We maintain our executive offices at MacArthur Place in Santa Ana, California. In 2005, The First American Corporation expanded its three-building office campus through the addition of two four-story office buildings totaling approximately 226,000 square feet, a two-story, free standing, 52,000 square foot technology center and a two-story parking structure, bringing the total square footage to approximately 490,000 square feet. The original three office buildings, totaling approximately 210,000 square feet, and the fixtures thereto and underlying land, are subject to a deed of trust and security agreement securing payment of a promissory note evidencing a loan made in October 2003, to our principal title insurance subsidiary in the original sum of $55.0 million. This loan is payable in monthly installments of principal and interest, is fully amortizing and matures November 1, 2023. The outstanding principal balance of this loan was $41.7 million as of December 31, 2010. Our title insurance subsidiary owns and operates these properties, and leases approximately 106,956 square feet within one of the buildings to CoreLogic for its executive offices pursuant to a lease that was entered into in connection with the separation. The technology center referred to above is primarily utilized and maintained by the Company but also houses physically segregated servers belonging to CoreLogic which are maintained by CoreLogic.
The selected historical consolidated financial data for First American Financial Corporation (the “Company”) for the five-year period ended December 31, 2010, have been derived from the Company’s consolidated financial statements presented in Item 8. The selected historical consolidated financial data should be read in conjunction with the Consolidated Financial Statements and Notes thereto, “Item 1 - Business,” and “
On the record date for the Distribution, TFAC issued to the Company and its principal title insurance subsidiary, First American Title Insurance Company (“FATICO”), a number of shares of its common stock that resulted in the Company and FATICO collectively owning 12.9 million shares of CoreLogic’s common stock immediately following the Separation. See Note 18 Transactions with CoreLogic/TFAC to the consolidated financial statements for further discussion of the CoreLogic stock;
The Company’s title insurance and services segment issues title insurance policies on residential and commercial property in the United States and offers similar products and services internationally. This segment also provides escrow and closing services, accommodates tax-deferred exchanges of real estate, maintains, manages and provides access to title plant records and images and provides banking, trust and investment advisory services. The Company, through its principal title insurance subsidiary and such subsidiary’s affiliates, transacts its title insurance business through a network of direct operations and agents. Through this network, the Company issues policies in the 49 states that permit the issuance of title insurance policies and the District of Columbia. The Company also offers title insurance and similar products, as well as related services, either directly or through joint ventures in foreign countries, including Canada, the United Kingdom and various other established and emerging markets.
The Company utilizes an independent third party actuary who produces a report with estimates and projections of the same financial items described above. The third party actuary’s analysis uses generally accepted actuarial methods that may in whole or in part be different from those used by the in-house actuary. The third party actuary’s report is used to validate the reasonableness of the in-house analysis.
Fair Value of Investment Portfolio. The Company classifies the fair value of its debt and equity securities using a three-level hierarchy for fair value measurements that distinguishes between market participant
If the Company does not expect to recover the amortized cost basis of a debt security with declines in fair value (even if the Company does not intend to sell the debt security and it is not more likely than not that the Company will be required to sell the debt security before the recovery of its remaining amortized cost basis), the losses the Company considers to be the credit portion of the other-than-temporary impairment loss (“credit loss”) is recognized in earnings and the non-credit portion is recognized in other comprehensive income. The credit loss is the difference between the present value of the cash flows expected to be collected and the amortized cost basis of the debt security. The cash flows expected to be collected are discounted at the rate implicit in the security immediately prior to the recognition of the other-than-temporary impairment.
The table below summarizes the primary assumptions used at December 31, 2010 in estimating the cash flows expected to be collected for these securities.
When, in the opinion of management, a decline in the fair value of an equity security (including common and preferred stock) and, prior to the first quarter of 2009, a debt security is considered to be other-than-temporary, such security is written down to its fair value. When assessing if a decline in value is other-than-temporary, the factors considered include the length of time and extent to which fair value has been below cost, the probability that the Company will be unable to collect all amounts due under the contractual terms of the
Impairment testing for goodwill and other indefinite-lived intangible assets. The Company is required to perform an annual impairment test for goodwill and other indefinite-lived intangible assets for each reporting unit. This annual test, which the Company has elected to perform every fourth quarter, utilizes a variety of valuation techniques, all of which require it to make estimates and judgments. Fair value is determined by employing an expected present value technique, which utilizes multiple cash flow scenarios that reflect a range of possible outcomes and an appropriate discount rate. The use of comparative market multiples (the “market approach”) compares the reporting unit to other comparable companies (if such comparables are present in the marketplace) based on valuation multiples to arrive at a fair value. The Company also uses certain of these valuation techniques in accounting for business combinations, primarily in the determination of the fair value of acquired assets and liabilities. In assessing the fair value, the Company utilizes the results of the valuations (including the market approach to the extent comparables are available) and considers the range of fair values determined under all methods and the extent to which the fair value exceeds the book value of the equity. The Company’s four reporting units are title insurance, home warranty, property and casualty insurance and trust and other services. The Company’s policy is to perform an annual impairment test for each reporting unit in the fourth quarter or sooner if circumstances indicate a possible impairment.
losses that could be material. The Company completed the required annual impairment testing for goodwill and other finite-lived intangible assets for the years ended December 31, 2010 and 2009, in the fourth quarter of each year. In 2010 and 2009, management concluded that, based on its assessment of the reporting units’ operations, the markets in which the reporting units operate and the long-term prospects for those reporting units that the more likely than not threshold for decline in value had not been met and that therefore no triggering events requiring an earlier analysis had occurred.
Income taxes. The Company accounts for income taxes under the asset and liability method, whereby deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company evaluates the need to establish a valuation allowance for deferred tax assets based upon the amount of existing temporary differences, the period in which they are expected to be recovered and expected levels of taxable income. A valuation allowance to reduce deferred tax assets is established when it is “more likely than not” that some or all of the deferred tax assets will not be realized.
Share-based compensation. The Company measures the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). The cost is recognized over the period during which an employee is required to provide services in exchange for the award. As stock-based compensation expense recognized in the results of operations is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company applies the long-form method for determining the pool of windfall tax benefits.
In accordance with the modified prospective method, the Company used the Black-Scholes option-pricing model for all unvested stock options as of December 31, 2005. The Company used the binomial lattice option-pricing model to estimate the fair value for any options granted after December 31, 2005. The Company utilizes the straight-line single option method of attributing the value of share-based compensation expense unless another expense attribution model is required by the guidance.
In addition to RSUs and stock options, the Company has an employee stock purchase plan that allows eligible employees to purchase common stock of the Company at 85.0% of the closing price on the last day of each month. The Company recognizes an expense in the amount equal to the discount.
In June 2009, the FASB issued guidance amending existing guidance surrounding the consolidation of variable interest entities (“VIE”) to require an enterprise to qualitatively assess the determination of the primary beneficiary of a VIE based on whether the entity (1) has the power to direct the activities of a VIE that most significantly impact the entity’s economic performance and (2) has the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the VIE. This guidance also requires an ongoing reconsideration of the primary beneficiary, and amends the events that trigger a reassessment of whether an entity is a VIE. Enhanced disclosures are also required to provide information about an enterprise’s involvement in a VIE. This statement is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited. The adoption of this standard had no impact on the Company’s consolidated financial statements.
In January 2010, the FASB issued updated guidance related to fair value measurements and disclosures, which requires a reporting entity to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and to describe the reasons for the transfers. In addition, in the reconciliation for fair value measurements using significant unobservable inputs, or Level 3, a reporting entity
In February 2010, the FASB issued updated guidance which amended the subsequent events disclosure requirements to eliminate the requirement for Securities and Exchange Commission (“SEC”) filers to disclose the date through which it has evaluated subsequent events, clarify the period through which conduit bond obligors must evaluate subsequent events and refine the scope of the disclosure requirements for reissued financial statements. The updated guidance was effective upon issuance. Except for the disclosure requirements, the adoption of the guidance had no impact on the Company’s consolidated financial statements.
