10-K 1 d263954d10k.htm FORM 10-K Form 10-K
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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

FORM 10-K

 

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

 

For the fiscal year ended December 31, 2011

 

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

 

 

 

LOGO

 

(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

 

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Common   New York Stock Exchange
(Title of each class)   (Name of each exchange on which registered)

 

Securities registered pursuant to Section 12(g) of the Act:

 

None

 

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  x     No  ¨

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

 

Indicate by check mark whether 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

 

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 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 Act).    Yes  ¨    No  x

 

The aggregate market value of voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2011 was $1,626,920,063.

 

On February 15, 2012, there were 105,445,082 shares of common stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s definitive proxy statement with respect to the 2012 annual meeting of the stockholders are incorporated by reference in Part III of this report. The definitive proxy statement or an amendment to this Form 10-K will be filed no later than 120 days after the close of registrant’s fiscal year.

 

 


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

 

   

SAVINGS TO BE ACHIEVED THROUGH EXPENSE MANAGEMENT EFFORTS;

 

   

THE COMPANY’S PURSUIT OF TARGETED GROWTH OPPORTUNITIES AND EVALUATION OF ADJACENT, COMPLIMENTARY BUSINESS SPACES;

 

   

THE EFFECT OF A DECREASE IN PRODUCTS OR SERVICES PURCHASED BY OR FOR THE BENEFIT OF THE COMPANY’S MOST SIGNIFICANT CUSTOMERS;

 

   

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

 

   

INTERNATIONAL EXPANSION AND THE ACCEPTANCE OF TITLE INSURANCE INTERNATIONALLY;

 

   

THE COMPANY’S CONTINUED PRACTICE OF ASSUMING AND CEDING LARGE TITLE INSURANCE RISKS THROUGH REINSURANCE;

 

   

THE COMPETITIVE IMPORTANCE OF PRICE AND QUALITY AND TIMELINESS OF SERVICE;

 

   

CONTINUED PRICE ADJUSTMENTS;

 

   

THE ADEQUACY OF THE ALLOWANCE AGAINST FORESEEABLE LOAN LOSSES;

 

   

THE LIKELIHOOD OF CHANGES IN EXPECTED ULTIMATE LOSSES AND CORRESPONDING LOSS RATES AND RELATED ASSUMPTIONS;

 

   

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

 

   

FUTURE PAYMENT OF DIVIDENDS;

 

   

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

 

   

POTENTIAL FUTURE IMPAIRMENT CHARGES AND RELATED ASSUMPTIONS;

 

   

THE COMPANY’S INTENTIONS WITH RESPECT TO ITS INVESTMENT IN CORELOGIC STOCK;

 

   

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

 

   

THE IMPACT OF UNCERTAINTY IN GENERAL ECONOMIC CONDITIONS AND TIGHT MORTGAGE CREDIT;

 

   

CONTINUED DECLINES IN FORECLOSURE REVENUES, COSTS ASSOCIATED WITH DEFENDING INSURED’S TITLE TO FORECLOSED PROPERTIES, AND THE IMPACT OF FORECLOSURE MATTERS ON THE COMPANY;

 

   

THE COMPANY’S CONTINUED MONITORING OF ORDER VOLUMES AND RELATED STAFFING LEVELS, AND ADJUSTMENTS TO STAFFING LEVELS AS NECESSARY;

 

   

UNCERTAINTY AND VOLATILITY IN THE CURRENT ECONOMIC ENVIRONMENT AND ITS EFFECT ON TITLE CLAIMS;

 

   

THE VARIANCE BETWEEN ACTUAL CLAIMS EXPERIENCE AND PROJECTIONS AND FUTURE RESERVE ADJUSTMENTS BASED ON UPDATED ESTIMATES OF FUTURE CLAIMS;

 

   

IMPROVEMENT OF SPECIALTY INSURANCE PROFIT MARGINS AS REVENUES INCREASE;

 

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

 

   

THE TIMING OF CLAIM PAYMENTS;

 

   

EXPECTED MATURITY DATES OF CERTAIN ASSETS AND LIABILITIES THAT ARE SENSITIVE TO CHANGES IN INTEREST RATES;

 

   

THE UNITED STATES GOVERNMENT’S COMMITMENT TO ENSURING THAT FANNIE MAE AND FREDDIE MAC HAVE SUFFICIENT CAPITAL TO PERFORM UNDER GUARANTEES ISSUED AND TO MEET THEIR DEBT OBLIGATIONS;

 

   

ASSUMPTIONS UNDERLYING GOODWILL VALUATIONS;

 

   

THE REALIZATION OF TAX BENEFITS ASSOCIATED WITH CERTAIN LOSSES, POTENTIAL TAX PROVISIONS IN CONNECTION WITH THE EARNINGS OF FOREIGN SUBSIDIARIES AND THE ADEQUACY OF TAX AND RELATED INTEREST ESTIMATES IN CONNECTION WITH EXAMINATIONS BY TAX AUTHORITIES;

 

   

NET ACTUARIAL LOSS AND PRIOR SERVICE CREDIT RELATING TO PENSION PLANS;

 

   

EXPECTED BENEFIT AND PENSION PLAN CONTRIBUTIONS, PAYMENTS AND INVESTMENT STRATEGY AND RETURN ASSUMPTIONS;

 

   

COMPENSATION COST RECOGNITION; AND

 

   

RESERVES FOR LIABILITIES ALLOCATED TO THE COMPANY IN CONNECTION WITH THE SEPARATION FROM THE FIRST AMERICAN CORPORATION,

 

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;

 

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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 THIS ANNUAL REPORT ON FORM 10-K.

 

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.

 

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PART I

 

Item 1.    Business

 

The Company

 

First American Financial Corporation (the “Company”) was incorporated in the state of Delaware in January 2008 to serve as the holding company of The First American Corporation’s (“TFAC’s”) financial services businesses following the spin-off of those businesses from TFAC (the “Separation”). The Separation was consummated on June 1, 2010, at which time the Company’s common stock was listed on the New York Stock Exchange under the ticker symbol “FAF.” In connection with the Separation, TFAC reincorporated in Delaware and assumed the name CoreLogic, Inc. The businesses operated by the Company’s subsidiaries have, in some instances, been in existence since the late 1800s.

 

The Company has its executive offices at 1 First American Way, Santa Ana, California 92707-5913. The Company’s telephone number is (714) 250-3000.

 

General

 

The Company, through its subsidiaries, is engaged in the business of providing financial services through its title insurance and services segment and its specialty insurance segment. The title insurance and services segment provides title insurance, closing and/or escrow services and similar or related services domestically and internationally in connection with residential and commercial real estate transactions. It also maintains, manages and provides access to title plant records and images and provides banking, trust and investment advisory services. The specialty insurance segment issues property and casualty insurance policies and sells home warranty products. In addition, our corporate function consists of certain financing facilities as well as the corporate services that support our business operations. Financial information regarding these business segments and the corporate function is included in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item 8. Financial Statements” of Part II of this report.

 

The substantial majority of our business is dependent upon activity in the real estate and mortgage markets, which are cyclical and seasonal. During the most recent real estate and mortgage cycle, we have primarily emphasized expense control and operational efficiency. However, in conjunction with our continuing efforts pertaining to operating efficiency, we are pursuing targeted growth opportunities and evaluating adjacent business spaces which are complimentary to our core title insurance and settlement services businesses.

 

Title Insurance and Services Segment

 

Our title insurance and services segment issues title insurance policies on residential and commercial property in the United States and offers similar or related products and services internationally. This segment also provides closing and/or escrow 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. In 2011, 2010, and 2009 the Company derived 92.6%, 92.5%, and 93.1% of its consolidated revenues, respectively, from this segment.

 

Overview of Title Insurance Industry

 

In many instances mortgage lenders and purchasers of real estate desire to be protected from loss or damage in the event of defects in the title they acquire. Title insurance is a means of providing such protection.

 

Title Policies.    Title insurance policies insure the interests of owners or lenders against defects in the title to real property. These defects include adverse ownership claims, liens, encumbrances or other matters affecting

 

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title. Title insurance policies are issued on the basis of a title report, which is typically prepared after a search of one or more of public records, maps, documents and prior title policies to ascertain the existence of easements, restrictions, rights of way, conditions, encumbrances or other matters affecting the title to, or use of, real property. In certain limited instances, a visual inspection of the property is also made. To facilitate the preparation of title reports, copies and/or abstracts of public records, maps, documents and prior title policies may be compiled and indexed to specific properties in an area. This compilation is known as a “title plant.”

 

The beneficiaries of title insurance policies are usually real estate buyers and mortgage lenders. A title insurance policy indemnifies the named insured and certain successors in interest against title defects, liens and encumbrances existing as of the date of the policy and not specifically excepted from its provisions. The policy typically provides coverage for the real property mortgage lender in the amount of its outstanding mortgage loan balance and for the buyer in the amount of the purchase price of the property. In some cases the policy might provide insurance in a greater amount where the buyer anticipates constructing improvements on the property. Coverage under a title insurance policy issued to a mortgage lender generally terminates upon repayment of the mortgage loan. Coverage under a title insurance policy issued to a buyer generally terminates upon the sale of the insured property.

 

Before issuing title policies, title insurers typically seek to limit their risk of loss by accurately performing title searches and examinations. The major expenses of a title company typically relate to such searches and examinations, the preparation of preliminary reports or commitments and the maintenance of title plants, and not from claim losses as in the case of property and casualty insurers.

 

The Closing Process.    Title insurance is essential to the real estate closing process in most transactions involving real property mortgage lenders. In a typical residential real estate sale transaction where title insurance is issued, a real estate broker, lawyer, developer, lender or closer involved in the transaction orders the title insurance on behalf of an insured. Once the order has been placed, a title insurance company or an agent typically conducts a title search to determine the current status of the title to the property. When the search is complete, the title insurer or agent prepares, issues and circulates a commitment or preliminary report to the parties to the transaction. The commitment or preliminary report identifies the conditions, exceptions and/or limitations that the title insurer intends to attach to the policy and identifies items appearing on the title that must be eliminated prior to closing.

 

The closing function, sometimes called an escrow in the western United States, is, depending on the local custom in the region, performed by a lawyer, an escrow company or a title insurance company or agent, generally referred to as a “closer.” Once documentation has been prepared and signed, and any required mortgage lender payoff demands are obtained, the transaction closes. The closer records the appropriate title documents and arranges the transfer of funds to pay off prior loans and extinguish the liens securing such loans. Title policies are then issued, typically insuring the priority of the mortgage of the real property mortgage lender in the amount of its mortgage loan and the buyer in the amount of the purchase price. The time between the opening of the title order and the issuance of the title policy is usually between 30 and 90 days. Before a closing takes place, however, the closer typically requests that the title insurer or agent provide an update to the commitment to discover any adverse matters affecting title and, if any are found, works with the seller to eliminate them so that the title insurer or agent issues the title policy subject only to those exceptions to coverage which are acceptable to the title insurer, the buyer and the buyer’s lender.

 

Issuing the Policy: Direct vs. Agency.    A title insurance policy can be issued directly by a title insurer or indirectly on behalf of a title insurer through agents, which may not themselves be licensed as insurers. Where the policy is issued by a title insurer, the search is performed by or on behalf of the title insurer, and the premium is collected and retained by the title insurer. Where the policy is issued by an agent, the agent typically performs the search, examines the title, collects the premium and retains a portion of the premium. The agent remits the remainder of the premium to the title insurer as compensation for the insurer bearing the risk of loss in the event a claim is made under the policy and for other services the insurer may provide. The percentage of the premium

 

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retained by an agent varies from region to region. A title insurer is obligated to pay title claims in accordance with the terms of its policies, regardless of whether it issues its policy directly or indirectly through an agent. Under certain circumstances the title insurer may seek recovery of all or a portion of this loss from the agent or its insurance carrier.

 

Premiums.    The premium for title insurance is typically due and earned in full when the real estate transaction is closed. Premiums generally are calculated with reference to the policy amount. The premium charged by a title insurer or an agent is subject to regulation in most areas. Such regulations vary from state to state.

 

Our Title Insurance Operations

 

Overview.    We conduct our title insurance and closing business through a network of direct operations and agents. Through this network, we issue policies in the 49 states that permit the issuance of title insurance policies and the District of Columbia. We also offer title insurance, closing services and similar or related products and services, either directly or through partners in foreign countries, including Canada, the United Kingdom and various other established and emerging markets as described in the “International Operations” section below.

 

Customers, Sales and Marketing.    We believe that three institutions, Bank of America Corporation, JPMorgan Chase & Co. and Wells Fargo & Company, together with their affiliates, originate approximately 50% of the mortgages in the United States. Each of these institutions purchases title insurance policies and other products and services from us. These institutions also benefit from products and services which are purchased for their benefit by others, such as title insurance policies purchased by borrowers as a condition to the making of a loan. The refusal of one or more of these institutions to purchase products and services from us or to accept our products and services that are to be purchased for their benefit could have a material adverse effect on the title insurance and services segment.

 

We distribute our title insurance policies and related products and services (directly as well as through our agents) through various channels. In our “distributed” channel, the direct distribution of our policies and related products and services occurs through local sales representatives located at hundreds of offices throughout the United States where real estate transactions are handled. Title insurance policies issued and other products and services delivered through this channel are primarily delivered in connection with sales and refinances of residential real property, although commercial transactions are also handled through this channel. We also distribute our title policies and related products and services through centralized channels, including a “commercial” channel that is focused on transactions involving commercial real estate, a “national lender” channel dedicated to refinance transactions involving large financial institutions, a “default” channel related to defaults and other pre-foreclosure activity, as well as foreclosures, and a “homebuilders” channel focused on newly constructed residential property.

 

Within each channel, our marketing efforts are focused on the primary sources of business referrals. For the distributed business, these are real estate agents and brokers, mortgage brokers, real estate attorneys, mortgage originators, homebuilders and escrow service providers. For the commercial channel we market primarily to investors, including real estate investment trusts, insurance companies and asset managers, as well as to law firms, commercial banks, investment banks, mortgage brokers and the owners of commercial real estate. In the national lender channel and the default channel our marketing efforts are focused on mortgage originators and servicers as well as governmental sponsored enterprises. We market primarily to homebuilders in the centralized homebuilder channel. Our marketing efforts emphasize our financial strength, the quality and timeliness of our services, process innovation and our national presence.

 

We supplement the efforts of our sales force with general advertising in various trade and professional journals.

 

Underwriting.    Before a title insurance policy is issued, a number of underwriting decisions are made. For example, matters of record revealed during the title search may require a determination as to whether an

 

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exception should be taken in the policy. We believe that it is important for the underwriting function to operate efficiently and effectively at all decision-making levels so that transactions may proceed in a timely manner. To perform this function, we have underwriters at the regional, divisional and corporate levels with varying levels of underwriting authority.

 

Agency Operations.    As described above, we issue title insurance policies directly as well as through a network of agents. Our agreements with our agents state the conditions under which the agent is authorized to issue title insurance policies on our behalf. The agency agreement also prescribes the circumstances under which the agent may be liable to us if a policy loss occurs. Such agency agreements typically are terminable without cause after a specified notice period has been met and are terminable immediately for cause. As is standard in our industry, our agents typically operate with a substantial degree of independence from us. We evaluate the profitability of our agency relationships on an ongoing basis, including a review of premium splits, deductibles and claims. As a result, from time to time we terminate or renegotiate the terms of many of our agency relationships.

 

In determining whether to engage an independent agent, we obtain information about the agent, including the agent’s experience and background. We maintain loss experience records for each agent and also maintain agent representatives and agent auditors. Our agents are typically subject to routine audit or examination. In addition to these routine examinations, an expanded examination typically will be triggered if certain “warning signs” are evident. Warning signs that can trigger an expanded examination include the failure to implement required accounting controls, shortages of escrow funds and failure to remit title insurance premiums on a timely basis. Adverse findings in an agency audit may result in various actions, including, if warranted, termination of the agency relationship.

 

International Operations.    We provide products and services in numerous countries outside of the United States, and our international operations accounted for approximately 9.9 percent of our title insurance and services segment revenues in 2011. Today we have direct operations and a physical presence in 12 countries including Canada and the United Kingdom. Additionally, we have partnered with leading local companies to provide services in many other countries. While reliable data are not available, we believe that we have the largest market share for title insurance outside of the United States. The Company’s revenues from external customers and long-lived assets are broken down between domestic and foreign operations in Note 23 Segment Financial Information to the consolidated financial statements included in “Item 8. Financial Statements and Supplementary Data” of Part II of this report.

 

Our range of international products and services is designed to lower our clients’ risk profiles and reduce their operating costs through enhanced operational efficiencies. In established markets, primarily British Commonwealth countries, we have combined title insurance with unique processing offerings to enhance the speed and efficiency of the mortgage and conveyancing processes. In these markets we also offer products designed to mitigate risk and otherwise facilitate real estate transactions. As financial institutions worldwide face increased capital requirements and heightened risk management requirements, we believe that title insurance could become a more widely accepted loss mitigation tool internationally. As the demand for risk mitigation products and greater efficiency in the real estate settlement process continues to grow, we believe we are well situated to seize these opportunities because of our industry expertise, financial strength, existing international licenses and contacts around the world. For example, we are licensed or otherwise authorized to do business in over 25 countries and we have partnered with entities authorized to do business in various additional countries.

 

Our international operations present risks that may not exist to the same extent in our domestic operations, including those associated with differences in the nature of the products provided, the scope of coverage provided by those products and the manner in which risk is underwritten. Limited claims experience in foreign jurisdictions makes it more difficult to set prices and reserve rates. There may also be risks associated with differences in legal systems and/or unforeseen regulatory changes.

 

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Title Plants.    Our network of title plants constitutes one of our principal assets. A title search is typically conducted by searching the abstracted information from public records or utilizing a title plant holding abstracted information from public records. While public title records generally are indexed by reference to the names of the parties to a given recorded document, our title plants primarily arrange their records on a geographic basis. Because of this difference, title plant records generally may be searched more efficiently, which we believe reduces the risk of errors associated with the search. Our title plants also index prior policies, adding to searching efficiency. Certain offices utilize jointly owned plants or utilize a plant under a joint user agreement with other title companies. In addition to these ownership interests, we are in the business of maintaining, managing and providing access to title plant records and images that may be owned by us or other parties. We believe that our title plants, whether wholly or partially owned or utilized under a joint user agreement, are among the best in the industry.

