We maintain our executive offices at MacArthur Place in Santa Ana, California. This office campus consists of five office buildings, a technology center and a two-story parking structure, totaling approximately 490,000 square feet. 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 $28.8 million as of December 31, 2015.
The selected historical consolidated financial data for First American Financial Corporation (the “Company”) as of and for each of the five years in the period ended December 31, 2015, have been derived from the Company’s consolidated financial statements. The selected historical consolidated financial data should be read in conjunction with “Item 8. Financial Statements and Supplementary Data,”“Item 1 - Business,” and “
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 THE FACTORS SET FORTH ON PAGE 3 OF THIS ANNUAL REPORT. THE FORWARD-LOOKING STATEMENTS SPEAK ONLY AS OF THE DATE THEY ARE MADE. THE COMPANY DOES NOT UNDERTAKE TO UPDATE FORWARD-LOOKING STATEMENTS TO REFLECT CIRCUMSTANCES OR EVENTS THAT OCCUR AFTER THE DATE THE FORWARD-LOOKING STATEMENTS ARE MADE.
“Other” primarily included foreign currency translation gains and losses, assets acquired in connection with claim settlements, and recoveries. “Other” for 2014 included a reinsurance receivable of $25.0 million that related to a large commercial title claim.
For further discussion of title provision recorded in 2015, 2014 and 2013, see Results of Operations, pages 36 and 37.
Typical inputs and assumptions to pricing models used to value the Company’s U.S. Treasury bonds, municipal bonds, foreign government bonds, governmental agency bonds, governmental agency mortgage-backed securities, U.S. and foreign corporate debt securities include, but are not limited to, benchmark yields, reported trades, broker-dealer quotes, credit spreads, credit ratings, bond insurance (if applicable), benchmark securities, bids, offers, reference data and industry and economic events. For mortgage-backed securities, inputs and assumptions may also include the structure of issuance, characteristics of the issuer, collateral attributes and prepayment speeds. Non-agency mortgage-backed securities and certain U.S. and foreign corporate debt securities were not actively traded and there were fewer observable inputs available requiring the use of more judgment in determining their fair values, which resulted in their classification as Level 3.
The Company recorded other-than-temporary impairment losses considered to be credit related on its debt securities of $2.2 million and $1.7 million for the years ended December 31, 2015 and 2014, respectively. The Company did not record any other-than-temporary impairment losses related to its debt securities for the year ended December 31, 2013.
When a decline in the fair value of an equity security, including common and preferred stock, is considered to be other-than-temporary, such equity security is written down to its fair value. When assessing if a decline in fair value is other-than-temporary, the factors considered include the length of time and extent to which fair value has been below cost, the probability that the Company will be unable to collect all amounts due under the contractual terms of the security, the seniority of the securities, issuer-specific news and other developments, the financial condition and prospects of the issuer (including credit ratings), macro-economic changes (including the outlook for industry sectors, which includes government policy initiatives) and the Company’s ability and intent to hold the security for a period of time sufficient to allow for any anticipated recovery.
When an equity security has been in an unrealized loss position and its fair value is less than 80% of cost for twelve consecutive months, the Company’s review of the security includes the above noted factors as well as other evidence that might exist supporting the view that the security will recover its value in the foreseeable future, typically within the next twelve months. If objective, substantial evidence does not indicate a likely recovery during that timeframe, the Company’s policy is that such losses are considered other-than-temporary and therefore an impairment loss is recorded. The Company did not record any other-than-temporary impairment losses related to its equity securities for the years ended December 31, 2015, 2014 and 2013.
The quantitative impairment test for goodwill utilizes a variety of valuation techniques, all of which require the Company 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, the Company utilizes the results of the valuations (including the market approach to the extent comparables are available) and considers the range of fair values determined under all methods and the extent to which the fair value exceeds the carrying amount of the reporting unit.
The Company elected to perform qualitative assessments for 2015, 2014 and 2013, the results of which supported the conclusion that the fair values of the Company’s reporting units were not more likely than not less than their carrying amounts and, therefore, a quantitative impairment test was not considered necessary. As a result of these assessments, the Company did not record any goodwill impairment losses for 2015, 2014 or 2013.
Impairment of equity method investments in affiliates. The carrying value of equity method investments in affiliates is written down, or impaired, to fair value when a decline in value is considered to be other-than-temporary. In making the determination as to whether an individual investment in an affiliate is impaired, the Company assesses the current and expected financial condition of each relevant entity, including, but not limited to, the anticipated ability of the entity to make its contractually required payments to the Company (with respect to debt obligations to the Company), the results of valuation work performed with respect to the entity, the entity’s anticipated ability to generate sufficient cash flows and the market conditions in the industry in which the entity is operating. The Company recognized impairment losses of $2.0 million, $22.5 million and $7.8 million on its equity method investments for 2015, 2014 and 2013, respectively.
In September 2015, the FASB issued updated guidance intended to simplify the accounting for adjustments made to provisional amounts recognized in a business combination and eliminates the requirement to retrospectively account for those adjustments. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2015 and applies prospectively to adjustments made to provisional amounts that occur after the effective date of this guidance with early adoption permitted for financial statements that have not been issued. The Company does not expect the adoption of this guidance to have a material impact on its consolidated financial statements.
In February 2015, the FASB issued updated guidance which changes the analysis that a reporting entity must perform to determine whether it should consolidate certain types of legal entities. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2015, with early adoption permitted. The Company expects the adoption of this guidance to have no impact on its consolidated financial statements.
The Company’s total revenues for the year ended December 31, 2015 were $5.2 billion, which reflected an increase of $0.5 billion, or 10.6%, when compared with $4.7 billion for the year ended December 31, 2014. This increase was primarily attributable to increases in commercial business, residential purchase transactions and residential refinance transactions during 2015. Direct premiums and escrow fees in the title insurance and services segment from commercial business, residential purchase transactions and residential refinance transactions increased 17.0%, 11.4% and 29.2%, respectively, in 2015 when compared to 2014.
