The insurance industry is a complicated area for investors, and the many niches within the sector can get confusing in a hurry. Anyone who's ever applied for a mortgage loan is probably familiar with title insurance, which most lenders require in order to guarantee that they'll get paid in the event of an ownership dispute over your property. First American Financial (FAF -0.87%) is a specialist in title insurance and related services, and the healthy real estate market in the past several years has led to successful performance from the company. Yet with higher interest rates, refinancing transactions have been on the decline, and that's posed a threat to First American's growth.
Coming into Thursday's fourth-quarter financial report, First American investors understood that the slightly weaker industry environment could cause some disruptions to growth. That made the title insurer's results a bit easier to swallow, as even though revenue declined, the company still showed plenty of encouraging signs for the future. Let's take a closer look at First American Financial and what it said about its results.
First American gets a big tax boost
First American Financial's fourth-quarter results weren't perfect, but they held up better than some had feared. Total revenue fell 1.5% to $1.48 billion, which was a bit better than the more than 2% top-line decline that most investors were expecting to see. A big one-time income item related to tax reform helped send GAAP net income sharply higher, but even accounting for that gain, adjusted net income of $107 million was higher by 32% from the year-earlier quarter. Adjusted earnings of $0.95 per share were better than the consensus forecast of $0.92 among those following the stock.
Tax reform gave First American a big boost. The company said that the remeasurement of net deferred tax liabilities helped add $114.1 million, or $1.01 per share, to its bottom line. That gain won't recur, but First American should still benefit from lower tax rates going forward.
Fundamentally, First American had to deal with some headwinds in its core business. In the title insurance and services segment, revenue was down 2% as direct order flows were particularly weak. Direct open orders fell by more than 34,000 to 231,500, while direct closed orders were down an even sharper 48,500 to 204,200. However, the business that First American did do was more profitable, with segment pre-tax income rising 10% on a nice boost in margin. Solid performance in the commercial area was also a key, with a big jump in average revenue contributing to growth even as order flows were mixed. First American also reported a shift toward higher-premium residential purchase transactions, which pay better than refinancings.
First American's other businesses were mixed. Information services revenue fell 1% as falling refinancing activity weighed on demand, but rising rates helped push investment income higher by 30%. In the specialty insurance segment, revenue inched higher by about 2%, but pre-tax profit got cut nearly in half due largely to high claim losses from California wildfire events.
Can First American Financial keep up the pace?
CEO Dennis Gilmore focused on the full-year results rather than its sluggish end to 2017. "Total revenue grew 4% [for the year]," Gilmore said, "primarily driven by strength in our purchase and commercial businesses, which offset the sharp drop in refinance transactions." The CEO also noted that the company stayed efficient in keeping margin levels high.
First American continues to believe that the future will stay strong. Housing market conditions appear to be holding up well despite slight interest rate increases, and generally strong economic prospects should put more prospective homebuyers in a position to seek mortgage loans.
First American Financial's stock has already reacted to the threat of higher rates, falling from its recent highs. Yet looking at its business performance, First American is doing everything it can to keep writing profitable business. As long as homeowners and commercial purchasers keep buying real estate, First American will be in a strong position to take advantage by providing services to them.