In July 2010, the FASB issued updated guidance related to credit risk disclosures for finance receivables and the related allowance for credit losses. The updated guidance requires entities to disclose information at disaggregated levels, specifically defined as “portfolio segments” and “classes”. Expanded disclosures include, among other things, roll-forward schedules of the allowance for credit losses and information regarding the credit quality of receivables (including their aging) as of the end of a reporting period. The updated guidance is effective for interim and annual reporting periods ending after December 15, 2010, although the disclosures of reporting period activity are required for interim and annual reporting periods beginning after December 15, 2010. Except for the disclosure requirements, the adoption of this standard had no impact on the Company’s consolidated financial statements.
In December 2010, the FASB issued updated guidance related to when goodwill impairment testing should include Step 2 for reporting units with zero or negative carrying amounts. The updated guidance modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts requiring those entities to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider
Residential mortgage originations in the United States (based on the total dollar value of the transactions) decreased 24.6% in 2010 when compared with 2009, according to the Mortgage Bankers Association’s January 14, 2011 Mortgage Finance Forecast (the “MBA Forecast”). This decrease was due to a decline in both purchase and refinance activity. According to the MBA Forecast, the dollar amount of refinance originations and purchase originations decreased 20.3% and 32.4%, respectively, in 2010 when compared with 2009. Residential mortgage originations in the United States increased 40.0% in 2009 when compared with 2008 according to the January 12, 2010 MBA Forecast. This increase reflected increases in refinance originations and purchase originations of 76.6% and 1.5%, respectively.
Despite the low interest rate environment, which has had a favorable effect on the Company’s businesses, mortgage credit still remains generally tight, which together with the uncertainty in general economic conditions,
continues to impact the demand for most of the Company’s products and services. These conditions have also had an impact on, and continue to impact, the performance and financial condition of some of the Company’s customers; should these parties continue to encounter significant issues, those issues may lead to negative impacts on the Company’s revenue, claims, earnings and liquidity.
Management expects the above mentioned conditions will continue impacting the Company. Given this outlook, the Company continues its focus on controlling costs by, among other cost containment initiatives, reducing employee counts and improving the efficiencies of previously centralized functions.
During the third quarter of 2010, the Company changed the presentation of its revenues for the title insurance and services segment. This change resulted in direct revenues from escrow and insured products being presented separately from direct revenues from non-insured products. Direct revenues from escrow and insured products are included in direct premiums and escrow fees, while direct revenues from non-insured products are included in information and other. Information and other is primarily comprised of revenues generated from fees associated with title search and related reports, title and other real property records and images, and other non-insured settlement services. This change also impacted the reporting of certain metrics discussed below, such as direct title orders opened and closed, average revenues per direct title order closed, provision for title insurance policy losses as a percentage of title insurance premiums and escrow fees, and premium taxes as a percentage of title insurance premiums and escrow fees. The Company has reclassified prior period data to conform to the current presentation.
direct operations, which reflected the decline in mortgage originations, offset in part by an increase in the average revenues per order closed. The increase in the average revenues per order closed was primarily due to an increase in commercial activity year over year. The decrease in direct premiums and escrow fees in 2009 from 2008 was primarily due to a decline in the average revenues per order closed, which was driven by an increase in the mix of lower premium refinance activity, offset in part by an increase in the number of orders closed by the Company’s direct operations. The increase in closing reflected the increase in mortgage originations year over year. The average revenues per order closed were $1,334, $1,158 and $1,301 for 2010, 2009 and 2008, respectively. The Company’s direct title operations closed 1,066,700, 1,305,000 and 1,236,600 domestic title orders during 2010, 2009 and 2008, respectively.
Net realized investment gains (losses) for the title insurance segment totaled gains of $8.7 million and $14.5 million for 2010 and 2009, respectively, and losses of $53.4 million for 2008. The net gains for 2010 and 2009 were primarily from the sale of certain debt securities and equity securities, respectively. The net losses for 2008 primarily reflected $38.8 million of impairment losses on other long-term investments, including $14.9 million related to an investment in non-voting convertible preferred stock, $17.1 million related to a note receivable of a diversified provider of real estate settlement services that declared bankruptcy and $6.8 million related to an investment in affiliate. Additionally, in 2008, the Company wrote-off $5.3 million in other accounts receivable related to the aforementioned diversified provider of real estate settlement services.
The title insurance segment (primarily direct operations) is labor intensive; accordingly, a major expense component is personnel costs. This expense component is affected by two competing factors: the need to monitor personnel changes to match the level of corresponding or anticipated new orders and the need to provide quality service.
The Company continues to closely monitor order volumes and related staffing levels and will adjust staffing levels as considered necessary. The Company’s direct title operations opened 1,458,400, 1,768,900, and 1,781,700 domestic title orders in 2010, 2009, and 2008, respectively, representing a decrease of 17.6% in 2010 from 2009 and a decrease of 0.7% in 2009 from 2008.
The premium split between underwriter and agents is in accordance with the respective agency contracts and can vary from region to region due to divergences in real estate closing practices, as well as rating structures. As a result, the percentage of title premiums retained by agents varies due to the geographical mix of revenues from agency operations. The percentage of title premiums retained by agents increased over the last three years due primarily to the geographic mix of agency revenues (i.e., the agency share or split varies from region to region and thus the geographic mix of agency revenues causes this variation), partially offset by the cancellation and/or modification of certain agency relationships with unfavorable splits.
The current economic environment continues to show more potential for volatility than usual over the short term, particularly in regard to real estate prices and mortgage defaults, which directly affect title claims. Relevant contributing factors include high foreclosure volume, tight credit markets, general economic instability and government actions that may mitigate or exacerbate recent trends. Other factors, including factors not yet identified, may also influence claims development. At this point, economic and certain market conditions appear to be improving, yet significant uncertainty remains. This environment results in increased potential for actual claims experience to vary significantly from projections, in either direction, which would directly affect the claims provision. If actual claims vary significantly from expected, reserves may need to be adjusted to reflect updated estimates of future claims.
The projected ultimate loss ratios, as of December 31, 2010, for policy years 2010 and 2009 are 4.9% and 5.2%, respectively, which are lower than the ratios for 2005 through 2008. These projections are based in part on an assumption that more favorable underwriting conditions existed in 2009 and 2010 than in 2005 through 2008,
including tighter loan underwriting standards and lower housing prices. Current claims data from policy years 2009 and 2010, while still at an early stage of development, supports this assumption.
In general, the title insurance business is a lower profit margin business when compared to the Company’s specialty insurance segment. The lower profit margins reflect the high cost of performing the essential services required before insuring title, whereas the corresponding revenues are subject to regulatory and competitive pricing restraints. Due to this relatively high proportion of fixed costs, title insurance profit margins generally improve as closed order volumes increase. Title insurance profit margins are affected by the composition (residential or commercial) and type (resale, refinancing or new construction) of real estate activity. In addition, profit margins from refinance transactions vary depending on whether they are centrally processed or locally processed. Profit margins from resale, new construction and centrally processed refinance transactions are generally higher than from locally processed refinance transactions because in many states there are premium discounts on, and cancellation rates are higher for, refinance transactions. Title insurance profit margins are also affected by the percentage of title insurance premiums generated by agency operations. Profit margins from direct operations are generally higher than from agency operations due primarily to the large portion of the premium that is retained by the agent. The pre-tax margin was 6.3% and 5.7% for the years ended December 31, 2010 and 2009, respectively. The pre-tax margin loss for the year ended December 31, 2008 was 2.2%.
Specialty insurance direct premiums increased 0.9% in 2010 over 2009 and decreased 5.8% in 2009 from 2008. The increase in 2010 was due to an increase in volume from the home warranty division offset by a decline in the property and casualty division. Home warranty benefitted from the First Time Homebuyer Credit that expired in April of 2010. The decreases in 2009 compared to 2008 primarily reflected declines in business volume impacting both the property and casualty insurance division and the home warranty division.
Investment income decreased 11.6% in 2010 from 2009 and 14.2% in 2009 from 2008. These decreases primarily reflected the decreased yields earned from the investment portfolio.
