We lease under a non-cancelable operating lease expiring in 2016 approximately 242,000 square feet in an office building in Houston, Texas, which is used for our corporate offices and for offices of several of our subsidiaries. In addition, we lease offices at approximately 495 additional locations that are used for branch offices, production, administrative and technology centers. These additional locations include significant leased facilities in Austin, Los Angeles, New York, Dallas, Toronto, San Diego and Denver.
The following table sets forth selected consolidated financial data, which were derived from our consolidated financial statements and should be read in conjunction with our audited consolidated financial statements, including the Notes thereto, beginning on page of this Report. See also
For the year ended December 31, 2012, net earnings attributable to Stewart of $109.2 million, or $4.61 per diluted share, represent an improvement of $106.8 million over the same period in 2011. Our strong operating results in 2012 allowed us to release in the fourth quarter $36.6 million ($1.50 per diluted share) of a tax asset valuation allowance (originally established in 2008), representing that portion of the allowance that had not been previously utilized to offset taxable income. The remaining valuation allowance of $12.1 million relates primarily to foreign tax credit carryforwards.
Total revenues in 2012 were $1.9 billion, an increase of 16.9 percent from $1.6 billion in 2011. Revenues from our title segment operations increased 14.6 percent, to $1.7 billion in 2012. Revenues from services provided by our mortgage services segment increased 44.0 percent to $178.0 million in 2012 from $123.6 million in 2011.
2012 title losses as a percentage of title revenues declined to 8.1 percent from 9.4 percent in 2011. Title losses, including adjustments to certain large claims in both periods, decreased 1.5 percent on the 14.7 percent increase in title operating revenues when compared to 2011. Our overall loss experience continued to improve relative to prior year periods and was in line with our actuarial expectations, which allowed us to maintain the lower loss provisioning rate adopted effective with policies issued in the third quarter 2012. Cash claim payments decreased 7.7 percent compared to 2011. Losses incurred on known claims decreased 12.2 percent compared to 2011. The decline in cash claim payments and losses incurred on known claims continues a trend noted for several quarters.
At each quarter end, our recorded reserve for title losses begins with the prior period’s reserve balance for claim losses, adds the current period provision to that balance and subtracts actual paid claims, resulting in an amount that our management compares to its actuarially-based calculation of the ending reserve balance necessary to provide for future title losses. The actuarially-based calculation is a paid loss development calculation where loss development factors are selected based on company data and input from our third-party actuaries. We also obtain input from third-party actuaries in the form of a reserve analysis utilizing generally accepted actuarial methods. While we are responsible for determining our loss reserves, we utilize this actuarial input to assess the overall reasonableness of our reserve estimation. If our recorded reserve amount is within a reasonable range (+/- 4.0%) of our actuarially-based reserve calculation and the actuary’s point estimate, but not at the point estimate, our management assesses the major factors contributing to the different reserve estimates in order to determine the overall reasonableness of our recorded reserve, as well as the position of the recorded reserves relative to the point estimate and the estimated range of reserves. The major factors considered can change from period to period and include items such as current trends in the real estate industry (which management can assess although there is a time lag in the development of this data for use by the actuary), the size and types of claims reported and changes in our claims management process. If the recorded amount is not within a reasonable range of our third-party actuary’s point estimate, we will adjust the recorded reserves in the current period and reassess the provision rate on a prospective basis. Once our reserve for title losses is recorded, it is reduced in future periods as a result of claims payments and may be increased or reduced by revisions to our estimate of the overall level of required reserves.
claim on the newly issued title insurance policy since such policy insures the holder (in this case, the new lender) that all previous liens on the property have been satisfied. Accordingly, these claim payments are charged to policy loss expense. These incurred losses are typically more severe in terms of dollar value compared with traditional title policy claims since the independent agency is often able, over time, to conceal misappropriation of escrow funds relating to more than one transaction through the constant volume of funds moving through its escrow accounts. As long as new funds continue to flow into escrow accounts, an independent agency can mask one or more defalcations. In declining real estate markets, lower transaction volumes result in a lower incoming volume of funds, making it more difficult to cover up the misappropriation with incoming funds. Thus, when the defalcation is discovered, it often relates to several transactions. In addition, the overall decline in an independent agency’s revenues, profits and cash flows increases the agency’s incentive to improperly utilize the escrow funds from real estate transactions.
