seasonal real estate cycle in the fourth quarter 1994. The average revenues per order closed were $778 for 1994 as compared with $678 for 1993. The increase reflected a change in the Company's business mix from predominantly lower margin refinance transactions in 1993 to a more balanced mix in 1994, including higher margin resale transactions. Operating revenues from agency title operations, which are more concentrated in the midwestern and eastern sectors of the country, decreased 21.5% in 1995 from 1994. The decrease reflects a slow first half of 1995 as discussed above, compounded by the inherent delay in reporting by agents of the resurgence in business for the latter part of 1995. Operating revenues from agency title operations increased 6.6% in 1994 over 1993. This increase was primarily attributable to the high level of orders closed with our agents during the fourth quarter 1993 and not reported to the Company until the beginning of 1994, as well as the increase in resale activity, offset in part by the decline in refinance transactions.
Real estate information operating revenues increased 53.7% in 1995 when compared with 1994. This increase was primarily attributable to $59.8 million of operating revenues contributed by new acquisitions, partially offset by the same economic factors affecting title insurance mentioned above. Operating revenues remained relatively constant for 1994 when compared with 1993; this constant level of revenues, in spite of a significant fourth quarter 1994 revenue reduction, was primarily attributable to the heavy volume of refinance transactions that continued through the end of 1993 and into the beginning of 1994, as well as approximately $6.0 million of revenues contributed by companies acquired during 1994.
Home warranty operating revenues increased 15.7% in 1995 over 1994 and 25.5% in 1994 over 1993. These increases were primarily attributable to improvements in certain of the residential resale markets in which this segment operates, successful geographic expansion, increased consumer awareness and an increase in the number of annual renewals.
INVESTMENT AND OTHER INCOME--Investment and other income increased 18.4% in 1995 over 1994 and 4.3% in 1994 over 1993. The increase in the current year was primarily attributable to gains on the sale of certain investments, a $.7 million fire insurance recovery and increased equity in earnings of affiliates of $.5 million, offset in part by a 9.3% decrease in the average investment portfolio balance. The increase in 1994 over 1993 was due to a 22.2% increase in the average investment portfolio balance, offset in part by a reduction of $1.4 million in equity in earnings of affiliates. See Note 9 to the consolidated financial statements for additional details on investment and other income.
The Company's title insurance segment is labor intensive; accordingly, a major variable expense component is salaries and other personnel costs. The expense component is affected by two competing factors: The need to monitor personnel changes to match corresponding or anticipated new orders, and the need to provide quality service. Commencing in the second quarter 1994 through the first quarter 1995, the Company's ability to match cost reductions with order declines was hampered by the continual upward adjustment of interest rates by the Federal Reserve Board. In addition, the Company's growth in operations servicing builder and lender business has created ongoing fixed costs required to service accounts, even when market conditions are producing fewer new orders.
Real estate information other operating expenses increased 63.2% in 1995 over 1994 and 26.8% in 1994 over 1993. The increase in 1995 was primarily attributable to $28.8 million relating to acquisitions, offset in part by cost-containment programs in light of a reduction in new tax service contracts in 1995. The increase in 1994 was attributable to the incremental costs incurred servicing the heavy volume of business during the first half of 1994, costs associated with developing and enhancing computer software, costs incurred in assimilating and expanding the mortgage credit reporting operations, and $2.0 million of other operating expenses attributable to acquisitions.
PROVISION FOR TITLE LOSSES AND OTHER CLAIMS--A summary by segment of the Company's provision for title losses and other claims is as follows:
The provision for title insurance losses expressed as a percentage of title insurance operating revenues was 6.6% in 1995, 7.6% in 1994, and 8.9% in 1993. The decreases were primarily attributable to an ongoing improvement in the Company's claims experience, as well as a reduction in major claims activity. The Company anticipates that the improvement over the past several years will continue in 1996. The provision for home warranty losses as a percentage of home warranty operating revenues was 58.0% in 1995, 53.4% in 1994, and 52.5% in 1993. These increases were primarily attributable to increases in the average number of claims per contract experienced during these periods, resulting from the home warranty operations offering extended coverages on its warranties.