Net income attributable to noncontrolling interests decreased $10.8 million, or 90.5%, in 2010 from 2009 and increased $0.4 million in 2009 over 2008. The decrease in net income attributable to noncontrolling interests in 2010 when compared to 2009 is due to the Company’s purchases of subsidiary shares from noncontrolling interests in 2009. The purchases of subsidiary shares did not significantly impact net income attributable to noncontrolling interests in 2009, because the majority of the Company’s purchases occurred late in the fourth quarter of 2009. Net income attributable to noncontrolling interests was relatively unchanged in 2009 when compared to 2008 due to the profits of the Company’s subsidiaries with noncontrolling interests not significantly fluctuating year over year, and the fact that the majority of the Company’s purchases of subsidiary shares from noncontrolling interests occurred late in the fourth quarter of 2009.
Cash Requirements. The Company’s current cash requirements include operating expenses, taxes, payments of interest and principal on its debt, capital expenditures, potential business acquisitions, payments in connection with employee benefit plans and dividends on its common stock. The Company continually assesses its capital allocation strategy, including decisions relating to dividends, share repurchases, capital expenditures, acquisitions and investments. Management expects that the Company will continue to pay quarterly cash dividends at or above the historical levels paid since the Separation. The timing, declaration and payment of future dividends, however, falls within the discretion of the Company’s board of directors and will depend upon many factors, including the Company’s financial condition and earnings, the capital requirements of our businesses, industry practice, restrictions imposed by applicable law and any other factors the board of directors deems relevant from time to time. The Company believes that all anticipated cash requirements for current operations will be met from internally generated funds, through cash dividends from subsidiaries and borrowings on its revolving credit facility, as needed. The Company’s short-term and long-term liquidity requirements are monitored regularly to ensure that it can meet its cash requirements. The Company forecasts the needs of its primary subsidiaries and periodically 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 liquid-asset position and its ability to generate cash flows from operations, management believes that its resources are sufficient to satisfy its anticipated operational cash requirements and obligations for at least the next twelve months.
The Company’s insurance subsidiaries generate cash from premiums earned and their respective investment portfolios and these funds are adequate to satisfy the payments of claims and other liabilities.
The principal nonoperating uses of cash and cash equivalents for the two years ended December 31, 2009 were for acquisitions (including the acquisition of noncontrolling interests), additions to the investment portfolio, capital expenditures, dividends paid to TFAC, distributions to noncontrolling shareholders and the repayment of debt. The most significant nonoperating sources of cash and cash equivalents were the proceeds from the allocated portion of TFAC debt, net investment activity by TFAC and proceeds from the sales and maturities of debt and equity securities. The net effect of all activities on total cash and cash equivalents was an increase of $97.4 million for 2010, and decreases of $92.4 million and $182.7 million for 2009 and 2008, respectively.
Financing. On April 12, 2010, the Company entered into a credit agreement with JPMorgan Chase Bank, N.A. (“JPMorgan”) in its capacity as administrative agent and a syndicate of lenders.
The credit agreement is comprised of a $400.0 million revolving credit facility. The revolving loan commitments terminate on the third anniversary of the date of closing, or June 1, 2013. On June 1, 2010, the Company borrowed $200.0 million under the facility and transferred such funds to CoreLogic, as previously contemplated in connection with the Separation. Proceeds may also be used for general corporate purposes. At September 30, 2010, the interest rate associated with the $200.0 million borrowed under the facility is 3.06%.
If at any time the rating by Moody’s Investor Service, Inc. (“Moody’s”) or Standard & Poor’s Ratings Group (“S&P”) of the senior, unsecured, long-term indebtedness for borrowed money of the Company that is not guaranteed by any other person or subject to any other credit enhancement is rated lower than Baa3 or BBB-, respectively, or is not rated by either such rating agency, then the loan commitments are subject to mandatory reduction from (a) 50% of the net proceeds of certain equity issuances by any Loan Party, (b) 50% of the net proceeds of certain debt incurred or issued by any Loan Party, (c) 25% of the net proceeds received by any Loan Party from the disposition of CoreLogic stock received in connection with the Separation and (d) the net proceeds received by any Loan Party from certain dispositions of assets, provided that the commitment reductions described above are only required to the extent necessary to reduce the total loan commitments to $200.0 million. The Company is only required to prepay loans to the extent that, after giving effect to any mandatory commitment reduction, the aggregate principal amount of all outstanding loans exceeds the remaining total loan commitments.
Notes and contracts payable (including allocated portion of TFAC debt) as a percentage of total capitalization was 12.8% at December 31, 2010, compared with 11.3% as of the prior year end. This increase was
Investment Portfolio. As of December 31, 2010, the Company’s debt and equity investment securities portfolio consists of approximately 88% of fixed income securities. As of that date, over 72% of the Company’s fixed income investments are held in securities that are United States government-backed or rated AAA, and approximately 96% of the fixed income portfolio is rated or classified as investment grade. Percentages are based on the amortized cost basis of the securities. Credit ratings are based on S&P and Moody’s published ratings. If a security was rated differently by both rating agencies, the lower of the two ratings was selected.
Approximately 27% of the Company’s municipal bonds portfolio has third party insurance in effect.
As of December 31, 2010, none of the non-agency mortgage-backed and asset-backed securities were on negative credit watch by S&P or Moody’s.
In addition to its debt and equity investment securities portfolio, the Company maintains certain money-market and other short-term investments.
The timing of claim payments is estimated and is not set contractually. Nonetheless, based on historical claims experience, the Company anticipates the above payment patterns. Changes in future claim settlement patterns, judicial decisions, legislation, economic conditions and other factors could affect the timing and amount of actual claim payments. The timing and amount of payments in connection with pension and supplemental benefit plans is based on the Company’s current estimate and requires the use of significant assumptions. Changes in significant assumptions could affect the amount and timing of pension and supplemental benefit plan payments. See Note 14 Employee Benefit Plans to the consolidated financial statements for additional discussion of management’s significant assumptions. The Company is not able to reasonably estimate the timing of payments, or the amount by which the liability for the Company’s uncertain tax positions will increase or decrease over time; therefore the liability of $11.1 million has not been included in the contractual obligations table. See Note 12 Income Taxes to the consolidated financial statements for additional discussion of the Company’s liability for uncertain tax positions.
Off-balance sheet arrangements. The Company administers escrow deposits and trust assets as a service to its customers. Escrow deposits totaled $3.03 billion and $2.46 billion at December 31, 2010 and 2009, respectively, of which $0.9 billion and $0.9 billion, respectively, were held at the Company’s federal savings
bank subsidiary, First American Trust, FSB. The escrow deposits held at First American Trust, FSB, are included in the accompanying consolidated balance sheets, in cash and cash equivalents at December 31, 2010 and 2009, respectively, with offsetting liabilities included in deposits. The remaining escrow deposits were held at third-party financial institutions.
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, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010 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, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the Management’s Annual Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedules, and on the Company’s internal control over financial reporting based on our audits (which was an integrated audit in 2010). We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
The Separation resulted in a net distribution from the Company to TFAC of $156.6 million. In connection with such distribution, the Company assumed $22.1 million of accumulated other comprehensive loss, net of tax, which was primarily related to the Company’s assumption of the unfunded portion of the defined benefit pension obligation associated with participants who were employees of the businesses retained by CoreLogic. See Note 14 Employee Benefit Plans to the consolidated financial statements for additional discussion of the defined benefit pension plan.
The Company’s historical financial statements prior to June 1, 2010 include assets, liabilities, revenues and expenses directly attributable to the Company’s operations. The Company’s historical financial statements prior to June 1, 2010 reflect allocations of corporate expenses from TFAC for certain functions provided by TFAC, including, but not limited to, general corporate expenses related to finance, legal, information technology, human resources, communications, compliance, facilities, procurement, employee benefits, and share-based compensation. These expenses have been allocated to the Company on the basis of direct usage when identifiable, with the remainder allocated on the basis of net revenue, domestic headcount or assets or a combination of such drivers. The Company considers the basis on which the expenses have been allocated to be a reasonable reflection of the utilization of services provided to or the benefit received by the Company during the periods presented. The Company’s historical financial statements prior to June 1, 2010 do not reflect the debt or interest expense it might have incurred if it had been a stand-alone entity. In addition, the Company expects to incur other expenses, not reflected in its historical financial statements prior to June 1, 2010, as a result of being a
separate publicly traded company. As a result, the Company’s historical financial statements prior to June 1, 2010 do not necessarily reflect what its financial position or results of operations would have been if it had been operated as a stand-alone public entity during the periods covered prior to June 1, 2010, and may not be indicative of the Company’s future results of operations and financial position.