 

Reserves for Claims and Losses.    We provide for losses associated with title insurance policies and other risk based products based upon our historical experience and other factors by a charge to expense when the related premium revenue is recognized. The resulting reserve for incurred but not reported claims together with the reserve for known claims reflects management’s best estimate of the total costs required to settle all claims reported to us and claims incurred but not reported, and are considered to be adequate for such purpose. Each period the reasonableness of the estimated reserves is assessed; if the estimate requires adjustment, such an adjustment is recorded.

 

Reinsurance and Coinsurance.    We plan to continue our practice of assuming and ceding large title insurance risks through the mechanism of reinsurance. In reinsurance arrangements, the primary insurer retains a certain amount of risk under a policy and cedes the remainder of the risk under the policy to the reinsurer. The primary insurer pays the reinsurer a premium in exchange for accepting this risk of loss. The primary insurer generally remains liable to its insured for the total risk, but is reinsured under the terms of the reinsurance agreement. Prior to 2010, our title insurance arrangements primarily involved other industry participants. Beginning in January of 2010, we established a global reinsurance program involving treaty reinsurance provided by a global syndicate of highly rated non-industry reinsurers. In addition to covering claims under policies issued while the program is in effect, the program also generally covers claims made under policies issued in certain prior years, as long as the losses are discovered while the program is in effect.

 

We also serve as a coinsurer in connection with certain transactions. In a coinsurance scenario, two or more insurers are selected by the insured and typically issue separate policies with respect to the subject property, with each coinsurer liable to the extent provided in the policy that it issues.

 

Competition.    The business of providing title insurance and related products and services is highly competitive. The number of competing companies and the size of such companies vary in the different areas in which we conduct business. Generally, in areas of major real estate activity, such as metropolitan and suburban localities, we compete with many other title insurers and agents. Our major nationwide competitors in our principal markets include Fidelity National Financial, Inc., Stewart Title Guaranty Company, Old Republic International Corporation, Lender Processing Services, Inc. and their affiliates. In addition to these national competitors, small nationwide, regional and local competitors, as well as numerous agency operations throughout the country, provide aggressive competition on the local level. Approximately 30 title insurance underwriters are currently members of the American Land Title Association, the title insurance industry’s national trade association. We are currently the second largest provider of title insurance in the United States, based on the most recent American Land Title Association market share data.

 

We believe that competition for title insurance and related products and services is based primarily on the price of the title insurance policy (except in states where a uniform price has been established by a regulator) and the price, quality and timeliness of the related products and services. Customer service is an important competitive factor because parties to real estate transactions are usually concerned with time schedules and costs associated with delays in closing transactions. In certain transactions, such as those involving commercial

 

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properties, financial strength is also important. As part of our on-going strategy, we regularly evaluate our pricing, and based on competitive, market and regulatory conditions and claims history, among other factors, intend to continue to adjust our prices as and where appropriate.

 

Trust and Investment Advisory Services.    Our federal savings bank subsidiary offers trust and investment advisory services, deposit services and asset management services. As of December 31, 2011, this company managed $1.5 billion of assets, administered fiduciary and custodial assets having a market value in excess of $2.8 billion, had assets of $1.2 billion, deposits of $1.1 billion and stockholder’s equity of $118.0 million.

 

Lending and Deposit Products.    During the third quarter of 2011, we began the multi-year process of winding-down the operations of our industrial bank, First Security Business Bank. Prior to initiating the wind-down, our industrial bank subsidiary accepted deposits and used these deposits to purchase or originate loans secured by commercial properties primarily in Southern California. Currently, the industrial bank continues to accept and service deposits and to service its existing loan portfolio, but is no longer originating or purchasing new loans. As of December 31, 2011, the industrial bank had approximately $100.6 million of deposits and $139.2 million of loans outstanding.

 

Loans made or acquired during 2011 by the industrial bank totaled $13.5 million, with an average new loan balance of $796 thousand. The average loan balance outstanding at December 31, 2011, was $616 thousand. Loans were made only on a secured basis, at loan-to-value percentages generally less than 70 percent. The majority of the industrial bank’s loans were made on a fixed-to-floating rate basis. The average yield on the industrial bank’s loan portfolio for the year ended December 31, 2011, was 6.51 percent. A number of factors are included in the determination of average yield, principal among which are loan fees and closing points amortized to income, prepayment penalties recorded as income, and amortization of discounts on purchased loans. The industrial bank’s average loan to value was approximately 43 percent at December 31, 2011.

 

The performance of the industrial bank’s loan portfolio is evaluated on an ongoing basis by management of the industrial bank. The industrial bank places a loan on non-accrual status when three payments become past due. When a loan is placed on non-accrual status, the industrial bank’s general policy is to reverse from income previously accrued but unpaid interest. Income on such loans is subsequently recognized only to the extent that cash is received and future collection of principal is probable. Interest income on non-accrual loans that would have been recognized during the year ended December 31, 2011, if all of such loans had been current in accordance with their original terms, totaled $163 thousand.

 

The following table sets forth the amount of the industrial bank’s non-performing loans as of the dates indicated.

 

     Year Ended December 31,  
     2011      2010      2009      2008      2007  
     (in thousands)  

Nonperforming Assets:

              

Loans accounted for on a nonaccrual basis

   $ 4,910       $ 2,441       $ 603       $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 4,910       $ 2,441       $ 603       $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

Based on a variety of factors concerning the creditworthiness of its borrowers, the industrial bank determined that it had seven non-performing assets as of December 31, 2011.

 

The industrial bank’s allowance for loan losses is established through charges to earnings in the form of provision for loan losses. Loan losses are charged to, and recoveries are credited to, the allowance for loan losses. The provision for loan losses is determined after considering various factors, such as loan loss experience, maturity of the portfolio, size of the portfolio, borrower credit history, the existing allowance for loan losses,

 

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current charges and recoveries to the allowance for loan losses, the overall quality of the loan portfolio, and current economic conditions, as determined by management of the industrial bank, regulatory agencies and independent credit review specialists. While many of these factors are essentially a matter of judgment and may not be reduced to a mathematical formula, we believe that, in light of the collateral securing its loan portfolio, the industrial bank’s current allowance for loan losses is an adequate allowance against foreseeable losses.

 

The following table provides certain information with respect to the industrial bank’s allowance for loan losses as well as charge-off and recovery activity.

 

     Year Ended December 31,  
     2011     2010     2009     2008     2007  
     (in thousands, except percentages)  

Allowance for Loan Losses:

          

Balance at beginning of year

   $ 3,271      $ 2,071      $ 1,600      $ 1,488      $ 1,440   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Charge-offs:

          

Real estate—mortgage

     —          —          —          —          —     

Assigned lease payments

     —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Recoveries:

          

Real estate—mortgage

     —          —          —          —          —     

Assigned lease payments

     —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (charge-offs) recoveries

     —          —          —          —          —     

Provision for losses

     900        1,200        471        112        48   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of year

   $ 4,171      $ 3,271      $ 2,071      $ 1,600      $ 1,488   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ratio of net charge-offs during the year to average loans outstanding during the year

     0     0     0     0     0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

The adequacy of the industrial bank’s allowance for loan losses is based on formula allocations and specific allocations. Formula allocations are made on a percentage basis, which is dependent on the underlying collateral, the type of loan, general economic conditions and historical losses. Specific allocations are made as problem or potential problem loans are identified and are based upon an evaluation by the industrial bank’s management of the status of such loans. Specific allocations may be revised from time to time as the status of problem or potential problem loans changes.

 

The following table shows the allocation of the industrial bank’s allowance for loan losses and the percent of loans in each category to total loans at the dates indicated.

 

    Year Ended December 31,  
    2011     2010     2009     2008     2007  
    Allowance     % of
Loans
    Allowance     % of
Loans
    Allowance     % of
Loans
    Allowance     % of
Loans
    Allowance     % of
Loans
 
    (in thousands, except percentages)  

Loan Categories:

                   

Real estate-mortgage

    4,171        100      $ 3,271        100      $ 2,071        100      $ 1,600        100      $ 1,488        100   

Other

    —          —          —          —          —          —          —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
  $ 4,171        100      $ 3,271        100      $ 2,071        100      $ 1,600        100      $ 1,488        100   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Specialty Insurance Segment

 

Property and Casualty Insurance.    Our 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. We are licensed to issue policies in all 50 states and the District of Columbia and actively issue policies in 43 states. In our largest market, California, we also offer preferred risk auto insurance to better compete with other carriers offering bundled home and auto insurance. We market our property and casualty insurance business using both direct distribution channels, including cross-selling through our existing closing-service activities, and through a network of independent brokers. Reinsurance is used extensively to limit risk associated with natural disasters such as windstorms, winter storms, wildfires and earthquakes.

 

Home Warranties.    Our home warranty business provides residential service contracts that cover residential systems, such as heating and air conditioning systems, and certain appliances against failures that occur as the result of normal usage during the coverage period. Most of these policies are issued on resale residences, although policies are also available in some instances for new homes. Coverage is typically for one year and is renewable annually at the option of the contract holder and upon our approval. Coverage and pricing typically vary by geographic region. Fees for the warranties generally are paid at the closing of the home purchase or directly by the consumer. Renewal premiums may be paid by a number of different options. In addition, the contract holder is responsible for a service fee for each trade call. First year warranties primarily are marketed through real estate brokers and agents, although we also market directly to consumers. We generally sell renewals directly to consumers. Our home warranty business currently operates in 39 states and the District of Columbia.

 

Corporate

 

The Company’s corporate function consists primarily of certain financing facilities as well as the corporate services that support our business operations.

 

Regulation

 

Many of our subsidiaries are subject to extensive regulation by applicable domestic or foreign regulatory agencies. The extent of such regulation varies based on the industry involved, the nature of the business conducted by the subsidiary (for example, licensed title insurers are subject to a heightened level of regulation compared to underwritten title companies), the subsidiary’s jurisdiction of organization and the jurisdictions in which it operates. In addition, the Company is subject to regulation as both an insurance holding company and a savings and loan holding company.

 

Our subsidiaries that operate in the title insurance industry or the property and casualty insurance industry are subject to regulation by state insurance regulators. Each of our underwriters, or insurers, is regulated primarily by the insurance department or equivalent governmental body within the jurisdiction of its organization, which oversees compliance with the laws and regulations pertaining to such insurer. For example, our primary title insurance underwriter is a California corporation and, accordingly, is primarily regulated by the California Department of Insurance. Insurance regulations pertaining to insurers typically place limits on, among other matters, the ability of the insurer to pay dividends to its parent company or to enter into transactions with affiliates. They also may require approval of the insurance commissioner prior to a third party directly or indirectly acquiring “control” of the insurer.

 

In addition, our insurers are subject to the laws of other jurisdictions in which they transact business, which laws typically establish supervisory agencies with broad administrative powers relating to issuing and revoking licenses to transact business, regulating trade practices, licensing agents, approving policy forms, accounting practices and financial practices, establishing requirements pertaining to reserves and capital and surplus as

 

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regards policyholders, requiring the deferral of a portion of all premiums in a reserve for the protection of policyholders and the segregation of investments in a corresponding amount, establishing parameters regarding suitable investments for reserves, capital and surplus, and approving rate schedules. The manner in which rates are established or changed ranges from states which promulgate rates, to states where individual companies or associations of companies prepare rate filings which are submitted for approval, to a few states in which rate changes do not need to be filed for approval. In addition, each of our insurers is subject to periodic examination by regulatory authorities both within its jurisdiction of organization as well as the other jurisdictions where it is licensed to conduct business.

 

Our underwritten title companies and property and casualty insurance agencies are also subject to certain regulation by insurance regulatory or banking authorities, including, but not limited to, minimum net worth requirements, licensing requirements, statistical reporting requirements, rate filing requirements and marketing restrictions.

 

In addition to state-level regulation, our domestic subsidiaries that operate in the insurance business, as well as our home warranty subsidiaries and certain other subsidiaries are subject to regulation by federal agencies, including the newly formed Consumer Financial Protection Bureau (“CFPB”). The CFPB has been given broad authority to regulate, among other areas, the mortgage and real estate markets in matters pertaining to consumers. This authority includes the enforcement of the Real Estate Settlement Procedures Act formerly placed with the Department of Housing and Urban Development.

 

In addition, our home warranty business is subject to regulation in some states by insurance authorities or other applicable regulatory entities. Our federal savings bank and industrial bank are both subject to regulation by the Federal Deposit Insurance Corporation. Prior to July 21, 2011, our federal savings bank was regulated by the United States Department of the Treasury’s Office of Thrift Supervision. Since July 21, 2011, the federal savings bank has been regulated by the Office of the Comptroller of the Currency, with the Federal Reserve Board supervising its parent holding companies. The industrial bank is regulated by the California Department of Financial Institutions.

 

Investment Policies

 

The Company’s investment portfolio activities such as policy setting, compliance reporting, portfolio reviews, and strategy are overseen by an investment committee made up of certain senior executives. Additionally, the Company’s regulated subsidiaries, including title insurance underwriters, property and casualty insurance companies and banking entities, have established and maintain an investment committee to oversee their own investment portfolios. The Company’s investment policies are designed to comply with regulatory requirements and to align the investment portfolio strategy with strategic objectives. For example, our federal savings bank is required to maintain at least 65 percent of its asset portfolio in loans or securities that are secured by real estate. Our federal savings bank currently does not make real estate loans, and therefore fulfills this regulatory requirement through investments in mortgage-backed securities. In addition, applicable law imposes certain restrictions upon the types and amounts of investments that may be made by our regulated insurance subsidiaries.

 

The Company’s investment policies further provide that investments are to be managed to balance earnings, liquidity, regulatory and risk objectives, and that investments should not expose the Company to excessive levels of credit risk, interest risk or liquidity risk.

 

As of December 31, 2011, our debt and equity investment securities portfolio consists of approximately 90 percent of fixed income securities. As of that date, over 70 percent of our fixed income investments are held in securities that are United States government-backed or rated AAA, and approximately 98 percent of the fixed income portfolio is rated or classified as investment grade. Percentages are based on the amortized cost basis of the securities. Credit ratings are based on Standard & Poor’s and Moody’s published ratings. If a security was rated differently by both rating agencies, the lower of the two ratings was selected.

 

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Our equity portfolio includes the CoreLogic common stock that was issued to us in connection with the Separation and which is further described in Note 19 Transactions with CoreLogic/TFAC to the consolidated financial statements included in “Item 8. Financial Statements and Supplementary Data” of Part II of this report.

 

In addition to our debt and equity investment securities portfolio, we maintain certain money-market and other short-term investments. We also hold strategic equity investments in companies engaged in the title insurance and settlement services industries.

 

Employees

 

As of December 31, 2011, the Company employed 16,117 people on either a part-time or full-time basis.

 

Available Information

 

The Company maintains a website, www.firstam.com, which includes financial information and other information for investors, including open and closed title insurance orders (which typically are posted approximately 12 days after the end of each calendar month). The Company’s Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge through the “Investors” page of the website as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the Securities and Exchange Commission. The Company’s website and the information contained therein or connected thereto are not intended to be incorporated into this Annual Report on Form 10-K, or any other filing with the Securities and Exchange Commission unless the Company expressly incorporates such materials.

 

Item 1A.    Risk Factors

 

You should carefully consider each of the following risk factors and the other information contained in this Annual Report on Form 10-K. The Company faces risks other than those listed here, including those that are unknown to the Company and others of which the Company may be aware but, at present, considers immaterial. Because of the following factors, as well as other variables affecting the Company’s operating results, past financial performance may not be a reliable indicator of future performance, and historical trends should not be used to anticipate results or trends in future periods.

 

1. Conditions in the real estate market generally impact the demand for a substantial portion of the Company’s products and services

 

Demand for a substantial portion of the Company’s products and services generally decreases as the number of real estate transactions in which its products and services are purchased decreases. The number of real estate transactions in which the Company’s products and services are purchased decreases in the following situations:

 

   

when mortgage interest rates are high or rising;

 

   

when the availability of credit, including commercial and residential mortgage funding, is limited; and

 

   

when real estate values are declining.

 

2. Unfavorable economic conditions may have a material adverse effect on the Company

 

Uncertainty and negative trends in general economic conditions in the United States and abroad, including significant tightening of credit markets and a general decline in the value of real property, historically have created a difficult operating environment for the Company’s businesses and other companies in its industries. In addition, the Company holds investments in entities, such as title agencies, settlement service providers and property and casualty insurance companies, and instruments, such as mortgage-backed securities, which may be

 

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negatively impacted by these conditions. The Company also owns a federal savings bank into which it deposits some of its own funds and some funds held in trust for third parties. This bank invests those funds and any realized losses incurred will be reflected in the Company’s consolidated results. The likelihood of such losses, which generally would not occur if the Company were to deposit these funds in an unaffiliated entity, increases when economic conditions are unfavorable. Depending upon the ultimate severity and duration of any economic downturn, the resulting effects on the Company could be materially adverse, including a significant reduction in revenues, earnings and cash flows, challenges to the Company’s ability to satisfy covenants or otherwise meet its obligations under debt facilities, difficulties in obtaining access to capital, challenges to the Company’s ability to pay dividends at currently anticipated levels, deterioration in the value of its investments and increased credit risk from customers and others with obligations to the Company.

 

3. Unfavorable economic or other conditions could cause the Company to write off a portion of its goodwill and other intangible assets

 

The Company performs an impairment test of the carrying value of goodwill and other indefinite-lived intangible assets annually in the fourth quarter or sooner if circumstances indicate a possible impairment. Finite-lived intangible assets are subject to impairment tests on a periodic basis. Factors that may be considered in connection with this review include, without limitation, underperformance relative to historical or projected future operating results, reductions in the Company’s stock price and market capitalization, increased cost of capital and negative macroeconomic, industry and company-specific trends. These and other factors could lead to a conclusion that goodwill or other intangible assets are no longer fully recoverable, in which case the Company would be required to write off the portion believed to be unrecoverable. Total goodwill and other intangible assets reflected on the Company’s consolidated balance sheet as of December 31, 2011 are approximately $0.9 billion. Any substantial goodwill and other intangible asset impairments that may be required could have a material adverse effect on the Company’s results of operations, financial condition and liquidity.