INTEREST--Interest expense remained relatively unchanged in 1995 when compared with 1994 primarily as the result of an average outstanding debt balance and comparable average interest rates. Interest expense increased 41.8% in 1994 over 1993 primarily due to $1.5 million of interest expense attributable to a
MINORITY INTERESTS--Minority interests in net income of consolidated subsidiaries decreased 27.6% in 1995 from 1994 and 44.1% in 1994 from 1993. The decrease in 1995 over 1994 was primarily attributable to the Company's purchases of shares from minority shareholders. The decrease in 1994 over 1993 was due to a decline in the profitability of the Company's less than 100% owned subsidiaries, the August 1994 sale of the Company's remaining interest in North American Title Insurance Company and the purchases of shares from minority shareholders.
The Company's profit margins and pretax profits vary according to a number of factors, including the volume, composition (residential or commercial) and type (resale, refinancing or new construction) of real estate activity. For example, in title insurance operations, commercial transactions tend to generate higher revenues and greater profit margins than residential transactions. Further, profit margins from refinancing activities are lower than those from resale activities because in many states there are premium discounts on, and cancellation rates are higher for, refinancing transactions. Cancellations of title orders adversely affect pretax profits because costs are incurred and expensed in opening and processing such orders but revenues are not generated. Also, the Company's direct title insurance business has significant fixed costs in addition to its variable costs. Accordingly, profit margins from the Company's direct title insurance business improve as the volume of title orders closed increases. Title insurance profit margins are also affected by the percentage of operating revenues generated by agency operations. Profit margins from direct operations are generally higher than from agency operations due primarily to the large portion of the premium that is retained by the agent. Real estate information pretax profits are generally unaffected by the type of real estate activity but increase as the volume of residential real estate loan transactions increases. Home warranty pretax profits improve as the volume of residential resales increases. In general, the title insurance business is a lower margin business when compared to the Company's other segments. The lower margins reflect the high fixed cost of producing title evidence whereas the corresponding revenues are subject to regulatory and competitive pricing constraints.
Insurers are generally not subject to state income or franchise taxes. However, in lieu thereof, a "premium" tax is imposed on certain operating revenues, as defined by statute. Tax rates and bases vary from state to state; accordingly, the total premium tax burden is dependent upon the geographical mix of title insurance and home warranty operating revenues. Premium taxes for title insurance decreased 12.5% in 1995 from 1994 and 13.1% in 1994 from 1993. These changes correspond to the relative decreases in title insurance operating revenues. Premium taxes as a percent of title insurance operating revenues remained relatively constant at approximately 1.2%. Premium taxes for home warranty increased 5.3% in 1995 over 1994 and 16.5% in 1994 over 1993. These changes reflect the level of home warranty premiums written during the respective periods.
Cash provided by operating activities amounted to $30.4 million, $53.9 million and $105.7 million for 1995, 1994 and 1993, respectively, after claim payments of $66.6 million, $87.6 million and $77.3 million, respectively. The principal non-operating uses of cash and cash equivalents for the three-year period ended December 31, 1995, were for additions to the investment portfolio, capital expenditures, company acquisitions and the repayment of debt. The most significant nonoperating sources of cash and cash equivalents were from proceeds from the sales and maturities of certain investments, and in 1994, proceeds from the sale of property and equipment and proceeds from the issuance of debt. The net effect of all activities on total cash and cash equivalents was a decrease of $8.3 million in 1995 and increases of $23.9 million and $10.5 million in 1994 and 1993, respectively.
Notes and contracts payable as a percentage of total capitalization as of December 31, 1995, was 19.1% as compared with 22.1% as of the prior year end. The decrease was primarily attributable to a $12.4 million net
decrease in debt. As part of the Company's strategy to extend the maturity of, and provide a long-term amortization schedule for, its outstanding demand and term indebtedness, the Company entered into a credit agreement with the Chase Manhattan Bank as agent on April 21, 1992. Under the terms of the credit agreement, the company borrowed $65.0 million on April 27, 1992, and used the proceeds thereof to retire approximately $63 million of demand and near-term indebtedness. During 1994, the Company amended the credit agreement to borrow an additional $20.0 million of variable rate indebtedness to pay off an existing higher rate trust deed note. In addition, the amendment provided for a $30.0 million revolving line of credit which remained unused as of December 31, 1995. This credit agreement is more fully described in Note 8 to the consolidated financial statements.
