First American(FAF) - 2018 Q4 - Annual Report

PART I Business First American Financial Corporation operates primarily in title insurance and services, heavily influenced by cyclical real estate markets and subject to extensive regulation - The company operates through two main segments: Title Insurance and Services, and Specialty Insurance. The Title Insurance and Services segment is the primary revenue driver, contributing 91.9% of consolidated revenues in 2018[14][16] - The Title Insurance and Services segment provides title insurance, closing/escrow services, and other real estate transaction-related products. This segment's business is distributed through both direct operations and a network of independent agents[16][29] - The Specialty Insurance segment offers property and casualty insurance for homeowners and renters, as well as home warranty products. The majority of its property and casualty policy liability is concentrated in the western U.S., with approximately 62% in California[46][47] - The company's international operations, part of the Title Insurance segment, accounted for approximately 5.6% of the segment's revenues in 2018, with a presence in Canada, the UK, South Korea, and Australia[35] - The company is subject to extensive regulation from state insurance departments, the Consumer Financial Protection Bureau (CFPB), and other federal and foreign agencies, which impacts operations, pricing, and affiliate transactions[49][50][55] - As of December 31, 2018, the company's investment portfolio consisted of 94% debt securities, with 97% of the debt portfolio rated as investment grade[59] - The company employed 18,251 people on a full-time or part-time basis as of December 31, 2018[62] Risk Factors The company faces significant risks from real estate market dependence, regulatory changes, data security threats, and potential investment portfolio losses - The company's business is substantially impacted by conditions in the real estate market; demand for its products decreases when interest rates rise, credit is limited, or real estate values decline[65] - Changes in government regulation, particularly from the Consumer Financial Protection Bureau (CFPB) and state insurance regulators, could limit operations, increase costs, or decrease demand for products[70][72] - Increasingly stringent data privacy laws, such as the California Consumer Privacy Act and GDPR, could impose significant compliance costs and potential liabilities[78] - A downgrade in the financial strength ratings of its title insurance underwriters could adversely affect the company's competitive position and results. The principal underwriter's ratings include 'A' from A.M. Best and 'A2' from Moody's[82] - Actual claims experience could materially differ from reserves. A 50 basis point change in the loss rates for the last six policy years would impact the IBNR reserve by approximately $122.4 million[84] - The company faces significant risks from system damage, failures, and cyber attacks, which could disrupt business and lead to the unauthorized disclosure of sensitive personal information[88][89] - As a holding company, its ability to pay dividends is dependent on distributions from its regulated insurance subsidiaries. For 2019, the maximum amount available for dividends from these subsidiaries without prior regulatory approval is $291.2 million[98] Unresolved Staff Comments The company reports that there are no unresolved staff comments from the Securities and Exchange Commission - Not applicable[101] Properties The company's principal executive offices are in Santa Ana, California, comprising a 490,000 square foot campus, with a portion securing a $19.2 million loan - The company's executive offices are in Santa Ana, California, consisting of a campus with five office buildings, a technology center, and a parking structure, totaling approximately 490,000 square feet[102] - Three office buildings on the campus are subject to a deed of trust securing a loan with an outstanding principal balance of $19.2 million as of December 31, 2018[102] Legal Proceedings The company is involved in non-ordinary course lawsuits and governmental examinations, with a potential $12.0 to $12.8 million Canadian excise tax assessment not expected to materially impact financial condition - The company faces several non-ordinary course lawsuits, primarily putative class actions, for which it is often not possible to assess the probability of loss or estimate a range of loss due to procedural hurdles and complex factual issues[107][108] - Specific pending lawsuits include allegations of improper debt collection, improper fees, failure to pay overtime, and improper handling of claims. None of these putative class actions have been certified[109][111] - Governmental agencies are conducting examinations into matters such as pricing practices, competition, and agency relationships in the title insurance industry[114] - The company anticipates a potential Canadian excise tax assessment ranging from $12.0 million to $12.8 million plus interest, but believes it is reasonably likely to prevail on appeal and has not recorded a liability[115] Mine Safety Disclosures The company reports that this item is not applicable - Not applicable[116] PART II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The company's common stock trades on the NYSE (FAF), with a $0.42 per share quarterly dividend declared and $163.6 million remaining in its share repurchase program - The company's common stock trades on the New York Stock Exchange (NYSE) under the ticker symbol FAF[119] - In January 2019, the board of directors declared a quarterly cash dividend of $0.42 per share. The company expects to continue paying