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First American 10-Q 2012
Form 10-Q

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2012

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission file number 001-34580

 

 

FIRST AMERICAN FINANCIAL

CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Incorporated in Delaware   26-1911571

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

1 First American Way, Santa Ana, California   92707-5913
(Address of principal executive offices)   (Zip Code)

(714) 250-3000

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨ (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY

PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

Indicate by check mark whether the registrant has filed all documents and reports to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.    Yes  ¨    No  ¨

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

On April 20, 2012, there were 106,160,140 shares of common stock outstanding.

 

 

 


FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

INFORMATION INCLUDED IN REPORT

 

PART I:

   FINANCIAL INFORMATION      4   

Item 1.

   Financial Statements (unaudited)      4   
   A. Condensed Consolidated Balance Sheets as of March 31, 2012 and December 31, 2011      4   
  

B. Condensed Consolidated Statements of Income for the three months ended March 31, 2012 and 2011

     5   
  

C. Condensed Consolidated Statements of Comprehensive Income for the three months ended March 31, 2012 and 2011

     6   
  

D. Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2012 and 2011

     7   
   E. Condensed Consolidated Statement of Stockholders’ Equity for the three months ended March 31, 2012      8   
   F. Notes to Condensed Consolidated Financial Statements      9   

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      35   

Item 3.

   Quantitative and Qualitative Disclosures About Market Risk      45   

Item 4.

   Controls and Procedures      45   

PART II:

   OTHER INFORMATION      46   

Item 1.

   Legal Proceedings      46   

Item 1A.

   Risk Factors      49   

Item 6.

   Exhibits      54   

Items 2 through 5 of Part II have been omitted because they are not applicable with respect to the current reporting period.

 

2


CERTAIN STATEMENTS IN THIS QUARTERLY REPORT ON FORM 10-Q, INCLUDING BUT NOT LIMITED TO THOSE RELATING TO:

 

   

THE HOLDING OF AND EXPECTED CASH FLOWS FROM DEBT SECURITIES AND ASSUMPTIONS RELATING THERETO;

   

CORELOGIC INC.’S FUTURE PERFORMANCE AND THE COMPANY’S INTENTIONS WITH RESPECT TO ITS INVESTMENT IN CORELOGIC STOCK;

   

EXPECTED BENEFIT AND PENSION PLAN CONTRIBUTIONS;

   

THE EFFECT OF LAWSUITS, REGULATORY AUDITS AND INVESTIGATIONS AND OTHER LEGAL PROCEEDINGS ON THE COMPANY’S FINANCIAL CONDITION, RESULTS OF OPERATIONS OR CASH FLOWS;

   

THE EFFECT OF PENDING ACCOUNTING PRONOUNCEMENTS ON THE COMPANY’S FINANCIAL STATEMENTS;

   

THE IMPACT ON THE COMPANY OF UNCERTAINTY IN GENERAL ECONOMIC CONDITIONS AND TIGHT CREDIT MARKETS;

   

SAVINGS TO BE ACHIEVED THROUGH EXPENSE MANAGEMENT EFFORTS;

   

FUTURE ACTIONS TO BE TAKEN IN CONNECTION WITH THE COMPANY’S REVIEW OF ITS AGENCY RELATIONSHIPS;

   

EXPECTED FORECLOSURE VOLUMES, COSTS ASSOCIATED WITH DEFENDING INSURED’S TITLE TO FORECLOSED PROPERTIES, AND THE IMPACT OF FORECLOSURE MATTERS ON THE COMPANY;

   

THE REALIZATION OF TAX BENEFITS ASSOCIATED WITH CERTAIN LOSSES AND UNRECOGNIZED TAX BENEFIT ESTIMATES;

   

FUTURE PAYMENT OF DIVIDENDS;

   

THE SUFFICIENCY OF THE COMPANY’S RESOURCES TO SATISFY OPERATIONAL CASH REQUIREMENTS; AND

   

THE LIKELIHOOD OF CHANGES IN EXPECTED ULTIMATE LOSSES AND CORRESPONDING LOSS RATES,

ARE 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 MAY CONTAIN THE WORDS “BELIEVE,” “ANTICIPATE,” “EXPECT,” “PLAN,” “PREDICT,” “ESTIMATE,” “PROJECT,” “WILL BE,” “WILL CONTINUE,” “WILL LIKELY RESULT,” OR OTHER SIMILAR WORDS AND PHRASES.

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:

 

   

INTEREST RATE FLUCTUATIONS;

   

CHANGES IN THE PERFORMANCE OF THE REAL ESTATE MARKETS;

   

VOLATILITY IN THE CAPITAL MARKETS;

   

UNFAVORABLE ECONOMIC CONDITIONS;

   

IMPAIRMENTS IN THE COMPANY’S GOODWILL OR OTHER INTANGIBLE ASSETS;

   

FAILURES AT FINANCIAL INSTITUTIONS WHERE THE COMPANY DEPOSITS FUNDS;

   

CHANGES IN APPLICABLE GOVERNMENT REGULATIONS;

   

HEIGHTENED SCRUTINY BY LEGISLATORS AND REGULATORS OF THE COMPANY’S TITLE INSURANCE AND SERVICES SEGMENT AND CERTAIN OTHER OF THE COMPANY’S BUSINESSES;

   

REGULATION OF TITLE INSURANCE RATES;

   

REFORM OF GOVERNMENT-SPONSORED MORTGAGE ENTERPRISES;

   

LIMITATIONS ON ACCESS TO PUBLIC RECORDS AND OTHER DATA;

   

PRODUCT MIGRATION;

   

CHANGES RESULTING FROM INCREASES IN THE SIZE OF THE COMPANY’S CUSTOMERS;

   

CHANGES IN MEASURES OF THE STRENGTH OF THE COMPANY’S TITLE INSURANCE UNDERWRITERS, INCLUDING RATINGS AND STATUTORY SURPLUSES;

   

LOSSES IN THE COMPANY’S INVESTMENT PORTFOLIO;

   

EXPENSES OF AND FUNDING OBLIGATIONS TO THE PENSION PLAN;

   

MATERIAL VARIANCE BETWEEN ACTUAL AND EXPECTED CLAIMS EXPERIENCE;

   

DEFALCATIONS, INCREASED CLAIMS OR OTHER COSTS AND EXPENSES ATTRIBUTABLE TO THE COMPANY’S USE OF TITLE AGENTS;

   

SYSTEMS INTERRUPTIONS AND INTRUSIONS, WIRE TRANSFER ERRORS OR UNAUTHORIZED DATA DISCLOSURES;

   

INABILITY TO REALIZE THE BENEFITS OF THE COMPANY’S OFFSHORE STRATEGY;

   

INABILITY OF THE COMPANY’S SUBSIDIARIES TO PAY DIVIDENDS OR REPAY FUNDS; AND

   

OTHER FACTORS DESCRIBED IN PART II, ITEM 1A OF THIS QUARTERLY REPORT ON FORM 10-Q.

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.

 

3


PART I: FINANCIAL INFORMATION

 

Item 1. Financial Statements.

FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Condensed Consolidated Balance Sheets

(in thousands, except par values)

(unaudited)

 

     March 31,
2012
    December 31,
2011
 

Assets

    

Cash and cash equivalents

   $ 672,529      $ 418,299   

Accounts and accrued income receivable, net

     236,763        227,847   

Income taxes receivable

     —          20,431   

Investments:

    

Deposits with savings and loan associations and banks

     66,230        56,201   

Debt securities

     2,186,123        2,201,911   

Equity securities

     217,828        184,000   

Other long-term investments

     199,501        200,805   
  

 

 

   

 

 

 
     2,669,682        2,642,917   
  

 

 

   

 

 

 

Loans receivable, net

     130,431        139,191   

Property and equipment, net

     339,056        337,578   

Title plants and other indexes

     517,122        513,998   

Deferred income taxes

     44,893        39,617   

Goodwill

     832,412        818,420   

Other intangible assets, net

     57,811        59,994   

Other assets

     152,494        152,045   
  

 

 

   

 

 

 
   $ 5,653,193      $ 5,370,337   
  

 

 

   

 

 

 

Liabilities and Equity

    

Deposits

   $ 1,386,659      $ 1,093,236   

Accounts payable and accrued liabilities

     690,253        735,934   

Due to CoreLogic, Inc. (“CoreLogic”), net

     41,832        35,951   

Deferred revenue

     147,967        155,626   

Reserve for known and incurred but not reported claims

     992,719        1,014,676   

Income taxes payable

     24,594        —     

Notes and contracts payable

     276,684        299,975   
  

 

 

   

 

 

 
     3,560,708        3,335,398   
  

 

 

   

 

 

 

Commitments and contingencies (Note 15)

    

Stockholders’ equity:

    

Preferred stock, $0.00001 par value, Authorized-500 shares; Outstanding-none

     —          —     

Common stock, $0.00001 par value:

    

Authorized-300,000 shares; Outstanding-106,079 shares and 105,410 shares as of March 31, 2012 and December 31, 2011, respectively

     1        1   

Additional paid-in capital

     2,087,089        2,081,242   

Retained earnings

     147,446        124,816   

Accumulated other comprehensive loss

     (147,063     (177,459
  

 

 

   

 

 

 

Total stockholders’ equity

     2,087,473        2,028,600   

Noncontrolling interests

     5,012        6,339   
  

 

 

   

 

 

 

Total equity

     2,092,485        2,034,939   
  

 

 

   

 

 

 
   $ 5,653,193      $ 5,370,337   
  

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

4


FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Condensed Consolidated Statements of Income

(in thousands, except per share amounts)

(unaudited)

 

     For the Three Months Ended
March 31,
 
     2012     2011  

Revenues

    

Direct premiums and escrow fees

   $ 413,786      $ 361,094   

Agent premiums

     376,986        399,921   

Information and other

     155,760        150,758   

Investment income

     22,377        20,771   

Net realized investment gains (losses)

     456        (547

Net other-than-temporary impairment (“OTTI”) losses recognized in earnings:

    

Total OTTI losses on debt securities

     (240     (124

Portion of OTTI losses on debt securities recognized in other comprehensive loss

     (2,362     (173
  

 

 

   

 

 

 
     (2,602     (297
  

 

 

   

 

 

 
     966,763        931,700   
  

 

 

   

 

 

 

Expenses

    

Personnel costs

     305,279        283,302   

Premiums retained by agents

     302,164        319,987   

Other operating expenses

     189,150        190,390   

Provision for policy losses and other claims

     86,678        129,512   

Depreciation and amortization

     18,059        19,099   

Premium taxes

     10,848        9,043   

Interest

     3,035        3,816   
  

 

 

   

 

 

 
     915,213        955,149   
  

 

 

   

 

 

 

Income (loss) before income taxes

     51,550        (23,449

Income tax expense (benefit)

     20,441        (8,208
  

 

 

   

 

 

 

Net income (loss)

     31,109        (15,241

Less: Net (loss) income attributable to noncontrolling interests

     (184     94   
  

 

 

   

 

 

 

Net income (loss) attributable to the Company

   $ 31,293      $ (15,335
  

 

 

   

 

 

 

Net income (loss) per share attributable to the Company’s stockholders (Note 9):

    

Basic

   $ 0.30      $ (0.15
  

 

 

   

 

 

 

Diluted

   $ 0.29      $ (0.15
  

 

 

   

 

 

 

Cash dividends per share

   $ 0.08      $ 0.06   
  

 

 

   

 

 

 

Weighted-average common shares outstanding (Note 9):

    

Basic

     105,621        104,660   
  

 

 

   

 

 

 

Diluted

     107,480        104,660   
  

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

5


FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Condensed Consolidated Statements of Comprehensive Income

(in thousands)

(unaudited)

 

     For the Three Months Ended
March 31,
 
     2012     2011  

Net income (loss)

   $ 31,109      $ (15,241
  

 

 

   

 

 

 

Other comprehensive income (loss), net of tax:

    

Unrealized gain (loss) on securities

     20,374        (369

Unrealized gain on securities for which credit-related portion was recognized in earnings

     2,903        650   

Foreign currency translation adjustment

     5,865        4,319   

Pension benefit adjustment

     1,257        3,251   
  

 

 

   

 

 

 

Total other comprehensive income, net of tax

     30,399        7,851   
  

 

 

   

 

 

 

Comprehensive income (loss)

     61,508        (7,390

Less: Comprehensive (loss) income attributable to noncontrolling interests

     (181     175   
  

 

 

   

 

 

 

Comprehensive income (loss) attributable to the Company

   $ 61,689      $ (7,565
  

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

6


FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

 

     For the Three Months Ended
March 31,
 
     2012     2011  

Cash flows from operating activities:

    

Net income (loss)

   $ 31,109      $ (15,241

Adjustments to reconcile net income (loss) to cash used for operating activities:

    

Provision for policy losses and other claims

     86,678        129,512   

Depreciation and amortization

     18,059        19,099   

Excess tax benefits from share-based compensation

     —          (971

Share-based compensation

     6,148        5,011   

Net realized investment (gains) losses

     (456     547   

Net OTTI losses recognized in earnings

     2,602        297   

Equity in earnings of affiliates

     (1,839     (493

Dividends from equity method investments

     2,324        398   

Changes in assets and liabilities excluding effects of acquisitions and noncash transactions:

    

Claims paid, including assets acquired, net of recoveries

     (116,085     (117,413

Net change in income tax accounts

     32,716        (21,671

Increase in accounts and accrued income receivable

     (8,383     (4,383

Decrease in accounts payable and accrued liabilities

     (59,395     (57,646

Net change in due to CoreLogic, net

     (48     18,985   

Decrease in deferred revenue

     (7,758     (7,030

Other, net

     7,040        (477
  

 

 

   

 

 

 

Cash used for operating activities

     (7,288     (51,476
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Net cash effect of acquisitions/dispositions

     (14,000     —     

Purchase of subsidiary shares from / other decreases in noncontrolling interests

     —          (66

Net increase in deposits with banks

     (9,660     (13,253

Net decrease in loans receivable

     8,760        4,298   

Purchases of debt and equity securities

     (182,648     (210,206

Proceeds from sales of debt and equity securities

     101,310        74,303   

Proceeds from maturities of debt securities

     111,736        84,921   

Net (increase) decrease in other long-term investments

     (692     680   

Proceeds from note receivable from CoreLogic

     —          570   

Capital expenditures

     (18,172     (12,604

Proceeds from sale of property and equipment

     685        378   
  

 

 

   

 

 

 

Cash used for investing activities

     (2,681     (70,979
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Net change in deposits

     293,423        157,980   

Proceeds from issuance of debt

     53        185   

Repayment of debt

     (23,569     (3,335

Net payments in connection with share-based compensation plans

     (1,150     (2,317

Distributions to noncontrolling interests

     (506     (94

Excess tax benefits from share-based compensation

     —          971   

Cash dividends

     (6,328     (6,267
  

 

 

   

 

 

 

Cash provided by financing activities

     261,923        147,123   

Effect of exchange rate changes on cash

     2,276        1,863   
  

 

 

   

 

 

 

Net increase in cash and cash equivalents

     254,230        26,531   

Cash and cash equivalents—Beginning of period

     418,299        728,746   
  

 

 

   

 

 

 

Cash and cash equivalents—End of period

   $ 672,529      $ 755,277   
  

 

 

   

 

 

 

Supplemental information:

    

Cash paid (received) during the period for:

    

Interest

   $ 3,060      $ 3,718   

Premium taxes

   $ 16,095      $ 12,210   

Income taxes, net

   $ (11,989   $ 12,494   

Noncash investing and financing activities:

    

Net noncash contribution from The First American Corporation (“TFAC”) as a result of separation

   $ —        $ 5,581   

Liabilities assumed in connection with acquisitions

   $ 432      $ —     

See notes to condensed consolidated financial statements.

 

7


FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Condensed Consolidated Statement of Stockholders’ Equity

(in thousands)

(unaudited)

 

     First American Financial Corporation Stockholders              
     Shares      Common
stock
     Additional
paid-in
capital
    Retained
earnings
    Accumulated
other
comprehensive
loss
    Noncontrolling
interests
    Total  

Balance at December 31, 2011

     105,410       $ 1       $ 2,081,242      $ 124,816      $ (177,459   $ 6,339      $ 2,034,939   

Net income (loss) for three months ended March 31, 2012

     —           —           —          31,293        —          (184     31,109   

Dividends on common shares

     —           —           —          (8,482     —          —          (8,482

Shares issued in connection with share-based compensation plans

     669         —           (969     (181     —          —          (1,150

Share-based compensation expense

     —           —           6,148        —          —          —          6,148   

Purchase of subsidiary shares from /other decreases in noncontrolling interests

     —           —           668        —          —          (668     —     

Sale of subsidiary shares to /other increases in noncontrolling interests

     —           —           —          —          —          28        28   

Distributions to noncontrolling interests

     —           —           —          —          —          (506     (506

Other comprehensive income (Note 14)

     —           —           —          —          30,396        3        30,399   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at March 31, 2012

     106,079       $ 1       $ 2,087,089      $ 147,446      $ (147,063   $ 5,012      $ 2,092,485   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

8


FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 1 – Basis of Condensed Consolidated Financial Statements

Spin off

First American Financial Corporation (the “Company”) became a publicly traded company following its spin-off from its prior parent, The First American Corporation (“TFAC”), on June 1, 2010 (the “Separation”). On that date, TFAC distributed all of the Company’s outstanding shares to the record date shareholders of TFAC on a one-for-one basis (the “Distribution”). After the Distribution, the Company owned TFAC’s financial services businesses and TFAC, which reincorporated and assumed the name CoreLogic, Inc. (“CoreLogic”), continued to own its information solutions businesses.

Basis of Presentation

The condensed consolidated financial information included in this report has been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and Article 10 of Securities and Exchange Commission (“SEC”) Regulation S-X. The principles for condensed interim financial information do not require the inclusion of all the information and footnotes required by generally accepted accounting principles for complete financial statements. Therefore, these financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2011. The condensed consolidated financial statements included herein are unaudited; however, in the opinion of management, they contain all normal recurring adjustments necessary for a fair statement of the consolidated results for the interim periods. Certain 2011 amounts have been reclassified to conform to the 2012 presentation.

Recently Adopted Accounting Pronouncements

In October 2010, the Financial Accounting Standards Board (“FASB”) issued updated guidance related to accounting for costs associated with acquiring or renewing insurance contracts. The updated guidance modifies the definition of the types of costs incurred by insurance entities that can be capitalized in the acquisition of new and renewal contracts. Under the updated guidance only costs based on successful efforts (that is, acquiring a new or renewal contract) including direct-response advertising costs are eligible for capitalization. The updated guidance is effective for the interim and annual periods beginning after December 15, 2011. The adoption of the guidance, on a prospective basis, did not have a material impact on the Company’s condensed consolidated financial statements.

In May 2011, the FASB issued updated guidance that is intended to improve the comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with U.S. generally accepted accounting principles and International Financial Reporting Standards. The amendments are of two types: (i) those that clarify the FASB’s intent about the application of existing fair value measurement and disclosure requirements and (ii) those that change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. The updated guidance is effective for interim and annual periods beginning after December 15, 2011. Except for the disclosure requirements, the adoption of the guidance had no impact on the Company’s condensed consolidated financial statements.

In June 2011, the FASB issued updated guidance that is intended to increase the prominence of other comprehensive income in financial statements. The updated guidance eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity, and requires either consecutive presentation of the statement of net income and other comprehensive income or in a single continuous statement of comprehensive income. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2011. The adoption of the guidance had no impact on the Company’s condensed consolidated financial statements.

Pending Accounting Pronouncements

In December 2011, the FASB issued updated guidance requiring entities to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. The updated guidance is effective for interim and annual reporting periods beginning on or after January 1, 2013. Except for the disclosure requirements, management does not expect the adoption of this guidance to have a material impact on the Company’s condensed consolidated financial statements.

 

9


FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements - (Continued)

(Unaudited)

 

Note 2 – Escrow Deposits, Like-kind Exchange Deposits and Trust Assets

The Company administers escrow deposits and trust assets as a service to its customers. Escrow deposits totaled $4.1 billion and $3.1 billion at March 31, 2012 and December 31, 2011, respectively, of which $1.2 billion and $0.9 billion, respectively, were held at the Company’s federal savings bank subsidiary, First American Trust, FSB. The escrow deposits held at First American Trust, FSB, are included in the accompanying condensed consolidated balance sheets, in cash and cash equivalents and debt and equity securities, with offsetting liabilities included in deposits. The remaining escrow deposits were held at third-party financial institutions.

Trust assets totaled $3.0 billion and $2.8 billion at March 31, 2012 and December 31, 2011, respectively, and were held at First American Trust, FSB. 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. However, 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. As a result of holding these customers’ assets in escrow, the Company has ongoing programs for realizing economic benefits, including investment programs, borrowing agreements, and vendor services arrangements with various financial institutions. The effects of these programs are included in the condensed consolidated financial statements as income or a reduction in expense, as appropriate, 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 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 $721.5 million and $564.7 million at March 31, 2012 and December 31, 2011, respectively. The like-kind exchange deposits were 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 bank deposits with institutions insured by the Federal Deposit Insurance Corporation. The Company could be held contingently liable to the customer for the transfers of property, disbursements of proceeds and the return on the proceeds.

 

10


FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements - (Continued)

(Unaudited)

 

Note 3 – Debt and Equity Securities

The amortized cost and estimated fair value of investments in debt securities, all of which are classified as available-for-sale, are as follows:

 

     Amortized      Gross unrealized     Estimated     

Other-than-
temporary

impairments

 

(in thousands)

   cost      gains      losses     fair value      in AOCI  

March 31, 2012

             

U.S. Treasury bonds

   $ 109,035       $ 1,843       $ (816   $ 110,062       $ —     

Municipal bonds

     357,372         18,013         (674     374,711         —     

Foreign bonds

     224,883         2,186         (654     226,415         —     

Governmental agency bonds

     173,059         1,100         (373     173,786         —     

Governmental agency mortgage-backed securities

     989,290         9,207         (1,143     997,354         —     

Non-agency mortgage-backed securities (1)

     37,553         1,189         (7,805     30,937         29,727   

Corporate debt securities

     262,721         10,661         (524     272,858         —     
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 
   $ 2,153,913       $ 44,199       $ (11,989   $ 2,186,123       $ 29,727   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

December 31, 2011

             

U.S. Treasury bonds

   $ 71,995       $ 2,236       $ —        $ 74,231       $ —     

Municipal bonds

     329,935         19,272         (84     349,123         —     

Foreign bonds

     212,200         3,026         (206     215,020         —     

Governmental agency bonds

     195,784         1,970         (1     197,753         —     

Governmental agency mortgage-backed securities

     1,066,656         10,816         (925     1,076,547         —     

Non-agency mortgage-backed securities (1)

     42,089         478         (11,933     30,634         32,089   

Corporate debt securities

     248,921         10,420         (738     258,603         —     
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 
   $ 2,167,580       $ 48,218       $ (13,887   $ 2,201,911       $ 32,089   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) At March 31, 2012, the $37.6 million amortized cost is net of $2.6 million in other-than-temporary impairments determined to be credit related which have been recognized in earnings for the three months ended March 31, 2012. At December 31, 2011, the $42.1 million amortized cost is net of $9.1 million in other-than-temporary impairments determined to be credit related which have been recognized in earnings for the year ended December 31, 2011. At March 31, 2012, the $7.8 million gross unrealized losses include $7.1 million of unrealized losses for securities determined to be other-than-temporarily impaired and $0.7 million of unrealized losses for securities for which an other-than-temporary impairment has not been recognized. At December 31, 2011, the $11.9 million gross unrealized losses include $11.4 million of unrealized losses for securities determined to be other-than-temporarily impaired and $0.5 million of unrealized losses for securities for which an other-than-temporary impairment has not been recognized. The $29.7 million and $32.1 million other-than-temporary impairments recorded in accumulated other comprehensive income (“AOCI”) through March 31, 2012 and December 31, 2011, respectively, represent the amount of other-than-temporary impairment losses recognized in AOCI which, starting January 1, 2009, were not included in earnings due to the fact that the losses were not considered to be credit related. Other-than-temporary impairments were recognized in AOCI for non-agency mortgage-backed securities only.

 

11


FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements - (Continued)

(Unaudited)

 

The cost and estimated fair value of investments in equity securities, all of which are classified as available-for-sale, are as follows:

 

(in thousands)

   Cost      Gross unrealized     Estimated
fair value
 
      gains      losses    

March 31, 2012

          

Preferred stocks

   $ 7,098       $ 597       $ (3   $ 7,692   

Common stocks (1)

     225,127         6,817         (21,808     210,136   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 232,225       $ 7,414       $ (21,811   $ 217,828   
  

 

 

    

 

 

    

 

 

   

 

 

 

December 31, 2011

          

Preferred stocks

   $ 7,007       $ 678       $ (17   $ 7,668   

Common stocks (1)

     224,880         3,793         (52,341     176,332   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 231,887       $ 4,471       $ (52,358   $ 184,000   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

(1) CoreLogic common stock with a cost basis of $167.6 million at March 31, 2012 and December 31, 2011, and an estimated fair value of $145.8 million and $115.5 million at March 31, 2012 and December 31, 2011, respectively, is included in common stocks. In connection with the Separation, TFAC issued to the Company a number of shares of its common stock. Under the terms of the Separation and Distribution Agreement, if the Company chooses to dispose of 1% or more of CoreLogic’s outstanding common stock at a given date, the Company must first provide CoreLogic with the option to purchase the shares. The Company has agreed to dispose of the shares within five years after the Separation or to bear any adverse tax consequences arising as a result of holding the shares for a longer period.

