EX-99.(A) 4 dex99a.htm INFORMATION STATEMENT Information Statement
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Exhibit 99(a)

LOGO

The First American Corporation

1 First American Way

Santa Ana, California, 92707-5913

Tel: (800) 854-3643 Fax: []

[], 2010

Dear Fellow Shareholder:

I am pleased to inform you that the board of directors of The First American Corporation (“First American”) has approved the distribution of all of the shares of common stock of First American Financial Corporation (“FinCo”) to the shareholders of First American.

As a result of the distribution, First American’s shareholders will own all of the outstanding shares of FinCo and will continue to own all of the shares of First American. First American following the distribution, which we refer to as the “Information Company” or “InfoCo”, will continue to operate the information solutions businesses of First American. The Information Company will change its name to [] and will change the symbol under which its common shares are listed on the New York Stock Exchange from “FAF” to “[].” FinCo will adopt First American’s stock symbol after the distribution and have its common stock listed on the New York Stock Exchange under the symbol “FAF.”

Following the distribution, FinCo will own and operate First American’s financial services businesses, which consist primarily of First American’s current title insurance and services segment and its specialty insurance segment. The Information Company will own and operate First American’s information solutions businesses, which consist primarily of First American’s information and outsourcing solutions, data and analytic solutions and loss mitigation and business solutions segments.

The distribution of shares of common stock of FinCo will occur on [], 2010, by way of a pro rata dividend to First American’s shareholders. Each First American shareholder will be entitled to receive [] shares of FinCo common stock for each common share of First American held by such shareholder at the close of business on [], the record date for the distribution. The dividend will be issued in book-entry form only, which means that no physical share certificates will be issued. Cash will be issued in lieu of any fractional shares of common stock of FinCo you would have otherwise received.

Our board of directors believes that creating independent, focused companies will ultimately create value for our shareholders because it is the most effective way to manage our businesses. It should also facilitate investor understanding of our businesses.

Shareholder approval of the distribution is not required, nor are you required to take any action to receive your shares of FinCo common stock. Following the distribution, you will own common stock in both FinCo and the Information Company. The enclosed information statement, which is being mailed to all First American shareholders, describes the distribution of FinCo common stock in detail and contains other important information about FinCo. We urge you to read the information statement carefully.

I want to thank you, at this exciting time, for your support of First American and for your continued support of FinCo and InfoCo.

 

Yours sincerely,

/s/    PARKER S. KENNEDY

Parker S. Kennedy
Chairman and Chief Executive Officer
The First American Corporation


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[Insert First American Financial Corporation Logo]

[Insert First American Financial Corporation Letterhead]

[], 2010

Dear First American Financial Corporation Stockholder:

It is our pleasure to welcome you as a stockholder of our new company, First American Financial Corporation. We expect to adopt First American’s stock symbol after the distribution and have our common stock listed on the New York Stock Exchange under the symbol “FAF.”

Following First American’s distribution of shares of our common stock to you, First American Financial will be an independent, publicly traded company. This independence enhances our ability to focus on the objectives and strategic needs of our businesses and enables our stockholders to better understand our company. It also facilitates our efforts to more closely align the interests of our employees with the interests of our stockholders by enabling us to offer our employees incentive opportunities more directly linked to the performance of the financial services businesses. In pursuing this effort we have a single goal—creating long-term value for our stockholders.

We invite you to learn more about our company and the distribution by reviewing the enclosed information statement.

First American Financial inherits the rich and successful history of First American’s financial services businesses. We look forward to this new chapter and thank you for your support.

 

Very truly yours,

/s/    DENNIS J. GILMORE

Dennis J. Gilmore
Chief Executive Officer
First American Financial Corporation


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INFORMATION STATEMENT

[Insert First American Financial Corporation Logo]

COMMON STOCK

(par value $0.00001 per share)

On January 15, 2008, First American announced that its board of directors had approved a plan to separate First American into two independent, publicly traded companies: one, First American Financial Corporation or “FinCo” will be comprised of First American’s financial services businesses and the other, the remaining “Information Company” or “InfoCo” will be comprised of its information solutions businesses. First American intends to accomplish this separation through the distribution to its shareholders of all shares of FinCo common stock. The Information Company will change its name to [] following the distribution and also change the symbol under which its common shares are listed on the New York Stock Exchange from “FAF” to “[].” We anticipate that the distribution will be tax-free for U.S. federal income tax purposes.

On [], the distribution date, each First American shareholder will receive [] shares of FinCo common stock for each common share of First American held at the close of business on [], the record date for the distribution, and First American will cease to own any shares of FinCo common stock. Accordingly, immediately following the distribution, First American shareholders will own 100 percent of the outstanding common stock of FinCo. You will not be required to make any payment or surrender or exchange your First American common shares to receive your shares of our common stock. In addition, no shareholder vote is required for the separation to occur. First American is not asking you for a proxy.

We are sending you this information statement to describe the effects of FinCo’s separation from InfoCo. We expect the distribution to occur on []. Effective as of that date, our transfer agent will distribute shares of our common stock to each eligible holder of First American common shares by crediting book-entry accounts with that holder’s proportionate number of whole shares of common stock. Eligible holders will receive a cash payment in lieu of any fractional interest in our common stock.

Prior to the effective date and in connection with the separation, First American will issue to FinCo and our principal title insurance subsidiary a number of shares that will result collectively in FinCo and such subsidiary owning approximately $250 million of InfoCo’s issued and outstanding common shares following the distribution. We expect to dispose of these shares within five years following the separation.

The trading market for FinCo’s common stock has not yet been established. We expect, however, that a limited market for its common stock, commonly known as a “when-issued” trading market, will develop on or shortly before the record date for the distribution. FinCo will adopt First American’s stock symbol after the separation and have its common stock listed on the NYSE under the symbol “FAF.”

As you review this information statement, you should carefully consider the matters described in the “Risk Factors” section.

The Securities and Exchange Commission and state securities regulators have not approved or disapproved of these securities, or determined if this information statement is truthful or complete. Any representation to the contrary is a criminal offense.

The date of this information statement is [].


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TABLE OF CONTENTS

 

INTRODUCTION

   ii

SUMMARY

   1

RISK FACTORS

   11

SPECIAL NOTE ABOUT FORWARD-LOOKING STATEMENTS

   22

QUESTIONS AND ANSWERS ABOUT THE SEPARATION

   26

THE SEPARATION

   31

TRADING MARKET

   41

DIVIDENDS

   42

CAPITALIZATION

   43

SELECTED HISTORICAL COMBINED FINANCIAL AND OTHER DATA

   44

UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS

   45

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

   51

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

   75

BUSINESS

   77

RELATIONSHIP WITH INFOCO

   89

MANAGEMENT

   94

CERTAIN RELATIONSHIPS, RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

   130

DESCRIPTION OF MATERIAL INDEBTEDNESS

   131

SECURITY OWNERSHIP OF FIRST AMERICAN AND FINCO

   132

DESCRIPTION OF CAPITAL STOCK

   135

TREATMENT OF OUTSTANDING EQUITY-BASED ARRANGEMENTS

   139

SHARES ELIGIBLE FOR FUTURE SALE

   140

WHERE YOU CAN FIND MORE INFORMATION

   141

FINANCIAL STATEMENTS

   F-1

 

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INTRODUCTION

On January 15, 2008, First American announced that its board of directors had approved a plan to separate First American into two independent, publicly traded companies: one comprised of First American’s financial services businesses and one comprised of its information solutions businesses. The separation will occur through the distribution to First American shareholders of all of the common stock of First American Financial Corporation, which we refer to as FinCo, the subsidiary of First American that holds or will hold, through its respective subsidiaries, the assets and liabilities of the financial services businesses.

On [], the distribution date, each First American shareholder will receive [] shares of FinCo common stock for each common share of First American held at the close of business on the record date and First American will cease to own any shares of FinCo common stock. Immediately following the distribution, First American’s shareholders will own 100 percent of the outstanding common stock of InfoCo and FinCo. You will not be required to make any payment or surrender or exchange your First American common shares to receive your shares of FinCo common stock. Eligible holders will receive a cash payment in lieu of any fractional interest in our common stock.

After the separation, if you have questions relating to the separation or your FinCo shares, you can contact us directly. Our contact information is:

First American Financial Corporation

Investor Relations

1 First American Way

Santa Ana, California 92707

Telephone: (714) 250-5214

Facsimile: (714) 250-3304

www.firstam.com

After the separation, you can also contact the Information Company with any questions. The Information Company’s contact information will be:

The First American Corporation

Investor Relations

4 First American Way

Santa Ana, California 92707

Telephone: (714) 250-3504

Facsimile: (714) 250-6293

[website]

 

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SUMMARY

This summary highlights information contained in this information statement relating to FinCo and the FinCo common stock being distributed to the First American shareholders. You should read the entire information statement, including the risk factors, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” historical combined financial statements, unaudited pro forma condensed combined financial statements and the respective notes to those historical and pro forma financial statements.

Except as otherwise indicated or unless the context otherwise requires, “FinCo” refers to First American Financial Corporation following the distribution; “we,” “us” and “our” refer to FinCo and its subsidiaries for periods of time following the distribution and refer to the businesses that are expected to be part of FinCo and its subsidiaries for periods of time prior to the distribution; “First American” refers to The First American Corporation prior to the distribution and “Information Company” and “InfoCo” refer to The First American Corporation following the distribution. Except as otherwise indicated or unless the context otherwise requires, the information included in this information statement assumes the completion of the separation.

The historical combined financial statements for FinCo have been prepared on a “carve-out” basis to reflect the operations, financial condition and cash flows specifically allocable to us during all periods shown. The unaudited pro forma condensed combined financial statements adjust the historical combined financial statements to give effect to our separation from First American, the anticipated post-separation capital structure and other adjustments directly attributable to the distribution.

The Company

Our businesses consist primarily of First American’s title insurance and services segment and its specialty insurance segment. Accordingly, as an independent, publicly traded company, FinCo will consist of the following reportable segments and a corporate function:

 

   

Our title insurance and services segment provides title insurance, escrow or closing services and related financial services in connection with residential and commercial real estate transactions. It also maintains, manages and provides access to automated title plant records and images and provides thrift, trust and investment advisory services.

 

   

Our specialty insurance segment provides property and casualty insurance, including homeowners insurance, and also provides home warranty policies.

Financial information regarding each of these business segments is included in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and “Financial Statements” sections of this information statement.

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 products and services internationally. This segment also provides escrow and closing services, accommodates tax-deferred exchanges of real estate, maintains, manages and provides access to automated title plant records and images and provides investment advisory, trust, lending and deposit services.

We conduct our title insurance 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 and similar products, as well as related services, either directly or through joint ventures in foreign countries, including Canada, the United Kingdom and various other established and emerging markets.

 

 

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Specialty Insurance

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 actively issues 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.

Home Warranties. Our home warranty business provides residential service contracts that cover residential systems and appliances against failures that occur as the result of normal usage during the coverage period. This business currently operates in 34 states and the District of Columbia.

Strengths

Financial Strength. Our principal title insurance underwriter, First American Title Insurance Company, maintained approximately $802.3 million of statutory surplus capital as of December 31, 2009. In addition, at the time of the distribution, relative to our title industry peers, we expect to have a low debt-to-capital ratio, a sound investment portfolio and strong financial strength ratings. This financial strength benefits our policyholders. We believe it also improves our ability to market our products, particularly in connection with commercial and international transactions as well as domestic transactions involving lenders with a national presence or other parties that are focused on counter-party credit risk.

Brand Recognition. We have been a leader in the title industry for more than a century. Customers, including consumers, independent escrow or closing services companies, real estate agents and brokers, developers, mortgage brokers, mortgage bankers, financial institutions and attorneys, associate the “First American” brand with stability and customer service. We believe that this strong brand awareness in the real estate community enhances the demand for our products and services.

Diversified Geographic, Distribution and Product Mix. We conduct business in all 50 states as well as various countries including Canada, the United Kingdom and others. We also market various title and related products through several channels. The ability to generate revenues across a diversified mix of geographies, with a variety of products and through multiple distribution channels enables us to benefit from opportunities as they arise. At the same time, this diversity potentially mitigates the effects of negative trends that may occur in a given geography or product line.

Long-term Customer Relationships. We have many long-term relationships with both national and local customers. In some cases we have been providing our products and services to particular lenders, real estate agents, brokers and attorneys for decades. The loyalty of many of our customers provides a recurring level of transaction activity.

Strong Market Position. According to American Land Title Association data, we maintained approximately 28.7 percent of the domestic title insurance market as of September 30, 2009. This strong market position enables us to achieve economies of scale and to leverage efficiently our technology and global resources.

Technology. We have developed an integrated proprietary technology application to facilitate uniformity across our direct title operations and our escrow and closing services in the United States. This technology permits us to share information and coordinate efforts at all levels of the title production and closing process. A common approach across technology applications is also being developed to standardize other functions such as agency administration, title claims management, procurement and various corporate functions. We believe this uniform approach increases our efficiency and permits us to better serve our customers.

 

 

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Global Resources. Over the last decade we believe that we have been both an industry and a marketplace leader in global production. We currently utilize these global resources in the performance of various functions that support our businesses, including many aspects of title production. Performing these functions globally significantly decreases our labor costs, allows for enhanced leveraging of our integrated technology applications, and improves customer responsiveness by permitting on-shore and off-shore personnel to work together, in many instances, over a 24-hour cycle. The majority of individuals supporting our off-shore efforts are employed either by us or by entities in which we have an ownership interest. Even where we do not maintain an ownership interest, our off-shore service providers generally have a workforce dedicated to our business. This enables us to control quality, ensure security and effectively manage costs. We have maintained long-term relationships with most of these service providers, although the agreements are generally terminable by either party upon 90 to 180 days’ prior notice. We maintain relationships with service providers in varying geographies to provide for continuity in the event of any temporary or permanent loss of capacity in any given location. We believe that our extensive global experience and dedicated resources give us a competitive advantage over industry participants that do not have, or are now attempting to develop, similar capabilities.

Management Expertise. Our chief executive officer, Dennis J. Gilmore, who has over twenty years of experience in the settlement services industry, leads a team of innovative, experienced operators throughout our businesses. These operators include the five leaders of our title company’s domestic and international operations, who have a combined 128 years of experience in the industry. In addition to leading our businesses through the ongoing centralization and cost restructuring efforts, Mr. Gilmore led the expansion over the last ten years of First American’s network of global resources. Our executive chairman, Parker S. Kennedy, has over thirty years of experience in the title insurance industry. During this time he has developed and maintained loyal relationships with customers, employees and other industry participants that continue to benefit our company.

Strategy

Increase Operating Margins. We believe that consistent application of the following principles will enhance our earnings:

 

   

Simplification of processes, functions and structures wherever feasible;

 

   

Standardization of these processes and functions across our businesses;

 

   

Centralization of administrative functions where economies of scale can be achieved and expertise can be developed more readily at fewer locations;

 

   

Leveraging uniform technology applications and global resources to lower costs and improve efficiency; and

 

   

Focusing on our customers and on developing our strengths as a leader in the settlement services industry, avoiding the distractions of unrelated businesses.

Centralize Administrative Activities. We intend to continue to centralize capital management, claims handling, technology initiatives, agency administration and most corporate services, while maintaining a customer-focused localized approach to customer-facing functions and other areas where local knowledge is essential to our effectiveness.

Employ Enterprise-wide Technology Platforms. As a complement to the uniform technology application we currently utilize for our domestic operations, we intend to continue consolidating disparate administrative technology applications into uniform major technology platforms. The operation of enterprise-wide technology platforms generally reduces technology spending and also enhances our ability to report, receive and analyze information on a company-wide basis. We also intend to continue to integrate on-shore and off-shore resources through the continued development and deployment of uniform technology platforms to facilitate the global sharing of data and work-product.

 

 

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Leverage Global Resources. We maintain a significant global workforce dedicated to our business. These resources have enabled us to operate more efficiently, control costs and improve customer responsiveness. As we simplify and standardize processes and functions, we intend to continue to identify those that can be performed more efficiently and effectively through the utilization of these global resources.

Strengthen Customer Relationships Through Superior Service. Throughout our history, we have developed strong relationships with our customers, including many of the large financial institutions in the United States and abroad. We intend to strengthen these important relationships and develop similar relationships with new customers through continuous improvement and by providing superior service.

React Quickly to Changing Market Conditions. The real estate and mortgage markets are cyclical and seasonal. We intend to maintain the flexibility necessary to react quickly to market downturns and to maintain a disciplined approach as market conditions improve.

Focus on Specialized Distribution Channels. We intend to focus on obtaining growth through specialized distribution channels, such as commercial, default, homebuilder and centralized lender channels. Historically business obtained through these channels has been more profitable than other title business due in part to lower facilities and administrative expenses.

Continue to Grow International Operations. Over the past 20 years we believe we have led the industry in expanding our product offerings to other nations, in some cases establishing a market in countries where no market had previously existed. We see opportunities for growth in established foreign markets such as Canada and the United Kingdom as well as emerging markets that either are introducing Western style mortgage systems or have demonstrated a need for greater efficiency in the real estate settlement process. We believe we are ideally situated to seize these opportunities because of our expertise in the industry, financial strength, existing international licenses and meaningful relationships around the world. We intend to take a disciplined, long-term approach to our international expansion.

Risk Factors

We face risks in connection with our specific businesses and the general conditions and trends of the industry in which we operate, including the following:

 

   

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

 

   

Unfavorable economic conditions may have a material adverse effect on FinCo

 

   

Unfavorable economic or other conditions could cause FinCo to write off a portion of its goodwill and other intangible assets

 

   

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

 

   

Failures at financial institutions at which we deposit funds could adversely affect FinCo

 

   

Changes in government regulation could prohibit or limit FinCo’s operations or make it more burdensome to conduct such operations

 

   

Scrutiny of our businesses and the industries in which we operate by governmental entities and others could adversely affect FinCo’s operations and financial condition

 

   

FinCo may find it difficult to acquire necessary data

 

   

Regulation of title insurance rates could adversely affect FinCo’s results of operations

 

 

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

 

   

After the separation, FinCo will be responsible for First American’s pension plan, which is currently underfunded, and pension expenses and funding obligations could increase significantly as a result of the weak performance of financial markets and its effect on plan assets

 

   

Weakness in the commercial real estate market or an increase in the amount or severity of claims in connection with commercial real estate transactions could adversely affect FinCo’s results of operations

 

   

Actual claims experience could materially vary from the expected claims experience reflected in FinCo’s reserve for incurred but not reported title claims

 

   

Systems interruptions and intrusions may impair the delivery of FinCo’s products and services

 

   

FinCo may not be able to realize the benefits of its offshore strategy

 

   

Product migration may result in decreased revenue

 

   

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

 

   

FinCo’s investment portfolio is subject to certain risks and could experience losses

We also will face risks in connection with our separation from First American, including the following:

 

   

FinCo’s historical and pro forma combined financial statements are not necessarily representative of the results FinCo would have achieved as an independent, publicly traded company and may not be a reliable indicator of future results

 

   

The separation transaction could give rise to liabilities, increased competition or other unfavorable effects that may not have otherwise arisen

 

   

FinCo will be responsible for a portion of First American’s contingent and other corporate liabilities, primarily those relating to stockholder litigation

 

   

FinCo will share responsibility for certain of its and InfoCo’s income tax liabilities for tax periods prior to and including the distribution date

 

   

The ownership by FinCo’s executive officers and directors of equity interests of InfoCo may create, or may create the appearance of, conflicts of interest

 

   

If the distribution or certain internal transactions undertaken in anticipation of the separation are determined to be taxable for U.S. federal income tax purposes, FinCo, its stockholders that are subject to U.S. federal income tax and InfoCo will incur significant U.S. federal income tax liabilities

 

   

As an independent, publicly traded company, FinCo may not enjoy the same benefits that it did as a part of First American

 

   

FinCo may desire to satisfy its cash requirements with the proceeds from the sale of InfoCo shares which may be illiquid or decrease in value

 

   

FinCo might not be able to engage in desirable strategic transactions and equity issuances following the separation because of restrictions relating to U.S. federal income tax requirements for tax-free distributions

These and other risks are discussed in the section entitled “Risk Factors” in this information statement.

 

 

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Summary Historical Condensed Combined Financial Data

The summary historical condensed combined financial data for First American Financial Corporation (“FinCo”) for the five-year period ended December 31, 2009 have been derived from the combined financial statements of FinCo. The summary historical condensed combined financial data should be read in conjunction with the Combined Financial Statements and notes thereto and Management’s Discussion and Analysis included elsewhere in this information statement.

Our summary historical condensed combined financial data may not be indicative of our future performance and does not necessarily reflect what our financial position and results of operations would have been had we operated as a separate, stand-alone entity during the periods presented, including changes that will occur in our operations and capitalization as a result of our separation from First American.

 

     Year Ended December 31,
     2009     2008     2007     2006     2005
     (in thousands)

Revenues:

          

Operating revenues

   $ 3,938,616      $ 4,284,800      $ 5,884,502      $ 6,459,310      $ 6,301,272

Investment and other income

     133,439        173,748        269,488        226,871        163,624

Net realized investment losses (gains) and OTTI losses recognized in earnings

     (25,221     (90,823     (77,858     (594     974
                                      
     4,046,834        4,367,725        6,076,132        6,685,587        6,465,870
                                      

Expenses:

          

Selling, general and administrative expenses

     3,842,489        4,483,640        6,284,965        6,313,994        5,841,903
                                      

Income (loss) before income taxes

     204,345        (115,915     (208,833     371,593        623,967

Income tax expense (benefit)

     70,068        (43,433     (86,387     157,901        221,752
                                      

Net income (loss)

     134,277        (72,482     (122,446     213,692        402,215

Less: Net income attributable to noncontrolling interests

     11,888        11,523        20,537        23,875        27,471
                                      

Net income (loss) attributable to FinCo

   $ 122,389      $ (84,005   $ (142,983   $ 189,817      $ 374,744
                                      

Total assets

   $ 5,530,281      $ 5,720,757      $ 5,354,531      $ 5,658,505      $ 5,270,320

Notes and contracts payable

   $ 119,313      $ 153,969      $ 306,582      $ 372,338      $ 360,437

Allocated portion of First American debt (Note A)

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

Invested equity (Note B)

   $ 2,019,800      $ 1,891,841      $ 1,930,774      $ 2,564,369      $ 2,549,170

Note A—We were allocated $140.0 million from First American’s line of credit in June and July 2008 as this amount directly relates to our operations. First American drew on its line of credit and transferred the cash to our subsidiary in 2008 to fund our subsidiary’s statutory capital and surplus.

Note B—Invested equity refers to the combined net assets of FinCo which reflects First American’s combined investment in FinCo and excludes noncontrolling interests.

 

 

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The Separation

The following is a brief summary of the terms of the separation.

 

Distributing company

The First American Corporation, which we refer to as “First American” prior to the separation and the “Information Company” or “InfoCo” after the separation.

 

Separated company

First American Financial Corporation, a Delaware corporation which we refer to as “FinCo” and, prior to the separation, a wholly owned subsidiary of First American.

 

Primary purpose of the separation

First American’s board of directors believes that creating independent, focused companies will ultimately create value for its shareholders because it is the most effective way to manage its businesses. First American’s board of directors also believes that the separation will facilitate investor understanding of its businesses which should result in an enhanced realization of the value of those businesses. First American will be separated into two independent, publicly traded companies. FinCo will hold the financial services businesses and InfoCo will hold the information solutions businesses.

 

Conditions to the distribution

The distribution is subject to the satisfaction or, if permissible under the Separation and Distribution Agreement, waiver by First American of certain conditions, including, among other things:

 

   

the Securities and Exchange Commission shall have declared effective FinCo’s Registration Statement on Form 10, and no stop order shall be in effect;

 

   

First American shall have received a private letter ruling from the Internal Revenue Service, which we refer to as the IRS Ruling, substantially to the effect that the distribution will qualify as a tax-free transaction for U.S. federal income tax purposes under Sections 368(a)(1)(D) and 355 of the Internal Revenue Code of 1986, as amended, which we refer to as the Code;

 

   

First American shall have received the opinion of Deloitte & Touche LLP, in form and substance reasonably satisfactory to First American, regarding the qualification of the distribution as a tax-free transaction for federal income tax purposes under Sections 368(a)(1)(D) and 355 of the Code, confirming the tax-free status of the distribution for U.S. federal income tax purposes to the extent that such qualification is not addressed by the IRS Ruling, which opinion shall not have been withdrawn or modified;

 

   

First American and FinCo shall have received all necessary approvals from applicable insurance, banking and other regulators of FinCo’s businesses;

 

   

FinCo shall have entered into a new senior secured credit facility with available borrowing capacity of approximately $400 million, of which $200 million is expected to be drawn and transferred to InfoCo in connection with the separation;

 

 

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First American shall have issued to FinCo and our principal title insurance subsidiary a number of shares that will result collectively in FinCo and such subsidiary owning approximately $250 million of InfoCo’s issued and outstanding common shares following the distribution as described below under “Ownership of InfoCo shares following the separation”;

 

   

FinCo shall have transferred a total of $143 million, $43 million of which was transferred on December 31, 2009, in cash to First American and its joint venture partner in connection with the anticipated purchase of the noncontrolling interest in one of First American’s joint ventures;

 

   

the listing of FinCo’s common stock on the NYSE shall have been approved, subject to official notice of issuance;

 

   

all permits, registrations and consents required under the securities or blue sky laws in connection with the distribution shall have been received;

 

   

the First American board of directors shall have received an opinion from Duff & Phelps LLC (“Duff & Phelps”), in form and substance satisfactory to the board of directors, regarding InfoCo’s solvency and adequacy of capital immediately after the distribution and an opinion of Gibson, Dunn & Crutcher LLP that, upon the distribution, the shares of FinCo common stock will be fully paid, freely transferable and non-assessable; and

 

   

no order, injunction or decree issued by any court of competent jurisdiction or other legal restraint or prohibition preventing consummation of the distribution or any of the transactions related thereto shall be in effect.

The fulfillment of the foregoing conditions will not create any obligation on First American’s part to effect the distribution. First American has the right not to complete the distribution if, at any time, First American’s board of directors determines, in its sole discretion, that the distribution is not in the best interests of First American or its shareholders or that market conditions are such that it is not advisable to proceed with the transaction.

 

Incurrence of debt

In connection with the separation, we expect to enter into a new senior secured credit facility with available borrowing capacity of approximately $400 million, of which $200 million is expected to be drawn and transferred to InfoCo in connection with the separation. For additional information about our current and planned financing arrangements, see “Description of Material Indebtedness.”

 

Securities to be distributed

First American will own 100 percent of our common stock outstanding immediately prior to the distribution. Based on the approximately [] common shares of First American outstanding on [], 2010, and applying the distribution ratio of [] shares of common stock of FinCo for each First American common share, approximately [] shares of our common stock will be distributed to First American record date shareholders. The number of shares of common stock that

 

 

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First American will distribute to its shareholders will be reduced to the extent that cash will be issued in lieu of fractional shares.

 

Distribution ratio

Each holder of First American common shares will receive [] shares of FinCo common stock for each common share of First American held on [], the record date for the distribution. Cash will be distributed in lieu of any fractional shares of FinCo common stock.

 

Record date

The record date for the distribution is the close of business on [].

 

Distribution date

The distribution date is [], 2010.

 

Trading market and symbol

We expect to receive authorization to adopt First American’s current stock symbol after the distribution and have our common stock listed on the NYSE under the symbol “FAF.” We anticipate that, on or prior to the record date for the distribution, trading of our common stock will begin on a “when-issued” basis and will continue up to and including the distribution date. See “The Separation—Trading Between the Record Date and Distribution Date.”