 

4. Failures at financial institutions at which the Company deposits funds could adversely affect the Company

 

The Company deposits substantial funds in financial institutions. These funds include amounts owned by third parties, such as escrow deposits. Should one or more of the financial institutions at which deposits are maintained fail, there is no guarantee that the Company would recover the funds deposited, whether through Federal Deposit Insurance Corporation coverage or otherwise. In the event of any such failure, the Company also could be held liable for the funds owned by third parties.

 

5. Changes in government regulation could prohibit or limit the Company’s operations, make it more burdensome to conduct such operations or result in decreased demand for the Company’s products and services

 

Many of the Company’s businesses, including its title insurance, property and casualty insurance, home warranty, banking, trust and investment businesses, are regulated by various federal, state, local and foreign governmental agencies. These and other of the Company’s businesses also operate within statutory guidelines. The industry in which the Company operates and the markets into which it sells its products are also regulated and subject to statutory guidelines. Changes in the applicable regulatory environment, statutory guidelines or interpretations of existing regulations or statutes, enhanced governmental oversight or efforts by governmental agencies to cause customers to refrain from using the Company’s products or services could prohibit or limit its future operations or make it more burdensome to conduct such operations or result in decreased demand for the Company’s products and services. The impact of these changes would be more significant if they involve jurisdictions in which the Company generates a greater portion of its title premiums, such as the states of Arizona, California, Florida, Michigan, New York, Ohio, Pennsylvania and Texas and the province of Ontario, Canada. These changes may compel the Company to reduce its prices, may restrict its ability to implement price increases or acquire assets or businesses, may limit the manner in which the Company conducts its business or otherwise may have a negative impact on its ability to generate revenues, earnings and cash flows.

 

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6. Scrutiny of the Company’s businesses and the industries in which it operates by governmental entities and others could adversely affect its operations and financial condition

 

The real estate settlement services industry, an industry in which the Company generates a substantial portion of its revenue and earnings, is subject to heightened scrutiny by regulators, legislators, the media and plaintiffs’ attorneys. Though often directed at the industry generally, these groups may also focus their attention directly on the Company’s businesses. In either case, this scrutiny may result in changes which could adversely affect the Company’s operations and, therefore, its financial condition and liquidity.

 

Governmental entities have routinely inquired into certain practices in the real estate settlement services industry to determine whether certain of the Company’s businesses or its competitors have violated applicable laws, which include, among others, the insurance codes of the various jurisdictions and the Real Estate Settlement Procedures Act and similar state, federal and foreign laws. Departments of insurance in the various states, either separately or in conjunction with federal regulators and applicable regulators in international jurisdictions, also periodically conduct targeted inquiries into the practices of title insurance companies in their respective jurisdictions. Further, from time to time plaintiffs’ lawyers may target the Company and other members of the Company’s industry with lawsuits claiming legal violations or other wrongful conduct. These lawsuits may involve large groups of plaintiffs and claims for substantial damages. Any of these types of inquiries or proceedings may result in a finding of a violation of the law or other wrongful conduct and may result in the payment of fines or damages or the imposition of restrictions on the Company’s conduct which could impact its operations and financial condition. Moreover, these laws and standards of conduct often are ambiguous and, thus, it may be difficult to ensure compliance. This ambiguity may force the Company to mitigate its risk by settling claims or by ending practices that generate revenues, earnings and cash flows.

 

7. Regulation of title insurance rates could adversely affect the Company’s results of operations

 

Title insurance rates are subject to extensive regulation, which varies from state to state. In many states the approval of the applicable state insurance regulator is required prior to implementing a rate change. This regulation could hinder the Company’s ability to promptly adapt to changing market dynamics through price adjustments, which could adversely affect its results of operations, particularly in a rapidly declining market.

 

8. Reform of government-sponsored enterprises could negatively impact the Company

 

Historically a substantial proportion of home loans originated in the United States were sold to and, generally, resold in a securitized form by, the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). As a condition to the purchase of a home loan Fannie Mae and Freddie Mac generally required the purchase of title insurance for their benefit and, as applicable, the benefit of the holders of home loans they may have securitized. The federal government currently is considering various alternatives to reform Fannie Mae and Freddie Mac. The role, if any, that these enterprises or other enterprises fulfilling a similar function will play in the mortgage process following the adoption of any reforms is not currently known. The timing of the adoption and, thereafter, the implementation of the reforms is similarly unknown. Due to the significance of the role of these enterprises, the mortgage process itself may substantially change as a result of these reforms and related discussions. It is possible that these entities, as reformed, or the successors to these entities may require changes to the way title insurance is priced or delivered, changes to standard policy terms or other changes which may make the title insurance business less profitable. These reforms may also alter the home loan market, such as by causing higher mortgage interest rates due to decreased governmental support of mortgage-backed securities. These consequences could be materially adverse to the Company and its financial condition.

 

9. The Company may find it difficult to acquire necessary data

 

Certain data used and supplied by the Company are subject to regulation by various federal, state and local regulatory authorities. Compliance with existing federal, state and local laws and regulations with respect to such

 

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data has not had a material adverse effect on the Company’s results of operations, financial condition or liquidity to date. Nonetheless, federal, state and local laws and regulations in the United States designed to protect the public from the misuse of personal information in the marketplace and adverse publicity or potential litigation concerning the commercial use of such information may affect the Company’s operations and could result in substantial regulatory compliance expense, litigation expense and a loss of revenue. The suppliers of data to the Company face similar burdens and, consequently, the Company may find it financially burdensome to acquire necessary data.

 

10. Product migration may result in decreased revenue

 

Customers of many real estate settlement services the Company provides increasingly require these services to be delivered faster, cheaper and more efficiently. Many of the traditional products it provides are labor and time intensive. As these customer pressures increase, the Company may be forced to replace traditional products with automated products that can be delivered electronically and with limited human processing. Because many of these traditional products have higher prices than corresponding automated products, the Company’s revenues may decline.

 

11. Increases in the size of the Company’s customers enhance their negotiating position vis-à-vis the Company and may decrease their need for the services offered by the Company

 

Many of the Company’s customers are increasing in size as a result of consolidation or the failure of their competitors. For example, the Company believes that three lenders collectively originate approximately 50 percent of mortgage loans in the United States. As a result, the Company may derive a higher percentage of its revenues from a smaller base of customers, which would enhance the negotiating power of these customers with respect to the pricing and the terms on which these customers purchase the Company’s products and other matters. Moreover, these larger customers may prove more capable of performing in-house some or all of the services the Company provides or, with respect to the Company’s title insurance products, more willing to assume the risk of title defects themselves and, consequently, the demand for the Company’s products and services may decrease. These circumstances could adversely affect the Company’s revenues and profitability. Changes in the Company’s relationship with any of these customers, the loss of all or a portion of the business the Company derives from these customers or any refusal of these customers to accept the Company’s policies could have a material adverse effect on the Company.

 

12. A downgrade by ratings agencies, reductions in statutory surplus maintained by the Company’s title insurance underwriters or a deterioration in other measures of financial strength may negatively affect the Company’s results of operations and competitive position

 

Certain of the Company’s customers use measurements of the financial strength of the Company’s title insurance underwriters, including, among others, ratings provided by ratings agencies and levels of statutory surplus maintained by those underwriters, in determining the amount of a policy they will accept and the amount of reinsurance required. Each of the major ratings agencies currently rates the Company’s title insurance operations. The Company’s principal title insurance underwriter’s financial strength ratings are “A3” by Moody’s, “A-” by Fitch, “BBB+” by Standard & Poor’s and “A-” by A.M. Best. These ratings provide the agencies’ perspectives on the financial strength, operating performance and cash generating ability of those operations. These agencies continually review these ratings and the ratings are subject to change. Statutory surplus, or the amount by which statutory assets exceed statutory liabilities, is also a measure of financial strength. The Company’s principal title insurance underwriter maintained approximately $817.6 million of statutory surplus capital as of December 31, 2011. The current minimum statutory surplus capital required to be maintained by California law is $500,000. Accordingly, if the ratings or statutory surplus of these title insurance underwriters are reduced from their current levels, or if there is a deterioration in other measures of financial strength, the Company’s results of operations, competitive position and liquidity could be adversely affected.

 

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13. The Company’s investment portfolio is subject to certain risks and could experience losses

 

The Company maintains a substantial investment portfolio, primarily consisting of fixed income securities (including mortgage-backed securities) and, as of December 31, 2011, common stock of CoreLogic with a cost basis of $167.6 million and an estimated fair value of $115.5 million that was issued to the Company in connection with its separation from CoreLogic. The investment portfolio also includes money-market and other short-term investments, as well as some preferred and other common stock. Securities in the Company’s investment portfolio are subject to certain economic and financial market risks, such as credit risk, interest rate (including call, prepayment and extension) risk and/or liquidity risk. Because a substantial proportion of the portfolio consists of the common stock of a single issuer, CoreLogic, the risk of loss in the portfolio also is impacted by factors that influence the value of CoreLogic’s stock, including, but not limited to, CoreLogic’s financial results and the market’s perception of CoreLogic’s and its industry’s prospects. Additionally, the risk of loss associated with the portfolio is increased during periods, such as the present period, of instability in credit markets and economic conditions. If the carrying value of the investments exceeds the fair value, and the decline in fair value is deemed to be other-than-temporary, the Company will be required to write down the value of the investments, which could have a material adverse effect on the Company’s results of operations, statutory surplus and financial condition.

 

14. The Company’s pension plan is currently underfunded and pension expenses and funding obligations could increase significantly as a result of weak performance of financial markets and its effect on plan assets

 

The Company is responsible for the obligations of its defined benefit pension plan, which it assumed from its former parent, The First American Corporation, on June 1, 2010 in connection with the spin-off transaction which was consummated on that date. The plan was closed to new entrants effective December 31, 2001 and amended to “freeze” all benefit accruals as of April 30, 2008. The Company’s future funding obligations for this plan depend, among other factors, upon the future performance of assets held in trust for the plan. The pension plan was underfunded as of December 31, 2011 by approximately $128.7 million and the Company may need to make significant contributions to the plan. In addition, pension expenses and funding requirements may also be greater than currently anticipated if the market values of the assets held by the pension plan decline or if the other assumptions regarding plan earnings and expenses require adjustment.

 

The Company’s obligations under this plan could have a material adverse effect on its results of operations, financial condition and liquidity.

 

15. Actual claims experience could materially vary from the expected claims experience reflected in the Company’s reserve for incurred but not reported claims

 

The Company maintains a reserve for incurred but not reported (“IBNR”) claims pertaining to its title, escrow and other insurance and guarantee products. The majority of this reserve pertains to title insurance policies, which are long-duration contracts with the majority of the claims reported within the first few years following the issuance of the policy. Generally, 75 to 85 percent of claim amounts become known in the first six years of the policy life, and the majority of IBNR reserves relate to the six most recent policy years. A material change in expected ultimate losses and corresponding loss rates for policy years older than six years, while possible, is not considered reasonably likely. However, changes in expected ultimate losses and corresponding loss rates for recent policy years are considered likely and could result in a material adjustment to the IBNR reserves. Based on historical experience, management believes a 50 basis point change to the loss rates for the most recent policy years, positive or negative, is reasonably likely given the long duration nature of a title insurance policy. For example, if the expected ultimate losses for each of the last six policy years increased or decreased by 50 basis points, the resulting impact on the Company’s IBNR reserve would be an increase or decrease, as the case may be, of $120.4 million. The estimates made by management in determining the appropriate level of IBNR reserves could ultimately prove to be inaccurate and actual claims experience may vary from the expected claims experience.

 

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16. The issuance of the Company’s title insurance policies and related activities by title agents, which operate with substantial independence from the Company, could adversely affect the Company

 

The Company’s title insurance subsidiaries issue a significant portion of their policies through title agents that operate with a substantial degree of independence from the Company. While these title agents are subject to certain contractual limitations that are designed to limit the Company’s risk with respect to their activities, there is no guarantee that the agents will fulfill their contractual obligations to the Company. In addition, regulators are increasingly seeking to hold the Company responsible for the actions of these title agents and, under certain circumstances, the Company may be held liable directly to third parties for actions (including defalcations) or omissions of these agents. As a result, the Company’s use of title agents could result in increased claims on the Company’s policies issued through agents and an increase in other costs and expenses.

 

17. Systems interruptions and intrusions, wire transfer errors and unauthorized data disclosures may impair the delivery of the Company’s products and services, harm the Company’s reputation and result in material claims for damages

 

System interruptions and intrusions may impair the delivery of the Company’s products and services, resulting in a loss of customers and a corresponding loss in revenue. The Company’s businesses depend heavily upon computer systems located in its data centers. Certain events beyond the Company’s control, including natural disasters, telecommunications failures and intrusions into the Company’s systems by third parties could temporarily or permanently interrupt the delivery of products and services. These interruptions also may interfere with suppliers’ ability to provide necessary data and employees’ ability to attend work and perform their responsibilities. The Company also relies on its systems, employees and domestic and international banks to transfer funds. These transfers are susceptible to user input error, fraud, system interruptions or intrusions, incorrect processing and similar errors that could result in lost funds that may be significant. As part of its business, the Company maintains non-public personal information on consumers. There can be no assurance that unauthorized disclosure will not occur either through system intrusions or the actions of third parties or employees. Unauthorized disclosures could adversely affect the Company’s reputation and expose it to material claims for damages.

 

18. The Company may not be able to realize the benefits of its offshore strategy

 

The Company utilizes lower cost labor in foreign countries, such as India and the Philippines, among others. These countries are subject to relatively high degrees of political and social instability and may lack the infrastructure to withstand natural disasters. Such disruptions could decrease efficiency and increase the Company’s costs in these countries. Weakness of the United States dollar in relation to the currencies used in these foreign countries may also reduce the savings achievable through this strategy. Furthermore, the practice of utilizing labor based in foreign countries has come under increased scrutiny in the United States and, as a result, some of the Company’s customers may require it to use labor based in the United States. Laws or regulations that require the Company to use labor based in the United States or effectively increase the cost of the Company’s foreign labor also could be enacted. The Company may not be able to pass on these increased costs to its customers.

 

19. As a holding company, the Company depends on distributions from its subsidiaries, and if distributions from its subsidiaries are materially impaired, the Company’s ability to declare and pay dividends may be adversely affected; in addition, insurance and other regulations limit the amount of dividends, loans and advances available from the Company’s insurance subsidiaries

 

The Company is a holding company whose primary assets are investments in its operating subsidiaries. The Company’s ability to pay dividends is dependent on the ability of its subsidiaries to pay dividends or repay funds. If the Company’s operating subsidiaries are not able to pay dividends or repay funds, the Company may not be able to fulfill parent company obligations and/or declare and pay dividends to its stockholders. Moreover, pursuant to insurance and other regulations under which the Company’s insurance subsidiaries operate, the amount of dividends, loans and advances available is limited. As of December 31, 2011, under such regulations, the maximum amount of dividends, loans and advances available in 2012 from these insurance subsidiaries was $181.1 million.

 

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20. Certain provisions of the Company’s bylaws and certificate of incorporation may reduce the likelihood of any unsolicited acquisition proposal or potential change of control that the Company’s stockholders might consider favorable

 

The Company’s bylaws and certificate of incorporation contain provisions that could be considered “anti-takeover” provisions because they make it harder for a third-party to acquire the Company without the consent of the Company’s incumbent board of directors. Under these provisions:

 

   

election of the Company’s board of directors is staggered such that only one-third of the directors are elected by the stockholders each year and the directors serve three year terms prior to reelection;

 

   

stockholders may not remove directors without cause, change the size of the board of directors or, except as may be provided for in the terms of preferred stock the Company issues in the future, fill vacancies on the board of directors;

 

   

stockholders may act only at stockholder meetings and not by written consent;

 

   

stockholders must comply with advance notice provisions for nominating directors or presenting other proposals at stockholder meetings; and

 

   

the Company’s board of directors may without stockholder approval issue preferred shares and determine their rights and terms, including voting rights, or adopt a stockholder rights plan.

 

While the Company believes that they are appropriate, these provisions, which may only be amended by the affirmative vote of the holders of approximately 67 percent of the Company’s issued voting shares, could have the effect of discouraging an unsolicited acquisition proposal or delaying, deferring or preventing a change of control transaction that might involve a premium price or otherwise be considered favorably by the Company’s stockholders.

 

21. The Company could have conflicts with CoreLogic

 

The Company and CoreLogic were part of a single publicly traded company, The First American Corporation, until the Company’s separation from CoreLogic on June 1, 2010. Conflicts with CoreLogic may arise as a result of the Company’s agreements with CoreLogic. Competition between the companies also could result in conflicts. While current competition between the companies is not material, the extent of future competition could increase. In addition, the Company’s chairman of the board of directors, Parker S. Kennedy, is also chairman emeritus of CoreLogic. As such, conflicts of interest with respect to matters potentially or actually affecting both companies may arise. Conflicts, competition or conflicts of interest pertaining to the Company’s relationship with CoreLogic could adversely affect the Company.

 

Item 1B.    Unresolved Staff Comments

 

None.

 

Item 2.    Properties

 

We maintain our executive offices at MacArthur Place in Santa Ana, California. In 2005, The First American Corporation expanded its three-building office campus through the addition of two four-story office buildings totaling approximately 226,000 square feet, a two-story, free standing, approximately 52,000 square foot technology center and a two-story parking structure, bringing the total square footage to approximately 490,000 square feet. The original three office buildings, totaling approximately 210,000 square feet, and the fixtures thereto and underlying land, are subject to a deed of trust and security agreement securing payment of a promissory note evidencing a loan made in October 2003, to our principal title insurance subsidiary in the original sum of $55.0 million. This loan is payable in monthly installments of principal and interest, is fully amortizing and matures November 1, 2023. The outstanding principal balance of this loan was $39.3 million as of December 31, 2011. Our title insurance subsidiary owns and operates these properties, and leases approximately 107,000 square feet within one of the buildings to CoreLogic for its executive offices pursuant to a lease entered into in connection with the

 

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Separation. The technology center referred to above is primarily utilized and maintained by the Company but also houses physically segregated servers belonging to CoreLogic which are maintained by CoreLogic.

