We lease under a non-cancelable lease expiring in 2016 approximately 277,000 square feet in an office building in Houston, Texas, which is used for our corporate offices and for offices of several of our subsidiaries. In addition, we lease offices at approximately 625 additional locations that are used for branch offices, regional headquarters and technology centers. These additional locations include significant leased facilities in Dallas, Denver, Los Angeles, Reno, San Diego, Seattle and Toronto.
Our leases expire from 2009 through 2017 and have an average term of five years, although our typical lease term ranges from three to five years. We believe we will not have any difficulty obtaining renewals of leases as they expire or, alternatively, leasing comparable properties. The aggregate annual rent expense under all leases was approximately $61.9 million in 2008.
Based upon contractual maturities of the notes. At December 31, 2008, $52.0 million of this amount would be due on demand upon notice from our lenders. See Note 10 to the consolidated financial statements.
Our results were negatively impacted by strengthening of policy loss reserves by $32.0 million as a result of larger than expected claims payments and incurred claims history for policy years 2005, 2006 and 2007. This brings the total strengthening for these policy years to $37.4 million. We do not currently anticipate future reserve strengthening for these policy years. Our policy loss reserves in 2008 also reflect charges of $41.7 million relating to large title losses and defalcations attributable to independent agencies. These charges were partially offset by insurance recoveries of $11.6 million received during the year.
Industry experts expect the downturn in the real estate and related lending markets to continue through at least 2009. Therefore, our consolidated financial condition and results of operations will continue to be subject to adverse market conditions.
Due to the inherent uncertainty in predicting future title policy losses, significant judgment is required by both our management and our third party actuaries in estimating reserves. As a consequence, our ultimate liability may be materially greater or less than current reserves and/or our third party actuary’s calculation.
Our accruals for revenues on unreported policies from agencies were not material to our consolidated assets or stockholders’ equity at December 31, 2008 and 2007. The differences between the amounts our agencies have subsequently reported to us compared to our estimated accruals are substantially offset by any differences arising from prior years’ accruals and have been immaterial to consolidated assets and stockholders’ equity during each of the three prior years. We believe our process provides the most reliable estimation of the unreported revenues on policies and appropriately reflects the trends in agency policy activity.
We believe this implied control premium is reasonable based on average premiums for transactions in the insurance industry, as well as the unique characteristics of our Class B Common Stock.
Our primary business is title insurance and settlement-related services. We close transactions and issue title policies on homes and commercial and other real properties located in all 50 states, the District of Columbia and international markets through policy-issuing offices and agencies. We also provide post-closing lender services, automated county clerk land records, property ownership mapping, geographic information systems, property information reports, document preparation, background checks and expertise in Internal Revenue Code Section 1031 tax-deferred property exchanges.
Factors affecting revenues. The principal factors that contribute to changes in operating revenues for our title and REI segments include:
Industry data. Published mortgage interest rates and other selected residential data for the years ended December 31, 2008, 2007 and 2006 follow (amounts shown for 2008 are preliminary and subject to revision). The amounts below may not relate directly to or provide accurate data for forecasting our operating revenues or order counts.
Most industry experts project mortgage interest rates to remain low in 2009. Refinancing mortgage originations increased late in 2008 and early 2009 due to lower interest rates and government efforts to strengthen credit markets. Industry experts agree that mortgage originations will increase moderately in 2009 mainly due to refinancing originations, but decrease in 2010.
Trends and order counts. For the three years ending 2008, mortgage interest rates (30-year, fixed-rate) have fluctuated from a monthly high of 6.8% in July 2006 to a monthly low of 5.3% in December 2008. As a result of the above, and the effects of the collapsed subprime mortgage lending market and limited availability of credit, mortgage originations decreased 32.0% from 2006 through 2008. Sales of new and existing homes decreased 54.1% and 24.2%, respectively, in this same two-year period.
As a result of the above trends, our direct order levels have decreased significantly from 2006 to 2008, which is consistent with the decline of the U.S. real estate market.
The number of direct title orders we closed follows (in thousands):
We cannot predict the outcome of proposed regulations. However, to the extent that rate decreases are mandated in the future, the outcome could materially affect our consolidated financial condition or results of operations.
Stewart Title of California, Inc., our subsidiary, is a defendant in four putative class action lawsuits filed in California state and federal courts. These lawsuits are commonly referred to as “wage and hour” lawsuits. These lawsuits generally claim, among other things, that (i) the plaintiffs were misclassified as exempt employees and were not paid overtime, (ii) the overtime payments made to non-exempt employees were miscalculated and (iii) the plaintiffs worked overtime hours, but were not paid. The plaintiffs seek compensatory damages, statutory compensation, penalties and restitution, exemplary and punitive damages, declaratory relief, interest and attorneys fees. We are seeking to consolidate the two federal court cases. All of these cases are in the discovery stage, and their outcomes cannot be predicted with certainty at this time. We intend to vigorously defend ourselves against the allegations. We do not believe that the outcomes will materially affect our consolidated financial condition or results of operations.