The Consumer Financial Protection Bureau (“CFPB”) has broad authority to regulate, among other areas, the mortgage and real estate markets in matters which impact consumers. The CFPB has implemented regulations pertaining to the mortgage and settlement industries, including the TILA-RESPA integrated disclosure (TRID) rule. Implementation of the TRID rule, which applies to certain mortgage loan transactions originated on or after October 3, 2015, has required extensive modifications to the process of closing a federally-regulated mortgage loan. Compliance with the TRID rule also requires heightened coordination among market participants, including by settlement service providers, such as the Company and its agents, with lenders and others. After experiencing some initial delays in closings, by the end of the fourth quarter of 2015, the Company’s direct residential business returned to its typical closing timeframes. The full impact on closing timeframes for the Company’s residential agency business for the fourth quarter of 2015 is not yet known. While initial facts and circumstances related to the Company’s implementation of the TRID rule appear positive, the full impact of the TRID rule and the extent to which such impact is temporary or permanent is not currently known. There can be no assurance that the Company, its agents or other market participants will ultimately succeed in their implementation efforts, or that consumers or the CFPB will be satisfied with the manner in which the TRID rule has been implemented. The TRID rule may also impact other areas of the mortgage industry, including the volume of loans being originated.
Direct premiums and escrow fees increased $231.4 million, or 13.6%, in 2015 from 2014 and decreased $105.2 million, or 5.8%, in 2014 from 2013. The increase in direct premiums and escrow fees in 2015 from 2014 was primarily due to an increase in the domestic average revenues per order closed and an increase in domestic title orders closed by the Company’s direct operations. The decrease in direct premiums and escrow fees in 2014 from 2013 was primarily due to a decrease in the number of domestic title orders closed by the Company’s direct operations, partially offset by an increase in the domestic average revenues per order closed. The domestic average revenues per order closed were $2,012, $1,886 and $1,498 for 2015, 2014 and 2013, respectively. The 6.7% increase in average revenues per order closed in 2015 from 2014 was primarily due to higher real estate values and a greater number of large commercial deals that closed when compared to the prior year, partially offset by an increase in the mix of direct revenues generated from lower premium residential refinance transactions. The 25.9% increase in average revenues per order closed in 2014 from 2013 was primarily due to an increase in the mix of direct revenues generated from higher premium residential purchase and commercial transactions, higher real estate values, and a greater number of large commercial deals that closed when compared to the prior year. The Company’s direct title operations closed 882,400, 816,400 and 1,103,400 domestic title orders during 2015, 2014 and 2013, respectively. The 8.1% increase in orders closed in 2015 from 2014 and the 26.0% decrease in orders closed in 2014 from 2013 were generally consistent with the changes in residential mortgage origination activity in the United States as reported in the MBA Forecast.
Information and other revenues increased $15.0 million, or 2.3%, in 2015 from 2014 and decreased $6.1 million, or 0.9%, in 2014 from 2013. Excluding the $23.2 million impact of new acquisitions for the year ended December 31, 2015, information and other revenues decreased $8.2 million, or 1.2%, in 2015 compared to 2014. The decrease in 2015 from 2014, adjusted for the impact of new acquisitions, was due to lower demand for the Company’s default information products as a result of the decrease in domestic loss mitigation activities, partially offset by higher demand for certain of the Company’s non-insured services and products, which is directionally consistent with the increase in title insurance and services segment transaction volumes and revenue. Excluding the $55.7 million impact of new acquisitions for the year ended December 31, 2014, information and other revenues decreased $61.9 million, or 9.4%, in 2014 compared to 2013. The decrease in 2014 from 2013, adjusted for the impact of new acquisitions, was primarily attributable to lower demand for the Company’s default and title plant information products as a result of the decrease in domestic loss mitigation, foreclosure and mortgage origination activities.
Net realized investment losses for the title insurance and services segment totaled $7.4 million for 2015 and were primarily from the impairment of internally developed software and losses from the sales of equity securities, partially offset by gains from the sale of real estate. Net realized investment gains were $23.9 million for 2014 and were primarily from the sales of debt and equity securities and the sale of real estate. Net realized investment gains were $3.3 million for 2013 and were primarily from the sale of real estate. Net realized investment gains for 2015, 2014 and 2013 included $9.3 million, $7.5 million and $2.5 million, respectively, of gains from the sale of real estate, and included impairment losses of $10.9 million, $2.4 million and $1.1 million, respectively, primarily related to software and certain non-marketable investments accounted for using the cost method.
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 and state regulations. As a result, the percentage of title premiums retained by agents can vary due to the geographic mix of revenues from agency operations. The increase in the percentage of title premiums retained by agents in 2015 from 2014 was primarily due to a change in the geographic mix of agency revenues towards higher agent-retention regions, partially offset by increased revenue from the issuance of closing protection letters since agents typically do not retain a portion of this revenue. The decrease in the percentage of title premiums retained by agents in 2014 from 2013 was primarily due to increased revenue from the issuance of closing protection letters and a change in the geographic mix of agency revenues towards lower agent-retention regions.
Other operating expenses (principally related to direct operations) increased $8.8 million, or 1.2%, in 2015 from 2014 and decreased $37.3 million, or 4.8%, in 2014 from 2013. Excluding the $13.1 million impact of new acquisitions for the year ended December 31, 2015, other operating expenses decreased $4.3 million, or 0.6%, in 2015 compared to 2014. The decrease in 2015 from 2014, adjusted for the impact of new acquisitions, was primarily attributable to higher bank earnings credits and lower professional services expenses, partially offset by higher production related expenses driven by higher order volumes and increased software related expenses. The increase in bank earnings credits was driven by higher average balances invested with third-party financial institutions and higher average earnings credit rates associated with those investments in 2015 when compared to 2014. Excluding the $29.0 million impact of new acquisitions for the year ended December 31, 2014, other operating expenses decreased $66.3 million, or 8.6%, in 2014 compared to 2013. The decrease in 2014 from 2013, adjusted for the impact of new acquisitions, was primarily attributable to lower production related expenses driven by lower order volumes.