 

One of our subsidiaries in the title insurance and services segment leases an aggregate of approximately 150,000 square feet of office space in four buildings of the International Technology Park in Bangalore, India pursuant to various lease agreements. Most of the space is leased pursuant to agreements that expire in 2014 and the current term of each of the other leases expires in 2012.

 

The office facilities we occupy are, in all material respects, in good condition and adequate for their intended use.

 

Item 3.    Legal Proceedings

 

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,

 

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

 

   

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 for the District of New Jersey,

 

   

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

 

   

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

 

   

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

 

   

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 and

 

   

Tello v. First American Title Insurance Company, filed on July 14, 2009 and pending in the United States District Court for the District of New Hampshire.

 

All of these lawsuits are putative class actions. A court has 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

 

   

Barton v. First American Title Insurance Company, et al, filed March 10, 2008 and pending in the United States District Court for the Northern District of California,

 

   

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,

 

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

 

   

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

 

Katin is a putative class action. A class has been certified in Gale. 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 for the District 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,

 

   

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,

 

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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, are putative class actions for which a class has not been certified. In Sjobring a class was certified but that certification was subsequently vacated. 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.

 

On March 5, 2010, Bank of America, N.A. filed a complaint in the North Carolina General Court of Justice, Superior Court Division against United General Title Insurance Company and First American Title Insurance Company alleging that the defendants failed to pay or failed to timely respond to certain claims made on title insurance policies issued in connection with home equity loans or lines of credit that are now in default.

 

On April 1, 2010, the Company filed a third party complaint within the same litigation against Fiserv Solutions, Inc. for breach of contract, indemnification and other matters relating to the plaintiff’s allegations.

 

During the fourth quarter of 2011, the Company, Bank of America and Fiserv settled the lawsuit through mediation. As a result of the settlement, the Company recorded a charge of $19.2 million in the fourth quarter, which is in addition to the $13.0 million charge recorded in the third quarter of 2011 and is net of all recoveries. The settlement extinguishes all Company liability in connection with policies issued to Bank of America of the type that are the subject of the lawsuit, whether or not Bank of America has submitted a claim with respect to such policies. The court approved of the settlement on December 8, 2011 and dismissed the case with prejudice.

 

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.

 

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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.

 

Item 4.    Mine Safety Disclosures

 

Not applicable.

 

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PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Common Stock Market Prices and Dividends

 

The Company’s common stock trades on the New York Stock Exchange (ticker symbol FAF). The approximate number of record holders of common stock on February 15, 2012, was 3,002.

 

High and low stock prices and dividends declared for 2011 and for June 2 through December 31, 2010 are set forth in the table below. June 2, 2010 was the first day that the Company’s common stock traded regular way on the New York Stock Exchange following the Company’s separation from The First American Corporation on June 1, 2010.

 

     2011      2010  

Period

   High-low range      Cash
dividends
     High-low range      Cash dividends  

Quarter Ended March 31

   $ 14.45-$17.37       $ 0.06                   

Quarter Ended June 30 (1)

   $ 14.50-$16.68       $ 0.06       $ 12.03-$15.74       $ 0.06   

Quarter Ended September 30

   $ 12.45-$16.36       $ 0.06       $ 11.90-$15.95       $ 0.06   

Quarter Ended December 31

   $ 10.51-$13.72       $ 0.06       $ 13.51-$15.25       $ 0.06   

 

(1) For the quarter ended June 30, 2010, the high-low range is between June 2 through June 30, 2010.

 

We expect that the Company will continue to pay quarterly cash dividends at or above the current level. The timing, declaration and payment of future dividends, however, falls within the discretion of the Company’s board of directors and will depend upon many factors, including the Company’s financial condition and earnings, the capital requirements of our businesses, industry practice, restrictions imposed by applicable law and any other factors the board of directors deems relevant from time to time. In addition, the ability to pay dividends also is potentially affected by the restrictions described in Note 2 Statutory Restrictions on Investments and Stockholders’ Equity to the consolidated financial statements included in “Item 8. Financial Statements and Supplementary Data” of Part II of this report.

 

Unregistered Sales of Equity Securities

 

During the year ended December 31, 2011, the Company did not issue any unregistered common stock.

 

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Purchases of Equity Securities by the Issuer and Affiliated Purchasers

 

The following table describes purchases by the Company of the Company’s common stock which settled during each period set forth in the table. Prices in column (b) include commissions. Purchases described in column (c) were made pursuant to the share repurchase program initially announced by the Company on March 16, 2011. Under this plan, which has no expiration date, the Company may repurchase up to $150.0 million of the Company’s issued and outstanding common stock. Cumulatively the Company has repurchased $2.5 million (including commissions) of its shares and had the authority to repurchase an additional $147.5 million (including commissions) under the plan.

 

Period

   (a)
Total
Number of
Shares
Purchased
     (b)
Average
Price Paid
per Share
     (c)
Total Number of
Shares
Purchased as Part
of Publicly
Announced Plans
or Programs
     (d)
Maximum
Approximate Dollar
Value of Shares
that May Yet Be
Purchased Under
the Plans or
Programs
 

October 1 to October 31, 2011

                           $ 150,000,000   

November 1 to November 30, 2011

                           $ 150,000,000   

December 1 to December 31, 2011

     203,900       $ 12.27         203,900       $ 147,497,665   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     203,900       $ 12.27         203,900       $ 147,497,665   

 

Stock Performance Graph

 

The following performance graph and related information shall not be deemed “soliciting material” or “filed” with the SEC, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, each as amended, except to the extent that it is specifically incorporated by reference into such filing.

 

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The following graph compares the cumulative total stockholder return on the Company’s common stock with the corresponding cumulative total returns of the Russell 2000 Financial Services Index and a peer group index for the period from June 2, 2010, the first day the Company’s common stock traded in the regular way market on the New York Stock Exchange, through December 31, 2011. The comparison assumes an investment of $100 on June 2, 2010 and reinvestment of dividends. This historical performance is not indicative of future performance.

 

LOGO

 

Comparison of Cumulative Total Return

 

     First
American Financial
Corporation
(FAF) (1)
     Custom Peer
Group (1)(2)
     Russell 2000
Financial
Services Index (1)
 

June 2, 2010

   $ 100       $ 100       $ 100   

December 31, 2010

   $ 104       $ 105       $ 112   

December 31, 2011

   $ 90       $ 110       $ 109   

 

(1) As calculated by Bloomberg Financial Services, to include reinvestment of dividends.
(2) The peer group consists of the following companies: American Financial Group, Inc.; Assurant, Inc.; Cincinnati Financial Corporation; Fidelity National Financial, Inc.; The Hanover Insurance Group, Inc.; Kemper Corporation; Lender Processing Services, Inc.; Mercury General Corporation; Old Republic International Corp.; White Mountains Insurance Group Ltd., and W.R. Berkley Corporation each of which operates in a business similar to a business operated by the Company. The compensation committee of the Company utilizes the compensation practices of these companies as benchmarks in setting the compensation of its executive officers.

 

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Item 6.    Selected Financial Data

 

The selected historical consolidated financial data for First American Financial Corporation (the “Company”) for the five-year period ended December 31, 2011, have been derived from the Company’s consolidated financial statements presented in Item 8. The selected historical consolidated financial data should be read in conjunction with the Consolidated Financial Statements and Notes thereto, “Item 1—Business,” and “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

The Company became a publicly traded company in connection with its spin-off from its prior parent, The First American Corporation (“TFAC”), on June 1, 2010 (the “Separation”). The Company’s historical financial statements prior to June 1, 2010 have been derived from the consolidated financial statements of TFAC and represent carve-out stand-alone combined financial statements. The combined financial statements prior to June 1, 2010 include items attributable to the Company and allocations of general corporate expenses from TFAC. As a result, the Company’s selected historical consolidated financial data prior to June 1, 2010 do not necessarily reflect what its financial position or results of operations would have been if it had been operated as a stand-alone public entity during the periods covered prior to June 1, 2010, and may not be indicative of the Company’s future results of operations and financial position. See Note 1 Description of the Company to the consolidated financial statements for further discussion of the Separation and basis of presentation.

 

First American Financial Corporation and Subsidiary Companies

 

     Year Ended December 31,  
     2011     2010     2009     2008     2007  
     (in thousands, except percentages, per share amounts and employee  data)  

Revenues

   $ 3,820,574      $ 3,906,612      $ 4,046,834      $ 4,367,725      $ 6,076,132   

Net income (loss)

   $ 78,579      $ 128,956      $ 134,277      $ (72,482   $ (122,446

Net income attributable to noncontrolling interests

   $ 303      $ 1,127      $ 11,888      $ 11,523      $ 20,537   

Net income (loss) attributable to the Company

   $ 78,276      $ 127,829      $ 122,389      $ (84,005   $ (142,983

Total assets

   $ 5,370,337      $ 5,821,826      $ 5,530,281      $ 5,720,757      $ 5,354,531   

Notes and contracts payable

   $ 299,975      $ 293,817      $ 119,313      $ 153,969      $ 306,582   

Allocated portion of TFAC debt (Note A)

   $ —        $ —        $ 140,000      $ 140,000      $ —     

Stockholders’ equity or TFAC’s invested equity (Note B)

   $ 2,028,600      $ 1,980,017      $ 2,019,800      $ 1,891,841      $ 1,930,774   

Return on average stockholders’ equity or TFAC’s invested equity

     3.9     6.4     6.3     (4.4 )%      (6.4 )% 

Dividends on common shares (Note C)

   $ 24,784      $ 18,553      $ —        $ —        $ —     

Per share of common stock (Note D)—
Net income (loss) attributable to the Company:

          

Basic

   $ 0.74      $ 1.23      $ 1.18      $ (0.81   $ (1.37

Diluted

   $ 0.73      $ 1.20      $ 1.18      $ (0.81   $ (1.37

Stockholders’ equity or TFAC’s invested equity

   $ 19.24      $ 18.96      $ 19.42      $ 18.19      $ 18.56   

Cash dividends

   $ 0.24      $ 0.18      $ —        $ —        $ —     

Number of common shares outstanding (Note E)—Weighted average during the year:

          

Basic

     105,197        104,134        104,006        104,006        104,006   

Diluted

     106,914        106,177        104,006        104,006        104,006   

End of year

     105,410        104,457        104,006        104,006        104,006   

Other Operating Data (unaudited):

          

Title orders opened (Note F)

     1,254        1,469        1,771        1,780        2,221   

Title orders closed (Note F)

     918        1,079        1,301        1,239        1,538   

Number of employees (Note G)

     16,117        16,879        13,963        15,147        19,783   

 

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Note A—Prior to the Separation, a portion of TFAC’s combined debt, in the amount of $140.0 million, was allocated to the Company based on amounts directly incurred for the Company’s benefit. In connection with the Separation, the Company borrowed $200.0 million under its revolving credit facility and transferred such funds to CoreLogic, which fully satisfied the Company’s $140.0 million allocated portion of TFAC debt.

 

Note B—Stockholders’ equity refers to the stockholders of the Company and excludes noncontrolling interests. TFAC’s invested equity refers to the net assets of the Company which reflects TFAC’s investment in the Company prior to the Separation and excludes noncontrolling interests.

 

Note C—The Company did not declare dividends prior to the Separation as it was not a stand-alone publicly traded company until the Separation.

 

Note D—Per share information relating to net income is based on weighted-average number of shares outstanding for the years presented. Per share information relating to stockholders’ equity is based on shares outstanding at the end of each year.

 

Note E—Number of common shares outstanding for prior years was computed using the number of shares of common stock outstanding immediately following the Separation, as if such shares were outstanding for the entire period prior to the Separation.

 

Note F—Title order volumes are those processed by the direct domestic title operations of the Company and do not include orders processed by agents.

 

Note G—Number of employees is based on actual employee headcount. The increase in headcount in 2010 was due to certain offshore functions being performed internally by the Company that prior to the Separation were performed by TFAC. This increase in headcount is substantially related to employees employed outside of the United States.

 

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Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

This Management’s Discussion and Analysis contains certain financial measures, including adjusted title insurance and services segment operating expenses and personnel costs, that are not presented in accordance with generally accepted accounting principles (“GAAP”). The Company is presenting these non-GAAP financial measures because they provide the Company’s management and readers of the Annual Report on Form 10-K with additional insight into the operational performance of the Company relative to earlier periods and relative to the Company’s competitors. The Company does not intend for these non-GAAP financial measures to be a substitute for any GAAP financial information. Readers of this Annual Report on Form 10-K should use these non-GAAP financial measures only in conjunction with the comparable GAAP financial measures.

 

Spin-off

 

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 owns TFAC’s financial services businesses and TFAC, which reincorporated and assumed the name CoreLogic, Inc. (“CoreLogic”), continues to own its information solutions businesses. The Company’s common stock trades on the New York Stock Exchange under the “FAF” ticker symbol and CoreLogic’s common stock trades on the New York Stock Exchange under the ticker symbol “CLGX.”

 

To effect the Separation, TFAC and the Company entered into a Separation and Distribution Agreement (the “Separation and Distribution Agreement”) that governs the rights and obligations of the Company and CoreLogic regarding the Distribution. It also governs the relationship between the Company and CoreLogic subsequent to the completion of the Separation and provides for the allocation between the Company and CoreLogic of TFAC’s assets and liabilities. The Separation and Distribution Agreement identifies assets, liabilities and contracts that were allocated between CoreLogic and the Company as part of the Separation and describes the transfers, assumptions and assignments of these assets, liabilities and contracts. In particular, the Separation and Distribution Agreement provides that, subject to the terms and conditions contained therein:

 

   

All of the assets and liabilities primarily related to the Company’s business—primarily the business and operations of TFAC’s title insurance and services segment and specialty insurance segment—have been retained by or transferred to the Company;

 

   

All of the assets and liabilities primarily related to CoreLogic’s business—primarily the business and operations of TFAC’s data and analytic solutions, information and outsourcing solutions and risk mitigation and business solutions segments—have been retained by or transferred to CoreLogic;

 

   

On the record date for the Distribution, TFAC issued to the Company and its principal title insurance subsidiary, First American Title Insurance Company (“FATICO”), a number of shares of its common stock that resulted in the Company and FATICO collectively owning 12.9 million shares of CoreLogic’s common stock immediately following the Separation, some of which have subsequently been sold. See Note 19 Transactions with CoreLogic/TFAC to the consolidated financial statements for further discussion of the CoreLogic stock;

 

   

The Company effectively assumed $200.0 million of the outstanding liability for indebtedness under TFAC’s senior secured credit facility through the Company’s borrowing and transferring to CoreLogic of $200.0 million under the Company’s credit facility in connection with the Separation. See Note 10 Notes and Contracts Payable to the consolidated financial statements for further discussion of the Company’s credit facility.

 

The Separation resulted in a net distribution from the Company to TFAC of $151.4 million. In connection with such distribution, the Company assumed $22.1 million of accumulated other comprehensive loss, net of tax, which was primarily related to the Company’s assumption of the unfunded portion of the defined benefit pension

 

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obligation associated with participants who were employees of the businesses retained by CoreLogic. See Note 14 Employee Benefit Plans to the consolidated financial statements for additional discussion of the defined benefit pension plan.

 

Principles of Consolidation

 

The consolidated financial statements have been prepared in accordance with generally accepted accounting principles and reflect the consolidated operations of the Company as a separate, stand-alone publicly traded company subsequent to June 1, 2010. The consolidated financial statements include the accounts of First American Financial Corporation and all controlled subsidiaries. All significant intercompany transactions and balances have been eliminated. Investments in which the Company exercises significant influence, but does not control and is not the primary beneficiary, are accounted for using the equity method. Investments in which the Company does not exercise significant influence over the investee are accounted for under the cost method.

 

Principles of Combination and Basis of Presentation

 

The Company’s historical financial statements prior to June 1, 2010 have been prepared in accordance with generally accepted accounting principles and have been derived from the consolidated financial statements of TFAC and represent carve-out stand-alone combined financial statements. The combined financial statements prior to June 1, 2010 include items attributable to the Company and allocations of general corporate expenses from TFAC.

 

The Company’s historical financial statements prior to June 1, 2010 include assets, liabilities, revenues and expenses directly attributable to the Company’s operations. The Company’s historical financial statements prior to June 1, 2010 reflect allocations of corporate expenses from TFAC for certain functions provided by TFAC, including, but not limited to, general corporate expenses related to finance, legal, information technology, human resources, communications, compliance, facilities, procurement, employee benefits, and share-based compensation. These expenses have been allocated to the Company on the basis of direct usage when identifiable, with the remainder allocated on the basis of net revenue, domestic headcount or assets or a combination of such drivers. The Company considers the basis on which the expenses have been allocated to be a reasonable reflection of the utilization of services provided to or the benefit received by the Company during the periods presented. The Company’s historical financial statements prior to June 1, 2010 do not reflect the debt or interest expense it might have incurred if it had been a stand-alone entity. In addition, the Company expects to incur other expenses, not reflected in its historical financial statements prior to June 1, 2010, as a result of being a separate publicly traded company. As a result, the Company’s historical financial statements prior to June 1, 2010 do not necessarily reflect what its financial position or results of operations would have been if it had been operated as a stand-alone public entity during the periods covered prior to June 1, 2010, and may not be indicative of the Company’s future results of operations and financial position.

 

Reportable Segments

 

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 closing and/or escrow 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

 

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insurance and other insurance and guarantee products, as well as similar or related products and 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 certain 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 function consists primarily of certain financing facilities as well as the corporate services that support the Company’s business operations.

 

Critical Accounting Policies and Estimates

 

The Company’s management considers the accounting policies described below to be critical in preparing the Company’s consolidated financial statements. These policies require management to make estimates and judgments that affect the reported amounts of certain assets, liabilities, revenues, expenses and related disclosures of contingencies. See Note 1 Description of the Company to the consolidated financial statements for a more detailed description of the Company’s accounting policies.

 

Revenue recognition.    Title premiums on policies issued directly by the Company are recognized on the effective date of the title policy and escrow fees are recorded upon close of the escrow. Revenues from title policies issued by independent agents are recorded when notice of issuance is received from the agent, which is generally when cash payment is received by the Company. Revenues earned by the Company’s title plant management business are recognized at the time of delivery, as the Company has no significant ongoing obligation after delivery.