The Company had the following net unrealized gains (losses) as of March 31, 2012 and December 31, 2011:

 

(in thousands)

   As of
March 31,
2012
    As of
December 31,
2011
 

Debt securities for which an other-than-temporary impairment has been recognized

   $ (5,873   $ (10,937

Debt securities—all other

     38,083        45,268   

Equity securities

     (14,397     (47,887
  

 

 

   

 

 

 
   $ 17,813      $ (13,556
  

 

 

   

 

 

 

Sales of debt and equity securities resulted in realized gains of $2.0 million and $0.7 million and realized losses of $0.1 million and $0.7 million for the three months ended March 31, 2012 and 2011, respectively.

 

12


FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements - (Continued)

(Unaudited)

 

The Company had the following gross unrealized losses as of March 31, 2012 and December 31, 2011:

 

     Less than 12 months     12 months or longer     Total  

(in thousands)

   Estimated
fair value
     Unrealized
losses
    Estimated
fair value
     Unrealized
losses
    Estimated
fair value
     Unrealized
losses
 

March 31, 2012

               

Debt securities:

               

U.S. Treasury bonds

   $ 44,552       $ (816   $ —         $ —        $ 44,552       $ (816

Municipal bonds

     34,495         (674     —           —          34,495         (674

Foreign bonds

     78,545         (654     —           —          78,545         (654

Governmental agency bonds

     49,028         (373     —           —          49,028         (373

Governmental agency mortgage-backed securities

     330,281         (890     39,156         (253     369,437         (1,143

Non-agency mortgage-backed securities

     —           —          23,059         (7,805     23,059         (7,805

Corporate debt securities

     36,852         (507     1,353         (17     38,205         (524
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total debt securities

     573,753         (3,914     63,568         (8,075     637,321         (11,989

Equity securities

     813         (14     145,791         (21,797     146,604         (21,811
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 574,566       $ (3,928   $ 209,359       $ (29,872   $ 783,925       $ (33,800
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

December 31, 2011

               

Debt securities:

               

U.S. Treasury bonds

   $ —         $ —        $ —         $ —        $ —         $ —     

Municipal bonds

     7,186         (43     1,896         (41     9,082         (84

Foreign bonds

     30,508         (206     690         —          31,198         (206

Governmental agency bonds

     13,828         (1     4,150         —          17,978         (1

Governmental agency mortgage-backed securities

     280,114         (793     43,835         (132     323,949         (925

Non-agency mortgage-backed securities

     —           —          26,500         (11,933     26,500         (11,933

Corporate debt securities

     40,682         (708     1,290         (30     41,972         (738
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total debt securities

     372,318         (1,751     78,361         (12,136     450,679         (13,887

Equity securities

     131,768         (52,358     —           —          131,768         (52,358
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 504,086       $ (54,109   $ 78,361       $ (12,136   $ 582,447       $ (66,245
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Substantially all securities in the Company’s non-agency mortgage-backed portfolio are senior tranches and all were investment grade at the time of purchase, however all have been downgraded below investment grade since purchase. The table below summarizes the composition of the Company’s non-agency mortgage-backed securities by collateral type, year of issuance and current credit ratings. Percentages are based on the amortized cost basis of the securities and credit ratings are based on Standard & Poor’s Ratings Services (“S&P”) and Moody’s Investor Service, Inc. (“Moody’s”) published ratings. If a security was rated differently by both rating agencies, the lower of the two ratings was selected. All amounts and ratings are as of March 31, 2012.

 

(in thousands, except percentages and number of securities)

   Number
of
Securities
     Amortized
Cost
     Estimated
Fair
Value
     Non-Investment
Grade/
Not Rated
 

Non-agency mortgage-backed securities:

           

Prime single family residential:

           

2007

     1       $ 5,371       $ 4,031         100.0

2006

     6         15,899         11,963         100.0

2005

     1         3,797         3,054         100.0

Alt-A single family residential:

           

2007

     2         12,486         11,889         100.0
  

 

 

    

 

 

    

 

 

    

 

 

 
     10       $ 37,553       $ 30,937         100.0
  

 

 

    

 

 

    

 

 

    

 

 

 

 

13


FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements - (Continued)

(Unaudited)

 

As of March 31, 2012, none of the non-agency mortgage-backed securities were on negative credit watch by S&P or Moody’s.

The amortized cost and estimated fair value of debt securities at March 31, 2012, by contractual maturities, are as follows:

 

000000 000000 000000 000000 000000

(in thousands)

   Due in one
year or less
     Due after
one
through
five
years
     Due after
five
through
ten
years
     Due after
ten years
     Total  

U.S. Treasury bonds

              

Amortized cost

     45,702         19,278         43,921         134         109,035   

Estimated fair value

     45,973         20,682         43,219         188         110,062   

Municipal bonds

              

Amortized cost

     2,131         102,850         139,977         112,414         357,372   

Estimated fair value

     2,158         106,599         148,652         117,302         374,711   

Foreign bonds

              

Amortized cost

     33,455         160,494         30,934         —           224,883   

Estimated fair value

     33,785         161,865         30,765         —           226,415   

Governmental agency bonds

              

Amortized cost

     2,343         83,363         69,862         17,491         173,059   

Estimated fair value

     2,376         83,726         69,751         17,933         173,786   

Corporate debt securities

              

Amortized cost

     5,137         103,615         134,485         19,484         262,721   

Estimated fair value

     5,190         106,697         140,737         20,234         272,858   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total debt securities excluding mortgage-backed securities

              

Amortized cost

     88,768         469,600         419,179         149,523         1,127,070   

Estimated fair value

     89,482         479,569         433,124         155,657         1,157,832   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total mortgage-backed securities

              

Amortized cost

                 1,026,843   

Estimated fair value

                 1,028,291   

Total debt securities

              

Amortized cost

                 2,153,913   

Estimated fair value

                 2,186,123   

Other-than-temporary impairment—debt securities

Although dislocations in the capital and credit markets have largely recovered, there continues to be volatility and disruption concerning certain vintages of non-agency mortgage-backed securities. The primary factors negatively impacting certain vintages of non-agency mortgage-backed securities include stringent borrowing guidelines that result in the inability of borrowers to refinance, high unemployment, continued declines in real estate values, uncertainty regarding the timing and effectiveness of governmental solutions and a general slowdown in economic activity. The Company determines if a non-agency mortgage-backed security in a loss position is other-than-temporarily impaired by comparing the present value of the cash flows expected to be collected from the security to its amortized cost basis. If the present value of the cash flows expected to be collected exceed the amortized cost of the security, the Company concludes that the security is not other-than-temporarily impaired. The Company performs this analysis on all non-agency mortgage-backed securities in its portfolio that are in an unrealized loss position. The methodology and key assumptions used in estimating the present value of cash flows expected to be collected are described below. For the securities that were determined not to be other-than-temporarily impaired at March 31, 2012, the present value of the cash flows expected to be collected exceeded the amortized cost of each security.

 

14


FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements - (Continued)

(Unaudited)

 

If the Company intends to sell a debt security in an unrealized loss position or determines that it is more likely than not that the Company will be required to sell a debt security before it recovers its amortized cost basis, the debt security is other-than-temporarily impaired and it is written down to fair value with all losses recognized in earnings. As of March 31, 2012, the Company does not intend to sell any debt securities in an unrealized loss position and it is not more likely than not that the Company will be required to sell debt securities before recovery of their amortized cost basis.

If the Company does not expect to recover the amortized cost basis of a debt security with declines in fair value (even if the Company does not intend to sell the debt security and it is not more likely than not that the Company will be required to sell the debt security before the recovery of its remaining amortized cost basis), the losses the Company considers to be the credit portion of the other-than-temporary impairment loss (“credit loss”) is recognized in earnings and the non-credit portion is recognized in other comprehensive income. The credit loss is the difference between the present value of the cash flows expected to be collected and the amortized cost basis of the debt security. The cash flows expected to be collected are discounted at the rate implicit in the security immediately prior to the recognition of the other-than-temporary impairment.

Expected future cash flows for debt securities are based on qualitative and quantitative factors specific to each security, including the probability of default and the estimated timing and amount of recovery. The detailed inputs used to project expected future cash flows may be different depending on the nature of the individual debt security. Specifically, the cash flows expected to be collected for each non-agency mortgage-backed security are estimated by analyzing loan-level detail to estimate future cash flows from the underlying assets, which are then applied to the security based on the underlying contractual provisions of the securitization trust that issued the security (e.g. subordination levels, remaining payment terms, etc.). The Company uses third-party software to determine how the underlying collateral cash flows will be distributed to each security issued from the securitization trust. The primary assumptions used in estimating future collateral cash flows are prepayment speeds, default rates and loss severity. In developing these assumptions, the Company considers the financial condition of the borrower, loan to value ratio, loan type and geographical location of the underlying property. The Company utilizes publicly available information related to specific assets, generally available market data such as forward interest rate curves and CoreLogic’s securities, loans and property data and market analytics tools.

The table below summarizes the primary assumptions used at March 31, 2012 in estimating the cash flows expected to be collected for these securities.

 

     Weighted average     Range

Prepayment speeds

     7.3   4.0% – 9.4%

Default rates

     7.4   2.5% – 13.1%

Loss severity

     29.7   7.7% – 46.2%

As a result of the Company’s security-level review, it recognized other-than-temporary impairments considered to be credit related on its non-agency mortgage-backed securities of $2.6 million in earnings for the three months ended March 31, 2012. It is possible that the Company could recognize additional other-than-temporary impairment losses on some securities it owns at March 31, 2012 if future events or information cause it to determine that a decline in value is other-than-temporary.

 

15


FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements - (Continued)

(Unaudited)

 

The following table presents the change in the credit portion of the other-than-temporary impairments recognized in earnings on debt securities for which a portion of the other-than-temporary impairments related to other factors was recognized in other comprehensive income (loss) for the three months ended March 31, 2012 and 2011.

 

     For the Three
Months Ended March 31,
 

(in thousands)

   2012      2011  

Credit loss on debt securities held at beginning of period

   $ 34,176       $ 25,108   

Addition to credit loss for which an other-than-temporary impairment was previously recognized

     2,602         297   

Addition to credit loss for which an other-than-temporary impairment was not previously recognized

     —           —     
  

 

 

    

 

 

 

Credit loss on debt securities held as of March 31

   $ 36,778       $ 25,405   
  

 

 

    

 

 

 

Other-than-temporary impairment—equity securities

When, in the Company’s opinion, a decline in the fair value of an equity security, including common and preferred stock, is considered to be other-than-temporary, such equity security is written down to its fair value. When assessing if a decline in value is other-than-temporary, the factors considered include the length of time and extent to which fair value has been below cost, the probability that the Company will be unable to collect all amounts due under the contractual terms of the security, the seniority of the securities, issuer-specific news and other developments, the financial condition and prospects of the issuer (including credit ratings), macro-economic changes (including the outlook for industry sectors, which includes government policy initiatives) and the Company’s ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery.

When an equity security has been in an unrealized loss position for greater than twelve months, the Company’s review of the security includes the above noted factors as well as the evidence, if any, that exists to support that the security will recover its value in the foreseeable future, typically within the next twelve months. If objective, substantial evidence does not indicate a likely recovery during that timeframe, the Company’s policy is that such losses are considered other-than-temporary and therefore an impairment loss is recorded. The Company did not record any other-than-temporary impairments related to its equity securities for the three months ended March 31, 2012 or 2011.

At March 31, 2012, the Company owned 8.9 million shares of CoreLogic common stock with a cost basis of $167.6 million and an estimated fair value of $145.8 million. The Company assessed its investment in CoreLogic for other-than-temporary impairment due to the fact that its investment has been in an unrealized loss position for greater than twelve months. Based on the factors considered, the Company’s opinion is that the decline in the fair value of CoreLogic’s common stock is not other-than-temporary; therefore, the unrealized loss of $21.8 million was recorded in accumulated other comprehensive loss on the Company’s condensed consolidated balance sheet. The factors considered by the Company include, but are not limited to, (i) the Company has the ability and intent to hold the common stock for a period of time sufficient to allow for recovery, (ii) CoreLogic’s financial results for the quarter ended December 31, 2011 were positive, (iii) the Company believes CoreLogic’s board of directors and management are focused on enhancing shareholder value, (iv) the Company believes improving economic and marketplace conditions will positively impact CoreLogic’s financial results, (v) the positive performance of CoreLogic’s common stock during the first quarter of 2012, and (vi) the favorable nature of a recent research report for CoreLogic from an independent securities analyst reflecting a twelve month price target that exceeds the Company’s carrying value. It is possible that the Company could recognize an other-than-temporary impairment related to its CoreLogic common stock if future events or information cause it to determine that the decline in value is other-than-temporary. The Company will continue to closely monitor and regularly review its investment in CoreLogic common stock.

 

16


FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements - (Continued)

(Unaudited)

 

Fair value measurement

The Company classifies the fair value of its debt and equity securities using a three-level hierarchy for fair value measurements that distinguishes between market participant assumptions developed based on market data obtained from sources independent of the reporting entity (observable inputs) and the reporting entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The hierarchy level assigned to each security in the Company’s available-for-sale portfolio is based on management’s assessment of the transparency and reliability of the inputs used in the valuation of such instrument at the measurement date. The three hierarchy levels are defined as follows:

Level 1 – Valuations based on unadjusted quoted market prices in active markets for identical securities. The fair value of equity securities are classified as Level 1.

