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| STC > SEC Filings for STC > Form 10-Q on 6-Aug-2009 | All Recent SEC Filings |
6-Aug-2009
Quarterly Report
Management's overview. We reported a net loss attributable to Stewart of
$58.2 million for the six months ended June 30, 2009 compared with a net loss
attributable to Stewart of $53.9 million for the same period in 2008. On a
diluted per share basis, our net loss attributable to Stewart was $3.21 for the
first six months of 2009 compared with a net loss attributable to Stewart of
$2.98 for the first six months of 2008. Revenues for the first six months of
2009 decreased 9.5% to $744.2 million from $822.7 million for the same period
last year. Losses before taxes and noncontrolling interests decreased
$34.6 million to $50.4 million from $85.0 million for the six months ended
June 30, 2009 and 2008, respectively.
Before consideration of a $19.2 million reserve strengthening charge and
$22.4 million for charges relating to several independent agency defalcations
and fraud, partially offset by $9.2 million for insurance recoveries, our
year-to-date loss reflects a significant improvement as a result of extensive
cost reduction efforts undertaken in 2008 and 2009. A significant reduction was
achieved in both employee costs and other operating costs for the first half of
2009 as compared to the first half of 2008. Revenues benefited from an increase
in market share and refinance orders closed.
We continue to aggressively reduce costs and improve productivity in our core
title operations. In addition to workforce reductions described below, we are
pursuing the implementation of title search and production efficiencies
company-wide through our regional production center initiative. As a result,
significant savings per order processed are being achieved in operationally
mature centers.
Separately, our back-office centralization initiatives also remain on target and
began generating benefits during 2009 in the areas of human resources, finance
and accounting, procurement and information technology by reducing employee and
operating expenses. Significant future savings will be achieved once we complete
implementation of our enterprise systems in 2010.
Title losses for the first half of 2009 were somewhat offset by recoveries of
$9.2 million under our fidelity bond, while no such recoveries were recorded in
the first half of 2008. As a result, our title loss ratio for the six months
ended June 30, 2009 and 2008 was 12.1% and 10.1% of title revenues,
respectively. In addition to the agency defalcations mentioned above, all of the
large claims, except one, are related to prior year policies issued by canceled
agencies. We believe the actions taken to restructure our agency network will
reduce future losses considerably and bring overall losses more in line with a
normal, historical range.
According to Fannie Mae and other industry experts, the real estate and related
lending markets continue to face challenges. New and existing home sales and
prices continue to decline. Purchase originations are expected to decline
further in 2009 as compared to 2008. Although purchase originations are
projected to decrease in 2009, total mortgage originations are expected to
increase in 2009 due to refinance originations, which generate lower revenue per
file closed as compared to purchase originations. Notwithstanding these market
conditions, we experienced increasing new title orders and closings during the
first half of 2009.
Critical accounting estimates. Actual results can differ from our accounting
estimates. While we do not anticipate significant changes in our estimates,
there is a risk that such changes could have a material impact on our
consolidated financial condition or results of operations for future periods.
Title loss reserves
Our most critical accounting estimate is providing for title loss reserves. Our
liability for estimated title losses as of June 30, 2009 comprises both known
claims ($150.7 million) and our estimate of claims that may be reported in the
future ($328.2 million). The amount of the reserve represents the aggregate
future payments (net of recoveries) that we expect to incur on policy and escrow
losses and in costs to settle claims.
Provisions for title losses, as a percentage of title operating revenues, were
12.1% and 10.1% for the six months ended June 30, 2009 and 2008, respectively.
Actual loss payment experience, including the impact of large losses, is the
primary reason for increases or decreases in our loss provision. A change of 100
basis points in this percentage, a reasonably likely scenario based on our
historical loss experience, would have increased or decreased our provision for
title losses and pretax loss approximately $7.1 million for the six months ended
June 30, 2009.
Our method for recording the reserves for title losses on both an interim and
annual basis begins with the calculation of our current loss provision rate,
which is applied to our current premiums resulting in a title loss expense for
the period. This loss provision rate is set to provide for losses on current
year policies and is determined using moving average ratios of recent actual
policy loss payment experience (net of recoveries) to premium revenues.
At each quarter end, our recorded reserve for title losses begins with the prior
period's reserve balance for claim losses, adds the current period provision to
that balance and subtracts actual paid claims, resulting in an amount that our
management compares to its actuarially-based calculation of the ending reserve
balance. The actuarially-based calculation is a paid loss development
calculation where loss development factors are selected based on company data
and input from our third-party actuaries. We also obtain input from third-party
actuaries in the form of a reserve analysis utilizing generally accepted
actuarial methods. While we are responsible for determining our loss reserves,
we utilize this actuarial input to assess the overall reasonableness of our
reserve estimation. If our recorded reserve amount is within a reasonable range
of our actuarially-based reserve calculation and the actuary's point estimate
(+/- 3.0%), but not at the point estimate, our management assesses the major
factors contributing to the different reserve estimates in order to determine
the overall reasonableness of our recorded reserve, as well as the position of
the recorded reserves relative to the point estimate and the estimated range of
reserves. The major factors considered can change from period to period and
include items such as current trends in the real estate industry (which
management can assess although there is a time lag in the development of this
data for use by the actuary), the size and types of claims reported and changes
in our claims management process. If the recorded amount is not within a
reasonable range of our third-party actuary's point estimate, we will adjust the
recorded reserves in the current period and reassess the provision rate on a
prospective basis. Once our reserve for title losses is recorded, it is reduced
in future periods as a result of claims payments and may be increased or reduced
by revisions to our estimate of the overall level of required reserves.
Large claims (those exceeding $1.0 million on a single claim), including large
title losses due to independent agency defalcations, are analyzed and reserved
for separately due to the higher dollar amount of loss, lower volume of claims
reported and sporadic reporting of such claims. Large title losses due to
independent agency defalcations typically occur when the independent agency
misappropriates funds from escrow accounts under its control. Such losses are
usually discovered when the independent agency fails to pay off an outstanding
mortgage loan at closing (or immediately thereafter) from the proceeds of the
new loan. Once the previous lender determines that its loan has not been paid
off timely, it will file a claim against the title insurer. It is at this point
that the title insurance underwriter is alerted to the potential theft and
begins its investigation. As is industry practice, these claims are considered a
claim on the newly issued title insurance policy since such policy insures the
holder (in this case, the new lender) that all previous liens on the property
have been satisfied. Accordingly, these claim payments are charged to policy
loss expense. These incurred losses are typically more severe in terms of dollar
value compared with traditional title policy claims because the independent
agency is often able to conceal misappropriation of escrow funds relating to
more than one transaction over time through the constant volume of funds moving
through its escrow accounts. As long as new funds continue to flow into escrow
accounts, an independent agent can mask one or more defalcations. In declining
real estate markets, lower transaction volumes result in a lower incoming volume
of funds, making it more difficult to cover up the misappropriation with
incoming funds. Thus, when the defalcation is discovered, it often relates to
several transactions. In addition, the overall decline in an independent
agency's revenues, profits and cash flows increases the agency's incentive to
improperly utilize the escrow funds from real estate transactions.
Internal controls relating to independent agencies include, but are not limited
to, periodic audits, site visits and reconciliations of policy inventories and
premiums. The audits and site visits cover examination of the escrow account
bank reconciliations and an examination of a sample of closed transactions. In
some instances, we are limited in our scope by attorney agents who cite client
confidentiality. Certain states have mandated a requirement for annual reviews
of all agents by their underwriter. We also determine whether our independent
agencies have appropriate internal controls as defined by the American Land
Title Association and Stewart. However, even with adequate internal controls in
place, their effectiveness can be circumvented by collusion or improper
management override at the independent agencies. To aid in the selection of
agencies to review, Stewart has developed an agency risk model that aggregates
data from different areas to identify possible problems. This is not a guarantee
that all agencies with deficiencies will be identified. In addition, we are not
typically the only underwriter for which an independent agency issues policies,
and agencies may not always provide complete financial records for our review.
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.
Agency revenues
We recognize revenues on title insurance policies written by independent
agencies (agencies) when the policies are reported to us. In addition, where
reasonable estimates can be made, we accrue for revenues on policies issued but
not reported until after period end. We believe that reasonable estimates can be
made when recent and consistent policy issuance information is available. Our
estimates are based on historical reporting patterns and other information about
our agencies. We also consider current trends in our direct operations and in
the title industry. In this accrual, we are not estimating future transactions.
We are estimating revenues on policies that have already been issued by agencies
but not yet reported to or received by us. We have consistently followed the
same basic method of estimating unreported policy revenues for more than
10 years.
Our accruals for revenues on unreported policies from agencies were not material
to our consolidated assets or stockholders' equity as of June 30, 2009 and
December 31, 2008. 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 estimate of
the unreported revenues on policies and appropriately reflects the trends in
agency policy activity.
Goodwill and other long-lived assets
Our evaluation of goodwill is normally completed annually in the third quarter
using June 30 balances, but an evaluation may also be made whenever events may
indicate impairment. This evaluation is based on a combination of a discounted
cash flow analysis (DCF) and market approaches that incorporate market multiples
of comparable companies and our own market capitalization. The DCF model
utilizes historical and projected operating results and cash flows, initially
driven by estimates of changes in future revenue levels, and risk-adjusted
discount rates. Our projected operating results are primarily driven by
anticipated mortgage originations, which we obtain from projections by industry
experts. Fluctuations in revenues, followed by our ability to appropriately
adjust our employee count and other operating expenses, are the primary reasons
for increases or decreases in our projected operating results. Our market-based
valuation methodologies utilize (i) market multiples of earnings and/or other
operating metrics of comparable companies and (ii) our market capitalization and
a control premium based on market data and factors specific to our ownership and
corporate governance structure. To the extent that our future operating results
are below our projections, or in the event of continued adverse market
conditions, an interim review for impairment may be required.
We evaluate goodwill based on two reporting units (Title and REI). Goodwill is
assigned to these reporting units at the time the goodwill is initially
recorded. Once assigned to a reporting unit, the goodwill is pooled and no
longer attributable to a specific acquisition. All activities within a reporting
unit are available to support the carrying value of the goodwill. At each
quarter end, we also consider the carrying value of our stockholders' equity as
compared with our market capitalization and the implied control premium to
reconcile these amounts.
As a result of overall market volatility, including our market capitalization,
we updated our evaluation of goodwill through June 30, 2009. Based upon our
updated evaluation, we have concluded that our goodwill was not impaired as of
June 30, 2009. However, to the extent that our future operating results are
below projections, or in the event of continued adverse market conditions, a
future review for impairment may be required.
We also evaluate the carrying values of title plants and other long-lived assets
when events occur that may indicate impairment. The process of determining
impairment for our goodwill and other long-lived assets relies on projections of
future cash flows, operating results, discount rates and overall market
conditions, including our market capitalization. Uncertainties exist in these
projections and are subject to changes relating to factors such as interest
rates and overall real estate and financial market conditions, our market
capitalization and overall stock market performance. Actual market conditions
and operating results may vary materially from our projections.
Based on this evaluation, we estimate and expense to current operations any loss
in value of these assets. As part of our process, we obtain input from
third-party appraisers regarding the fair value of our reporting units. While we
are responsible for assessing whether an impairment of goodwill exists, we
utilize the input from third-party appraisers to assess the overall
reasonableness of our conclusions.
In the second quarter of 2008, our REI segment incurred an impairment charge of
$6.0 million relating to its internally developed software that we subsequently
determined would not be deployed into production. There were no other material
impairment write-offs of goodwill or other long-lived assets during the six
months ended June 30, 2009 or 2008.
Operations. Our business has two operating segments: title insurance-related
services and real estate information. These segments are closely related due to
the nature of their operations and common customers.
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 in
international markets. 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 exchanges.
Factors affecting revenues. The principal factors that contribute to changes in
operating revenues for our title and REI segments include:
mortgage interest rates;
ratio of purchase transactions compared with refinance transactions;
ratio of closed orders to open orders;
home prices;
consumer confidence;
demand by buyers;
number of households;
availability of loans for borrowers;
premium rates;
market share;
opening of new offices and acquisitions;
number of commercial transactions, which typically yield higher premiums; and
government or regulatory initiatives.
To the extent inflation causes increases in the prices of homes and other real
estate, premium revenues are also increased. Premiums are determined in part by
the insured values of the transactions we handle. These factors may override the
seasonal nature of the title insurance business. Historically, our first quarter
is the least active and our third and fourth quarters are the most active in
terms of title insurance revenues.
RESULTS OF OPERATIONS
Comparisons of our results of operations for the three and six months ended
June 30, 2009 with the three and six months ended June 30, 2008 follow. Factors
contributing to fluctuations in our results of operations are presented in the
order of their monetary significance and we have quantified, when necessary,
significant changes. Results from our REI segment are included in our
discussions regarding the three and six months ended June 30, 2009 as those
amounts are not material in relation to consolidated totals. When relevant, we
have discussed our REI segment's results separately.
Our statements on home sales and loan activity are based on published industry
data from sources including Fannie Mae, the National Association of Realtorsฎ,
the Mortgage Bankers Association and Freddie Mac. We also use information from
our direct operations.
Operating environment. Data as of June 2009 compared with the same period in
2008 indicates annualized sales of new and existing homes, seasonally adjusted,
decreased 21.3% and 0.2%, respectively. June 2009 existing home sales were a
seasonally adjusted annual rate of 4.89 million versus 4.90 million a year
earlier. One-to-four family residential lending fell from an estimated
$580 billion in the second quarter of 2008 to $523 billion in the first quarter
of 2009 (most recent data available). The decline in lending volume was
primarily a result of decreasing home sales, lower home prices and reduced
financing activity, primarily due to disruptions in the credit markets which led
to tightening of mortgage lending standards. The decline in lending volume was
partially offset by an increase in refinancing activities by lenders. Commercial
lending activity industry-wide declined by 70% during the first quarter of 2009
(most recent data available) compared with the same period of 2008.
According to Fannie Mae and other industry experts, the real estate and related
lending markets continue to face challenges. New and existing home sales and
prices continue to decline. Purchase originations are expected to decline
further in 2009 as compared to 2008. Although purchase originations are
projected to decrease in 2009, total mortgage originations are expected to
increase in 2009 due to refinance originations, which generate lower revenue per
file closed as compared to purchase originations. Notwithstanding these market
conditions, we experienced an increase in new title orders and closings during
the first half of 2009.
Six months ended June 30, 2009 compared with six months ended June 30, 2008
Title revenues. Our revenues from direct operations decreased $55.2 million, or
14.5%, in the first six months of 2009 compared with the first six months of
2008. The largest revenue decreases, in terms of dollars, were in our Canadian
operations (partially due to the strengthening of the U.S. dollar), Texas, other
foreign operations, California and New York. Revenues from commercial and other
large transactions in the first six months of 2009 decreased $30.9 million, or
47.4%, from prior-year levels of $65.1 million.
Our direct orders closed increased 2.9% in the six months ended June 30, 2009
compared with the six months ended June 30, 2008 although the average revenue
per closing decreased 17.1% in the first six months ended June 30, 2009 compared
with the six months ended June 30, 2008. Our increase in direct orders closed
and decrease in average revenue per closing continue to be driven by a shift in
the mix of orders, with the first six months of 2009 experiencing fewer large
commercial orders, lower home prices and many more residential refinancing
orders than the first six months of 2008. On average, refinance premium rates
are 60% of the title premium revenue of a similarly priced sale transaction.
Revenues from agencies decreased $20.4 million, or 5.0%, for the six months
ended June 30, 2009 compared with the six months ended June 30, 2008. This
decrease largely follows the decline in our direct revenues but, to a lesser
extent, is due to the impact of international and commercial transactions on our
direct operations noted above, which are not as significant to our agency
business. The largest decreases in revenues from agencies during the six months
ended June 30, 2009 were in Florida, Texas, New York and Virginia, partially
offset by increases in California.
REI revenues. Real estate information operating revenues were $29.1 million and
$26.0 million in the first six months of 2009 and 2008, respectively. The
increase of 12.0% from 2008 was due to a significant rise in our loan
modification services. This increase was partially offset by the reduction in
post-closing lender services activity due to a decrease in residential lending
volume. This increase was also partially offset by the reduction in the number
of Section 1031 tax-deferred property exchanges caused by the continued decline
in the real estate market.
Investments. Investment income decreased $4.7 million, or 30.4%, for the first
six months of 2009 compared with the first six months of 2008 primarily due to
decreases in the average invested balances and, to a lesser extent, to decreases
in yields. Certain investment gains and losses, which are included in our
results of operations in investment and other losses - net, were realized as
part of the ongoing management of our investment portfolio for the purpose of
improving performance.
For the six months ended June 30, 2009, investment and other losses - net
included realized losses of $6.6 million for the impairment of equity method and
cost-basis investments, $1.3 million for the impairment of equity securities
available-for-sale, $1.5 million related to office closure costs and
$0.8 million for the impairment and sale of real estate. The realized losses
were partially offset by realized gains of $3.0 million related to the sale of
debt and equity investments available-for-sale and $1.6 million related to the
sale of a cost-basis investment.
For the six months ended June 30, 2008, investment and other losses - net
included realized losses of $4.9 million for the sale of debt and equity
investments available-for-sale, $4.1 million for the impairment of equity method
and cost-basis investments and $2.7 million for office closure costs. The
realized losses were partially offset by realized gains of $5.0 million for the
sale of debt and equity investments available-for-sale and $0.8 million for
sales of title plants and real estate.
Retention by agencies. The amounts retained by title agencies, as a percentage
of revenues generated by them, were 82.6% and 81.6% in the first six months of
2009 and 2008, respectively. Amounts retained by title agencies are based on
agreements between agencies and our underwriters. This retention percentage may
vary from year-to-year due to the geographical mix of agency operations, the
volume of title revenues and, in some states, laws or regulations.
Employee costs. Our employee costs and certain other operating expenses are
sensitive to inflation. Employee costs for the combined business segments
decreased $60.9 million, or 20.4%, to $237.1 million for the six months ended
June 30, 2009 from $298.0 million for the six months ended June 30, 2008. We
reduced our employee count company-wide by approximately 100 during the first
six months of 2009 and approximately 2,300 since the beginning of 2008. This
decrease in employee count is the primary reason for the decline in employee
costs.
In our REI segment, total employee costs for the first six months of 2009
decreased $4.5 million, or 24.0%, from the same period in 2008 primarily in our
lender services and property information businesses due to headcount reduction
related to lower transaction volumes, even though our mortgage modification
services significantly increased.
Other operating expenses. Other operating expenses decreased $36.0 million, or
20.8%, in the first six months of 2009 compared with the first six months of
2008 primarily due to lower business promotion costs, rent and other occupancy
expenses, outside search fees, technology costs, certain REI expenses, travel,
premium taxes, auto and airplane expenses, delivery fees and insurance. These
decreases were offset somewhat by an increase in bad debt expense. Other
operating expenses were favorably impacted by credits of $5.9 million relating
to the reversal of an accrual for a legal matter resolved in our favor and a
change in estimate for another legal matter. The remaining decreases in other
operating expenses were due to implementation of title search and production
efficiencies company-wide through our regional production center initiative and
the benefits from our back-office centralization initiatives in the areas of
human resources, finance and accounting, procurement and information technology.
Other operating expenses also include general supplies, telephone, insurance,
copy supplies, equipment rental, repairs and maintenance, postage, title plant
expenses, litigation, title plant rent, professional fees and attorney fees.
Most of our operating expenses are fixed in nature, although some follow, to
varying degrees, the changes in transaction volume and revenues.
Title losses. Provisions for title losses, as a percentage of title operating
revenues, were 12.1% and 10.1% for the first six months of 2009 and 2008,
respectively. The first six months of 2009 included a reserve strengthening
adjustment of $19.2 million relating to policy years 2005, 2006 and 2007 due to
higher than expected loss payments and incurred loss experience for these policy
. . .
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