Internal controls relating to independent agencies include, but are not limited to, pre-signing and periodic audits, site visits and reconciliations of policy inventories and premiums. The audits and site visits cover examination of the escrow account bank reconciliations and an examination of a sample of closed transactions. In some instances, the scope of our review is limited by attorney agencies that cite client confidentiality. Certain states have mandated annual reviews of all agencies by their underwriter. We also determine whether our independent agencies have appropriate internal controls as defined by the American Land Title Association and us. However, even with adequate internal controls in place, their effectiveness can be circumvented by collusion or improper override of the controls by management at the independent agencies. To aid in the selection of independent agencies to review, we have developed an agency risk model that aggregates data from different areas to identify possible problems. This is not a guarantee that all independent agencies with deficiencies will be identified. In addition, we are typically not the only underwriter for which an independent agency issues policies, and independent agencies may not always provide complete financial records for our review.
Industry data. Published mortgage interest rates and other selected residential data for the years ended December 31, 2012, 2011 and 2010 follow (amounts shown for 2012 are preliminary and subject to revision). The amounts below may not relate directly to or provide accurate data for forecasting our operating revenues or order counts.
A comparison of our results of operations for 2012 with 2011 and 2011 with 2010 follows. Factors contributing to fluctuations in results of operations are presented in the order of their monetary significance, and we have quantified, when necessary, significant changes. Results from our mortgage services and corporate segments are included in year-to-year discussions and, when relevant, are discussed separately.
compared to 2010 due to a decrease in residential refinancing closings in the same periods. Direct operating revenues, excluding large commercial policies, decreased 1.5%, while the average revenue per closing decreased 6.7% in 2011 compared to 2010.
Revenues from independent agencies increased $130.2 million, or 14.8%, in 2012 and decreased $37.4 million, or 4.1%, in 2011. The largest increases in revenues from independent agencies in 2012 were in New York, Texas, California and Pennsylvania, partially offset by decreases in Illinois, Maryland, and Minnesota. The largest increases in revenues from independent agencies in 2011 were in New York, Illinois, Michigan, and Minnesota, partially offset by decreases in California, Florida, New Jersey, and Utah. Revenues from independent agencies net of amounts retained by those agencies increased 16.3% in 2012 and declined 4.9% in 2011.
Mortgage services revenues. Mortgage services operating revenues increased $50.8 million, or 45.3%, and $20.3 million, or 22.2%, in 2012 and 2011, respectively. The increases in 2012 and 2011 were primarily due to a significant rise in demand for our servicing support services, including loan modification services. The service offerings in our mortgage services segment continue to expand, with new servicing support projects driving the increase in revenues during 2012. The acquisition of PMH Financial in the third quarter 2011 also contributed to the 2011 increase in mortgage services revenues. Demand for mortgage services offerings are influenced by the number and scale of government programs and lender projects which may result in significant fluctuations in mortgage services revenues. Demand from lenders is increasingly being driven by their desire to more broadly outsource aspects of their servicing support operations, a trend that we expect will continue in 2013. As the real estate market recovers and distressed servicing projects naturally retrench, new service offerings have been introduced which allow our customers to outsource various aspects of their servicing operations to us. Our focus is on providing mortgage process outsourcing services which are high-quality, flexible and responsive. We expect these service offerings to be more sustainable over market cycles.
In 2010, investment and other gains - net included realized gains of $11.8 million from the sale of debt instruments and investments available-for-sale, $6.3 million primarily from a transfer of the rights to internally developed software, $1.2 million from the sale of interests in subsidiaries and $3.0 million from the sale of real estate.