Level 2 – Valuations based on observable inputs (other than Level 1 prices), such as quoted prices for similar assets at the measurement date; quoted prices in markets that are not active; or other inputs that are observable, either directly or indirectly. The Level 2 category includes U.S. Treasury bonds, municipal bonds, foreign bonds, governmental agency bonds, governmental agency mortgage-backed securities and corporate debt securities, many of which are actively traded and have market prices that are readily verifiable.

Level 3 – Valuations based on inputs that are unobservable and significant to the overall fair value measurement, and involve management judgment. The Level 3 category includes non-agency mortgage-backed securities which are currently not actively traded.

If the inputs used to measure fair value fall in different levels of the fair value hierarchy, a financial security’s hierarchy level is based upon the lowest level of input that is significant to the fair value measurement. The valuation techniques and inputs used to estimate the fair value of the Company’s debt and equity securities are summarized as follows:

Debt Securities

The fair value of debt securities was based on the market values obtained from an independent pricing service that were evaluated using pricing models that vary by asset class and incorporate available trade, bid and other market information and price quotes from well-established independent broker-dealers. The independent pricing service monitors market indicators, industry and economic events, and for broker-quoted only securities, obtains quotes from market makers or broker-dealers that it recognizes to be market participants. The pricing service utilizes the market approach in determining the fair value of the debt securities held by the Company. Additionally, the Company obtains an understanding of the valuation models and assumptions utilized by the service and has controls in place to determine that the values provided represent fair value. The Company’s validation procedures include comparing prices received from the pricing service to quotes received from other third party sources for securities with market prices that are readily verifiable. If the price comparison results in differences over a predefined threshold, the Company will assess the reasonableness of the changes relative to prior periods given the prevailing market conditions and assess changes in the issuers’ credit worthiness, performance of any underlying collateral and prices of the instrument relative to similar issuances. To date, the Company has not made any material adjustments to the fair value measurements provided by the pricing service.

Typical inputs and assumptions to pricing models used to value the Company’s U.S. Treasury bonds, governmental agency bonds, governmental agency mortgage-backed securities, municipal bonds, foreign bonds and corporate debt securities include, but are not limited to, benchmark yields, reported trades, broker-dealer quotes, credit spreads, credit ratings, bond insurance (if applicable), benchmark securities, bids, offers, reference data and industry and economic events. For mortgage-backed securities, inputs and assumptions may also include the structure of issuance, characteristics of the issuer, collateral attributes and prepayment speeds. The fair value of non-agency mortgage-backed securities was obtained from the independent pricing service referenced above and subject to the Company’s validation procedures discussed above. However, due to the fact that these securities were not actively traded, there was less observable inputs available requiring the pricing service to use more judgment in determining the fair value of the securities, therefore the Company classified non-agency mortgage-backed securities as Level 3.

The significant unobservable inputs used in the fair value measurement of the Company’s non-agency mortgage-backed securities are prepayment rates, default rates, and loss severity in the event of default. Significant increases (decreases) in any of those inputs in isolation would result in a significantly lower (higher) fair value measurement. Generally, a change in the assumption used for default rates is accompanied by a directionally similar change in the assumption used for the loss severity and a directionally opposite change in the assumption used for prepayment rates.

 

17


FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements - (Continued)

(Unaudited)

 

Equity Securities

The fair value of equity securities, including preferred and common stocks, were based on quoted market prices for identical assets that are readily and regularly available in an active market.

The following table presents the Company’s available-for-sale investments measured at fair value on a recurring basis as of March 31, 2012 and December 31, 2011, classified using the three-level hierarchy for fair value measurements:

 

(in thousands)

   Estimated fair value as
of March 31, 2012
     Level 1      Level 2      Level 3  

Debt securities:

           

U.S. Treasury bonds

   $ 110,062       $ —         $ 110,062       $ —     

Municipal bonds

     374,711         —           374,711         —     

Foreign bonds

     226,415         —           226,415         —     

Governmental agency bonds

     173,786         —           173,786         —     

Governmental agency mortgage-backed securities

     997,354         —           997,354         —     

Non-agency mortgage-backed securities

     30,937         —           —           30,937   

Corporate debt securities

     272,858         —           272,858         —     
  

 

 

    

 

 

    

 

 

    

 

 

 
     2,186,123         —           2,155,186         30,937   
  

 

 

    

 

 

    

 

 

    

 

 

 

Equity securities:

           

Preferred stocks

     7,692         7,692         —           —     

Common stocks

     210,136         210,136         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 
     217,828         217,828         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 2,403,951       $ 217,828       $ 2,155,186       $ 30,937   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(in thousands)

   Estimated fair value as
of December 31, 2011
     Level 1      Level 2      Level 3  

Debt securities:

           

U.S. Treasury bonds

   $ 74,231       $ —         $ 74,231       $ —     

Municipal bonds

     349,123         —           349,123         —     

Foreign bonds

     215,020         —           215,020         —     

Governmental agency bonds

     197,753         —           197,753         —     

Governmental agency mortgage-backed securities

     1,076,547         —           1,076,547         —     

Non-agency mortgage-backed securities

     30,634         —           —           30,634   

Corporate debt securities

     258,603         —           258,603         —     
  

 

 

    

 

 

    

 

 

    

 

 

 
     2,201,911         —           2,171,277         30,634   
  

 

 

    

 

 

    

 

 

    

 

 

 

Equity securities:

           

Preferred stocks

     7,668         7,668         —           —     

Common stocks

     176,332         176,332         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 
     184,000         184,000         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 2,385,911       $ 184,000       $ 2,171,277       $ 30,634   
  

 

 

    

 

 

    

 

 

    

 

 

 

The Company did not have any transfers in and out of Level 1 and Level 2 measurements during the three months ended March 31, 2012 and 2011. The Company’s policy is to recognize transfers between levels in the fair value hierarchy at the end of the reporting period.

 

18


FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements - (Continued)

(Unaudited)

 

The following table presents a summary of the changes in fair value of Level 3 available-for-sale investments for the three months ended March 31, 2012 and 2011:

 

     For the Three
Months Ended March 31,
 

(in thousands)

   2012     2011  

Fair value at beginning of period

   $ 30,634      $ 47,534   

Total gains/(losses) (realized and unrealized):

    

Included in earnings:

    

Realized losses

     —          —     

Net other-than-temporary impairment losses recognized in earnings

     (2,602     (297

Included in other comprehensive loss

     4,839        2,585   

Settlements

     (1,934     (3,452

Sales

     —          —     

Transfers into Level 3

     —          —     

Transfers out of Level 3

     —          —     
  

 

 

   

 

 

 

Fair value as of March 31

   $ 30,937      $ 46,370   
  

 

 

   

 

 

 

Unrealized gains (losses) included in earnings for the period relating to Level 3 available-for-sale investments that were still held at the end of the period:

    

Net other-than-temporary impairment losses recognized in earnings

   $ (2,602   $ (297
  

 

 

   

 

 

 

The Company did not purchase any non-agency mortgage-backed securities during the three months ended March 31, 2012 and 2011.

Note 4 – Financing Receivables

Financing receivables are summarized as follows:

 

     March 31,
2012
    December 31,
2011
 
     (in thousands)  

Loans receivable, net:

    

Real estate–mortgage

    

Multi-family residential

   $ 11,934      $ 12,028   

Commercial

     121,940        130,724   

Other

     1,396        1,403   
  

 

 

   

 

 

 
     135,270        144,155   

Allowance for loan losses

     (4,011     (4,171

Participations sold

     (851     (861

Deferred loan fees, net

     23        68   
  

 

 

   

 

 

 

Loans receivable, net

     130,431        139,191   
  

 

 

   

 

 

 

Other long-term investments:

    

Notes receivable–secured

     13,835        14,776   

Notes receivable–unsecured

     3,133        4,207   

Loss reserve

     (1,676     (3,402
  

 

 

   

 

 

 

Notes receivable, net

     15,292        15,581   
  

 

 

   

 

 

 

Total financing receivables, net

   $ 145,723      $ 154,772   
  

 

 

   

 

 

 

 

19


FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements - (Continued)

(Unaudited)

 

Aging analysis of loans and notes receivable at March 31, 2012, is as follows:

 

    Total     Current     30-59 days
past due
    60-89 days
past due
    90 days
or more
past due
    Nonaccrual
status
 
    (in thousands)  

Loans Receivable:

           

Multi-family residential

  $ 11,934      $ 11,934      $ —        $ —        $ —        $ —     

Commercial

    121,940        119,588        —          168        —          2,184   

Other

    1,396        1,396        —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
  $ 135,270      $ 132,918      $ —        $ 168      $ —        $ 2,184   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Notes Receivable:

           

Secured

  $ 13,835      $ 13,591      $ —        $ —        $ —        $ 244   

Unsecured

    3,133        2,071        —          —          —          1,062   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
  $ 16,968      $ 15,662      $ —        $ —        $ —        $ 1,306   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Aging analysis of loans and notes receivable at December 31, 2011, is as follows:

 

    Total     Current     30-59 days
past due
    60-89 days
past due
    90 days
or more
past due
    Nonaccrual
status
 
    (in thousands)  

Loans Receivable:

           

Multi-family residential

  $ 12,028      $ 12,028      $ —        $ —        $ —        $ —     

Commercial

    130,724        123,736        1,918        170        —          4,900   

Other

    1,403        1,403        —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
  $ 144,155      $ 137,167      $ 1,918      $ 170      $ —        $ 4,900   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Notes Receivable:

           

Secured

  $ 14,776      $ 10,712      $ —        $ —        $ —        $ 4,064  

Unsecured

    4,207        108        —          —          —          4,099  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
  $ 18,983      $ 10,820      $ —        $ —        $ —        $ 8,163   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The Company performs an analysis of its allowance for loan losses on a quarterly basis. In determining the allowance, the Company considers various factors, such as changes in lending policies and procedures, changes in the nature and volume of the portfolio, changes in the trend of the volume and severity of past due and classified loans, changes to the concentration of credit, as well as changes in legal and regulatory requirements. The allowance for loan losses is maintained at a level that is considered appropriate by the Company to provide for known risks in its portfolio.

Loss reserves are established for notes receivable based upon an estimate of probable losses for the individual notes. A loss reserve is established on an individual note when it is deemed probable that the Company will be unable to collect all amounts due in accordance with the contractual terms of the note. The loss reserve is based upon the Company’s assessment of the borrower’s overall financial condition, resources and payment record; and, if appropriate, the realizable value of any collateral. These estimates consider all available evidence including the expected future cash flows, estimated fair value of collateral on secured notes, general economic conditions and trends, and other relevant factors, as appropriate. Notes are placed on non-accrual status when management determines that the collectibility of contractual amounts is not reasonably assured.

 

20


FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements - (Continued)

(Unaudited)

 

Note 5 – Goodwill

A reconciliation of the changes in the carrying amount of goodwill by operating segment, for the three months ended March 31, 2012, is as follows:

 

(in thousands)

   Title
Insurance
and Services
     Specialty
Insurance
     Total  

Balance as of December 31, 2011

   $ 771,655       $ 46,765       $ 818,420   

Acquisitions

     12,642         —           12,642   

Other net adjustments

     1,350         —           1,350   
  

 

 

    

 

 

    

 

 

 

Balance as of March 31, 2012

   $ 785,647       $ 46,765       $ 832,412   
  

 

 

    

 

 

    

 

 

 

The Company’s four reporting units for purposes of testing impairment are title insurance, home warranty, property and casualty insurance and trust and other services. There is no accumulated impairment for goodwill as the Company has never recognized any impairment for its reporting units.

In accordance with accounting guidance and consistent with prior years, the Company’s policy is to perform an annual goodwill impairment test for each reporting unit in the fourth quarter. An impairment analysis has not been performed during the three months ended March 31, 2012 as no triggering events requiring such an analysis occurred.

Note 6 – Other Intangible Assets

Other intangible assets consist of the following:

 

(in thousands)

   March 31,
2012
    December 31,
2011
 

Finite-lived intangible assets:

    

Customer lists

   $ 70,080      $ 69,763   

Covenants not to compete

     26,274        29,441   

Trademarks

     10,067        9,551   

Patents

     2,840        2,840   
  

 

 

   

 

 

 
     109,261        111,595   

Accumulated amortization

     (69,304     (69,397
  

 

 

   

 

 

 
     39,957        42,198   

Indefinite-lived intangible assets:

    

Licenses

     17,854        17,796   
  

 

 

   

 

 

 
   $ 57,811      $ 59,994   
  

 

 

   

 

 

 

Amortization expense for finite-lived intangible assets was $2.9 million and $3.6 million for the three months ended March 31, 2012 and 2011, respectively.

