principally of field title offices and ancillary services operations) for their operating and debt service needs. We maintain investments in accordance with certain statutory requirements for the funding of statutory premium reserves. Statutory reserve funds are required to be fully funded and invested in high-quality securities and short-term investments. Statutory reserve funds are not available for current claim payments, which must be funded from current operating cash flow. Included in investments in debt and equity securities are statutory reserve funds of approximately$535.7 million and$483.4 million atSeptember 30, 2020 andDecember 31, 2019 , respectively. In addition, included within cash and cash equivalents are statutory reserve funds of approximately$21.1 million and$39.7 million atSeptember 30, 2020 andDecember 31, 2019 , respectively. As ofSeptember 30, 2020 , our known claims reserve totaled$61.4 million and our estimate of claims that may be reported in the future, under generally accepted accounting principles, totaled$405.4 million . In addition to this, we had cash and investments (excluding equity method investments) of$322.7 million , which are available for underwriter operations, including claims payments, and acquisitions. The ability of Guaranty to pay dividends to its parent is governed byTexas insurance law. The TDI must be notified of any dividend declared, and any dividend in excess of the statutory maximum of 20% of surplus (approximately$115.0 million as ofDecember 31, 2019 ) would be, by regulation, considered extraordinary and subject to pre-approval by the TDI. Also, theTexas Insurance Commissioner may raise an objection to a planned distribution during the notification period. Guaranty's actual ability or intent to pay dividends to its parent may be constrained by business and regulatory considerations, such as the impact of dividends on surplus and liquidity, which could affect its ratings and competitive position, the amount of insurance it can write and its ability to pay future dividends. During the nine months endedSeptember 30, 2020 , Guaranty paid a dividend of$30.0 million to its parent. 26 --------------------------------------------------------------------------------
As the parent company conducts no operations apart from its wholly-owned subsidiaries, the discussion below focuses on consolidated cash flows.
Nine Months Ended
2020 2019
($ in millions)
Net cash provided by operating activities 140.9 107.3
Net cash (used) provided by investing activities (156.1) 53.4
Net cash provided (used) by financing activities 66.7 (33.0)
Operating activities. Our principal sources of cash from operations are premiums
on title policies and revenue from title service-related transactions, ancillary
services and other operations. Our independent agencies remit cash to us net of
their contractual retention. Our principal cash expenditures for operations are
employee costs, operating costs and title claims payments.
Net cash provided by operations in the first nine months of 2020 improved by
$33.6 million , compared to the first nine months of 2019, primarily due to the
higher net income generated and lower claim payments. Also included in the net
cash provided by operations in 2019 was the $50.0 million FNF merger termination
fee. Although our business is labor intensive, we are focused on a
cost-effective, scalable business model which includes utilization of
technology, centralized back and middle office functions and business process
outsourcing. We are continuing our emphasis on cost management, especially in
light of the current economic environment due to the COVID-19 pandemic,
specifically focusing on lowering unit costs of production and improving
operating margins in our direct title and ancillary services businesses. Our
plans to improve margins include additional automation of manual processes, and
further consolidation of our various systems and production operations. We are
currently investing in the technology necessary to accomplish these goals.
Investing activities. Cash used and provided by investing activities is
primarily driven by proceeds from matured and sold investments, purchases of
investments, capital expenditures and acquisition of title offices and other
businesses. During the first nine months of 2020, total proceeds from securities
investments sold and matured were $72.4 million , compared to $65.6 million
during the same period in 2019. Cash used for purchases of securities
investments was $75.5 million during the first nine months of 2020, compared to
$2.2 million during the same period in 2019, when we invested more in cash
equivalents and short-term investments due to favorable interest rates.
During the first nine months of 2020, we used $146.5 million of cash for
acquisitions of certain title offices and U.S Appraisals; while during the first
nine months of 2020 and 2019, we used $10.5 million and $12.0 million ,
respectively, of cash for purchases of property and equipment. We maintain
investment in capital expenditures at a level that enables us to implement
technologies for increasing our operational and back-office efficiencies and to
pursue growth in key markets.
Financing activities and capital resources. During the third quarter 2020, we
generated net proceeds of approximately $109.0 million from an issuance of new
shares of Common Stock (refer also to Note 1-D to the condensed
consolidated financial statements). We used the proceeds primarily for the
acquisition of several title offices during the third quarter 2020. During the
first nine months of 2020 and 2019, we paid total dividends of $22.2 million and
$21.3 million , respectively, or $0.90 per common share for both periods.
Total debt and stockholders' equity were $101.3 million and $950.9 million ,
respectively, as of September 30, 2020 . Payments on notes payable during the
first nine months of 2020 and 2019 of $10.3 million and $23.9 million ,
respectively, and notes payable additions of $2.4 million and $23.5 million ,
respectively, were related to short-term loan agreements in connection with our
Section 1031 tax-deferred property exchange (Section 1031) business. At
September 30, 2020 , the outstanding balance of our line of credit facility was
$98.9 million , while the available balance of the line of credit was $98.6
million , net of an unused $2.5 million letter of credit. At September 30, 2020 ,
our debt-to-equity ratio, excluding our Section 1031 notes, was approximately
10.6%, below the 20% we have set as our unofficial internal limit on leverage.