 

Tax consequences

First American expects to receive a private letter ruling from the Internal Revenue Service substantially to the effect that the distribution will qualify as a tax-free transaction for U.S. federal income tax purposes under Sections 368(a)(1)(D) and 355 of the Code. In addition to obtaining the IRS Ruling, First American expects to obtain an opinion from Deloitte & Touche LLP regarding certain aspects of the transaction that are not covered by the IRS Ruling. Assuming that the distribution qualifies as a tax-free transaction for U.S. federal income tax purposes under Sections 368(a)(1)(D) and 355 of the Code, for U.S. federal income tax purposes no gain or loss will be recognized by a stockholder that is subject to U.S. federal income tax, and no amount will be included in the income of such stockholder upon the receipt of our common stock pursuant to the distribution, except with respect to any cash received by such stockholder in lieu of a fractional share of FinCo stock. See “Risk Factors—Risks Relating to Separating from First American—If the distribution or certain internal transactions undertaken in anticipation of the separation are determined to be taxable for U.S. federal income tax purposes, we, our stockholders that are subject to U.S. federal income tax and InfoCo could incur significant U.S. federal income tax liabilities” and “The Separation—Certain U.S. Federal Income Tax Consequences of the Distribution.”

Each stockholder is urged to consult his, her or its tax advisor as to the specific tax consequences of the distribution to that stockholder, including the effect of any state, local or non-U.S. tax laws and of changes in applicable tax laws.

 

Risk factors

We face both general and specific risks and uncertainties relating to our business, our relationship with First American and InfoCo and our being an independent, publicly traded company. We also are subject to risks relating to the separation. You should read carefully “Risk Factors,” beginning on page 11 of this information statement.

 

 

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No fractional shares

First American will not distribute any fractional common shares of FinCo. Instead, an independent agent will aggregate fractional shares into whole shares, sell the whole shares in the open market at prevailing market prices and distribute the aggregate net cash proceeds of the sales pro rata to each holder who otherwise would have been entitled to receive a fractional share in the distribution. Recipients of cash in lieu of fractional shares will not be entitled to any interest on payments made in lieu of fractional shares. The receipt of cash in lieu of fractional shares generally will be taxable to the recipient stockholders that are subject to U.S. federal income tax as described in “The Separation—Certain U.S. Federal Income Tax Consequences of the Distribution.”

 

Relationship with InfoCo after the separation

We will enter into a Separation and Distribution Agreement and other agreements to effect the separation and provide a framework for our relationships with InfoCo after the distribution. These agreements will govern the relationships between InfoCo and FinCo subsequent to the completion of the separation and provide for the allocation to us of certain of InfoCo’s assets, liabilities and obligations. For a discussion of these arrangements, see “Relationship with InfoCo.” We also will be a party to certain agreements evidencing commercial relationships with InfoCo. Many of these commercial relationships were in existence prior to the contemplation of the separation.

 

Ownership of InfoCo shares following the separation

Prior to the distribution date and in connection with the separation, First American will issue to FinCo and our principal title insurance subsidiary a number of shares that will result collectively in FinCo and such subsidiary owning approximately $250 million of InfoCo’s issued and outstanding common shares following the distribution. We expect to dispose of these shares within five years following the separation. For a discussion of the issuance, see “Relationship with InfoCo—Ownership of InfoCo Shares.”

 

Dividend policy

Following the distribution, we expect that we initially will pay approximately $24 million per year in dividends to holders of our common stock. As a holding company, we will depend on distributions from our subsidiaries to declare and pay dividends, and insurance and other regulations may limit the amount of dividends, loans and advances available from our insurance subsidiaries. The timing, declaration and payment of future dividends to holders of our common stock falls within the discretion of our board of directors and will depend upon many factors, including the statutory requirements of Delaware law, our financial condition and earnings, the capital requirements of our businesses, industry practice and any other factors the board of directors deems relevant from time to time. Our credit agreement also will likely contain provisions limiting our ability to pay dividends.

 

 

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RISK FACTORS

You should carefully consider each of the following risks, which we believe are the principal risks that FinCo is expected to face when it becomes an independent publicly traded company, including risks we currently face, risks anticipated to arise as a result of the separation from First American and risks related principally to the securities markets and ownership of FinCo common stock. Our business also may be adversely affected by risks and uncertainties not known or risks that are currently not considered to be material.

Should any of the following risks and uncertainties develop into actual events, our business, financial condition, results of operations, cash flows and liquidity position could be materially and adversely affected, the trading price of our common stock could decline and you could lose all or part of your investment.

Risks Relating to FinCo’s Business

We expect to face the following risks in connection with our businesses and the general conditions and trends of the industries in which FinCo will operate.

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

Demand for a substantial portion of our products and services generally decreases as the number of real estate transactions in which our products and services are purchased decreases. The number of real estate transactions in which our 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.

Unfavorable economic conditions may have a material adverse effect on FinCo

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 our businesses and other companies in our industries. In addition, we hold 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 negatively impacted by these conditions. We also own a federal savings bank into which we deposit some of our 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 our combined results. The likelihood of such losses, which generally would not occur if we 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 FinCo could be materially adverse, including a significant reduction in revenues, earnings and cash flows, challenges to FinCo’s ability to satisfy covenants or otherwise meet its obligations under debt facilities, difficulties in obtaining access to capital, challenges to FinCo’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 it.

Unfavorable economic or other conditions could cause FinCo to write off a portion of its goodwill and other intangible assets

We perform 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,

 

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reductions in FinCo’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 we would be required to write off the portion believed to be unrecoverable. Total goodwill and other intangible assets reflected on our pro forma balance sheet as of December 31, 2009 is approximately $879.9 million. Any substantial goodwill and other intangible asset impairments that may be required could have a material adverse effect on FinCo’s results of operations, financial condition and liquidity.

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

Certain of our customers use measurements of the financial strength of our 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 our title insurance operations. Our principal title insurance underwriter is currently rated no lower than the “A-” equivalent by all rating agencies except Standard & Poor’s, which has rated it at “BBB+”. 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. Our principal title insurance underwriter maintained approximately $802.3 million of statutory surplus capital as of December 31, 2009. 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, FinCo’s results of operations, competitive position and liquidity could be adversely affected.

Failures at financial institutions at which we deposit funds could adversely affect FinCo

We deposit 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 FinCo would recover the funds deposited, whether through Federal Deposit Insurance Corporation coverage or otherwise. In the event of any such failure, FinCo also could be held liable for the funds owned by third parties.

Changes in government regulation could prohibit or limit FinCo’s operations or make it more burdensome to conduct such operations

Many of our businesses, including our title insurance, property and casualty insurance, home warranty, thrift, trust and investment businesses, are regulated by various federal, state, local and foreign governmental agencies. These and other of our businesses also operate within 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 our products or services could prohibit or limit FinCo’s future operations or make it more burdensome to conduct such operations. These changes may compel FinCo to reduce its prices, may restrict its ability to implement price increases or acquire assets or businesses, may limit the manner in which FinCo conducts its business or otherwise may have a negative impact on its ability to generate revenues, earnings and cash flows.

Scrutiny of our businesses and the industries in which we operate by governmental entities and others could adversely affect FinCo’s operations and financial condition

The real estate settlement services industry, an industry in which FinCo generates a substantial portion of its revenue and earnings, has become subject to heightened scrutiny by regulators, legislators, the media and

 

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plaintiffs’ attorneys. Though often directed at the industry generally, these groups may also focus their attention directly on our businesses. In either case, this scrutiny may result in changes which could adversely affect FinCo’s operations and, therefore, its financial condition and liquidity.

Governmental entities have inquired into certain practices in the real estate settlement services industry to determine whether certain of our businesses or their 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 and federal laws. Departments of insurance in the various states, either separately or in conjunction with federal regulators, also periodically conduct inquiries, generally referred to at the state level as “market conduct exams,” into the practices of title insurance companies in their respective jurisdictions. Further, from time to time plaintiffs’ lawyers may target us and other members of our 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 FinCo’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 FinCo to mitigate its risk by settling claims or by ending practices that generate revenues, earnings and cash flows.

FinCo may find it difficult to acquire necessary data

Certain data used and supplied by FinCo 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 data has not had a material adverse effect on our 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 our operations and could result in substantial regulatory compliance expense, litigation expense and a loss of revenue. The suppliers of data to us face similar burdens and, consequently, we may find it financially burdensome to acquire necessary data.

Regulation of title insurance rates could adversely affect FinCo’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 FinCo’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.

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

FinCo will be a holding company whose primary assets are investments in its operating subsidiaries. FinCo’s ability to pay dividends will be dependent on the ability of its subsidiaries to pay dividends or repay funds. If FinCo’s operating subsidiaries are not able to pay dividends or repay funds, FinCo 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 FinCo’s insurance subsidiaries operate, the amount of dividends, loans and advances available is limited. Under such regulations, the maximum amount of dividends, loans and advances available in 2010 from these insurance subsidiaries, is $258.0 million.

 

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After the separation, FinCo will be responsible for First American’s pension plan, which is currently underfunded, and pension expenses and funding obligations could increase significantly as a result of the weak performance of financial markets and its effect on plan assets

After the separation, FinCo will be responsible for the obligations of First American’s defined benefit pension plan, which was closed to new entrants effective December 31, 2001 and amended to “freeze” all benefit accruals as of April 30, 2008. FinCo’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, 2009 by approximately $83.1 million and FinCo 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. In addition, InfoCo is expected to issue a $23 million promissory note to FinCo which approximates the unfunded portion of the liability attributable to the plan participants that are InfoCo employees. There is no guarantee that InfoCo will fulfill its obligation under the note or that the amount of the note will be sufficient to ultimately cover the unfunded portion of the liability attributable to these InfoCo employees. FinCo’s obligations under this plan could have a material adverse effect on its results of operations, financial condition and liquidity.

Weakness in the commercial real estate market or an increase in the amount or severity of claims in connection with commercial real estate transactions could adversely affect FinCo’s results of operations

We issue title insurance policies in connection with commercial real estate transactions. Premiums paid and limits on these policies are large relative to policies issued on residential transactions. Because a claim under a single policy could be significant, title insurers often seek reinsurance or coinsurance from other insurance companies, both within and outside the industry. We both receive and provide such coverage. Additionally, the pretax margin derived from these policies generally is higher than on other policies. Disruptions in the commercial real estate market, including limitations on available credit and defaults on loans secured by commercial real estate, may result in a decrease in the number of commercial policies issued by us and/or an increase in the number of claims we incur on commercial policies. As a reference, commercial premiums earned by us in 2009 decreased nearly 50 percent compared with the amount earned in 2006. A further decrease in the number of commercial policies issued by us or an increase in the amount or severity of claims we incur on commercial policies could adversely affect FinCo’s results of operations.

Actual claims experience could materially vary from the expected claims experience reflected in FinCo’s reserve for incurred but not reported (“IBNR”) title claims

Title insurance policies are long-duration contracts with the majority of the claims reported within the first few years following the issuance of the policy. Generally, 70 to 80 percent of claim amounts become known in the first five years of the policy life, and the majority of IBNR reserves relate to the five most recent policy years. A material change in expected ultimate losses and corresponding loss rates for policy years older than five 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 believed to be reasonably likely given the long duration nature of a title insurance policy. For example, if the expected ultimate losses for each of the last five policy years increased or decreased by 50 basis points, the resulting impact on FinCo’s IBNR reserve would be an increase or decrease, as the case may be, of $123.3 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.

Systems interruptions and intrusions may impair the delivery of FinCo’s products and services

System interruptions and intrusions may impair the delivery of FinCo’s products and services, resulting in a loss of customers and a corresponding loss in revenue. Our businesses depend heavily upon computer systems

 

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located in our data centers. Certain events beyond FinCo’s control, including natural disasters, telecommunications failures and intrusions into FinCo’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.

FinCo may not be able to realize the benefits of its offshore strategy

We utilize 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 FinCo’s costs in these countries. Weakness of the U.S. 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 FinCo’s customers may require it to use labor based in the United States. FinCo may not be able to pass on the increased costs of higher priced United States-based labor to its customers.

Product migration may result in decreased revenue

Customers of many real estate settlement services we provide increasingly require these services to be delivered faster, cheaper and more efficiently. Many of the traditional products we provide are labor and time intensive. As these customer pressures increase, FinCo 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, FinCo’s revenues may decline.

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

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

 

   

election of FinCo’s board of directors is to be 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 we issue 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

 

   

FinCo’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.

These provisions, which may only be amended by the affirmative vote of the holders of approximately 67 percent of FinCo’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 FinCo’s stockholders.

FinCo’s investment portfolio is subject to certain risks and could experience losses

We maintain a substantial investment portfolio, primarily consisting of fixed income securities (including mortgage-backed and asset-backed securities), but also including money-market and other short-term

 

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investments, as well as some common and preferred stock. Securities in our 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. 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, we will be required to write down the value of the investments, which could have a material adverse effect on our results of operations, statutory surplus and financial condition.

Risks Relating to Separating from First American

We face the following risks in connection with our separation from First American:

FinCo’s historical and pro forma combined financial statements are not necessarily representative of the results FinCo would have achieved as an independent, publicly traded company and may not be a reliable indicator of future results

The historical and pro forma combined financial statements included in this information statement do not necessarily reflect the financial condition, results of operations or cash flows that FinCo would have achieved as an independent, publicly traded company during the periods presented or those that we will achieve in the future, as a result of the following factors, among others:

 

   

Prior to the separation, FinCo’s business has been operated by First American as part of its broader corporate organization, rather than as an independent, publicly traded company. In addition, prior to the separation, First American, or one of its affiliates, performed significant corporate functions, including tax, treasury and human resources administration and certain governance functions, including internal audit and external financial reporting, that will be performed directly by FinCo following the separation. The historical and pro forma financial statements reflect allocations of corporate expenses from First American for these and similar functions but may not reflect what actual expenses as an independent, publicly traded company would have been or will be.

 

   

Prior to the separation, First American’s subsidiaries, including the information solutions businesses, generated cash necessary to maintain First American’s dividend. Following the separation, the cash necessary to maintain FinCo’s dividend, which is anticipated to be approximately 30 percent of First American’s current dividend, will be generated solely by FinCo’s operations. Many of FinCo’s subsidiaries are subject to regulatory capital requirements and restrictions on the amounts that can be distributed to their parent company. The absence of cash distributions from the information solutions businesses, in combination with regulatory restrictions on distributions from FinCo’s subsidiaries, could affect FinCo’s ability to maintain the dividend that is currently anticipated.

 

   

First American historically has managed the cash and working capital needs of the financial services businesses as part of its company-wide cash management practices. Following the completion of the separation, FinCo will be required to independently manage and finance its cash and working capital needs. Without the ability to obtain funds from the information solutions businesses, we may need to obtain additional financing from banks, through public offerings or private placements of debt or equity securities or other arrangements. These methods of financing may be more expensive or difficult to obtain as an independent company than they would if we remained part of First American.

 

   

Other significant changes may occur in FinCo’s cost structure, management, financing and business operations as a result of operating independently from First American.

The separation transaction could give rise to liabilities, increased competition or other unfavorable effects that may not have otherwise arisen

The separation transaction may lead to increased operating and other expenses, both of a non-recurring and a recurring nature, and changes to certain operations, which expenses or changes could arise pursuant to arrangements made with InfoCo or the triggering of rights and obligations to third parties. In addition, InfoCo

 

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may provide more competition in FinCo’s lines of business than it would have if the companies remained together. While the extent of future competition between InfoCo and FinCo is unknown, both parties will own significant real property databases. With the exception of the noncompetition agreement in the tax servicing business described under “Relationship with InfoCo—Noncompetition Agreement,” there will be no prohibition on either InfoCo or FinCo competing with the other party. Litigation with InfoCo or other third parties could also arise out of the transaction, and FinCo could experience unfavorable reactions to the separation from customers, employees, ratings agencies or other interested parties.

FinCo will be responsible for a portion of First American’s contingent and other corporate liabilities, primarily those relating to stockholder litigation

Under the Separation and Distribution Agreement and other agreements, subject to certain exceptions contained in the Tax Sharing Agreement, each of FinCo and InfoCo will agree to assume and be responsible for 50 percent of certain of First American’s contingent and other corporate liabilities. All external costs and expenses associated with the management of these contingent and other corporate liabilities will be shared equally. These contingent and other corporate liabilities primarily relate to consolidated securities litigation and any actions with respect to the separation plan or the distribution brought by any third party. Contingent and other corporate liabilities that are specifically related to only the information solutions or financial services business will generally be fully allocated to InfoCo or FinCo, respectively.

If any party responsible for such liabilities were to default on its payment of any of these assumed obligations, the non-defaulting party may be required to pay the amounts in default. Accordingly, under certain circumstances, FinCo may be obligated to pay amounts in excess of the agreed-upon share of the assumed obligations related to such contingent and other corporate liabilities, including associated costs and expenses.

FinCo will share responsibility for certain of its and InfoCo’s income tax liabilities for tax periods prior to and including the distribution date

Under the Tax Sharing Agreement, FinCo is generally responsible for all taxes that are attributable to members of the FinCo group of companies or the assets, liabilities or businesses of the FinCo group of companies and InfoCo is generally responsible for all taxes attributable to members of the InfoCo group of companies or the assets, liabilities or businesses of the InfoCo group of companies. Generally, any liabilities arising from adjustments to prior year (or partial year with respect to 2010) consolidated tax returns will be shared in proportion to each company’s percentage of the tax liability for the relevant year (or partial year with respect to 2010), unless the adjustment is attributable to either party, in which case the adjustment will generally be for the account of such party. In addition to this potential liability associated with adjustments for prior periods, if InfoCo were to fail to pay any tax liability it is required to pay under the Tax Sharing Agreement, FinCo could be legally liable under applicable tax law for such liabilities and required to make additional tax payments. Accordingly, under certain circumstances, FinCo may be obligated to pay amounts in excess of its agreed-upon share of tax liabilities.

First American’s income tax returns have been, and FinCo’s income tax returns will be examined periodically by various tax authorities. In connection with such examinations, tax authorities, including the U.S. Internal Revenue Service, have in the past raised issues and proposed tax adjustments. First American is currently contesting approximately $1.2 million in proposed tax adjustments. Amounts related to these tax adjustments and other tax contingencies that have been assessed as more likely than not to occur and are estimable have been recorded through First American’s income tax provision, equity or goodwill, as appropriate. The calculation of tax liabilities involves dealing with the uncertainties in the application of complex tax regulations in a multitude of jurisdictions across our global operations. We recognize potential liabilities and record tax liabilities for anticipated tax audit issues in the United States and other tax jurisdictions based on our

 

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estimate of whether, and the extent to which, additional income taxes will be due. We adjust these liabilities in light of changing facts and circumstances; however, due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from our current estimate of tax liabilities.

The ownership by FinCo’s executive officers and directors of equity interests of InfoCo may create, or may create the appearance of, conflicts of interest

Because of their current or former positions with First American, substantially all of FinCo’s executive officers, including our executive chairman and our chief executive officer, and most of our director nominees, beneficially own common shares of First American and, accordingly, will beneficially own common shares of InfoCo after the distribution. Our executive chairman, who will also serve as InfoCo’s executive chairman, will additionally continue to own options to purchase common shares of InfoCo and InfoCo restricted stock units. These equity interests may create, or appear to create, conflicts of interest when these individuals are faced with decisions that could benefit or affect the equity holders of InfoCo in ways that do not benefit or affect FinCo in the same manner.

If the distribution or certain internal transactions undertaken in anticipation of the separation are determined to be taxable for U.S. federal income tax purposes, FinCo, its stockholders that are subject to U.S. federal income tax and InfoCo will incur significant U.S. federal income tax liabilities

First American expects to receive a private letter ruling from the Internal Revenue Service regarding the U.S. federal income tax consequences of the distribution of FinCo’s common stock to the First American shareholders substantially to the effect that the distribution, except for cash received in lieu of a fractional share, will qualify as tax-free under Sections 368(a)(1)(D) and 355 of the Code. The private letter ruling also is expected to provide that certain internal transactions undertaken in anticipation of the separation will qualify for favorable treatment under the Code. In addition to obtaining the private letter ruling, First American expects to obtain an opinion from Deloitte & Touche LLP confirming the tax-free status of the distribution and certain internal transactions. The private letter ruling and the opinion rely or will rely on certain facts and assumptions, and certain representations and undertakings, from us or First American regarding the past and future conduct of First American’s respective businesses and other matters. Notwithstanding the private letter ruling and the opinion, the Internal Revenue Service could determine on audit that the distribution or the internal transactions should be treated as taxable transactions if it determines that any of these facts, assumptions, representations or undertakings is not correct or has been violated, or that the distribution should be taxable for other reasons, including as a result of significant changes in stock or asset ownership after the distribution. If the distribution ultimately is determined to be taxable, the distribution could be treated as a taxable dividend or capital gain to you for U.S. federal income tax purposes, and you could incur significant U.S. federal income tax liabilities. In addition, InfoCo would recognize gain in an amount equal to the excess of the fair market value of FinCo’s common stock distributed to First American shareholders on the distribution date over First American’s tax basis in such common stock.

In addition, under the terms of the Tax Sharing Agreement, in the event the distribution were determined to be taxable and such determination was the result of actions taken after the distribution by FinCo or InfoCo, the party responsible for such failure would be responsible for all taxes imposed on FinCo or InfoCo as a result thereof. If such determination is not the result of actions taken after the distribution by FinCo or InfoCo, then FinCo and InfoCo would each be responsible for 50 percent of any taxes imposed as a result of such determination. Such tax amounts, if imposed, would be significant.

As an independent, publicly traded company, FinCo may not enjoy the same benefits that it did as a part of First American

There is a risk that, by separating from First American, FinCo may become more susceptible to market fluctuations and other adverse events than it would have been were it still a part of the current First American organizational structure. As part of First American, the financial services businesses have been able to enjoy

 

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certain benefits from First American’s operating diversity, purchasing power, available capital for investments, flexibility in tax planning and opportunities to pursue integrated strategies with First American’s other businesses. As an independent, publicly traded company, FinCo will not have similar diversity or integration opportunities and may not have similar purchasing power, flexibility in tax planning or access to capital markets.

FinCo may desire to satisfy its cash requirements with the proceeds from the sale of InfoCo shares which may be illiquid or decrease in value

In connection with the separation, First American will issue to FinCo and our principal title insurance subsidiary a number of shares that will result collectively in FinCo and such subsidiary owning approximately $250 million of InfoCo’s issued and outstanding common shares following the distribution. We will agree to dispose of these shares within five years after the separation or to bear any adverse tax consequences arising out of holding the shares for longer than that period, as further discussed under “Relationship with InfoCo—Tax Sharing Agreement.” FinCo may desire to liquidate this stock to fulfill its cash requirements at a time where there may be a limited market for InfoCo shares or the shares may have declined in value, which could adversely impact FinCo’s ability to meet its cash requirements.

FinCo might not be able to engage in desirable strategic transactions and equity issuances following the separation because of restrictions relating to U.S. federal income tax requirements for tax-free distributions

FinCo’s and InfoCo’s ability to engage in significant equity transactions could be limited or restricted after the distribution in order to preserve for U.S. federal income tax purposes the tax-free nature of the distribution by First American. Even if the distribution otherwise qualifies for tax-free treatment under Sections 368(a)(1)(D) and 355 of the Code, it may result in corporate level taxable gain to InfoCo under Section 355(e) of the Code if 50 percent or more, by vote or value, of InfoCo’s or FinCo’s common stock are acquired or issued as part of a plan or series of related transactions that includes the distribution. For this purpose, any acquisitions or issuances of First American’s common shares within two years before the distribution, and any acquisitions or issuances of InfoCo’s or FinCo’s common stock within two years after the distribution, generally are presumed to be part of such a plan, although FinCo or InfoCo may be able to rebut that presumption. Prior to the distribution, First American will issue to FinCo and our principal title insurance subsidiary a number of shares that will result collectively in FinCo and such subsidiary owning approximately $250 million of InfoCo’s issued and outstanding common shares following the distribution. We expect the amount of shares issued to represent approximately [] percent of First American’s shares outstanding at the time of the issuance. In addition, in November 2009 First American issued approximately 9.5 million common shares in connection with its acquisition of the minority interest shares of its then publicly traded subsidiary, First Advantage Corporation. This represented approximately 9 percent of First American’s shares currently outstanding. Both of these issuances could count towards the 50 percent limitation, which could hinder FinCo’s ability to issue additional shares during the two year period following the distribution. If an acquisition or issuance of InfoCo’s or FinCo’s common stock triggers the application of Section 355(e) of the Code, InfoCo would recognize taxable gain for which FinCo could be wholly or partially liable as described above.

Under the Tax Sharing Agreement, there are restrictions on FinCo’s and InfoCo’s ability to take actions that could cause the distribution to fail to qualify as a tax-free transaction, including a redemption of equity securities, a sale or other disposition of a substantial portion of assets, an acquisition of a business or assets with equity securities. These restrictions will apply for 25 months following the distribution, unless the party seeking to engage in such activity obtains the consent of the other party or obtains a private letter ruling from the Internal Revenue Service or an unqualified opinion of a nationally recognized firm that such action will not cause the distribution to fail to qualify as a tax-free transaction, and such letter ruling or opinion, as the case may be, is acceptable to each party.

Moreover, the Tax Sharing Agreement generally provides that each party thereto is responsible for any taxes imposed on the other party as a result of the failure of the distribution to qualify as a tax-free transaction under the Code if such failure is attributable to post-distribution actions taken by or in respect of the responsible party

 

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or its stockholders, regardless of when the actions occur after the distribution, the other party consents to such actions or such party obtains a favorable letter ruling or opinion of tax counsel as described above. For example, FinCo would be responsible for a third party’s acquisition of it at a time and in a manner that would cause such failure. These restrictions may prevent it from entering into transactions which might be advantageous to its stockholders.

Risks Relating to FinCo’s Common Stock

There is no existing market for FinCo common stock and a trading market that will provide you with adequate liquidity may not develop. In addition, once FinCo common stock begins trading, the market price of shares of FinCo common stock may fluctuate widely

There currently is no public market for our common stock. We anticipate that, on or prior to the record date for the distribution, trading of shares of our common stock will begin on a “when-issued” basis and will continue through the distribution date. We cannot assure you that an active trading market for shares of our common stock will develop as a result of the distribution or be sustained in the future.

We cannot predict the prices at which shares of our common stock may trade after the distribution. The market price of our common stock may fluctuate widely, depending upon many factors, including:

 

   

our business profile and market capitalization may not fit the investment objectives of certain First American shareholders;

 

   

a shift in our investor base;

 

   

our quarterly or annual earnings;

 

   

actual or anticipated fluctuations in our operating results;

 

   

changes in accounting standards, policies, guidance, interpretations or principles;

 

   

announcements by us or our competitors of significant acquisitions or dispositions;

 

   

the failure of securities analysts to cover our common stock after the distribution;

 

   

changes in earnings estimates by securities analysts or our ability to meet those estimates;

 

   

the operating and stock price performance of other comparable companies; and

 

   

overall market fluctuations and general economic conditions.

Substantial sales of shares of our common stock may occur in connection with the distribution, which could cause our stock price to decline

The shares of FinCo common stock that First American distributes to its stockholders generally may be sold immediately in the public market. We expect that some First American shareholders, including possibly some of its larger shareholders, will sell the shares of our common stock received in the distribution because, among other reasons, our business profile or market capitalization as an independent, publicly traded company does not fit their investment objectives. Moreover, index funds tied to the Standard & Poor’s 500 Index and other indices hold First American common shares. Unless we are included in these indices from the date of the distribution, these index funds will be required to sell shares of our common stock that they receive in the distribution. The sales of significant amounts of our common stock or the perception in the market that these sales will occur could adversely affect the market price of shares of our common stock.

Your percentage ownership of our common stock may be diluted in the future

Your percentage ownership of our common stock may be diluted in the future because of subsequent share issuances, including issuances pursuant to equity awards that we expect will be granted to our directors, officers

 

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and employees and the accelerated vesting of other equity awards. Prior to the record date for the distribution, we expect that First American will approve the First American Financial Corporation 2010 Incentive Compensation Plan, which will provide for the grant of equity-based awards, including restricted stock, restricted stock units, stock options, share appreciation rights and other equity-based awards to our directors, officers and other employees.

