The Company owns two adjacent office buildings in Santa Ana, California, which house its executive offices, its trust and banking subsidiary and the Orange County title insurance branch operations. This complex, which contains approximately 105,000 square feet of floor space and an enclosed parking area, comprises one city block. The Company also owns an 18,000 square foot office building, located across the street from its main offices, that will provide space for expansion of its home office operations.
The Company's real estate information subsidiary, First American Real Estate Information Services, Inc. ("FAREISI"), owns a building in Irving, Texas, which houses its national operations center. This building contains 70,000 square feet of office space and was purchased in September 1992. FAREISI's corporate headquarters are housed in a leased office building located in St. Petersburg, Florida. In addition, FAREISI and its subsidiaries lease office space in more than 75 locations throughout the United States, principally for their respective operations.
In January 1997, FAREISI executed a lease for a 231,000 square foot office building in Dallas, Texas. This building will provide FAREISI with the adequate space needed to consolidate their expanded operations. Occupancy of this building will commence in April 1997.
- -------- Note A--On January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." As a result, the Company recognized a benefit of $4.2 million, or $.37 per share representing the cumulative effect of a change in accounting for income taxes.
Note B--Per share information relating to net income is based on the weighted average number of shares outstanding for the years presented. Per share information relating to stockholders' equity is based on shares outstanding at the end of each year.
Note C--Title order volumes are those processed by the direct title operations of the Company and do not include orders processed by agents.
Operating revenues from direct title operations increased 21.0% in 1996 when compared with the same period of the prior year. This increase was attributable to a 16.2% increase in the number of title orders closed by the Company's direct operations, as well as a 4.1% increase in the average revenues per order closed. The Company's direct operations closed 775,100 title orders during 1996, as compared with 667,200 title orders closed during 1995. This increase was primarily due to the continuation of lower mortgage interest rates, the improved national real estate economy and an increase in the Company's national market share. The average revenues per order closed were $808 for 1996, as compared with $776 for the same period of the prior year. This increase was primarily attributable to an increased mix of residential resale activity and, to lesser extent, a resurgence in commercial real estate activity. Operating revenues from direct title operations decreased 8.0% in 1995 as compared with 1994. This decrease was primarily attributable to a 7.7% decrease in the number of title orders closed by the Company's direct operations. The Company's direct title operations closed 667,200 title orders during 1995, as compared with 722,900 title orders closed during 1994. This decrease was attributable to higher interest rates and inclement weather which resulted in reduced national real estate activity in the first half of 1995. Operating revenues from agency title operations, which are more concentrated in the midwestern and eastern sectors of the country, increased 24.1% in 1996 over 1995 and decreased 21.5% in 1995 from 1994. These fluctuations were primarily attributable to the same factors affecting direct operations mentioned above, compounded by the inherent delay in the reporting by agents.
Investment and other income. Investment and other income increased 14.6% in 1996 over 1995. This increase was primarily attributable to an increase in realized investment gains of $1.7 million, as well as an increase in fixed income securities, offset in part by a 5.4% decrease in the average investment portfolio balance. Investment and other income increased 18.4% in 1995 over 1994. This increase was primarily due to a $.7 million fire insurance recovery, an increase of $1.3 million in realized investment gains and increased equity in earnings of affiliates, offset in part by a 9.3% decrease in the average investment portfolio balance. See Note 9 to the consolidated financial statements for additional details on investment and other income.
Title insurance personnel expenses increased 17.1% in 1996 over 1995. This increase was primarily attributable to the costs incurred servicing the heavy volume of title orders that commenced during the latter part of 1995 and continued into 1996 and, to a lesser extent, acquisition activity. The Company's direct operations opened 1,026,900 orders in 1996, an increase of 14.8% when compared with the 894,400 orders opened during 1995. Title insurance personnel expenses decreased 4.4% in 1995 from 1994. This decrease related directly to the Company's intensified efforts during the latter part of 1994 and the beginning of 1995 to adjust personnel and related expense levels commensurate with new order counts. This cost-containment process stabilized the cost of the labor base at a more acceptable level as business improved during the second quarter 1995. This decrease was offset, in part, by acquisition activity and modest personnel increases in the second half of 1995.
Real estate information personnel expenses increased 56.8% in 1996 over 1995. This increase was primarily attributable to costs incurred servicing the increase in business volume, as well as approximately $8.6 million of costs attributable to company acquisitions. Personnel expenses increased 60.1% in 1995 over 1994. This increase was primarily due to $20.0 million of personnel costs associated with company acquisitions, offset in part by personnel reductions associated with the decline in tax service contracts which began in the last half of 1994 and continued into the first half of 1995. Contributing to the increases in 1996 and 1995 were costs associated with in-house development of new electronic communications delivery systems for information- based products.
Home warranty personnel expenses increased 17.6% in 1996 over 1995 and 9.0% in 1995 over 1994. These increases were primarily due to the additional personnel required to service the increased business volume in the states this segment currently services, as well as new geographic expansion and modest salary increases.