27
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Effect of changes in foreign currency exchange rates. The effect of changes in
foreign currency exchange rates on our cash and cash equivalents on the
consolidated statements of cash flows was a net decrease of $0.5 million during
the first nine months of 2020 and a net increase of $1.2 million during the same
period in 2019. Our principal foreign operating unit is in Canada , and, on
average, the value of the Canadian dollar relative to the U.S. dollar
depreciated in 2020 and improved in 2019.
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We believe we have sufficient liquidity and capital resources to meet the cash
needs of our ongoing operations, including in the current economic and real
estate environment created by the COVID-19 pandemic. However, we may determine
that additional debt or equity funding is warranted to provide liquidity for
achievement of strategic goals or acquisitions or for unforeseen circumstances.
Other than scheduled maturities of debt, operating lease payments and
anticipated claims payments, we have no material contractual commitments. We
expect that cash flows from operations and cash available from our underwriters,
subject to regulatory restrictions, will be sufficient to fund our operations,
including claims payments. However, to the extent that these funds are not
sufficient, we may be required to borrow funds on terms less favorable than we
currently have or seek funding from the equity market, which may not be
successful or may be on terms that are dilutive to existing stockholders.
Contingent liabilities and commitments. See discussion of contingent liabilities and commitments in Note 10 to the condensed consolidated financial statements.
Other comprehensive income (loss). Unrealized gains and losses on available-for-sale debt securities investments and changes in foreign currency exchange rates are reported net of deferred taxes in accumulated other comprehensive income (loss), a component of stockholders' equity, until they are realized. During the first nine months of 2020, net unrealized investment gains of$14.8 million , net of taxes, which increased our other comprehensive income, were primarily related to a net increase in the fair values of our overall bond securities investment portfolio mainly driven by the effect of lower interest rates and partially offset by higher credit spreads. During the first nine months of 2019, net unrealized investment gains of$18.1 million , net of taxes, which increased our other comprehensive income, were primarily related to increases in the fair values of our overall bond securities investment portfolio driven by reduced interest rates and credit spreads. Changes in foreign currency exchange rates, primarily related to our Canadian andUnited Kingdom operations, decreased our other comprehensive income, net of taxes, by$3.4 million in the first nine months of 2020; while they increased our other comprehensive income, net of taxes, by$1.9 million for the same period in 2019. Off-balance sheet arrangements. We do not have any material source of liquidity or financing that involves off-balance sheet arrangements, other than our contractual obligations under operating leases. We also routinely hold funds in segregated escrow accounts pending the closing of real estate transactions and have qualified intermediaries in tax-deferred property exchanges for customers pursuant to Section 1031 of the Internal Revenue Code. The Company holds the proceeds from these transactions until a qualifying exchange can occur. In accordance with industry practice, these segregated accounts are not included on the balance sheet. See Note 16 in our 2019 Form 10-K. Forward -looking statements. Certain statements in this report are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements relate to future, not past, events and often address our expected future business and financial performance. These statements often contain words such as "expect," "anticipate," "intend," "plan," "believe," "seek," "will," "foresee" or other similar words. Forward-looking statements by their nature are subject to various risks and uncertainties that could cause our actual results to be materially different than those expressed in the forward-looking statements. These risks and uncertainties include, among other things, the volatility of economic conditions, including the duration and effects of the COVID-19 pandemic; adverse changes in the level of real estate activity; changes in mortgage interest rates, existing and new home sales, and availability of mortgage financing; our ability to respond to and implement technology changes, including the completion of the implementation of our enterprise systems; the impact of unanticipated title losses or the need to strengthen our policy loss reserves; any effect of title losses on our cash flows and financial condition; the ability to attract and retain highly productive sales associates; the impact of vetting our agency operations for quality and profitability; independent agency remittance rates; changes to the participants in the secondary mortgage market and the rate of refinancing that affects the demand for title insurance products; regulatory non-compliance, fraud or defalcations by our title insurance agencies or employees; 28
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our ability to timely and cost-effectively respond to significant industry changes and introduce new products and services; the outcome of pending litigation; the impact of changes in governmental and insurance regulations, including any future reductions in the pricing of title insurance products and services; our dependence on our operating subsidiaries as a source of cash flow; our ability to access the equity and debt financing markets when and if needed; our ability to grow our international operations; seasonality and weather; and our ability to respond to the actions of our competitors. These risks and uncertainties, as well as others, are discussed in more detail in our documents filed with theSecurities and Exchange Commission , including in Part I, Item 1A "Risk Factors" in our 2019 Form 10-K, as updated and supplemented in Part II, Item 1A of our Quarterly Report on Form 10-Q for the quarter endedJune 30, 2020 , and as maybe further updated and supplemented from time to time in our future Quarterly Reports on Form 10-Q, and our Current Reports on Form 8-K. All forward-looking statements included in this report are expressly qualified in their entirety by such cautionary statements. We expressly disclaim any obligation to update, amend or clarify any forward-looking statements contained in this report to reflect events or circumstances that may arise after the date hereof, except as may be required by applicable law.
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