Retention by agencies. Amounts retained by title agencies are based on agreements between the agencies and our title underwriters. On average, amounts retained by independent agencies, as a percentage of revenues generated by them, were 82.3%, 82.5% and 82.4% in the years 2012, 2011 and 2010, respectively. The average retention percentage may vary from year-to-year due to the geographical mix of agency operations, the volume of title revenues and, in some states, laws or regulations. Due to the variety of such laws or regulations, as well as competitive factors, the average retention rate can differ significantly from state to state. Although general conditions in the real estate industry are improving nationwide, the recovery in specific markets has varied considerably. In addition, a high proportion of our independent agencies are in states with retention rates greater than 80% and the markets in those states have recovered relatively faster than the nation as a whole, which has resulted in our average retention percentage remaining in the 82%-83% range. We expect our average retention rate to remain in this range over the near to medium term. However, we continue to adjust independent agency contracts in an economically sound manner, and we expect the mix of agency business to normalize as real estate markets continue to stabilize nationally resulting in lower average retention percentages in the aggregate. The slight increase in agent retention in 2011 was attributable to a shift in geographic mix of revenues from independent agents, as relatively more revenues were realized in states with lower remittance rates, thus lowering the overall average remittance rate. The fluctuations in 2010 were also affected by the uneven recovery of real estate markets across the nation; those states with higher agency retention percentages experienced a disproportionate increase in transaction activity in 2009.
We began the process of vetting our network of independent agencies several years ago with the emphasis on managing for quality and profitability. Since fourth quarter 2008, our average annual remittance rate per independent agency has increased more than 95 percent while we have reduced the number of independent agencies in our network by approximately 40 percent. Further, the policy loss ratio of our current independent agency network for the year ended December 31, 2012 is less than one-third of its level in the comparable 2008 period.
Employee costs. Our employee costs and certain other operating expenses are sensitive to inflation. Employee costs for the combined business segments increased $72.6 million, or 15.5%, in 2012 and $2.3 million, or 0.5%, in 2011. The number of persons we employed at December 31, 2012, 2011 and 2010 was approximately 6,300, 5,600 and 5,700, respectively.
In our mortgage services segment, total employee costs as a percentage of operating revenue fell to 61.1% from 62.9% in 2011. Actual costs increased $30.5 million, or 39.1%, in 2012, primarily due to increases in staffing requirements to support new contracts awarded in late 2011 and early 2012. In 2011, actual costs increased $4.4 million, or 5.9%, primarily due to increases in staffing driven by increased demand for our loan modification services.
Other operating expenses. Other operating expenses include costs that are fixed in nature, costs that follow, to varying degrees, changes in transaction volumes and revenues and costs that fluctuate independently of revenues. Costs that are fixed in nature include attorney fees, equipment rental, insurance, professional fees, rent and other occupancy expenses, repairs and maintenance, technology costs, telephone and title plant rent. Costs that follow, to varying degrees, changes in transaction volumes and revenues include fee attorney splits, bad debt expenses, certain mortgage services expenses, copy supplies, delivery fees, outside search fees, postage, premium taxes and title plant expenses. Costs that fluctuate independently of revenues include auto expenses, general supplies, litigation defense and settlement costs, promotion costs and travel.
In 2012, other operating expenses for the combined business segments increased $30.3 million, or 11.8%. Costs fixed in nature increased $3.6 million, or 3.1%, in 2012, primarily due to increases in audit, accounting and technology costs, partially offset by decreases in rent and other occupancy expenses. Costs that follow, to varying degrees, changes in transaction volumes and revenues increased $13.3 million, or 13.9%, in 2012 due to increases in outside search fees, bad debt expense and premium taxes. These increases were partially offset by decreases in certain mortgage service expenses. Costs that fluctuate independently of revenues increased $13.4 million, or 30.3%, in 2012 due primarily to litigation-related expenses.
The year ended December 31, 2012 included charges of $18.2 million (1.1% of title operating revenues) resulting from large title claims relating to policies issued in prior years. As anticipated, our overall loss experience continued to improve relative to prior year periods and was in line with our actuarial expectations, which allowed us to lower the overall loss provision rate effective with policies issued in the third quarter. Losses incurred on known claims for the year 2012 decreased 12.2% compared to the year 2011.
Excluding the impact of the reserve strengthening charges, large losses, and defalcations (net of recoveries), title losses as a percent of title operating revenues were 7.1%, 7.9% and 8.6% in 2012, 2011 and 2010, respectively.