The Company considers cash equivalents to be all short-term investments that have an initial maturity of 90 days or less and are not restricted for statutory deposit or premium reserve requirements.
Deposits with savings and loan associations and banks are short-term investments with initial maturities of more than 90 days.
Equity securities are carried at fair value and consist primarily of investments in marketable common stocks of corporate entities.
The performance of the Company’s loan portfolio is evaluated on an ongoing basis by management. Loans receivable are impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans receivable are measured at the present value of expected future cash flows discounted at the loan’s effective interest rate. As a practical expedient, the loan may be valued based on its observable market price or the fair value of the collateral, if the loan is collateral-dependent. No indications of material impairment of loans receivable were identified during the three-year period ended December 31, 2010.
Title insurance policies are long-duration contracts with the majority of the claims reported to the Company within the first few years following the issuance of the policy. Generally, 70 to 80 percent of claim amounts become known in the first five years of the policy life, and the majority of IBNR reserves relate to the five most recent policy years. A material change in expected ultimate losses and corresponding loss rates for policy years older than five years, while possible, is not considered reasonably likely by the Company. However, changes in expected ultimate losses and corresponding loss rates for recent policy years are considered likely and could result in a material adjustment to the IBNR reserves. Based on historical experience, the Company believes that a 50 basis point change to one or more of the loss rates for the most recent policy years, positive or negative, is reasonably likely given the long duration nature of a title insurance policy. If the expected ultimate losses for each of the last five policy years increased or decreased by 50 basis points, the resulting impact on the IBNR reserve would be an increase or decrease, as the case may be, of $105.1 million. The estimates made by management in determining the appropriate level of IBNR reserves could ultimately prove to be inaccurate and actual claims experience may vary from expected claims experience.
Title insurance, property and casualty insurance and home warranty companies, like other types of insurers, are generally not subject to state income or franchise taxes. However, in lieu thereof, most states impose a tax based primarily on insurance premiums written. This premium tax is reported as a separate line item in the consolidated statements of income (loss) in order to provide a more meaningful disclosure of the taxation of the Company.
The Company recognizes the effect of income tax positions only if sustaining those positions is “more likely than not.” Changes in recognition or measurement of uncertain tax positions are reflected in the period in which a change in judgment occurs. The Company recognizes interest and penalties, if any, related to uncertain tax positions in tax expense.
The Company measures the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). The cost is recognized over the period during which an employee is required to provide services in exchange for the award. As stock-based compensation expense recognized in the results of operations is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company applies the long-form method for determining the pool of windfall tax benefits.
The Company’s primary means of share-based compensation is granting restricted stock units (“RSUs”). The fair value of a RSU grant is generally based on the market value of the Company’s shares on the date of grant and is generally recognized as compensation expense over the vesting period. RSUs granted to certain key employees have graded vesting and have a service and performance requirement and are therefore expensed using the accelerated multiple-option method to record share-based compensation expense. In addition, other RSUs granted to certain executive officers have a service and market requirement and are therefore expensed using the graded-vesting method to record share-based compensation expense. Due to the existence of the market requirement, the Company calculates the fair value on grant date using a Monte-Carlo Simulation to simulate a range of possible future stock prices for the Company. All other RSU awards have graded vesting and service is the only requirement to vest in the award and are therefore generally expensed using the straight-line single option method to record share-based compensation expense. RSUs receive dividend equivalents in the form of RSUs having the same vesting requirements as the RSUs initially granted.
Basic earnings (loss) per share is computed by dividing net income (loss) available to the Company’s stockholders by the weighted-average number of common shares outstanding. The computation of diluted earnings per share is similar to the computation of basic earnings per share, except that the weighted-average number of common shares outstanding is increased to include the number of additional common shares that would have been outstanding if dilutive stock options had been exercised and RSUs were vested. The dilutive effect of stock options and unvested RSUs is computed using the treasury stock method, which assumes any proceeds that could be obtained upon the exercise of stock options and vesting of RSUs would be used to purchase common shares at the average market price for the period. The assumed proceeds include the purchase price the grantee pays, the hypothetical windfall tax benefit that the Company receives upon assumed exercise or vesting and the hypothetical average unrecognized compensation expense for the period. The Company calculates the assumed proceeds from excess tax benefits based on the “as-if” deferred tax assets calculated under share based compensation standards.
Per share information for the current year and prior years was computed using the number of shares of common stock outstanding immediately following the Separation, as if such shares were outstanding for the entire period.
The Company recognizes the overfunded or underfunded status of defined benefit postretirement plans as an asset or liability on its consolidated balance sheets and recognizes changes in the funded status in the year in which changes occur, through accumulated other comprehensive income (loss). The funded status is measured as the difference between the fair value of plan assets and benefit obligation (the projected benefit obligation for pension plans and the accumulated postretirement benefit obligation for the other postretirement plans). Actuarial gains and losses and prior service costs and credits that have not been recognized as a component of net periodic benefit cost previously are recorded as a component of accumulated other comprehensive income (loss). Plan assets and obligations are measured as of December 31.
The Company assumes and cedes large title insurance risks through the mechanism of reinsurance. Additionally, the Company’s property and casualty insurance business uses reinsurance to limit risk associated with natural disasters such as windstorms, winter storms, wildfires and earthquakes. 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 income statement. The total amount of premiums assumed and ceded in connection with reinsurance was less than 1.0% of premium and escrow fees for the Company’s title insurance and property and casualty businesses for each of the three years ended December 31, 2010. Payments and recoveries on reinsured losses for the Company’s title insurance and property and casualty businesses were immaterial during the three years ended December 31, 2010.
In January 2010, the FASB issued updated guidance related to fair value measurements and disclosures, which requires a reporting entity to disclose separately the amounts of significant transfers in and out of Level 1
In March 2010, the FASB issued updated guidance that amends and clarifies the guidance on how entities should evaluate credit derivatives embedded in beneficial interests in securitized financial assets. The updated guidance eliminates the scope exception for bifurcation of embedded credit derivatives in interests in securitized financial assets, unless they are created solely by subordination of one financial instrument to another. The updated guidance is effective for interim financial reporting periods beginning after June 15, 2010, with adoption permitted at the beginning of each entity’s first fiscal quarter beginning after issuance. The adoption of this standard had no impact on the Company’s consolidated financial statements.
In July 2010, the FASB issued updated guidance related to credit risk disclosures for financing receivables and the related allowance for credit losses. The updated guidance requires entities to disclose information at disaggregated levels, specifically defined as “portfolio segments” and “classes”. Expanded disclosures include, among other things, roll-forward schedules of the allowance for credit losses and information regarding the credit quality of receivables (including their aging) as of the end of a reporting period. The updated guidance for disclosures of reporting period activity are required for interim and annual reporting periods beginning after December 15, 2010. Except for the disclosure requirements, management does not expect the adoption of this standard to have a material impact on the Company’s consolidated financial statements.
In January 2010, the FASB issued updated guidance related to fair value measurements and disclosures, which requires a reporting entity to disclose separately, a reconciliation for fair value measurements using significant unobservable inputs (Level 3) information about purchases, sales, issuances and settlements (that is, on a gross basis rather than one net number). The updated guidance is effective for interim or annual financial reporting periods beginning after December 15, 2010 and for interim periods within the fiscal year. Management does not expect the adoption of this standard to have a material impact on the Company’s consolidated financial statements.
The Company’s principal title insurance subsidiary, FATICO, maintained statutory surplus of $854.6 million and $802.3 million as of December 31, 2010 and 2009, respectively. Statutory net income for the years ended December 31, 2010 and 2009 was $73.3 million and $213.1 million, respectively. Statutory net loss for the year ended December 31, 2008 was $89.4 million.
(1) CoreLogic common stock with a cost basis of $242.6 million and an estimated fair value of $239.5 million is included in common stocks at December 31, 2010. See Note 18 Transactions with CoreLogic/TFAC to the consolidated financial statements for additional discussion of the CoreLogic common stock.