Premiums retained by agents. A summary of agent retention and agent revenues is as follows:
Real estate information other operating expenses increased 53.6% in 1996 over 1995 and 63.2% in 1995 over 1994. These increases were primarily attributable to costs incurred servicing the increased business activity, as well as $7.0 million and $28.8 million of other operating costs relating to acquisitions in 1996 and 1995, respectively, offset in part by cost- containment programs. Contributing to the increases were costs incurred developing and enhancing new electronic communications delivery systems for information-based products and costs associated with assimilating and expanding this segment's increased operations.
The provision for title insurance losses expressed as a percentage of title insurance operating revenues was 4.6% in 1996, 6.6% in 1995, and 7.6% in 1994. These decreases reflect an ongoing improvement in the Company's claims experience. The provision for home warranty losses as a percentage of home warranty operating revenues was 60.1% in 1996, 58.0% in 1995 and 53.4% in 1994. These increases were primarily attributable to increases in the average number of claims per contract experienced during these periods, resulting from the home warranty operation offering extended coverages on its warranties.
Interest. Interest expense decreased 23.2% in 1996 when compared with 1995. This decrease was primarily attributable to a 13.5% reduction in the average outstanding debt balance and a reduced interest rate option on the Company's variable rate indebtedness. See Note 8 to the consolidated financial statements for a description of the Company's borrowings under its bank credit agreement. Interest expense remained relatively unchanged in 1995 when compared with 1994 primarily as the result of a constant average outstanding debt balance and comparable average interest rates.
Minority interests. Minority interests in net income of consolidated subsidiaries increased 23.1% in 1996 over 1995 and decreased 27.6% in 1995 from 1994. The increase in 1996 over 1995 was primarily attributable to the relatively strong operating results of the Company's less than 100% owned subsidiaries, offset in part by purchases of shares from minority shareholders. The decrease in 1995 over 1994 was primarily attributable to the Company's purchase of shares from minority shareholders.
The increases in corporate expenses were primarily attributable to increased costs associated with supporting the overall growth of the Company's businesses as well as unallocated expenses associated with employee benefit plans.
Net income. Net income and per share information are summarized as follows:
Financial statement schedules not listed above are either omitted because they are not applicable or the required information is shown in the consolidated financial statements or in the notes thereto.
The consolidated financial statements include the accounts of The First American Financial Corporation and all majority-owned subsidiaries. All significant intercompany transactions and balances have been eliminated. Certain 1994 and 1995 amounts have been reclassified to conform with the 1996 presentation.
Deposits with savings and loan associations and banks are short-term investments with initial maturities of more than 90 days. The carrying amount of these investments is a reasonable estimate of fair value due to their short-term nature.
Other long-term investments consist primarily of investments in affiliates, which are accounted for under the equity method of accounting, and notes receivable, which are carried at the lower of cost or estimated realizable value.
In connection with settlement of title insurance and other claims, the Company sometimes purchases mortgages, deeds of trust, real property, or judgment liens. These assets, sometimes referred to as "salvage assets," are carried at the lower of cost or estimated realizable value.
The Company provides for claim losses relating to its home warranty business based on the average cost per claim as applied to the total of new claims incurred. The average cost per claim is calculated using the average of the most recent twelve months of claims experience.
Revenues from tax service contracts are recognized proportionately over the estimated duration of the contracts as the related servicing costs are estimated to occur. The majority of the servicing costs, approximately 70%, is incurred in the year of the contract is executed, with the remaining 30% incurred over the remaining service life of the contract.
Revenues from home warranty contracts are recognized ratably over the 12- month duration of the contracts.
Investments carried at $14.5 million were on deposit with state treasurers in accordance with statutory requirements for the protection of policyholders at December 31, 1996.
FATICO maintained statutory capital and surplus of $208.3 million and $205.6 million at December 31, 1996 and 1995, respectively. Statutory net income for the years ended December 31, 1996, 1995 and 1994 was $34.6 million, $11.4 million and $15.5 million, respectively.
Sales of debt and equity securities resulted in realized gains of $3,257,000, $1,316,000 and $108,000 and realized losses of $646,000, $358,000 and $457,000 for the years ended December 31, 1996, 1995 and 1994, respectively. The fair value of debt and equity securities was estimated using quoted market prices.
Real estate loans are secured by properties located in Southern California. The average yields on the Company's loan portfolio for the years ended December 31, 1996 and 1995, were 11% and 12% respectively. Average yields are affected by amortization of discounts on loans purchased from other institutions, prepayment penalties recorded as income, loan fees amortized to income, and the market interest rates charged by thrift and loan institutions.
The above amounts are net of valuation reserves of $10.3 million and $11.2 million at December 31, 1996 and 1995, respectively.
The fair value of notes receivable was $10.1 million and $12.0 million at December 31, 1996 and 1995, respectively, and was estimated based on the discounted value of the future cash flows using the current rates at which similar loans would be made to borrowers of similar credit quality.