We cannot assure you that we will pay any dividends

Due to extraordinary cash expenses, actual expenses exceeding contemplated costs, funding of capital expenditures or increases in reserves, among other reasons, we cannot assure you that we will have sufficient surplus under Delaware law to be able to pay any dividends. As a holding company, we will depend on distributions from our subsidiaries, and if distributions from our subsidiaries are materially impaired, our 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 our insurance subsidiaries. If we do not pay dividends, the price of our common stock that you receive in the distribution must appreciate for you to receive a gain on your investment in our common stock. This appreciation may not occur.

 

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SPECIAL NOTE ABOUT FORWARD-LOOKING STATEMENTS

CERTAIN STATEMENTS IN THIS INFORMATION STATEMENT OR IN OUR OTHER FILINGS OR IN ORAL PRESENTATIONS OR OTHER STATEMENTS MADE BY OUR MANAGEMENT THAT ARE NOT PURELY HISTORICAL, INCLUDING BUT NOT LIMITED TO THOSE RELATING TO:

 

   

THE DISTRIBUTION OF ALL OF THE COMMON STOCK OF FINCO TO THE SHAREHOLDERS OF FIRST AMERICAN, THE FORM, TIMING AND TAX-FREE NATURE THEREOF, THE RATIO THEREFOR, THE LISTING OF SHARES IN CONNECTION THEREWITH AND THE TRADING MARKETS AND MARKET PRICES FOR FINCO AND INFOCO SHARES;

 

   

THE RESPECTIVE BUSINESSES OF FINCO AND INFOCO FOLLOWING THE SEPARATION;

 

   

THE EFFECT OF THE SEPARATION ON SHAREHOLDER VALUE AND INVESTOR UNDERSTANDING OF OUR BUSINESSES;

 

   

THE ISSUANCE OF FIRST AMERICAN SHARES TO FINCO PRIOR TO THE SEPARATION AND FINCO’S OWNERSHIP OF INFOCO SHARES FOLLOWING THE SEPARATION;

 

   

FINCO’S FINANCIAL STRENGTH AT THE TIME OF THE DISTRIBUTION AND THE OPINION EXPECTED TO BE OBTAINED REGARDING THE SOLVENCY AND CAPITALIZATION OF INFOCO FOLLOWING THE SEPARATION;

 

   

FINCO’S ABILITY TO MITIGATE THE EFFECTS OF NEGATIVE ECONOMIC TRENDS THROUGH DIVERSIFIED GEOGRAPHIES, PRODUCTS AND DISTRIBUTION CHANNELS;

 

   

THE EFFECT OF THE LOYALTY OF FINCO’S CUSTOMERS;

 

   

THE EXECUTION AND EFFECT OF SIMPLIFICATION, STANDARDIZATION, CENTRALIZATION AND OFF-SHORE EFFORTS AND INITIATIVES;

 

   

FINCO’S CONTINUED CENTRALIZATION OF CAPITAL MANAGEMENT, CLAIMS HANDLING, TECHNOLOGY INITIATIVES, AGENCY ADMINISTRATION AND CORPORATE SERVICES; INTEGRATION OF ON-SHORE AND OFF-SHORE RESOURCES THROUGH TECHNOLOGY; AND SIMPLIFICATION AND STANDARDIZATION OF PROCESSES AND FUNCTIONS THROUGH THE UTILIZATION OF GLOBAL RESOURCES AND THE EFFECTS THEREOF;

 

   

THE STRENGTHENING OF FINCO’S RELATIONSHIPS WITH NEW AND EXISTING CUSTOMERS;

 

   

FINCO’S MAINTENANCE OF FLEXIBILITY NECESSARY TO REACT QUICKLY TO MARKET DOWNTURNS AND A DISCIPLINED APPROACH AS MARKET CONDITIONS IMPROVE;

 

   

FINCO’S FOCUS ON OBTAINING GROWTH THROUGH SPECIALIZED DISTRIBUTION CHANNELS;

 

   

FINCO’S APPROACH TO INTERNATIONAL EXPANSION;

 

   

FINCO’S NEW SENIOR CREDIT FACILITY, THE BORROWING CAPACITY, TERMS THEREOF AND DRAWS TO BE MADE THEREUNDER IN CONNECTION WITH THE SEPARATION, AND THE ALLOCATION AND REPAYMENT OF DEBT BETWEEN FINCO AND INFOCO;

 

   

THE TAX EFFECTS OF THE DISTRIBUTION AND THE INTERNAL REVENUE SERVICE PRIVATE LETTER RULING AND OPINION OF DELOITTE & TOUCHE EXPECTED TO BE RECEIVED BY FINCO RELATING THERETO;

 

   

THE AGREEMENTS TO BE ENTERED INTO BETWEEN FINCO AND INFOCO IN CONNECTION WITH THE SEPARATION, THE TERMS THEREOF AND EXPECTED COSTS THEREUNDER, AS WELL AS THE ENTRY INTO CERTAIN ORDINARY COURSE COMMERCIAL AGREEMENTS BETWEEN FINCO AND INFOCO AND CHANGES TO RESULTS OF OPERATIONS RESULTING THEREFROM;

 

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FUTURE PAYMENT OF DIVIDENDS AND THE AMOUNTS THEREOF;

 

   

PAYMENT OF COSTS IN CONNECTION WITH THE SEPARATION AND THE ALLOCATION THEREOF;

 

   

THE ANTICIPATED OPPORTUNITIES AND BENEFITS OF FINCO AND INFOCO AS SEPARATE COMPANIES;

 

   

ANTICIPATED COSTS AND EXPENSES OF FINCO RELATED TO BEING AN INDEPENDENT PUBLICLY TRADED COMPANY FOLLOWING THE SEPARATION;

 

   

THE ALLOCATION OF CERTAIN ASSETS AND LIABILITIES AND THE EFFECT THEREOF;

 

   

CONDITIONS TO THE SEPARATION AND THE SATISFACTION THEREOF;

 

   

THE EFFECT OF THE ISSUES FACING FINCO’S CUSTOMERS;

 

   

THE IMPACT OF CONTINUED WEAKNESS IN THE REAL ESTATE AND MORTGAGE MARKETS ON FINCO’S BUSINESS;

 

   

FINCO’S CONTINUED EFFORTS TO CONTROL COSTS, SCRUTINIZE THE PROFITABILITY OF ITS AGENCY RELATIONSHIPS, INCREASE ITS OFFSHORE LEVERAGE AND DEVELOP NEW SALES OPPORTUNITIES;

 

   

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

 

   

EXPECTED FUTURE CASH FLOWS FOR DEBT SECURITIES AND THE ASSUMPTIONS RELATED THERETO;

 

   

THE EFFECT OF PENDING AND RECENT ACCOUNTING PRONOUNCEMENTS ON FINCO’S FINANCIAL STATEMENTS;

 

   

POTENTIAL FOR VOLATILITY IN THE CURRENT ECONOMIC ENVIRONMENT AND ITS EFFECT ON TITLE CLAIMS, THE VARIANCE BETWEEN ACTUAL CLAIMS EXPERIENCE AND PROJECTIONS AND THE NEED TO ADJUST RESERVES BASED ON UPDATED ESTIMATES OF FUTURE CLAIMS;

 

   

EXPECTED LOSS RATIOS FOR VARIOUS POLICY YEARS AND THE LIKELIHOOD OF CHANGES TO LOSS RATES FOR RECENT POLICY YEARS, THE EFFECT OF INCREASED MORTGAGE LOAN UNDERWRITING STANDARDS AND LOWER RESIDENTIAL REAL ESTATE PRICES ON CLAIMS RISK FOR TITLE INSURANCE POLICIES ISSUED IN LATE 2007, 2008 AND CURRENTLY AND THE EXPECTATION THAT CERTAIN TEMPORARY ECONOMIC CONDITIONS WILL NOT PERSIST THROUGHOUT THE DEVELOPMENT LIFETIME OF RECENT POLICY YEARS;

 

   

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;

 

   

THE TIMING OF CLAIM PAYMENTS;

 

   

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

 

   

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

 

   

THE IMPACT OF UNCERTAINTY IN THE REAL ESTATE AND MORTGAGE MARKETS ON FINCO’S LINES OF BUSINESS;

 

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FUTURE COMMERCIAL TITLE INSURANCE PROFIT MARGINS;

 

   

FINCO’S CONTINUED PRACTICE OF ASSUMING AND CEDING LARGE TITLE INSURANCE RISKS THROUGH REINSURANCE AND COINSURANCE;

 

   

FINCO’S ANTICIPATED INVESTMENT POLICIES;

 

   

FINCO’S EXECUTIVE OFFICES, OWNERSHIP THEREOF, LEASE OF A PORTION THEREOF TO INFOCO AND THE OUTSTANDING LOAN SECURED THEREBY;

 

   

THE EFFECT OF LAWSUITS, REGULATORY AUDITS AND INVESTIGATIONS AND OTHER LEGAL PROCEEDINGS ON FINCO’S FINANCIAL CONDITION, RESULTS OF OPERATIONS AND CASH FLOWS, AND THE ADEQUACY OF RESERVES THEREFOR;

 

   

ANTICIPATED DIRECTORS, EXECUTIVE OFFICERS, BOARD OF DIRECTORS STRUCTURE AND COMMITTEES FOLLOWING THE DISTRIBUTION;

 

   

COMPENSATION OF FINCO DIRECTORS AND EXECUTIVE OFFICERS, POTENTIAL DETERMINATIONS, PERSPECTIVES AND PHILOSOPHIES OF THE FINCO COMPENSATION COMMITTEE RELATING THERETO AND THE POST-SEPARATION TREATMENT OF FIRST AMERICAN’S EQUITY-BASED AWARDS;

 

   

FINCO’S FUTURE POLICY REGARDING RELATED PARTY TRANSACTIONS;

 

   

PROVISIONS OF THE AMENDED AND RESTATED CERTIFICATE OF INCORPORATION AND BYLAWS OF FINCO AND THE EFFECT THEREOF ON TAKEOVER AND CHANGE IN CONTROL ATTEMPTS, SOLICITATION OF PROXIES AND ACTIONS BY STOCKHOLDERS;

 

   

CLASSES AND NUMBER OF SHARES OF STOCK TO BE AUTHORIZED AND ISSUED BY FINCO, THE RIGHTS AND PRIVILEGES RELATING THERETO AND THE TRANSFERABILITY THEREOF;

 

   

FINCO’S TRANSFER AGENT;

 

   

PERIODIC REPORTS TO BE FILED BY FINCO WITH THE SECURITIES AND EXCHANGE COMMISSION;

 

   

POTENTIAL FUTURE IMPAIRMENT CHARGES RESULTING FROM VOLATILITY IN THE CURRENT MARKETS OR OTHER FUTURE EVENTS, INFORMATION AND THE PASSAGE OF TIME AND FINCO’S ASSESSMENT THAT THE FINANCIAL SERVICES SECTOR WILL RETURN TO A MORE NORMAL OPERATING ENVIRONMENT; AND

 

   

ESTIMATED NET LOSS AND PRIOR SERVICE CREDIT AND CASH CONTRIBUTIONS RELATING TO PENSION PLANS;

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:

 

   

CHANGES IN THE PERFORMANCE OF THE REAL ESTATE MARKETS;

 

   

INTEREST RATE FLUCTUATIONS;

 

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UNFAVORABLE ECONOMIC CONDITIONS;

 

   

GENERAL VOLATILITY IN THE CAPITAL MARKETS;

 

   

IMPAIRMENTS IN FINCO’S GOODWILL OR OTHER INTANGIBLE ASSETS;

 

   

DETERIORATIONS IN MEASURES OF FINCO’S FINANCIAL STRENGTH;

 

   

CHANGES IN APPLICABLE GOVERNMENT REGULATIONS;

 

   

HEIGHTENED SCRUTINY BY LEGISLATORS AND REGULATORS OF FINCO’S BUSINESSES;

 

   

THE INABILITY TO CONSUMMATE THE SPIN-OFF TRANSACTION OR TO CONSUMMATE IT IN THE FORM ORIGINALLY PROPOSED AS A RESULT OF, AMONG OTHER FACTORS, THE INABILITY TO OBTAIN NECESSARY REGULATORY APPROVALS, THE FAILURE TO OBTAIN THE FINAL APPROVAL OF FIRST AMERICAN’S BOARD OF DIRECTORS, THE INABILITY TO OBTAIN THIRD PARTY CONSENTS OR UNDESIRABLE CONCESSIONS OR ACCOMMODATIONS REQUIRED TO BE MADE TO OBTAIN SUCH CONSENTS, THE LANDSCAPE OF THE REAL ESTATE AND MORTGAGE CREDIT MARKETS, MARKET CONDITIONS, THE INABILITY TO TRANSFER ASSETS INTO THE ENTITY BEING SPUN-OFF OR UNFAVORABLE REACTIONS FROM CUSTOMERS, RATINGS AGENCIES, INVESTORS OR OTHER INTERESTED PERSONS;

 

   

THE INABILITY TO REALIZE THE BENEFITS OF THE PROPOSED SPIN-OFF TRANSACTION AS A RESULT OF THE FACTORS DESCRIBED IMMEDIATELY ABOVE, AS WELL AS, AMONG OTHER FACTORS, INCREASED BORROWING COSTS, COMPETITION BETWEEN THE RESULTING COMPANIES, UNFAVORABLE REACTIONS FROM EMPLOYEES, THE INABILITY OF FINCO TO PAY THE ANTICIPATED LEVEL OF DIVIDENDS, THE TRIGGERING OF RIGHTS AND OBLIGATIONS BY THE TRANSACTION OR ANY LITIGATION ARISING OUT OF OR RELATED TO THE SEPARATION;

 

   

LIMITATIONS ON ACCESS TO PUBLIC RECORDS AND OTHER DATA;

 

   

REGULATION OF TITLE INSURANCE RATES;

 

   

LOSSES IN FINCO’S INVESTMENT PORTFOLIO;

 

   

EXPENSES AND FUNDING OBLIGATIONS TO FIRST AMERICAN’S PENSION PLAN;

 

   

WEAKNESS IN THE COMMERCIAL REAL ESTATE MARKET AND INCREASES IN THE AMOUNT OR SEVERITY OF COMMERCIAL REAL ESTATE TRANSACTION CLAIMS; AND

 

   

THOSE FACTORS DESCRIBED IN THE “RISK FACTORS,” SECTION AS WELL AS OTHER SECTIONS OF THIS INFORMATION STATEMENT.

THE FORWARD-LOOKING STATEMENTS SPEAK ONLY AS OF THE DATE THEY ARE MADE. WE DO 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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QUESTIONS AND ANSWERS ABOUT THE SEPARATION

 

How will the separation of FinCo work?

The separation will be accomplished through a series of transactions in which the equity interests of the entities that hold all of the assets and liabilities of First American’s financial services businesses (meaning the businesses for which pro forma financial information is provided herein) will be transferred to FinCo and the shares of FinCo common stock will be distributed by First American to its stockholders on a pro rata basis.

 

Why is the separation of FinCo structured as a distribution?

First American believes that a distribution of FinCo shares to its shareholders is a tax-efficient way to separate the businesses.

 

When will the distribution occur?

We expect that First American will distribute the shares of FinCo common stock on [], 2010, to holders of record of First American common shares on [], 2010, the record date.

 

What do stockholders need to do to participate in the distribution?

You do not need to do anything to participate in the distribution, but we urge you to read this entire document carefully. Stockholders who hold First American common shares as of the record date will not be required to take any action to receive FinCo common stock in the distribution. No stockholder approval of the distribution is required or sought. We are not asking you for a proxy. You will not be required to make any payment or surrender or exchange your First American common shares to receive your FinCo common stock.

 

Can First American decide to cancel the distribution of the FinCo common stock even if all the conditions have been met?

Yes. The distribution is subject to the satisfaction or waiver of certain conditions. See “The Separation—Conditions to the Distribution.” First American has the right to terminate the distribution, even if all of the conditions are satisfied, if at any time the board of directors of First American determines that the distribution is not in the best interests of First American and its shareholders or that market conditions are such that it is not advisable to proceed with the separation.

 

Does FinCo plan to pay dividends?

Yes. Following the distribution, we expect that initially FinCo will pay approximately $24 million per year in dividends to holders of its common stock. The timing, declaration and payment of future dividends, however, falls within the discretion of FinCo’s board of directors and will depend upon many factors, including restrictions contained in FinCo’s credit facility, the statutory requirements of Delaware law, FinCo’s financial condition and earnings, the capital requirements of FinCo’s businesses, industry practice and any other factors the board of directors deems relevant from time to time. As a holding company, FinCo will depend on distributions from its subsidiaries, and if distributions from its subsidiaries are materially

 

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impaired, its ability to declare and pay dividends may be adversely affected; in addition, insurance and other regulations will limit the amount of dividends, loans and advances available from its insurance subsidiaries.

 

Will FinCo have any debt?

Yes. In connection with the separation, we expect to enter into a new senior secured credit facility with available borrowing capacity of approximately $400 million, of which $200 million is expected to be drawn and transferred to InfoCo in connection with the separation. We will also continue to be responsible for the outstanding loan that is secured by a portion of our main offices in Santa Ana, California with a balance of $43.9 million as of December 31, 2009. For additional information relating to our current and planned financing arrangements, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources,” “Unaudited Pro Forma Condensed Combined Financial Statements” and “Description of Material Indebtedness.”

 

Will FinCo own any of InfoCo after the separation?

Yes. First American will issue to FinCo and our principal title insurance subsidiary a number of shares that will result collectively in FinCo and such subsidiary owning approximately $250 million of InfoCo’s issued and outstanding common shares following the distribution. We expect to dispose of these shares within five years following the separation.

 

Who will pay the separation costs?

First American will pay the costs of separation incurred prior to the separation, consisting largely of tax restructuring, debt refinancing, professional services and employee-related costs. Costs relating to the separation incurred after the distribution generally will be borne by the party incurring such costs. In addition, we also will incur costs as we implement organizational changes necessary for us to operate as an independent, publicly traded company.

 

What are the U.S. federal income tax consequences of the distribution to First American shareholders that are subject to U.S. federal income tax?

First American expects to receive a private letter ruling from the Internal Revenue Service substantially to the effect that the distribution will qualify as a tax-free transaction for U.S. federal income tax purposes under Sections 368(a)(1)(D) and 355 of the Code. In addition to obtaining the IRS Ruling, First American expects to obtain an opinion from Deloitte & Touche LLP regarding certain aspects of the transaction that are not covered by the IRS Ruling. Assuming that the distribution qualifies as a tax-free transaction for U.S. federal income tax purposes under Sections 368(a)(1)(D) and 355 of the Code, no gain or loss will be recognized by a stockholder that is subject to U.S. federal income tax, and no amount will be included in the income of a stockholder that is subject to U.S. federal income tax upon the receipt of our common stock pursuant to the distribution, except with respect to any cash received in lieu of a

 

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fractional share of FinCo stock. See “Risk Factors—Risks Relating to Separating from First American—If the distribution or certain internal transactions undertaken in anticipation of the separation are determined to be taxable for U.S. federal income tax purposes, FinCo, its stockholders that are subject to U.S. federal income tax and InfoCo will incur significant U.S. federal income tax liabilities” and “The Separation—Certain U.S. Federal Income Tax Consequences of the Distribution.”

Each stockholder is urged to consult his, her or its tax advisor as to the specific tax consequences of the distribution to that stockholder, including the effect of any state, local or non-U.S. tax laws and of changes in applicable tax laws.

 

What will be the relationships between InfoCo and FinCo following the separation?

Before the separation, we will enter into a Separation and Distribution Agreement, a Tax Sharing Agreement and other agreements with First American to effect the separation and provide a framework for our relationship with InfoCo after the separation. These agreements will govern the relationships between InfoCo and FinCo subsequent to the completion of the separation plan and will provide for the allocation to us of certain of First American’s assets, liabilities and obligations. The Separation and Distribution Agreement requires us to assume or retain the liabilities of First American primarily related to our business and, with the exception of certain tax liabilities, 50 percent of certain contingent and other corporate liabilities of First American, and establishes the amount of indebtedness that each separated company initially will incur and retain. The Tax Sharing Agreement generally provides that, with respect to any consolidated tax return that includes the members of the FinCo group and the InfoCo group, (a) FinCo is generally responsible for all taxes that are attributable to members of the FinCo group of companies or the assets, liabilities or businesses of the FinCo group of companies (including any such liabilities arising from adjustments to prior year or partial year with respect to 2010) and (b) InfoCo is generally responsible for all taxes attributable to members of the InfoCo group of companies or the assets, liabilities or businesses of the InfoCo group of companies (including any such liabilities arising from adjustments to prior year or partial year with respect to 2010). If the distribution itself, or certain preparatory internal transactions in connection therewith become taxable other than due to an action or omission of either party, FinCo and InfoCo will share the tax liability evenly. See “Relationship with InfoCo.” The companies also are or will be parties to certain ordinary course commercial agreements.

 

Will I receive physical certificates representing FinCo common stock following the separation?

No. Following the separation, FinCo will not be issuing physical certificates representing common stock. Instead, First American will electronically issue FinCo common stock to you or to your bank or brokerage firm on your behalf by way of direct registration in book-

 

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entry form. A benefit of issuing shares electronically in book-entry form is that there will be none of the physical handling and safekeeping responsibilities that are inherent in owning physical share certificates.

 

What if I want to sell my InfoCo common shares or my FinCo common stock?

You should consult with your financial advisors, such as your stockbroker, bank or tax advisor. Neither InfoCo nor FinCo makes any recommendations on the purchase, retention or sale of InfoCo or FinCo common stock.

Beginning on or shortly before the record date and continuing through the distribution date, there will be two markets in First American common shares: a “regular-way” market and an “ex-distribution” market. First American common shares that trade on the regular-way market will trade with an entitlement to FinCo common stock to be distributed pursuant to the distribution. Shares that trade on the ex-distribution market prior to the distribution will trade without an entitlement to receive FinCo common stock upon the distribution. This ex-distribution market essentially will be a market for InfoCo shares. If you decide to sell any shares before the distribution, you should make sure your stockbroker, bank or other nominee understands whether you want to sell your First American common shares (along with the right to receive FinCo common stock in the distribution) or sell solely the FinCo common stock you will receive in the distribution. If you sell First American common shares in the “regular-way” market up to and including the distribution date, you will be selling your right to receive FinCo common stock in the distribution.

 

Where will I be able to trade FinCo common stock?

There currently is no public market for our common stock. We expect to adopt First American’s stock symbol after the distribution and have our common stock listed on the NYSE under the symbol “FAF.” We anticipate that trading in our common stock will begin on a “when-issued” basis shortly before the record date and will continue through the distribution date, and that “regular-way” trading in our common stock will begin on the first trading day following the distribution date. If trading begins on a “when-issued” basis, you may be able to purchase or sell FinCo common stock up to and including the distribution date, but your transaction will not settle until after the distribution date. We cannot predict the trading prices for our common stock before, on or after the distribution date.

 

Will the number of First American shares I own change as a result of the distribution?

No.

 

What will happen to the listing of First American’s common shares?

We expect that in connection with the distribution, the symbol under which First American’s common stock is listed on the NYSE will change from “FAF” to “[].”

 

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Will the distribution of the common stock of FinCo affect the market price of my First American shares?

Yes. As a result of the distribution, we expect the trading price of First American common shares immediately following the distribution (which will effectively become InfoCo common shares at that time) to be lower than immediately prior to the distribution because the trading price will no longer reflect the value of the financial services businesses. We also believe that, until market participants have fully analyzed the value of First American without the financial services business, the price of InfoCo common shares may fluctuate significantly. In addition, although First American believes that over time, following the separation, the common stock of the two independent, publicly traded companies should have a higher aggregate market value, on a fully distributed basis and assuming the same market conditions, than if First American were to remain under its current configuration, it is possible that the combined trading prices of the common stock of InfoCo and FinCo after the distribution may be less than the trading price of First American common shares before the distribution.

 

Are there risks to owning FinCo common stock?

Yes. Our business is subject to both general and specific risks relating to our business, our relationship with InfoCo and our becoming an independent, publicly traded company. Our business also is subject to risks relating to the separation. These and other risks are described in “Risk Factors.” We encourage you to read that section carefully.

 

Where can First American shareholders get more information?

Before or after the separation, if you have any questions relating to the separation, FinCo’s common stock or the distribution thereof, you should contact:

First American Investor Relations

1 First American Way

Santa Ana, California 92707

Telephone: (714) 250-5214

Facsimile: (714) 250-3304

www.firstam.com

For questions regarding InfoCo or its common stock following the distribution, you should contact:

The First American Corporation Investor Relations

4 First American Way

Santa Ana, California 92707

Telephone: (714) 250-3504

Facsimile: (714) 250-6293

[website]

 

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THE SEPARATION

General

On January 15, 2008, First American announced that its board of directors had approved a plan to separate First American into two independent, publicly traded companies: one comprised of First American’s financial services businesses, which we refer to as FinCo, and one comprised of its information solutions businesses, which we refer to as InfoCo. First American intends to accomplish this separation through the distribution to its shareholders of all shares of FinCo common stock. FinCo will adopt First American’s stock symbol after the separation and have our common stock listed on the NYSE under the symbol “FAF.” Following the distribution InfoCo will change its name to [] and also change the symbol under which its common stock is listed on the New York Stock Exchange from “FAF” to “[].”

First American’s board of directors and its senior leadership, in consultation with financial and legal advisors, evaluated a broad range of strategic alternatives to the proposed separation, including the continuation of its current operating strategy. The management of First American and its board of directors concluded that separating into two independent, publicly traded companies would be the best way to organize the companies to meet their long-term goals.

In connection with the separation, the First American board of directors considered, among other things, the benefits to the businesses and First American shareholders that are expected to result from the separation, the capital allocation strategies and dividend policies for both companies, the allocation of First American’s existing assets, liabilities and businesses between the companies, the terms of certain commercial relationships between the companies that will exist following the separation, the corporate governance arrangements that will be in place at both companies and the members of senior management at both companies.

The distribution of the shares of FinCo common stock is being made in furtherance of the separation plan. On [], the distribution date, each First American shareholder will receive [] shares of FinCo common stock for each common share of First American held at the close of business on the record date for the distribution, and First American will cease to own any shares of FinCo common stock. Immediately following the distribution, First American shareholders will own 100 percent of the outstanding common stock of FinCo and InfoCo. You will not be required to make any payment or surrender or exchange your First American common shares to receive your shares of FinCo common stock.

The distribution of our common stock as described in this information statement is subject to the satisfaction or waiver of certain conditions. For a more detailed description of these conditions, see “Conditions to the Distribution.”

Reasons for the Separation

First American’s board of directors regularly reviews the businesses that First American operates to ensure that First American’s resources are utilized in a manner that is in the best interests of First American’s shareholders. First American’s board of directors has come to the conclusion that creating independent, focused companies for its financial services group and its information solutions group is the most effective way to manage First American’s businesses. The creation of independent companies enhances each group’s ability to focus on the objectives and strategic needs of its businesses. It also facilitates each group’s efforts to more closely align the interests of its employees with the interests of its stockholders by enabling the group to offer its employees incentive opportunities more directly linked to the performance of its businesses.

In addition, over the last several years, it became apparent to First American’s board of directors and senior management that the disparate nature of First American’s financial services and information businesses made it difficult for analysts and the market generally to understand First American. The board of directors and senior management believed that, consequently, the market undervalued the company. First American’s board of

 

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directors believes that separating the financial services and information businesses into two publicly traded companies will lead to enhanced investor understanding of its businesses, which should ultimately improve shareholder value.

First American believes that the separation will provide the separated companies with opportunities and benefits that would not be available to the companies on a combined basis. These opportunities and benefits, which the First American board of directors considered in approving the separation, include, among others, that:

 

   

Each company will be able to focus on its core business and growth opportunities, which will enhance each company’s ability to respond quickly and effectively to developments in the market in which it operates. In addition, after the separation, the businesses within each company will no longer need to compete internally for capital with affiliated businesses operating in industries with different capital requirements.

 

   

The management of each company will be able to design and implement strategies that focus on the business characteristics of that company and to concentrate its available financial resources wholly on its own operations.