In February 2008, an antitrust class action was filed in the United States District Court for the Eastern District of New York against Stewart Title Insurance Company, Monroe Title Insurance Corporation, Stewart Information Services Corporation (SISCO), several other unaffiliated title insurance companies and the Title Insurance Rate Service Association, Inc. (TIRSA). The complaint alleges that the defendants violated Section 1 of the Sherman Act by collectively filing proposed rates for title insurance in New York through TIRSA, a state-authorized and licensed rate service organization.
Complaints were subsequently filed in the federal district courts for the Eastern and Southern Districts of New York and federal district courts in Pennsylvania, New Jersey, Ohio, Florida (since dismissed), Massachusetts, Arkansas, California, Washington, West Virginia, Texas and Delaware. All of the complaints make similar allegations, except that certain of the complaints also allege violations of RESPA statutes and various state consumer protection laws. The complaints generally request treble damages in unspecified amounts, declaratory and injunctive relief, and attorneys’ fees. At least 72 such complaints are currently pending (and have been consolidated in the aforementioned jurisdictions), each of which names SISCO and/or one or more of our affiliates as a defendant. Although we cannot predict the outcome of these actions, we intend to vigorously defend ourselves against the allegations and do not believe that the outcome will materially affect our consolidated financial condition or results of operations.
Title revenues. Our revenues from direct title operations decreased $240.6 million, or 25.4%, in 2008 and $81.3 million, or 7.9%, in 2007. The largest revenue decreases in 2008 were in California, Texas, New York, Florida, and Washington, partially offset by increases in New Jersey and Pennsylvania. The largest revenue decreases in 2007 were in California, Florida, Nevada and Arizona, partially offset by increases in Canada, New York and Texas. Acquisitions increased revenues $3.5 million and $22.1 million in 2008 and 2007, respectively. Revenues from commercial and large transactions decreased $53.9 million to $117.0 million in 2008 after increasing $22.6 million to $170.9 million in 2007. In 2008, the decreases in residential and commercial title revenues were a result of the dramatic decline in the U.S. real estate market.
The number of our direct closings, excluding large commercial policies, decreased 24.6% in 2008 and 19.2% in 2007. However, the average revenue per closing, excluding large commercial policies, was comparable in 2008 and increased 9.4% in 2007.
Revenues from agencies decreased 22.8% and 21.3% in 2008 and 2007, respectively. The decrease in both years was primarily due to the impact of a reduction in home sales and prices in most markets and the overall decline in business related to market conditions. The largest decreases in revenues from agencies in 2008 were in Florida, New York, Pennsylvania, Virginia, Georgia and California. The largest decreases in revenues from agencies in 2007 were in Florida, California, Virginia, Maryland and Ohio.
The decrease in 2007 primarily resulted from the sale of our mapping and aerial photography businesses, GlobeXplorer and AirPhotoUSA, to DigitalGlobe®. We continue to acquire spatial and digital imagery from these companies and use these images in certain of the products sold in our operations or directly sell these images through our real estate information portal, PropertyInfo Corporation. We recorded a pretax gain of $3.2 million from the sale of these subsidiaries, which is included in our results of operations in investment and other gains - net in our consolidated statements of earnings, retained earnings and comprehensive earnings. The impact of the sale transaction and these businesses’ operations was not material to our consolidated financial condition, results of operations or cash flows.
Investment income. Investment income decreased $6.9 million, or 19.2%, in 2008 and increased $1.2 million, or 3.3%, in 2007. The decrease in 2008 was primarily due to decreases in average invested balances and yields, whereas the increase in 2007 was primarily due to higher yields.
Employee costs. Our employee costs and certain other operating expenses are sensitive to inflation. Employee costs for the combined business segments decreased $135.3 million, or 19.6%, in 2008 and $39.4 million, or 5.4%, in 2007. The number of persons we employed at December 31, 2008, 2007 and 2006 was approximately 6,300, 8,500 and 9,900, respectively.
In our REI segment, the total employee costs decreased $13.4 million, or 27.8%, from 2008 primarily due to cost saving initiatives as a result of the current operating environment. For 2007, the total REI employee costs decreased $2.8 million, or 5.5%, from 2006 primarily due to the sale of our mapping and aerial photography businesses and also due to decreases in our Section 1031 tax-deferred exchange business.