The Company had the following net unrealized gains (losses) as of December 31, 2010, 2009 and 2008:
The Company had the following gross unrealized losses as of December 31, 2010 and December 31, 2009:
Substantially all securities in the Company’s non-agency mortgage-backed and asset-backed portfolio are senior tranches and were investment grade at the time of purchase, however many have been downgraded below investment grade since purchase. The table below summarizes the composition of the Company’s non-agency mortgage-backed and asset-backed securities by collateral type, year of issuance and current credit ratings. Percentages are based on the amortized cost basis of the securities and credit ratings are based on Standard & Poor’s Ratings Group (“S&P”) and Moody’s Investors Service, Inc. (“Moody’s”) published ratings. If a security was rated differently by either rating agency, the lower of the two ratings was selected. All amounts and ratings are as of December 31, 2010.
The amortized cost and estimated fair value of debt securities at December 31, 2010, by contractual maturities, are as follows:
Although dislocations in the capital and credit markets have largely recovered, there continues to be volatility and disruption concerning certain vintages of non-agency mortgage-backed securities. The primary factors negatively impacting certain vintages of non-agency mortgage-backed securities include stringent borrowing guidelines that result in the inability of borrowers to refinance, high unemployment, continued declines in real estate values, uncertainty regarding the timing and effectiveness of governmental solutions and a general slowdown in economic activity. As of December 31, 2010, gross unrealized losses on non-agency mortgage-backed and asset-backed securities for which an other-than-temporary impairment has not been recognized were $6.1 million (which represents 6 securities), all of which have been in an unrealized loss position for longer than 12 months. The Company determines if a non-agency mortgage-backed and asset-backed security in a loss position is other-than-temporarily impaired by comparing the present value of the cash flows expected to be collected from the security to its amortized cost basis. If the present value of the cash flows expected to be collected exceed the amortized cost of the security, the Company concludes that the security is not other-than-temporarily impaired. The Company performs this analysis on all non-agency mortgage-backed and
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, 2010, the Company does not intend to sell any debt securities in an unrealized loss position and it is not more likely than not that the Company will be required to sell debt securities before recovery of their amortized cost basis.
December 31, 2010 and 2009, respectively, while $2.2 million and $26.2 million of other-than-temporary impairment losses were considered to be related to factors other than credit and were therefore recognized in other comprehensive income for the years ended December 31, 2010 and 2009, respectively. The amounts remaining in other comprehensive income for the years ended December 31, 2010 and 2009 should not be recorded in earnings, because the losses were not considered to be credit related based on the Company’s other-than-temporary impairment analysis as discussed above.
It is possible that the Company could recognize additional other-than-temporary impairment losses on some securities it owns at December 31, 2010 if future events or information cause it to determine that a decline in value is other-than-temporary.
Credit loss on debt securities held as of January 1, 2009 was $0 as there was no cumulative effect adjustment recorded related to initially applying the newly issued accounting guidance that established a new method of recognizing and measuring other-than-temporary impairments of debt securities. There was no cumulative effect adjustment recorded because there were no other-than-temporary impairment adjustments previously recognized on the debt securities held by the Company at January 1, 2009.
When an equity security has been in an unrealized loss position for greater than twelve months, the Company’s review of the security includes the above noted factors as well as what evidence, if any, exists to support that the security will recover its value in the foreseeable future, typically within the next twelve months.
If objective, substantial evidence does not indicate a likely recovery during that timeframe, the Company’s policy is that such losses are considered other-than-temporary and therefore an impairment loss is recorded. The Company recorded other-than-temporary impairment of $1.7 million during the year ended December 31, 2010 relating to the Company’s preferred equity securities as a component of net other-than-temporary impairment losses recognized in earnings. During the prior year, the Company concluded that objective substantive evidence was not available on 51 common equity securities and 15 preferred equity securities that had been in a loss position for greater than twelve months. Accordingly, for the year ended December 31, 2009, the Company recorded an other-than-temporary impairment charge of $16.0 million and $5.1 million, relating to its common and preferred equity securities, respectively, as a component of net other-than-temporary impairment losses recognized in earnings. The prior year impairment loss includes a $2.9 million other-than-temporary impairment charge upon the Company’s election to convert its preferred stock in Citigroup Inc. into common stock of that entity under the terms of Citigroup’s publicly announced exchange offer. For the year ended December 31, 2008, we recognized an other-than-temporary impairment charge in earnings of $31.2 million related to our investments in perpetual preferred securities issued by the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”). The impairment was due to actions taken by the United States government with respect to Fannie Mae and Freddie Mac.
Typical inputs and assumptions to pricing models used to value the Company’s U.S. Treasury bonds, governmental agency bonds, governmental agency mortgage-backed securities, municipal bonds, foreign bonds and corporate debt securities include, but are not limited to, benchmark yields, reported trades, broker-dealer quotes, credit spreads, credit ratings, bond insurance (if applicable), benchmark securities, bids, offers, reference data and industry and economic events. For mortgage-backed and asset-backed securities, inputs and assumptions may also include the structure of issuance, characteristics of the issuer, collateral attributes and prepayment speeds. The fair value of non-agency mortgage-backed and asset-backed securities was obtained from the independent pricing service referenced above and subject to the Company’s validation procedures discussed above. However, due to the fact that these securities were not actively traded, there was less observable inputs available requiring the pricing service to use more judgment in determining the fair value of the securities, therefore the Company classified non-agency mortgage-backed and asset-backed securities as Level 3.
The Company did not have any transfers in and out of Level 1 and Level 2 measurements during the years ended December 31, 2010 and 2009. The Company’s policy is to recognize transfers between levels in the fair value hierarchy at the end of the reporting period.
The Company did not purchase any non-agency mortgage-backed and asset-backed securities during the years ended December 31, 2010 and 2009. Also, the Company did not have a material amount of gains or losses on sales of non-agency mortgage-backed and asset-backed securities for the years ended December 31, 2010 and 2009. During the quarter ended December 31, 2009, we determined that the fair values of our non-agency mortgage-backed and asset-backed securities were estimated using certain significant unobservable inputs, which resulted in a Level 3 classification. Our policy is to report transfers into Level 3 as of the end of the period.
A reconciliation of the changes in the carrying amount of goodwill by operating segment, for the years ended December 31, 2010 and 2009, is as follows:
The activity in the above reconciliation for other/ post acquisition adjustments primarily relates to the effect of foreign currency exchange adjustments.
The Company’s 2010, 2009 and 2008 evaluations did not indicate impairment in any of its reporting units. There is no accumulated impairment for goodwill as the Company has never recognized any impairment to its reporting units. Due to significant volatility in the current markets, the Company’s operations may be negatively impacted in the future to the extent that exposure to impairment losses may be increased.
“Other” primarily represents reclassifications to the reserve for assets acquired in connection with claim settlements and purchase accounting adjustments related to company acquisitions and foreign currency gains/losses. Claims activity associated with reinsurance is not material and, therefore, not presented separately. Current year payments include $123.6 million, $125.2 million and $148.1 million in 2010, 2009 and 2008, respectively, that primarily relate to the Company’s specialty insurance segment. Prior year payments include $18.6 million, $20.4 million and $23.3 million in 2010, 2009 and 2008, respectively, that relate to the Company’s specialty insurance segment.
The current economic environment appears to have more potential for volatility than usual over the short term, particularly in regard to real estate prices and mortgage defaults, which directly affect title claims. Relevant contributing factors include high foreclosure volumes, tight credit markets, general economic instability and
A general decline in real estate prices can expose lenders to greater risk of losses on mortgage loans, as loan-to-value ratios increase and defaults and foreclosures increase. The current environment may continue to have increased potential for claims on lenders’ title policies, particularly if defaults and foreclosures are at elevated levels. Title insurance claims exposure for a given policy year is also affected by the quality of mortgage loan underwriting during the corresponding origination year. The Company believes that sensitivity of claims to external conditions in real estate and mortgage markets is an inherent feature of title insurance’s business economics that applies broadly to the title insurance industry. Lenders have experienced high losses on mortgage loans originated during several prior policy years. These losses have led to higher title insurance claims on lenders policies, and also have accelerated the reporting of claims that would have been realized later under more normal conditions.
The projected ultimate loss ratios, as of December 31, 2010, for policy years 2010 and 2009 are 4.9% and 5.2%, respectively, which are lower than the ratios for 2005 through 2008. These projections are based in part on an assumption that more favorable underwriting conditions existed in 2009 and 2010 than in 2005 through 2008, including tighter loan underwriting standards and lower housing prices. Current claims data from both policy years 2009 and 2010, while still at an early stage of development, supports this assumption.