Estimated amortization expense for finite-lived intangible assets anticipated for the next five years is as follows:

 

Year

   (in thousands)  

Remainder of 2012

   $ 8,588   

2013

   $ 10,740   

2014

   $ 6,584   

2015

   $ 3,531   

2016

   $ 2,557   

2017

   $ 1,116   

 

21


FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements - (Continued)

(Unaudited)

 

Note 7 – Loss Reserves

A summary of the Company’s loss reserves, broken down into its components of known title claims, incurred but not reported claims (“IBNR”) and non-title claims, follows:

 

(in thousands, except percentages)

   March 31, 2012     December 31, 2011  

Known title claims

   $ 150,463         15.1   $ 162,019         15.9

IBNR

     806,828         81.3     816,603         80.5
  

 

 

    

 

 

   

 

 

    

 

 

 

Total title claims

     957,291         96.4     978,622         96.4

Non-title claims

     35,428         3.6     36,054         3.6
  

 

 

    

 

 

   

 

 

    

 

 

 

Total loss reserves

   $ 992,719         100.0   $ 1,014,676         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

The provision for title insurance losses was $52.2 million, or 7.2% of title premiums and escrow fees, and $96.4 million, or 13.9% of title premiums and escrow fees, for the three months ended March 31, 2012 and 2011, respectively. The current quarter rate of 7.2% reflected an ultimate loss rate of 6.2% for the current policy year and included $7.2 million in net unfavorable development for prior policy years, primarily 2007 and 2008. Approximately $4.3 million of the net unfavorable development related to the Company’s guaranteed valuation product offered in Canada. There is substantial uncertainty as to the ultimate loss emergence for this product due to the following factors, among others, (i) claims associated with this product are generally made only after a foreclosure on the related property and foreclosure rates in Canada are difficult to predict and (ii) limited historical loss data exists as a result of the relatively recent introduction of this product in 2003. While the Company believes its claims reserve attributable to this product is adequate, because of this uncertainty, the potential for adverse loss development relative to this product is significantly higher than for title insurance. The first quarter of 2011 rate of 13.9% reflected an ultimate loss rate of 5.2% for the 2011 policy year, a $45.3 million reserve strengthening adjustment related to the guaranteed valuation product offered in Canada, and a $14.6 million charge which reflected adverse development for certain prior policy years.

Note 8 – Income Taxes

The Company’s effective income tax rate (income tax expense as a percentage of income before income taxes) was 39.7% for the three months ended March 31, 2012 and 35.0% for the same period of the prior year. The differences between the U.S. federal statutory rate of 35% and the effective rates were primarily attributable to losses in foreign jurisdictions for which no tax benefit was provided, and the impact of state taxes.

In connection with the Separation, the Company and TFAC entered into a Tax Sharing Agreement, dated June 1, 2010 (the “Tax Sharing Agreement”), which governs the Company’s and CoreLogic’s respective rights, responsibilities and obligations for certain tax related matters. At March 31, 2012 and December 31, 2011 the Company had a payable to CoreLogic of $2.5 million related to these matters which is included in due to CoreLogic, net on the Company’s condensed consolidated balance sheets.

At March 31, 2012 and December 31, 2011, the Company had a net payable to CoreLogic of $41.3 million and $35.4 million, respectively, related to tax matters prior to the Separation. This amount is included in the Company’s condensed consolidated balance sheet in due to CoreLogic, net.

The Company evaluates the realizability of its deferred tax assets by assessing its valuation allowance and by adjusting the amount of such allowance, if necessary. The factors used to assess the likelihood of realization are the Company’s forecast of future taxable income and available tax planning strategies that could be implemented to realize the deferred tax assets. Failure to achieve forecasted taxable income in the applicable taxing jurisdictions could affect the ultimate realization of deferred tax assets and could result in an increase in the Company’s effective tax rate on future earnings.

During the current quarter, the Company released a valuation allowance of $5.3 million previously recorded against certain of its deferred tax assets. Specifically, management determined that it is more likely than not that all its tax capital loss items will be realized prior to expiration as the result of favorable market value activity in its equity securities portfolio during the current quarter. Application of the accounting guidance related to intraperiod tax allocations resulted in the valuation allowance being released to other comprehensive income and tax expense, in the amounts of $4.5 million and $0.8 million, respectively.

The Company continues to monitor the realizability of recognized losses, impairment losses, and unrecognized losses, for which there is no associated valuation allowance, recorded through March 31, 2012. The Company believes it is more likely than not that the tax benefits associated with those losses will be realized. However, this determination is a judgment and could be impacted by further market fluctuations, among other factors.

As of March 31, 2012 and December 31, 2011, the liability for income taxes associated with uncertain tax positions was $51.1 million and $17.3 million, respectively. The increase in the liability as of March 31, 2012 was primarily attributable to the Company’s claim for a timing adjustment in a prior-year tax return. The liabilities could be reduced by $35.9 million and $2.9 million, respectively, of offsetting tax benefits associated with the correlative effects of potential adjustments including timing adjustments and state income taxes. The net amounts of $15.2 million and $14.4 million, respectively, if recognized, would favorably affect the Company’s effective tax rate.

 

22


FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements - (Continued)

(Unaudited)

 

The Company’s continuing practice is to recognize interest and penalties, if any, related to uncertain tax positions in tax expense. As of March 31, 2012 and December 31, 2011, the Company had accrued $3.8 million and $3.6 million, respectively, of interest and penalties (net of tax benefits) related to uncertain tax positions.

It is reasonably possible that the amount of the unrecognized benefit with respect to certain of the Company’s unrecognized tax positions may significantly increase or decrease within the next 12 months. These changes may be the result of items such as ongoing audits or the expiration of federal and state statute of limitations for the assessment of taxes. The Company estimates that there will be no increase or decrease in unrecognized tax benefits within the next 12 months.

The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction, various state jurisdictions, and various non-U.S. jurisdictions. The primary non-federal jurisdictions are California, Oregon, Michigan, Texas, Canada, and the United Kingdom. The Company is no longer subject to U.S. federal, state, and non-U.S. income tax examinations by taxing authorities for years prior to 2005.

Note 9 – Earnings Per Share

The following table presents the calculation of basic and diluted net income (loss) per share:

 

     For the Three Months Ended
March 31,
 

(in thousands, except per share amounts)

   2012      2011  

Numerator

     

Net income (loss) attributable to the Company

   $ 31,293       $ (15,335

Less: dividends and undistributed earnings allocated to unvested restricted stock units

     92         —     
  

 

 

    

 

 

 

Net income (loss) allocated to common stockholders

   $ 31,201       $ (15,335
  

 

 

    

 

 

 

Denominator

     

Basic weighted-average shares

     105,621         104,660   

Effect of dilutive employee stock options and restricted stock units

     1,859         —     
  

 

 

    

 

 

 

Diluted weighted-average shares

     107,480         104,660   
  

 

 

    

 

 

 

Net income (loss) per share attributable to the Company’s stockholders

     

Basic

   $ 0.30       $ (0.15
  

 

 

    

 

 

 

Diluted

   $ 0.29       $ (0.15
  

 

 

    

 

 

 

Restricted stock units (“RSUs”) granted by the Company generally have graded vesting, include a service condition and receive dividend equivalents. Certain unvested RSUs contain nonforfeitable rights to dividends as they are eligible to participate in undistributed earnings without meeting service condition requirements. These awards are considered participating securities under the guidance which require the use of the two-class method when computing basic and diluted earnings per share. The two-class method reduces earnings allocated to common stockholders by dividends and undistributed earnings allocated to participating securities. For the three months ended March 31, 2011, the two-class method was not applicable for purposes of calculating earnings per share as restricted stock units do not participate in net losses of the Company.

For the three months ended March 31, 2012, 1.5 million stock options and RSUs were excluded from the weighted-average diluted shares outstanding due to their antidilutive effect.

For the three months ended March 31, 2011, 3.0 million potential dilutive shares of common stock (representing all potential dilutive shares) were excluded from the weighted-average diluted shares outstanding due to the net loss for the period.

 

23


FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements - (Continued)

(Unaudited)

 

Note 10 – Employee Benefit Plans

Net periodic cost related to the Company’s defined benefit pension and supplemental benefit plans during the three months ended March 31, 2012 and 2011 includes the following components:

 

     For the Three Months Ended
March 31,
 

(in thousands)

   2012     2011  

Expense:

    

Service cost

   $ 428      $ 557   

Interest cost

     7,434        7,578   

Expected return on plan assets

     (3,787     (3,845

Amortization of prior service credit

     (1,096     (1,096

Amortization of net loss

     6,825        6,514   
  

 

 

   

 

 

 
   $ 9,804      $ 9,708   
  

 

 

   

 

 

 

The Company contributed $7.1 million to the defined benefit pension and supplemental benefit plans during the three months ended March 31, 2012, and expects to contribute an additional $27.2 million during the remainder of 2012. These contributions include both those required by funding regulations as well as discretionary contributions necessary to provide benefit payments to participants of certain of the Company’s non-qualified supplemental benefit plans.

Note 11 – Fair Value of Financial Instruments

Guidance requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practical to estimate that value. In the measurement of the fair value of certain financial instruments, other valuation techniques were utilized if quoted market prices were not available. These derived fair value estimates are significantly affected by the assumptions used. Additionally, the guidance excludes certain financial instruments including those related to insurance contracts, pension and other postretirement benefits, and equity method investments.

In estimating the fair value of the financial instruments presented, the Company used the following methods and assumptions:

Cash and cash equivalents

The carrying amount for cash and cash equivalents is a reasonable estimate of fair value due to the short-term maturity of these investments.

Accounts and accrued income receivable, net

The carrying amount for accounts and accrued income receivable, net is a reasonable estimate of fair value due to the short-term maturity of these assets.

Loans receivable, net

The fair value of loans receivable, net was estimated based on the discounted value of the future cash flows using the current rates being offered for loans with similar terms to borrowers of similar credit quality.

Investments

The carrying amount of deposits with savings and loan associations and banks is a reasonable estimate of fair value due to their short-term nature.

The methodology for determining the fair value of debt and equity securities is discussed in Note 3 Debt and Equity Securities to the condensed consolidated financial statements.

The fair value of notes receivable, net is estimated based on the discounted value of the future cash flows using approximate current market rates being offered for notes with similar maturities and similar credit quality.

 

24


FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements - (Continued)

(Unaudited)

 

Deposits

The carrying value of escrow and passbook accounts approximates fair value due to the short-term nature of this liability. The fair value of investment certificate accounts was estimated based on the discounted value of future cash flows using a discount rate approximating current market rates for similar liabilities.

Accounts payable and accrued liabilities

The carrying amount for accounts payable and accrued liabilities is a reasonable estimate of fair value due to the short-term maturity of these liabilities. The Company did not include the carrying amounts and fair values of pension costs and other retirement plans as the guidance excludes them from disclosure.

Due to CoreLogic, net

The carrying amount for due to CoreLogic, net is a reasonable estimate of fair value due to the short-term maturity of this liability.

Notes and contracts payable

The fair values of notes and contracts payable were estimated based on the current rates offered to the Company for debt of the same remaining maturities.

The carrying amounts and fair values of the Company’s financial instruments as of March 31, 2012 and December 31, 2011 are presented in the following table:

 

     March 31, 2012      December 31, 2011  

(in thousands)

   Carrying
Amount
     Fair Value      Carrying
Amount
     Fair Value  

Financial Assets:

           

Cash and cash equivalents

   $ 672,529       $ 672,529       $ 418,299       $ 418,299   

Accounts and accrued income receivable, net

   $ 236,763       $ 236,763       $ 227,847       $ 227,847   

Loans receivable, net

   $ 130,431       $ 137,210       $ 139,191       $ 144,868   

Investments:

           

Deposits with savings and loan associations and banks

   $ 66,230       $ 66,230       $ 56,201       $ 56,201   

Debt securities

   $ 2,186,123       $ 2,186,123       $ 2,201,911       $ 2,201,911   

Equity securities

   $ 217,828       $ 217,828       $ 184,000       $ 184,000   

Notes receivable, net

   $ 15,292       $ 14,280       $ 15,581       $ 14,534   

Financial Liabilities:

           

Deposits

   $ 1,386,659       $ 1,387,185       $ 1,093,236       $ 1,093,771   

Accounts payable and accrued liabilities

   $ 259,855       $ 259,855       $ 303,478       $ 303,478   

Due to CoreLogic, net

   $ 41,832       $ 41,832       $ 35,951       $ 35,951   

Notes and contracts payable

   $ 276,684       $ 281,841       $ 299,975       $ 304,806   

 

25


FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements - (Continued)

(Unaudited)

 

The following table presents the fair value of the Company’s financial instruments as of March 31, 2012 and December 31, 2011, classified using the three-level hierarchy for fair value measurements:

 

(in thousands)

   Fair Value as of
March 31, 2012
     Level 1      Level 2      Level 3  

Financial Assets:

           

Cash and cash equivalents

   $ 672,529       $ 672,529      $ —         $ —     

Accounts and accrued income receivable, net

   $ 236,763       $ 236,763       $ —         $ —     

Loans receivable, net

   $ 137,210       $ —         $ —        $ 137,210  

Investments:

           

Deposits with savings and loan associations and banks

   $ 66,230       $ 66,230      $ —        $  

Debt securities

   $ 2,186,123       $ —         $ 2,155,186       $ 30,937   

Equity securities

   $ 217,828       $ 217,828      $ —         $ —     

Notes receivable, net

   $ 14,280       $ —         $ —         $ 14,280   

Financial Liabilities:

           

Deposits

   $ 1,387,185       $ 1,345,147       $ 42,038       $ —     

Accounts payable and accrued liabilities

   $ 259,855       $ 259,855       $ —         $ —     

Due to CoreLogic, net

   $ 41,832       $ 41,832       $ —         $ —     

Notes and contracts payable

   $ 281,841       $ —         $ 268,906       $ 12,935   

 

(in thousands)

   Fair Value as of
December 31, 2011
     Level 1      Level 2      Level 3  

Financial Assets:

           

Cash and cash equivalents

   $ 418,299       $ 418,299       $ —         $ —     

Accounts and accrued income receivable, net

   $ 227,847       $ 227,847       $ —         $ —     

Loans receivable, net

   $ 144,868       $ —         $ —         $ 144,868   

Investments:

           

Deposits with savings and loan associations and banks

   $ 56,201       $ 56,201       $ —         $ —     

Debt securities

   $ 2,201,911       $ —         $ 2,171,277       $ 30,634   

Equity securities

   $ 184,000       $ 184,000       $ —         $ —     

Notes receivable, net

   $ 14,534       $ —         $ —         $ 14,534   

Financial Liabilities:

           

Deposits

   $ 1,093,771       $ 1,049,464       $ 44,307       $ —    

Accounts payable and accrued liabilities

   $ 303,478       $ 303,478       $ —         $ —     

Due to CoreLogic, net

   $ 35,951       $ 35,951       $ —         $ —    

Notes and contracts payable

   $ 304,806       $ —         $ 291,178       $ 13,628   

Note 12 – Share-Based Compensation Plans

The following table presents the share-based compensation expense associated with the Company’s share-based compensation plans for the three months ended March 31, 2012 and 2011:

 

     For the Three Months Ended
March 31,
 

(in thousands)

   2012      2011  

Restricted stock units

   $ 5,886       $ 4,703   

Stock options

     —           9   

Employee stock purchase plan

     262         230   
  

 

 

    

 

 

 
   $ 6,148       $ 4,942   
  

 

 

    

 

 

 

The following table summarizes RSU activity for the three months ended March 31, 2012:

 

(in thousands, except weighted-average grant-date fair value)

   Shares     Weighted-average
grant-date
fair value
 

RSUs unvested at December 31, 2011

     3,141      $ 12.83   

Granted during 2012

     683      $ 15.48   

Vested during 2012

     (869   $ 14.53   

Forfeited during 2012

     (55   $ 8.63   
  

 

 

   

 

 

 

RSUs unvested at March 31, 2012

     2,900      $ 13.02   
  

 

 

   

 

 

 

 

26


FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements - (Continued)

(Unaudited)

 

The following table summarizes stock option activity for the three months ended March 31, 2012:

 

(in thousands, except weighted-average exercise price and contractual term)

   Number
outstanding
    Weighted-
average
exercise price
     Weighted-
average
remaining
contractual term
     Aggregate
intrinsic
value
 

Balance at December 31, 2011

     2,636      $ 14.89         

Exercised during 2012

     (95   $ 10.08         

Forfeited during 2012

     (23   $ 19.96         
  

 

 

   

 

 

       

Balance at March 31, 2012

     2,518      $ 15.02         2.4       $ 6,660   
  

 

 

   

 

 

    

 

 

    

 

 

 

Vested at March 31, 2012

     2,518      $ 15.02         2.4       $ 6,660   
  

 

 

   

 

 

    

 

 

    

 

 

 

Exercisable at March 31, 2012

     2,518      $ 15.02         2.4       $ 6,660   
  

 

 

   

 

 

    

 

 

    

 

 

 

All stock options issued under the Company’s plans are vested and no share-based compensation expense related to such stock options remains to be recognized.

Note 13 – Stockholders’ Equity

In March 2011, the Company’s board of directors approved a stock repurchase plan which authorizes the repurchase of up to $150.0 million of the Company’s common stock. Purchases may be made from time to time by the Company in the open market at prevailing market prices or in privately negotiated transactions. The Company did not repurchase any shares of its common stock during the three months ended March 31, 2012. As of March 31, 2012, the Company had repurchased and retired 203,900 shares of its common stock for a total purchase price of $2.5 million.

Note 14 – Other Comprehensive Income (Loss)

Comprehensive income is a more inclusive financial reporting methodology that includes disclosure of certain financial information that historically has not been recognized in the calculation of net income.

 

27


FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements - (Continued)

(Unaudited)

 

Components of other comprehensive income (loss) for the three months ended March 31, 2012 are as follows:

 

(in thousands)

   Net unrealized
gains (losses)
on securities
    Foreign
currency
translation
adjustment
     Pension
benefit
adjustment
    Accumulated
other
comprehensive
income (loss)
 

Balance at December 31, 2011

   $ (13,409   $ 4,793       $ (168,837   $ (177,453

Pretax change

     26,529        5,865         2,096        34,490   

Pretax change in other-than-temporary impairments for which credit-related portion was recognized in earnings

     4,839        —           —          4,839   

Tax effect

     (8,091     —           (839     (8,930
  

 

 

   

 

 

    

 

 

   

 

 

 

Balance at March 31, 2012

   $ 9,868      $ 10,658       $ (167,580   $ (147,054
  

 

 

   

 

 

    

 

 

   

 

 

 

Allocated to the Company

   $ 9,859      $ 10,658       $ (167,580   $ (147,063

Allocated to noncontrolling interests

     9        —           —          9   
  

 

 

   

 

 

    

 

 

   

 

 

 

Balance at March 31, 2012

   $ 9,868      $ 10,658       $ (167,580   $ (147,054
  

 

 

   

 

 

    

 

 

   

 

 

 

Note 15 – Litigation and Regulatory Contingencies

The Company and its subsidiaries are parties to a number of non-ordinary course lawsuits. Frequently these lawsuits are similar in nature to other lawsuits pending against the Company’s competitors.

For those non-ordinary course lawsuits where the Company has determined that a loss is both probable and reasonably estimable, a liability representing the best estimate of the Company’s financial exposure based on known facts has been recorded. Actual losses may materially differ from the amounts recorded.

For a substantial majority of these lawsuits, however, it is not possible to assess the probability of loss. Most of these lawsuits are putative class actions which require a plaintiff to satisfy a number of procedural requirements before proceeding to trial. These requirements include, among others, demonstration to a court that the law proscribes in some manner the Company’s activities, the making of factual allegations sufficient to suggest that the Company’s activities exceeded the limits of the law and a determination by the court—known as class certification—that the law permits a group of individuals to pursue the case together as a class. If these procedural requirements are not met, either the lawsuit cannot proceed or, as is the case with class certification, the plaintiffs lose the financial incentive to proceed with the case (or the amount at issue effectively becomes de minimus). Frequently, a court’s determination as to these procedural requirements is subject to appeal to a higher court. As a result of, among other factors, ambiguities and inconsistencies in the myriad laws applicable to the Company’s business and the uniqueness of the factual issues presented in any given lawsuit, the Company often cannot determine the probability of loss until a court has finally determined that a plaintiff has satisfied applicable procedural requirements.

Furthermore, because most of these lawsuits are putative class actions, it is often impossible to estimate the possible loss or a range of loss amounts, even where the Company has determined that a loss is reasonably possible. Generally class actions involve a large number of people and the effort to determine which people satisfy the requirements to become plaintiffs—or class members—is often time consuming and burdensome. Moreover, these lawsuits raise complex factual issues which result in uncertainty as to their outcome and, ultimately, make it difficult for the Company to estimate the amount of damages which a plaintiff might successfully prove. In addition, many of the Company’s businesses are regulated by various federal, state, local and foreign governmental agencies and are subject to numerous statutory guidelines. These regulations and statutory guidelines often are complex, inconsistent or ambiguous, which results in additional uncertainty as to the outcome of a given lawsuit—including the amount of damages a plaintiff might be afforded—or makes it difficult to analogize experience in one case or jurisdiction to another case or jurisdiction.

Most of the non-ordinary course lawsuits to which the Company and its subsidiaries are parties challenge practices in the Company’s title insurance business, though a limited number of cases also pertain to the Company’s other businesses. These lawsuits include, among others, cases alleging, among other assertions, that the Company, one of its subsidiaries and/or one of its agents:

 

   

charged an improper rate for title insurance in a refinance transaction, including

 

   

Boucher v. First American Title Insurance Company, filed on May 16, 2007 and pending in the United States District Court for the Western District of Washington,

 

28


FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements - (Continued)

(Unaudited)

 

   

Hamilton v. First American Title Insurance Company, filed on August 22, 2007 and pending in the United States District Court for the Northern District of Texas,

 

   

Hamilton v. First American Title Insurance Company, et al., filed on August 25, 2008 and pending in the Superior Court of the State of North Carolina, Wake County,

 

   

Haskins v. First American Title Insurance Company, filed on September 29, 2010 and pending in the United States District Court of New Jersey,

 

   

Johnson v. First American Title Insurance Company, filed on May 27, 2008 and pending in the United States District Court of Arizona,

 

   

Lang v. First American Title Insurance Company of New York, filed on March 9, 2012 and pending in the United States District Court of New York,

 

   

Levine v. First American Title Insurance Company, filed on February 26, 2009 and pending in the United States District Court of Pennsylvania,

 

   

Lewis v. First American Title Insurance Company, filed on November 28, 2006 and pending in the United States District Court for the District of Idaho,

 

   

Loef v. First American Title Insurance Company, filed on August 16, 2008 and pending in the United States District Court of Maine,

 

   

Raffone v. First American Title Insurance Company, filed on February 14, 2004 and pending in the Circuit Court, Nassau County, Florida, and

 

   

Slapikas v. First American Title Insurance Company, filed on December 19, 2005 and pending in the United States District Court for the Western District of Pennsylvania.

All of these lawsuits are putative class actions. A court has only granted class certification in Loef, Hamilton (North Carolina), Johnson, Lewis, Raffone and Slapikas. An appeal to a higher court is pending with respect to the granting of class certification in Hamilton (North Carolina). For the reasons stated above, the Company has been unable to assess the probability of loss or estimate the possible loss or the range of loss or, where the Company has been able to make an estimate, the Company believes the amount is immaterial to the financial statements as a whole.

 

   

purchased minority interests in title insurance agents as an inducement to refer title insurance underwriting business to the Company or gave items of value to title insurance agents and others for referrals of business, in each case in violation of the Real Estate Settlement Procedures Act, including

 

   

Edwards v. First American Financial Corporation, filed on June 12, 2007 and pending in the United States District Court for the Central District of California, and

 

   

Galiano v. First American Title Insurance Company, et al., filed on February 8, 2008 and pending in the United States District Court for the Eastern District of New York.

Galiano is a putative class action for which a class has not been certified. In Edwards a narrow class has been certified. The United States Supreme Court is reviewing whether the Edwards plaintiff has the legal right to sue. For the reasons stated above, the Company has been unable to assess the probability of loss or estimate the possible loss or the range of loss.

 

   

conspired with its competitors to fix prices or otherwise engaged in anticompetitive behavior, including

 

29


FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements - (Continued)

(Unaudited)

 

   

Holt v. First American Title Insurance Company, et al., filed March 11, 2008 and pending in the United States District Court for the Eastern District of Pennsylvania,

 

   

Katz v. First American Title Insurance Company, et al., filed March 18, 2008 and pending in the United States District Court for the Northern District of Ohio,

 

   

McCray v. First American Title Insurance Company, et al., filed October 15, 2008 and pending in the United States District Court of Delaware, and

 

   

Swick v. First American Title Insurance Company, et al., filed March 19, 2008, and pending in the United States District Court of New Jersey.

All of these lawsuits are putative class actions for which a class has not been certified. For the reasons described above, the Company has not yet been able to assess the probability of loss or estimate the possible loss or the range of loss.

 

   

engaged in the unauthorized practice of law, including

 

   

Gale v. First American Title Insurance Company, et al., filed on October 16, 2006 and pending in the United States District Court of Connecticut, and

 

   

Katin v. First American Signature Services, Inc., et al., filed on May 9, 2007 and pending in the United States District Court of Massachusetts.

Katin is a putative class action for which a class has not been certified. A class has been certified in Gale, however the Company’s motion to decertify the class is pending. For the reasons described above, the Company has not yet been able to assess the probability of loss or estimate the possible loss or the range of loss.

 

   

misclassified employees and failed to pay overtime, including

 

   

Bartko v. First American Title Insurance Company, filed on November 8, 2011, and pending in the Superior Court of the State of California, Los Angeles.

Bartko is a putative class action for which a class has not been certified. For the reasons described above, the Company has not yet been able to assess the probability of loss or estimate the possible loss or the range of loss.

 

   

overcharged or improperly charged fees for products and services provided in connection with the closing of real estate transactions, denied home warranty claims, recorded telephone calls, acted as an unauthorized trustee and gave items of value to developers, builders and others as inducements to refer business in violation of certain other laws, such as consumer protection laws and laws generally prohibiting unfair business practices, and certain obligations, including

 

   

Carrera v. First American Home Buyers Protection Corporation, filed on September 23, 2009 and pending in the Superior Court of the State of California, County of Los Angeles,

 

   

Chassen v. First American Financial Corporation, et al., filed on January 22, 2009 and pending in the United States District Court of New Jersey,

 

   

Coleman v. First American Home Buyers Protection Corporation, et al., filed on August 24, 2009 and pending in the Superior Court of the State of California, County of Los Angeles,

 

   

Eberhard v. First American Title Insurance Company, et al., filed on April 4, 2011 and pending in the Court of Common Pleas Cuyahoga County, Ohio,

 

   

Eide v. First American Title Company, filed on February 26, 2010 and pending in the Superior Court of the State of California, County of Kern,

 

30


FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements - (Continued)

(Unaudited)

 

   

Gunning v. First American Title Insurance Company, filed on July 14, 2008 and pending in the United States District Court for the Eastern District of Kentucky,

 

   

Kaufman v. First American Financial Corporation, et al., filed on December 21, 2007 and pending in the Superior Court of the State of California, County of Los Angeles,

 

   

Kirk v. First American Financial Corporation, filed on June 15, 2006 and pending in the Superior Court of the State of California, County of Los Angeles,

 

   

Sjobring v. First American Financial Corporation, et al., filed on February 25, 2005 and pending in the Superior Court of the State of California, County of Los Angeles,

 

   

Smith v. First American Title Insurance Company, filed on November 23, 2011 and pending in the United States District Court for the Western District of Washington,

 

   

Tavenner v. Talon Group, filed on August 18, 2009 and pending in the United States District Court for the Western District of Washington, and

 

   

Wilmot v. First American Financial Corporation, et al., filed on April 20, 2007 and pending in the Superior Court of the State of California, County of Los Angeles.

All of these lawsuits, except Sjobring and Tavenner, are putative class actions for which a class has not been certified. In Sjobring a class was certified but that certification was subsequently vacated. In Tavenner, the Company has filed a notice of appeal of the class certification. For the reasons described above, the Company has not yet been able to assess the probability of loss or estimate the possible loss or the range of loss.

While some of the lawsuits described above may be material to the Company’s operating results in any particular period if an unfavorable outcome results, the Company does not believe that any of these lawsuits will have a material adverse effect on the Company’s overall financial condition or liquidity.

The Company also is a party to non-ordinary course lawsuits other than those described above. With respect to these lawsuits, the Company has determined either that a loss is not probable or that the possible loss or range of loss is not material to the financial statements as a whole.

The Company’s title insurance, property and casualty insurance, home warranty, banking, thrift, trust and investment advisory businesses are regulated by various federal, state and local governmental agencies. Many of the Company’s other businesses operate within statutory guidelines. Consequently, the Company may from time to time be subject to audit or investigation by such governmental agencies. Currently, governmental agencies are auditing or investigating certain of the Company’s operations. These audits or investigations include inquiries into, among other matters, pricing and rate setting practices in the title insurance industry, competition in the title insurance industry, real estate settlement service customer acquisition and retention practices and agency relationships. With respect to matters where the Company has determined that a loss is both probable and reasonably estimable, the Company has recorded a liability representing its best estimate of the financial exposure based on known facts. While the ultimate disposition of each such audit or investigation is not yet determinable, the Company does not believe that individually or in the aggregate they will have a material adverse effect on the Company’s financial condition, results of operations or cash flows. These audits or investigations could, however, result in changes to the Company’s business practices which could ultimately have a material adverse impact on the Company’s financial condition, results of operations or cash flows.

The Company and its subsidiaries also are involved in numerous ongoing routine legal and regulatory proceedings related to their operations. While the ultimate disposition of each proceeding is not determinable, the ultimate resolution of any of such proceedings, individually or in the aggregate, could have a material adverse effect on the Company’s financial condition, results of operations or cash flows in the period of disposition.

 

31


FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements - (Continued)

(Unaudited)

 

Note 16 – Segment Information

The Company consists of the following reportable segments and a corporate function:

 

   

The Company’s title insurance and services segment issues title insurance policies on residential and commercial property in the United States and offers similar products and services internationally. This segment also provides escrow and closing services; accommodates tax-deferred exchanges of real estate; maintains, manages and provides access to title plant records and images and provides banking, trust and investment advisory services. The Company, through its principal title insurance subsidiary and such subsidiary’s affiliates, transacts its title insurance business through a network of direct operations and agents. Through this network, the Company issues policies in the 49 states that permit the issuance of title insurance policies and the District of Columbia. The Company also offers title insurance and other insurance and guarantee products, as well as related settlement services, either directly or through joint ventures in foreign countries, including Canada, the United Kingdom and various other established and emerging markets.

 

   

The Company’s specialty insurance segment issues property and casualty insurance policies and sells home warranty products. The property and casualty insurance business provides insurance coverage to residential homeowners and renters for liability losses and typical hazards such as fire, theft, vandalism and other types of property damage. This business is licensed to issue policies in all 50 states and actively issues policies in 43 states. In its largest market, California, it also offers preferred risk auto insurance to better compete with other carriers offering bundled home and auto insurance. The home warranty business provides residential service contracts that cover residential systems and appliances against failures that occur as the result of normal usage during the coverage period. This business currently operates in 39 states and the District of Columbia.

The corporate division consists of certain financing facilities as well as the corporate services that support the Company’s business operations. Eliminations consist of inter-segment revenues and related expenses included in the results of the operating segments.

During the first quarter of 2012, the Company changed the allocation of certain expenses within its reportable segments and corporate division to reflect the performance of the Company’s reportable segments as reported to the chief operating decision maker. The expenses that were impacted as a result of the change in allocation include shared services expenses, benefit plan expense and interest expense. Prior period segment data has been reclassified to conform to the current presentation. For the three months ended March 31, 2011, income before income taxes for the Company’s reportable segments were impacted as follows: increase of $2.9 million to the title insurance and services segment, increase of $0.2 million to the specialty insurance segment, and decrease of $3.1 million to the corporate division.

Selected financial information by reporting segment is as follows:

For the three months ended March 31, 2012:

 

(in thousands)

   Revenues     Income (loss)
before
income taxes
    Depreciation
and
amortization
     Capital
expenditures
 

Title Insurance and Services

   $ 891,221      $ 60,822      $ 16,333       $ 17,594   

Specialty Insurance

     74,198        12,824        1,055         578   

Corporate

     2,248        (22,096     671         —     

Eliminations

     (904     —          —           —     
  

 

 

   

 

 

   

 

 

    

 

 

 
   $ 966,763      $ 51,550      $ 18,059       $ 18,172   
  

 

 

   

 

 

   

 

 

    

 

 

 

 

32


FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements - (Continued)

(Unaudited)

 

For the three months ended March 31, 2011:

 

(in thousands)

   Revenues     Income (loss)
before
income taxes
    Depreciation
and
amortization
     Capital
expenditures
 

Title Insurance and Services

   $ 861,924      $ (15,696   $ 17,171       $ 12,169   

Specialty Insurance

     68,831        12,414        1,016         411   

Corporate

     1,579        (20,552     912         24   

Eliminations

     (634     385        —           —     
  

 

 

   

 

 

   

 

 

    

 

 

 
   $ 931,700      $ (23,449   $ 19,099       $ 12,604   
  

 

 

   

 

 

   

 

 

    

 

 

 

 

Note 17 – Subsequent Events

On April 17, 2012, the Company entered into a senior secured credit agreement with JPMorgan Chase Bank, N.A. (“JPMorgan”) in its capacity as administrative agent and the lenders party thereto. The credit agreement is comprised of a $600.0 million revolving credit facility. Unless terminated earlier, the revolving loan commitments will terminate on April 17, 2016.

The agreement replaces the Company’s $400.0 million senior secured credit agreement dated as of April 12, 2010, which was terminated immediately prior to entry into the new agreement. In connection with the closing, the Company paid off the $200.0 million outstanding balance under the prior agreement and borrowed $200.0 million under the new agreement. Proceeds under the credit agreement may be used for general corporate purposes.

 

33


FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements - (Continued)

(Unaudited)

 

The Company’s obligations under the credit agreement are originally guaranteed by the following Company subsidiaries: First American Data Co., LLC, First American Data Tree LLC, Data Trace Information Services LLC and Smart Title Solutions LLC (collectively with any future guarantors under the facility, the “Guarantors”).

To secure the obligations of the Company and the Guarantors (collectively, the “Loan Parties”) under the credit agreement, the Company and certain other Loan Parties entered into a pledge agreement (the “Pledge Agreement”) with JPMorgan in its capacity as collateral agent (the “Collateral Agent”) and, pursuant thereto, pledged fifty percent of the equity interests of each of the Guarantors and a nine percent equity interest in First American Title Insurance Company. The security will be released in the event that, and remain released for as long as, the Company’s long-term issuer rating or long-term counterparty credit rating (the “Debt Rating”) is BBB- or higher by S&P and Baa3 or higher by Moody’s.

In the event that the Debt Rating by S&P is below BBB- (or there is no Debt Rating from S&P) and, in addition, such rating by Moody’s is lower than Baa3 (or there is no Debt Rating from Moody’s), then the loan commitments are subject to mandatory reduction from (a) 50 percent of the net proceeds of certain equity issuances by any Loan Party, and (b) 50 percent of the net proceeds of certain debt incurred or issued by any Loan Party, provided that the commitment reductions described above are only required to the extent necessary to reduce the total loan commitments to $300.0 million. The Company is only required to prepay loans to the extent that, after giving effect to any mandatory commitment reduction, the aggregate principal amount of all outstanding loans exceeds the remaining total loan commitments.

At the Company’s election, borrowings under the credit agreement bear interest at (a) a base rate plus an applicable spread or (b) an adjusted LIBOR rate plus an applicable spread. The base rate is generally the greatest of (x) 0.50 percent in excess of the federal funds rate, (y) JPMorgan’s prime rate, and (z) one-month LIBOR plus one percent. The adjusted LIBOR rate is generally LIBOR times JPMorgan’s statutory reserve rate for Eurocurrency funding. The applicable spread varies depending upon the Debt Rating assigned by Moody’s and S&P. The minimum applicable spread for base rate borrowings is 0.75 percent and the maximum is 1.50 percent. The minimum applicable spread for adjusted LIBOR rate borrowings is 1.75 percent and the maximum is 2.50 percent. 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 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 and the Collateral Agent may exercise remedies under the collateral documents. Upon the occurrence of certain insolvency and bankruptcy events of default the loans will automatically accelerate.

 

34


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

CERTAIN STATEMENTS IN THIS QUARTERLY REPORT ON FORM 10-Q, INCLUDING BUT NOT LIMITED TO THOSE SET FORTH ON PAGE 3 OF THIS QUARTERLY REPORT ARE 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 MAY CONTAIN THE WORDS “BELIEVE,” “ANTICIPATE,” “EXPECT,” “PLAN,” “PREDICT,” “ESTIMATE,” “PROJECT,” “WILL BE,” “WILL CONTINUE,” “WILL LIKELY RESULT,” OR OTHER SIMILAR WORDS AND PHRASES.

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 PAGE 3 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 POLICIES AND ESTIMATES

Critical accounting policies are those policies used in the preparation of First American Financial Corporation’s (the “Company’s”) financial statements that require management to make estimates and judgments that affect the reported amounts of certain assets, liabilities, revenues, expenses and related disclosure of contingencies. A summary of these policies can be found in the Management’s Discussion and Analysis section of the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

Recently Adopted Accounting Pronouncements

In October 2010, the Financial Accounting Standards Board (“FASB”) issued updated guidance related to accounting for costs associated with acquiring or renewing insurance contracts. The updated guidance modifies the definition of the types of costs incurred by insurance entities that can be capitalized in the acquisition of new and renewal contracts. Under the updated guidance only costs based on successful efforts (that is, acquiring a new or renewal contract) including direct-response advertising costs are eligible for capitalization. The updated guidance is effective for the interim and annual periods beginning after December 15, 2011. The adoption of the guidance, on a prospective basis, did not have a material impact on the Company’s condensed consolidated financial statements.

In May 2011, the FASB issued updated guidance that is intended to improve the comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with U.S. generally accepted accounting principles and International Financial Reporting Standards. The amendments are of two types: (i) those that clarify the FASB’s intent about the application of existing fair value measurement and disclosure requirements and (ii) those that change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. The updated guidance is effective for interim and annual periods beginning after December 15, 2011. Except for the disclosure requirements, the adoption of the guidance had no impact on the Company’s condensed consolidated financial statements.

