TOP CONTRIBUTORS

Lawrence Tanzman

FAF AT A GLANCE

P/E ► 24.8 AVG EV/EBITDA ► 23.4 AVG ROA ► 2.2% AVG ROE ► 4.1% AVG Debt to Equity ► 1.96 AVG Interest Coverage Ratio ► 44.9 VERY HIGH

 

 

 

 

 

 

First American (NYSE: FAF) is the largest provider of title insurance in the U.S. by revenue.^[1] Title Insurance protects buyers and lenders in a real estate transaction by insuring against defects in a real estate title, such as unknown claims to the property or restrictions on what the owner can do with the property. In 2007, First American earned 30.04% of the US title revenues.^[1] Title insurance made up 70% of the company's 2007 revenue.^[2]

First American's revenues are strongly tied to the real estate market. The more real estate closings and mortgage refinances, the more First American can earn. With residential mortgages decreasing 14.2% and refinance originations decreasing 11.5% in 2007, the entire title insurance industry has struggled to maintain revenues.^[3] Despite the industry-wide pressures, First American had operating margins of 4.82%, the highest in its peer group, in the trailing twelve month period ending in August of 2008. ^[4][5]

In 2008, shareholders filed a class action lawsuit against the company, claiming that First American artificially inflated the appraisal values of certain homes with mortgage policies, and these illegal activities inflated the share price of First American.^[6]

Company Overview

First American Revenue and Income ^[7]

Business Financials

First American's Title and Specialty Insurance revenues decreased by 8.6% in 2007 compared to 2006 due to a decline in mortgage originations.^[3] Mortgage originations also declined in 2006 compared to 2005, but First American still managed to increase operating revenues due to increased revenues from the Specialty Insurance, property information, and First Advantage segments.^[2] From 2003-2006 First American earned net incomes in excess of $250 million,^[7] but the company ran a net loss of $3 million in 2007 due to a substantial net loss from Title Insurance operations.^[7] First American has been distributing its net income to shareholders through dividends, and for Q2 2008 their Earnings Per Share were $0.45^[8] and their quarterly dividend was $0.22 per share. ^[9]

First American 2007 Revenue by Segment ^[2]

Business Segments

• Direct Operations (37% of sales) Direct Operations refer to title insurance policies that First American deals directly with policy buyers. First American negotiates over the premium paid and performs the search and inspection on the real estate title in question. Then, the company issues the insurance policy and is responsible for any future losses incurred with respect to that policy. Direct Operations earn larger revenues per policy than Agency Operations because First American keeps all the revenue from a given policy. Revenues from Direct Operations grew from $3.02 billion in 2005 ^[2] to $3.06 billion in 2006^[2], but then subsequently shrank to $2.90 billion in 2007.^[2]
• Agency Operations (33% of sales): Agency Operations revenue comes from First American using an insurance agent from outside the company to perform the search and inspection on the real estate title. First American then underwrites the insurance policy by assuming the risk of a defect in the title arising in the future. For Agency Operations, the agent earns part of the title insurance premium for their search and inspection service. The rest of the fee goes to First American for assuming the risk tied to the title. Agency Operations earn a smaller revenue per title because the agent takes a cut. First American earned $2.86 billion in 2005 from Agency Operations. ^[2] This number grew to $3.00 billion in 2006 ^[2] but then decreased to $2.62 billion in 2007. ^[2]

Title insurance operations made up -66% of the 2007 EBIT.^[10]

• Specialty Insurance (4% of sales, 11% of EBIT^[10]): First American offers Home Warranties, Property, and Casualty insurance. The company earned $275 million in 2005 and $309 million in 2006 from Specialty Insurance. ^[2] In 2007, this number decreased to $302 million. ^[2]
• Mortgage Information (6% of sales, 28% of EBIT^[10]): This segment provides information to companies about taxes on real estate property, issues concerning flood zones, and information and software to process mortgages that have defaulted. Revenues from the Mortgage Information segment were $584 million, $527 million, and $507 million in 2005, 2006, and 2007, respectively. ^[2] Management attributed these decreases to declining volumes of mortgage originations. ^[11]
• Property Information (9% of sales, 61% of EBIT^[10]): The Property Information segment provides appraisals, data, and analysis on mortgages, loans, and real property. This segment also provides historical records relating to individual titles. These records are used by title insurers to inspect a title for defects. This segment generated $511 million in revenue in 2005, $600 million in revenue in 2006, and $741 million in revenue in 2007. ^[2]
• First Advantage (11% of sales, 66% of EBIT^[10]): First Advantage is a publicly traded company (NASDAQ: FADV) of which First American owns a majority stake. First Advantage provides lender, data, dealer, employer, multifamily, and investigative and litigation support services. First Advantage revenues grew from $636 million in 2005 to $809 million in 2006. ^[2] This revenue grew further in 2007 to $857 million. ^[2]

The following are operating metrics that describe measurements of performance specific to First American's industry:

• Average Premium per Direct Title Order is calculated as total revenue from Direct Operations divided by the number of Direct Title Orders Closed. The measures the revenue per closed order. The increase in this measure over the past three years reflects an appreciation of real estate prices because the premium earned is proportional to the value of the property in the title.
• Number of Direct Title Orders Closed is a measure of the volume of title orders processed. A title order is closed after the search and inspection of the title is complete and the real estate transaction involving the title is closed. The full title premium is not received until the order is closed. The decrease in Closed Orders reflects a decrease in mortgage originations, real estate transactions, and refinances.^[2]
• Claims Loss Provision is the amount of money that First American sets aside to cover claims on insurance policies. The money set aside in a given year is intended to cover not only claims from that year, but also claims from previous years. First American significantly increased its Claims Loss Provision in 2007 to account for higher than expected title losses.^[13]
• Title Premiums are the total revenues from premiums from both Direct and Agency operations. These premiums are the primary income for First American.
• Claims loss provision/Premiums is a percentage measure of how much money is set aside to cover claims relative to the total amount of premiums earned. This measure shows profitability because it measures how much First American's insurance policies are costing the company relative to how much revenue they generate. The percentage grew over the past three years due to decreasing title premiums^[2] and management's decision to increase the Claims Loss Provision to account for higher than expected title losses.^[13]

Legal Proceedings

In 2008, shareholders filed a class action lawsuit against the First American Corporation. The plaintiffs are the group of shareholders who purchased shares of First American between April 26, 2006 and November 6, 2007, defined as the "Class Period".^[14] The plaintiffs claim that First American colluded with Washington Mutual to inflate the appraisal values of real estate properties. During the Class Period, the stock price of First American reached $55.11, but declined to $30.07 on the discovery of the false appraisals.^[14] In addition, insider activity during the Class Period included more than $9 million in revenues from insider shares sold.^[14] The plaintiffs are seeking compensatory damages for losses due to the false appraisals, an amount that will be decided during the trial.^[14]

Key Trends and Forces

Declining Mortgage Originations adversely affect Title Revenues

Nearly every mortgage is issued along with a title insurance policy. Therefore, when fewer mortgages are issued, there are fewer title insurance policies issued. In 2007, residential mortgage originations decreased 14.2% and refinance originations decreased 11.5% ^[3]. Over this same time period, First Americans operating revenues from Title and Specialty Insurance decreased 8.6%. ^[3]

Government Regulations Set Title Premiums in many States

Title Insurance is heavily regulated in the United States. The rates which First American is allowed to charge for a policy are often set by the state or county. For example, in 2006 California moved to slash the rates First American can charge for insurance for real estate closings, mortgage refinancings, and escrow services by 23%, 16%, and 27%, respectively.^[15] These rate cuts were estimated to reduce sales of Title Insurance in California by $1 billion,^[15] a state in which First American has a 37.28% market share.^[1] Title Insurance is similarly regulated in the rest of the United States, and therefore revenues are dependent on the government set rates.

Interest Rates affect the volume of mortgage refinances

The Federal Funds Rate remained low during 2003, floating between 1.00% and 1.25%.^[16] During periods of low interest, mortgage refinance volumes grow because property owners can pay off their old mortgage and get a new, cheaper one. More refinances mean more Title Insurance policies, because a new policy is issued along with each refinance. The reverse occurs when the Fed raises its rate, as it did from 2003 until September of 2007.^[16] The volume of direct title orders closed for First American was 2,021,000 in 2003^[7] when interest rates averaged 1.13%.^[16] The volume dropped to only 1,697,000 in 2007^[7] when interest rates averaged 5.08%.^[16]

Competition

Competitors to First American are either in the Title Insurance industry, Information Services industry, or both. The following are First American's four largest competitors in these industries:

• Fidelity National Financial (FNF) is the second largest title insurer in the US by revenue.^[1] Fidelity earned 70% of its 2007 revenue from Title Insurance.^[17] Fidelity also competes with First American for escrow, closing and processing related fees tied to real estate transactions.
• LandAmerica Financial Group (LFG) is the third largest title insurer in the US by revenue.^[1] LandAmerica Financial Group earned 88.1% of its 2007 income from its Title Insurance Operations, competing directly with First American for title premiums.^[18]
• Old Republic International (ORI) is an insurance underwriter operating in three segments: General Insurance, Mortgage Guaranty, and Title Insurance. Old Republic's primary source of revenue is its General Insurance segment, which earned nearly 60% of the company's 2007 revenue. The General Insurance segment provides property and liability insurance. Only 21.4% of the company's revenue came from Title Insurance.^[19] While Old Republic earned less revenue from Title Insurance than First American, Old Republic is not as susceptible to fluctuations in the real estate market.
• Stewart Information Services (STC) Stewart Information Services has two operating segments: Title Insurance and Real Estate Information. 94% of the company's 2007 revenue came from Title Operations.^[20] Both of Stewart Information Service's operating segments compete with the respective operating segments of First American.

First American's smaller specialty insurance segment also competes with large specialty insurance providers.

Market Share

First American has the largest market share by revenue for US title insurance according to the American Land Title Association.^[1] First American earns the largest revenue of its peer group, $8.2 billion in 2007^[7] versus runner up Fidelity National Financial with $5.5 billion. ^[28] First American has 37,354 employees,^[4] the largest number versus its peer group. First American also has earned the highest operating margin for the trailing twelve month period; it had a margin of 4.82%.^[4] The other top four Title Insurers ran operating margins of less than 1.00% over the trailing twelve month period.^[4][5]

References

1. ↑ ^{1.0 1.1 1.2 1.3 1.4 1.5 1.6} 2007 Market Share by Family and State - DISTRIBUTION
2. ↑ ^{2.00 2.01 2.02 2.03 2.04 2.05 2.06 2.07 2.08 2.09 2.10 2.11 2.12 2.13 2.14 2.15 2.16 2.17 2.18 2.19 2.20 2.21 2.22} FAF 2007 10-K, Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations, page 29
3. ↑ ^{3.0 3.1 3.2 3.3} FAF 2007 10-K, Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations, page 28
4. ↑ ^{4.0 4.1 4.2 4.3} Yahoo Competitors for FAF
5. ↑ ^{5.0 5.1} Yahoo Competitors for ORI
6. ↑ Bronstein, Gewirtz & Grossman, LLC Announces That A Class Action Has Been Filed Against The First American Corporation, Reuters, July 4, 2008
7. ↑ ^{7.0 7.1 7.2 7.3 7.4 7.5 7.6 7.7 7.8} FAF 2007 10-K, Item 6: Selected Financial Data, page 23
8. ↑ First American swings to profit in Q2, beats estimates, RTTNews.com, July 31, 2008
9. ↑ Yahoo First American Statistics
10. ↑ ^{10.0 10.1 10.2 10.3 10.4} FAF 2007 10-K, Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations, page 37
11. ↑ FAF 2007 10-K, Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations, page 30
12. ↑ ^{12.0 12.1 12.2} FAF 2007 10-K, Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations, page 34
13. ↑ ^{13.0 13.1 13.2 13.3 13.4} FAF 2007 10-K, Item 8: Financial Statements and Supplementary Data, page 66
14. ↑ ^{14.0 14.1 14.2 14.3} Class Action Complaint
15. ↑ ^{15.0 15.1} Cuts In Title Insurance Rates Sought, LA Times, July 20, 2006
16. ↑ ^{16.0 16.1 16.2 16.3} Historical Federal Funds Rates from moneycafe.com
17. ↑ FNF 2007 10-K, Item 6: Selected Financial Data, page 42
18. ↑ LFG 2007 Annual Report, Item 1: Business, page 8
19. ↑ ORI 2007 Annual Report, Item 1: Business, page 3
20. ↑ STC 2007 Annual Report, Item 6: Selected Financial Data, page 13
21. ↑ FAF 2007 10-K, Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations, page 29
22. ↑ FNF 2007 10-K, Item 8: Financial Statements and Supplementary Data, pages 106
23. ↑ LFG 2007 10-K, Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations, page 44
24. ↑ FAF 2007 10-K, Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations, page 34
25. ↑ FNF 2007 10-K, Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations, page 36
26. ↑ LFG 2007 10-K, Item 8: Financial Statements and Supplementary Data, page 83
27. ↑ FAF 2007 10-K, Item 8: Financial Statements and Supplementary Data, page 46
28. ↑ ^{28.0 28.1} FNF 2007 10-K, Item 8: Financial Statements and Supplementary Data, page 58
29. ↑ LFG 2007 10-K, Item 8: Financial Statements and Supplementary Data, page 107
30. ↑ FAF 2007 10-K, Item 8: Financial Statements and Supplementary Data, Page 66
31. ↑ FNF 2007 10-K, Item 6: Selected Financial Data, page 27
32. ↑ LFG 2007 10-K, Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations, page 39