The aggregate annual maturities for notes and contracts payable in each of the five years after December 31, 2010, are as follows:
For the years ended December 31, 2010, 2009 and 2008, domestic and foreign pretax income (loss) from continuing operations before noncontrolling interests was $213.5 million and $(1.4) million, $195.2 million and $9.1 million and $(132.4) million and $16.5 million, respectively.
The primary components of temporary differences that give rise to the Company’s net deferred tax assets are as follows:
The exercise of stock options represents a tax benefit and has been reflected as a reduction of taxes payable and an increase to equity. The benefits or expenses recorded were $1.1 million benefit, $0.0 million benefit and $0.4 million expense for the years ended December 31, 2010, 2009 and 2008, respectively.
In connection with the Separation, the Company and TFAC entered into a Tax Sharing Agreement, dated June 1, 2010 (the “Tax Sharing Agreement”), which governs the Company’s and CoreLogic’s respective rights, responsibilities and obligations. Pursuant to the Tax Sharing Agreement, CoreLogic will prepare and file the consolidated federal income tax return, and any other tax returns that include both CoreLogic and the Company for all taxable periods ending on or prior to June 1, 2010. The Company will prepare and file all tax returns that include solely the Company for all taxable periods ending after that date. As part of the Tax Sharing Agreement, the Company is contingently responsible for 50% of certain Separation-related tax liabilities. At December 31, 2010, the Company has a $2.3 million payable to CoreLogic related to these matters which is included in due to CoreLogic/TFAC, net on the Company’s consolidated balance sheet.
The Company has a capital loss carryforward of $83.3 million that expires in 2012. In addition, the Company has net impairment and unrealized capital losses of $21.0 million which includes $38.2 million of unrealized losses related to debt securities that the Company has the ability and intent to hold to recovery. The Company continues to monitor the realizability of these losses and believes it is more likely than not that the tax benefits associated with these losses will be realized. In making that determination the Company has identified certain prudent and feasible tax planning strategies that the Company will implement unless the need to do so is eliminated in the future. However, this determination is a judgment and could be impacted by further market fluctuations.
The valuation allowance relates to deferred tax assets for certain state net operating loss carryforwards and the Company’s foreign operations. The Company evaluates the realizability of its deferred tax assets by assessing the valuation allowance and by adjusting the amount of such 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. Failure to achieve the forecasted taxable income in the applicable taxing jurisdictions could affect the ultimate realization of deferred tax assets and could result in an increase in the Company’s effective tax rate on future earnings. The activity in the valuation allowance results from the Company’s decision to deduct its foreign taxes paid, rather than claim a foreign tax credit, and its assessment that certain capital losses were realizable. This decrease was partially offset by an increase in the valuation allowance related to certain foreign net operating losses.
A reconciliation of the beginning and ending amount of unrecognized tax benefits for the years ended December 31, 2010, 2009 and 2008 is as follows:
The Company’s continuing practice is to recognize interest and penalties, if any, related to uncertain tax positions in tax expense. As of December 31, 2010 and 2009, the Company had accrued $2.4 million and $2.0 million, respectively, of interest and penalties (net of tax benefits of $0.9 million and $0.7 million, respectively) related to uncertain tax positions.
It is reasonably possible that the amount of the unrecognized benefit with respect to certain of the Company’s unrecognized tax positions may significantly increase or decrease within the next 12 months. These changes may be the result of items such as ongoing audits or the expiration of federal and state statute of limitations for the assessment of taxes. The Company estimates that decreases in unrecognized tax benefits within the next 12 months will total approximately $1.5 million.
For the years ended December 31, 2009 and 2008, basic and diluted earnings per share were computed using the number of shares of common stock outstanding immediately following the Separation, as if such shares were outstanding for the entire period.
The Company’s deferred compensation plan allows participants to defer up to 100% of their salary, commissions and bonus. Participants allocate their deferrals among a variety of investment crediting options (known as “deemed investments”). Deemed investments mean that the participant has no ownership interest in the funds they select; the funds are only used to measure the gains or losses that will be attributed to their deferral account over time. Participants can elect to have their deferral balance paid out in a future year while they are still employed or after their employment ends. The deferred compensation plan is exempt from most provisions of ERISA because it is only available to a select group of management and highly compensated employees and is not a qualified employee benefit plan. To preserve the tax-deferred savings advantages of a nonqualified deferred compensation plan, federal law requires that it be unfunded or informally funded. The participants’ deferrals and any earnings on those deferrals are general unsecured obligations of the Company. The Company is informally funding the deferred compensation plan through a tax-advantaged investment known as variable universal life insurance. Deferred compensation plan assets are held as an asset of the Company within a special trust, called a “Rabbi Trust.” At December 31, 2010, the value of the assets in the Rabbi Trust are $60.0 million and the unfunded liability is $61.9 million, and these amounts are included in the consolidated balance sheets in other assets and pension costs and other retirement plans, respectively. At December 31, 2009, the value of the assets in the Rabbi Trust that relate to the Company’s employees and have been allocated to the Company are $61.2 million and the unfunded liability that relates to the Company’s employees and has been allocated to the Company is $60.3 million, and these amounts are included in the consolidated balance sheets in other assets and pension costs and other retirement plans, respectively.
The Company’s defined benefit pension plan is a noncontributory, qualified, defined benefit plan with benefits based on the employee’s compensation and years of service. The defined benefit pension plan was closed to new entrants effective December 31, 2001 and amended to “freeze” all benefit accruals as of April 30, 2008.
The Company also has nonqualified, unfunded supplemental benefit plans covering certain key management personnel. Benefits under the Executive and Management Supplemental Benefit Plans are based on a participant’s final average compensation, which is computed as the average compensation of the last five full calendar years preceding retirement. Maximum benefits under the Executive and Management Supplemental Benefit Plans are 30% and 15% of final average compensation, respectively. The Company’s compensation committee amended and restated the Executive and Management Supplemental Benefit Plans effective as of January 1, 2011. The plans were amended to make the following changes, among others: (i) close the plans to new participants; (ii) fix the period over which the final average compensation that is used to calculate a participant’s benefit is determined as the one-year average of the five-year period ending on December 31,
The following table summarizes the balance sheet impact, including benefit obligations, assets and funded status associated with (i) the Company’s employees who participated in TFAC’s defined benefit pension and supplemental benefit plans prior to the Separation and (ii) the Company’s defined benefit pension and supplemental benefit plans following the Separation:
Weighted-average actuarial assumptions used to determine costs for the plans were as follows:
Assumptions for the expected long-term rate of return on plan assets 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 real and expected returns for the asset classes covered by the investment policy 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.
The following table provides the funded status of (i) TFAC’s defined benefit pension and supplemental benefit plan obligations related to the Company’s employees prior to the Separation and (ii) the Company’s defined benefit pension and supplemental benefit plans following the Separation:
The Company has a pension investment policy designed to meet or exceed the expected rate of return on plan assets assumption. The investment objective is to increase the pension plan’s funding status to being fully funded on a plan termination basis. Under the policy, as the funded status of the pension plan improves, the investment manager is to implement a lower risk strategy in order to minimize funded status volatility, according to the predetermined asset allocation strategy disclosed below. This strategy is intended to provide the best balance of minimizing funded status volatility while maintaining upside potential over time in order to fully fund the pension plan. To achieve this, the pension plan assets are monitored regularly to determine the funded status of the plan. The investment manager is responsible for ensuring that the portfolio is invested in compliance with the stated guidelines and that the individual investments are within acceptable risk tolerance levels. The investment manager will invest the assets of the plan in equity and fixed income debt securities and cash. Sufficient liquidity is also maintained to provide cash flow for ongoing needs.
Cash investments may be made in short-term securities, such as commercial paper or variable rate notes, or in money market funds. The short-term securities are investment grade with a maturity of less than 13 months. Fixed income investments must be government or government agency obligations, corporate debt or preferred stock, or fixed income mutual funds. The corporate debt securities are investment grade. Common stock investments may be either individual issues or stock mutual funds. The Company’s pension investment policy prohibits the use of the following financial instruments: options, short sales, commodities, derivatives, letter stock, private or direct placements and margin purchases. At December 31, 2010 and 2009, the Company’s pension plan assets also include $6.3 million and $5.7 million, respectively, of investment contracts with insurance companies as part of an acquired plan.