The provision for policy losses and other claims, expressed as a percentage of title insurance premiums and escrow fees, was 6.6%, 7.1% and 8.9% for the years ended December 31, 2015, 2014 and 2013, respectively.
The current year rate of 6.6% reflects an ultimate loss rate of 4.2% for the current policy year and a $93.1 million net increase in loss reserve estimates for prior policy years. The increase in loss reserve estimates for prior policy years was primarily attributable to a change in methodology used by the Company’s internal actuary to estimate total ultimate losses. Historically, the internal actuary’s model did not separate claims experience for large title claims from normal title claims activity. A large title claim is defined as a title claim with a total ultimate loss in excess of $2.5 million. With this change in methodology, the model now separates claims experience for large title claims from normal title claims activity when developing reserve estimates. As a result, loss reserve estimates for prior policy years increased, primarily for policy years 2004 through 2007. The change in methodology was implemented due to the increased frequency of large title claims experienced over the last several years and the volatility associated with the timing and severity of large title claims. The Company accounted for this change in methodology as a change in accounting estimate.
As of December 31, 2015, the IBNR claims reserve for the title insurance and services segment was $844.4 million, which reflected management’s best estimate. The Company’s internal actuary determined a range of reasonable estimates of $719.5 million to $922.0 million. The range limits are $124.9 million below and $77.6 million above management’s best estimate, respectively, and represent an estimate of the range of variation among reasonable estimates of the IBNR reserve. Actuarial estimates are sensitive to assumptions used in models, as well as the structures of the models themselves, and to changes in claims payment and incurral patterns, which can vary materially due to economic conditions, among other factors.
The prior year rate of 7.1% reflected an ultimate loss rate of 5.3% for policy year 2014 and a net increase in loss reserve estimates for prior policy years of $64.1 million. The increase in loss reserve estimates for prior policy years reflected claims development above expected levels during 2014, primarily from domestic commercial policies. The reserve strengthening associated with domestic commercial policies was $41.4 million and was primarily attributable to several large commercial claims, net of anticipated recoveries, mainly from mechanics liens, and primarily related to policy years 2003, 2005 and 2007. Other factors, including a large international commercial claim from policy year 2004, also contributed to the net increase in loss reserve estimates for prior policy years.
Based on current expectations for claims activity, in 2016, the Company expects its provision for policy losses and other claims, expressed as a percentage of title insurance premiums and escrow fees, to decline from 6.6%, the loss rate for 2015, to between 5% and 6%. However, this estimate may change based on actual claims experience among other factors.
Net realized investment gains for the specialty insurance segment totaled $1.5 million, $5.3 million and $1.4 million for 2015, 2014 and 2013, respectively, and were primarily from the sales of debt and equity securities.
Personnel costs and other operating expenses increased $7.8 million, or 7.2%, in 2015 from 2014 and $7.7 million, or 7.7%, in 2014 from 2013. The increase in 2015 from 2014 was primarily related to higher corporate allocations for shared services support, higher offshore labor expense related to increased customer support activities associated with the increased volume in the home warranty business, and higher advertising expense in the home warranty business. The increase in 2014 from 2013 was primarily related to higher salary expense associated with higher average employee headcount during the current year related to increased volume in the home warranty business, higher incentive compensation related to higher revenue and profitability, higher production related expenses due to increased volumes, and increased amortization of deferred acquisition costs.
The provision for property and casualty claims, expressed as a percentage of property and casualty insurance premiums, was 66.4% in 2015, 60.1% in 2014 and 55.4% in 2013. The increase in rate in 2015 from 2014 was primarily attributable to wildfires in northern California, hail storms in New Mexico, and an increase in the severity of claims, partially offset by a decrease in the frequency of claims. The increase in rate in 2014 from 2013 was primarily attributable to higher claims severity and frequency. 2014 was impacted by the severe winter weather experienced in the first quarter and the California wildfires that occurred during the second quarter.
Net realized investment losses totaled $0.6 million in 2015 and were primarily attributable to the impairment of a non-marketable investment accounted for using the cost method. Net realized investment gains totaled $0.9 million and $4.5 million in 2014 and 2013, respectively, and were attributable to the sale of non-marketable investments accounted for using the cost method.
Depreciation and amortization expense was $0.5 million, $2.8 million and $3.1 million in 2015, 2014 and 2013, respectively. The decrease in 2015 was due to a noncompete asset that was fully amortized during 2014.
Eliminations primarily represent interest income and related interest expense associated with intercompany notes between the Company’s segments, which are eliminated in the consolidated financial statements. The Company’s inter-segment eliminations were not material for the years ended December 31, 2015, 2014 and 2013.
The Company’s effective income tax rates (income tax expense as a percentage of income before income taxes) were 33.3% for 2015, 33.2% for 2014 and 39.8% for 2013. The differences in the effective tax rates were primarily due to changes in state and foreign income taxes resulting from fluctuations in the Company’s noninsurance and foreign subsidiaries’ contribution to pretax income and changes in the ratio of permanent differences to income before income taxes. In addition, the tax rate for 2014 reflected non-recurring tax benefits resulting from certain adjustments to the Company’s state and non-U.S. tax accounts. The 2015 rate includes a benefit for the release of valuation allowances previously provided against certain foreign net operating losses and other deferred tax assets.