REPORT OF INDEPENDENT ACCOUNTANTS ON THE CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
Title plants and other indexes are carried at original cost. Appraised values are used in conjunction with the acquisition of purchased subsidiaries. The cost of daily maintenance (updating) of these plants and other indexes are charged to expense as incurred. Because properly maintained title plants and other indexes have indefinite lives and do not diminish in value with the passage of time, no provision has been made for depreciation.
In connection with settlement of title insurance and other claims, the Company sometimes purchases mortgages, deeds of trust, real property, or judgment liens. These assets, sometimes referred to as "salvage assets," are carried at the lower of cost or estimated realizable value, net of any indebtedness thereon. Judgment liens primarily represent funds expended by the Company to purchase judgments to satisfy title claims.
Revenues from tax service contracts are recognized proportionately over the estimated duration of the contracts as the related servicing costs are estimated to occur. The majority of the servicing costs, approximately 70%, is incurred in the year the contract is executed, with the remaining 30% incurred over the remaining service life of the contract.
Certain amounts and disclosures included in the consolidated financial statements require management to make estimates which could differ from actual results.
Pursuant to insurance and other regulations of the various states in which the Company's title insurance subsidiary, First American Title Insurance Company (FATICO), operates, the amount of dividends, loans and advances available to the parent company from FATICO is limited, principally for the protection of policyholders. Under such statutory regulations, the maximum amount of dividends, loans and advances available to the parent company from FATICO in 1996 is $44.6 million.
Investments carried at $12.8 million were on deposit with state treasurers in accordance with statutory requirements for the protection of policyholders at December 31, 1995.
The amortized cost and estimated fair value of debt securities at December 31, 1995, by contractual maturities, are as follows:
Sales of debt and equity securities resulted in realized gains of $1,316,000, $108,000 and $332,000 and realized losses of $358,000, $457,000 and $38,000 for the years ended December 31, 1995, 1994 and 1993, respectively. The fair value of debt and equity securities was estimated using quoted market prices.
The fair value of loans receivable was $47.2 million and $41.7 million at December 31, 1995 and 1994, respectively, and was estimated based on the discounted value of the future cash flows using the current rates being offered for loans with similar terms to borrowers of similar credit quality.
The allowance for loan losses is maintained at a level that is considered appropriate by management to provide for known and inherent risks in the portfolio.
The fair value of investment certificate accounts was $31.6 million and $25.6 million at December 31, 1995 and 1994, respectively, and was estimated based on the discounted value of the future cash flows using a discount rate approximating current market for similar liabilities. The carrying value of the passbook account approximates fair value due to the short-term nature of this liability.
"Other" primarily represents reclassifications to the reserve for assets acquired in connection with claim settlements. Included in "Other" for 1995 is $10.0 million in purchase accounting adjustments. Claims activity associated with reinsurance is not material and, therefore, not presented separately.
At December 31, 1995, the Company's borrowings under its bank credit agreement consisted of $7.6 million of fixed rate indebtedness ($8.4 million at December 31, 1994), maturing in April 1999 and bearing interest at 9.38% per annum; and $41.6 million of variable rate indebtedness ($52.6 million at December 31, 1994), maturing in October 2000 and bearing interest at the higher of Chase Manhattan Bank's prime lending rate or the federal funds rate plus 1/2%. The Company may, at its election, use a reduced interest rate option of LIBOR plus 1 1/4% for the majority of the variable rate indebtedness.
During November 1994, the Company amended the credit agreement to borrow an additional $20.0 million of variable rate indebtedness to pay off an existing higher rate trust deed note. In addition, the amendment provided for a $30.0 million revolving line of credit which was unused as of December 31, 1995.
The terms of the amended credit agreement provide for quarterly amortization of all credit agreement indebtedness. The minimum quarterly payment is $1.7 million and the maximum quarterly payment is $3.0 million. The Company has the right to prepay the variable rate indebtedness but may prepay the fixed rate indebtedness only with the consent of the holder thereof. In addition, pursuant to the terms of the credit agreement, the Company must satisfy a number of financial convenants and has agreed to be bound by certain restrictive covenants. These covenants include, among others, limitations on the incurrence of additional indebtedness and/or liens, as well as restrictions on defined investments, acquisitions, dispositions, payments of dividends and capital expenditures. Further, the Company is required to maintain minimum levels of capital and earnings and meet predetermined debt to equity ratios and fixed charge coverage ratios.