In June 2011, the FASB issued updated guidance that is intended to increase the prominence of other comprehensive income in financial statements. The updated guidance eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity, and requires either consecutive presentation of the statement of net income and other comprehensive income or in a single continuous statement of comprehensive income. In addition, the option to present reclassification adjustments in the notes to financial statements has been eliminated. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2011. In December 2011, the FASB issued updated guidance deferring the effective date of the change in presentation of reclassification adjustments. The adoption of the guidance that became effective in the first quarter of 2012 had no impact on the Company’s condensed consolidated financial statements.

 

35


Pending Accounting Pronouncements

In December 2011, the FASB issued updated guidance requiring entities to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. The updated guidance is effective for interim and annual reporting periods beginning on or after January 1, 2013. Except for the disclosure requirements, management does not expect the adoption of this guidance to have a material impact on the Company’s condensed consolidated financial statements.

OVERVIEW

The Company became a publicly traded company following its spin-off from its prior parent, The First American Corporation (“TFAC”) on June 1, 2010 (the “Separation”). On that date, TFAC distributed all of the Company’s outstanding shares to the record date shareholders of TFAC on a one-for-one basis (the “Distribution”). After the Distribution, the Company owned TFAC’s financial services businesses and TFAC, which reincorporated and assumed the name CoreLogic, Inc. (“CoreLogic”), continued to own its information solutions businesses.

Beginning at the end of September 2010, various lenders’ foreclosure processes came under the review and scrutiny of a number of regulators such as the state Attorneys General, the Federal Reserve and other agencies. Additionally, a growing number of court rulings have called into question some foreclosure practices and regulators have conducted and continue to conduct investigations into such practices. Many of the country’s largest lenders and other key parties also have entered into consent decrees and settlement agreements which require them, among other things, to alter their foreclosure processes. The ultimate effect of the court rulings, regulatory investigations, consent decrees, settlement agreements and related matters pertaining to foreclosure processing are currently unknown, and the Company may incur costs associated with its duty to defend its insureds’ title to foreclosed properties they have purchased. The Company also believes that, as a result of these matters, its revenues tied to foreclosures have declined. However, the Company believes that, as a result of the settlement of inquiries into these processes, foreclosure volumes may begin to increase, though any expected increase of foreclosure volume may be offset by foreclosure alternatives, such as short sales. As of the current date, these matters have not had a material adverse effect on the Company. Though the Company will continue to monitor foreclosure developments, at this time the Company does not believe these matters will have a material adverse effect on the Company in the future.

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, refinancings and foreclosures of residential and commercial real estate. In the 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 real estate transactions. Traditionally, the greatest volume of real estate activity, particularly residential resale, has occurred in the spring and summer months. However, changes in interest rates, as well as other economic factors, can cause fluctuations in the traditional pattern of real estate activity.

Residential mortgage originations in the United States (based on the total dollar value of the transactions) increased 5.3% in the first quarter of 2012 when compared with the first quarter of 2011, according to the Mortgage Bankers Association’s April 17, 2012 Mortgage Finance Forecast (the “MBA Forecast”). According to the MBA Forecast, the dollar amount of purchase originations decreased 24.5% and refinance originations increased 21.9% in the first quarter of 2012 when compared with the first quarter of 2011.

A low interest rate environment typically has a favorable impact on many of the Company’s businesses, however in recent years mortgage credit has been generally tight, which together with the uncertainty in general economic conditions, has impacted the demand for most of the Company’s products and services. During the first quarter of 2012, following a gradual improvement in the general economy, the Company observed an increase in mortgage activity as evidenced by an increase in title orders opened. The Company’s direct title operations opened 377,200 title orders during the three months ended March 31, 2012, an increase of 31.4% when compared with 287,100 title orders opened during the same period of the prior year. The increase in title orders opened was driven primarily by a significant increase in refinance activity and a modest increase in resale transactions. While market conditions and order volumes demonstrated improvement during the first quarter of 2012, the Company continues to maintain a tight control on expenses.

During 2011, the Company completed an expense reduction program, primarily directed at its shared services function in the title insurance and services segment that is expected to yield approximately $40 million in annualized cost savings. The Company’s results for the three months ended March 31, 2012 benefited from the expense reduction program when compared to the same period of the prior year.

During the first quarter of 2012, the Company changed the allocation of certain expenses within its reportable segments and corporate division to reflect the performance of the Company’s reportable segments as reported to the chief operating decision maker. The expenses that were impacted as a result of the change in allocation include shared services expenses, benefit plan expense and interest expense. Prior period segment data has been reclassified to conform to the current presentation. For the three months ended March 31, 2011, income before income taxes for the Company’s reportable segments were impacted as follows: increase of $2.9 million to the title insurance and services segment, increase of $0.2 million to the specialty insurance segment, and decrease of $3.1 million to the corporate division.

 

36


Title Insurance and Services

 

     Three Months Ended March 31,  

(in thousands, except percentages)

   2012     2011     $ Change     % Change  

Revenues

        

Direct premiums and escrow fees

   $ 343,639      $ 295,431      $ 48,208        16.3

Agent premiums

     376,986        399,921        (22,935     (5.7

Information and other

     155,289        150,427        4,862        3.2   

Investment income

     17,321        17,568        (247     (1.4

Net realized investment gains (losses)

     588        (1,126     1,714        152.2   

Net other-than-temporary impairment losses recognized in earnings

     (2,602     (297     (2,305     N/M 1 
  

 

 

   

 

 

   

 

 

   

 

 

 
     891,221        861,924        29,297        3.4   
  

 

 

   

 

 

   

 

 

   

 

 

 

Expenses

        

Personnel costs

     277,577        259,067        18,510        7.1   

Premiums retained by agents

     302,164        319,987        (17,823     (5.6

Other operating expenses

     171,752        175,513        (3,761     (2.1

Provision for policy losses and other claims

     52,179        96,376        (44,197     (45.9

Depreciation and amortization

     16,333        17,171        (838     (4.9

Premium taxes

     9,733        8,039        1,694        21.1   

Interest

     661        1,467        (806     (54.9
  

 

 

   

 

 

   

 

 

   

 

 

 
     830,399        877,620        (47,221     (5.4
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

   $ 60,822      $ (15,696   $ 76,518        487.5
  

 

 

   

 

 

   

 

 

   

 

 

 

Margins

     6.8     (1.8 )%      8.6     477.8
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Not meaningful

Direct premiums and escrow fees were $343.6 million for the three months ended March 31, 2012, an increase of $48.2 million, or 16.3%, when compared with the same period of the prior year. This increase was due to an increase in the number of title orders closed by the Company’s direct operations, which reflected the increase in mortgage originations, and a slight increase in average revenues per order closed. The slight increase in average revenues per order closed in the first quarter of 2012 when compared to the first quarter of 2011 was primarily attributable to an increase in the mix of direct revenues generated from higher premium commercial transactions. The Company’s direct title operations closed 261,300 title orders during the three months ended March 31, 2012, an increase of 15.8% when compared with 225,600 title orders closed during the same period of the prior year. The average revenues per order closed was $1,315 for the three months ended March 31, 2012, an increase of 0.4% when compared with $1,310 for the three months ended March 31, 2011.

 

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Agent premiums were $377.0 million for the three months ended March 31, 2012, a decrease of $22.9 million, or 5.7%, 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, first quarter agent premiums primarily reflect fourth quarter mortgage origination activity. The decrease in agent premiums quarter over quarter was consistent with the decrease in the Company’s direct premiums and escrow fees in the fourth quarter of 2011 as compared with the fourth quarter of 2010. The Company continuously analyzes the terms and profitability of its title agency relationships and, where it deems it necessary, amends agent agreements to the extent possible.

Information and other revenues, which primarily consist of revenues generated from fees associated with title search and related reports, title and other real property records and images, and other non-insured settlement services, were $155.3 million for the three months ended March 31, 2012, an increase of $4.9 million, or 3.2%, when compared with the same period of the prior year. This increase was primarily attributable to higher demand for the Company’s title plant information and increased international service revenues, offset in part by lower default information revenues. The higher demand for the Company’s title plant information was driven by the increase in mortgage origination activity. International service revenues increased due to a rebound in the Canadian real estate market, primarily driven by refinance activity. Default related information revenues were negatively impacted by a decline in foreclosure activity and increased market competition.

Net other-than-temporary impairment losses for the title insurance and services segment totaled $2.6 million and $0.3 million for the three months ended March 31, 2012 and 2011, respectively. The other-than-temporary impairment losses recognized in the first quarter of 2012 and 2011 relate to the Company’s non-agency mortgage-backed securities portfolio.

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 competing 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 $277.6 million for the three months ended March 31, 2012, an increase of $18.5 million, or 7.1%, when compared with the same period of the prior year. The increase was primarily due to higher commission and bonus expense as both revenues and profits have improved relative to the prior year, as well as increased healthcare related expenses and one additional payroll day in the current quarter.

Agents retained $302.2 million of title premiums generated by agency operations for the three months ended March 31, 2012, which compares with $320.0 million for the same period of the prior year. The percentage of title premiums retained by agents was 80.2% and 80.0% for the three months ended March 31, 2012 and 2011, respectively. The increase in the agent retention percentage was primarily due to a large commercial deal that closed during the first quarter of 2011 with a favorable agent split.

Other operating expenses for the title insurance and services segment were $171.8 million for the three months ended March 31, 2012, a decrease of $3.8 million, or 2.1%, when compared with the same period of the prior year. This decrease was primarily due to lower office related expenses resulting from the Company’s consolidation and closure of certain title offices. Further contributing to the decrease in other operating expenses was a decline in professional services costs. These decreases were partially offset by an increase in production related expenses due to improved refinance activity.

 

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The provision for policy losses and other claims was $52.2 million, or 7.2% of title premiums and escrow fees, and $96.4 million, or 13.9% of title premiums and escrow fees, for the three months ended March 31, 2012 and 2011, respectively. The current quarter rate of 7.2% reflected an ultimate loss rate of 6.2% for the current policy year and included $7.2 million in net unfavorable development for prior policy years, primarily 2007 and 2008. Approximately $4.3 million of the net unfavorable development related to the Company’s guaranteed valuation product offered in Canada. There is substantial uncertainty as to the ultimate loss emergence for this product due to the following factors, among others, (i) claims associated with this product are generally made only after a foreclosure on the related property and foreclosure rates in Canada are difficult to predict and (ii) limited historical loss data exists as a result of the relatively recent introduction of this product in 2003. While the Company believes its claims reserve attributable to this product is adequate, because of this uncertainty, the potential for adverse loss development relative to this product is significantly higher than for title insurance. The first quarter of 2011 rate of 13.9% reflected an ultimate loss rate of 5.2% for the 2011 policy year, a $45.3 million reserve strengthening adjustment related to the guaranteed valuation product offered in Canada and a $14.6 million charge which reflected adverse development for certain prior policy years.

Premium taxes were $9.7 million and $8.0 million for the three months ended March 31, 2012 and 2011, respectively. Premium taxes as a percentage of title insurance premiums and escrow fees were 1.4% and 1.2% for the three months ended March 31, 2012 and 2011, respectively.

In general, the title insurance business is a lower profit margin business when compared to the Company’s specialty insurance segment. The lower profit margins 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 this relatively high proportion of fixed costs, title insurance profit margins generally improve as closed order volumes increase. Title insurance profit margins are affected by the composition (residential or commercial) and type (resale, refinancing or new construction) of real estate activity. In addition, profit margins from refinance transactions vary depending on whether they are centrally processed or locally processed. Profit margins from resale, new construction and centrally processed refinance transactions are generally higher than from locally processed refinance transactions because in many states there are premium discounts on, and cancellation rates are higher for, refinance transactions. 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 margin for the three months ended March 31, 2012 was 6.8% and the pre-tax margin loss for the three months ended March 31, 2011 was 1.8%.

Specialty Insurance

 

     Three Months Ended March 31,  

(in thousands, except percentages)

   2012     2011     $ Change     % Change  

Revenues

        

Direct premiums

   $ 70,147      $ 65,663      $ 4,484        6.8

Information and other

     475        329        146        44.4

Investment income

     2,465        2,508        (43     (1.7

Net realized investment gains

     1,111        331        780        235.6   
  

 

 

   

 

 

   

 

 

   

 

 

 
     74,198        68,831        5,367        7.8   
  

 

 

   

 

 

   

 

 

   

 

 

 

Expenses

        

Personnel costs

     13,663        11,651        2,012        17.3   

Other operating expenses

     11,042        9,610        1,432        14.9   

Provision for policy losses and other claims

     34,499        33,136        1,363        4.1   

Depreciation and amortization

     1,055        1,016        39        3.8   

Premium taxes

     1,115        1,004        111        11.1   
  

 

 

   

 

 

   

 

 

   

 

 

 
     61,374        56,417        4,957        8.8   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

   $ 12,824      $ 12,414      $ 410        3.3
  

 

 

   

 

 

   

 

 

   

 

 

 

Margins

     17.3     18.0     (0.7 )%      (3.9 )%