Cash requirements. The Company generates cash primarily from the sale of its products and services and investment income. The Company’s current cash requirements include operating expenses, taxes, payments of principal and interest on its debt, capital expenditures and dividends on its common stock, and may include business acquisitions and repurchases of its common stock. Management forecasts the cash needs of the holding company and its primary subsidiaries and regularly reviews their short-term and long-term projected sources and uses of funds, as well as the asset, liability, investment and cash flow assumptions underlying such forecasts. Due to the Company’s ability to generate cash flows from operations and its liquid-asset position, management believes that its resources are sufficient to satisfy its anticipated operational cash requirements and obligations for at least the next twelve months.
In March 2014, the Company’s board of directors approved an increase in the size of the Company’s stock repurchase plan from $150.0 million to $250.0 million, of which $182.9 million remained as of December 31, 2015. Purchases may be made from time to time by the Company in the open market at prevailing market prices or in privately negotiated transactions. The Company did not repurchase any shares of its common stock during the year ended December 31, 2015 and as of December 31, 2015, had repurchased and retired 3.2 million shares of its common stock under the current authorization for a total purchase price of $67.1 million. In January 2016, the Company repurchased and retired 14 thousand shares of its common stock for a total purchase price of $454 thousand.
Holding company. First American Financial Corporation is a holding company that conducts all of its operations through its subsidiaries. The holding company’s current cash requirements include payments of principal and interest on its debt, taxes, payments in connection with employee benefit plans, dividends on its common stock and other expenses. The holding company is dependent upon dividends and other payments from its operating subsidiaries to meet its cash requirements. The Company’s target is to maintain a cash balance at the holding company equal to at least twelve months of estimated cash requirements. At certain points in time, the actual cash balance at the holding company may vary from this target due to, among other factors, the timing and amount of cash payments made and dividend payments received. Pursuant to insurance and other regulations under which the Company’s insurance subsidiaries operate, the amount of dividends, loans and advances available to the holding company is limited, principally for the protection of policyholders. As of December 31, 2015, under such regulations, the maximum amount of dividends, loans and advances available to the holding company from its insurance subsidiaries in 2016, without prior approval from applicable regulators, was $547.9 million. Such restrictions have not had, nor are they expected to have, an impact on the holding company’s ability to meet its cash obligations.
As of December 31, 2015, the holding company’s sources of liquidity included $289.8 million of cash and cash equivalents and $700.0 million available on the Company’s revolving credit facility. Management believes that liquidity at the holding company is sufficient to satisfy anticipated cash requirements and obligations for at least the next twelve months.
Financing. The Company maintains a credit agreement with JPMorgan Chase Bank, N.A. in its capacity as administrative agent and the lenders party thereto. The credit agreement is comprised of a $700.0 million revolving credit facility. Unless terminated earlier, the revolving loan commitments under the credit agreement will terminate on May 14, 2019. The obligations of the Company under the credit agreement are neither secured nor guaranteed. Proceeds under the credit agreement may be used for general corporate purposes. At December 31, 2015, the Company had no outstanding borrowings under the facility.
At the Company’s election, borrowings under the credit agreement bear interest at (a) the Alternate Base Rate plus the applicable spread or (b) the Adjusted LIBOR rate plus the applicable spread (in each case as defined in the agreement). The Company may select interest periods of one, two, three or six months or (if agreed to by all lenders) such other number of months for Eurodollar borrowings of loans. The applicable spread varies depending upon the debt rating assigned by Moody’s Investor Service, Inc. (“Moody’s”) and/or Standard & Poor’s Rating Services (“S&P”). The minimum applicable spread for Alternate Base Rate borrowings is 0.625% and the maximum is 1.00%. The minimum applicable spread for Adjusted LIBOR rate borrowings is 1.625% and the maximum is 2.00%. The rate of interest on Incremental Term Loans will be established at or about the time such loans are made and may differ from the rate of interest on revolving loans.
The credit agreement includes representations and warranties, reporting covenants, affirmative covenants, negative covenants, financial covenants and events of default customary for financings of this type. Upon the occurrence of an event of default the lenders may accelerate the loans. Upon the occurrence of certain insolvency and bankruptcy events of default the loans will automatically accelerate. As of December 31, 2015, the Company was in compliance with the financial covenants under the credit agreement.
In addition to amounts available under its credit facility, certain subsidiaries of the Company are parties to master repurchase agreements which are used as part of the Company’s liquidity management activities and to support its risk management activities. In particular, securities loaned or sold under repurchase agreements may be used as short-term funding sources. During 2015, the Company financed securities for funds received totaling $47.2 million under these agreements. As of December 31, 2015, no amounts remained outstanding under these agreements.
Notes and contracts payable as a percentage of total capitalization was 17.5% and 18.6% at December 31, 2015 and 2014, respectively. Notes and contracts payable are further described in Note 9 Notes and Contracts Payable to the consolidated financial statements.
Contractual obligations. A summary of the Company’s contractual obligations at December 31, 2015, by due date, is as follows:
The timing of claim payments is estimated and is not set contractually. Nonetheless, based on historical claims experience, the Company anticipates the above payment patterns. Changes in future claim settlement patterns, judicial decisions, legislation, economic conditions and other factors could affect the timing and amount of actual claim payments. The timing and amount of payments in connection with pension and supplemental benefit plans are based on the Company’s current estimate and require the use of significant assumptions. Changes in significant assumptions could affect the amount and timing of pension and supplemental benefit plan payments. See Note 13 Employee Benefit Plans to the consolidated financial statements for additional discussion of management’s significant assumptions. The Company is not able to reasonably estimate the timing of payments, or the amount by which the liability for the Company’s uncertain tax positions will increase or decrease over time; therefore the liability of $23.8 million has not been included in the contractual obligations table. See Note 11 Income Taxes to the consolidated financial statements for additional discussion of the Company’s liability for uncertain tax positions.