Income taxes. Our effective tax rates were (37.3)%, 79.9% and (179.2)% for 2012, 2011 and 2010, respectively, based on earnings before taxes and after deducting noncontrolling interests, which were earnings (loss) of $79.5 million, $11.7 million and ($4.5) million in 2012, 2011 and 2010, respectively. Our effective income tax rate in 2012 was driven principally by the release of a valuation allowance of $36.6 million that had been established against U.S. deferred tax assets. As of December 31, 2012, our valuation allowance against deferred tax assets was $12.1 million, relating primarily to foreign tax credit carryforwards.
Our effective income tax rate in 2011 was driven by foreign and state taxes and income taxes associated with subsidiaries not included in our consolidated federal tax return, net of tax benefits from certain tax claims, and by a $7.2 million decrease in the valuation allowance against our deferred tax assets.
Contractual obligations. Our material contractual obligations at December 31, 2012 were:
Material contractual obligations consist primarily of notes payable, convertible senior notes, operating leases and estimated title losses. The timing above for payments of notes payable is based upon contractually stated payment terms of each debt agreement. The convertible senior notes will mature in 2014 unless converted into shares of common stock earlier.
Subsequent to year-end, we exchanged an aggregate of $20.7 million of the convertible senior notes for an aggregate of 1,691,074 shares of common stock plus cash for accrued and unpaid interest. Following these transactions, an aggregate of $44.3 million of convertible senior notes remain outstanding.
A substantial majority of our consolidated cash and investments as of December 31, 2012 was held by Stewart Title Guaranty Company (Guaranty) and its subsidiaries. The use and investment of these funds, dividends to the holding company, and cash transfers between Guaranty and its subsidiaries and the holding company are subject to certain legal and regulatory restrictions. In general, Guaranty may use its cash and investments in excess of its legally-mandated statutory premium reserve (established in accordance with requirements under Texas law) to fund its insurance operations, including claims payments. Guaranty may also, subject to certain limitations and upon regulatory approval, pay dividends to the holding company and/or provide funds to its subsidiaries (whose operations consist principally of field title offices) for their operating and debt service needs.
Our business is labor intensive, although we continue to make progress in automating our services, which allows us to more easily adjust staffing levels as order volumes fluctuate. There are typically delays between changes in market conditions and changes in staffing levels; therefore, employee costs do not change at the same rate as revenues change.
During the years ended 2012 and 2011, acquisitions resulted in additions to goodwill of $4.2 million and $7.6 million, respectively. We made no acquisitions in 2010.
As previously disclosed and in accordance with a settlement agreement in the amount of $7.6 million, we issued 635,863 shares of Common Stock in January 2011 to settle our “wage and hour” class action lawsuits filed in California state and federal courts against our subsidiary Stewart Title of California, Inc. We did not receive any proceeds from the issuance of these shares. Additionally in the second quarter of 2011, we satisfied a residual note balance of $1.3 million related to the acquisition of remaining interest in a subsidiary through the issuance of stock held in treasury.
The effect of changes in foreign currency rates on the consolidated statements of cash flows was a net increase in cash and cash equivalents of $1.8 million in 2012, a net decrease of $0.8 million in 2011 and a net increase of $0.8 million in 2010. Our principal foreign operating unit is in Canada, and, on average, the value of the U.S. dollar relative to the Canadian dollar increased during 2012.
We believe we have sufficient liquidity and capital resources to meet the cash needs of our ongoing operations. However, if we determine that supplemental debt, including additional convertible debentures, or equity funding is warranted to provide additional liquidity for unforeseen circumstances or strategic acquisitions, we may pursue those sources of cash. Other than scheduled maturities of debt, operating lease payments, purchase agreements and anticipated claims payments, we have no material commitments. We expect that cash flows from operations and cash available from our underwriters, subject to regulatory restrictions, will be sufficient to fund our operations, including claims payments. However, to the extent that these funds are not sufficient, we may be required to borrow funds on terms less favorable than we currently have, or seek funding from the equity market, which may not be successful or may be on terms that are dilutive to existing shareholders.
Other-than-temporary impairments of investments. We recorded other-than-temporary impairments of $0.8 million and $3.5 million in 2012 and 2011, respectively, relating to impairment of cost-basis investments.