 

   

The separation will provide investors with two investment options that may be more attractive to investors than the investment option of one combined company. Investors will have the opportunity to invest individually in each of the independent, publicly traded companies. Certain investors may want to invest in companies that are focused on only one of the company’s businesses and the demand for the independent, publicly traded companies by such investors may increase the demand for each company’s shares relative to the demand for First American’s shares. The separation is expected to reduce the complexity of the combined company and enhance current First American investors’ ability to diversify.

 

   

Each independent, publicly traded company will have a capital structure designed to meet its needs. As an independent, publicly traded company, FinCo’s capital structure is expected to generate customer confidence in its financial stability, to facilitate selective acquisitions, strategic alliances and partnerships, and to fund internal expansion, all of which are important for FinCo to remain competitive in our industry.

 

   

Although there can be no assurance, First American believes that, over time, following the separation, the common stock of the independent, publicly traded companies should have a higher aggregate market value, on a fully distributed basis and assuming the same market conditions, than if First American were not to complete the separation. Moreover, the separation should permit each independent, publicly traded company to effect acquisitions and raise capital, if necessary, in an optimal manner with less dilution of the existing stockholders’ interests.

 

   

The separation will permit the creation of equity securities, for each of the independent, publicly traded companies with a value that is expected to reflect more closely the performance of each company’s employees. Each company will be in a position to create equity compensation arrangements for employees that more closely align incentives to the performance of the company employing these individuals.

First American’s board of directors considered a number of risks and potentially negative factors in evaluating the separation, including the potential decreased capital available for investment, the loss of synergies (including duplicative corporate costs) from operating as one company, potential disruptions to the businesses as a result of the separation, the potential effect of the separation on the anticipated credit ratings of the separated companies, risks associated with refinancing First American’s debt, potential inability to achieve the benefits expected from the separation, the reaction of First American’s shareholders to the separation, the possibility that the plan of execution might not be completed and the one-time and ongoing costs of the separation. The board of directors concluded that the potential benefits of the separation outweighed these factors.

 

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In view of the wide variety of factors considered in connection with the evaluation of the separation and the complexity of these matters, the First American board of directors did not find it useful to, and did not attempt to, quantify, rank or otherwise assign relative weights to the factors considered.

First American’s board of directors expects to receive an opinion from Duff & Phelps regarding InfoCo’s solvency and adequacy of capital immediately after the separation.

The Number of Shares You Will Receive

For each share of First American common stock that you own at the close of business on [], the record date, you will receive [] shares of our common stock on the distribution date. First American will not distribute any fractional shares to you. Instead, an independent agent will aggregate fractional shares into whole shares, sell the whole shares in the open market at prevailing market prices and distribute the aggregate net cash proceeds of the sales pro rata, based on the fractional share such holder would otherwise be entitled to receive, to each holder who otherwise would have been entitled to receive a fractional share in the distribution. The distribution agent, in its sole discretion, without any influence by InfoCo or FinCo, will determine when, how, through which broker-dealer and at what price to sell the whole shares. Any broker-dealer used by the distribution agent will not be an affiliate of either InfoCo or FinCo.

The aggregate net cash proceeds of these sales pertaining to fractional shares generally will be taxable for U.S. federal income tax purposes. See “Certain U.S. Federal Income Tax Consequences of the Distribution” for an explanation of the tax consequences of the distribution. If you physically hold certificates for First American common shares and are the registered holder, you will receive a check from the distribution agent in an amount equal to your pro rata share of the aggregate net cash proceeds of the sales. We estimate that it will take approximately ten business days from the distribution date for the distribution agent to complete the distribution of the aggregate net cash proceeds. If you hold your First American common shares through a bank or brokerage firm, your bank or brokerage firm will receive, on your behalf, your pro rata share of the aggregate net cash proceeds of the sales and will electronically credit your account for your share of such proceeds.

When and How You Will Receive the Distribution

First American will distribute our common stock on [], 2010, the distribution date. Wells Fargo Shareowner Services will serve as transfer agent and registrar for our common stock.

If you own First American common shares as of the close of business on the record date, the FinCo common stock that you are entitled to receive in the distribution will be issued electronically, as of the distribution date, to you or to your bank or brokerage firm on your behalf by way of direct registration in book-entry form. Registration in book-entry form refers to a method of recording share ownership when no physical share certificates are issued to stockholders, as is the case in this distribution. If you sell common shares of First American in the “regular-way” market up to and including the distribution date, you will be selling your right to receive our common stock in the distribution.

Commencing on or shortly after the distribution date, if you hold physical share certificates that represent your common shares of First American and you are the registered holder of the First American shares represented by those certificates, the distribution agent will mail to you an account statement that indicates the number of our common stock that have been registered in book-entry form in your name.

Most First American shareholders hold their common shares of First American through a bank or brokerage firm. In such cases, the bank or brokerage firm would be said to hold the shares in “street name” and ownership would be recorded on the bank or brokerage firm’s books. If you hold your First American common shares through a bank or brokerage firm, your bank or brokerage firm will credit your account for the shares of FinCo common stock that you are entitled to receive in the distribution. If you have any questions concerning the mechanics of having shares held in “street name,” we encourage you to contact your bank or brokerage firm.

 

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Results of the Separation

After its separation from First American, FinCo will be an independent, publicly traded company. Immediately following the distribution, we expect to have approximately [] stockholders of record, based on the number of registered holders of First American common shares on [], and approximately [] outstanding common shares. The actual number of shares to be distributed will be determined on the record date and will reflect any exercise of First American options between the date the First American board of directors declares the dividend for the distribution and the record date for the distribution. The distribution will not affect the number of outstanding shares of common stock of InfoCo. First American will not distribute any fractional shares of FinCo common stock. Instead, an independent agent will aggregate fractional shares into whole shares, sell the whole shares in the open market at prevailing market prices and distribute the aggregate net cash proceeds of the sales pro rata to each holder who otherwise would have been entitled to receive a fractional share in the distribution.

Before the separation, FinCo will enter into a Separation and Distribution Agreement, Tax Sharing Agreement and other agreements with First American to effect the separation and provide a framework for FinCo’s relationship with InfoCo after the separation. These agreements will govern the relationship between InfoCo and FinCo subsequent to the completion of the separation and provide for the allocation between InfoCo and FinCo of First American’s assets, liabilities and obligations. The Separation and Distribution Agreement, in particular, requires us to assume a portion of certain of InfoCo’s contingent corporate liabilities and establishes the amount of the debt that each separated company initially will incur.

For a more detailed description of these agreements, see “Relationship with InfoCo.”

Incurrence of Debt

It is anticipated that FinCo will enter into a new senior credit facility with available borrowing capacity of approximately $400 million in connection with the separation, guaranteed by our title plant management and imaging subsidiaries and secured by the equity of such subsidiaries and 9 percent of the shares of our principal title insurance underwriter. It is further anticipated that FinCo will immediately draw $200 million on such facility and transfer that amount to InfoCo to repay First American debt that FinCo will be expected to repay in connection with the separation.

We will also continue to be responsible for the outstanding loan that is secured by a portion of our executive offices in Santa Ana, California. The principal balance on this loan as of December 31, 2009 was approximately $43.9 million. This facility may be restructured in connection with the separation.

For additional information about our current and planned financing arrangements, see “Description of Material Indebtedness.”

Ownership in InfoCo

Prior to the effective date and in connection with the separation, First American will issue to FinCo and our principal title insurance subsidiary a number of shares that will result collectively in FinCo and such subsidiary owning approximately $250 million of InfoCo’s issued and outstanding common shares following the distribution. We will agree to dispose of these shares within five years after the separation or to bear any adverse tax consequences arising out of holding the shares for longer than that period, as further discussed under “Relationship with InfoCo—Tax Sharing Agreement.”

Certain U.S. Federal Income Tax Consequences of the Distribution

The following is a summary of the material U.S. federal income tax consequences of the distribution to “U.S. holders” (as defined below) of First American common shares. The following is based on the Code, the

 

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Treasury regulations promulgated thereunder, and interpretations of the Code and Treasury regulations by the courts and the Internal Revenue Service, all as they exist as of the date of this information statement and all of which are subject to change, possibly with retroactive effect. Any such change could affect the accuracy of the statements and conclusions set forth in this document.

For purposes of this discussion, the term “U.S. holder” means a beneficial owner of First American common shares that is, for U.S. federal income tax purposes:

 

   

an individual who is a citizen or resident of the United States;

 

   

a corporation, or other entity taxable as a corporation for U.S. federal income tax purposes, created or organized under the laws of the United States, any state thereof, or the District of Columbia;

 

   

an estate, the income of which is subject to U.S. federal income tax regardless of its source; or

 

   

a trust if (1) a court within the United States is able to exercise primary supervision over the administration of the trust and one or more U.S. persons have the authority to control all substantial decisions of the trust or (2) it has a valid election in effect under applicable U.S. Treasury regulations to be treated as a U.S. person.

If an entity or arrangement that is treated as a partnership for U.S. federal income tax purposes holds First American common shares, the tax treatment of a partner in such entity generally will depend on the status of the partners and the activities of the partnership. If you are a partner in a partnership holding First American common shares, please consult your tax advisor.

This discussion only addresses holders of First American common shares that are U.S. holders and hold such shares as a capital asset within the meaning of Section 1221 of the Code. This summary does not discuss all tax considerations that may be relevant to First American shareholders in light of their particular circumstances, nor does it address the consequences to First American shareholders subject to special treatment under the U.S. federal income tax laws, such as tax-exempt entities, persons that are not U.S. holders, persons who acquire First American common shares pursuant to the exercise of employee stock options or otherwise as compensation, insurance companies, dealers or traders in securities, mutual funds, partnerships or other flow-through entities and their partners or members, U.S. expatriates, holders liable for the alternative minimum tax, holders whose functional currency is not the U.S. dollar, or holders who hold their First American common shares as part of a hedge, straddle, constructive sale or conversion transaction). In addition, this summary does not address any state, local or non-U.S. tax consequences of the transactions.

Each stockholder is urged to consult his, her or its tax advisor as to the specific tax consequences of the distribution to that stockholder, including the effect of any state, local or non-U.S. tax laws and of changes in applicable tax laws.

Principal U.S. Federal Income Tax Consequences of the Distribution to First American and Shareholders of First American

First American expects to receive a private letter ruling from the Internal Revenue Service substantially to the effect that, for U.S. federal income tax purposes, the distribution will qualify as tax free to First American and its stockholders under Sections 368(a)(1)(D) and 355 of the Code. In addition to obtaining the private letter ruling, First American expects to obtain an opinion from Deloitte & Touche LLP regarding certain aspects of the transaction that are not covered by the IRS Ruling.

Assuming that the distribution qualifies as a transaction that is generally tax-free for U.S. federal income tax purposes under Sections 355 and 368(a)(1)(D) of the Code:

 

   

no gain or loss will be recognized by First American for U.S. federal income tax purposes as a result of the distribution, other than gain or income arising in connection with certain internal restructurings

 

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undertaken in connection with the distribution and with respect to any “excess loss account” or “intercompany transaction” required to be taken into account by First American under U.S. Treasury regulations relating to consolidated federal income tax returns;

 

   

no gain or loss will be recognized by, or be included in the income of, a holder of First American common shares for U.S. federal income tax purposes solely as the result of the receipt of shares of our common stock in the distribution, except with respect to any cash received in lieu of fractional shares;

 

   

for U.S. federal income tax purposes, the basis of the shares of InfoCo common shares and FinCo common stock in the hands of First American shareholders immediately after the distribution, including any fractional share interest for which cash is received, will be the same as the basis of the First American common shares immediately before the distribution, and will be allocated among the InfoCo common shares and shares of FinCo common stock, including any fractional share interest for which cash is received, in proportion to their relative fair market values on the date of the distribution;

 

   

the holding period for U.S. federal income tax purposes of shares of FinCo common stock received by a First American shareholder, including any fractional share interest for which cash is received, will include the holding period of the stockholder’s First American common shares, provided that such shares are held as a capital asset on the date of the distribution; and

 

   

a First American shareholder who receives cash in lieu of a fractional share in the distribution will be treated as having sold such fractional share for cash and generally will recognize capital gain or loss for U.S. federal income tax purposes in an amount equal to the difference between the amount of cash received and the First American shareholder’s adjusted tax basis in the fractional share. That gain or loss will be long-term capital gain or loss if the stockholder’s holding period for its First American common shares exceeds one year.

The private letter ruling also is expected to provide that certain internal transactions undertaken in anticipation of the separation will qualify for favorable tax treatment under the Code, and First American expects to receive an opinion to the effect that those transactions and certain other internal transactions should qualify for favorable tax treatment.

If a First American shareholder holds different blocks of First American common shares (generally, First American common shares acquired on different dates or at different prices), such holder should consult its tax advisor regarding the determination of the basis and holding period of shares of FinCo common stock received in the distribution in respect of particular blocks of First American common stock.

Current U.S. Treasury regulations require each First American shareholder that is subject to U.S federal income tax reporting and that receives our common stock in the distribution to attach to his, her or its U.S. federal income tax return for the year in which the distribution occurs a detailed statement setting forth such data as may be appropriate to show the applicability of Section 355 of the Code to the distribution.

Certain U.S. Federal Income Tax Consequences to First American and Stockholders of First American if the Distribution is Taxable

Although the private letter ruling generally is binding on the Internal Revenue Service, it is based on assumptions and representations made by First American that certain conditions that are necessary to obtain favorable tax treatment under the Code have been satisfied, and this ruling does not constitute an independent determination by the Internal Revenue Service that these conditions have been satisfied. If the factual representations and assumptions are incorrect in any material respect at the time of the distribution, the private letter ruling could be revoked retroactively or modified by the Internal Revenue Service. We are not aware of any facts or circumstances, however, that would cause these representations or assumptions to be untrue or incomplete in any material respect.

 

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The opinion that First American expects to obtain from Deloitte & Touche LLP is based on assumptions and representations made by First American. If these representations and assumptions are incorrect in any material respect, our ability to rely on the opinion would be jeopardized. An opinion of counsel represents counsel’s best legal judgment and is not binding on the Internal Revenue Service or any court. We cannot assure you that the Internal Revenue Service will agree with the conclusions expected to be set forth in the opinion, and it is possible that the Internal Revenue Service or another tax authority could adopt a position contrary to one or all of those conclusions and that a court could sustain that contrary position. We are not aware of any facts or circumstances, however, that would cause these representations or assumptions to be untrue or incomplete in any material respect.

If, notwithstanding the conclusions in the private letter ruling and the opinion, it is ultimately determined that the distribution does not qualify as tax-free for U.S. federal income tax purposes, then First American would recognize gain in an amount equal to the excess of the fair market value of our common stock distributed to First American shareholders on the distribution date over First American’s tax basis in such shares.

In addition, if, notwithstanding the conclusions in the private letter ruling and the opinion, it is ultimately determined that the distribution does not qualify as tax-free for U.S. federal income tax purposes, then each stockholder that is subject to U.S. federal income tax and who receives our common stock in the distribution could be treated as receiving a taxable distribution in an amount equal to the fair market value of such stock. You could be taxed on the full value of the stock that you receive, without reduction for any portion of your basis in your First American common shares, as a dividend for U.S. federal income tax purposes to the extent of your pro rata share of First American’s current and accumulated earnings and profits, including earnings and profits resulting from First American’s recognition of gain on the distribution. Because First American is expected to have significant earnings and profits at the time of the distribution, all or a substantial portion of the distribution could be taxable as a dividend. Under current law, assuming certain holding period and other requirements are met, individual citizens or residents of the United States are subject to U.S. federal income tax on dividends at a maximum rate of 15 percent. Amounts in excess of your pro rata share of First American’s current and accumulated earnings and profits could be treated as a non-taxable return of capital to the extent of your basis in your First American common shares and thereafter as capital gain, assuming you hold your First American common shares as capital assets. Under current law, individual citizens or residents of the United States are subject to U.S. federal income tax on long-term capital gains (that is, capital gains on assets held for more than one year) at a maximum rate of 15 percent. Certain First American shareholders would be subject to additional special rules governing taxable distributions, such as those that relate to the dividends received deduction and extraordinary dividends. A stockholder’s tax basis in FinCo’s common stock received in a taxable distribution generally would equal the fair market value of FinCo’s common stock on the distribution date, and the holding period for that stock would begin the day after the distribution date. The holding period for the stockholder’s InfoCo common shares would not be affected by the fact that the distribution was taxable.

Even if the distribution otherwise qualifies for tax-free treatment under Sections 368(a)(1)(D) and 355 of the Code, it may result in corporate level taxable gain to First American under Section 355(e) of the Code if 50 percent or more, by vote or value, of our common stock or InfoCo’s common stock are acquired or issued as part of a plan or series of related transactions that includes the distribution. For this purpose, any acquisitions or issuances of First American’s common shares within two years before the distribution, and any acquisitions or issuances of our common stock or InfoCo’s common stock within two years after the distribution, generally are presumed to be part of such a plan, although we or InfoCo may be able to rebut that presumption. Prior to the distribution, First American will issue to FinCo and our principal title insurance subsidiary a number of shares that will result collectively in FinCo and such subsidiary owning approximately $250 million of InfoCo’s issued and outstanding common shares following the distribution. We expect the amount of shares issued to represent approximately [] percent of First American’s shares outstanding at the time of the issuance. In addition, in November 2009 First American issued approximately 9.5 million common shares in connection with its acquisition of the noncontrolling interest shares of its then publicly traded subsidiary, First Advantage Corporation. This represented approximately 9 percent of First American’s shares currently outstanding. Both of these issuances could count towards the 50 percent limitation, which could hinder FinCo’s ability to issue

 

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additional shares during the two year period following the distribution. If an acquisition or issuance of our stock or InfoCo’s stock triggers the application of Section 355(e) of the Code, First American would recognize taxable gain, as described above, but the distribution would be tax-free to the First American shareholders, as described above.

Certain Consequences under the Tax Sharing Agreement if the Distribution or the Internal Transactions are Taxable

In connection with the distribution, FinCo and InfoCo will enter into a Tax Sharing Agreement pursuant to which FinCo and InfoCo will agree to be responsible for certain tax liabilities and obligations following the distribution. FinCo’s indemnification obligations will include a covenant to indemnify InfoCo for any taxes and costs that they incur as a result of any action, misrepresentation or omission by us that causes the distribution to fail to qualify for tax-free treatment under the Code. In addition, InfoCo will similarly agree to indemnify FinCo for any taxes or costs that it causes us to incur as a result of each of its actions, misrepresentations or omissions that causes the distribution or certain internal transactions to fail to qualify for favorable tax treatment under the Code. We also will be responsible for 50 percent of any taxes resulting from the failure of the distribution or certain internal transactions to qualify for favorable tax treatment under the Code, which failure is not due to the actions, misrepresentations or omissions of FinCo or InfoCo. In addition, even if we were not contractually required to indemnify InfoCo for tax liabilities if the distribution or certain internal transactions were to fail to qualify for favorable tax treatment under the Code, we nonetheless may be legally liable under applicable U.S. federal income tax law for certain U.S. federal income tax liabilities incurred by U.S. affiliates of InfoCo if such affiliates were to fail to pay such tax liabilities. See “Relationship with InfoCo—Tax Sharing Agreement” for a more detailed discussion of the Tax Sharing Agreement.

The foregoing is a summary of certain U.S. federal income tax consequences of the distribution under current law and is for general information only. The foregoing does not purport to address all U.S. federal income tax consequences or tax consequences that may arise under the tax laws of other jurisdictions or that may apply to particular categories of stockholders. Each First American shareholder should consult his, her or its tax advisor as to the particular tax consequences of the distribution to such stockholder, including the application of U.S. federal, state, local and non-U.S. tax laws, and the effect of possible changes in tax laws that may affect the tax consequences described above.

Market for Common Stock

A public market for FinCo’s common stock does not yet exist. A condition to the distribution is the listing on the NYSE of FinCo’s common stock. We expect to adopt First American’s stock symbol after the separation and have our common stock listed on the NYSE under the symbol “FAF.”

Trading Between the Record Date and Distribution Date

Beginning on or shortly before the record date and continuing through the distribution date, there will be two markets in First American common shares: a “regular-way” market and an “ex-distribution” market. First American common shares that trade on the regular-way market will trade with an entitlement to FinCo common stock to be distributed pursuant to the distribution. Shares that trade on the ex-distribution market (essentially an InfoCo market prior to the distribution) will trade without an entitlement to FinCo common stock to be distributed pursuant to the distribution. Therefore, if you sell First American common shares in the “regular-way” market up to and including the distribution date, you will not receive FinCo common stock in the distribution. If you own First American common shares at the close of business on the record date and sell those shares on the “ex-distribution” market, up to and including the distribution date, you will receive the shares of FinCo common stock that you would be entitled to receive pursuant to your ownership of First American common shares because you owned these shares of common stock at the close of business on the record date.

Furthermore, we anticipate that, beginning on or shortly before the record date and continuing through the distribution date, there will be a “when-issued” market in FinCo’s common stock. “When-issued” trading refers

 

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to a sale or purchase made conditionally, because the security has been authorized but not yet issued. The “when-issued” trading market will be a market for FinCo’s common stock that will be distributed to First American shareholders on the distribution date. If you owned First American common shares at the close of business on the record date, you would be entitled to our common stock distributed pursuant to the distribution. You may trade this entitlement to our common stock, without the First American common shares you own, on the “when-issued” market. On the first trading day following the distribution date, “when-issued” trading with respect to FinCo’s common stock will end and “regular-way” trading will begin.

Conditions to the Distribution

We expect that the distribution will be effective on [], 2010, the distribution date, provided that, among other conditions described in this information statement, the following conditions shall have been satisfied or, if permissible under the Separation and Distribution Agreement, waived by First American:

 

   

The Securities and Exchange Commission shall have declared effective FinCo’s Registration Statement on Form 10, of which this information statement is a part, under the Securities Exchange Act of 1934, no stop order relating to the Registration Statement shall be in effect and this information statement shall have been mailed to holders of First American common shares.

 

   

First American shall have received a private letter ruling from the Internal Revenue Service substantially to the effect that the distribution will qualify as a tax-free reorganization for U.S. federal income tax purposes under Sections 368(a)(1)(D) and 355 of the Code.

 

   

First American and FinCo shall have received all necessary approvals from applicable insurance, banking and other regulators of FinCo’s businesses.

 

   

First American shall have received the opinion discussed above under “Principal U.S. Federal Income Tax Consequences of the Distribution to First American and Stockholders of First American” from Deloitte & Touche LLP regarding the tax-free status of the distribution for U.S. federal income tax purposes to the extent that such matter is not addressed by the IRS Ruling.

 

   

FinCo shall have entered into a new senior secured credit facility with available borrowing capacity of approximately $400 million, of which $200 million is expected to be drawn in connection with the separation, as further described in “Description of Material Indebtedness.”

 

   

First American shall have issued to FinCo and our principal title insurance subsidiary a number of shares that will result collectively in FinCo and such subsidiary owning approximately $250 million of InfoCo’s issued and outstanding common shares following the distribution, as described below under “Relationship with InfoCo—Ownership of InfoCo Shares.”

 

   

FinCo shall have transferred a total of $143 million, $43 million of which was transferred on December 31, 2009, in cash to First American and its joint venture partner in connection with the anticipated purchase of the noncontrolling interest in one of First American’s joint ventures;

 

   

The listing of FinCo’s common stock on the NYSE shall have been approved, subject to official notice of issuance.

 

   

All permits, registrations and consents required under the securities or blue sky laws of states or other political subdivisions of the United States or of other non-U.S. jurisdictions in connection with the distribution shall have been received.

 

   

First American’s board of directors shall have received an opinion from Duff & Phelps, in form and substance satisfactory to the board of directors, regarding InfoCo’s solvency and adequacy of capital immediately after the distribution, and an opinion of Gibson, Dunn & Crutcher LLP that, upon the distribution, the shares of our common stock will be fully paid, freely transferable and non-assessable.

 

   

All material governmental approvals and other material consents, including consents from noteholders and lenders, if any, necessary to consummate the distribution shall have been received.

 

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No order, injunction or decree issued by any court of competent jurisdiction or other legal restraint or prohibition preventing consummation of the distribution or any of the transactions related thereto, including the transfers of assets and liabilities contemplated by the Separation and Distribution Agreement, shall be in effect.

The fulfillment of the foregoing conditions does not create any obligation on First American’s part to effect the distribution. First American’s board of directors has reserved the right, in its sole discretion, to amend, modify or abandon the distribution and related transactions at any time prior to the distribution date. First American has the right not to complete the distribution if, at any time, First American’s board of directors determines, in its sole discretion, that the distribution is not in the best interests of First American or its stockholders.

Opinion of Duff & Phelps

The draft form of opinion of Duff & Phelps to be issued in connection with the separation will be attached to a subsequently filed form of this information statement as Annex A. The ultimate delivery of Duff & Phelps’s opinion is subject to satisfactory completion of its due diligence and financial analysis. First American expects that Duff & Phelps will confirm its opinion immediately prior to the completion of the separation. The opinion will set forth, among other things, the assumptions made, procedures followed, matters considered and limitations on the review undertaken by Duff & Phelps in connection with the opinion. You should read the opinion carefully and in its entirety. Duff & Phelps’s opinion will be delivered for the information and assistance of First American’s board of directors in connection with its consideration of the separation.

As background for its analysis, Duff & Phelps will meet with key managers to discuss, in detail, the history, current operations and future outlook for InfoCo. Duff & Phelps’s financial analysis and related solvency opinion will be based on, among other things, available historical and projected financial statements and operating data for First American provided by its management and advisors, an estimate of the post-spin-off cash balance of InfoCo provided by First American’s management or otherwise publicly available sources of information. Duff & Phelps will review transaction documentation relating to the spin-offs, including this information statement. Duff & Phelps will review industry and comparative public company financial data, to the extent available, obtained from published or other available sources. Duff & Phelps will use generally accepted valuation and analytical techniques as the basis for its analysis and solvency opinion.

With regard to the rendering of its solvency opinion, First American asked Duff & Phelps to determine whether, as of the date of its opinion, after giving effect to the distribution:

 

   

the fair saleable value of InfoCo’s assets exceeds the value of its liabilities, including all contingent and other liabilities;

 

   

InfoCo will not have an unreasonably small amount of capital for the businesses in which it is engaged or in which management has indicated it intends to engage;

 

   

InfoCo will be able to pay its liabilities, including all contingent and other liabilities, as they become due; and

 

   

relying on the financial statements of InfoCo and determining the value of the assets and liabilities of InfoCo and the property distributed based on the value of such assets, liabilities and property as reflected on the financial statements of InfoCo in accordance with generally accepted accounting principles, InfoCo meets the requirements set forth within Sections 500 and 501 of the California Corporations Code.

Reason for Furnishing this Information Statement

This information statement is being furnished solely to provide information to First American’s shareholders who are entitled to receive FinCo common stock in the distribution. The information statement is not, and is not to be construed as, an inducement or encouragement to buy, hold or sell any securities. We believe that the information in this information statement is accurate as of the date set forth on the cover. Changes may occur after that date and neither First American nor FinCo undertakes any obligation to update such information except in the normal course of their respective public disclosure obligations or as required by law.

 

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TRADING MARKET

A public market for shares of FinCo common stock does not yet exist. An active trading market may not develop or be sustained. We expect, however, that a limited market for shares of FinCo common stock, commonly known as a “when-issued” trading market, will develop on or shortly before the record date and continue through the distribution date. We expect to adopt the stock symbol of First American after the distribution and have our common stock listed on the NYSE under the symbol “FAF.”

We cannot predict the prices at which shares of FinCo common stock may trade before the distribution on a “when-issued” basis or after the distribution. Those prices will be determined by the marketplace and may be significantly below the book value per share of FinCo’s common stock. Prices at which trading in shares of FinCo’s common stock occurs may fluctuate significantly. Those prices may be influenced by many factors, including quarter to quarter variations in FinCo’s actual or anticipated financial results or those of other companies in the industry in which it operates or the markets that it serves, investor perception of FinCo and its industry and general economic and market conditions. In addition, the stock market in general has experienced extreme price and volume fluctuations that have affected the market price of many stocks and that have often been unrelated or disproportionate to the operating performance of these companies. These are just some factors that may adversely affect the market price of shares of FinCo’s common stock. See “Risk Factors—Risks Relating to Our Common Stock—There is no existing market for shares of FinCo common stock and a trading market that will provide you with adequate liquidity may not develop. In addition, once shares of FinCo’s common stock begin trading, the market price of FinCo stock may fluctuate widely.”