The Company’s target asset allocation is based on funded status as follows:
The following table presents (i) TFAC’s defined benefit pension plan assets prior to the Separation and (ii) the Company’s defined benefit pension plan assets following the Separation measured at fair value as of December 31, 2010 and 2009, classified using the fair value hierarchy:
As other long-term investments, which consist primarily of investments in affiliates, are not publicly traded, reasonable estimate of the fair values could not be made without incurring excessive costs.
The carrying amount for due to TFAC, net is a reasonable estimate of fair value due to the short-term maturity of this liability.
The fair value of notes and contracts payable and allocated portion of TFAC debt were estimated based on the current rates offered to the Company for debt of the same remaining maturities.
The carrying amounts and fair values of the Company’s financial instruments as of December 31, 2010 and 2009 are presented in the following table.
In connection with the Separation, the Company established the First American Financial Corporation 2010 Employee Stock Purchase Plan (the “ESPP”). The ESPP allows eligible employees to purchase common stock of the Company at 85.0% of the closing price on the last day of each month. Prior to the Separation, the Company’s employees participated in TFAC’s employee stock purchase plan. There were 175,000, 208,000 and 251,000 shares issued in connection with the Company’s and TFAC’s plans for the years ended December 31, 2010, 2009 and 2008, respectively. At December 31, 2010, there were 1,825,000 shares reserved for future issuances.
The following table summarizes stock option activity related to the Company’s employees participating in TFAC’s equity award plans prior to the Separation and activity under the Company’s equity award plans subsequent to the Separation through December 31, 2010:
(1) At the date of the Separation, TFAC’s outstanding stock options held by employees of the Company and former employees of its businesses were converted into Company stock options using a conversion ratio based on the closing price of TFAC common stock on June 1, 2010 divided by the closing price of the Company’s common stock on June 1, 2010.
As of December 31, 2010, there was $10 thousand of total unrecognized compensation cost related to nonvested stock options for the Company’s employees that is expected to be recognized during the first quarter of 2011.
The following table summarizes RSU activity related to the Company’s employees participating in TFAC’s equity award plans prior to the Separation and activity under the Company’s equity award plans subsequent to the Separation through December 31, 2010:
The Company leases certain office facilities, automobiles and equipment under operating leases, which, for the most part, are renewable. The majority of these leases also provide that the Company pay insurance and taxes.
The Company also guarantees the obligations of certain of its subsidiaries. These obligations are included in the Company’s consolidated balance sheets as of December 31, 2010 and 2009.
Prior to the Separation, the Company was allocated corporate income and overhead expenses from TFAC for corporate-related functions based on an allocation methodology that considered the number of the Company’s domestic headcount, the Company’s total assets and total revenues or a combination of those drivers. General corporate overhead expense allocations include executive management, tax, accounting and auditing, legal and treasury services, payroll, human resources and certain employee benefits and marketing and communications. The Company was allocated general net corporate expenses of $23.3 million from TFAC during the current year prior to the June 1, 2010 Separation, and $57.0 million and $65.5 million for the years ended December 31, 2009 and 2008, respectively, which are included within the investment income, net realized investment losses, personnel costs, other operating expenses, depreciation and amortization and interest expense line items in the accompanying consolidated statements of income.
At December 31, 2009, the Company held notes receivable from TFAC totaling $187.8 million with a weighted average interest rate of 4.49%. The notes have maturity dates ranging from 2010 to 2020. In connection with the Separation, TFAC’s corresponding notes payable were assumed by the Company. Therefore, these notes receivable from TFAC eliminate in consolidation with TFAC’s notes payable assumed by the Company, resulting in no balance being reported on the Company’s consolidated balance sheet as of December 31, 2010. Interest income earned on the notes receivable totaled $3.4 million in the current year prior to the June 1, 2010 Separation, and $11.0 million and $8.9 million for the years ended December 31, 2009 and 2008, respectively. Following the Separation, there is no interest income reflected in connection with these notes receivable from TFAC.
During the years ended December 31, 2009 and 2008, the Company made cash dividend payments of $83.0 million and $10.0 million, respectively, to TFAC which were recorded as a reduction of invested equity on the Company’s consolidated balance sheets. No cash dividends were paid to TFAC during 2010.
Under the Separation and Distribution Agreement and other agreements, subject to certain exceptions contained in the Tax Sharing Agreement, each of the Company and CoreLogic agreed to assume and be responsible for 50% of certain of TFAC’s contingent and other corporate liabilities. All external costs and expenses associated with the management of these contingent and other corporate liabilities will be shared equally. These contingent and other corporate liabilities primarily relate to consolidated securities litigation and any actions with respect to the Separation or the Distribution brought by any third party. Contingent and other
corporate liabilities that are related to only the information solutions or financial services businesses will generally be fully allocated to CoreLogic or the Company, respectively. At December 31, 2010, no reserves were considered necessary for such liabilities.
At December 31, 2010 and December 31, 2009, the Company’s federal savings bank subsidiary, First American Trust, FSB, held $11.9 million and $20.1 million, respectively, of interest and non-interest bearing deposits owned by CoreLogic. These deposits are included in deposits in the consolidated balance sheets. Interest expense on the deposits was immaterial for all periods presented.
Prior to the Separation, the Company owned three office buildings that were leased to the information solutions businesses of TFAC under the terms of formal lease agreements. In connection with the Separation, the Company distributed one of the office buildings to CoreLogic, and currently owns two office buildings that are leased to CoreLogic under the terms of formal lease agreements. Rental income associated with these properties totaled $6.2 million for the year ended December 31, 2010 and $8.5 million and $6.5 million for the years ended December 31, 2009 and 2008, respectively.
The Company and CoreLogic are also parties to certain ordinary course commercial agreements and transactions. The expenses associated with these transactions, which primarily relate to purchases of data and other settlement services totaled $21.4 million for the year ended December 31, 2010, and $46.4 million and $50.8 million for the years ended December 31, 2009 and 2008, respectively, and are included in other operating expenses in the Company’s consolidated statements of income. The Company also sells data and provides other settlement services to CoreLogic through ordinary course commercial agreements and transactions resulting in revenues totaling $11.8 million, $6.6 million and $2.5 million for the years ended December 31, 2010, 2009, and 2008, respectively, which are included in direct premiums and escrow fees and information and other in the Company’s consolidated statements of income.
The change in net unrealized gains on securities includes reclassification adjustments of $12.5 million, $16.0 million and $0.7 million of net realized gains on debt and equity securities for the years ended December 31, 2010, 2009 and 2008, respectively.
For a substantial majority of these lawsuits, however, it is not possible to assess the probability of loss. Most of these lawsuits are putative class actions which require a plaintiff to satisfy a number of procedural requirements before proceeding to trial. These requirements include, among others, demonstration to a court that the law proscribes in some manner the Company’s activities, the making of factual allegations sufficient to suggest that the Company’s activities exceeded the limits of the law and a determination by the court-known as class certification-that the law permits a group of individuals to pursue the case together as a class. If these procedural requirements are not met, either the lawsuit cannot proceed or, as is the case with class certification, the plaintiffs lose the financial incentive to proceed with the case (or the amount at issue effectively becomes de minimus). Frequently, a court’s determination as to these procedural requirements are subject to appeal to a higher court. As a result of, among other factors, ambiguities and inconsistencies in the myriad of laws applicable to the Company’s business and the uniqueness of the factual issues presented in any given lawsuit, the Company often cannot determine the probability of loss until a court has finally determined that a plaintiff has satisfied applicable procedural requirements.
charged an improper rate for title insurance in a refinance transaction, including
Campbell v. First American Title Insurance Company, filed on August 16, 2008 and pending in the United States District Court for the District of Maine,
Hamilton v. First American Title Insurance Company, filed on August 22, 2007 and pending in the United States District Court for the Northern District of Texas,
Haskins v. First American Title Insurance Company, filed on September 29, 2010 and pending in the United States District Court for the District of New Jersey,
Johnson v. First American Title Insurance Company, filed on May 27, 2008 and pending in the United States District Court for the District of Arizona,
Lewis v. First American Title Insurance Company, filed on November 28, 2006 and pending in the United States District Court for the District of Idaho,
Tello v. First American Title Insurance Company, filed on July 14, 2009 and pending in the United States District Court for the District of New Hampshire.