 

Direct premiums of the Company’s specialty insurance segment include revenues from home warranty contracts which are recognized ratably over the 12-month duration of the contracts, and revenues from property and casualty insurance policies which are also recognized ratably over the 12-month duration of the policies.

 

Interest on loans of the Company’s thrift subsidiary is recognized on the outstanding principal balance on the accrual basis. Loan origination fees and related direct loan origination costs are deferred and recognized over the life of the loan. Revenues earned by the other products in the Company’s trust and banking operations are recognized at the time of delivery, as the Company has no significant ongoing obligation after delivery.

 

Provision for policy losses.    The Company provides for title insurance losses by a charge to expense when the related premium revenue is recognized. The amount charged to expense is generally determined by applying a rate (the loss provision rate) to total title insurance premiums and escrow fees. The Company’s management estimates the loss provision rate at the beginning of each year and reassesses the rate quarterly to ensure that the resulting incurred but not reported (“IBNR”) loss reserve and known claims reserve included in the Company’s consolidated balance sheets together reflect management’s best estimate of the total costs required to settle all IBNR and known claims. If the ending IBNR reserve is not considered adequate, an adjustment is recorded.

 

The process of assessing the loss provision rate and the resulting IBNR reserve involves evaluation of the results of both an in-house actuarial review and independent actuarial analysis. The Company’s in-house actuary performs a reserve analysis utilizing generally accepted actuarial methods that incorporate cumulative historical

 

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claims experience and information provided by in-house claims and operations personnel. Current economic and business trends are also reviewed and used in the reserve analysis. These include real estate and mortgage markets conditions, changes in residential and commercial real estate values, and changes in the levels of defaults and foreclosures that may affect claims levels and patterns of emergence, as well as any company-specific factors that may be relevant to past and future claims experience. Results from the analysis include, but are not limited to, a range of IBNR reserve estimates and a single point estimate for IBNR as of the balance sheet date.

 

For recent policy years at early stages of development (generally the last three years), IBNR is estimated by applying an expected loss rate to total title insurance premiums and escrow fees and adjusting for policy year maturity using the estimated loss development patterns. The expected loss rate and patterns are based on historical experience and the relationship of the history to the applicable policy years. This is a generally accepted actuarial method of determining IBNR for policy years at early development ages. IBNR calculated in this way differs from the IBNR that a multiplicative loss development factor calculation would produce. Factor-based development effectively extrapolates results to date forward through the lifetime of the policy year’s development.

 

For more mature policy years (generally, policy years aged more than three years), IBNR is estimated using multiplicative loss development factor calculations. These years were exposed to adverse economic conditions during 2007 through 2011 that may have resulted in acceleration of claims and one-time losses. The possible extrapolation of these losses to future development periods by using factors was considered. The impact of economic conditions during 2007 through 2011 is believed to account for a much less significant portion of losses on policy years 2004 and prior than on more recent policy years. Policy years 2004 and prior were at relatively mature ages when the adverse development period began in 2007, and much of their losses had already been incurred by then. In addition, the loss development factors for policy years 2004 and prior are low enough that the potential for over-extrapolation is limited to an acceptable level.

 

The Company utilizes an independent third party actuary who produces a report with estimates and projections of the same financial items described above. The third party actuary’s analysis uses generally accepted actuarial methods that may in whole or in part be different from those used by the in-house actuary. The third party actuary’s report is used to assess the reasonableness of the in-house analysis.

 

The Company’s management uses the IBNR point estimate from the in-house actuary’s analysis and other relevant information it may have concerning claims to determine what it considers to be the best estimate of the total amount required for the IBNR reserve.

 

Title insurance policies are long-duration contracts with the majority of the claims reported to the Company within the first few years following the issuance of the policy. Generally, 75 to 85 percent of claim amounts become known in the first six years of the policy life, and the majority of IBNR reserves relate to the six most recent policy years. A material change in expected ultimate losses and corresponding loss rates for policy years older than six years, while possible, is not considered reasonably likely by the Company. However, changes in expected ultimate losses and corresponding loss rates for recent policy years are considered likely and could result in a material adjustment to the IBNR reserves. Based on historical experience, the Company believes that a 50 basis point change to one or more of the loss rates for the most recent policy years, positive or negative, is reasonably likely given the long duration nature of a title insurance policy. If the expected ultimate losses for each of the last six policy years increased or decreased by 50 basis points, the resulting impact on the IBNR reserve would be an increase or decrease, as the case may be, of $120.4 million. The estimates made by management in determining the appropriate level of IBNR reserves could ultimately prove to be inaccurate and actual claims experience may vary from expected claims experience.

 

The Company provides for property and casualty insurance losses when the insured event occurs. The Company provides for claims losses relating to its home warranty business based on the average cost per claim as applied to the total of new claims incurred. The average cost per home warranty claim is calculated using the average of the most recent 12 months of claims experience.

 

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

 

(in thousands except percentages)    December 31, 2011     December 31, 2010  

Known title claims

   $ 162,019         15.9   $ 192,268         17.4

IBNR

     816,603         80.5     875,627         79.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Total title claims

     978,622         96.4     1,067,895         96.4

Non-title claims

     36,054         3.6     40,343         3.6
  

 

 

    

 

 

   

 

 

    

 

 

 

Total loss reserves

   $ 1,014,676         100.0   $ 1,108,238         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

 

Fair Value of Investment Portfolio.    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:

 

Fair value of 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.

 

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Typical inputs and assumptions to pricing models used to value the Company’s U.S. Treasury bonds, municipal bonds, foreign bonds, governmental agency bonds, governmental agency mortgage-backed securities 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.

 

Other-than-temporary impairment–debt securities

 

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 December 31, 2011, 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 December 31, 2011 in estimating the cash flows expected to be collected for these securities.

 

     Weighted average     Range  

Prepayment speeds

     8.0     6.4%—10.0%   

Default rates

     5.1     1.8%—10.5%   

Loss severity

     30.4     7.9%—39.7%   

 

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Fair value of equity securities

 

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

 

Other-than-temporary impairment–equity securities

 

When, in the opinion of management, a decline in the fair value of an equity security (including common and preferred stock) and, prior to the first quarter of 2009, a debt security is considered to be other-than-temporary, such 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 and duration 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 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.

 

At December 31, 2011, 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 $115.5 million. While the Company’s investment in CoreLogic common stock has not been in an unrealized loss position for greater than twelve months, the Company assessed its investment in CoreLogic for other-than-temporary impairment due to the significant amount of shares owned. In August 2011, CoreLogic announced that its board of directors had formed a committee of independent directors to explore options aimed at enhancing shareholder value including cost savings initiatives, an evaluation of CoreLogic’s capital structure, repurchases of debt and common stock, the disposition of business lines, the sale or business combination of CoreLogic and other alternatives. CoreLogic’s board of directors also announced that it retained a financial adviser to assist the committee in its evaluation. Based on the factors considered, the Company’s opinion is the decline in the fair value of CoreLogic’s common stock is not other-than-temporary; therefore, the unrealized loss of $52.1 million was recorded in accumulated other comprehensive loss on the Company’s consolidated balance sheet. The factors considered by the Company include, but are not limited to, (i) the fair value of the common stock has been below cost for less than twelve months, (ii) the Company has the ability and intent to hold the common stock for a period of time sufficient to allow for recovery, (iii) the process of exploring options aimed at enhancing shareholder value in which CoreLogic is engaged, and (iv) in January 2012, CoreLogic issued updated 2011 guidance and full year 2012 guidance containing information that the Company assessed as positive. 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.

 

Impairment testing for goodwill and other indefinite-lived intangible assets.    The Company is required to perform an annual impairment test for goodwill and other indefinite-lived intangible assets for each reporting unit. This annual test, which the Company has elected to perform every fourth quarter, utilizes a variety of valuation techniques, all of which require it to make estimates and judgments. Fair value is determined by employing an expected present value technique, which utilizes multiple cash flow scenarios that reflect a range of possible outcomes and an appropriate discount rate. The use of comparative market multiples (the “market approach”) compares the reporting unit to other comparable companies (if such comparables are present in the marketplace) based on valuation multiples to arrive at a fair value. The Company also uses certain of these

 

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valuation techniques in accounting for business combinations, primarily in the determination of the fair value of acquired assets and liabilities. In assessing the fair value, the Company utilizes the results of the valuations (including the market approach to the extent comparables are available) and considers the range of fair values determined under all methods and the extent to which the fair value exceeds the book value of the equity. The Company’s four reporting units are title insurance, home warranty, property and casualty insurance and trust and other services. The Company’s policy is to perform an annual impairment test for each reporting unit in the fourth quarter or sooner if circumstances indicate a possible impairment.

 

Management’s impairment testing process includes two steps. The first step (“Step 1”) compares the fair value of each reporting unit to its book value. The fair value of each reporting unit is determined by using discounted cash flow analysis and market approach valuations. If the fair value of the reporting unit exceeds its book value, the goodwill is not considered impaired and no additional analysis is required. However, if the book value is greater than the fair value, a second step (“Step 2”) must be completed to determine if the fair value of the goodwill exceeds the book value of the goodwill.

 

Step 2 involves calculating an implied fair value of goodwill for each reporting unit for which the first step indicated impairment. The implied fair value of goodwill is determined in a manner similar to the amount of goodwill calculated in a business combination, by measuring the excess of the estimated fair value of the reporting unit, as determined in the first step, over the aggregate estimated fair values of the individual assets, liabilities and identifiable intangibles as if the reporting unit was being acquired in a business combination. If the implied fair value of goodwill exceeds the carrying value of goodwill assigned to the reporting unit, there is no impairment. If the carrying value of goodwill assigned to a reporting unit exceeds the implied fair value of the goodwill, an impairment loss is recorded for the excess. An impairment loss cannot exceed the carrying value of goodwill assigned to a reporting unit, and the loss establishes a new basis in the goodwill. Subsequent reversal of goodwill impairment losses is not permitted.

 

The valuation of goodwill requires assumptions and estimates of many critical factors including revenue growth rates and operating margins, discount rates and future market conditions, determination of market multiples and the establishment of a control premium, among others. Forecasts of future operations are based, in part, on operating results and the Company’s expectations as to future market conditions. These types of analyses contain uncertainties because they require the Company to make assumptions and to apply judgments to estimate industry economic factors and the profitability of future business strategies. However, if actual results are not consistent with the Company’s estimates and assumptions, the Company may be exposed to future impairment losses that could be material. The Company completed the required annual impairment testing for goodwill and other finite-lived intangible assets for the years ended December 31, 2011 and 2010, in the fourth quarter of each year. In 2011 and 2010, management concluded that, based on its assessment of the reporting units’ operations, the markets in which the reporting units operate and the long-term prospects for those reporting units that the more likely than not threshold for decline in value had not been met and that therefore no triggering events requiring an earlier analysis had occurred.

 

Impairment testing for long-lived assets.    Management uses estimated future cash flows (undiscounted and excluding interest) to measure the recoverability of long-lived assets held and used, including intangible assets with finite lives, whenever events or changes in circumstances indicate that the carrying value of an asset may not be fully recoverable. At such time impairment in value of a long-lived asset is identified, the impairment is measured as the amount by which the carrying amount of the long-lived asset exceeds its fair value.

 

Income taxes.    The Company accounts for income taxes under the asset and liability method, whereby deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The

 

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Company evaluates the need to establish a valuation allowance for deferred tax assets based upon the amount of existing temporary differences, the period in which they are expected to be recovered and expected levels of taxable income. A valuation allowance to reduce deferred tax assets is established when it is “more likely than not” that some or all of the deferred tax assets will not be realized.

 

The Company recognizes the effect of income tax positions only if sustaining those positions is “more likely than not.” Changes in recognition or measurement of uncertain tax positions are reflected in the period in which a change in judgment occurs. The Company recognizes interest and penalties, if any, related to uncertain tax positions in tax expense.

 

Depreciation and amortization lives for assets.    Management is required to estimate the useful lives of several asset classes, including capitalized data, internally developed software and other intangible assets. The estimation of useful lives requires a significant amount of judgment related to matters such as future changes in technology, legal issues related to allowable uses of data and other matters.

 

Share-based compensation.    The Company measures the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. The cost is recognized in the Company’s financial statements over the requisite service period of the award using the straight-line method for awards that contain only a service condition and the graded vesting method for awards that contain a performance or market condition. The share-based compensation expense recognized is based on the number of shares ultimately expected to vest, net of forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

The Company’s primary means of share-based compensation is granting restricted stock units (“RSUs”). RSUs granted generally have graded vesting and include a service condition; and for certain key employees and executives also include either a performance or market condition. RSUs receive dividend equivalents in the form of RSUs having the same vesting requirements as the RSUs initially granted.

As of December 31, 2011, 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.

In addition, the Company has an employee stock purchase plan that allows eligible employees to purchase common stock of the Company at 85.0% of the closing price on the last day of each month. The Company recognizes an expense in the amount equal to the discount.

 

Employee benefit plans.    The Company recognizes the overfunded or underfunded status of defined benefit postretirement plans as an asset or liability on its consolidated balance sheets and recognizes changes in the funded status in the year in which changes occur, through accumulated other comprehensive income (loss). The funded status is measured as the difference between the fair value of plan assets and benefit obligation (the projected benefit obligation for pension plans and the accumulated postretirement benefit obligation for the other postretirement plans). Actuarial gains and losses and prior service costs and credits that have not been recognized as a component of net periodic benefit cost previously are recorded as a component of accumulated other comprehensive income (loss). Plan assets and obligations are measured as of December 31.

 

Recently Adopted Accounting Pronouncements:

 

In January 2010, the Financial Accounting Standards Board (“FASB”) issued updated guidance related to fair value measurements and disclosures, which requires a reporting entity to disclose separately, a reconciliation for fair value measurements using significant unobservable inputs (Level 3) information about purchases, sales, issuances and settlements (that is, on a gross basis rather than one net number). The updated guidance is effective for interim or annual financial reporting periods beginning after December 15, 2010 and for interim periods within the fiscal year. Except for the disclosure requirements, the adoption of this guidance had no impact on the Company’s consolidated financial statements.

 

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In July 2010, the FASB issued updated guidance related to credit risk disclosures for finance receivables and the related allowance for credit losses. The updated guidance requires entities to disclose information at disaggregated levels, specifically defined as “portfolio segments” and “classes”. Expanded disclosures include, among other things, roll-forward schedules of the allowance for credit losses and information regarding the credit quality of receivables (including their aging) as of the end of a reporting period. The updated guidance is effective for interim and annual reporting periods ending after December 15, 2010, although the disclosures of reporting period activity are required for interim and annual reporting periods beginning after December 15, 2010. Except for the disclosure requirements, the adoption of this guidance had no impact on the Company’s consolidated financial statements.

 

In December 2010, the FASB issued updated guidance related to disclosure of supplementary pro forma information in connection with business combinations. The updated guidance clarifies the acquisition date that should be used for reporting pro forma financial information when comparative financial statements are presented. The updated guidance also expands supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The updated guidance is effective for annual reporting periods beginning on or after December 15, 2010. The adoption of this guidance had no impact on the Company’s consolidated financial statements.

 

In December 2010, the FASB issued updated guidance related to when goodwill impairment testing should include Step 2 for reporting units with zero or negative carrying amounts. The updated guidance modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts requiring those entities to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating an impairment may exist. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2010. The adoption of this guidance had no impact on the Company’s consolidated financial statements.

 

In September 2011, the FASB issued updated guidance that is intended to simplify how entities test goodwill for impairment. The updated guidance permits entities to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test as required under current accounting guidance. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2011. Early adoption is permitted, including for interim and annual goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the more recent interim and annual period have not yet been issued. The Company adopted this guidance in the fourth quarter of 2011, in connection with performing its annual goodwill impairment test and elected to bypass the qualitative assessment and performed the first step of the two-step goodwill impairment test. The adoption of this guidance had no impact on the Company’s 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 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

 

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requires 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. Management expects the adoption of the guidance that remains effective beginning in the first quarter of 2012 to have no impact on the Company’s 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 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 update is effective for interim and annual periods beginning after December 15, 2011. Except for the disclosure requirements, management does not expect the adoption of this guidance to have a material impact on the Company’s consolidated financial statements.

 

In October 2010, the 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 interim and annual reporting periods beginning after December 15, 2011. Management does not expect the adoption of this guidance to have a material impact on the Company’s consolidated financial statements.

 

Results of Operations

 

Overview

 

A substantial portion of the revenues for the Company’s title insurance and services segment results from the sale and refinancing of residential and commercial real estate. In the specialty insurance segment, revenues associated with the initial year of coverage in both the home warranty and property and casualty operations are impacted by the level of 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) decreased 19.7% in 2011 when compared with 2010, according to the Mortgage Bankers Association’s January 18, 2012 Mortgage Finance Forecast (the “MBA Forecast”). This decrease was due to a decline in both purchase and refinance activity. According to the MBA Forecast, the dollar amount of purchase originations and refinance originations decreased 14.6% and 21.9%, respectively, in 2011 when compared with 2010. Residential mortgage originations in the United States decreased 21.2% in 2010 when compared with 2009 according to the MBA Forecast. This decrease reflected decreases in purchase originations and refinance originations of 32.6% and 15.1%, respectively.

 

A low interest rate environment typically has a favorable impact on many of the Company’s businesses, however mortgage credit remains generally tight, which together with the uncertainty in general economic conditions, continues to impact the demand for most of the Company’s products and services.

 

Given the performance of the mortgage and real estate markets in 2011 and the outlook for 2012, the Company continued its expense management efforts. 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

 

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expected to yield approximately $40 million in annualized cost savings, which the Company began realizing in the third quarter of 2011. The program was incremental to the Company’s ongoing efforts to manage expenses to order volumes at the division level. Overall, the Company reduced its domestic employee count by 6.3% and its office footprint by 9.1%, which contributed to a decrease in personnel and other operating expenses of 3.9% in 2011 compared to 2010. This reduction in expenses compares favorably to the 2.2% decrease in total revenues in 2011 compared to 2010.