The aggregate annual maturities for notes and contracts payable in each of the five years after December 31, 1995, are as follows (in thousands):
Pursuant to the method prescribed under Accounting Principles Board Opinion (APB) No. 11, "Accounting for Income Taxes," which was effective for years ending prior to January 1, 1993, deferred income taxes were recognized for income and expense items reported in different periods for financial reporting and income tax purposes using the applicable tax rate for the year in which the differences originated. Deferred taxes under APB No. 11 were not permitted to be adjusted for subsequent changes in tax rates.
The Company did not restate its financial statements for prior years since such restatement is not required under SFAS No. 109. Instead, the Company recognized a benefit of $4.2 million, or $.37 per share, representing the cumulative effect of a change in accounting for income taxes. The cumulative effect represented the adjustment of previously recorded deferred tax assets and liabilities to reflect lower prevailing tax rates, and the related adjustment of certain other balance sheet accounts. The effect of the adjustments to other balance sheet accounts was to increase deferred revenue by $11.5 million, accrued expenses by $3.0 million and reserves for claims by $0.8 million, and to decrease goodwill by $1.9 million.
The Company maintains a valuation allowance for certain temporary differences for which it is more likely than not the Company will not receive benefits.
The rates of increase in future compensation levels for the plans of 4 1/2% and 5% and the weighted average discount rates of 7 3/4% and 8 1/4% were used in determining the actuarial present value of the projected benefit obligation at December 31, 1995 and 1994, respectively. The majority of pension plan assets are invested in U.S. government securities, time deposits and common stocks with projected long-term rates of return of 9%.
Effective January 1, 1995, the Company adopted The First American Financial Corporation 401(k) Savings Plan ("The Savings Plan"), which is available to substantially all employees. The Savings Plan allows for employee elective contributions up to the maximum deductible amount as determined by the Internal Revenue Code.
Total rental expense for all operating leases and month-to-month rentals was $58.6 million, $50.1 million and $46.0 million for 1995, 1994 and 1993, respectively.
On April 13, 1990, a class action was filed in the United States District Court in Phoenix, Arizona, against First American Title Insurance Company and a number of other title insurers. This action seeks damages and injunctive relief based on the defendants' participation in rating bureaus in Arizona and Wisconsin.
The Company does not believe that the ultimate resolution of these actions will have a materially adverse effect on its financial condition or results of operations.
The Company's operations include four reportable segments: title insurance, real estate information, home warranty and trust and banking. The title insurance segment issues policies which are insured statements of the condition of title to real property. The real estate information segment provides to lender customers the status of tax payments on real property securing their loans, credit information derived from at lease two credit bureau sources and flood zone determination reports which provide information on whether or not a property is in a special flood hazard area. The home warranty segment issues one-year warranties which protect homeowners against defects in home fixtures. The trust and banking segment provides full-service trust and depository services, accepts deposits and makes real estate secured loans.
The title insurance and real estate information segments operate through networks of offices nationwide. The Company offers its title services through both direct operations and agents throughout the Unites States. It also provides title services abroad in the Bahama Islands, Bermuda, Canada, Guam, Mexico, Puerto Rico, the U.S. Virgin Islands, and the United Kingdom. Home warranty services are available in Arizona, California, Nevada, Texas and Washington. The trust, banking and thrift businesses operate in Southern California.
Note A--Amount represents accounts written off, net of recoveries. Note B--Amount represents a reclassification to the reserve for assets acquired in connection with claim settlements. Note C--Amount represents claim payments, net of recoveries. Note D--Amount represents elimination of reserve in connection with disposition and/or revaluation of the related asset. Note E--Amount represents elimination of reserve in connection with utilization of the related temporary differences.
Note A--Amount represents accounts written off, net of recoveries. Note B--Amount represents a reclassification to the reserve for assets acquired in connection with claim settlements. Note C--Amount represents claim payments, net of recoveries. Note D--Amount represents elimination of reserve in connection with disposition and/or revaluation of the related asset. Note E--Amount represents the valuation allowance established for certain temporary differences for which it is more likely than not the Company will not receive future benefits. The valuation allowance is in accordance with the provisions set forth in SFAS 109, which was adopted by the Company in the current year.