In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of." SFAS No. 121 became effective for 1996 and requires companies to assess for potential impairments of long-lived assets and certain identifiable intangibles when there is evidence that events or changes in circumstances have made recovery of an asset's carrying value unlikely. Adoption of this standard did not have a materially adverse effect on the Company's financial condition or results of operations.
The carrying value of the passbook account approximates fair value due to the short-term nature of this liability. The fair value of investment certificate accounts was $38.0 million and $31.6 million at December 31, 1996 and 1995, respectively, and was estimated based on the discounted value of the future cash flows using a discount rate approximating current market for similar liabilities.
NOTE 7. RESERVE FOR KNOWN AND INCURRED BUT NOT REPORTED CLAIMS:
The terms of the amended credit agreement provide for quarterly amortization of all credit agreement indebtedness. The minimum quarterly payment is $1.7 million and the maximum quarterly payment is
The aggregate annual maturities for notes and contracts payable in each of the five years after December 31, 1996, are as follows (in thousands):
The fair value of notes and contracts payable was $70.6 million and $77.7 million at December 31, 1996 and 1995, respectively, and was estimated based on the current rates offered to the Company for debt of the same remaining maturities. The weighted average interest rate for the Company's notes and contracts payable was 7 1/4% and 7 1/2% at December 31, 1996 and 1995, respectively.
The primary components of temporary differences which give rise to the Company's net deferred tax asset are as follows:
The Company has federal net operating loss carryforwards of approximately $1.7 million at December 31, 1996, which expire in 1999. The utilization of these net operating losses is limited to future federal taxable income of First American Real Estate Information Services, Inc., a wholly owned subsidiary of the Company. The utilization of the loss carryforward is also subject to limitations prescribed by Section 382 of the Internal Revenue Code.
The Company's principal profit sharing plan was amended effective January 1, 1995, to discontinue future contributions. The plans holds 1,594,000 and 1,675,000 shares of the Company's common stock, representing 14% and 15% of the total shares outstanding at December 31, 1996, and 1995 respectively. Contributions to the Company's profit sharing plans totaled $2.0 million for 1994.
The Company also has a Stock Bonus Plan for key employees pursuant to which 50,000, 65,000 and 55,000 common shares were awarded for 1996, 1995 and 1994, respectively, resulting in a charge to operations of $1.3 million, $1.2 million and $1.9 million, respectively. The Plan, as amended December 9, 1992, provides that a total of up to 300,000 common shares may be awarded in any one year.
The options awarded under The Stock Option Plan are not exercisable until April 24, 1997, at which time 134,000 of the options outstanding at December 31, 1996 may be exercised.
Total rental expense for all operating leases and month-to-month rentals was $63.9 million, $58.6 million and $50.1 million for 1996, 1995 and 1994, respectively.
On April 13, 1990, a class action was filed in the United States District Court in Phoenix, Arizona (the "District Court"), against First American Title Insurance Company and a number of other title insurers. This action sought damages and injunctive relief based on the defendants' participation in rating bureaus in Arizona and Wisconsin. This action was consolidated in the District Court, for pretrial matters, with an action filed in the United States District Court for the Eastern District of Wisconsin that presented claims on behalf of a purported class of purchasers of title insurance in Wisconsin.
sources, flood zone determination reports which provide information on whether or not a property is in a special flood hazard area, as well as other real estate-related information services. The home warranty segment issues one-year warranties which protect homeowners against defects in home fixtures. The trust and banking segment provides full-service trust and depository services, accepts deposits and makes real estate secured loans.
The Company's primary business segments are cyclical in nature, with the spring and summer months historically being the strongest. However, interest rate adjustments by the Federal Reserve Board, as well as other economic factors, can cause unusual fluctuations in the Company's quarterly operating results. See Management's Discussion and Analysis on pages 13-19 of this report for further discussion of the Company's results of operations.
The aggregate annual maturities for notes and contracts payable in each of the five years after December 31, 1996, are $14,714,000, $12,374,000, $10,831,000, $7,313,000, and $136,000, respectively.
- ------- Note A--Amount represents accounts written off, net of recoveries. Note B--Amount represents $33,000 in purchase accounting adjustments, net of a reclassification of $4,948,000 to the reserve for assets acquired in connection with claim settlements. Note C--Amount represents claim payments, net of recoveries. Note D--Amount represents elimination of reserve in connection with disposition and/or revaluation of the related asset. Note E--Amount represents elimination of reserve in connection with the expiration of the related temporary differences.
- ------- Note A--Amount represents accounts written off, net of recoveries. Note B--Amount represents $10,023,000 in purchase accounting adjustments, net of a reclassification of $3,019,000 to the reserve for assets acquired in connection with claim settlements. Note C--Amount represents claim payments, net of recoveries. Note D--Amount represents elimination of reserve in connection with disposition and/or revaluation of the related asset. Note E--Amount represents elimination of reserve in connection with the expiration of the related temporary differences.