Off-balance sheet arrangements. The Company administers escrow deposits and trust assets as a service to its customers. Escrow deposits totaled $6.6 billion and $6.3 billion at December 31, 2015 and 2014, respectively, of which $2.6 billion and $2.2 billion, respectively, were held at the Company’s federal savings bank subsidiary, First American Trust, FSB. The escrow deposits held at First American Trust, FSB are temporarily invested in cash and cash equivalents and debt securities, with offsetting liabilities included in deposits in the accompanying consolidated balance sheets. The remaining escrow deposits were held at third-party financial institutions.
The Company facilitates tax-deferred property exchanges for customers pursuant to Section 1031 of the Internal Revenue Code and tax-deferred reverse exchanges pursuant to Revenue Procedure 2000-37. As a facilitator and intermediary, the Company holds the proceeds from sales transactions and takes temporary title to property identified by the customer to be acquired with such proceeds. Upon the completion of each such exchange, the identified property is transferred to the customer or, if the exchange does not take place, an amount equal to the sales proceeds or, in the case of a reverse exchange, title to the property held by the Company is transferred to the customer. Like-kind exchange funds held by the Company totaled $2.8 billion and $2.4 billion at December 31, 2015 and 2014, respectively. The like-kind exchange deposits are held at third-party financial institutions and, due to the structure utilized to facilitate these transactions, the proceeds and property are not considered assets of the Company and, therefore, are not included in the accompanying consolidated balance sheets. All such amounts are placed in deposit accounts insured, up to applicable limits, by the Federal Deposit Insurance Corporation. The Company could be held contingently liable to the customer for the transfers of property, disbursements of proceeds and the returns on such proceeds.
In our opinion, the consolidated financial statements listed in the accompanying index, present fairly, in all material respects, the financial position of First American Financial Corporation and its subsidiaries at December 31, 2015 and 2014, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2015 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Annual Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedules, and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Adjustments to reconcile net income to cash provided by operating activities:
Amortization of premiums and accretion of discounts on debt securities, net
The consolidated financial statements have been prepared in accordance with generally accepted accounting principles (“GAAP”) and reflect the consolidated operations of the Company. The consolidated financial statements include the accounts of First American Financial Corporation and all controlled subsidiaries. All significant intercompany transactions and balances have been eliminated. Investments in affiliates in which the Company exercises significant influence, but does not control and is not the primary beneficiary, are accounted for using the equity method. Investments in affiliates in which the Company does not exercise significant influence over the investee are accounted for under the cost method.
Certain 2014 and 2013 amounts have been reclassified to conform to the 2015 presentation.
During the fourth quarter of 2015, the Company reclassified certain revenues and expenses related to closing protection letters and temporary labor costs. The Company made comparable reclassifications to its consolidated statements of income for the years ended December 31, 2014 and 2013 to conform to the 2015 presentation. The impact to the Company’s title insurance and services segment included decreases to direct premiums and escrow fees and increases to agent premiums of $25.8 million and $16.5 million, increases to personnel costs of $23.9 million and $42.2 million, increases to premiums retained by agents of $1.2 million and $0.8 million, and decreases to other operating expenses of $25.1 million and $43.0 million for the years ended December 31, 2014 and 2013, respectively. The impact to the Company’s specialty insurance segment included increases to personnel costs and decreases to other operating expenses of $1.0 million and $1.2 million for the years ended December 31, 2014 and 2013, respectively.
The Company classifies its publicly traded debt and equity securities as available-for-sale with unrealized gains or losses recorded as a component of accumulated other comprehensive loss. See Note 14 Fair Value Measurements for additional discussion of the determination of fair value. Interest income, as well as the related amortization of premium and accretion of discount, on debt securities is recognized under the effective yield method and included in the accompanying consolidated statements of income in net investment income. Realized gains and losses on sales of debt and equity securities are determined on a first-in, first-out basis.
If the Company intends to sell a debt security in an unrealized loss position or determines that it is more likely than not that the Company will be required to sell a debt security before it recovers its amortized cost basis, the debt security is other-than-temporarily impaired and it is written down to fair value with all losses recognized in earnings. As of December 31, 2015, the Company did not intend to sell any debt securities in an unrealized loss position and it is not more likely than not that the Company will be required to sell debt securities before recovery of their amortized cost basis.
As a result of the Company’s security-level review, the Company recognized $2.2 million and $1.7 million of other-than-temporary impairment losses considered to be credit related on its debt securities for the years ended December 31, 2015 and 2014, respectively. The Company did not recognize any other-than-temporary impairment losses considered to be credit related in 2013. It is possible that the Company could recognize additional other-than-temporary impairment losses on securities it owns at December 31, 2015 if future events or information cause it to determine that a decline in fair value is other-than-temporary.
Cumulative credit loss on debt securities held at end of period
The carrying value of investments in affiliates is written down, or impaired, to fair value when a decline in value is considered to be other-than-temporary. In making the determination as to whether an individual investment in an affiliate is impaired, the Company assesses the current and expected financial condition of each relevant entity, including, but not limited to, the anticipated ability of the entity to make its contractually required payments to the Company (with respect to debt obligations to the Company), the results of valuation work performed with respect to the entity, the entity’s anticipated ability to generate sufficient cash flows and the market conditions in the industry in which the entity is operating. The Company recognized impairment losses on equity method investments in affiliates of $2.0 million, $22.5 million and $7.8 million for the years ended December 31, 2015, 2014 and 2013, respectively.
Amounts paid for acquisitions are allocated to the tangible assets acquired, liabilities assumed and intangible assets acquired based on their estimated fair value at the date of acquisition. The excess of the fair value of purchase consideration over the fair values of the identifiable assets and liabilities is recorded as goodwill. Acquisition-related costs are expensed in the periods in which the costs are incurred. The results of operations of acquired businesses are included in the consolidated financial statements from the date of acquisition.
The Company’s finite-lived intangible assets consist of customer relationships, noncompete agreements, trademarks and patents. These assets are amortized on a straight-line basis over their useful lives ranging from 1 to 20 years and are subject to impairment assessments when there is an indication of a triggering event or abandonment. The Company’s indefinite-lived other intangible assets consist of licenses which are not amortized but rather assessed for impairment by comparing the fair values to carrying amounts at least annually, and when an indicator of potential impairment has occurred.