Other operating expenses also include travel, telephone, delivery, rental equipment, repairs and maintenance, auto and airplane, copy expenses, title plant expenses, postage, professional fees and attorneys’ fees.
Title loss provisions in 2007 included $28.4 million for large title claims, primarily related to independent agency defalcations, and an adjustment to reserves of $5.0 million related to claims that may have been incurred but not yet reported to us, which resulted from the increase in the frequency of large claims. In addition, we recorded a reserve increase of $7.5 million related to higher than expected loss payment experience for policy years 2004 through 2006. As a result of this policy loss experience, we also increased our provision for year 2007 policies by approximately $8.2 million.
Title loss provisions included $9.2 million for large claims primarily related to agency defalcations in 2006.
Income taxes. Our effective tax rates, based on earnings before taxes and after deducting minority interests (a loss of $239.7 million and $64.1 million, and earnings of $66.3 million in 2008, 2007 and 2006, respectively), were (0.9%), 37.3% and 34.8% for 2008, 2007 and 2006, respectively. Our effective tax rate in 2008 was significantly impacted by a valuation allowance of $86.2 million against our deferred tax assets. The valuation allowance was established in accordance with current accounting standards due to the Company’s cumulative three-year operating losses. The valuation allowance will be evaluated for reversal, subject to certain potential limitations, as we return to profitability. For 2007, our effective tax rate increased primarily due to the level of our operating losses compared with our significant permanent differences, such as tax-exempt income, which remain relatively fixed in amount in 2007 and 2006.
Material contractual obligations consist primarily of notes payable, operating leases and estimated title losses. The timing above for payments of notes payable is based upon the contractually stated payment terms of each debt agreement although certain of these agreements can be called by the issuing banks at any time. Operating leases are primarily for office space and expire over the next 10 years. The timing above for the payments of estimated title losses is not set by contract. Rather, it is projected based on historical payment patterns. The actual timing of estimated title loss payments may vary materially from the above projection since claims, by their nature, are complex and paid over long periods of time. Loss reserves represent a total estimate only, whereas the other contractual obligations are determinable as to timing and amounts. Title losses paid were $136.8 million, $117.6 million and $107.2 million in 2008, 2007 and 2006, respectively.
Our liquidity at December 31, 2008 at the holding company was comprised of cash and investments aggregating $15.4 million and short-term liabilities of $7.4 million. We know of no commitments or uncertainties that are reasonably likely to materially affect our ability to fund our cash needs at our holding company. See Notes 10 and 18 to our accompanying consolidated financial statements.
A substantial majority of our remaining consolidated cash and investments at December 31, 2008 was held by Guaranty and its subsidiaries. The use and investment of these funds, dividends to the holding company, and cash transfers between Guaranty and its subsidiaries and the holding company are subject to certain legal and regulatory restrictions. In general, Guaranty may use its cash and investments in excess of its legally-mandated statutory premium reserve (established in accordance with legal requirements under Texas regulatory provisions) to fund its insurance operations, including claims payments. Guaranty may also, subject to certain limitations and upon regulatory approval, pay dividends to the holding company and/or provide funds to its subsidiaries (whose operations consist principally of field title agency offices) for their operating and debt service needs. See Notes 2 and 3 to our accompanying consolidated financial statements.
Our principal sources of cash from operations are premiums on title policies and title service-related receipts. Our independent agencies remit cash to us net of their contractual retention. Our principal cash expenditures for operations are employee costs, operating costs, and title claims payments.
Our negative cash flow from operations in 2008 was primarily due to our net loss, which in turn was driven by declining revenues from rapidly declining home sales combined with falling sales prices as discussed earlier. While we took aggressive actions in response to market conditions, we were unable to reduce cash expenditures for employee and other operating expenses as timely as revenues fell.
Although we have made significant progress in automating our services, our business continues to be labor intensive. As order volumes decline, we adjust staffing levels accordingly, but there is typically a lag between changes in market conditions and changes in personnel, so employee costs do not decline at the same rate as revenues decline. Further, we incur costs based on total orders received, while our revenues are earned based on orders actually closed. A decline in closing ratios from historical trends will have an adverse impact on operating results and, consequently, on cash flows. We reduced our number of employees by almost 2,200 during 2008, and the significant annualized cash savings from these reductions have not been fully realized in our 2008 operating results.
Other operating costs consist of both fixed (such as rent and other occupancy costs) and variable (such as taxes due to the various states on premium revenues) components, but are predominately fixed in nature. Since the end of December 2005, when the real estate market began to turn down, we have closed over 325 offices or branch locations. However, the leases have not yet expired on all of these locations, and we continue to incur cash rent payments on those that have not been sublet. Over the course of 2009, over 30 leases on closed offices not sublet will expire and not be renewed. All discretionary spending was sharply curtailed in 2008 and will continue to be closely monitored in 2009. We also negotiated new contracts in 2008 with vendors in key spending categories and will benefit in 2009 from the full year effect of lower prices achieved.
