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First American Financial Inches Ahead Despite Rising Rates

By Dan Caplinger - Oct 26, 2017 at 10:16AM

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Find out how the title insurance company is making up for weaker refinancing activity.

If you need a mortgage, you'll almost certainly need title insurance, and First American Financial (FAF 1.14%) specializes in offering title coverage and related services to those buying residential and commercial real estate. That's been a high-growth industry in recent years, thanks to the renewed boom in real estate following the financial crisis. More recently, though, rising interest rates have led some to worry that the housing market could be in danger of a pullback, and title insurers have seen a drop in business from those seeking to refinance their mortgages because of the lack of cheaper financing options.

Coming into Thursday's third-quarter financial report, First American investors were prepared for the challenges that the company faces, but they still wanted to see some signs of stability even as the market environment grows more volatile. First American's results were solid, but many focused on the slowdown in key areas of its business that could point to longer-term adverse trends. Let's look more closely at First American Financial to see what its performance can tell us about the stock's prospects.

Logo of First American Financial's title insurance unit.

Image source: First American Financial.

First American stays strong

First American Financial's third-quarter results were generally favorable. Revenue was up almost 1% to $1.52 billion, slightly beating the unchanged sales that most of those following the stock were expecting to see. A big one-time charge related to the termination of First American's pension plan sent GAAP net income down by four-fifths from year-ago levels, but after allowing for that charge and other extraordinary items, adjusted earnings of $1.05 per share were higher than the consensus forecast from investors of $1 per share.

The key title insurance and services business showed the crosswinds that First American has had to fight. Overall segment revenue was up about 0.1%, but pretax segment income was down 4% from the year-ago quarter. First American said that the number of direct title orders that it closed plunged by a fifth to 214,300, but average revenue per order jumped by almost a quarter, leading the two figures to roughly offset each other. Slower refinancing activity was primarily responsible for the transaction volume hit, but title premiums tend to be higher on home purchase transactions and on commercial real estate purchases. Rising real estate values also added to performance, because title insurance costs are related to the value of the property covered. Although closed commercial order counts fell by 900 to 19,400, average revenue per order jumped almost 10% to $9,000. First American also brought in 6% more revenue from its information products division, and higher interest rates helped boost investment income by nearly a third from the year-earlier period.

First American's specialty insurance business did even better. Revenue was up about 8%, and pretax income more than tripled due largely to more favorable loss experience and higher premiums in the home warranty business. The company's property and casualty business saw higher claim losses, but loss ratios remained encouraging.

What's next for First American Financial?

CEO Dennis Gilmore was fine with how First American did during the quarter. "We are seeing sustained growth in our purchase business," Gilmore said, "and the positive momentum in our commercial business continued." The CEO also noted that despite refinance market declines, that market has hit an equilibrium at which First American can appropriately respond to lower volumes.

First American also sees a bright future. Seasonal strength in the commercial business and continued growth opportunities for home purchase activity should make the fourth quarter relatively strong. Moreover, Gilmore said that he doesn't expect any significant impact on First American's results from the recent hurricanes and wildfires hitting different areas of the country.

Even with the optimistic outlook from the company, shareholders didn't seem entirely comfortable with First American Financial's assessment of the situation. The stock fell more than 2% in premarket trading following the announcement. Yet if the title insurer can deal with rising interest rates and their negative impact on refinancing transactions as well as it has recently, then First American has already demonstrated an ability to endure tougher conditions without seeing material impacts to its fundamental business performance.

Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool recommends First American Financial. The Motley Fool has a disclosure policy.

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