 

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DIVIDENDS

Following the distribution, we expect that FinCo initially will pay approximately $24 million per year in dividends to holders of its common stock. As a holding company, FinCo will depend on distributions from its subsidiaries to declare and pay dividends, and insurance and other regulations limit the amount of dividends, loans and advances available from its insurance subsidiaries. The timing, declaration and payment of future dividends, however, falls within the discretion of FinCo’s board of directors and will depend upon many factors, including FinCo’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, FinCo’s credit facility is expected to limit its ability to pay dividends. If FinCo’s senior, unsecured long-term debt rating is lower than “Baa3” by Moody’s or lower than “BBB-” by S&P or is not rated by either Moody’s or S&P (unless at the time FinCo’s senior, unsecured long-term debt is rated “Ba2” or better by Moody’s and “BB” or better by S&P and the commitments under the credit facility are equal to or less than $200 million), FinCo’s ability to pay dividends, make other restricted payments (as defined) and make certain investments during any fiscal year will be limited to the sum of $50,000,000 plus 50% of cumulative net income from distribution date.

 

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CAPITALIZATION

The following table presents our capitalization at December 31, 2009, on a historical basis and on an unaudited pro forma basis for the separation. Pro forma for the separation includes our anticipated post-separation capital structure and the impact of the separation financing transactions. The separation and our anticipated post-separation capital structure are described in the notes to the Unaudited Pro Forma Condensed Combined Balance Sheet under the Unaudited Pro Forma Condensed Combined Financial Statements and are presented as if the separation and the related transactions and events had been consummated on December 31, 2009.

The assumptions used and pro forma adjustments derived from such assumptions are based on currently available information, and we believe such assumptions are reasonable under the circumstances.

This table should be read in conjunction with “Selected Historical Combined Financial and Other Data,” “Description of Material Indebtedness,” “Description of Share Capital,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the combined financial statements for FinCo and the “Unaudited Pro Forma Condensed Combined Financial Statements” and accompanying notes included in this information statement.

The table below is not necessarily indicative of what our capitalization would have been had the distribution and post-separation been completed on the date assumed. The capitalization table below may not reflect the capitalization or financial condition which would have resulted had we been operating as an independent, publicly traded company at that date and is not necessarily indicative of our future capitalization or financial condition. The capitalization reflects the impact of separation financing transactions, including replacing the allocated portion of First American debt with a new credit facility.

 

     December 31, 2009  
     Historical     Pro Forma
for the
Separation
 
     (in thousands)  

Indebtedness:

    

Notes and contracts payable

   $ 119,313      $ 119,313   

Allocated portion of First American debt

     140,000        —     

New credit facility (Note A)

     —          200,000   
                

Total indebtedness

     259,313        319,313   
                

Equity:

    

Common stock (Note B)

     —          —     

First American’s invested equity (Note B)

     2,167,291        1,969,828   

Accumulated other comprehensive loss

     (147,491     (165,645

Noncontrolling interests

     13,051        13,051   
                

Total equity

     2,032,851        1,817,234   
                

Total capitalization

   $ 2,292,164      $ 2,136,547   
                

Note A—As a condition of the separation, we anticipate entering into a new credit facility that will have available credit of $400.0 million, for which we anticipate drawing $200.0 million on the separation date. The funds received from this credit facility will be used to pay down the allocated portion of First American debt.

Note B—Represents the issuance of approximately [] shares of FinCo common stock at a par value of $0.00001 per share (assuming a distribution ratio of [] share(s) of FinCo common stock for every [] share(s) of outstanding First American common stock).

 

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SELECTED HISTORICAL COMBINED FINANCIAL AND OTHER DATA

The selected historical combined financial data for First American Financial Corporation (“FinCo”) for the five-year period ended December 31, 2009, have been derived from the combined financial statements of FinCo. The selected historical combined financial data should be read in conjunction with the Combined Financial Statements and notes thereto and Management’s Discussion and Analysis included elsewhere in this information statement.

Our selected historical combined financial data may not be indicative of our future performance and does not necessarily reflect what our financial position and results of operations would have been had we operated as a separate, stand-alone entity during the periods presented, including changes that will occur in our operations and capitalization as a result of our separation from First American.

 

     Year Ended December 31,  
     2009     2008     2007     2006     2005  
     (in thousands, except percentages)  

Revenues

   $ 4,046,834      $ 4,367,725      $ 6,076,132      $ 6,685,587      $ 6,465,870   

Net income (loss)

   $ 134,277      $ (72,482   $ (122,446   $ 213,692      $ 402,215   

Net income attributable to noncontrolling interests

   $ 11,888      $ 11,523      $ 20,537      $ 23,875      $ 27,471   

Net income (loss) attributable to FinCo

   $ 122,389      $ (84,005   $ (142,983   $ 189,817      $ 374,744   

Total assets

   $ 5,530,281      $ 5,720,757      $ 5,354,531      $ 5,658,505      $ 5,270,320   

Notes and contracts payable

   $ 119,313      $ 153,969      $ 306,582      $ 372,338      $ 360,437   

Allocated portion of First American debt (Note A)

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

Invested equity (Note B)

   $ 2,019,800      $ 1,891,841      $ 1,930,774      $ 2,564,369      $ 2,549,170   

Return on average invested equity

     6.3     (4.4 )%      (6.4 )%      7.4     16.8

Other operating data:

          

Title orders opened (Note C)

     1,991        1,961        2,402        2,510        2,700   

Title orders closed (Note C)

     1,503        1,399        1,697        1,866        2,017   

Number of employees (Note D)

     13,963        15,147        19,783        23,418        24,416   

Note A—We were allocated $140.0 million from First American’s line of credit in June and July 2008 as this amount directly relates to our operations. First American drew on its line of credit and transferred the cash to our subsidiary in 2008 to fund our subsidiary’s statutory capital and surplus.

Note B—Invested equity refers to the combined net assets of FinCo which reflects First American’s combined investment in FinCo and excludes noncontrolling interests.

Note C—Title order volumes are those processed by our direct title operations and do not include orders processed by agents.

Note D—Number of employees in 2009, 2008, 2007, 2006 and 2005 is based on actual employee headcount, including employees of unconsolidated subsidiaries.

 

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UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS

The following unaudited pro forma condensed combined financial statements of FinCo present the historical financial statements of FinCo with adjustments to give effect to the separation from First American, including the transfer of cash and other assets to First American as well as the incurrence of incremental debt of approximately $60 million (including the interest expense related to the debt), and the issuance of share capital. The unaudited pro forma condensed combined balance sheet as of December 31, 2009 is presented as if the separation of FinCo and the related financing transactions had been completed on December 31, 2009. The unaudited pro forma condensed combined income statement for the year ended December 31, 2009 is presented as if the separation of FinCo and related financing transactions had been completed on January 1, 2009. Additionally, for purposes of the unaudited pro forma condensed combined income statement we have assumed the completion of the buy-in of the noncontrolling interests in certain of our businesses, which was completed in December 2009 and was a requirement to effect the separation, occurred as of January 1, 2009. The pro forma adjustments are based upon available information and assumptions that we believe are reasonable. While such adjustments are subject to change based upon the finalization of the terms of the separation and the underlying separation agreements, in management’s opinion, the pro forma adjustments have been developed on a reasonable and rational basis.

For the year ended December 31, 2009, First American allocated to us general corporate expenses in the amount of $57.0 million. General corporate expenses include, but are not limited to, costs related to finance, legal, information technology, human resources, communications, procurement, facilities, employee benefits and incentives, and stock-based compensation. Effective with the separation, we will assume responsibility for all of these functions and related costs and anticipate our costs as a stand-alone entity will be higher than those allocated to us. In the first year following the separation, these operating costs are estimated to be approximately $10.5 million to $12.0 million higher than the general corporate expenses historically allocated from First American. No pro forma adjustments have been made to our financial statements to reflect the additional costs and expenses described in this paragraph because they are projected amounts based on judgmental estimates and, as such, are not includable as pro forma adjustments in accordance with the requirements of Rule 11-02 of Regulation S-X.

As of December 31, 2009, we have reserves of $18.1 million for litigation specific to our business included in our historical combined financial statements which are separate and distinct from the commercial and corporate level litigation of First American for which we will share in the cost of resolution in accordance with the terms of the separation agreement. These contingent corporate liabilities primarily relate to the consolidated securities litigation and actions with respect to the separation plan or the distribution. As summarized under “Relationship With InfoCo—Separation and Distribution Agreement,” FinCo will assume 50 percent of specified contingent and other corporate liabilities of First American, which relate primarily to certain commercial and corporate-level litigation that First American is party to and which, based on an assessment of each case, First American believes it is appropriate for both FinCo and InfoCo to share equally in the resolution of such litigation. Currently, based on the most recent review of each case, First American has determined that under generally accepted accounting principles there are no reserves necessary for these contingent and corporate liabilities. First American has assigned the responsibility to manage each case to either FinCo or InfoCo and the responsible entity will determine the ultimate total liability, if any, related to the cases; we will record our share of such liability when the responsible party determines a reserve is necessary in accordance with generally accepted accounting principles. Based on the results of these assessments to date, we have not included any pro forma adjustments for those contingent liabilities.

As part of the separation, we will enter into transition services agreements with First American for the provision of certain corporate level services. There is uncertainty regarding how much, if any, those service agreements will be utilized and therefore the level of expected costs (the fees to be paid will be predominantly based on usage, such as hourly rates or per item costs, as opposed to predetermined fees). Given these factors, we have not included any amounts related to the agreements in the pro forma condensed combined financial statements, as we do not believe that any such amounts would meet the “factually supportable” and “ongoing

 

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impact on the financial statements” criteria established for pro forma adjustments. As it relates to the ongoing commercial relationships that will be in place between us and InfoCo (primarily related to purchases and sales of data and other settlement services), the terms and conditions of the ongoing commercial relationships are expected to be materially consistent with the terms and conditions currently in place between the two organizations and reflected in our historical combined financial statements. As a result, we do not anticipate any material changes to our results of operations and therefore do not believe any adjustment to the pro forma condensed combined income statement is required

These unaudited pro forma condensed combined financial statements should be read in conjunction with our “Management’s Discussion and Analysis” and our audited combined financial statements and accompanying notes included in this information statement. The unaudited pro forma condensed combined financial statements are not necessarily indicative of the results of operations or financial position of FinCo that would have been reported had the separation been completed as of the dates presented, and are not necessarily representative of the future consolidated results of operations or financial position of our company.

 

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First American Financial Corporation

Unaudited Pro Forma Condensed Combined Balance Sheet

December 31, 2009

(in thousands)

 

    As Reported     Pro Forma
Adjustments
    Pro Forma
Total
 

Assets

     

Cash and cash equivalents

  $ 583,028      $ (106,400 )(1),(7)    $ 476,628   

Accounts and accrued income receivable, net

    239,166        —          239,166   

Income tax receivable

    27,265        —          27,265   

Investments:

     

Deposits with savings and loan associations and banks

    123,774        —          123,774   

Debt securities

    1,838,719        —          1,838,719   

Equity securities

    51,020        250,000  (2)      301,020   

Other long-term investments

    275,275        (80,295 )(3 b,c)      194,980   

Related party notes receivable

    187,825        (164,825 )(3 a,d)      23,000   
      —       

Loans receivable, net

    161,897        —          161,897   

Property and equipment, net

    358,571        (16,254 )(4)      342,317   

Title plants and other indexes

    488,135        —          488,135   

Deferred income taxes

    101,818        12,204  (6)      114,022   

Goodwill

    800,986        —          800,986   

Other intangible assets, net

    78,892        —          78,892   

Other assets

    213,910        6,400  (7)      220,310   
                       

Total Assets

  $ 5,530,281      $ (99,170   $ 5,431,111   
                       

Liabilities and Stockholder's Equity

     

Demand deposits

    1,153,574      $ —        $ 1,153,574   

Accounts payable and accrued liabilities

    699,766        16,247  (5)      716,013   

Related party payable, net

    12,264        —          12,264   

Deferred revenue

    144,756        —          144,756   

Reserve for known and incurred but not reported claims

    1,227,757        —          1,227,757   

Deferred income taxes

    —          40,200  (6)      40,200   

Notes and contracts payable

    119,313        200,000  (7)      319,313   

Allocated portion of First American debt

    140,000        (140,000 )(7)      —     
                       

Total Liabilities

    3,497,430        116,447        3,613,877   
                       

Invested Capital

     

Common stock

    —          —    (9)      —     

First American's invested equity

    2,167,291        (197,463 )(8),(9)      1,969,828   

Accumulated other comprehensive loss

    (147,491     (18,154 )(5)      (165,645

Noncontrolling interests

    13,051        —          13,051   
                       

Total Equity

    2,032,851        (215,617     1,817,234   
                       

Total Liabilities and Stockholder's Equity

  $ 5,530,281      $ (99,170   $ 5,431,111   
                       

 

 

(1) As a condition of consummating the separation, First American will purchase the noncontrolling interest in a joint venture. We are required to fund a portion of the buyout and this amount represents the cash payment of $100 million that we anticipate making to First American to fund our share of First American’s purchase of the noncontrolling interest in the joint venture. This noncontrolling interest is not part of our historical combined financial statements as of December 31, 2009.

 

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(2) As a condition to the separation, we will be transferred a $250 million ownership interest in the common stock of InfoCo which we will account for as a marketable equity security. The $250 million investment is expected to represent a []% ownership interest in InfoCo.
(3) The pro forma adjustment to other long-term investments and related party notes receivable is comprised of several items:
  a. First, there are approximately $187.8 million of notes receivable from The First American Corporation recorded in our historical financial statements which reflect a loan we made to First American. At the separation, the corresponding note payable recorded by First American will be transferred to us and eliminated against our notes receivable.
  b. Second, there are approximately $9.7 million of investment assets held by First American that have not been attributed to FinCo for purposes of the historical financial statements as they were held for general investment purposes and not specifically for our benefit. The investments will be transferred to FinCo at the separation and we are therefore including those investment assets.
  c. Third, there are several investments in affiliates held by us, with investment balances totaling $90.0 million, that we have agreed to transfer to InfoCo upon the consummation of the separation and we are eliminating those investment assets.
  d. Fourth, First American’s defined benefit plans, which are currently underfunded, will be assumed by FinCo and the obligation related to the InfoCo employees will be transferred as well (see Note 5 below). Upon the consummation of the separation, we will be issued a note receivable from InfoCo of approximately $23 million that represents the net present value of the unfunded portion of the liability associated with the InfoCo employees as well as administrative costs associated with administering the plan for those employees. The note will bear interest at a fixed rate, expected to be approximately 7%, and have a maturity date of []. We anticipate that the fixed rate will be a market rate for similar instruments.
(4) The pro forma adjustment represents the transfer to InfoCo of certain real estate property assets, net, that under the terms of the separation agreement InfoCo will retain but have historically been used in our business and included in our historical combined balance sheet.
(5) As referenced in Note 3d, upon separation the entire obligation associated with First American’s defined benefit plans will be assumed by FinCo. Our historical financial statements reflect the accounting for the pension obligation attributable to our employees that is expected to be transferred to us upon separation. Under the terms of the separation agreements, we will assume the pension obligation associated with all First American employees and InfoCo will fund the obligation relating to the InfoCo employees as of the spin off date by issuance of a note receivable. The pro forma adjustment represents the incremental net pension liability of $16.2 million and incremental accumulated other comprehensive loss of $18.2 million related to those plans that are currently not attributed to FinCo for purposes of the historical financial statements as these amounts are attributable to employees of InfoCo and the First American Corporation. The actual pension liability and associated other comprehensive loss will be finalized at the separation date.
(6) This adjustment represents the income tax effects of the pro forma adjustments at the expected statutory tax rates.
(7) As a condition of the separation, we anticipate entering into a new credit facility that will have available credit of $400.0 million, for which we anticipate drawing $200.0 million in connection with the separation, with an interest rate of LIBOR plus 275 basis points. The funds received from this credit facility will be used to pay down $200.0 million of First American’s existing credit facility that will expire upon consummation of the separation transaction. We currently have $140.0 million of the First American credit facility attributed to us in the historical financial statements and this pro forma adjustment represents the reclassification of our allocated First American debt to notes payable and the incremental $60.0 million in debt we will incur as part of the separation. This pro forma adjustment also reflects the $60.0 million payment as a distribution to First American through our invested equity. The effective interest on the new credit facility is expected to be 4.07%, which includes the amortization of the anticipated fees and costs associated with obtaining the credit facility. We have used 0.25% as the base LIBOR borrowing rate which is the current 90 day LIBOR rate. Additionally, we have included an adjustment to record deferred financing fees of $6.4 million.
(8) The pro forma adjustment represents the net impact of the pro forma entries on our invested equity balance.
(9) Represents the issuance of approximately [] shares of FinCo common stock at a par value of $0.00001 per share (assuming a distribution ratio of [] share(s) of FinCo common stock for every [] share(s) of outstanding First American common stock).

 

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First American Financial Corporation

Unaudited Pro Forma Condensed Combined Income Statement

Year Ended December 31, 2009

(in thousands)

 

    As Reported   Pro Forma
Adjustments
    Pro Forma
Total

Revenues:

     

Operating revenues

  $ 3,938,616   $ —        $ 3,938,616

Investment and other income

    108,218     (11,657 )(1)      96,561
                   

Total Revenues

    4,046,834     (11,657     4,035,177
                   

Salaries and other operating expenses

    3,740,195     1,530  (2),(3)      3,741,725

Depreciation and amortization

    82,475     (463 )(4)      82,012

Interest

    19,819     2,772  (5)      22,591
                   

Total Expenses

    3,842,489     3,839        3,846,328
                   

Income before income taxes

  $ 204,345     (15,496     188,849

Income tax expense/(benefit)

    70,068     (3,639 )(6)      66,429
                   

Net income

    134,277     (11,857     122,420

Less: Net income attributable to noncontrolling interests

    11,888     (7,342 )(7)      4,546
                   

Net income attributable to FinCo

  $ 122,389   $ (4,515   $ 117,874
                   

Pro forma net income per share—basic (8)

     
         

Pro forma weighted average shares outstanding (8)

     
         

 

(1) The pro forma adjustment represents the net impact of:
  a. the elimination of the historical interest income associated with the notes receivable (see Note 3a to the unaudited pro forma condensed combined balance sheet) from First American of $11.0 million for the year ended December 31, 2009;
  b. the elimination of the historical equity in earnings from affiliates for certain investments that will not be retained after the separation date of $0.3 million for the year ended December 31, 2009;
  c. the elimination of lease income of $2.0 million for the year ended December 31, 2009 earned on certain real estate property assets that will be transferred to First American;
  d. interest income of $1.6 million to be earned on the note receivable from InfoCo related to the defined benefit plans (see Note 3d to the unaudited pro forma condensed combined balance sheet above).
(2) The pro forma adjustment represents the incremental pension expense associated with the InfoCo and First American employees of $1.5 million for the year ended December 31, 2009 (See Note 5 to the unaudited pro forma condensed combined balance sheet).
(3) The historical amounts include an allocation of First American corporate expenses. These costs may not be representative of the future costs we will incur as a separate public company. No pro forma adjustments have been made to our pro forma financial statements to reflect the additional costs and expenses described in this paragraph because they are projected amounts based on judgmental estimates and, as such, are not includable as pro forma adjustments in accordance with the requirements of Rule 11-02 of Regulation S-X. We estimate the incremental costs associated with operating as a separate public company to be between $10.5 million to $12.0 million, relating to staff additions and other infrastructure costs. These amounts were estimated using First American historical costs adjusted for current market conditions as applicable.
(4) The pro forma adjustment relates to the elimination of the historical depreciation and amortization on the real estate property that will be transferred to First American at the separation date.
(5)

The pro forma adjustment represents the incremental interest expense and amortization of deferred financing costs associated with our new credit facility, which we anticipate will have $200 million of

 

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borrowings outstanding at the separation date (see further discussion at Footnote 7 to the unaudited pro forma condensed combined balance sheet above). We anticipate that the borrowings will bear interest at 90 day LIBOR plus 275 basis points. The adjustment assumes an average principal amount outstanding of $200 million and a weighted average interest rate of approximately 4.07% on the aggregate borrowings based on a 90 day LIBOR rate of 0.25%. A change of one-eighth of 1% (12.5 basis points) in the interest rate associated with these borrowings would result in additional annual interest expense of approximately $.3 million (in the case of an increase to the rate) or an annual reduction to interest expense of approximately $.3 million (in the case of a decrease in the rate).

(6) This amount represents the estimated income tax impact of the pro forma adjustments using the statutory rate of 40.2%.
(7) In preparation for and as a condition to the consummation of the separation, in the fourth quarter of 2009, we purchased the noncontrolling interests in certain of our businesses. For purposes of these pro forma financial statements, we have assumed the purchase occurred on January 1, 2009 and therefore we have eliminated the net income attributable to noncontrolling interests associated with those businesses.
(8) Pro forma net income per share is calculated using [] outstanding shares of First American as of December 31, 2009 because upon the completion of the separation, the number of our shares of outstanding common stock will equal [] the number of First American outstanding shares on the record date of the distribution.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

The following information should be read in conjunction with the “Selected Historical Combined Financial and Other Data”, and the “Combined Financial Statements” for FinCo, included elsewhere in this information statement. The following discussion may contain forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this information statement, particularly in “Risk Factors” and “Special Note About Forward-Looking Statements.”

This Management’s Discussion and Analysis contains certain financial measures, in particular the presentation of certain balances excluding the impact of acquisitions and other non-recurring items, that are not presented in accordance with generally accepted accounting principles (“GAAP”). We are presenting these non-GAAP financial measures because they provide us and readers of this information statement with additional insight into our operational performance relative to earlier periods and relative to our competitors. We do not intend for these non-GAAP financial measures to be a substitute for any GAAP financial information. Readers of this information statement should use these non-GAAP financial measures only in conjunction with the comparable GAAP financial measures.

Overview

We are engaged in the business of providing financial services through our title insurance and services segment and our specialty insurance segment. The title insurance and services segment provides title insurance, escrow and similar or related financial services domestically and internationally in connection with residential and commercial real estate transactions, manages title plants and provides imaged real estate documents to our customers. It also provides thrift, trust and advisory services. The specialty insurance segment issues property and casualty insurance policies and sells home warranty products. In addition, our corporate division consists of certain financing facilities as well as the corporate services that support FinCo’s business operations.

Separation from First American

On January 15, 2008, First American announced that its board of directors had approved a plan to separate First American into two independent publicly traded companies, one consisting of First American’s financial services businesses, FinCo, and one for its information solutions businesses, InfoCo. First American expects to accomplish this by way of a dividend distribution of the common stock of FinCo, First American’s wholly owned subsidiary, to First American’s shareholders. Immediately following the distribution, First American shareholders will own 100 percent of the outstanding common stock of FinCo. Prior to the distribution, certain internal transactions will occur so that FinCo directly or indirectly owns all of First American’s financial services businesses (i.e., the businesses for which financial information is presented herein). The remaining entity, InfoCo, will own all of First American’s remaining information solutions businesses. FinCo will adopt the “FAF” ticker symbol and its shares of common stock will be traded on the New York Stock Exchange under that symbol. InfoCo will change its name and ticker symbol following the separation.

The consummation of the separation is subject to various closing conditions, including the effectiveness of the Registration Statement on Form 10 of which this information statement is a part, receipt of approvals from domestic and international insurance regulators and the approval of banking regulators, some of which have already been received, receipt of a favorable ruling from the Internal Revenue Service as to the tax-free nature of the transaction and the final approval of First American’s board of directors, among others. While many of these conditions are outside of First American’s control, we and First American currently expect to complete the separation in the second quarter of 2010.

 

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Basis of Presentation

Our historical financial statements include assets, liabilities, revenues and expenses directly attributable to our operations. Our historical financial statements reflect allocations of certain corporate expenses from First American. These expenses have been allocated to us on a basis that we consider to reflect fairly or reasonably the utilization of the services provided to or the benefit obtained by our businesses. Our historical financial statements do not reflect the debt or interest expense we might have incurred if we had been a stand-alone entity. In addition, we expect to incur other expenses, not reflected in our historical financial statements, as a result of being a separate publicly traded company. As a result, our historical financial statements do not necessarily reflect what our financial position or results of operations would have been if we had been operated as a stand-alone public entity during the periods covered, and may not be indicative of our future results of operations and financial position.

Our combined financial statements have been prepared in accordance with generally accepted accounting principles and have been derived from the consolidated financial statements of First American and represent carve-out stand-alone combined financial statements. The combined financial statements include items attributable to FinCo and allocations of general corporate expenses from First American.

Our historical financial statements reflect allocations of corporate expenses from First American for certain functions provided by First American, 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 us 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. Both we and First American consider 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 us during the periods presented. The allocations may not, however, reflect the expense we would have incurred as an independent, publicly-traded company for the periods presented. Actual costs that may have been incurred if we had been a stand-alone company would depend on a number of factors, including the chosen organizational structure, what functions were outsourced or performed by employees and strategic decisions made in areas such as information technology and infrastructure. Following the separation, we will perform these functions using our own resources or purchased services. For an interim period, however, some of these functions will continue to be provided by First American under the transition services agreements. In addition to the transition services agreements, we will enter into a number of commercial agreements with First American in connection with the separation, many of which are expected to have terms longer than one year.

A portion of First American’s consolidated debt has been allocated to us based on amounts directly incurred for our benefit. Interest expense has been allocated in the same proportions as debt. Both we and First American believe the allocation basis for debt and interest expense is reasonable. However, these amounts may not be indicative of the actual amounts that we would have incurred had we been operating as an independent, publicly-traded company for the periods presented. See Note 10 Notes and Contracts Payable and Allocated Portion of First American Debt to the combined financial statements for further discussion of our long-term obligations.

Reportable Segments

We consist primarily of First American’s title insurance and services segment and its specialty insurance segment. We consist of the following reportable segments and a corporate function:

 

   

Our title insurance and services segment issues title insurance policies on residential and commercial property in the United States and offers similar products and services internationally. This segment also provides escrow and closing services, accommodates tax-deferred exchanges of real estate and provides investment advisory, trust, lending and deposit services. This segment is also in the business of maintaining, managing and providing access to automated title plant records and images that may be

 

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owned by us or other parties. We, through our principal title insurance subsidiary and such subsidiary’s affiliates, transact our title insurance 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. In Iowa, we provide title abstracts only because title insurance is not permitted by law. We also offer title insurance and similar products, as well as related services, either directly or through joint ventures in foreign countries, including Canada, the United Kingdom and various other established and emerging markets. The international operations account for an immaterial amount of our income before income taxes.

 

   

Our specialty insurance segment issues property and casualty insurance policies and sells home warranty products. The property and casualty insurance business provides insurance coverage to residential homeowners and renters for liability losses and typical hazards such as fire, theft, vandalism and other types of property damage. This business is licensed to issue policies in all 50 states and actively issues policies in 43 states. In its largest market, California, it also offers preferred risk auto insurance to better compete with other carriers offering bundled home and auto insurance. The home warranty business provides residential service contracts that cover residential systems and appliances against failures that occur as the result of normal usage during the coverage period. This business currently operates in 34 states and the District of Columbia.

The corporate division consists of certain financing facilities as well as the corporate services that support our business operations.

Critical Accounting Policies and Estimates

We consider the accounting policies described below to be critical in the preparation of our combined financial statements. These policies require us 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 FinCo to the combined financial statements for a more detailed description of our accounting policies.

Revenue recognition. Title premiums on policies issued directly by us 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 us. Revenues earned by our title plant management business are recognized at the time of delivery, as we have no significant ongoing obligation after delivery. Revenues from home warranty contracts are recognized ratably over the 12-month duration of the contracts. Revenues from property and casualty insurance policies are also recognized ratably over the 12-month duration of the policies. Interest on loans of our 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 our trust and banking operations are recognized at the time of delivery, as we have no significant ongoing obligation after delivery.

Provision for title losses. We provide 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 title insurance premiums, escrow and other related fees. We estimate the loss provision rate at the beginning of each year and reassess the rate quarterly to ensure that the resulting incurred but not reported (“IBNR”) loss reserve and known claims reserve included in our combined balance sheets together reflect our 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. Our in-house actuary performs a

 

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reserve analysis utilizing generally accepted actuarial methods that incorporate cumulative historical 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 was determined by applying an expected loss rate to title insurance premiums, escrow and other related fees and adjusting for policy year maturity using the estimated loss development pattern. The expected loss rate is 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, and when claims data reflects unusual impacts. IBNR calculated in this way differs from the IBNR 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. We believe the expected loss rate method is appropriate for recent policy years, because of the high level of loss emergence during the past three calendar years. This loss emergence is believed to consist largely of acceleration of claims that otherwise would have been realized later and one-time losses. Both of these effects are results of temporary economic conditions that are not expected to persist throughout the development lifetime of those policy years.

For more mature policy years (generally, policy years aged more than three years), IBNR was determined using multiplicative loss development factor calculations. These years were also exposed to adverse economic conditions during 2007-2009 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 2007-2009 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 2006 and prior are low enough that the potential for over-extrapolation is limited to an acceptable level.

We utilize 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 a second estimate that is used to validate the reasonableness of the in-house analysis.

We use the point estimate of the projected IBNR from the in-house actuary’s analysis and other relevant information we may have concerning claims to determine what we consider 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 us within the first few years following the issuance of the policy. Generally, 70 to 80 percent of claim amounts become known in the first five years of the policy life, and the majority of IBNR reserves relate to the five most recent policy years. A material change in expected ultimate losses and corresponding loss rates for policy years older than five years, while possible, is not considered reasonably likely by us. 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, we believe 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 five 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 $123.3 million. The estimates we made 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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A summary of our 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,
2009
    December 31,
2008
 

Known title claims

   $ 206,439    16.8   $ 241,302    18.2

IBNR

     978,854    79.7     1,035,779    78.1
                          

Total title claims

     1,185,293    96.5     1,277,081    96.3

Non-title claims

     42,464    3.5     49,201    3.7
                          

Total loss reserves

   $ 1,227,757    100.0   $ 1,326,282    100.0
                          

Fair Value of Investment Portfolio. We classify our publicly traded debt and equity securities as available-for-sale and carry them at fair value with unrealized gains or losses classified as a component of accumulated other comprehensive loss.

We determine the fair value of our 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 us (observable inputs) and our 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 our available-for-sale portfolio is based on our 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 included in the Level 1 category was based on quoted prices that are readily and regularly available in an active market.

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 fair value of fixed maturity and short-term investments included in the Level 2 category 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. This pricing service, which is a provider of financial market data, analytics and related services to financial institutions, provides us one price for each security. 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 Level 2 category includes foreign bonds, governmental agency bonds, governmental agency mortgage-backed and asset-backed securities and corporate debt securities, many of which are actively traded and have market prices that are readily verifiable. Level 2 also includes non-agency mortgage-backed and asset-backed securities and municipal bonds which are currently not actively traded securities. When the value from an independent pricing service is utilized, we obtain an understanding of the valuation models and assumptions utilized by the service and have controls in place to determine that the values provided represent current values. Typical inputs and assumptions to pricing models used to value securities include, but are not limited to, benchmark yields, reported trades, broker-dealer quotes, issue spreads, benchmark securities, bids, offers, reference data and industry and economic events. For mortgage-backed and asset-backed securities, inputs and assumptions may also include the structure of issuance, characteristics of the issuer, collateral attributes, prepayment speeds and credit ratings. Our non-agency mortgage-backed and asset-backed securities consist of senior tranches of securitizations and the underlying borrowers are substantially all prime. Our validation procedures include assessing the reasonableness of the changes relative to prior periods given the prevailing market conditions, comparison of the prices received from the pricing service to quotes received from other third party sources for securities with market prices that are readily verifiable, changes in the issuers’ credit

 

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worthiness, performance of any underlying collateral and prices of the instrument relative to similar issuances. To date, we have not made any adjustments to the results provided by the pricing service.

Level 3—Valuations based on inputs that are unobservable and significant to the overall fair value measurement, and involve management judgment.

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. A number of our investment grade corporate bonds are frequently traded in active markets and market prices for these securities existed at December 31, 2009. These securities were classified as Level 2 at December 31, 2009 because the valuation models use observable market inputs in addition to traded prices.

In the first quarter of 2009, we adopted newly issued accounting guidance that establishes a new method of recognizing and measuring other-than-temporary impairment of debt securities. We assess the unrealized losses in our debt security portfolio under this guidance, primarily the non-agency mortgage-backed and asset-backed securities. If we intend to sell a debt security in an unrealized loss position or determine that it is more likely than not that we 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, 2009, we do not intend to sell any debt securities in an unrealized loss position and it is not more likely than not that we will be required to sell debt securities before recovery of their amortized cost basis.

If we do not expect to recover the amortized cost basis of a debt security with declines in fair value (even if we do not intend to sell it and it is not more likely than not that we will be required to sell the debt security before the recovery of the debt security’s remaining amortized cost basis), the losses we consider 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 and asset-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.). We use 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, we consider the financial condition of the borrower, loan to value ratio, loan type and geographical location of the underlying property. We utilize publicly available information related to specific assets, generally available market data such as forward interest rate curves and First American’s securities, loans and property data and market analytics tools.

The table below summarizes the primary assumptions used at December 31, 2009 in estimating the cash flows expected to be collected for these securities.

 

     Weighted average     Range

Prepayment speeds

   6.9   3.9% – 14.6%

Default rates

   5.1   0.0% – 18.5%

Loss severity

   32.6   0.0% – 64.4%

When, in our opinion, 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

 

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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 we 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 our 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, our review of the security includes the above noted factors as well as what 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, our policy is that such losses are considered other-than-temporary and therefore an impairment loss is recorded.

Impairment testing for goodwill, other intangible assets and long-lived assets. We are required to perform an annual impairment test for goodwill and other indefinite-lived intangible assets for each reporting unit. This annual test, which we elected to perform every fourth quarter, utilizes a variety of valuation techniques, all of which require us 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. In assessing the fair value, we use the results of the valuations (including the market approach to the extent comparables are available) and consider the range of fair values determined under all methods and the extent to which the fair value exceeds the book value of the equity. Our four reporting units are title insurance, home warranty, property and casualty insurance and trust and other services. Our policy is to perform an annual impairment test for each reporting unit in the fourth quarter or sooner if circumstances indicate a possible impairment.

Our 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, cash flows, market multiples and discount rates. Forecasts of future operations are based, in part, on operating results and our expectations as to future market conditions. These types of analyses contain uncertainties because they require us 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 our estimates and assumptions, we may be exposed to an additional impairment loss that could be material. Due to significant volatility in the current markets, our operations may be negatively impacted in the future to the extent that exposure to impairment charges may be required. We completed the required annual impairment testing for goodwill for the years ended December 31, 2009 and 2008,

 

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in the fourth quarter of each year. In 2009 and 2008, we concluded that, based on our 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.

As of the date of the 2009 annual impairment review, the title insurance reporting unit included $756.9 million of goodwill. The fair value of this reporting unit under the income and market value approaches exceeded the carrying value of the reporting unit’s book value by approximately 13.7% and 13.4%, respectively. The property and casualty insurance reporting unit included $33.5 million of goodwill as of our 2009 annual impairment review. The fair value of this reporting unit under the income and market value approaches exceeded the carrying value of the reporting unit’s book value by approximately 35.5% and 7.2%, respectively. Determining the fair value of a reporting unit is judgmental in nature and requires the use of significant estimates and assumptions, including revenue growth rates and operating margins, discount rates and future market conditions, determination of market multiples, among others. It is reasonably possible that changes in the judgments, assumptions and estimates we made in assessing the fair value of our goodwill could cause these or other reporting units to become impaired. There were no other reporting units that we deemed to have a reasonable risk of material impairment charge at this time.

We use estimated future cash flows (undiscounted and excluding interest) to measure the recoverability of long-lived assets held and used whenever events or changes in circumstances indicate that the carrying value of an asset may not be fully recoverable. At such time that an impairment in value of an intangible or 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. We account 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. We evaluate 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.

We recognize 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. We recognize interest and penalties, if any, related to uncertain tax positions in tax expense. As a result of adopting the accounting guidance for uncertain tax positions, we recorded a cumulative effect adjustment of $3.1 million as a reduction to retained earnings as of January 1, 2007.

Our operations have been included in the consolidated federal tax return of First American. In addition, we have filed consolidated and unitary state income tax returns with First American in jurisdictions where required or permitted. The income taxes associated with our inclusion in First American’s consolidated federal and state income tax returns are included in the income tax receivable line item on the accompanying combined balance sheets. The provision for income taxes is computed as if we filed our federal and state income tax returns on a stand-alone basis.

Depreciation and amortization lives for assets. We are 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.

 

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Share-based compensation. We have and will participate in First American’s share-based compensation plans up to the date of the separation and record compensation expense based on First American equity awards granted to our employees.

First American 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 (with limited exceptions). The cost is recognized over the period during which an employee is required to provide services in exchange for the award. In accordance with the modified prospective method, First American continues to use the Black-Scholes option-pricing model for all unvested options as of December 31, 2005. First American selected the binomial lattice option-pricing model to estimate the fair value for any options granted after December 31, 2005. First American utilizes the straight-line single option method of attributing the value of share-based compensation expense unless another expense attribution model is required by the guidance. As stock-based compensation expense recognized in the results of operations is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. First American applies the long-form method for determining the pool of windfall tax benefits.

First American’s primary means of share-based compensation is granting restricted stock units (“RSUs”). The fair value of any RSU grant is based on the market value of First American’s shares on the date of grant and is generally recognized as compensation expense over the vesting period. RSUs granted to certain key employees have graded vesting and have a service and performance requirement and are therefore expensed using the accelerated multiple-option method to record share-based compensation expense. All other RSU awards have graded vesting and service is the only requirement to vest in the award and are therefore generally expensed using the straight-line single option method to record share-based compensation expense. RSUs receive dividend equivalents in the form of RSUs having the same vesting requirements as the RSUs initially granted.

In connection with the separation, all outstanding First American equity awards, whether vested or unvested, will convert into awards with respect to shares of common stock of the company that continues to employ the holder following the separation. The number of shares underlying each such award and, with respect to options, the per share exercise price of each such award will be adjusted to maintain, on a post-separation basis, the pre-separation value of such awards. We expect no material change to the vesting terms or other terms and conditions applicable to the awards.

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

Recent Accounting Pronouncements:

In June 2009, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance surrounding the Hierarchy of Generally Accepted Accounting Principles. This guidance established the FASB Accounting Standards Codification (“the Codification” or “ASC”) as the official single source of authoritative GAAP. All guidance contained in the Codification carries an equal level of authority. All existing accounting standards are superseded. All other accounting guidance not included in the Codification will be considered non-authoritative. The Codification also includes all relevant SEC guidance organized using the same topical structure in separate sections within the Codification. Following the Codification, the FASB will not issue new standards in the form of Statements, FASB Staff Positions or Emerging Issues Task Force Abstracts. Instead, it will issue Accounting Standards Updates which will serve to update the Codification, provide background information about the guidance and provide the basis for conclusions on the changes to the Codification. The Codification is not intended to change GAAP, but it will change the way GAAP is organized and presented. The Codification is effective for financial statements issued for interim and annual periods ending after September 15, 2009. Except for codifying existing GAAP, the adoption of this statement did not have an impact on the determination or reporting of our combined financial statements.

 

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In September 2006, the FASB issued guidance related to defining fair value, establishing a framework for measuring fair value within GAAP, and expanding disclosure requirements regarding fair value measurements. Although this guidance does not require any new fair value measurements, its application may, in certain instances, change current practice. Where applicable, this guidance simplifies and codifies fair value related guidance previously issued within GAAP. In February 2008, the FASB issued authoritative guidance which delayed the effective date for application of the fair value framework to non-financial assets and non-financial liabilities until January 1, 2009. The provisions of this guidance related to financial assets and liabilities were applied as of January 1, 2008, and had no material effect on our combined financial statements. The fair value framework relating to non-financial assets and non-financial liabilities was applied as of January 1, 2009, and had no material effect on our combined financial statements. In October 2008, the FASB issued supplemental guidance relating to determining the fair value of a financial asset when the market for that asset is not active. This guidance clarifies the application of the fair value framework in cases where a market is not active. We considered the supplemental guidance in our determination of estimated fair values as of December 31, 2009 and 2008, and the impact was not material.

In February 2007, the FASB issued authoritative guidance permitting companies to elect to measure many financial assets and liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. We adopted this guidance effective January 1, 2008, but did not apply it to any assets or liabilities and, therefore, the adoption had no effect on our combined financial statements.

In April 2009, the FASB issued authoritative guidance surrounding the determination of fair value when the volume and level of activity for an asset or liability have significantly decreased and identifying transactions that are not orderly. The guidance indicates that if an entity determines that either the volume and/or level of activity for an asset or liability has significantly decreased (from normal conditions for that asset or liability) or price quotations or observable inputs are not associated with orderly transactions, increased analysis and management judgment will be required to estimate fair value. The guidance is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted. Further, this guidance must be applied prospectively. We elected to adopt the guidance in the first quarter of 2009. The adoption of the guidance did not have a material impact on our combined financial statements.

In April 2009, the FASB issued guidance relating to fair value disclosures in public entity financial statements for financial instruments. This guidance increases the frequency of those disclosures, requiring public entities to provide the disclosures on a quarterly basis, rather than annually. The guidance is effective for interim and annual periods ending after June 15, 2009. We adopted this guidance in the second quarter of 2009. Except for the disclosure requirements, the adoption of this guidance did not have an impact on our combined financial statements.

In April 2009, the FASB issued guidelines which establish a new method of recognizing and reporting other-than-temporary impairments of debt securities. It also contains additional disclosure requirements related to debt and equity securities and changes existing impairment guidance. For debt securities, the “ability and intent to hold” provision is eliminated, and impairment is considered to be other-than-temporary if an entity (i) intends to sell the security, (ii) more likely than not will be required to sell the security before recovering its cost, or (iii) does not expect to recover the security’s entire amortized cost basis (even if the entity does not intend to sell). This new framework does not apply to equity securities (i.e., impaired equity securities will continue to be evaluated under previously existing guidance). The “probability” standard relating to the collectability of cash flows is eliminated, and impairment is now considered to be other-than-temporary if the present value of cash flows expected to be collected from the debt security is less than the amortized cost basis of the security. The guidance also provides that for debt securities which (i) an entity does not intend to sell and (ii) it is not more likely than not that the entity will be required to sell before the anticipated recovery of its remaining amortized cost basis, the impairment is separated into the amount related to estimated credit losses and the amount related to all other factors. The amount of the total impairment related to all other factors is recorded in accumulated other comprehensive loss and the amount related to estimated credit loss is recognized as a charge against current period earnings. This guidance is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted. We elected to adopt this guidance in the first quarter of 2009. See the discussion in Note 3 Debt and Equity Securities to the combined financial statements regarding the impact of adoption.

 

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In April 2009, the SEC issued authoritative guidance surrounding other-than-temporary impairment which amended existing SEC guidance relating to other-than-temporary impairment for certain investments in debt and equity securities. The guidance maintains the SEC staff’s previous views related to equity securities, but now excludes debt securities from its scope. We elected to adopt this guidance in the first quarter of 2009. There was no material impact on our combined financial statements as a result of adopting this guidance.

In December 2007, the FASB revised authoritative guidance surrounding business combinations. The guidance retains the fundamental requirements contained in the original pronouncement. For example, the acquisition method of accounting, previously known as the purchase method, is required to be used for all business combinations and for an acquirer to be identified for each business combination. This revised guidance establishes principles and requirements for how the acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree; recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. Further, this guidance requires contingent consideration to be recognized at its fair value on the acquisition date and, for certain arrangements, changes in fair value to be recognized in earnings until settled. This guidance also requires acquisition-related transaction and restructuring costs to be expensed rather than treated as part of the cost of the acquisition. We adopted this guidance on January 1, 2009 and the adoption did not have a material impact on our combined financial statements.

In April 2009, the FASB issued supplemental guidance surrounding accounting for assets acquired and liabilities assumed in a business combination that arise from contingencies. The FASB voted to carry forward the requirements under existing guidelines surrounding business combinations for acquired contingencies, which required contingencies to be recognized at fair value on the acquisition date if the fair value could be reasonably estimated during the allocation period. Otherwise, companies would typically account for the acquired contingencies in accordance with authoritative literature surrounding accounting for contingencies. As a result of the requirement to carry forward the accounting treatment for acquired contingencies, accounting for pre-acquisition contingencies may be an exception to the recognition and fair value measurement under authoritative guidance surrounding business combinations. Additionally, the FASB voted to change the accounting for an acquiree’s pre-existing contingent consideration arrangement that was assumed by the acquirer as part of the business combination. Such arrangements will now be accounted for as contingent consideration by the acquirer. The revised guidance is effective for all business combinations for which the acquisition date was on or after January 1, 2009. The adoption of this guidance had no impact on our combined financial statements.

In December 2007, the FASB issued guidance surrounding noncontrolling interest in consolidated financial statements—an amendment to existing authoritative literature. The newly issued guidance requires recharacterizing minority interests as noncontrolling interests in addition to classifying noncontrolling interest as a component of equity. The guidance also establishes reporting requirements to provide disclosures that identify and distinguish between the interests of the parent and the interests of noncontrolling owners. This guidance requires retroactive adoption of the presentation and disclosure requirements for existing minority interests—all other requirements are to be applied prospectively. All periods presented in these combined financial statements reflect the presentation and disclosure required by this guidance. All other requirements under the guidance are being applied prospectively. We adopted this guidance on January 1, 2009. Except for the presentation and disclosure requirements required by this guidance, there was no impact on our combined financial statements.

In May 2009, the FASB issued authoritative guidance relating to the disclosure of subsequent events. This guidance is modeled after the same principles as the subsequent event guidance in auditing literature with some terminology changes and additional disclosures. This guidance is effective for interim and annual periods ending after June 15, 2009, and is required to be applied prospectively. We adopted the guidance in the second quarter of 2009. Except for the disclosure requirements, the adoption of the guidance had no impact on our combined financial statements.

 

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In February 2010, the FASB issued updated guidance which amended the subsequent events disclosure requirements to eliminate the requirement for SEC filers to disclose the date through which it has evaluated subsequent events, clarify the period through which conduit bond obligors must evaluate subsequent events and refine the scope of the disclosure requirements for reissued financial statements. The updated guidance was effective upon issuance. Except for the disclosure requirements, the adoption of the guidance had no impact on our combined financial statements.

In December 2008, the FASB issued guidance that expands the disclosures required in an employer’s financial statements about pension and other postretirement benefit plan assets. The new disclosures include more details about the categories of plan assets and information regarding fair value measurements. This guidance is effective for fiscal years ending after December 15, 2009. We adopted the guidance in the fourth quarter of 2009 and except for the disclosure requirements, the adoption had no impact on our combined financial statements.

Pending Accounting Pronouncements:

In January 2010, the FASB issued updated guidance related to fair value measurements and disclosures, which requires a reporting entity to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and to describe the reasons for the transfers. In addition, in the reconciliation for fair value measurements using significant unobservable inputs, or Level 3, a reporting entity should disclose separately information about purchases, sales, issuances and settlements (that is, on a gross basis rather than one net number). The updated guidance also requires that an entity should provide fair value measurement disclosures for each class of assets and liabilities and disclosures about the valuation techniques and inputs used to measure fair value for both recurring and non-recurring fair value measurements for Level 2 and Level 3 fair value measurements. The updated guidance is effective for interim or annual financial reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward activity in Level 3 fair value measurements, which are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. We do not expect the adoption of this standard will have a material impact on our combined financial statements.

In June 2009, the FASB issued guidelines relating to transfers of financial assets which amended existing guidance by removing the concept of a qualifying special purpose entity and establishing a new “participating interest” definition that must be met for transfers of portions of financial assets to be eligible for sale accounting, clarifies and amends the derecognition criteria for a transfer to be accounted for as a sale, and changes the amount that can be recognized as a gain or loss on a transfer accounted for as a sale when beneficial interests are received by the transferor. Enhanced disclosures are also required to provide information about transfers of financial assets and a transferor’s continuing involvement with transferred financial assets. This guidance must be applied as of the beginning of an entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited. We do not expect the adoption of this standard will have a material impact on our combined financial statements.

In June 2009, the FASB issued guidance amending existing guidance surrounding the consolidation of variable interest entities to require an enterprise to qualitatively assess the determination of the primary beneficiary of a variable interest entity (“VIE”) based on whether the entity (1) has the power to direct the activities of a VIE that most significantly impact the entity’s economic performance and (2) has the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the VIE. This guidance also requires an ongoing reconsideration of the primary beneficiary, and amends the events that trigger a reassessment of whether an entity is a VIE. Enhanced disclosures are also required to provide information about an enterprise’s involvement in a VIE. This statement is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier

 

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application is prohibited. We are currently evaluating the effect that adoption of this standard will have on our combined financial position and results of operations when it becomes effective in 2010.

Results of Operations

Overview

A substantial portion of the revenues for our title insurance and services segment result from resales and refinancings of residential real estate and, to a lesser extent, from commercial transactions and the construction and sale of new housing. In the specialty insurance segment, revenues associated with the initial year of coverage in both the home warranty and property and casualty operations are impacted by volatility in real estate transactions. Traditionally, the greatest volume of real estate activity, particularly residential resale, has occurred in the spring and summer months. However, changes in interest rates, as well as other economic factors, can cause fluctuations in the traditional pattern of real estate activity.

Residential mortgage originations in the United States (based on the total dollar value of the transactions) increased 40.0% in 2009 when compared with 2008, according to the Mortgage Bankers Association’s January 12, 2010 Mortgage Finance Forecast (the “MBA Forecast”). This increase was primarily due to increased refinance activity. According to the MBA Forecast, the dollar amount of refinance originations and purchase originations increased 76.6% and 1.5%, respectively, in 2009 when compared with 2008. Residential mortgage originations in the United States decreased 23.3% in 2008 when compared with 2007 according to the January 12, 2009 MBA Forecast. This decrease reflected declines in refinance originations and purchase originations of 23.1% and 23.6%, respectively.

Notwithstanding the increase in mortgage originations in 2009 over 2008, our combined operating revenues decreased 8.1% year over year. The decrease in operating revenues was primarily due to lower average revenues per title order closed, which reflected an increased mix of lower-premium refinance orders and a decreased mix of higher-premium commercial and resale orders, as well as the continued decline in home values.

Comparing 2008 with 2007, total operating revenues decreased 27.2%. The decrease in operating revenues was primarily due to the overall declines in mortgage originations, as well as the decline in home values. Offsetting the impact of these factors was the growth in default-related revenues and market share growth at our larger mortgage banking customers.

Our realized pre-tax net investment losses and other-than-temporary impairment losses in 2009, 2008 and 2007 were $25.2 million, $90.8 million and $77.9 million, respectively. These net losses were primarily due to permanent impairment charges.

Total expenses, before income taxes, decreased 14.3% in 2009 from 2008 and 28.7% in 2008 from 2007. The decrease for both years primarily reflected a decline in title insurance agent retention due in large part to the decline in title insurance agent revenues, reductions in employee compensation expense, primarily reflecting employee reductions, a decline in other operating expenses due to overall cost-containment programs and a reduction in interest expense. Contributing to the decrease for 2008 was a reduction in title insurance claims expense primarily due to a lower reserve strengthening adjustment recorded in 2008 as compared to 2007.

Net income attributable to FinCo was $122.4 million for 2009 and net loss attributable to FinCo was $84.0 million and $143.0 million for 2008 and 2007, respectively.

The continued tightening of mortgage credit and the uncertainty in general economic conditions continue to impact the demand for many of our products and services. These conditions have also had an impact on, and continue to impact, the performance and financial condition of some of our customers in different segments in which we operate; should these parties continue to encounter significant issues, those issues may lead to negative impacts on our revenue, claims, earnings and liquidity.

 

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We expect the above mentioned conditions will continue impacting many of our lines of business. Given this outlook, we continue our focus on controlling costs by reducing employee headcount, consolidating offices, centralizing agency and administrative functions, optimizing management structure and rationalizing our brand strategy. We plan to continue these efforts where appropriate. In addition, we will continue to scrutinize the profitability of our agency relationships, increase our offshore leverage and develop new sales opportunities. Beginning at the end of 2008, we initiated an effort to optimize claims handling process through, among other things, the centralization of claims handling, enhanced corporate control over the claims process and claims process standardization.

Title Insurance and Services

 

    2009     2008     2007     2009 vs. 2008     2008 vs. 2007  
                      $ Change     % Change     $ Change     % Change  
    (in thousands, except percentages)  

Revenues

             

Direct operating revenues

  $ 2,127,246      $ 2,269,039      $ 2,944,575      $ (141,793   (6.2   $ (675,536   (22.9

Agent operating revenues

    1,541,739        1,729,440        2,637,105        (187,701   (10.9     (907,665   (34.4
                                                   

Operating revenues

    3,668,985        3,998,479        5,581,680        (329,494   (8.2     (1,583,201   (28.4

Investment and other income

    117,741        158,253        248,483        (40,512   (25.6     (90,230   (36.3

Net realized investment losses and OTTI losses recognized in earnings

    (18,534     (84,515     (77,091     65,981      78.1        (7,424   (9.6
                                                   
    3,768,192        4,072,217        5,753,072        (304,025   (7.5     (1,680,855   (29.2
                                                   

Expenses

             

Salaries and other personnel costs

    1,141,961        1,307,742        1,719,704        (165,781   (12.7     (411,962   (24.0

Premiums retained by agents

    1,237,566        1,374,452        2,111,798        (136,886   (10.0     (737,346   (34.9

Other operating expenses

    832,910        964,010        1,178,637        (131,100   (13.6     (214,627   (18.2

Provision for policy losses and other claims

    205,819        343,559        710,663        (137,740   (40.1     (367,104   (51.7

Depreciation and amortization

    74,289        86,900        88,511        (12,611   (14.5     (1,611   (1.8

Premium taxes

    32,138        42,000        60,944        (9,862   (23.5     (18,944   (31.1

Interest

    14,337        24,739        42,600        (10,402   (42.0     (17,861   (41.9
                                                   
    3,539,020        4,143,402        5,912,857        (604,382   (14.6     (1,769,455   (29.9
                                                   

Income (loss) before income taxes

  $ 229,172      $ (71,185   $ (159,785   $ 300,357      421.9      $ 88,600      55.4   
                                                   

Margins

    6.1     (1.7 )%      (2.8 )%      7.8   447.9        1.0   37.1   
                                                   

Operating revenues from direct title operations decreased 6.2% in 2009 from 2008 and 22.9% in 2008 from 2007. The decrease in 2009 from 2008 was primarily due to a decline in average revenues per order closed, offset in part by an increase in the number of orders closed by our direct operations. The decrease in 2008 from 2007 was primarily due to a decline in both the number of orders closed by our direct operations and in the average revenues per order closed. The average revenues per order closed were $1,352, $1,558 and $1,666 for 2009, 2008 and 2007, respectively. Our direct title operations closed 1,503,300, 1,398,700 and 1,696,500 title orders during 2009, 2008 and 2007, respectively. The fluctuations in closings primarily reflected the change in mortgage origination activity. Operating revenues from agency title operations decreased 10.9% in 2009 from 2008 and 34.4% in 2008 from 2007. These decreases were primarily due to the same factors impacting direct title operations and the cancellation of certain agency relationships. We are continuing to analyze the terms and profitability of our title agency relationships and are working to amend agent agreements to the extent possible. Amendments being sought include, among others, changing the percentage of premiums retained by the agent and the deductible paid by the agent on claims; if changes to the agreements cannot be made, we may elect to terminate certain agreements.

Total operating revenues for the title insurance segment (direct and agency operations) contributed by new acquisitions were $11.5 million, $12.5 million and $67.8 million for 2009, 2008 and 2007, respectively.

 

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Investment and other income decreased 25.6% in 2009 from 2008 and 36.3% in 2008 from 2007. The decrease in 2009 from 2008 primarily reflected declining yields earned from the investment portfolio, a decrease in interest earned on certain escrow deposits, which reflected lower yields and lower balances, and a decrease in investment income at our trust division as a result of a decline in deposits. These decreases were partially offset by an increase in the average investment portfolio balance. The decrease in 2008 from 2007 primarily reflected declining yields earned from the investment portfolio and a decrease in interest earned on certain escrow deposits, which reflected lower yields and lower balances. These decreases were partially offset by an increase in investment income at our trust division as a result of increased deposits.

Net realized investment losses and other-than-temporary impairment losses recognized in earnings for the title insurance segment totaled $18.5 million, $84.5 million and $77.1 million for 2009, 2008 and 2007, respectively. Net realized losses in 2009 primarily reflected $33.1 million in realized impairment losses on this segment’s debt and equity investment portfolio, offset in part by certain realized net investment gains, which included an $8.4 million gain on the sale of a preferred equity security. Net realized losses in 2008 were primarily driven by a $37.3 million write-down to reflect the permanent impairment of a long-term investment in a title insurance agent, a $30.3 million impairment loss on preferred securities issued by the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) and $7.5 million in other long-term asset permanent impairments.

The title insurance segment (primarily direct operations) is labor intensive; accordingly, a major variable expense component is salaries and other 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 salaries and other personnel costs decreased 12.7% in 2009 from 2008 and 24.0% in 2008 from 2007. The decrease in 2009 from 2008 was primarily due to employee reductions, offset in part by employee separations costs, an increase in employee benefit expense due primarily to the profit-driven 401(k) match and salary expense associated with new acquisitions. We reduced staff by approximately 1,050 since the beginning of 2009, incurring $10.8 million in employee separation costs. The 401(k) match, which was not made in 2008, totaled $15.1 million in 2009. Salary expense associated with new acquisitions was $4.8 million. The decrease in 2008 from 2007 was attributable to employee reductions, salary reductions, the modification of bonus programs and reductions in employee benefits expense, including the profit-driven 401(k) match, offset in part by employee separation costs. The reduction in the profit-driven 401(k) match is due to the fact that we did not meet the requirement for a 401(k) plan match in 2008. We reduced staff by approximately 4,300 since the beginning of 2008, incurring approximately $23.7 million in employee separation costs.

We continue to closely monitor order volumes and related staffing levels and will adjust staffing levels as considered necessary. Our direct title operations opened 1,991,300, 1,960,800, and 2,401,500 orders in 2009, 2008, and 2007, respectively, representing an increase of 1.6% in 2009 over 2008 and a decrease of 18.4% in 2008 from 2007.

A summary of agent retention and agent revenues is as follows:

 

     2009     2008     2007  
     (in thousands, except percentages)  

Agent retention

   $ 1,237,566      $ 1,374,452      $ 2,111,798   
                        

Agent revenues

   $ 1,541,739      $ 1,729,440      $ 2,637,105   
                        

% retained by agents

     80.3     79.5     80.1
                        

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

 

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a result, the percentage of title premiums retained by agents varies due to the geographical mix of revenues from agency operations. This change was primarily due to the cancellation and/or modification of certain agency relationships with unfavorable splits, as well as regional variances (i.e., the agency share or split varies from region to region and thus the geographic mix of agency revenues causes this variation).

Title insurance other operating expenses (principally direct operations) decreased 13.6% in 2009 from 2008 and 18.2% in 2008 from 2007. The decrease in 2009 from 2008 was primarily due to lower occupancy costs as a result of the continued consolidation/closure of certain title offices and other cost-containment programs, offset in part by $6.3 million in other operating costs associated with new acquisitions and $4.4 million in costs associated with office consolidation/closures. The decrease in 2008 from 2007 was primarily due to a decline in title production costs associated with the decrease in business volume, lower occupancy costs as a result of the consolidation/ closure of certain title offices and other cost-containment programs. Partly offsetting these decreases were $26.0 million in costs associated with office consolidation/ closure and $5.0 million in other operating costs associated with new acquisitions.

The provision for title insurance losses, expressed as a percentage of title insurance premiums, escrow and other related fees, was 5.8% in 2009, 8.8% in 2008 and 13.0% in 2007. The current year rate reflects an expected ultimate loss rate of 6.0% for policy year 2009, with a minor downward adjustment to the reserve for certain prior policy years. The prior year rate of 8.8% included a $78.0 million reserve strengthening adjustment. The adjustment reflected changes in estimates for ultimate losses expected, primarily from policy years 2006 and 2007. The changes in estimates resulted primarily from higher than expected claims emergence, in both frequency and aggregate amounts, experienced during 2008, for those policy years. There were many factors that impacted the claims emergence, including but not limited to: decreases in real estate prices during 2008; increases in defaults and foreclosures during 2008; and higher than expected claims emergence from lenders policies. The rate of 13.0% for 2007 included $365.9 million in reserve strengthening adjustments, which reflected changes in estimates for ultimate losses expected, primarily from policy years 2004 through 2006. The changes in estimates resulted primarily from higher than expected claims emergence, in both frequency and aggregate amounts, experienced during 2007. There were many factors that impacted the claims emergence, including but not limited to decreases in real estate prices and increases in defaults and foreclosures during 2007. In addition, the reserve strengthening adjustments reflected a large single fraud loss resulting from a settlement during 2007 of a claim under a closing protection letter issued during 2005. The claim involved multiple properties and the settlement amount exceeded what had been included in reserves for that type of claim, such reserves having been established based on our actuarial analysis. Since the loss was determined to be an isolated event with no future trend component, the adjustment to reserves associated with the closing protection letter only impacted 2007. The reserve strengthening adjustments made during 2007 also reflected an increase in claims emergence from a large title agent related to the geographic expansion of the agent’s business combined with changes in economic conditions. In addition, the adjustments reflected higher-than-expected claims from a recently-acquired underwriter, due to changes in the business strategy with respect to the underwriter post-acquisition combined with unfavorable external economic events. We continuously monitor the impact, if any, of these types of events on our reserve balances and adjust the reserves when facts and circumstances indicate a change is warranted.

The current economic environment appears to have more potential for volatility than usual over the short term, particularly in regard to real estate prices and mortgage defaults, which directly affect title claims. Relevant contributing factors include 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 market conditions appear to be improving, 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 need to 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 are a large portion of our title insurance volume. These policies

 

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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. We believe 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 been experiencing higher losses on mortgage loans from prior years, including loans that were originated during the past several years. 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.

Loss ratios (projected to ultimate value) for policy years 1991-2004 are all below 6.0% and average 4.8%. By contrast, loss ratios for policy years 2005-2007 range from 7.6% to 7.9%. The major causes of the higher loss ratios for those three 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 for policy years 2009 and 2008 are 6.0% and 6.5%, respectively, which are lower than the ratios for 2005 through 2007. These projections are based in part on an assumption that more favorable underwriting conditions existed in 2008 and 2009 than in 2005-2007, including tighter loan underwriting standards and lower housing prices. Current claims data from both policy years 2008 and 2009, 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. Our underwritten title company (noninsurance) subsidiaries are subject to state income tax and do not pay premium tax. Accordingly, our total tax burden at the state level for the title insurance segment is composed of a combination of premium taxes and state income taxes. Premium taxes as a percentage of title insurance operating revenues were 0.9% for 2009 and 1.1% for 2008 and 2007.

In general, the title insurance business is a lower profit margin business when compared to our specialty insurance segment. The lower profit margins reflect the high cost of producing title evidence 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 refinancing 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 operating revenues 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 6.1% for the year ended December 31, 2009. The pre-tax margin losses for the years ended December 31, 2008 and 2007 were 1.7% and 2.8%, respectively.

 

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Specialty Insurance

 

     2009     2008     2007     2009 vs. 2008     2008 vs. 2007  
                       $ Change     % Change     $ Change     % Change  
     (in thousands, except percentages)  

Revenues

              

Operating revenues

   $ 269,631      $ 286,321      $ 302,822      $ (16,690   (5.8   $ (16,501   (5.4

Investment and other income

     13,431        15,657        18,848        (2,226   (14.2     (3,191   (16.9

Net realized investment (losses) gains and OTTI losses recognized in earnings

     (5,523     (4,161     1,771        (1,362   (32.7     (5,932   (335.0
                                                    
     277,539        297,817        323,441        (20,278   (6.8     (25,624   (7.9
                                                    

Expenses

              

Salaries and other personnel costs

     54,907        56,532        60,585        (1,625   (2.9     (4,053   (6.7

Other operating expenses

     41,601        46,840        47,934        (5,239   (11.2     (1,094   (2.3

Provision for policy losses and other claims

     140,895        166,004        165,192        (25,109   (15.1     812      0.5   

Depreciation and amortization

     4,275        3,329        2,190        946      28.4        1,139      52.0   

Premium taxes

     4,346        4,366        4,776        (20   (0.5     (410   (8.6

Interest

     25        24        7        1      4.2        17      242.9   
                                                    
     246,049        277,095        280,684        (31,046   (11.2     (3,589   (1.3
                                                    

Income before income taxes

   $ 31,490      $ 20,722      $ 42,757      $ 10,768      52.0      $ (22,035   (51.5
                                                    

Margins

     11.3     7.0     13.2     4.4   63.1        (6.3 )%    (47.4
                                                    

Specialty insurance operating revenues decreased 5.8% in 2009 from 2008 and 5.4% in 2008 from 2007. These decreases primarily reflected declines in business volume impacting both the property and casualty insurance division and the home warranty division.

Investment and other income decreased 14.2% in 2009 from 2008 and 16.9% in 2008 from 2007. These decreases primarily reflected the decreased yields earned from the investment portfolio.

Net realized investment losses and other-than-temporary impairment losses recognized in earnings for the specialty insurance segment totaled $5.5 million in 2009, compared with net realized losses of $4.2 million in 2008 and net realized gains of $1.8 million for 2007. The current year net realized losses were primarily driven by impairment losses taken on certain debt, preferred equity and common equity securities. The prior year losses were primarily due to realized losses on the sale of certain securities.

Specialty insurance salaries and other personnel costs and other operating expenses decreased 6.6% in 2009 from 2008 and 4.7% in 2008 from 2007. The decreases were 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 operating revenues, was 53.9% in 2009, 60.5% in 2008 and 53.8% in 2007. The decrease in rate in 2009 from 2008 was primarily due to a reduction in the average cost of claims. The increase in rate in 2008 over 2007 was primarily due to an increase in the severity of claims due in part to an increase in the cost of replacing air conditioners with models that met new federal guidelines related to energy efficiency.

 

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The provision for property and casualty claims, expressed as a percentage of property and casualty operating revenues, was 49.8% in 2009, 54.3% in 2008 and 55.6% in 2007. The decrease in the rate in 2009 from 2008 was the result of a decline in seasonal winter storm and wildfire losses, as well as lower routine or core losses.

Premium taxes as a percentage of specialty insurance operating revenues were 1.6% in 2009, 1.5% in 2008 and 1.6% in 2007.

A large part of the revenues for the specialty insurance businesses are not dependent on the level of real estate activity, due to the fact that a large portion are generated from renewals. 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 11.3%, 7.0% and 13.2% for 2009, 2008 and 2007, respectively.

Corporate Division

 

    2009     2008     2007     2009 vs. 2008     2008 vs. 2007  
                      $ Change     % Change     $ Change     % Change  
    (in thousands, except percentages)  

Revenues

             

Investment and other income

  $ 2,267      $ (162   $ 2,157      $ 2,429      1,499.4      $ (2,319   (107.5

Net realized investment losses

    (1,164     (2,147     (2,538     983      45.8        391      15.4   
                                                   
    1,103        (2,309     (381     3,412      147.8        (1,928   (506.0
                                                   

Expenses

             

Salaries and other personnel costs

    21,324        23,901        42,338        (2,577   (10.8     (18,437   (43.5

Other operating expenses

    26,728        31,777        44,971        (5,049   (15.9     (13,194   (29.3

Depreciation and amortization

    3,911        5,013        4,115        (1,102   (22.0     898      21.8   

Interest

    5,457        2,452        —          3,005      122.6        2,452      —     
                                                   
    57,420        63,143        91,424        (5,723   (9.1     (28,281   (30.9
                                                   

Loss before income taxes

  $ (56,317   $ (65,452   $ (91,805   $ 9,135      14.0      $ 26,353      28.7   
                                                   

Corporate salaries and other personnel costs decreased 10.8% in 2009 from 2008 and decreased 43.5% in 2008 from 2007. The decrease in 2009 from 2008 was primarily due to changes in technology initiatives and the impact of other corporate-wide cost saving initiatives that we implemented. The decrease in 2008 from 2007 was primarily due to changes in technology initiatives, salary reductions, employee reductions and the impact of other corporate-wide cost saving initiatives we implemented. Contributing to the reduction in 2008 from 2007 was a decrease in employee benefit and retirement costs.

Corporate other operating expenses decreased 15.9% in 2009 from 2008 and 29.3% in 2008 from 2007. These decreases were primarily due to cost reductions.

Interest expense increased $3.0 million in 2009 over 2008 and increased $2.5 million in 2008 over 2007. Interest expense in 2009 and 2008 related to draws made in 2008 used for our operations in the amount of $140.0 million under First American’s credit agreement that was allocated to us. First American drew on its line of credit and transferred the cash to our subsidiary in 2008 to fund our subsidiary’s statutory capital and surplus. Interest expense in 2009 reflects a full year of expense, while interest expense in 2008 reflects approximately half a year of expense, as the draws were made in the second and third quarters of 2008.

 

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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,  
     2009     2008     2007  
     (in thousands)  

Taxes calculated at federal rate

   $ 67,360      $ (44,321   $ (78,992

State taxes, net of federal benefit

     (612     3,735        1,419   

Tax effect of noncontrolling interests

     681        1,096        2,443   

Dividends received deduction

     (1,381     (526     (1,288

Change in liability for income taxes associated with uncertain tax positions

     (8,776     (1,710     (2,731

Exclusion of certain meals and entertainment expenses

     2,675        3,745        5,139   

Foreign taxes in excess of (less than) federal rate

     10,365        (1,535     112   

Other items, net

     (244     (3,917     (12,489
                        
   $ 70,068      $ (43,433   $ (86,387
                        

Our effective income tax rate (income tax expense as a percentage of income before income taxes), was 34.3% for 2009, 37.5% for 2008 and 41.4% for 2007. The absolute differences in the effective tax rates for 2009 and 2008 were primarily due to changes in the ratio of permanent differences to income before income taxes and noncontrolling interests, reserve adjustments recorded in 2009 and 2008, for which corresponding tax benefits were recognized, as well as changes in state and foreign income taxes resulting from fluctuations in our noninsurance and foreign subsidiaries’ contribution to pretax profits. In addition, certain interest and penalties relating to uncertain tax positions were released during the year based on changes in facts and circumstances associated with the related tax uncertainty. The changes in the liability for income taxes associated with uncertain tax positions in 2009, 2008 and 2007 relate primarily to statutes of limitation closures.

Net income (loss) and net income (loss) attributable to FinCo

Net income (loss) is summarized as follows:

 

     2009    2008     2007  
     (in thousands)  

Net income (loss)

   $ 134,277    $ (72,482   $ (122,446

Less: Net income attributable to noncontrolling interests

     11,888      11,523        20,537   
                       

Net income (loss) attributable to FinCo

   $ 122,389    $ (84,005   $ (142,983
                       

Net income attributable to noncontrolling interests increased $0.4 million in 2009 over 2008 and decreased $9.0 million in 2008 from 2007. Net income attributable to noncontrolling interests was relatively unchanged in 2009 when compared to 2008 due to the profits of our subsidiaries with noncontrolling interests not significantly fluctuating year over year. In addition, the majority of our purchases of subsidiary shares from noncontrolling interests occurred late in the fourth quarter of 2009, which did not result in a significant impact to net income attributable to noncontrolling interests for 2009. The decrease in net income attributable to noncontrolling interests in 2008 from 2007 was primarily due to decreases in the profits of certain companies, of which we are the majority owner, within our title insurance and services segment for 2008 and purchases of subsidiary shares from noncontrolling interests related to our specialty insurance segment during 2008 and 2007.

 

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Liquidity and Capital Resources

Cash provided by operating activities amounted to $229.7 million and $105.2 million for the years ended December 31, 2009 and 2008, respectively, and cash used by operating activities amounted to $60.6 million for the year ended December 31, 2007, after net claim payments of $452.2 million, $482.2 million and $467.7 million, respectively. The principal nonoperating uses of cash and cash equivalents for the three years ended December 31, 2009 were for acquisitions (including the acquisition of noncontrolling interests), additions to the investment portfolio, capital expenditures, dividends, distributions to noncontrolling shareholders and the repayment of debt. The most significant nonoperating sources of cash and cash equivalents were the proceeds from the allocated portion of First American debt, net investment activity by First American, and proceeds from the sales and maturities of certain marketable and other long-term investments. The net effect of all activities on total cash and cash equivalents were decreases of $140.6 million, $182.7 million and $644.4 million for 2009, 2008 and 2007, respectively.

In 2008, First American drew down on its credit line in the amount of $140.0 million and distributed the cash to our subsidiary to fund our subsidiary’s statutory capital and surplus. Consequently, this amount has been pushed down in our combined financial statements and we have recorded the corresponding interest expense in our combined statements of income (loss). In November 2005, First American amended its $500.0 million credit agreement that was originally entered into in August 2004. The November 2005 amendment extended the expiration date to November 2010 and permitted First American to increase the credit amount to $750.0 million under certain circumstances. In July 2007, the credit agreement was further amended to extend the expiration date to July 2012. In November 2009, the credit agreement was again amended to allow for First American to acquire the remaining noncontrolling interest in one of its subsidiaries. Under the credit agreement First American is required to maintain certain minimum levels of capital and earnings and meet predetermined debt-to-capitalization ratios. At December 31, 2009, First American was in compliance with the debt covenants under the amended and restated credit agreement.

As a condition of the separation, we anticipate entering into a new credit facility that will have available credit of $400.0 million, for which we anticipate drawing $200.0 million in connection with the separation. The funds received from this credit facility will be used to pay down the $140.0 million of First American debt allocated to us. The incremental $60.0 million draw represents the additional portion of the borrowings on the First American credit facility that we anticipate paying to First American at the separation date and will be reflected as a distribution to First American through invested equity.

Notes and contracts payable as well as the allocated portion of First American debt, as a percentage of total capitalization, was 11.3% as of December 31, 2009, as compared with 13.0% as of the prior year end. This decrease was primarily attributable to the decrease in debt levels during the year and the increase in equity due to profitability and increase in other comprehensive income. Notes and contracts payable and the allocated portion of First American debt are more fully described in Note 10 Notes and Contracts Payable and Allocated Portion of First American Debt to the combined financial statements.

As of December 31, 2009, our debt and equity investment securities portfolio consists of approximately 96% of fixed income securities. As of that date, over 83% of our fixed income investments are held in securities that are United States government-backed or rated AAA, and approximately 96% 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 (“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.

 

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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
 

December 31, 2009

      

U.S. Treasury bonds

   100.0   0.0   0.0

Municipal bonds

   99.2   0.8   0.0

Foreign bonds

   100.0   0.0   0.0

Governmental agency bonds

   100.0   0.0   0.0

Governmental agency mortgage-backed and asset-backed securities

   100.0   0.0   0.0

Non-agency mortgage-backed and asset-backed securities

   11.3   7.5   81.2

Corporate debt securities

   90.1   4.9   5.0

Preferred stock

   0.0   8.1   91.9
                  
   92.9   0.9   6.2
                  

Approximately 35% of our municipal bonds portfolio has third party insurance in effect.

The table below summarizes the composition of our non-agency mortgage-backed and asset-backed securities by collateral type, year of issuance and credit ratings. 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.

 

(in thousands, except percentages and number of securities)

  Amortized
Cost
  Estimated
Fair
Value
  Number
of
Securities
  A-Ratings
or Higher
    BBB+
to BBB-
Ratings
    Non-
Investment
Grade
 

Non-agency mortgage-backed securities:

           

Prime single family residential:

           

2007

  $ 7,615   $ 2,558   1   0.0   0.0   100.0

2006

    44,789     25,458   11   0.0   0.5   99.5

2005

    13,967     10,292   8   37.2   49.5   13.3

2003

    941     853   4   100.0   0.0   0.0

Alt-A single family residential:

           

2007

    22,542     16,286   2   0.0   0.0   100.0

Non-agency asset-backed securities

    4,600     3,754   5   100.0   0.0   0.0
                                 
  $ 94,454   $ 59,201   31   11.4   7.5   81.1
                                 

As of December 31, 2009, eleven non-agency mortgage-backed and asset-backed securities with an amortized cost of $30.8 million and an estimated fair value of $19.9 million were on negative credit watch by S&P or Moody’s.

We assessed our non-agency mortgage-backed and asset-backed securities portfolio to determine what portion of the portfolio, if any, is other-than-temporarily impaired at December 31, 2009. Our analysis of the portfolio included our expectations of the future performance of the underlying collateral, including, but not limited to, prepayments, defaults, and loss severity assumptions. In developing these expectations, we utilized publicly available information related to individual assets, analysts’ expectations on the expected performance of similar underlying collateral and certain of First American’s securities data and market analytic tools. Based on this analysis, we recognized total other-than-temporary impairments of $45.0 million associated with non-agency mortgage-backed and asset-backed securities for the year ended December 31, 2009. $18.8 million of other-than-

 

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temporary impairments were considered to be credit related, which is the difference between the present value of the cash flows expected to be collected and the amortized cost basis, and were recognized in earnings for the year ended December 31, 2009 and the remaining $26.2 million of other-than-temporary impairment losses were considered to be related to factors other than credit and were recognized in accumulated other comprehensive loss for the year ended December 31, 2009.

In addition to our debt and equity investment securities portfolio, we maintain certain money-market and other short-term investments.

Due to our liquid-asset position and our ability to generate cash flows from operations, we believe that our resources are sufficient to satisfy our anticipated operational cash requirements and obligations for at least the next twelve months. After the separation, we expect to pay an annual cash dividend of $24.0 million to our shareholders.

Off-balance sheet arrangements and contractual obligations. We administer escrow deposits and trust assets as a service to our customers. Escrow deposits totaled $2.9 billion and $3.8 billion at December 31, 2009 and 2008, respectively, of which $0.9 billion and $1.04 billion, respectively, were held at our federal savings bank subsidiary, First American Trust, FSB. The escrow deposits held at First American Trust, FSB, are included in the accompanying combined balance sheets, with $794.3 million and $909.3 million included in debt and equity securities at December 31, 2009, and 2008, respectively, and $70.6 million and $135.2 million included in cash and cash equivalents at December 31, 2009 and 2008, respectively, with offsetting liabilities included in demand deposits. The remaining escrow deposits were held at third-party financial institutions.

Trust assets totaled $2.9 billion and $3.4 billion at December 31, 2009 and 2008, respectively, and were held at First American Trust, FSB. Escrow deposits held at third-party financial institutions and trust assets are not considered our assets under U.S. generally accepted accounting principles (“GAAP”) and, therefore, are not included in the accompanying combined balance sheets. However, we could be held contingently liable for the disposition of these assets.

In conducting our operations, we often hold customers’ assets in escrow, pending completion of real estate transactions. As a result of holding these customers’ assets in escrow, we have 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 combined financial statements as income or a reduction in expense, as appropriate, based on the nature of the arrangement and benefit earned.

We facilitate 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, we hold the proceeds from sales transactions and take 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 us is transferred to the customer. Like-kind exchange funds held by us for the purpose of completing such transactions totaled $385.0 million and $553.1 million at December 31, 2009 and 2008, respectively, of which $186.0 million and $173.9 million at December 31, 2009 and 2008, respectively, were held at our thrift subsidiary, First Security Business Bank (“FSBB”). The like-kind exchange deposits held at FSBB are included in the accompanying combined balance sheets, in cash and cash equivalents with offsetting liabilities included in demand 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 our assets under GAAP and, therefore, are not included in the accompanying combined balance sheets. All such amounts are placed in bank deposits with FDIC insured institutions. We could be held contingently liable to the customer for the transfers of property, disbursements of proceeds and the return on the proceeds.

 

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A summary, by due date, of our total contractual obligations at December 31, 2009, is as follows:

 

    Notes and
contracts
payable
  Interest on
notes and
contracts
payable
  Operating
leases
  Claim
losses
  Allocated
portion of
First American
debt (1)
  Interest on
allocated portion
of First American
debt
  Total
    (in thousands)

2010

  $ 40,520   $ 5,702   $ 96,573   $ 319,490     —     $ 1,829   $ 464,114

2011

    19,279     3,776     71,331     195,279     —       1,829     291,494

2012

    7,784     2,821     50,611     149,600   $ 140,000     1,067     351,883

2013

    4,914     2,498     35,382     113,577     —       —       156,371

2014

    11,642     2,114     21,454     84,724     —       —       119,934

Later years

    35,174     26,335     28,481     365,087     —       —       455,077
                                         
  $ 119,313   $ 43,246   $ 303,832   $ 1,227,757   $ 140,000   $ 4,725   $ 1,838,873
                                         

 

(1) We are contractually obligated to repay the $140.0 million allocated portion of First American debt July 2012, however we anticipate the debt will be repaid in 2010, in connection with the separation.

The timing of claim payments is estimated and is not set contractually. Nonetheless, based on historical claims experience, we anticipate 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. We are not able to reasonably estimate the timing of payments, or the amount by which the liability for our uncertain tax positions will increase or decrease over time; therefore the liability of $10.4 million has not been included in the contractual obligations table (see Note 12 Income Taxes to the combined financial statements). We anticipate that the $140.0 million allocated portion of First American debt will be repaid in connection with the separation. We anticipate repaying the amount owed by drawing $200.0 million on the credit facility we expect to put in place prior to the separation. The incremental $60.0 million draw represents the additional portion of the borrowings on the First American credit facility that we anticipate we will be responsible for paying to First American at the separation date and will be reflected as a distribution to First American through invested equity. We anticipate this new credit facility will mature in 2013.

Pursuant to various insurance and other regulations, the maximum amount of dividends, loans and advances available to us in 2010 from our insurance subsidiaries is $258.0 million. Such restrictions have not had, nor are they expected to have, an impact on our ability to meet our cash obligations. See Note 2 Statutory Restrictions on Investments and Invested Equity to the combined financial statements.

 

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QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk

We have interest rate risk associated with certain financial instruments. We monitor our risk associated with fluctuations in interest rates and make investment decisions to manage the perceived risk. However, we do 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, 2009 that are sensitive to changes in interest rates and presents cash flows and the related weighted average interest rates by expected maturity dates.

 

    2010     2011     2012     2013     2014     Thereafter     Total   Fair Value  
    (in thousands except percentages)  

Assets

               

Deposits with Savings and Loans

               

Book Value

  $ 123,774                $ 123,774   $ 123,774   

Average Interest Rate

    1.34                 100.0

Debt Securities

               

Amortized Cost

  $ 105,022      59,116        149,016      127,645      134,524      1,285,508      $ 1,860,831   $ 1,838,719   

Average Interest Rate

    1.84   5.24     3.08   3.07   3.52   2.75       98.8

Related Party Notes Receivable

               

Book Value

  $ 135,000      423            52,402      $ 187,825   $ 187,094   

Average Interest Rate

    4.50   3.00         4.48       99.6

Loans Receivable

               

Book Value

  $ 43      3,111        3,221      2,260      2,808      153,385      $ 164,828   $ 165,130   

Average Interest Rate

    3.00   7.35     7.52   6.95   6.26   6.67       100.2

Liabilities

               

Interest Bearing Escrow Deposits

               

Book Value

  $ 670,308                $ 670,308   $ 670,308   

Average Interest Rate

    0.61                 100.0

Variable Rate Demand Deposits

               

Book Value

  $ 215,031                $ 215,031   $ 215,031   

Average Interest Rate

    0.33                 100.0

Fixed Rate Demand Deposits

               

Book Value

  $ 27,829      9,896        5,238      616      2,035        $ 45,614   $ 46,249   

Average Interest Rate

    3.10   3.10     4.05   3.92   3.17         101.4

Notes and Contracts Payable

               

Book Value

  $ 40,520      19,279        7,784      4,914      11,642      35,174      $ 119,313   $ 119,804   

Average Interest Rate

    5.44   5.55     4.96   4.89   4.85   5.20       100.4

Allocated portion of First American debt

               

Book Value

      $ 140,000            $ 140,000   $ 124,206   

Average Interest Rate

        1.31             88.7

Equity Price Risk

We are also subject to equity price risk related to our equity securities portfolio. At December 31, 2009, we had equity securities with a cost of $48.1 million and fair value of $51.0 million. We currently manage our equity price risk through an investment committee made up of certain senior executives which is advised by an internal investment advisory committee.

Foreign Currency Risk

Although we have exchange rate risk for our operations in certain foreign countries, these operations, in the aggregate, are not material to our financial condition or results of operations. We do not hedge any of our foreign exchange risk.

Credit Risk

Our corporate, municipal, foreign, non-agency mortgage-backed and asset-backed and, to a lesser extent, our agency securities are subject to credit risk. We manage our credit risk through diversification and concentration limits by asset type as established by our investment committee.

 

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Our non-agency mortgage-backed and asset-backed securities credit risk is analyzed by monitoring servicer reports and through utilization of sophisticated cash flow models to measure the underlying collateral pools. We performed a sensitivity analysis on the estimated investment losses on our non-agency mortgage-backed and asset-backed securities portfolio assuming a hypothetical 20% increase in credit losses on the underlying pools of mortgages or other assets. At December 31, 2009, such an increase in credit losses would result in an approximate decline in cash flows on the non-agency portfolio of less than 4.0%. Actual results could vary from the estimated results of the sensitivity analysis.

We hold a large concentration in US government agency securities, including agency mortgage-backed securities. In the event of discontinued US government support of its agencies, material credit risk could be observed in the portfolio. We view that scenario unlikely but possible.

Our overall investment securities portfolio maintains an average credit quality of AA.

 

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BUSINESS

General

FinCo, through its subsidiaries, will be 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, escrow or closing services and similar or related financial services domestically and internationally in connection with residential and commercial real estate transactions. It also maintains, manages and provides access to automated title plant records and images and provides thrift, 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 each of these business segments is included in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Financial Statements” sections of this information statement.

Strengths

Financial Strength. Our principal title insurance underwriter, First American Title Insurance Company, maintained approximately $802.3 million of statutory surplus capital as of December 31, 2009. In addition, at the time of the distribution, relative to our title industry peers, we expect to have a low debt-to-capital ratio, a sound investment portfolio and strong financial strength ratings. This financial strength benefits our policyholders. We believe it also improves our ability to market our products, particularly in connection with commercial and international transactions as well as domestic transactions involving lenders with a national presence or other parties that are focused on counter-party credit risk.

Brand Recognition. We have been a leader in the title industry for more than a century. Customers, including consumers, independent escrow or closing services companies, real estate agents and brokers, developers, mortgage brokers, mortgage bankers, financial institutions and attorneys, associate the “First American” brand with stability and customer service. We believe that this strong brand awareness in the real estate community enhances the demand for our products and services.

Diversified Geographic, Distribution and Product Mix. We conduct business in all 50 states as well as various countries including Canada, the United Kingdom and others. We also market various title and related products through several channels. The ability to generate revenues across a diversified mix of geographies, with a variety of products and through multiple distribution channels enables us to benefit from opportunities as they arise. At the same time, this diversity potentially mitigates the effects of negative trends that may occur in a given geography or product line.

Long-term Customer Relationships. We have many long-term relationships with both national and local customers. In some cases we have been providing our products and services to particular lenders, real estate agents, brokers and attorneys for decades. The loyalty of many of our customers provides a recurring level of transaction activity.

Strong Market Position. According to American Land Title Association data, we maintained approximately 28.7 percent of the domestic title insurance market as of September 30, 2009. This strong market position enables us to achieve economies of scale and to leverage efficiently our technology and global resources.

Technology. We have developed an integrated proprietary technology application to facilitate uniformity across our direct title operations and our escrow/closing services in the United States. This technology permits us to share information and coordinate efforts at all levels of the title production and closing process. A common approach across technology applications is also being developed to standardize other functions such as agency administration, title claims management, procurement and various corporate functions. We believe this uniform approach increases our efficiency and permits us to better serve our customers.

 

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Global Resources. Over the last decade we believe that we have been both an industry and a marketplace leader in global production. We currently utilize these global resources in the performance of various functions that support our businesses, including many aspects of title production. Performing these functions globally significantly decreases our labor costs, allows for enhanced leveraging of our integrated technology applications, and improves customer responsiveness by permitting on-shore and off-shore personnel to work together, in many instances, over a 24-hour cycle. The majority of individuals supporting our off-shore efforts are employed either by us or by entities in which we have an ownership interest. Even where we do not maintain an ownership interest, our off-shore service providers generally have a workforce dedicated to our business. This enables us to control quality, ensure security and effectively manage costs. We have maintained long-term relationships with most of these service providers, although the agreements are generally terminable by either party upon 90 to 180 days’ prior notice. We maintain relationships with service providers in varying geographies to provide for continuity in the event of any temporary or permanent loss of capacity in any given location. We believe that our extensive global experience and dedicated resources give us a competitive advantage over industry participants that do not have, or are now attempting to develop, similar capabilities.

Management Expertise. Our chief executive officer, Dennis J. Gilmore, who has over twenty years of experience in the settlement services industry, leads a team of innovative, experienced operators throughout our businesses. These operators include the five leaders of our title company’s domestic and international operations, who have a combined 128 years of experience in the industry. In addition to leading our businesses through the ongoing centralization and cost restructuring efforts, Mr. Gilmore led the expansion over the last ten years of First American’s network of global resources. Our executive chairman, Parker S. Kennedy, has over thirty years of experience in the title insurance industry. During this time he has developed and maintained loyal relationships with customers, employees and other industry participants that continue to benefit our company.

Strategy

Increase Operating Margins. We believe that consistent application of the following principles will enhance our earnings:

 

   

Simplification of processes, functions and structures wherever feasible;

 

   

Standardization of these processes and functions across our businesses;

 

   

Centralization of administrative functions where economies of scale can be achieved and expertise can be developed more readily at fewer locations;

 

   

Leveraging uniform technology applications and global resources to lower costs and improve efficiency; and

 

   

Focusing on our customers and on developing our strengths as a leader in the settlement services industry, avoiding the distractions of unrelated businesses.

Centralize Administrative Activities. We intend to continue to centralize capital management, claims handling, technology initiatives, agency administration and most corporate services, while maintaining a customer-focused localized approach to customer-facing functions and other areas where local knowledge is essential to our effectiveness.

Employ Enterprise-wide Technology Platforms. As a complement to the uniform technology application we currently utilize for our domestic operations, we intend to continue consolidating disparate administrative technology applications into uniform major technology platforms. The operation of enterprise-wide technology platforms generally reduces technology spending and also enhances our ability to report, receive and analyze information on a company-wide basis. We also intend to continue to integrate on-shore and off-shore resources through the continued development and deployment of uniform technology platforms to facilitate the global sharing of data and work-product.

 

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Leverage Global Resources. We maintain a significant global workforce dedicated to our business. These resources have enabled us to operate more efficiently, control costs and improve customer responsiveness. As we simplify and standardize processes and functions, we intend to continue to identify those that can be performed more efficiently and effectively through the utilization of these global resources.

Strengthen Customer Relationships Through Superior Service. Throughout our history, we have developed strong relationships with our customers, including many of the large financial institutions in the United States and abroad. We intend to strengthen these important relationships and develop similar relationships with new customers through continuous improvement and by providing superior service.

React Quickly to Changing Market Conditions. The real estate and mortgage markets are cyclical and seasonal. We intend to maintain the flexibility necessary to react quickly to market downturns and to maintain a disciplined approach as market conditions improve.

Focus on Specialized Distribution Channels. We intend to focus on obtaining growth through specialized distribution channels, such as commercial, default, homebuilder and centralized lender channels. Historically business obtained through these channels has been more profitable than other title business due in part to lower facilities and administrative expenses.

Continue to Grow International Operations. Over the past 20 years we believe we have led the industry in expanding our product offerings to other nations, in some cases establishing a market in countries where no market had previously existed. We see opportunities for growth in established foreign markets such as Canada and the United Kingdom as well as emerging markets that either are introducing Western style mortgage systems or have demonstrated a need for greater efficiency in the real estate settlement process. We believe we are ideally situated to seize these opportunities because of our expertise in the industry, financial strength, existing international licenses and meaningful relationships around the world. We intend to take a disciplined, long-term approach to our international expansion.

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 products and services internationally. This segment also provides escrow and closing services, accommodates tax-deferred exchanges of real estate, maintains, manages and provides access to automated title plant records and images and provides investment advisory, trust, lending and deposit services.

Overview of Title Insurance Industry

In most real estate transactions, 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 title. Title insurance policies are issued on the basis of a title report, which is typically prepared after a search of the 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 instances, a visual inspection of the property is also made. To facilitate the preparation of title reports, copies 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

 

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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 unless the owner carries back a mortgage or makes certain warranties as to the title.

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 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, a real estate broker, lawyer, developer, lender or closer involved in the transaction orders 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 company 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 often 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 mortgage lender payoff demands are in hand, the transaction is “closed.” 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 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 requests that the title insurer 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 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 policy can be issued directly by a title insurer or indirectly on behalf of a title insurer through agents, which are not themselves 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. The percentage of the premium 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.

Premiums. The premium for title insurance is 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 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

 

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District of Columbia. In Iowa, we provide title abstracts only because title insurance is not permitted by law. We also offer title insurance and similar products, as well as related services, either directly or through joint ventures in foreign countries, including Canada, the United Kingdom and various other established and emerging markets as described in the “International Operations” section below.

Beginning in 2007, in response to deteriorating market conditions and as part of an effort to enhance our operating efficiency and improve our margins, we began to focus on controlling costs by reducing employee count, consolidating offices, centralizing agency and administrative functions, optimizing management structure and rationalizing our brand strategy. We plan to continue these efforts where appropriate. In addition, we will continue to scrutinize the profitability of our agency relationships, increase our offshore leverage and develop new sales opportunities. Beginning at the end of 2008, we initiated an effort to optimize our claims handling process through, among other things, centralization of claims handling, enhanced corporate control over the claims process and claims process standardization. We substantially completed our claims centralization project during the third quarter of 2009.

Sales and Marketing. Though we endeavor to educate customers on the value of title insurance and the closing process, we can most efficiently market to our primary sources of business referrals, including escrow or closing service providers, real estate agents and brokers, developers, mortgage brokers, mortgage bankers, lenders and attorneys. In addition, we also market our title insurance services directly to large corporate customers and mortgage lenders and servicers. We actively market to mortgage servicers, foreclosure outsourcing providers and investors who are important sources of title insurance business during periods with high levels of foreclosures. We also market our title insurance services to independent agents. Our marketing efforts emphasize the combination of our products, the quality and timeliness of our services, process innovation and our national presence.

We provide our sales personnel with training in our product and service offerings, as well as selling techniques, and local management is responsible for hiring the sales staff and ensuring that sales personnel are properly trained. We also maintain a client relations group to coordinate sales to institutional customers, such as lenders, mortgage servicers, foreclosure outsourcing providers and investors.

We have expanded our commercial business base primarily through increased commercial sales efforts. Because commercial transactions involve higher coverage amounts and higher premiums, commercial title insurance business generally generates greater profit margins than does residential title insurance business. Though current market conditions have proven difficult for this business, we expect that on a relative basis, over the long term, these characteristics still apply. Accordingly, we plan to continue to emphasize our commercial sales program. Our national commercial services division also has a dedicated sales force. One of the responsibilities of the sales personnel of this division is the coordination of marketing efforts directed at large real estate lenders and companies developing, selling, buying or brokering properties on a multi-state basis.

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

International Operations. Over the past 20 years, we have led the industry in global expansion by investing in the development and growth of operations in international markets. We now provide products and services in over 60 countries, and our international operations accounted for approximately 8 percent of our title revenues in 2009. 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. According to data from the American Land Title Association, as of September 30, 2009, our reported overall title insurance market share was close to 60 percent internationally.

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.

 

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We believe that key opportunities for growth exist not only in the relatively established markets, but also in the emerging markets that are heavily reliant on expensive manual business processes and dated technology and land registry systems. As the number of countries adopting Western style mortgage systems continues to increase and as the demand for greater efficiency in the real estate settlement process continues to grow, 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 thirty-nine countries and we have partnered with entities authorized to do business in various additional countries.

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 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 to whom we give varying levels of underwriting authority.

Agency Operations. 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. Although such agency agreements typically are terminable without cause after a specified notice period has been met and are terminable immediately for cause, certain agents have negotiated terms that are more favorable to them. Beginning in early 2008, we intensified our effort to evaluate all of our agency relationships, including a review of premium splits, deductibles and claims. As a result, we terminated or renegotiated the terms of many of our agency relationships. We have also centralized the receipt of agency remittances and are in the process of centralizing other agent-related administrative activities, and we continue to evaluate the profitability of agency relationships.

We have an agent selection process and an agent audit program. 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 conduct periodic audits of our agents. We also maintain agent representatives and agent auditors. Agent auditors routinely perform an examination of the agent’s escrow trust accounts and supporting accounting records. In addition to these routine examinations, an expanded examination 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.

Title Plants. Our network of title plants constitutes one of our principal assets. A title search is conducted by searching the public records or utilizing a title plant holding duplicate public records. While public title records generally are indexed by reference to the names of the parties to a given recorded document, most title plants 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. Most title plants also index prior policies, adding to searching efficiency. Many title plants are automated, or available on-line. 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 automated 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.

Our title plants are carried on our combined balance sheets at original cost, which includes the cost of producing or acquiring interests in title plants or the appraised value of subsidiaries’ title plants at dates of acquisition for companies accounted for as purchases. Thereafter, the cost of daily maintenance of these plants is charged to expense as incurred. A properly maintained title plant has an indefinite life and does not diminish in value with the passage of time. Therefore, in accordance with generally accepted accounting principles, no

 

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provision is made for amortization of these plants. Since each document must be reviewed and indexed into the title plant, such maintenance activities constitute a significant item of expense. We are able to offset a portion of title plant maintenance costs through joint ownership and access agreements with other title insurers and title agents. We continually analyze our title plants for impairment. This analysis includes, but is not limited to, the effects of obsolescence, duplication, demand and other economic events.

Reserves for Claims and Losses. We provide for title insurance losses based upon our historical experience and other factors by a charge to expense when the related premium revenue is recognized. The resulting reserve for known claims and incurred but not reported 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 is 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.

In settling claims, we occasionally purchase and ultimately sell an insured’s interest in the underlying real property or the interest of a claimant adverse to the insured. These assets are carried at the lower of cost or fair value, less costs to sell, and are included in “Other assets” in our combined balance sheets.

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 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 title insurance business 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. Over 30 title insurance underwriters, for example, are members of the American Land Title Association, the title insurance industry’s national trade association. Our major nationwide competitors in our principal markets include Fidelity National Financial, Inc., Stewart Title Guaranty Company and Old Republic International Corporation. 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. During 2008, LandAmerica Financial Group, Inc., believed to be the third largest provider of title insurance in the United States at the time, filed for bankruptcy protection and sold certain of its title insurance underwriters and other assets to Fidelity, which at the time we believed to be the second largest provider of title insurance, which combination produced the largest title insurance provider. In addition to these competitors, small nationwide, regional and local competitors as well as numerous agency operations throughout the country provide aggressive competition on the local level.

We believe that competition for title insurance business is based primarily on both the price of the policy and the quality and timeliness of the service, 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 properties, financial strength is also important. In those states where prices are established by regulatory authorities, the price of title insurance policies is not likely to be an important competitive factor. We continuously 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.

 

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Trust and Investment Advisory Services. Since 1960, we have conducted a general trust business in California, acting as trustee when so appointed pursuant to court order or private agreement. In 1985, we formed a banking subsidiary into which our subsidiary trust operation was merged. During August 1999, this subsidiary converted from a state-chartered bank to a federal savings bank. This subsidiary, First American Trust, FSB, offers investment advisory services and manages equity and fixed-income securities. As of December 31, 2009, this company managed $1.5 billion of assets, administered fiduciary and custodial assets having a market value in excess of $2.9 billion, had assets of $1.0 billion, deposits of $954.6 million and stockholder’s equity of $63.7 million.

Lending and Deposit Products. During 1988, we acquired an industrial bank that accepts deposits and uses deposited funds to originate and purchase loans secured by commercial properties primarily in Southern California. As of December 31, 2009, this company, First Security Business Bank, had approximately $260.6 million of deposits and $161.9 million of loans outstanding.

Loans made or acquired during 2009 by the bank totaled $23.7 million, with an average new loan balance of $1,327,627. The average loan balance outstanding at December 31, 2009, was $678,130. Loans are made only on a secured basis, at loan-to-value percentages generally less than 70 percent. The bank specializes in making commercial real estate loans. The majority of the bank’s loans are made on a fixed-to-floating rate basis. The average coupon on the bank’s loan portfolio as of December 31, 2009, was 6.78 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 bank’s primary competitors in the Southern California commercial real estate lending market are local community banks, other industrial banks and, to a lesser extent, commercial banks. The bank’s average loan to value was approximately 44 percent at December 31, 2009.

The performance of the bank’s loan portfolio is evaluated on an ongoing basis by management of the bank. The bank places a loan on non-accrual status when two payments become past due. When a loan is placed on non-accrual status, the 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, 2009, if all of such loans had been current in accordance with their original terms, totaled $12,084.

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

 

     Year Ended December 31
     2009    2008    2007    2006    2005
     (in thousands)

Nonperforming Assets:

              

Loans accounted for on a nonaccrual basis

   $ 603    $ —      $ —      $ —      $ —  
                                  

Total

   $ 603    $ —      $ —      $ —      $ —  
                                  

Based on a variety of factors concerning the creditworthiness of its borrowers, the bank determined that it had one non-performing asset as of December 31, 2009.

The 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, 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 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 bank’s current allowance for loan losses is an adequate allowance against foreseeable losses.

 

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

 

     Year Ended December 31  
     2009     2008     2007     2006     2005  
     (in thousands, except percentages)  

Allowance for Loan Losses:

          

Balance at beginning of year

   $ 1,600      $ 1,488      $ 1,440      $ 1,410      $ 1,350   
                                        

Charge-offs:

          

Real estate—mortgage

     —          —          —          —          —     

Assigned lease payments

     —          —          —          —          —     
                                        
     —          —          —          —          —     
                                        

Recoveries:

          

Real estate—mortgage

     —          —          —          —          —     

Assigned lease payments

     —          —          —          —          —     
                                        
     —          —          —          —          —     
                                        

Net (charge-offs) recoveries

     —          —          —          —          —     

Provision for losses

     471        112        48        30        60   
                                        

Balance at end of year

   $ 2,071      $ 1,600      $ 1,488      $ 1,440      $ 1,410   
                                        

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

     0     0     0     0     0
                                        

The adequacy of the 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 and general economic conditions. Specific allocations are made as problem or potential problem loans are identified and are based upon an evaluation by the 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 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
    2009   2008   2007   2006   2005
    Allowance   % of
Loans
  Allowance   % of
Loans
  Allowance   % of
Loans
  Allowance   % of
Loans
  Allowance   % of
Loans
    (in thousands, except percentages)

Loan Categories:

                   

Real estate-mortgage

  $ 2,071   100   $ 1,600   100   $ 1,488   100   $ 1,440   100   $ 1,410   100

Other

    —     —       —     —       —     —       —     —         —  
                                                 
  $ 2,071   100   $ 1,600   100   $ 1,488   100   $ 1,440   100   $ 1,410   100
                                                 

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 actively issues 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

 

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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 and 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 and are recognized monthly over the initial contract period. 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 34 states and the District of Columbia.

Corporate

A portion of First American’s corporate function, consisting of certain financing facilities as well as the corporate services that support our business operations, will form FinCo’s corporate function.

Regulation

The title insurance business is heavily regulated by state insurance regulatory authorities. These authorities generally possess broad powers with respect to the licensing of title insurers, the types and amounts of investments that title insurers may make, insurance rates, forms of policies and the form and content of required annual statements, as well as the power to audit and examine title insurers. Under state laws, certain levels of capital and surplus must be maintained and certain amounts of securities must be segregated or deposited with appropriate state officials. Various state statutes require title insurers to defer a portion of all premiums in a reserve for the protection of policyholders and to segregate investments in a corresponding amount. Further, most states restrict the amount of dividends and distributions a title insurer may make to its shareholders.

Our property and casualty businesses are subject to regulation by state insurance regulators in the states in which they transact business.

The nature and extent of regulation to which insurance companies are subject may vary from jurisdiction to jurisdiction, but typically involves prior approval of the acquisition of “control” of an insurance company, regulation of certain transactions entered into by an insurance company with any of its affiliates, the amount and payment of dividends by an insurance company, approval of premium rates and policy forms for many lines of insurance, standards of solvency and minimum amounts of capital and surplus which must be maintained. In order to issue policies on a direct basis in a state, the property and casualty insurer must generally be licensed by such state. In certain circumstances, such as placements through licensed surplus lines brokers, it may conduct business without being admitted and without being subject to rate and policy form approvals.

Our home warranty business is subject to regulation in some states by insurance authorities or other applicable regulatory entities. Our federal savings bank and thrift are both subject to regulation by the Federal Deposit Insurance Corporation. In addition, our federal savings bank is regulated by the United States Department of the Treasury’s Office of Thrift Supervision, and the thrift is regulated by the California Department of Financial Institutions.

Investment Policies

Subject to oversight by our board of directors, we generally intend to continue First American’s practice of overseeing investment activities at the parent company by an investment committee made up of certain senior executives, which is advised by, and has delegated certain functions to, an investment advisory committee. The

 

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investment advisory committee’s members are expected to include the company’s portfolio manager and certain treasury department personnel. Certain day-to-day investment decisions are expected to be delegated to the investment advisory committee, to be made within the guidelines and pursuant to the direction provided by the investment committee from time to time. Policy setting, oversight, and significant individual investment decisions are expected to occur at the investment committee level. In addition, a number of our regulated subsidiaries, including our title insurance underwriters, property and casualty insurance companies and federal savings bank are required to oversee their own investments and maintain investment committees at the subsidiary level. The investment policies and objectives of these regulated subsidiaries depend to a large extent on their particular business and regulatory considerations. 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. The bank currently does not make real estate loans, and therefore fulfills this regulatory requirement predominately through investments in mortgage backed securities. In addition, state laws impose certain restrictions upon the types and amounts of investments that may be made by our regulated insurance subsidiaries.

Pursuant to our investment policy, fiduciary funds are to be managed in a manner designed to ensure return of the principal to the underlying beneficiaries and, where appropriate, an investment return to us. The policy further provides that operating and investment funds are to be managed to balance our earnings, liquidity, regulatory and risk objectives, and that investments should not expose us to excessive levels of credit risk, interest (including call, prepayment and extension) risk or liquidity risk.

As of December 31, 2009, our debt and equity investment securities portfolio consists of approximately 96 percent of fixed income securities. As of that date, over 83 percent of our fixed income investments are held in securities that are United States government-backed or rated AAA, and approximately 96 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.

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, 2009, we employed approximately 13,963 people on either a part-time or full-time basis. Of these employees, approximately 11 percent were employed outside of the United States and approximately 3 percent were employed at unconsolidated subsidiaries.

Properties

We expect to maintain First American’s executive offices at MacArthur Place in Santa Ana, California. In 2005, First American 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, 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 $43.9 million as of December 31, 2009. Our title insurance subsidiary will continue to own and operate these properties, and will lease approximately 24,000 square feet within one of the buildings to InfoCo for its executive offices following the separation pursuant to a lease to be entered into in connection with the separation. The technology center referred to above will be primarily utilized and maintained by FinCo following the separation but will also house physically segregated servers belonging to InfoCo which will continue to be maintained by InfoCo following the separation.

 

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One of our subsidiaries in the title insurance and services segment leases an aggregate of approximately 134,000 square feet of office space in four buildings of the International Technology Park in Bangalore, India. Five of the six leases associated with this space expire in 2012 and the sixth expires in 2010. We have the option to terminate all of the leases in the International Technology Park in 2011.

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

Legal Proceedings

Our subsidiaries have been named in various lawsuits, most of which relate to their title insurance operations. In cases where it has been determined that a loss is both probable and reasonably estimable, a liability representing the best estimate of our financial exposure based on known facts has been recorded. In accordance with accounting guidance, we maintained a reserve for these lawsuits totaling $18.1 million at December 31, 2009. Actual losses may materially differ from the amounts recorded. We do not believe that the ultimate resolution of these cases, either individually or in the aggregate, will have a material adverse effect on our financial condition, results of operations or cash flows.

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. The plaintiff alleges 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. According to the complaint, Fiserv Solutions, Inc., as agent for the defendants, was authorized to issue certificates evidencing that a given loan was insured. The complaint also indicates that plaintiff was required to satisfy certain criteria before title would be insured. This involved (a) reviewing borrower statements to the lender when applying for the loan, (b) reviewing the borrower’s credit report and (c) addressing secured mortgages appearing on the credit report which did not appear on the borrower’s loan application. The plaintiff alleges that the failure to pay or timely respond to the subject claims was done in bad faith and constitutes a breach of the title insurance policies issued to the plaintiff. The plaintiff is seeking monetary damages, punitive damages where permitted, treble damages where permitted, attorneys fees and costs where permitted, declaratory judgment and pre-judgment and post-judgment interest. We are in the process of assessing this complaint and while it is not feasible to predict with certainty the outcome, the ultimate resolution could have a material adverse effect on our financial condition, results of operations or cash flows in the period of disposition.

Our title insurance, property and casualty insurance, home warranty, thrift, trust and investment advisory businesses are regulated by various federal, state and local governmental agencies. Many of our other businesses operate within statutory guidelines. Consequently, we may from time to time be subject to audit or investigation by such governmental agencies. Currently, governmental agencies are auditing or investigating certain of our financial services 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, title insurance customer acquisition and retention practices. With respect to matters where we have determined that a loss is both probable and reasonably estimable, we have recorded a liability representing our best estimate of the financial exposure based on known facts. In accordance with accounting guidance, we maintained a reserve for these matters totaling $2.0 million at December 31, 2009. While the ultimate disposition of each such audit or investigation is not yet determinable, we do not believe that individually or in the aggregate, they will have a material adverse effect on FinCo’s financial condition, results of operations or cash flows. These audits or investigations could result in changes to business practices which could ultimately have a material adverse impact on FinCo’s financial condition, results of operations or cash flows.

Our 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 FinCo’s financial condition, results of operations or cash flows in the period of disposition.

 

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RELATIONSHIP WITH INFOCO

This section summarizes material arrangements between InfoCo and FinCo that are expected to exist following the separation. These arrangements are intended to provide for an orderly transition to our status as an independent, publicly traded company. The companies also are or will be parties to certain ordinary course commercial agreements. Additional or modified agreements, arrangements and transactions may be entered into between InfoCo and FinCo after the separation.

Ownership of InfoCo Shares

On the record date for the distribution, First American will issue a number of shares to us that will result in FinCo and its principal title insurance subsidiary collectively owning approximately $250 million of InfoCo’s issued and outstanding common shares following the distribution. By virtue of our ownership of First American common shares on the record date, we will also receive FinCo common stock in the distribution, which will be canceled promptly following its issuance. We will agree to dispose of the InfoCo common shares within five years after the separation or to bear any adverse tax consequence arising out of holding the shares for longer than that period, as further discussed under “Relationship with InfoCo—Tax Sharing Agreement.”

Agreements with InfoCo

Before the separation, we will enter into a Separation and Distribution Agreement and other agreements with First American to effect the separation and provide a framework f