All of these lawsuits are putative class actions. A court has granted class certification only in Campbell, Hamilton (North Carolina), Hamilton (Texas), Johnson, Lewis, Raffone and Slapikas. An appeal to a higher court is pending with respect to the granting of class certification in Hamilton (Texas) and a motion to decertify the class in Campbell is pending. For the reasons stated above, the Company has been unable to assess the probability of loss or estimate the possible loss or the range of loss or, where the Company has been able to make an estimate, the Company believes the amount is immaterial to the financial statements as a whole.
purchased minority interests in title insurance agents as an inducement to refer title insurance underwriting business to the Company, gave items of value to title insurance agents and others for referrals of business and paid marketing fees to real estate brokers as an inducement to refer home warranty business, in each case in violation of the Real Estate Settlement Procedures Act, including
Edwards v. First American Financial Corporation, filed on June 12, 2007 and pending in the United States District Court for the Central District of California,
Galiano v. First American Title Insurance Company, et al., filed on February 8, 2008 and pending in the United States District Court for the Eastern District of New York,
Paul v. First American Home Buyers Protection Corporation, filed on July 29, 2010 and pending in the United States District Court, Middle District of Florida, Ft. Myers Division and
All of these lawsuits are putative class actions for which a class has not been certified, except in Edwards. In Edwards a narrow class has been certified and information is being exchanged for the purpose of enabling the plaintiff to argue whether a broader class is appropriate. In addition, a petition for a hearing on the legal right of the Edwards plaintiff to sue is pending in the United States Supreme Court. For the reasons stated above, the Company has been unable to assess the probability of loss or estimate the possible loss or the range of loss.
Diaz v. First American Home Buyers Protection Corporation, filed on March 10, 2009 and pending in the United States District Court for the Southern District of California,
While some of the lawsuits described above may be material to our operating results in any particular period if an unfavorable outcome results, the Company does not believe that any of these lawsuits will have a material adverse effect on the Company’s overall financial condition.
Additionally, on March 5, 2010, Bank of America, N.A. filed a complaint in the North Carolina General Court of Justice, Superior Court Division against United General Title Insurance Company and First American Title Insurance Company. The plaintiff alleges that the defendants failed to pay or failed to timely respond to certain claims made on title insurance policies issued in connection with home equity loans or lines of credit that are now in default. According to the complaint, these title insurance policies, which did not require a title search, were intended to protect against the risks of certain defects in the title to real property, including undisclosed intervening liens, vesting problems and legal description errors, that would have been discovered if the plaintiff had conducted a full title search. As indicated in the complaint, Fiserv Solutions, Inc. (“Fiserv”), as agent for the defendants, was authorized to issue certificates evidencing that a given loan was insured. The complaint also indicates that plaintiff was required to satisfy certain criteria before title would be insured. This involved (a) reviewing borrower statements to the lender when applying for the loan, (b) reviewing the borrower’s credit report and (c) addressing secured mortgages appearing on the credit report which did not appear on the borrower’s loan application. The plaintiff alleges that the failure to pay or timely respond to the subject claims was done in bad faith and constitutes a breach of the title insurance policies issued to the plaintiff. The plaintiff is seeking monetary damages, punitive damages where permitted, treble damages where permitted, attorneys fees and costs where permitted, declaratory judgment and pre-judgment and post-judgment interest.
On April 1, 2010, the Company filed an answer to Bank of America’s complaint and filed a third party complaint within the same litigation against Fiserv for breach of contract, indemnification and other matters. The Company’s agreement with Fiserv required Fiserv, among other things, to ensure that the Company’s policies were issued in accordance with prudent practices, to refrain from issuing the Company’s policies unless it had determined the product could be properly issued in accordance with the Company’s standards and to provide reasonable assistance in claims handling. The agreement also required Fiserv to indemnify the Company for certain losses, including losses resulting from Fiserv’s failure to comply with its agreement with the Company or with Company instructions or from its negligence or misconduct.
As indicated above, this lawsuit pertains to claims on title insurance policies issued by the defendants. The Company provides for title insurance losses through a known claims reserve and an IBNR claims reserve (for a discussion of the Company’s reserve for known and IBNR claims, see Note 1 Description of the Company and Note 9 Reserve for Known and Incurred But Not Reported Claims to the consolidated financial statements). A portion of the known claims reserve is attributable to certain of the claims that are the subject of this lawsuit and a portion of the IBNR claims reserves is attributable to the title insurance products that are the subject of the lawsuit and similar products issued to others. The ultimate outcome of this lawsuit is subject to a number of uncertainties, including the amount of responsibility that a court may apportion to Fiserv, whether a court determines that the defendants are entitled to certain documents requested as part of the claims submission process, the contents of those documents and whether a court interprets the title insurance policies that are the subject of the lawsuit in a manner consistent with the Company’s understanding. As a result of this uncertainty, it is currently not possible to estimate whether the loss or range of loss is greater than the amount of the known claims reserve and the IBNR claims reserve attributable to the claims that are the subject of this lawsuit. If this uncertainty is resolved in a manner that is unfavorable to the Company, the ultimate resolution of this lawsuit could have a material adverse effect on the Company’s financial condition, results of operations, cash flows or liquidity.
The Company’s title insurance, property and casualty insurance, home warranty, thrift, trust and investment advisory businesses are regulated by various federal, state and local governmental agencies. Many of the Company’s other businesses operate within statutory guidelines. Consequently, the Company may from time to time be subject to audit or investigation by such governmental agencies. Currently, governmental agencies are auditing or investigating certain of the Company’s operations. These audits or investigations include inquiries into, among other matters, pricing and rate setting practices in the title insurance industry, competition in the title insurance industry, title insurance customer acquisition and retention practices and agency relationships. With respect to matters where the Company has determined that a loss is both probable and reasonably estimable, the Company has recorded a liability representing its best estimate of the financial exposure based on known facts. While the ultimate disposition of each such audit or investigation is not yet determinable, the Company does not believe that individually or in the aggregate they will have a material adverse effect on the Company’s financial condition, results of operations or cash flows. These audits or investigations could, however, result in changes to the Company’s business practices which could ultimately have a material adverse impact on the Company’s financial condition, results of operations or cash flows.
During the year ended December 31, 2010, the Company completed five acquisitions for an aggregate purchase price of $10.9 million in cash and $0.5 million in notes payable. The purchase price of each acquisition was allocated to the assets acquired and liabilities assumed using a variety of valuation techniques including discounted cash flow analysis. These five acquisitions have been included in the Company’s title insurance segment.
During the year ended December 31, 2009, the Company completed three acquisitions. These acquisitions were not material, individually or in the aggregate. These three acquisitions have been included in the Company’s title insurance segment. The aggregate purchase price for these acquisitions was $1.2 million in cash and $0.1 million in notes payable. The purchase price of each acquisition was allocated to the assets acquired and liabilities assumed using a variety of valuation techniques including discounted cash flow analysis.
(4) Per share information was computed using the number of shares of common stock outstanding immediately following the Separation, as if such shares were outstanding for the entire period prior to the Separation.
(2) Per share information was computed using the number of shares of common stock outstanding immediately following the Separation, as if such shares were outstanding for the entire period prior to the Separation.
(1) As other long-term investments are not publicly -traded, reasonable estimate of the fair values could not be made without incurring excessive costs.
First American Financial Corporation became a publicly traded company following its spin-off from its prior parent, The First American Corporation (“TFAC”) on June 1, 2010. On that date, TFAC distributed all of First American Financial Corporation’s outstanding shares to the record date shareholders of TFAC on a one-for-one basis. After the distribution, First American Financial Corporation owns TFAC’s financial services businesses and TFAC, which reincorporated and assumed the name CoreLogic, Inc. continues to own its information solutions businesses. As such, First American Financial Corporation’s Parent Company opening condensed balance sheet is as of June 1, 2010 and the condensed statements of income and cash flows are for the seven months ended December 31, 2010.