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STC > SEC Filings for STC > Form 10-Q on 2-Nov-2012All Recent SEC Filings

Show all filings for STEWART INFORMATION SERVICES CORP

Form 10-Q for STEWART INFORMATION SERVICES CORP


2-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

MANAGEMENT'S OVERVIEW

We reported net earnings attributable to Stewart of $34.7 million for the third quarter 2012 compared to $4.5 million for the same period in 2011. On a diluted per share basis, our net earnings attributable to Stewart were $1.45 for the third quarter 2012 compared to $0.22 for the same period in 2011. Pretax profit was $39.4 million for the third quarter 2012 compared to $7.7 million for the same period in 2011. Revenues were $520.7 million for the third quarter 2012 compared to $418.5 million for the same period in 2011, an increase of 24.4%.

Results for the nine months ended September 30, 2012 improved to a pretax profit of $62.7 million from $7.0 million for the same period in 2011. We reported net earnings attributable to Stewart of $47.4 million for the nine months ended September 30, 2012 compared to $0.2 million for the same period in 2011. On a diluted per share basis, our net earnings attributable to Stewart were $2.04 for the first nine months of 2012 compared to $0.01 for the same period in 2011. Revenues were $1.4 billion for the nine months ended September 30, 2012 compared to $1.2 billion for the same period in 2011, an increase of 16.8%.

Total title revenues in the third quarter 2012 increased 20.6% and 7.8% compared to the same quarter last year and sequentially from the second quarter 2012, respectively. Revenues from direct operations for the third quarter 2012 increased 15.0% and 0.8% compared to the same quarter last year and sequentially from the second quarter 2012, respectively. Revenues from commercial transactions, which are included in direct operations, increased 7.9% in the third quarter 2012 compared to the same quarter last year and decreased 1.8% sequentially from the second quarter 2012. International operating revenues, which are also included in direct operations, increased 5.1% in the third quarter 2012 compared to the same quarter last year and increased 3.6% sequentially from the second quarter 2012.

The momentum of the second quarter 2012 continued through the end of the third quarter 2012, resulting in much improved earnings per share for both the third quarter and year-to-date periods of 2012 when compared to the same periods in 2011. We continue to focus on our strategic initiatives and expect the benefits of more scalable operations to be sustained. Order counts coming into the third quarter were strong, and continued to be so throughout the quarter, resulting in our 7.3% sequential increase in title operating revenues and much stronger 40.7% increase in title pretax results for the third quarter 2012 when compared to the second quarter 2012. These results underscore our improved operating leverage resulting from a focus on consolidation and cost management of our back office operations as well as an emphasis on increasing remittance rates, improving the quality of our independent title agency network and reducing title claims. We are encouraged by the ongoing improvement in our title loss experience, leading to a reduction in our claims provisioning rate on policies issued in the third quarter.

We continue to experience solid growth in revenues from services provided by our real estate information (REI) segment. This growth in revenues was achieved with no sequential quarterly reduction in margins, as the pretax margin for this segment remained in excess of 30%. Our growth in revenue in the REI segment over the last two quarters has been the result of loss mitigation projects awarded in late 2011 and early 2012. These projects have matured and we expect revenues from them to decline throughout 2013. As the real estate market recovers, the distressed servicing projects will naturally retrench; consequently, the REI segment has developed service offerings and is pursuing contracts to take advantage of the recovery. We expect these service offerings to be more sustainable over market cycles and margins to stabilize in the 20-25% range.

As a percentage of title revenues, title losses were 7.3%, 8.7% and 9.0% in the third quarter 2012, second quarter 2012 and third quarter 2011, respectively. Title losses decreased 1.9% on the 19.9% increase in title operating revenues when compared to the third quarter 2011, including adjustments to certain large claims. As anticipated, our overall loss experience continued to improve relative to prior year periods and was generally in line with our actuarial expectations, which allowed us to lower the overall loss provisioning rate effective with policies issued in the third quarter. Cash claim payments in the third quarter 2012 decreased 20.7% from the third quarter 2011. Losses incurred on known claims decreased 14.7% compared to the third quarter 2011. The decline in cash claim payments and losses incurred on known claims continues a trend noted for several quarters.

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CRITICAL ACCOUNTING ESTIMATES

The preparation of the Company's Consolidated Financial Statements requires management to make estimates and judgments that affect the reported amounts of certain assets, liabilities, revenues, expenses and related disclosures surrounding contingencies and commitments.

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.

During the nine months ended September 30, 2012, the Company made no material changes to its critical accounting estimates as previously disclosed in Management's Discussion and Analysis in the Company's Annual Report on Form 10-K for the year ended December 31, 2011.

Operations. Our business has two main operating segments: title insurance-related services and REI. 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 international markets through policy-issuing offices and agencies. We also provide loan origination and servicing support; loan review services; loss mitigation; REO asset management; home and personal insurance services; tax-deferred exchanges; and technology to streamline the real estate process.

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Factors affecting revenues. The principal factors that contribute to changes in operating revenues for our title and REI segments include:

• mortgage interest rates;

• availability of mortgage loans;

• ability of potential purchasers to qualify for loans;

• ratio of purchase transactions compared with refinance transactions;

• ratio of closed orders to open orders;

• home prices;

• volume of distressed property transactions;

• consumer confidence;

• demand by buyers;

• number of households;

• premium rates;

• market share;

• opening of new offices and acquisitions;

• number of commercial transactions, which typically yield higher premiums;

• government or regulatory initiatives, including tax incentives; and

• number of REO and foreclosed properties and related debt.

Premiums are determined in part by the insured values of the transactions we handle. To the extent inflation causes increases in the prices of homes and other real estate, premium revenues are also increased. Conversely, falling home prices cause premium revenues to decline. These factors may override the seasonal nature of the title insurance business.

RESULTS OF OPERATIONS

Comparisons of our consolidated results of operations between the three and nine months ended September 30, 2012 and 2011 follow however, when relevant, we have discussed REI segment's results separately. 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.

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. We are continuing to see benefits in our results of operations from the improving real estate market, particularly in existing home sales. Data as of September 2012 compared with the same period in 2011 indicates annualized sales of existing homes, seasonally adjusted, increased 11.0% and annualized sales of new homes, seasonally adjusted, increased 45.1%. September 2012 existing home sales were at a seasonally adjusted annual rate of 4.8 million versus 4.3 million a year earlier. In addition, median home prices increased 9.6% from the third quarter 2011 and sequentially 2.5% from the second quarter 2012. A 5.0% increase in home prices results in approximately a mid-3% increase in title premiums. Even though interest rates continue to be low by historical standards, general economic conditions conducive to the housing market such as low unemployment and increasing household formation are not present. One-to-four family residential lending increased from an estimated $410 billion in the third quarter 2011 to $417 billion in the second quarter 2012 (most recent actual data available), primarily driven by an estimated $9 billion increase in refinance originations from the third quarter 2011 to the second quarter 2012 (most recent data available).

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Three and nine months ended September 30, 2012 compared with three and nine months ended September 30, 2011

Title revenues. Revenues from direct title operations increased $24.7 million, or 15.0% and $58.9 million, or 12.5%, respectively, in the third quarter and first nine months of 2012 compared to the same periods in 2011. Revenues in the third quarter and first nine months of 2012 increased primarily due to the increase in orders closed. The largest increases in revenues in the third quarter 2012 were in Texas, Canada and Utah, partially offset by decreases in New York. The largest revenue increases in the first nine months of 2012 were in Texas, Canada, Utah and Colorado, partially offset by decreases in New York and Nevada. In the third quarter 2012 compared to the third quarter 2011, revenues from commercial and other large transactions increased $2.0 million, or 7.9%. In the first nine months of 2012 compared to the first nine months of 2011, commercial revenues decreased $1.3 million, or $1.7%.

Direct orders closed increased 18.1% and 17.0%, respectively, while the average revenue per file closed decreased 3.0% and 4.1%, respectively, in the third quarter and first nine months of 2012 compared to the same periods in 2011 due to an increase in residential refinancing closings in the same periods. Direct operating revenues, excluding large commercial policies, increased 15.8% and 14.9%, respectively, while the average revenue per closing decreased 2.0% and 1.7% in the third quarter and first nine months of 2012 compared to the same periods in 2011. On average, refinance premium rates are 60% of the title premium revenue of a similarly priced sale transaction.

Revenues from independent agencies increased $53.2 million, or 23.3% and $95.1 million, or 15.0%, respectively, in the third quarter and first nine months of 2012 compared to the same periods in 2011. The largest increases in revenues from independent agencies in the third quarter 2012 were in California, Texas, Pennsylvania and Florida, partially offset by decreases in Minnesota and Maryland. The largest increases in revenues from independent agencies during the first nine months of 2012 were in California, Texas, New York and Florida, partially offset by decreases in Maryland, Minnesota, and Ohio. Revenues from independent agencies net of amounts retained by those agencies increased 24.6% and 16.2% in the third quarter and first nine months of 2012 compared to the same periods in 2011, respectively.

REI revenues. Operating revenues from services provided by the real estate information segment, increased $20.6 million, or 91.6% and $39.6 million or 51.8%, respectively, in the third quarter and first nine months of 2012 compared to the same periods in 2011. The increases were primarily due to lower margin projects awarded in late 2011 and early 2012. As the real estate market recovers, these projects will naturally retrench; consequently, the REI segment has developed service offerings and is pursuing contracts to take advantage of the recovery. However, demand for REI services will continue to be dependent on the number and scale of government programs and lender projects which may result in significant quarterly and annual fluctuations in REI revenues.

Investment income. Investment income decreased $0.6 million, or 14.4%, and $1.8 million, or 15.2%, respectively, in the third quarter and first nine months of 2012 compared to the same periods in 2011, primarily due to decreases in average yield. Certain investment gains and losses, which are included in our results of operations in investment and other gains (losses) - net, were realized as part of the ongoing management of our investment portfolio for the purpose of improving performance.

For the nine months ended 2011, investment and other gains (losses) - net included a $3.9 million charge representing the payoff value on a defaulted third party loan on which we served as guarantor partially offset by realized gains of $2.5 million from the sale of debt instruments available-for-sale.

Retention by agencies. Amounts retained by title agencies are based on agreements between agencies and our title underwriters. On average, amounts retained by independent agencies, as a percentage of revenues generated by them, were 82.3% and 82.5% in the third quarters of 2012 and 2011, respectively, and 82.5% and 82.7% in the first nine months of 2012 and 2011, respectively. The average retention percentage may vary from year-to-year or quarter-to-quarter due to the geographical mix of agency operations, the volume of title revenues and, in some states, laws or regulations. Due to the variety of such laws or regulations, as well as competitive factors, the average retention rate can differ significantly from state to state. Although general conditions in the real estate industry are improving nationwide, the recovery in specific markets has varied considerably. In addition, a high proportion of our independent agencies are in states with retention rates greater than 80% and the markets in those states have recovered relatively faster than the nation as a whole, which has resulted in our average retention percentage remaining in the 82% - 83% range. We expect our average retention rate to remain in this range over the near to medium term. However, we continue to adjust independent agency contracts in an economically sound manner, and we expect the mix of agency business to normalize as real estate markets continue to stabilize nationally resulting in lower average retention percentages in the aggregate.

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We began the process of vetting our network of independent agencies several years ago with the emphasis on managing for quality and profitability. Since 2008, our average annual remittance rate per independent agency has increased more than 85% while we have reduced the number of independent agencies in our network by approximately half. Further, the policy loss ratio of our current independent agency network for the trailing twelve months ended September 30, 2012 is less than one-third of its level in the comparable 2008 period.

Employee costs. Our employee costs and certain other operating expenses are sensitive to inflation. Employee costs in the third quarter and first nine months of 2012 increased 20.8% and 13.9%, respectively, from the same periods in 2011. The increase in employee costs for these periods is due to increases in title operating revenues and revenues generated by our REI operations. As a percentage of total operating revenues, however, employee costs declined to 26.9% in the third quarter 2012 from 27.6% in the third quarter 2011 and 27.4% in the second quarter 2012.

In the third quarter and first nine months of 2012, employee costs in the title segment increased 10.9% and 5.3%, respectively, over the same periods in 2011 to support the 19.9% and 14.0% increases in title operating revenues for the same periods. Employee costs in our REI operations increased as expected for the third quarter and first nine months of 2012 as a result of increased staffing requirements to support new contracts awarded in late 2011 and early 2012.

Other operating expenses. Other operating expenses include costs that are fixed in nature, costs that follow, to varying degrees, changes in transaction volumes and revenues and costs that fluctuate independently of revenues. Costs that are fixed in nature include attorney fees, equipment rental, insurance, professional fees, rent and other occupancy expenses, repairs and maintenance, technology costs, telephone and title plant rent. Costs that follow, to varying degrees, changes in transaction volumes and revenues include fee attorney splits, bad debt expenses, certain REI expenses, copy supplies, delivery fees, outside search fees, postage, premium taxes and title plant expenses. Costs that fluctuate independently of revenues include auto expenses, general supplies, litigation defense and settlement costs, promotion costs and travel.

In the third quarter and first nine months of 2012 compared to the same periods in 2011, other operating expenses for the combined business segments increased $4.5 million, or 6.7% and $16.4 million, or 8.6%, respectively. Costs fixed in nature decreased $3.4 million, or 10.6%, in the third quarter 2012 primarily due to decreases in insurance and technology costs. For the first nine months of 2012, costs fixed in nature increased $2.9 million, or 3.3%, primarily due to increases in professional fees and technology costs partially offset by declines in rent and other occupancy expenses. The increase in professional fees was primarily attributable to outsourcing the internal audit function in June 2012.

Costs that follow, to varying degrees, changes in transaction volumes and revenues increased $6.8 million, or 29.5% and $12.1 million, or 17.5%, in the third quarter and first nine months of 2012, respectively. The increases in these costs for the third quarter 2012 are primarily due to increases in outside search fees, fee attorney splits, premium taxes and bad debt expense resulting from increased transaction volume and revenues. The increase in these costs for the first nine months of 2012 are primarily due to increases in outside search fees and bad debt expense also resulting from increased transaction volumes and revenues. Costs that fluctuate independently of revenues increased $1.0 million, or 8.6% and $1.4 million, or 4.1%, in the third quarter 2012 and first nine months of 2012, respectively, primarily due to an increase in litigation-related costs.

Title losses. While trending favorably, losses from title policy claims continue to remain higher than historical levels. Provisions for title losses, as a percentage of title revenues, were 7.3% and 9.0% in the third quarter 2012 and 2011, respectively, and 8.3% and 9.2% in the first nine months of 2012 and 2011, respectively, including adjustments to certain large claims.

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Cash claim payments in the third quarter and first nine months of 2012 decreased 20.7% and 11.9%, respectively, from the same periods in 2011. Losses incurred on known claims in the third quarter and first nine months of 2012 decreased 14.7% and 14.8%, respectively, from the same periods in 2011. The decline in cash claim payments and losses incurred on known claims continues a trend noted for several quarters. Our overall loss experience continued to improve relative to prior year periods and was generally in line with our actuarial expectations, which allowed us to lower the overall loss provisioning rate effective with policies issued in the third quarter.

Our liability for estimated title losses as of September 30, 2012 comprises both known claims ($137.4 million) and our estimate of claims that may be reported in the future ($378.9 million). The amount of the reserve represents the aggregate future payments (net of recoveries recognized) that we expect to incur on policy and escrow losses and in costs to settle claims.

Income taxes. Our effective tax rates were 6.1% and 23.3% for the third quarter 2012 and 2011 and 14.8% and 93.2% for the first nine months of 2012 and 2011, respectively, based on earnings before taxes and after deducting noncontrolling interests, which when aggregated are $36.9 million and $5.9 million for the third quarter 2012 and 2011 and $55.7 million and $2.8 million for the first nine months of 2012 and 2011, respectively. Income tax expense for the three and nine months ended September 30, 2012 and 2011 consists principally of taxes in foreign jurisdictions for our profitable international operations and of U.S. federal tax on entities not included in our U.S. consolidated return. For the first nine months of 2012 and 2011, income tax expense was partially offset by favorable tax adjustments in our foreign operations. No U.S. federal current income tax expense has been recorded on current year earnings of the Company's U.S. tax-consolidated subsidiaries due to expected utilization of net operating loss carryforwards and the reversal of valuation allowances that previously had been established against those net operating losses. Remaining valuation allowances will be evaluated for reversal as we return to sustained profitability.

LIQUIDITY AND CAPITAL RESOURCES

Our liquidity and capital resources represent our ability to generate cash flow to meet our obligations to our shareholders, customers (payments to satisfy claims on title policies), vendors, employees, lenders and others. As of September 30, 2012, our cash and investments, including amounts reserved pursuant to statutory requirements, aggregated $698.7 million.

A substantial majority of our consolidated cash and investments as of September 30, 2012 was held by Stewart Title Guaranty Company (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 requirements under Texas law) to fund its insurance operations, including claims payments. Guaranty may also, subject to certain limitations, provide funds to its subsidiaries (whose operations consist principally of field title offices) for their operating and debt service needs.

Guaranty cannot pay a dividend to its parent in excess of certain limits without the approval of the Texas Insurance Commissioner. As of December 31, 2011, the maximum dividend that could be paid in 2012 after such approval in 2012 is $74.4 million. Guaranty did not pay a dividend in the nine months ended September 30, 2012 or 2011. However, the maximum dividend permitted by law is not necessarily indicative of Guaranty's actual ability to pay dividends, which may be constrained by business and regulatory considerations, such as the impact of dividends on surplus, which could affect its ratings or competitive position, the amount of insurance it can write and its ability to pay future dividends. Further, depending on business and regulatory conditions, we may in the future need to retain cash in Guaranty or even raise cash in the capital markets to contribute to it in order to maintain its ratings or statutory capital position. Such a requirement could be the result of investment losses, reserve charges, adverse operating conditions in the current economic environment or changes in interpretation of statutory accounting requirements by regulators.

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Cash held at the parent company totaled $14.6 million at September 30, 2012. As noted above, as a holding company, the parent is funded principally by cash from its subsidiaries in the form of dividends, for operating and other administrative expense reimbursements, and pursuant to intercompany tax sharing agreements. The expense reimbursements are paid in accordance with the management agreements among us and our subsidiaries. As the parent company conducts no operations apart from its wholly-owned subsidiaries, the discussion below focuses on consolidated cash flows.

                                                          For the Nine  Months
                                                          Ended September 30,
                                                          2012             2011
                                                         (dollars in millions)
    Net cash provided (used) by operating activities          56.8           (4.9 )
    Net cash used by investing activities                    (10.6 )        (23.0 )
    Net cash used by financing activities                    (11.5 )         (2.6 )

Operating activities

Our principal sources of cash from operations are premiums on title policies and revenue from title service-related transactions, mortgage service support and REO related services. 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.

Cash provided by operations for the first nine months of 2012 was $56.8 million, an improvement of $61.7 million from the $4.9 million used by operations during the same period in 2011. This improvement is primarily related to the $50.0 million increase in pretax earnings when comparing the same periods, along with a $17.2 million improvement in cash paid for claims for the same periods. This improvement is partially offset by a $14.6 million increase in receivables relating primarily to the increase in revenues in our REI servicing support and REO related businesses. We expect to collect these receivables during the fourth quarter 2012.

Our business is labor intensive, although we continue to make progress in automating our services, which allows us to more easily adjust staffing levels as order volumes fluctuate. There are typically delays between changes in market conditions and changes in staffing levels; therefore, employee costs do not change at the same rate as revenues change.

The insurance regulators of the states in which our underwriters are domiciled require our statutory premium reserves to be fully funded, segregated and invested in high-quality securities and short-term investments. As of September 30, 2012, cash and investments funding the statutory premium reserve aggregated $443.2 million and our statutory estimate of claims that may be reported in the future totaled $378.9 million. In addition to this restricted cash and investments, we had unrestricted cash and investments (excluding equity method investments) of $136.4 million, which are available for underwriter operations, including claims payments.

Investing activities

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