Capital expenditures were $18.0 million, $31.4 million, and $42.0 million in 2008, 2007, and 2006, respectively. Capital expenditures declined significantly from prior year levels since almost no new offices were opened in 2008 due to poor economic conditions and we sharply curtailed spending in all other areas. We expect that capital expenditures will continue to decline in 2009 as the recession continues and we continue to aggressively manage cash flow. We have no material commitments for capital expenditures.
During 2008, we purchased $241.5 million of investments from our exchanger funds (See Note 10 to consolidated financial statements). To fund these purchases, we drew $241.5 million under the related line of credit and pledged the investments to secure the line. Under the terms of the line of credit and related settlement agreement, we expect to repay it by June 30, 2010 by surrendering the related investments - pledged. Prior to June 30, 2010, any redemptions by the issuers of the investments owned by us would be utilized to reduce the line of credit. We do not expect to have any future net cash flow from the settlement of these investments or on the related line of credit.
In addition, we borrowed $47.2 million from banks in 2008, $43.0 million of which was under short term lines of credit. Of these borrowings, $4.0 million was repaid prior to year end, $24.0 million was repaid in February 2009, and the remainder is scheduled to be repaid by June 2009. In addition, $24.0 million of other debt repayments were made in 2008 in accordance with the underlying terms of the debt, which were generally in line with scheduled payments in prior years. At December 31, 2008, we had no available borrowing capacity since the majority of our debt consists of individual unsecured term notes and the lines of credit expire as they are repaid. Of the debt outstanding at December 31, 2008, $107.2 million can be called by the issuing banks at any time. We do not expect that any of these borrowings will be called during the next twelve months. Instead, we expect to extinguish the debt from available cash or cash flows from operations as payments become due under the terms of each debt agreement.
We paid $1.7 million in cash dividends to our shareholders in 2008, representing $0.10 per common share outstanding. In 2007 and 2006, we paid cash dividends of $12.7 million and $12.9 million, respectively, representing $0.75 per common share outstanding. Our dividend was reduced based on our operating performance and our desire to conserve cash. The declaration of any future dividend is at the discretion of our Board of Directors.
The effect of changes in foreign currency rates on the consolidated statements of cash flows was a net decrease in cash and cash equivalents of $10.9 million as compared with an increase of $3.0 million and $2.4 million in 2007 and 2006, respectively. Our principal foreign operating unit is in Canada, and the value of the U.S. dollar relative to the Canadian dollar declined significantly during 2008.
Due to the significant cash savings from the actions taken in 2008 as described above and elsewhere in this Form 10-K, and based on our available cash and investments as well as our expected operating results in 2009, we believe we have sufficient liquidity to meet the cash needs of our ongoing operations without supplemental debt or equity funding.
Other comprehensive (loss) earnings. Unrealized gains and losses on investments and changes in foreign currency exchange rates are reported net of deferred taxes in accumulated other comprehensive earnings, a component of stockholders’ equity, until realized. The 2008 net unrealized investment losses of $1.0 million, which increased our comprehensive loss, were related to temporary declines in market values of equity, municipal bond and corporate bond investments and partially offset by increases in the government bond investments. For 2007 and 2006, unrealized investment gains of $1.9 million and $0.8 million, respectively, increased comprehensive earnings primarily due to changes in bond values caused by interest rate decreases. Changes in foreign currency exchange rates, primarily related to our Canadian operations, increased comprehensive loss by $18.3 million, net of taxes, in 2008 and increased comprehensive earnings $9.9 million and $1.6 million, net of taxes, in 2007 and 2006, respectively.
Forward-looking statements. Certain statements in this report are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements related to future, not past, events and often address our expected future business and financial performance. These statements often contain words such as “expect,” “anticipate,” “intend,” “plan,” “believe,” “seek,” “will” or other similar words. Forward-looking statements by their nature are subject to various risks and uncertainties that could cause our actual results to be materially different than those expressed in the forward-looking statements. These risks and uncertainties include, among other things, the severity and duration of current financial and economic conditions, the impact of recent significant decreases in the level of real estate activity, continued weakness or further adverse changes in the level of real estate activity, our ability to respond to and implement technology changes, the impact of unanticipated title losses on the need to further strengthen our policy loss reserves and any effect of title losses on our cash flows and financial condition, the impact of changes in governmental regulations, our dependence on our operating subsidiaries as a source of cash flow, the realization of expected expense savings resulting from our expense reduction steps taken in 2008, our ability to grow our international operations and our ability to respond to the actions of our competitors.