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. Title insurance claims exposure for a given policy year is also affected by the quality of mortgage loan underwriting during the corresponding origination year. The Company believes that sensitivity of claims to external conditions in real estate and mortgage markets is an inherent feature of title insurance’s business economics that applies broadly to the title insurance industry.
In addition, the Company has an employee stock purchase plan that allows eligible employees the option to purchase common stock of the Company at 85% of the lower of the closing price on either the first or last day of each offering period. The offering periods are three-month periods beginning on January 1, April 1, July 1 and October 1 of each fiscal year. The Company recognizes an expense in the amount equal to the value of the 15% discount and look-back feature over the three-month offering period.
The Company operates in other countries, including Canada, the United Kingdom, Australia and various other established and emerging markets. The functional currencies of the Company’s foreign subsidiaries are generally their respective local currencies. The financial statements of foreign subsidiaries with local currencies that were determined to be the functional currency are translated into U.S. dollars as follows: assets and liabilities at the exchange rate as of the balance sheet date, equity at the historical rates of exchange, and income and expense amounts at average rates prevailing throughout the period. Translation adjustments resulting from the translation of the subsidiaries’ accounts are included in accumulated other comprehensive loss as a separate component of stockholders’ equity. For those foreign subsidiaries where the U.S. dollar has been determined to be the functional currency, non-monetary foreign currency assets and liabilities are translated using historical rates, while monetary assets and liabilities are translated at current rates, with remeasurement gains and losses included in other operating expenses. Gains and losses resulting from foreign currency transactions are included within other operating expenses.
The Company assumes and cedes large title insurance risks through reinsurance. Additionally, the Company’s property and casualty insurance business purchases reinsurance to limit risk associated with large losses from single events. 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. The amount of premiums assumed and ceded is recorded as a component of direct premiums and escrow fees on the Company’s consolidated statements of income. The total amount of premiums assumed and ceded in connection with reinsurance was less than 1.0% of consolidated premium and escrow fees for each of the three years in the period ended December 31, 2015. During the year ended December 31, 2015 the Company realized recoveries of $23.8 million on reinsured losses related to a large commercial title claim for which the Company recorded a receivable of $25.0 million at December 31, 2014. A receivable of $2.0 million related to this large commercial claim, which the Company expects to collect during 2016, was included in the Company’s consolidated balance sheet in accounts and accrued income receivable at December 31, 2015. Payments and recoveries on reinsured losses for the Company’s title insurance and property and casualty businesses were immaterial during the years ended December 31, 2014 and 2013.
In April 2015, the FASB issued updated guidance intended to clarify the accounting treatment for cloud computing arrangements that include software licenses. Under the updated guidance, if a cloud computing arrangement includes a software license, the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2015, with early adoption permitted. The Company does not expect the adoption of this guidance to have a material impact on its consolidated financial statements.
In June 2014, the FASB issued updated guidance intended to eliminate the diversity in practice regarding share-based payment awards that include terms which provide for a performance target that affects vesting being achieved after the requisite service period. The new standard requires that a performance target which affects vesting and could be achieved after the requisite service period be treated as a performance condition that affects vesting and should not be reflected in estimating the grant-date fair value. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2015, with early adoption permitted. The Company expects the adoption of this guidance to have no impact on its consolidated financial statements.
Pursuant to insurance and other regulations under which the Company’s insurance subsidiaries operate, the amount of dividends, loans and advances available to the Company is limited, principally for the protection of policyholders. As of December 31, 2015, under such regulations, the maximum amount of dividends, loans and advances available to the Company from its insurance subsidiaries in 2016, without prior approval from applicable regulators, was $547.9 million.
Statutory accounting principles differ in some respects from GAAP, and these differences include, but are not limited to, non-admission of certain assets (principally limitations on deferred tax assets, capitalized furniture and other equipment, premiums and other receivables 90 days past due and assets acquired in connection with claim settlements other than real estate or mortgage loans secured by real estate), reporting of bonds at amortized cost, amortization of goodwill, deferral of premiums received as statutory premium reserve, supplemental reserve (if applicable) and exclusion of the incurred but not reported claims reserve.
Investments in debt securities at December 31, 2015, by contractual maturities, are as follows:
The table below outlines the composition of the investment portfolio, by credit rating, as of December 31, 2015:
The credit ratings in the above table reflect published ratings obtained from Standard & Poor’s Rating Services, DBRS, Inc., Fitch Ratings, Inc. and Moody’s Investor Services, Inc. If a security was rated differently among the rating agencies, the lowest rating was selected. Governmental agency mortgage-backed securities are not rated by any of the ratings agencies; however, these securities have been included in the above table in the A- Ratings or higher category because the payments of principal and interest are guaranteed by the governmental agency that issued the security.
As of December 31, 2015, the estimated fair value of total debt securities in an unrealized loss position included $87.3 million of bank loans, of which $82.9 million was non-investment grade; $75.8 million of high yield corporate debt securities, all of which was non-investment grade; and $39.1 million of emerging market debt securities, of which $6.1 million was non-investment grade.
For further discussion about the Company’s acquisitions in 2015 and 2014, see Note 20 Business Combinations.
Amortization expense for finite-lived intangible assets was $9.3 million, $12.6 million and $12.0 million for the years ended December 31, 2015, 2014 and 2013, respectively.
NOTE 8. Reserve for Known and Incurred But Not Reported Claims:
The projected ultimate loss ratios, as of December 31, 2015, for policy years 2015, 2014 and 2013 were 4.2%, 4.7% and 3.7%, respectively.