 

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 which require them, among other things, to alter their foreclosure processes. Though the ultimate effect of the court rulings, regulatory investigations, consent decrees and related matters pertaining to foreclosure processing are currently unknown, the Company believes that, as a result of these matters, its revenues tied to foreclosures have declined, and may continue to decline, especially in the short term, and the Company may incur costs associated with its duty to defend its insureds’ title to foreclosed properties they have purchased. 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.

 

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Title Insurance and Services

 

    2011     2010     2009     2011 vs. 2010     2010 vs. 2009  
                      $ Change     % Change     $ Change     % Change  
    (in thousands, except percentages)  

Revenues

             

Direct premiums and escrow fees

  $ 1,360,512      $ 1,391,093      $ 1,490,096      $ (30,581     (2.2   $ (99,003     (6.6

Agent premiums

    1,491,943        1,517,704        1,524,120        (25,761     (1.7     (6,416     (0.4

Information and other

    619,951        628,494        667,115        (8,543     (1.4     (38,621     (5.8

Investment income

    73,883        75,517        104,553        (1,634     (2.2     (29,036     (27.8

Net realized investment gains

    1,906        8,694        14,509        (6,788     (78.1     (5,815     (40.1

Net other-than-temporary impairment losses recognized in earnings

    (9,068     (7,912     (33,038     (1,156     (14.6     25,126        76.1   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    3,539,127        3,613,590        3,767,355        (74,463     (2.1     (153,765     (4.1
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Expenses

             

Personnel costs

    1,104,841        1,131,058        1,145,359        (26,217     (2.3     (14,301     (1.2

Premiums retained by agents

    1,195,282        1,222,274        1,229,229        (26,992     (2.2     (6,955     (0.6

Other operating expenses

    693,541        734,901        849,320        (41,360     (5.6     (114,419     (13.5

Provision for policy losses and other claims

    270,697        180,821        205,819        89,876        49.7        (24,998     (12.1

Depreciation and amortization

    69,229        72,566        76,038        (3,337     (4.6     (3,472     (4.6

Premium taxes

    40,972        33,645        32,138        7,327        21.8        1,507        4.7   

Interest

    5,923        8,803        14,336        (2,880     (32.7     (5,533     (38.6
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    3,380,485        3,384,068        3,552,239        (3,583     (0.1     (168,171     (4.7
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

  $ 158,642      $ 229,522      $ 215,116      $ (70,880     (30.9   $ 14,406        6.7   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Margins

    4.5     6.4     5.7     (1.9 )%      (29.7     0.7     12.3   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Direct premiums and escrow fees decreased 2.2% in 2011 from 2010 and 6.6% in 2010 from 2009. The decrease in 2011 from 2010 was primarily due to a decline in the number of title orders closed by the Company’s direct operations, which reflected the decline in mortgage originations, offset in part by an increase in the average revenues per order closed. The increase in the average revenues per order closed was primarily due to an increase in the mix of revenues from higher premium commercial activity year over year, as well as an increase in the average revenues per commercial order closed in 2011 when compared to 2010. The decrease in 2010 from 2009 was primarily due to a decline in the number of title orders closed by the Company’s direct operations, which reflected the decline in mortgage originations, offset in part by an increase in the average revenues per order closed. The increase in the average revenues per order closed was primarily due to an increase in the mix of revenues from commercial activity year over year and increases in title insurance rates across 28 states. The average revenues per order closed were $1,483, $1,289 and $1,145 for 2011, 2010 and 2009, respectively. The Company’s direct title operations closed 917,500, 1,079,000 and 1,301,100 domestic title orders during 2011, 2010 and 2009, respectively.

 

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Agent premiums decreased 1.7% in 2011 from 2010 and 0.4% in 2010 from 2009. 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 one quarter delay between the agent’s issuance of a title policy and the Company’s recognition of agent premiums. Therefore, full year agent premiums primarily reflect mortgage origination activity from the fourth quarter of the prior year through the third quarter of the current year. The decreases were primarily due to the same factors impacting direct title operations offset in part by increases in market share. According to the American Land Title Association’s most recent available market share data, the Company’s agency market share was 15.6%, 15.2% and 15.0% for the nine months ended September 30, 2011 and for the years ended December 31, 2010 and 2009, respectively. The Company analyzes the terms and profitability of its title agency relationships and works to amend agent agreements where appropriate. Amendments that are sought include, among others, changing the percentage of premiums retained by the agent and the deductible paid by the agent on claims; if appropriate changes to the agreements cannot be made, the Company may elect to terminate certain agreements.

 

Information and other revenue decreased 1.4% in 2011 from 2010 and 5.8% in 2010 from 2009. The decrease in 2011 from 2010 was primarily attributable to the same factors affecting the direct title operations, offset in part by a 3.4% increase in international and other revenue, which was primarily attributable to the Company’s Canadian operations. The decrease in 2010 from 2009 was primarily attributable to the same factors affecting the direct title operations and, additionally, a 14.5% decrease in default information and other revenue mainly due to a decline in foreclosure activity as a result of moratoriums on foreclosures and increased market competition, partially offset by increased loss mitigation activities.

 

Investment income decreased 2.2% in 2011 from 2010 and 27.8% in 2010 from 2009. The decrease in the current year was primarily attributable to lower interest income from the investment portfolio due to lower yields. The decrease in 2010 compared to 2009 was primarily due to income recognized from the sale of title plant copies in 2009 while similar sales did not occur in 2010; lower interest income from deposits in 2010 due to lower yields; and a reduction in interest income from intercompany notes receivable when compared to 2009 due to a reduction in the notes receivable balance.

 

Net realized investment gains for the title insurance and services segment totaled $1.9 million, $8.7 million and $14.5 million for 2011, 2010 and 2009, respectively. The gains for 2011, 2010 and 2009 were primarily from the sale of debt and equity securities and, to a lesser extent, certain fixed assets. The gains recognized in 2011 and 2010 were partially offset by $6.9 million and $3.4 million, respectively, in impairment losses recognized on other long-term investments.

 

Net other-than-temporary impairment losses for the title insurance and services segment totaled $9.1 million, $7.9 million and $33.0 million for 2011, 2010 and 2009, respectively. The majority of the net other-than-temporary impairment losses recognized in 2011 and 2010 related to the Company’s non-agency mortgage-backed securities portfolio. In 2009, the net other-than-temporary impairment losses pertained primarily to the Company’s equity securities portfolio and also to the non-agency mortgage-backed securities portfolios.

 

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.

 

Title insurance personnel costs decreased 2.3% in 2011 from 2010 and 1.2% in 2010 from 2009. The decrease in 2011 compared with 2010 was primarily attributable to a reduction in domestic employees and decreased expenses related to the Company’s employee benefit plans. These expense reductions were partially offset by increased commissions in the commercial division, which were the result of increased commercial revenues, and increased severance expense associated with a reduction in employees. Included in personnel costs for 2010, and not for 2009, was $22.0 million of expense associated with certain offshore functions that prior to

 

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the Separation were performed by TFAC and allocated to the Company. The allocations in prior years were included in the title insurance and services segment’s other operating expenses. Beginning in 2010, these offshore functions were part of the Company’s operations and the related personnel expenses were included in the title insurance and services segment’s personnel costs. Excluding the impact of these expenses, title insurance personnel costs decreased 3.2% in 2010 from 2009. This decrease was primarily due to domestic employee reductions, offset in part by increased expense in connection with the Company’s employee benefit plans.

 

The Company continues to closely monitor order volumes and related staffing levels and will adjust staffing levels as considered necessary. The Company’s direct title operations opened 1,254,100, 1,469,100 and 1,770,700 domestic title orders in 2011, 2010 and 2009, respectively, representing a decrease of 14.6% in 2011 from 2010 and a decrease of 17.0% in 2010 from 2009.

 

A summary of premiums retained by agents and agent premiums is as follows:

 

     2011     2010     2009  
     (in thousands, except percentages)  

Premiums retained by agents

   $ 1,195,282      $ 1,222,274      $ 1,229,229   
  

 

 

   

 

 

   

 

 

 

Agent premiums

   $ 1,491,943      $ 1,517,704      $ 1,524,120   
  

 

 

   

 

 

   

 

 

 

% retained by agents

     80.1     80.5     80.7

 

The premium split between underwriter and agents is in accordance with the respective agency contracts and can vary from region to region due to divergences in real estate closing practices, as well as rating structures. As a result, the percentage of title premiums retained by agents varies due to the geographical mix of revenues from agency operations. The percentage of title premiums retained by agents decreased over the last three years due to the cancellation and/or modification of certain agency relationships with unfavorable splits and a more favorable geographic mix of agency revenues. In 2011, the agent retention percentage was also impacted by a large commercial deal that closed in the first quarter with a favorable agent split.

 

Other operating expenses (principally related to direct operations) decreased 5.6% in 2011 from 2010 and 13.5% in 2010 from 2009. The decrease in 2011 from 2010 was primarily attributable to lower furniture and equipment related lease costs due to several lease buyouts that occurred during 2010, lower office related expenses resulting from the Company’s consolidation and/or closure of certain title offices, and a reduction in consulting expenses. These decreases were partially offset by an increase in production related expenses in the Company’s commercial, default and international businesses, and by higher legal expenses. The increased production related costs in the Company’s commercial and international businesses were due to higher transaction volumes, while the increase in the default business was due to product mix. Excluding the impact of the $22.0 million of allocations for certain offshore functions discussed in the personnel costs discussion above, the decrease in other operating expenses was 10.9% in 2010 from 2009. This decrease reflected lower occupancy costs as a result of the continued consolidation and/or closure of certain title offices and other cost-containment programs.

 

The provision for policy losses and other claims, expressed as a percentage of title insurance premiums and escrow fees, was 9.5%, 6.2% and 6.8% for the years ended December 31, 2011, 2010 and 2009, respectively. The current year rate of 9.5% reflected an ultimate loss rate of 5.6% for the current policy year, and included a $45.3 million reserve strengthening adjustment related to a guaranteed valuation product offered in Canada that experienced a meaningful increase in claims activity during the first quarter of 2011, a $32.2 million charge in connection with the settlement of Bank of America’s lawsuit against the Company and $34.2 million in unfavorable development for certain prior policy years, primarily 2007. For additional discussion regarding the Bank of America lawsuit see Note 21 Litigation and Regulatory Contingencies to the consolidated financial statements. The prior year rate of 6.2% reflected an expected ultimate loss rate of 4.9% for policy year 2010, with a net upward adjustment to the reserve for prior policy years. The changes in estimates resulted primarily

 

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from higher than expected claims emergence experienced during 2010 for policies issued prior to 2009, and lower than expected claims emergence experienced during 2010 for policy year 2009. The rate of 6.8% in 2009 reflected an expected ultimate loss rate of 7.0% for policy year 2009, with a minor downward adjustment to the reserve for certain prior policy years.

 

As of December 31, 2011, the title insurance and services segment’s IBNR reserve was $816.6 million, which reflected the best estimate from the Company’s internal actuarial analysis. The Company’s internal actuary also determined a range of reasonable estimates of $711.9 million to $990.9 million. The range limits are $104.7 million below and $174.3 million above the best estimate, respectively, and represent an estimate of the range of variation among reasonable estimates of the IBNR reserve.

 

Actuarial estimates are sensitive to assumptions used in models, as well as the structures of the models themselves, and to changes in claims payment and incurral patterns, which can vary materially due to economic conditions, among other factors.

 

Adverse loss development in 2011 included higher-than-expected claims emergence for commercial and lenders policies, particularly for policy years 2005 through 2007. Management believes that these policy years have higher ultimate loss ratios than historical averages, and that they also have experienced accelerated reporting and payment of claims, particularly on lenders policies. Reasons for higher loss levels and acceleration of claims reporting and payment include adverse underwriting conditions in real estate markets during 2005 through 2007, declines in real estate prices, increased levels of foreclosures and increased mechanics lien exposure due to failures of development projects.

 

The current economic environment continues to show more potential for volatility than usual over the short term, particularly in regard to real estate prices and mortgage defaults, which affect title claims. Relevant contributing factors include high foreclosure volume, tight credit markets, general economic instability and government actions that may mitigate or exacerbate recent trends. Other factors, including factors not yet identified, may also influence claims development. At this point, economic and certain market conditions appear to be stabilizing and improving in some respects, yet significant uncertainty remains. This environment results in increased potential for actual claims experience to vary significantly from projections, in either direction, which would directly affect the claims provision. If actual claims vary significantly from expected, reserves may be adjusted to reflect updated estimates of future claims.

 

The volume and timing of title insurance claims are subject to cyclical influences from real estate and mortgage markets. Title policies issued to lenders constitute a large portion of the Company’s title insurance volume. These policies insure lenders against losses on mortgage loans due to title defects in the collateral property. Even if an underlying title defect exists that could result in a claim, often the lender must realize an actual loss, or at least be likely to realize an actual loss, for title insurance liability to exist. As a result, title insurance claims exposure is sensitive to lenders’ losses on mortgage loans, and is affected in turn by external factors that affect mortgage loan losses.

 

A general decline in real estate prices can expose lenders to greater risk of losses on mortgage loans, as loan-to-value ratios increase and defaults and foreclosures increase. The current environment may continue to have increased potential for claims on lenders’ title policies, particularly if defaults and foreclosures are at elevated levels. Title insurance claims exposure for a given policy year is also affected by the quality of mortgage loan underwriting during the corresponding origination year. The Company believes that sensitivity of claims to external conditions in real estate and mortgage markets is an inherent feature of title insurance’s business economics that applies broadly to the title insurance industry. Lenders have experienced high losses on mortgage loans from prior years, including loans that were originated during the years 2005 through 2007. These losses have led to higher title insurance claims on lenders policies, and also have accelerated the reporting of claims that would have been realized later under more normal conditions.

 

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Loss ratios (projected to ultimate value) for policy years 2005 through 2008 are higher than loss ratios for policy years 1992 through 2004. The major causes of the higher loss ratios for those four policy years are believed to be confined mostly to that period. These causes included: rapidly increasing residential real estate prices which led to an increase in the incidences of fraud, lower mortgage loan underwriting standards and a higher concentration than usual of subprime mortgage loan originations.

 

The projected ultimate loss ratios, as of December 31, 2011, for policy years 2011, 2010 and 2009 were 5.6%, 4.7% and 5.2%, respectively, which are lower than the ratios for 2005 through 2008. These projections were based in part on an assumption that more favorable underwriting conditions existed in 2009 through 2011 than in 2005 through 2008, including tighter loan underwriting standards and lower housing prices. Current claims data from policy years 2009 through 2011, while still at an early stage of development, supports this assumption.

 

Insurers generally are not subject to state income or franchise taxes. However, in lieu thereof, a “premium” tax is imposed on certain operating revenues, as defined by statute. Tax rates and bases vary from state to state; accordingly, the total premium tax burden is dependent upon the geographical mix of operating revenues. The Company’s noninsurance subsidiaries are subject to state income tax and do not pay premium tax. Accordingly, the Company’s total tax burden at the state level for the title insurance and services segment is composed of a combination of premium taxes and state income taxes. Premium taxes as a percentage of title insurance premiums and escrow fees were 1.4%, 1.2% and 1.1% for the years ended December 31, 2011, 2010 and 2009, 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 was 4.5%, 6.4% and 5.7% for the years ended December 31, 2011, 2010 and 2009, respectively.

 

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Specialty Insurance

 

     2011     2010     2009     2011 vs. 2010     2010 vs. 2009  
                       $ Change     % Change     $ Change     % Change  
     (in thousands, except percentages)  

Revenues

              

Direct premiums

   $ 273,665      $ 272,863      $ 270,475      $ 802        0.3      $ 2,388        0.9   

Information and other

     1,531        —          —          1,531        —          —          —     

Investment income

     10,380        11,876        13,429        (1,496     (12.6     (1,553     (11.6

Net realized investment gains

     1,406        1,938        1,292        (532     (27.5     646        50.0   

Net other-than-temporary impairment losses recognized in earnings

     —          (111     (6,820     111        100.0        6,709        98.4   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     286,982        286,566        278,376        416        0.1        8,190        2.9   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Expenses

              

Personnel costs

     51,389        51,939        55,396        (550     (1.1     (3,457     (6.2

Other operating expenses

     38,106        42,385        41,975        (4,279     (10.1     410        1.0   

Provision for policy losses and other claims

     149,439        140,053        140,895        9,386        6.7        (842     (0.6

Depreciation and amortization

     4,197        5,341        4,295        (1,144     (21.4     1,046        24.4   

Premium taxes

     4,691        4,135        4,346        556        13.4        (211     (4.9

Interest

     17        18        25        (1     (5.6     (7     (28.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     247,839        243,871        246,932        3,968        1.6        (3,061     (1.2
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

   $ 39,143      $ 42,695      $ 31,444      $ (3,552     (8.3   $ 11,251        35.8   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Margins

     13.6     14.9     11.3     (1.3 )%      (8.7     3.6     31.9   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Specialty insurance direct premiums increased 0.3% in 2011 over 2010 and 0.9% in 2010 over 2009. The increases in 2011 and 2010 were due to increases in volume from the home warranty division partially offset by declines in volume in the property and casualty division. The first-time homebuyer credit, which expired in April of 2010, contributed to the increase in home warranty division volume in 2010 over 2009.

 

Investment income decreased 12.6% in 2011 from 2010 and 11.6% in 2010 from 2009. These decreases primarily reflected a decrease in interest income earned from the investment portfolio reflecting a decline in yields.

 

Net realized investment gains and net other-than-temporary impairment losses for the specialty insurance segment totaled gains of $1.4 million in 2011 and $1.8 million in 2010, compared with losses of $5.5 million in 2009. The 2011 and 2010 gains were primarily driven by the sale of debt and equity securities. The 2009 losses were primarily driven by other-than-temporary impairment losses taken on certain equity and debt securities partially offset by gains realized on the sale of equity securities.

 

Specialty insurance personnel costs and other operating expenses decreased 5.1% in 2011 from 2010 and 3.1% in 2010 from 2009. The decrease in 2011 from 2010 was primarily due to reduced marketing costs in the home warranty division. The decrease in 2010 from 2009 was primarily due to employee reductions as well as other cost-containment programs.