quarterly dividends at or above this level, subject to board discretion[119] Share Repurchases in Q4 2018 | Period | Total Shares Purchased | Average Price Paid per Share | Maximum Dollar Value Remaining | |:---|---:|---:|---:| | Oct 2018 | 70,000 | $44.16 | $179,346,548 | | Nov 2018 | 153,739 | $44.94 | $172,437,668 | | Dec 2018 | 201,394 | $43.70 | $163,637,006 | | Total Q4 | 425,133 | $44.22 | $163,637,006 | - As of December 31, 2018, the company had the authority to repurchase an additional $163.6 million of its common stock under its publicly announced plan[121] Selected Financial Data This section presents a five-year summary of key consolidated financial data, highlighting $5.75 billion in total revenues and $475.9 million in net income for 2018 Selected Financial Data (2016-2018) | (in thousands, except per share data) | 2018 | 2017 | 2016 | |:---|---:|---:|---:| | Revenues | $5,747,844 | $5,772,363 | $5,575,846 | | Net income attributable to the Company | $474,496 | $423,049 | $342,993 | | Total assets | $10,630,635 | $9,573,222 | $8,831,777 | | Stockholders' equity | $3,741,881 | $3,479,955 | $3,008,179 | | Diluted EPS | $4.19 | $3.76 | $3.09 | | Cash dividends declared per share | $1.60 | $1.44 | $1.20 | Management's Discussion and Analysis of Financial Condition and Results of Operations Management discusses financial condition and results, covering critical accounting estimates, new accounting standards, segment performance, liquidity, capital resources, and contractual obligations Critical Accounting Estimates Critical accounting estimates include the provision for policy losses, fair value of investments, litigation contingencies, and goodwill impairment, with IBNR reserves sensitive to market conditions - The provision for policy losses is a critical estimate, determined by applying a loss provision rate to premiums and escrow fees. The IBNR reserve is based on actuarial analysis of historical claims experience and current economic trends[140][141] - The IBNR reserve is highly sensitive to changes in assumptions. A 50 basis point change in the expected ultimate loss rates for the last six policy years would result in a $122.4 million change to the IBNR reserve[147] Loss Reserve Summary (in thousands) | Category | Dec 31, 2018 | Dec 31, 2017 | |:---|---:|---:| | Known title claims | $80,306 | $83,094 | | IBNR title claims | $877,134 | $875,724 | | Total title claims | $957,440 | $958,818 | | Non-title claims | $85,239 | $70,115 | | Total loss reserves | $1,042,679 | $1,028,933 | - The company performs an annual goodwill impairment assessment. For 2018 and 2017, qualitative assessments were performed for the title insurance and home warranty units, while a quantitative test was done for the property and casualty unit. No impairment was recorded in 2018, 2017, or 2016[176] Recently Adopted and Pending Accounting Pronouncements New accounting standards adopted in 2018 led to a $40.6 million adjustment to retained earnings for equity securities, with a new lease standard in 2019 expected to add $350 million in lease liabilities - Effective January 1, 2018, the company adopted new guidance requiring equity investments to be measured at fair value with changes recognized in net income. This resulted in a cumulative-effect adjustment to retained earnings of $40.6 million (net of tax)[196] - The company adopted the new revenue recognition standard (ASC 606) using the modified retrospective approach, which did not have a material impact on its consolidated financial statements[198] - The company will adopt new lease accounting guidance on January 1, 2019, and expects to record right-of-use assets and lease liabilities of approximately $350 million on its balance sheet[204] Results of Operations Total revenues for 2018 decreased 0.4% to $5.7 billion, impacted by lower refinance volumes, while net income increased to $474.5 million due to a lower effective tax rate - Total revenues for 2018 were $5.7 billion, a decrease of 0.4% from 2017, driven by lower agent premiums and realized investment losses[206] - The mortgage market environment in 2018 saw a 6.6% decrease in residential mortgage originations, with purchase originations up 3.7% and refinance originations down 25.6%[207] - The Tax Cuts and Jobs Act of 2017 had a favorable impact on the company's effective tax rate in 2018 and is expected to continue to do so in the future[215] Consolidated Income Statement Highlights (2016-2018) | (in thousands) | 2018 | 2017 | 2016 | |:---|---:|---:|---:| | Total Revenues | $5,747,844 | $5,772,363 | $5,575,846 | | Income before income taxes | $609,538 | $445,331 | $477,581 | | Net income | $475,898 | $421,863 | $343,476 | | Net income attributable to the Company | $474,496 | $423,049 | $342,993 | Liquidity and Capital Resources The company maintains strong liquidity with $793.2 million cash from operations in 2018, $327.3 million holding company cash, and $540.0 million available on its credit facility, prioritizing dividends and share repurchases - Cash provided by operating activities totaled $793.2 million in 2018, compared to $632.1 million in 2017 and $489.4 million in 2016[262] - The company increased its quarterly cash dividend by 11% to $0.42 per share in August 2018[263] - Under its share repurchase plan, the company bought back 425,000 shares for $18.8 million in 2018. As of Dec 31, 2018, $163.6 million remained authorized for future repurchases[264] - The holding company's liquidity sources included $327.3 million in cash and $540.0 million available on its $700.0 million revolving credit facility as of December 31, 2018[268][269] Contractual Obligations Summary (as of Dec 31, 2018) | (in thousands) | Total | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | |:---|---:|---:|---:|---:|---:| | Notes and contracts payable | $735,038 | $165,384 | $10,031 | $259,507 | $300,116 | | Operating leases | $334,793 | $76,375 | $122,879 | $70,807 | $64,732 | | Deposits | $3,786,183 | $3,786,183 | - | - | - | | Claims losses | $1,042,679 | $273,255 | $222,635 | $151,442 | $395,347 | Quantitative and Qualitative Disclosures About Market Risk Primary market risks include interest rate, equity price, and credit risks; a 100 basis point rate increase could decrease debt portfolio fair value by $198 million, and a 10% equity decline by $33.9 million - The company's primary market risk exposures are interest rate risk, equity price risk, foreign currency risk, and credit risk[287] - A hypothetical 100 basis point increase in interest rates would cause the fair value of the debt securities portfolio to decrease by approximately $198 million, or 3.5%, as of December 31, 2018[290] - A hypothetical 10% broad-based decline in equity market prices would decrease the fair value of the company's equity securities portfolio by $33.9 million as of December 31, 2018[293] - The company's investment securities portfolio maintains an average credit quality of AA, with credit risk managed through monitoring and diversification[298] Financial Statements and Supplementary Data This section presents the audited consolidated financial statements for 2018 and prior years, including the Independent Auditor's Report, Balance Sheets, Income Statements, and Cash Flows - The Report of Independent Registered Public Accounting Firm, PricewaterhouseCoopers LLP, issued an unqualified opinion on the consolidated financial statements and the effectiveness of internal control over financial reporting as of December 31, 2018[306] Consolidated Balance Sheet Highlights (in thousands) | | Dec 31, 2018 | Dec 31, 2017 | |:---|---:|---:| | Total Assets | $10,630,635 | $9,573,222 | | Total Liabilities | $6,885,247 | $6,090,197 | | Total Stockholders' Equity | $3,741,881 | $3,479,955 | Consolidated Statement of Income Highlights (in thousands) | | 2018 | 2017 | 2016 | |:---|---:|---:|---:| | Total Revenues | $5,747,844 | $5,772,363 | $5,575,846 | | Income before income taxes | $609,538 | $445,331 | $477,581 | | Net Income | $475,898 | $421,863 | $343,476 | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure The company reports that there were no changes in or disagreements with its accountants on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure - None[661] Controls and Procedures As of December 31, 2018, the CEO and CFO concluded disclosure controls were effective, and management assessed internal control over financial reporting as effective with no material changes - The CEO and CFO concluded that the company's disclosure controls and procedures were effective as of December 31, 2018[662] - Management assessed the company's internal control over financial reporting as effective as of December 31, 2018, using the COSO framework[666] - There were no changes in internal control over financial reporting during the fourth quarter of 2018 that materially affected, or are reasonably likely to materially affect, these controls[668] Other Information On February 19, 2019, the company amended employment agreements for four executive officers, extending terms to December 31, 2021, and adding clawback provisions - The company entered into amended and restated employment agreements with four key executives on February 19, 2019[669] - Key changes to the agreements include extending the term by one year to December 31, 2021, and adding language to subject executive compensation to clawback, forfeiture, or recoupment[669] PART III Part III incorporates information by reference from the 2019 Proxy Statement, covering directors, executive officers, corporate governance, compensation, security ownership, and principal accountant fees Directors, Executive Officers and Corporate Governance Information required by this item is incorporated by reference from the company's 2019 Proxy Statement - The information required by this item will be set forth in the 2019 Proxy Statement and is incorporated herein by reference[673] Executive Compensation Information required by this item is incorporated by reference from the company's 2019 Proxy Statement - The information required by this item will be set forth in the 2019 Proxy Statement and is incorporated herein by reference[674] Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Information required by this item is incorporated by reference from the company's 2019 Proxy Statement - The information required by this item will be set forth in the 2019 Proxy Statement and is incorporated herein by reference[675] Certain Relationships and Related Transactions, and Director Independence Information required by this item is incorporated by reference from the company's 2019 Proxy Statement - The information required by this item will be set forth in the 2019 Proxy Statement and is incorporated herein by reference[676] Principal Accountant Fees and Services Information required by this item is incorporated by reference from the company's 2019 Proxy Statement - The information required by this item will be set forth in the 2019 Proxy Statement and is incorporated herein by reference[677] PART IV Exhibits and Financial Statement Schedules This section provides an index of all financial statements, schedules, and exhibits filed with the Form 10-K report, including corporate governance and material contracts - This section contains the index of all financial statements, schedules, and exhibits filed with the report[688] Form 10-K Summary The company indicates that no Form 10-K summary is provided - None[704]