Trust deed notes with maturities through 2023, collateralized by land and buildings with a net book value of $50,514 and $52,414 at December 31, 2015 and 2014, respectively, weighted-average interest rate of 5.34% and 5.39%, at December 31, 2015 and 2014, respectively
The weighted-average interest rate for the Company’s notes and contracts payable was 4.51% and 4.52% at December 31, 2015 and 2014, respectively.
The Company maintains a credit agreement with JPMorgan Chase Bank, N.A. in its capacity as administrative agent and the lenders party thereto. The credit agreement is comprised of a $700.0 million revolving credit facility. Unless terminated earlier, the revolving loan commitments under the credit agreement will terminate on May 14, 2019. The obligations of the Company under the credit agreement are neither secured nor guaranteed. Proceeds under the credit agreement may be used for general corporate purposes. At December 31, 2015, the Company had no outstanding borrowings under the facility.
The aggregate annual maturities for notes and contracts payable for the next five years and thereafter, are as follows:
Investment expenses include fees paid to third party investment managers, which the Company began utilizing in 2014.
The exercise of stock options and vesting of RSUs represent a tax benefit that has been reflected as a reduction of taxes payable and an increase to equity. The benefits recorded were $9.5 million and $6.9 million for the years ended December 31, 2015 and 2014, respectively.
At December 31, 2015, the Company had available net operating loss carryforwards for income tax purposes totaling $92.9 million, consisting of federal, state and foreign losses of $0.4 million, $38.8 million and $53.7 million, respectively. Of the aggregate net operating losses, $28.0 million have an indefinite expiration and the remaining $64.9 million expire at various times beginning in 2016. The Company carries a valuation allowance of $6.7 million against its deferred tax assets. Of this amount, $5.7 million relates to net operating losses; the remaining $1.0 million relates to other foreign deferred tax assets. The year-over-year decrease in the overall valuation allowance is primarily due to the release of valuation allowances previously provided against certain foreign net operating losses and other deferred tax assets.
The Company evaluates the realizability of its deferred tax assets by assessing the valuation allowance and adjusts the allowance, if necessary. The factors used to assess the likelihood of realization are the Company’s forecast of future taxable income and available tax planning strategies that could be implemented to realize the net deferred tax assets. The ability or failure to achieve the forecasted taxable income in the applicable taxing jurisdictions could affect the ultimate realization of deferred tax assets. Based on future operating results in certain jurisdictions, it is possible that the current valuation allowance positions of those jurisdictions could be adjusted in the next 12 months.
As of December 31, 2015, 2014 and 2013, the liability for income taxes associated with uncertain tax positions was $23.8 million, $24.1 million and $47.8 million, respectively. The net decreases in the liabilities during 2015 and 2014 were primarily attributable to activity related to examinations conducted by various taxing authorities. The net decrease in the liability during 2013 was primarily attributable to the Company’s effective settlement of a prior year tax return position. The liabilities could be reduced by $3.4 million as of December 31, 2015 and 2014, and by $32.6 million as of December 31, 2013, due to offsetting tax benefits associated with the correlative effects of potential adjustments, including timing adjustments and state income taxes. The net amounts of $20.4 million, $20.7 million and $15.2 million as of December 31, 2015, 2014 and 2013, respectively, if recognized, would favorably affect the Company’s effective tax rate.
A reconciliation of the beginning and ending amount of unrecognized tax benefits for the years ended December 31, 2015, 2014 and 2013 is as follows:
The Company records a liability for potential tax assessments based on its estimate of the potential exposure. New tax laws and new interpretations of laws and rulings by tax authorities may affect the liability for potential tax assessments. Due to the subjectivity and complex nature of the underlying issues, actual payments or assessments may differ from estimates. To the extent the Company’s estimates differ from actual payments or assessments, income tax expense is adjusted. The Company’s income tax returns in several jurisdictions are being examined by various tax authorities. The Company believes that adequate amounts of tax and related interest, if any, from any adjustments that may result from these examinations have been provided for.
For the years ended December 31, 2015, 2014 and 2013, 6 thousand, 133 thousand and 11 thousand, respectively, of stock options and RSUs were excluded from the weighted-average diluted common shares outstanding due to their antidilutive effect.
The following table summarizes the benefit obligations, assets and funded status associated with the Company’s defined benefit pension and supplemental benefit plans:
Weighted-average actuarial assumptions used to determine costs for the plans for the years ended December 31, 2015 and 2014, were as follows:
Weighted-average actuarial assumptions used to determine benefit obligations for the plans at December 31, 2015 and 2014, were as follows:
At December 31, 2015, the Company elected to change the method it uses to estimate the interest and service components of net periodic cost for its defined benefit pension and supplemental benefit plans, which will impact the estimate of net periodic cost beginning in 2016. The Company will utilize a full yield curve approach in the estimation of these components by applying the specific spot rates along the yield curve used in the determination of the benefit obligation to the relevant projected cash flows. Previously, the Company estimated the interest and service cost components utilizing a single weighted-average discount rate derived from the yield curve used to measure the benefit obligation at the beginning of the period. This change compared to the previous method will impact the interest and service components of net periodic cost in future periods. The Company made this change to provide a more precise measurement of interest and service costs by improving the correlation between projected benefit cash flows to the corresponding spot yield curve rates. This change does not affect the measurement of the total benefit obligation as the change in the interest and service costs is offset in net actuarial gains and losses. The impact to interest and service costs is not expected to be significant. The Company will account for this change prospectively as a change in accounting estimate.
Assumptions for the expected long-term rate of return on assets of the defined benefit pension plans are based on future expectations for returns for each asset class based on the calculated market-related value of plan assets and the effect of periodic target asset allocation rebalancing, adjusted for the payment of reasonable expenses of the plan from plan assets. The expected long-term rate of return on assets was selected from within a reasonable range of rates determined by (1) historical actual and expected returns for the asset classes and (2) projections of inflation over the long-term period during which benefits are payable to plan participants. The Company believes the assumptions are appropriate based on the investment mix and long-term nature of the plan’s investments. The use of expected long-term returns on plan assets may result in recognized pension income that is greater or less than the actual returns of those plan assets in any given year. Over time, however, the expected long-term returns are designed to approximate the actual long-term returns, and therefore result in a pattern of income and cost recognition that more closely matches the pattern of the services provided by the employees.