 

The provision for home warranty claims, expressed as a percentage of home warranty premiums, was 56.1% in 2011, 50.6% in 2010 and 53.9% in 2009. The increase in rate in 2011 over 2010 was primarily due to an

 

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increase in business coming from the direct to consumer channel in 2011, which typically has a higher loss ratio than the traditional real estate channel. The decrease in rate in 2010 from 2009 was primarily due to a reduction in the average cost of claims and, to a lesser extent, fewer incidents.

 

The provision for property and casualty claims, expressed as a percentage of property and casualty insurance premiums, was 52.0% in 2011, 53.0% in 2010 and 49.8% in 2009. The decrease in rate in 2011 from 2010 was due to a reduction in seasonal claim events, partially offset by an increase in the frequency and severity of routine or non-event core losses. The increase in rate in 2010 over 2009 was primarily due to seasonal winter storms in the first and fourth quarters of 2010, including an unusual hailstorm over Arizona in October 2010, partially offset by lower routine or non-event core losses.

 

Premium taxes as a percentage of specialty insurance segment premiums were 1.7% in 2011, 1.5% in 2010 and 1.6% in 2009.

 

A large part of the revenues for the specialty insurance businesses are generated by renewals and are not dependent on the level of real estate activity. With the exception of loss expense, the majority of the expenses for this segment are variable in nature and therefore generally fluctuate consistent with revenue fluctuations. Accordingly, profit margins for this segment (before loss expense) are relatively constant, although as a result of some fixed expenses, profit margins (before loss expense) should nominally improve as revenues increase. Pre-tax margins were 13.6%, 14.9% and 11.3% for 2011, 2010 and 2009, respectively.

 

Corporate

 

     2011     2010     2009     2011 vs. 2010     2010 vs. 2009  
                       $ Change     % Change     $ Change     % Change  
     (in thousands, except percentages)  

Revenues

              

Investment income

   $ 2,151      $ 8,675      $ 2,267      $ (6,524     (75.2   $ 6,408        282.7   

Net realized investment losses

     (3,811     (423     (1,164     (3,388     NM 1       741        63.7   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     (1,660     8,252        1,103        (9,912     (120.1     7,149        648.1   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Expenses

              

Personnel costs

     30,249        31,437        15,810        (1,188     (3.8     15,627        98.8   

Other operating expenses

     22,102        26,302        18,171        (4,200     (16.0     8,131        44.7   

Depreciation and amortization

     3,463        2,735        3,879        728        26.6        (1,144     (29.5

Interest

     10,403        7,889        5,458        2,514        31.9        2,431        44.5   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     66,217        68,363        43,318        (2,146     (3.1     25,045        57.8   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income taxes

   $ (67,877   $ (60,111   $ (42,215   $ (7,766     (12.9   $ (17,896     (42.4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Not meaningful

 

Investment income totaled $2.2 million, $8.7 million and $2.3 million in 2011, 2010 and 2009, respectively. The variance in investment income for all three years is primarily attributable to fluctuations in the earnings on investments associated with the Company’s deferred compensation plan.

 

Net realized investment losses totaled $3.8 million, $0.4 million and $1.2 million in 2011, 2010 and 2009, respectively. The loss in 2011 was primarily related to the impairment of a non-marketable investment and the sale of a corporate fixed asset.

 

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Corporate personnel costs and other operating expenses were $52.4 million, $57.7 million and $34.0 million in 2011, 2010 and 2009, respectively. The Company experienced a higher level of corporate personnel costs and other operating expenses following the Separation when compared to the amounts allocated from TFAC prior to the Separation. Following the Separation, the Company is a separate publicly traded company, which resulted in a higher level of corporate costs in 2011 and 2010 when compared to 2009. Additionally, personnel costs associated with the Company’s deferred compensation plan were higher in 2010 when compared to 2011 and 2009. The increase in costs in 2010 associated with the Company’s deferred compensation plan was offset by the increase in income earned in 2010 on investments associated with the deferred compensation plan, as discussed above. Also, other operating expenses were higher in 2010 when compared to 2011 and 2009 due to professional services expenses incurred during 2010 related to the Separation.

 

Interest expense increased $2.5 million in 2011 over 2010 and increased $2.4 million in 2010 over 2009. Interest expense prior to the Separation related to draws made in 2008 used for the operations of the Company’s businesses in the amount of $140.0 million under TFAC’s credit agreement that was allocated to the Company. In connection with the Separation, the Company borrowed $200.0 million under its credit facility and paid off the allocated portion of TFAC’s debt. Interest expense increased in 2011 over 2010 and in 2010 over 2009 because the Company’s credit facility bears interest at a higher rate than the allocated portion of TFAC’s debt. Additionally, $4.2 million of interest expense related to intercompany notes payable to the title insurance and services and specialty segments was included for 2011 compared to $2.7 million of interest expense for 2010 and none for 2009.

 

Eliminations

 

Eliminations primarily represent interest income and related interest expense associated with intercompany notes between the Company’s segments, which are eliminated in the consolidated financial statements. The Company’s inter-segment eliminations were not material for the years ended December 31, 2011 and 2010. The Company did not record inter-segment eliminations for the year ended December 31, 2009, as there was no inter-segment income or expense.

 

Income Taxes

 

Income taxes differ from the amounts computed by applying the federal income tax rate of 35.0%. A reconciliation of this difference is as follows:

 

     Year ended December 31,  
     2011     2010     2009  
     (in thousands)  

Taxes calculated at federal rate

   $ 45,603      $ 74,237      $ 71,521   

State taxes, net of federal benefit

     2,499        3,340        (612

Dividends received deduction

     (140     (250     (1,381

Change in liability for tax positions

     2,548        4,626        (8,776

Exclusion of certain meals and entertainment expenses

     2,245        2,889        2,675   

Change in capital loss valuation allowance

     —          (14,683     —     

Foreign taxes in excess of federal rate

     1,740        9,802        10,365   

Other items, net

     (2,781     3,189        (3,724
  

 

 

   

 

 

   

 

 

 
   $ 51,714      $ 83,150      $ 70,068   
  

 

 

   

 

 

   

 

 

 

 

The Company’s effective income tax rate (income tax expense as a percentage of income before income taxes), was 39.7% for 2011, 39.2% for 2010 and 34.3% for 2009. The absolute differences in the effective tax rates were primarily due to changes in the ratio of permanent differences to income before income taxes, reserve adjustments recorded in 2009 for which corresponding tax benefits were recognized, as well as changes in state and foreign income taxes resulting from fluctuations in the Company’s noninsurance and foreign subsidiaries’

 

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contribution to pretax profits, and changes in the liability related to tax positions reported on the Company’s tax returns. In addition, the effective tax rate for 2010 reflects the release of a valuation allowance recorded against capital losses.

 

Net Income and Net Income Attributable to the Company

 

Net income and per share information are summarized as follows:

 

     2011      2010      2009  
     (in thousands, except per share amounts)  

Net income

   $ 78,579       $ 128,956       $ 134,277   

Less: Net income attributable to noncontrolling interests

     303         1,127         11,888   
  

 

 

    

 

 

    

 

 

 

Net income attributable to the Company

   $ 78,276       $ 127,829       $ 122,389   
  

 

 

    

 

 

    

 

 

 

Per share of common stock:

        

Net income attributable to the Company:

        

Basic

   $ 0.74       $ 1.23       $ 1.18   
  

 

 

    

 

 

    

 

 

 

Diluted

   $ 0.73       $ 1.20       $ 1.18   
  

 

 

    

 

 

    

 

 

 

Weighted-average shares:

        

Basic

     105,197         104,134         104,006   
  

 

 

    

 

 

    

 

 

 

Diluted

     106,914         106,177         104,006   
  

 

 

    

 

 

    

 

 

 

 

Net income attributable to noncontrolling interests decreased $0.8 million, or 73.1%, in 2011 from 2010 and $10.8 million, or 90.5%, in 2010 from 2009. The decrease in net income attributable to noncontrolling interests in 2010 when compared to 2009 is due to the Company’s purchases of subsidiary shares from noncontrolling interests in 2009. The purchases of subsidiary shares did not significantly impact net income attributable to noncontrolling interests in 2009, because the majority of the Company’s purchases occurred late in the fourth quarter of 2009.

 

Per share information for prior years was computed using the number of shares of common stock outstanding immediately following the Separation, as if such shares were outstanding for the entire period prior to the Separation. See Note 13 Earnings Per Share to the consolidated financial statements for further discussion of earnings per share.

 

Liquidity and Capital Resources

 

Cash Requirements.    The Company generates cash primarily from the sale of its products and services and investment income. The Company’s current cash requirements include operating expenses, taxes, payments of principal and interest on its debt, capital expenditures, potential business acquisitions and dividends on its common stock. Management forecasts the cash needs of the holding company and its primary subsidiaries and regularly reviews their short-term and long-term projected sources and uses of funds, as well as the asset, liability, investment and cash flow assumptions underlying such forecasts. Due to the Company’s ability to generate cash flows from operations and its liquid-asset position, management believes that its resources are sufficient to satisfy its anticipated operational cash requirements and obligations for at least the next twelve months.

 

The substantial majority of the Company’s business is dependent upon activity in the real estate and mortgage markets, which are cyclical and seasonal. Periods of increasing interest rates and reduced mortgage financing availability generally have an adverse effect on residential real estate activity and therefore typically decrease the Company’s revenues. In contrast, periods of declining interest rates and increased mortgage financing availability generally have a positive effect on residential real estate activity which typically increases

 

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the Company’s revenues. Residential purchase activity is typically slower in the winter months with increased volumes in the spring and summer months. Residential refinance activity is typically more volatile than purchase activity and is highly impacted by changes in interest rates. Commercial real estate volumes are less sensitive to changes in interest rates, but fluctuate based on local supply and demand conditions for space and mortgage financing availability.

 

Cash provided by operating activities amounted to $133.8 million, $155.5 million and $233.6 million for the years ended December 31, 2011, 2010 and 2009, respectively, after claim payments, net of recoveries, of $503.4 million, $456.2 million and $452.2 million, respectively. The principal nonoperating uses of cash and cash equivalents for the year ended December 31, 2011 were purchases of debt and equity securities, decreases in demand deposits at the Company’s banking operations, repayment of debt, capital expenditures and dividends paid to common stockholders. The most significant nonoperating sources of cash and cash equivalents for the year ended December 31, 2011 were proceeds from the sales and maturities of debt and equity securities, early payoff of the note receivable from CoreLogic, payments collected related to loans receivable and proceeds from the issuance of new debt. The principal nonoperating uses of cash and cash equivalents for the year ended December 31, 2010 were the repayment of debt (to TFAC and third parties), cash distribution to TFAC in connection with the Separation, additions to the investment portfolio, capital expenditures and dividends to common stockholders. The most significant nonoperating sources of cash and cash equivalents for the year ended December 31, 2010 were increases in the deposit balances at the Company’s banking operations, proceeds from the Company’s new revolving credit facility and proceeds from the sales and maturities of debt and equity securities. The net effect of all activities on total cash and cash equivalents was a decrease of $310.4 million for 2011, an increase of $97.4 million for 2010, and a decrease of $92.4 million for 2009.

 

The Company continually assesses its capital allocation strategy, including decisions relating to dividends, share repurchases, capital expenditures, acquisitions and investments. Management expects that the Company will continue to pay quarterly cash dividends at or above the current level. The timing, declaration and payment of future dividends, however, falls within the discretion of the Company’s board of directors and will depend upon many factors, including the Company’s financial condition and earnings, the capital requirements of the Company’s businesses, industry practice, restrictions imposed by applicable law and any other factors the board of directors deems relevant from time to time.

 

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. As of December 31, 2011, the Company had repurchased and retired 203,900 shares of its common stock for a total purchase price of $2.5 million.

 

Holding Company.    First American Financial Corporation is a holding company that conducts all of its operations through its subsidiaries. The holding company’s current cash requirements include payments of principal and interest on its debt, taxes, payments in connection with employee benefit plans, dividends on its common stock and other expenses. The holding company is dependent upon dividends and other payments from its operating subsidiaries to meet its cash requirements. The Company’s target is to maintain a cash balance at the holding company equal to at least twelve months of estimated cash requirements. At certain points in time, the actual cash balance at the holding company may vary from this target due to, among other potential factors, the timing and amount of cash payments made and dividend payments received. Pursuant to insurance and other regulations under which the Company’s insurance subsidiaries operate, the amount of dividends, loans and advances available to the holding company is limited, principally for the protection of policyholders. Under such regulations, the maximum amount of dividends, loans and advances available to the holding company from its insurance subsidiaries in 2012 is $181.1 million. Such restrictions have not had, nor are they expected to have, an impact on the holding company’s ability to meet its cash obligations.

 

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As of December 31, 2011, the holding company’s sources of liquidity include $147.3 million of cash, 6.0 million shares of CoreLogic common stock with an estimated fair value of $77.5 million and $200.0 million available on the Company’s $400.0 million revolving credit facility described below. Management believes that its liquidity at the holding company is sufficient to satisfy its anticipated cash requirements and obligations for at least the next twelve months.

 

Financing.    On April 12, 2010, the Company entered into a credit agreement with JPMorgan Chase Bank, N.A. (“JPMorgan”) in its capacity as administrative agent and a syndicate of lenders.

 

The credit agreement is comprised of a $400.0 million revolving credit facility. The revolving loan commitments terminate on the third anniversary of the date of closing, or June 1, 2013. On June 1, 2010, the Company borrowed $200.0 million under the facility and transferred such funds to CoreLogic, as previously contemplated in connection with the Separation. Proceeds may also be used for general corporate purposes. At December 31, 2011, the interest rate associated with the $200.0 million borrowed under the facility is 3.06%.

 

The Company’s obligations under the credit agreement are guaranteed by certain of the Company’s subsidiaries (the “Guarantors”). To secure the obligations of the Company and the Guarantors (collectively, the “Loan Parties”) under the credit agreement, the Loan Parties pledged all of the equity interests they own in each Data Trace and Data Tree company and a 9% equity interest in FATICO.

 

If at any time the rating by Moody’s Investor Service, Inc. (“Moody’s”) or Standard & Poor’s Ratings Group (“S&P”) of the senior, unsecured, long-term indebtedness for borrowed money of the Company that is not guaranteed by any other person or subject to any other credit enhancement is rated lower than Baa3 or BBB-, respectively, or is not rated by either such rating agency, then the loan commitments are subject to mandatory reduction from (a) 50% of the net proceeds of certain equity issuances by any Loan Party, (b) 50% of the net proceeds of certain debt incurred or issued by any Loan Party, (c) 25% of the net proceeds received by any Loan Party from the disposition of CoreLogic stock received in connection with the Separation and (d) the net proceeds received by any Loan Party from certain dispositions of assets, provided that the commitment reductions described above are only required to the extent necessary to reduce the total loan commitments to $200.0 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) the Alternate Base Rate plus the Applicable Rate or (b) the Adjusted LIBOR rate plus the Applicable Rate (in each case as defined in the agreement). The Company may select interest periods of one, two, three or six months or (if agreed to by all lenders) such other number of months for Eurodollar borrowings of loans. The Applicable Rate varies depending upon the rating assigned by Moody’s and/or S&P to the credit agreement, or if no such rating is in effect, the Index Debt Rating. The minimum Applicable Rate for Alternate Base Rate borrowings is 1.50% and the maximum is 2.25%. The minimum Applicable Rate for Adjusted LIBOR rate borrowings is 2.50% and the maximum is 3.25%.

 

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 automatically accelerate. At December 31, 2011, the Company is in compliance with the debt covenants under the credit agreement.

 

In addition to amounts available under the credit facility, certain subsidiaries of the Company are parties to master repurchase agreements which are used as part of the Company’s liquidity management activities and to

 

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support its risk management activities. In particular, securities loaned or sold under repurchase agreements are used as short-term funding sources. In 2011, the Company did not transfer or receive funds or securities under these agreements.

 

Notes and contracts payable as a percentage of total capitalization was 12.8% at December 31, 2011 and 2010. Notes and contracts payable are more fully described in Note 10 Notes and Contracts Payable to the consolidated financial statements.

 

Investment Portfolio.    The Company’s investment portfolio is primarily held at its insurance and banking subsidiaries. The Company maintains a high quality, liquid investment portfolio. As of December 31, 2011, the Company’s debt and equity investment securities portfolio consists of approximately 90% of fixed income securities. As of that date, over 70% of the Company’s fixed income investments are held in securities that are United States government-backed or rated AAA, and approximately 98% of the fixed income portfolio is rated or classified as investment grade. Percentages are based on the amortized cost basis of the securities. Credit ratings are based on S&P and Moody’s published ratings. If a security was rated differently by both rating agencies, the lower of the two ratings was selected.

 

The table below outlines the composition of the investment portfolio currently in an unrealized loss position by credit rating (percentages are based on the amortized cost basis of the investments). Credit ratings are based on S&P and Moody’s published ratings and are exclusive of insurance effects. If a security was rated differently by both rating agencies, the lower of the two ratings was selected:

 

     A-Ratings
or
Higher
    BBB+
to BBB-
Ratings
    Non-
Investment
Grade/Not
Rated
 

December 31, 2011

      

Municipal bonds

     95.8     0.0     4.2

Foreign bonds

     99.2     0.8     0.0

Governmental agency bonds

     100.0     0.0     0.0

Governmental agency mortgage-backed securities

     100.0     0.0     0.0

Non-agency mortgage-backed securities

     0.0     0.0     100.0

Corporate debt securities

     92.5     7.5     0.0

Preferred stock

     0.0     100.0     0.0
  

 

 

   

 

 

   

 

 

 
     89.9     1.3     8.8
  

 

 

   

 

 

   

 

 

 

 

In connection with the Separation, TFAC issued to the Company and FATICO a number of shares of its common stock that resulted in the Company and FATICO collectively owning 12.9 million shares of CoreLogic’s common stock immediately following the Separation. Due to the fact that a substantial proportion of the Company’s investment portfolio consists of the common stock of a single issuer, CoreLogic, the Company sold 4.0 million shares in April 2011 to reduce its unsystematic risk. At December 31, 2011, 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 $115.5 million. The Company holds 6.0 million shares at the holding company and the remaining 2.9 million shares at FATICO. 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 will continue to closely monitor and regularly review its investment in CoreLogic common stock.

 

In addition to its debt and equity investment securities portfolio, the Company maintains certain money-market and other short-term investments.

 

Capital expenditures.    Capital expenditures primarily consist of additions to property and equipment, capitalized software development costs and additions to title plants. Capital expenditures were $75.4 million, $88.7 million and $42.3 million for the years ended December 31, 2011, 2010 and 2009, respectively. The

 

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decrease in 2011 from 2010 was primarily attributable to a lower level of title plant additions in 2011 when compared to 2010. The increase in 2010 over 2009 was primarily related to a higher level of capitalized software development costs and title plant additions in 2010 when compared to 2009, and the buyout of several fixed asset operating leases in 2010.

 

Contractual obligations.    A summary, by due date, of the Company’s total contractual obligations at December 31, 2011, is as follows:

 

     Total      Less than 1
year
     1-3 years      3-5 years      More than
5 years
 
     (in thousands)  

Notes and contracts payable

   $ 299,975       $ 30,155       $ 221,910       $ 19,499       $ 28,411   

Interest on notes and contracts payable

     29,317         11,942         8,552         3,609         5,214   

Operating leases

     258,201         84,036         111,953         45,854         16,358   

Deposits

     1,093,236         1,072,703         14,961         5,572         —     

Claim losses

     1,014,676         256,048         257,998         151,435         349,195   

Pension and supplemental benefit plans

     520,349         34,150         79,382         51,687         355,130   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 3,215,754       $ 1,489,034       $ 694,756       $ 277,656       $ 754,308   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

The timing of claim payments is estimated and is not set contractually. Nonetheless, based on historical claims experience, the Company anticipates the above payment patterns. Changes in future claim settlement patterns, judicial decisions, legislation, economic conditions and other factors could affect the timing and amount of actual claim payments. The timing and amount of payments in connection with pension and supplemental benefit plans is based on the Company’s current estimate and requires the use of significant assumptions. Changes in significant assumptions could affect the amount and timing of pension and supplemental benefit plan payments. See Note 14 Employee Benefit Plans to the consolidated financial statements for additional discussion of management’s significant assumptions. The Company is not able to reasonably estimate the timing of payments, or the amount by which the liability for the Company’s uncertain tax positions will increase or decrease over time; therefore the liability of $17.3 million has not been included in the contractual obligations table. See Note 12 Income Taxes to the consolidated financial statements for additional discussion of the Company’s liability for uncertain tax positions.

 

Off-balance sheet arrangements.    The Company administers escrow deposits and trust assets as a service to its customers. Escrow deposits totaled $3.07 billion and $3.03 billion at December 31, 2011 and 2010, respectively, of which $0.9 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 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 $2.8 billion and $2.9 billion at December 31, 2011 and 2010, 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 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 consolidated financial statements as income or a reduction in expense, as appropriate, based on the nature of the arrangement and benefit received.

 

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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 $564.7 million and $609.9 million at December 31, 2011 and 2010, respectively, of which none and $408.8 million, respectively, were held at the Company’s subsidiary, First Security Business Bank (“FSBB”). The like-kind exchange deposits held at FSBB are included in the accompanying consolidated balance sheets in cash and cash equivalents with offsetting liabilities included in deposits. The remaining 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 consolidated balance sheets. Such amounts are placed in bank deposits with FDIC insured institutions. The Company could be held contingently liable to the customer for the transfers of property, disbursements of proceeds and the return on the proceeds.

 

During the third quarter of 2011, the Company began the multi-year process of winding-down the operations of FSBB. FSBB continues to accept and service certain deposits and to service its existing loan portfolio, but is no longer accepting like-kind exchange deposits or originating or purchasing new loans.

 

At December 31, 2011 and 2010, the Company was contingently liable for guarantees of indebtedness owed by affiliates and third parties to banks and others totaling $31.0 million and $34.9 million, respectively. The guarantee arrangements relate to promissory notes and other contracts, and contingently require the Company to make payments to the guaranteed party based on the failure of debtors to make scheduled payments according to the terms of the notes and contracts. The Company’s maximum potential amount of future payments under these guarantees totaled $31.0 million and $34.9 million at December 31, 2011 and 2010, respectively, and is limited in duration to the terms of the underlying indebtedness. The Company has not incurred any costs as a result of these guarantees and has not recorded a liability on its consolidated balance sheets related to these guarantees at December 31, 2011 and 2010.

 

Item 7A.    Quantitative and Qualitative Disclosures about Market Risk

 

Interest Rate Risk

 

The Company has interest rate risk associated with certain financial instruments. The Company monitors its risk associated with fluctuations in interest rates and makes investment decisions to manage accordingly. The Company does not currently use derivative financial instruments in any material amount to hedge these risks. The table below provides information about certain assets and liabilities as of December 31, 2011 that are sensitive to changes in interest rates and presents cash flows and the related weighted average interest rates by expected maturity dates.

 

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    2012     2013     2014     2015     2016     Thereafter     Total     Fair Value  
    (in thousands except percentages)  

Assets

               

Deposits with Savings and Loan Associations and Banks

               

Book Value

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

Average Interest Rate

    1.09              

Debt Securities

               

Amortized Cost

  $ 105,687        84,075        115,419        131,796        142,371        1,588,232      $ 2,167,580      $ 2,201,911   

Average Interest Rate

    3.42     4.17     3.42     3.26     3.58     2.60    

Notes Receivable

               

Book Value

  $ 2,767        1,561        4,359        968        1,382        7,946      $ 18,983      $ 14,534   

Average Interest Rate

    5.68     5.71     5.16     5.13     5.79     5.87    

Loans Receivable

               

Book Value

  $ 2,437        1,284        2,499        9,363        6,033        122,539      $ 144,155      $ 144,868   

Average Interest Rate

    7.25     6.33     6.14     6.08     6.99     6.44    

Liabilities

               

Interest Bearing Escrow Deposits

               

Book Value

  $ 744,917                $ 744,917      $ 744,917   

Average Interest Rate

    0.25              

Variable Rate Deposits

               

Book Value

  $ 26,840                $ 26,840      $ 26,840   

Average Interest Rate

    0.65              

Fixed Rate Deposits

               

Book Value

  $ 23,239        10,501        4,460        4,206        1,366        $ 43,772      $ 44,307   

Average Interest Rate

    1.55     1.82     2.27     2.70     1.91      

Notes and Contracts Payable

               

Book Value

  $ 30,155        208,451        13,459        15,327        4,172        28,411      $ 299,975      $ 304,806   

Average Interest Rate

    3.23     3.40     4.52     4.66     5.29     5.26    

 

Equity Price Risk

 

The Company is also subject to equity price risk related to its equity securities portfolio. At December 31, 2011, the Company had equity securities with a cost basis of $231.9 million and estimated fair value of $184.0 million. Included in the equity securities portfolio are shares of CoreLogic common stock, which the Company received in connection with the Separation, with a cost basis of $167.6 million and estimated fair value of $115.5 million at December 31, 2011. The Company manages its equity price risk, including the risk associated with its CoreLogic common stock, through an investment committee made up of certain senior executives which is advised by an experienced investment management staff.

 

Foreign Currency Risk

 

Although the Company has exchange rate risk for its operations in certain foreign countries, this risk is not material to the Company’s financial condition or results of operations. The Company does not hedge its foreign exchange risk.

 

Credit Risk

 

The Company’s corporate, municipal, foreign, non-agency mortgage-backed and, to a lesser extent, its agency securities are subject to credit risk. The Company manages its credit risk through actively monitoring issuer financial reports, credit spreads, security pricing and credit rating migration. Further, diversification and concentration limits by asset type and per issuer are established and monitored by the Company’s investment committee.

 

The Company’s non-agency mortgage-backed securities credit risk is analyzed by monitoring servicer reports and through utilization of sophisticated cash flow models to measure the default characteristics of the underlying collateral pools.

 

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The Company holds a large concentration in U.S. government agency securities, including agency mortgage-backed securities. In the event of discontinued U.S. government support of its federal agencies, material credit risk could be observed in the portfolio. The Company views that scenario as unlikely but possible. The federal government currently is considering various alternatives to reform the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). The nature and timing of the reforms is unknown, however the federal government recently reiterated its commitment to ensuring that Fannie Mae and Freddie Mac have sufficient capital to perform under any guarantees issued now or in the future and the ability to meet any of their debt obligations.

 

The Company’s overall investment securities portfolio maintains an average credit quality of AA.

 

Item 8.    Financial Statements and Supplementary Data

 

Separate financial statements for subsidiaries not consolidated and 50% or less owned persons accounted for by the equity method have been omitted because they would not constitute a significant subsidiary.

 

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INDEX

 

     Page No.  

Report of Independent Registered Public Accounting Firm

     60   

Financial Statements:

  

Consolidated Balance Sheets

     61   

Consolidated Statements of Income

     62   

Consolidated Statements of Comprehensive Income

     63   

Consolidated Statements of Equity

     64   

Consolidated Statements of Cash Flows

     65   

Notes to Consolidated Financial Statements

     66   

Unaudited Quarterly Financial Data

     127   

Financial Statement Schedules:

  

I.          Summary of Investments—Other than Investments in Related Parties

     128   

II.       Condensed Financial Information of Registrant

     129   

III.      Supplementary Insurance Information

     133   

IV.      Reinsurance

     135   

V.       Valuation and Qualifying Accounts

     136   

 

Financial statement schedules not listed are either omitted because they are not applicable or the required information is shown in the consolidated financial statements or in the notes thereto.

 

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Report of Independent Registered Public Accounting Firm

 

To the Board of Directors and Stockholders of

First American Financial Corporation:

 

In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of First American Financial Corporation and its subsidiaries at December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2011 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the Management’s Annual Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedules, and on the Company’s internal control over financial reporting based on our audits (which were integrated audits in 2011 and 2010). We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

 

As discussed in Note 1, amounts recorded for allocations of certain expenses directly attributable to the operations of First American Financial Corporation prior to June 1, 2010 are not necessarily representative of the amounts that would have been reflected in the financial statements had the Company operated as a separate, stand-alone entity.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

/s/ PRICEWATERHOUSECOOPERS LLP

PricewaterhouseCoopers LLP

Orange County, California

February 27, 2012

 

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FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

 

CONSOLIDATED BALANCE SHEETS

(in thousands, except par values)

 

     December 31,  
     2011     2010  

ASSETS

    

Cash and cash equivalents

   $ 418,299      $ 728,746   

Accounts and accrued income receivable, less allowances ($30,504 and $39,904)

     227,847        234,539   

Income taxes receivable

     20,431        22,266   

Investments:

    

Deposits with savings and loan associations and banks

     56,201        59,974   

Debt securities

     2,201,911        2,107,984   

Equity securities

     184,000        282,416   

Other long-term investments

     200,805        213,877   

Notes receivable from CoreLogic

     —          18,787   
  

 

 

   

 

 

 
     2,642,917        2,683,038   
  

 

 

   

 

 

 

Loans receivable, net

     139,191        161,526   

Property and equipment, net

     337,578        345,871   

Title plants and other indexes

     513,998        504,606   

Deferred income taxes

     39,617        96,846   

Goodwill

     818,420        812,031   

Other intangible assets, net

     59,994        70,050   

Other assets

     152,045        162,307   
  

 

 

   

 

 

 
   $ 5,370,337      $ 5,821,826   
  

 

 

   

 

 

 

LIABILITIES AND EQUITY

    

Deposits

   $ 1,093,236      $ 1,482,557   

Accounts payable and accrued liabilities:

    

Accounts payable

     27,525        33,350   

Personnel costs

     137,024        137,848   

Pension costs and other retirement plans

     432,456        409,317   

Other

     138,929        155,889   
  

 

 

   

 

 

 
     735,934        736,404   
  

 

 

   

 

 

 

Due to CoreLogic, net

     35,951        62,370   

Deferred revenue

     155,626        144,719   

Reserve for known and incurred but not reported claims

     1,014,676        1,108,238   

Notes and contracts payable

     299,975        293,817   
  

 

 

   

 

 

 
     3,335,398        3,828,105   
  

 

 

   

 

 

 

Commitments and contingencies

    

Stockholders’ equity:

    

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

     —          —     

Common stock, $0.00001 par value:

    

Authorized—300,000 shares; Outstanding—105,410 shares and 104,457 shares as of December 31, 2011 and 2010, respectively

     1        1   

Additional paid-in capital

     2,081,242        2,057,098   

Retained earnings

     124,816        72,074   

Accumulated other comprehensive loss

     (177,459     (149,156
  

 

 

   

 

 

 

Total stockholders’ equity

     2,028,600        1,980,017   

Noncontrolling interests

     6,339        13,704   
  

 

 

   

 

 

 

Total equity

     2,034,939        1,993,721   
  

 

 

   

 

 

 
   $ 5,370,337      $ 5,821,826   
  

 

 

   

 

 

 

 

See Notes to Consolidated Financial Statements

 

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FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

 

CONSOLIDATED STATEMENTS OF INCOME

(in thousands, except per share amounts)

 

     Year Ended December 31,  
   2011     2010     2009  

Revenues:

      

Direct premiums and escrow fees

   $ 1,634,177      $ 1,663,956      $ 1,760,571   

Agent premiums

     1,491,943        1,517,704        1,524,120   

Information and other

     621,483        628,504        667,115   

Investment income

     82,153        94,262        120,249   

Net realized investment (losses) gains

     (114     10,209        14,637   

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

      

Total OTTI losses on equity securities

     —          (1,722     (21,051

Total OTTI losses on debt securities

     (12,748     (8,497     (45,020

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

     3,680        2,196        26,213   
  

 

 

   

 

 

   

 

 

 
     (9,068     (8,023     (39,858
  

 

 

   

 

 

   

 

 

 
     3,820,574        3,906,612        4,046,834   
  

 

 

   

 

 

   

 

 

 

Expenses:

      

Personnel costs

     1,186,479        1,214,434        1,216,565   

Premiums retained by agents

     1,195,282        1,222,274        1,229,229   

Other operating expenses

     753,750        803,603        909,466   

Provision for policy losses and other claims

     420,136        320,874        346,714   

Depreciation and amortization

     76,889        80,642        84,212   

Premium taxes

     45,663        37,780        36,484   

Interest

     12,082        14,899        19,819   
  

 

 

   

 

 

   

 

 

 
     3,690,281        3,694,506        3,842,489   
  

 

 

   

 

 

   

 

 

 

Income before income taxes

     130,293        212,106        204,345   

Income taxes

     51,714        83,150        70,068   
  

 

 

   

 

 

   

 

 

 

Net income

     78,579        128,956        134,277   

Less: Net income attributable to noncontrolling interests

     303        1,127        11,888   
  

 

 

   

 

 

   

 

 

 

Net income attributable to the Company

   $ 78,276      $ 127,829      $ 122,389   
  

 

 

   

 

 

   

 

 

 

Net income per share attributable to the Company’s stockholders:

      

Basic

   $ 0.74      $ 1.23      $ 1.18   
  

 

 

   

 

 

   

 

 

 

Diluted

   $ 0.73      $ 1.20      $ 1.18   
  

 

 

   

 

 

   

 

 

 

Cash dividends per share

   $ 0.24      $ 0.18      $ —     
  

 

 

   

 

 

   

 

 

 

Weighted-average common shares outstanding:

      

Basic

     105,197        104,134        104,006   
  

 

 

   

 

 

   

 

 

 

Diluted

     106,914        106,177        104,006   
  

 

 

   

 

 

   

 

 

 

 

See Notes to Consolidated Financial Statements

 

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FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)

 

     Year Ended December 31,  
     2011     2010     2009  

Net income

   $ 78,579      $ 128,956      $ 134,277   
  

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss), net of tax:

      

Unrealized (loss) gain on securities

     (12,316     2,489        51,873   

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

     2,144        4,820        10,173   

Foreign currency translation adjustment

     (6,167     5,705        31,972   

Pension benefit adjustment

     (12,034     (10,629     20,846   
  

 

 

   

 

 

   

 

 

 

Total other comprehensive (loss) income, net of tax

     (28,373     2,385        114,864   
  

 

 

   

 

 

   

 

 

 

Comprehensive income

     50,206        131,341        249,141   

Less: Comprehensive income attributable to noncontrolling interests

     233        5,177        12,788   
  

 

 

   

 

 

   

 

 

 

Comprehensive income attributable to the Company

   $ 49,973      $ 126,164      $ 236,353   
  

 

 

   

 

 

   

 

 

 

 

See Notes to Consolidated Financial Statements

 

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FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

 

CONSOLIDATED STATEMENTS OF EQUITY

(in thousands)

 

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

Balance at December 31, 2008

    —          —          —          —          2,153,296        (261,455     82,424        1,974,265   

Net income for 2009

    —          —          —          —          122,389        —          11,888        134,277   

Sale of subsidiary shares to /other increases in noncontrolling interests

    —          —          —          —          —          —          30,348        30,348   

Purchase of subsidiary shares from /other decreases in noncontrolling interests

    —          —          —          —          26,948        —          (103,131     (76,183

Distributions to noncontrolling interests

    —          —          —          —          —          —          (9,378     (9,378

Dividends to TFAC

    —          —          —          —          (83,000     —          —          (83,000

Other comprehensive income (Note 20)

    —          —          —          —          —          113,964        900        114,864   

Net distributions to TFAC

    —          —          —          —          (52,342     —          —          (52,342
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2009

    —          —          —          —          2,167,291        (147,491     13,051        2,032,851   

Net income earned prior to June 1, 2010 separation

    —          —          —          —          36,777        —          147        36,924   

Net contributions from TFAC

    —          —          —          —          2,097        —          —          2,097   

Distribution to TFAC upon separation

    —          —          —          —          (156,570     (22,051     —          (178,621

Capitalization as a result of separation from TFAC

    —          —          2,047,528        —          (2,047,528     —          —          —     

Issuance of common stock at separation

    104,006        1        (1     —          —          —          —          —     

Net income earned following June 1, 2010 separation

    —          —          —          91,052        —          —          980        92,032   

Dividends on common shares

    —          —          —          (18,553     —          —          —          (18,553

Shares issued in connection with restricted stock unit, option and benefit plans

    451        —          2,855        (425     —          —          —          2,430   

Share-based compensation expense

    —          —          6,852