Subject to the requirements of the investment policy, the investment manager may use commingled investment vehicles including but not limited to mutual funds, common trust funds, commingled trusts, and exchange traded funds. The investment policy prohibits certain investment transactions, including derivatives and other illiquid investments (e.g., private equity and real estate), subject to certain exceptions.
A summary of the defined benefit pension plan’s asset allocations are as follows:
The Company expects to make cash contributions to its defined benefit and unfunded supplemental benefit plans of $23.4 million and $14.6 million, respectively, during 2016.
The Company categorizes its defined benefit pension plan assets, carried at fair value, using a three-level hierarchy for fair value measurements. See Note 14 Fair Value Measurements for a more in-depth discussion on the fair value hierarchy and a description for each level.
(b) Investments in passively managed index funds and actively managed mutual funds with holdings in domestic and foreign corporate bonds, foreign government bonds, mortgage-backed securities, and other fixed income instruments. These investments are valued using matrix pricing models and quoted prices of the securities in active markets.
If the inputs used to measure fair value fall into different levels of the fair value hierarchy, the hierarchy level assigned is based upon the lowest level of input that is significant to the fair value measurement.
The following table presents a summary of the changes in the fair values of Level 3 assets measured on a recurring basis for the years ended December 31, 2015 and 2014:
The fair value of notes receivable, net is estimated based on the discounted value of the future cash flows using approximate current market rates being offered for notes with similar maturities and credit quality.
The carrying value of escrow and other deposit accounts approximates fair value due to the short-term nature of these liabilities.
The First American Financial Corporation 2010 Incentive Compensation Plan (the “Incentive Compensation Plan”), effective May 28, 2010, permits the granting of stock options, stock appreciation rights, restricted stock, RSUs, performance units, performance shares and other stock-based awards. Eligible participants in the Incentive Compensation Plan include the Company’s directors and officers, as well as other employees. At December 31, 2015, 5.2 million shares of common stock remain available to be issued from either authorized and unissued shares or previously issued shares acquired by the Company, subject to certain annual limits based on the type of award granted. The Incentive Compensation Plan terminates 10 years from the effective date unless cancelled prior to that date by the Company’s board of directors.
The First American Financial Corporation 2010 Employee Stock Purchase Plan (the “ESPP”) allows eligible employees the option to purchase common stock of the Company at 85% of the lower of the closing price on either the first or last day of each quarterly offering period. There were 335,000 and 354,000 shares issued in connection with this plan for the years ended December 31, 2015 and 2014, respectively. At December 31, 2015, there were 3.1 million shares reserved for future issuances.
The following table summarizes RSU activity for the year ended December 31, 2015:
Total intrinsic value of options exercised for the years ended December 31, 2015, 2014 and 2013 was $9.7 million, $7.0 million and $6.0 million, respectively. This intrinsic value represents the difference between the fair market value of the Company’s common stock on the date of exercise and the exercise price of each option.
Future minimum rental payments under operating leases that have initial noncancelable lease terms in excess of one year as of December 31, 2015 are as follows:
At December 31, 2015 and 2014, the Company was contingently liable for guarantees of indebtedness owed by affiliates and third parties to banks and others totaling $8.2 million and $8.9 million, respectively. The guarantee arrangements relate to promissory notes and other contracts that contingently require the Company to make payments to the guaranteed party upon the failure of debtors to make scheduled payments according to the terms of the notes and contracts. The Company’s maximum potential obligation under these guarantees totaled $8.2 million and $8.9 million at December 31, 2015 and 2014, respectively, and is limited in duration to the terms of the underlying indebtedness. The Company has not incurred any costs as a result of these guarantees and has not recorded a liability on its consolidated balance sheets related to these guarantees at December 31, 2015 and 2014.
Components of AOCI allocated to the Company and noncontrolling interests at December 31, 2015, 2014 and 2013, are as follows:
In Edwards a narrow class has been certified. The Company believes the estimate of the possible loss or range of loss is not material to the consolidated financial statements as a whole.
overcharged or improperly charged fees for products and services, denied home warranty claims, failed to timely file certain documents, and gave items of value to developers, builders, brokers and others as inducements to refer business in violation of certain laws, such as consumer protection laws and laws generally prohibiting unfair business practices, and certain obligations, including
Downing v. First American Title Insurance Company, et al., filed on October 2, 2015 and pending in the United States District Court for the Northern District of Georgia,
All of these lawsuits, except Kaufman and Kirk, are putative class actions for which a class has not been certified. In Kaufman a class was certified but that certification was subsequently vacated. A trial of the Kirk matter has concluded, plaintiff has filed a notice of appeal and the Company filed a cross appeal. For the reasons described above, the Company has not yet been able to assess the probability of loss or estimate the possible loss or the range of loss or, where the Company has been able to make an estimate, the Company believes the amount is not material to the consolidated financial statements as a whole.
The Company and its subsidiaries also are involved in numerous ongoing routine legal and regulatory proceedings related to their operations. With respect to each of these proceedings, the Company has determined either that a loss is not reasonably possible or that the estimated loss or range of loss, if any, is not material to the consolidated financial statements as a whole.
During the years ended December 31, 2015 and 2014, the Company completed acquisitions for an aggregate purchase price of $32.3 million and $162.5 million, respectively. These acquisitions have been included in the Company’s title insurance and services segment.
Selected financial information about the Company’s operations, by segment, for the years ended December 31, 2015, 2014 and 2013, is as follows:
Long-lived assets allocated between domestic and foreign operations, by segment, as of December 31, 2015, 2014 and 2013, are as follows: