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STC > SEC Filings for STC > Form 10-Q on 3-May-2013All Recent SEC Filings

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Form 10-Q for STEWART INFORMATION SERVICES CORP


3-May-2013

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 $3.2 million, or $0.15 per share, for the first quarter 2013, representing an improvement of $15.4 million over the first quarter 2012 net loss of $12.2 million, or $0.63 loss per share. First quarter 2013 results include a non-cash charge of $5.4 million, or $0.26 per share, relating to the early retirement of $37.1 million of our 6% Convertible Senior Notes due 2014 (Notes), as well as a gain of $1.7 million, or $0.08 per share, on non-title-related insurance policy proceeds (no tax benefit or expense is associated with either item; thus no tax-related earnings per share effect).

Total revenues for the first quarter 2013 were $423.7 million, an increase of $38.7 million, or 10.1%, from $385.0 million for the first quarter 2012. Operating revenues increased 11.3% to $423.4 million in the first quarter 2013 compared to $380.4 million in the first quarter 2012. Compared to first quarter 2012, title revenues increased 11.4% in the first quarter 2013, while mortgage services revenues increased 10.1%.

Revenues from our title segment increased 11.2% from the first quarter 2012 and declined sequentially 18.6% from the fourth quarter 2012. Revenues from direct operations for the first quarter 2013 increased 5.5% compared to the same quarter last year and decreased 17.6% sequentially from the fourth quarter 2012. Our direct operations include local closing offices, commercial, and international operations. We generate commercial revenues both domestically and internationally; U.S. and Canadian commercial revenues increased 15.1% to $26.5 million from the first quarter 2012 and declined sequentially by 30.1% from the fourth quarter 2012. International operating revenues (including foreign-sourced commercial revenues) declined 8.5% to $19.9 million and declined sequentially from the fourth quarter by 29.4%. Domestic commercial title transactions industry-wide were strongly influenced in the fourth quarter 2012 by the anticipated increase in capital gain tax rates in 2013 and thus the sequential decline in commercial revenues was likely more pronounced than normal seasonality.

Revenues from our mortgage services segment increased 11.9% from the first quarter 2012, while declining 11.5% from the fourth quarter 2012. The sequential decline in revenues is largely due to the expiration of certain contracts providing distressed loan services. Mortgage services pretax earnings increased $2.2 million in the first quarter 2013 to $10.2 million (24.1% margin) from $8.0 million (21.1% margin) in the first quarter 2012, while decreasing $4.4 million sequentially from $14.6 million (30.5% margin) in the fourth quarter 2012. The offerings in our mortgage services segment continue to expand, with new projects within the broad category of servicing support helping drive the increase in revenues.

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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 three months ended March 31, 2013, 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, 2012.

Operations. Our business has three main operating segments: title insurance and related services, mortgage services and corporate.

Our primary business is title insurance and settlement-related services. We close transactions and issue title policies on homes, 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; and technology to streamline the real estate process.

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

• mortgage interest rates;

• inventory of existing homes available for sale;

• 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.

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. 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

A comparison of our results of operations for the three months ended March 31, 2013 with the three months ended March 31, 2012 follows. Factors contributing to fluctuations in the results of operations are presented in the order of their monetary significance, and we have quantified, when necessary, significant changes.

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Results from our mortgage services and corporate segments are included in the discussions and, when relevant, are discussed 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. We continue to see benefits in our results of operations from the improving real estate market, particularly in existing home sales. Data as of March 2013 compared with the same period in 2012 indicates annualized sales of existing homes, seasonally adjusted, increased 10.3% and annualized sales of new homes, seasonally adjusted, increased 18.5%. March 2013 existing home sales were at a seasonally adjusted annual rate of 4.9 million versus 4.5 million a year earlier. In addition, median home prices increased 11.2% from the first quarter 2012 and decreased sequentially 1.6% from the fourth quarter 2012. A 5.0% increase in home prices results in an approximately 3.5% increase in title premiums. Interest rates continue to remain low by historical standards. While job growth remains tepid and unemployment high, the housing market appears to be on a continuing path of recovery in sales volume and prices for new and existing homes. The inventory of available listings for sale on the market is less than normal, portending ongoing rising prices. One-to-four family residential lending increased from an estimated $380 billion in the first quarter 2012 to $464 billion in the first quarter 2013, primarily driven by an estimated $78 billion increase in refinance originations from the first quarter 2012 to the first quarter 2013. Sequentially, residential lending for purchase volumes declined as expected given seasonality in home sales from $133 billion in the fourth quarter of 2012 to $111 billion in the first quarter of 2013. Residential refinance lending volumes likewise contracted from $441 billion in the fourth quarter 2012 to $353 billion in the first quarter 2013. On average, refinance premium rates are 60% of the title premium revenue of a similarly priced sale transaction.

Title revenues. Revenues from direct title operations increased $8.2 million, or 5.5%, in the first quarter 2013 compared to the first quarter 2012. Revenues in the first quarter 2013 increased primarily due to the increase in orders closed. The largest increases in revenues were in Texas, Ohio and Illinois, partially offset by decreases in California, Canada and Florida. Revenues from commercial and other large transactions increased $3.5 million, or 15.2%.

Direct orders closed increased 3.6%, while the average revenue per file closed (including large commercial policies) was essentially the same in the first quarter 2013 compared to the first quarter 2012. Direct operating revenues, excluding large commercial policies, increased 2.0%, while the average revenue per closing decreased 1.6% in the first quarter 2013 compared to the first quarter 2012.

Revenues from independent agencies increased $31.3 million, or 16.0%, in the first quarter 2013 compared to the first quarter 2012. The largest increases in revenues from independent agencies in the first quarter 2013 were in Pennsylvania, New York, Georgia, Wisconsin and Virginia, partially offset by decreases in California and New Mexico. Revenues from independent agencies net of amounts retained by those agencies increased 20.2% in the first quarter 2013 compared to the first quarter 2012.

The Texas Department of Insurance increased title insurance premium rates in the state of Texas by 3.8% effective May 1, 2013. We do not believe the impact on our consolidated financial position or results of operation from this rate increase will be material.

Mortgage services revenues. Mortgage services operating revenues increased $3.4 million, or 10.1%, in the first quarter 2013 compared to the first quarter 2012. The offerings in our mortgage services segment continue to expand, with new projects within the broad category of servicing support helping drive the increase in revenues. As the real estate market recovers and distressed servicing projects (including those whose contract term ended in the first quarter) naturally retrench, new service offerings have been introduced allowing our customers to outsource other aspects of their servicing operations to us. Our focus is on providing mortgage process outsourcing services which are high-quality, flexible and responsive. We expect these service offerings to be sustainable over market cycles.

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Investment income. Investment income increased $0.5 million, or 16.5%, in the first quarter 2013 compared to the first quarter 2012, primarily due to increases in average balances. Certain investment gains and losses, which are included in our results of operations in investment and other (losses) gains - net, were realized as part of the ongoing management of our investment portfolio for the purpose of improving performance.

For the three months ended March 31, 2013, investment and other (losses) gains - net included a $5.4 million non-cash charge relating to the early retirement of convertible senior notes offset by a $1.7 million gain on non-title-related insurance policy proceeds.

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 82.2% and 82.8% in the first quarters of 2013 and 2012, respectively. The average retention percentage may vary from 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 somewhat 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.

We began the process of vetting our network of independent agencies several years ago with the emphasis on managing for quality and profitability. Since the fourth quarter 2008, our average annual premium revenue received per independent agency has increased more than 115% and we have reduced the number of independent agencies in our network by approximately 42%. Further, the policy loss ratio of our current independent agency network for the first quarter 2013 is less than one-fourth of its level in the fourth quarter 2008.

Employee costs. Our employee costs and certain other operating expenses are sensitive to inflation. Employee costs for the combined business segments increased 6.7% from the first quarter 2012. The increase in employee costs for these periods is due to increases in title operating revenues and revenues generated by our mortgage services segment. As a percentage of total operating revenues, however, employee costs declined to 32.3% in the first quarter 2013 from 33.7% in the first quarter 2012.

In the first quarter 2013, employee costs in the title segment increased 6.9%, over the same period in 2012 to support the 11.4% increase in title operating revenue for the same period. In our mortgage services segment, total employee costs as a percentage of operating revenue fell to 63.9% from 64.8% in the first quarter 2012. Actual costs increased $2.6 million, or 10.8%, in the first quarter 2013, primarily due to increases in staffing requirements to support new projects within the broad category of servicing support helping drive the increase in revenues.

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 mortgage services 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.

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In the first quarter 2013 compared to the same period in 2012, other operating expenses for the combined business segments decreased $1.1 million, or 1.6%. Costs fixed in nature decreased $0.6 million, or 1.9%, in the first quarter 2013 primarily due to decreases in attorney fees and rent and other occupancy costs offset by an increase in insurance costs. Costs that follow, to varying degrees, changes in transaction volumes and revenues increased $1.6 million, or 6.9% in the first quarter 2013. The increases in these costs for the first quarter 2013 are primarily due to increases in outside search fees, premium taxes and bad debt expense resulting from increased transaction volume and revenues. Costs that fluctuate independently of revenues decreased $2.1 million, or 17.4% in the first quarter 2013, primarily due to a decrease in litigation-related costs.

Title losses. Provisions for title losses, as a percentage of title revenues, were 6.1%, 9.1% and 7.6%, in the first quarter 2013, first quarter 2012 and fourth quarter 2012, respectively. Our policy loss ratio reflects an ongoing decline in prior policy year loss experience as well as our continued attention to prudent risk management and emphasis on quality and profitability of our network of independent agencies. Title losses decreased 24.9% on the 11.4% increase in title operating revenues when compared to the first quarter 2012. The title loss ratio in any given quarter is significantly influenced by any new large claims incurred as well as adjustments to reserves for existing large claims. We did not experience any new large title claims in the first quarter 2013 and adjustments to previously reserved large losses did not exceed our normal provisioning rate. Although there can be no assurances that this result for large losses will continue for the remainder of 2013, we continue to manage and resolve large claims prudently and in keeping with our commitments to our policyholders. Our overall loss experience on non-large claims continued to be in line with actuarial expectations, which allowed us to maintain the lower loss provisioning rate adopted effective with policies issued in the third quarter 2012.

Cash claim payments in the first quarter 2013 were comparable to the first quarter 2012 and increased 8.9% over the fourth quarter 2012 as payments on previously reserved large losses were made. Losses incurred on known claims in the first quarter 2013 decreased 54.0% from the first quarter 2012. The decline in losses incurred on known claims continues a trend observed for several quarters. Our overall loss experience on non-large claims continued to be in line with actuarial expectations, which allowed us to maintain the lower loss provisioning rate adopted effective with policies issued in the third quarter 2012.

Our liability for estimated title losses as of March 31, 2013 comprises both known claims ($119.2 million) and our estimate of claims that may be reported in the future ($389.6 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 42.7% and (30.2)% for the first three months of 2013 and 2012, respectively, based on earnings (loss) before taxes and after deducting noncontrolling interests, which when aggregated are $5.6 million and ($9.3) million for the first three months of 2013 and 2012, respectively. In the fourth quarter 2012, we released a significant portion of a previously established valuation allowance against deferred tax assets. As a result, our effective tax rate for the quarter ended March 31, 2013 reflects a more normalized effective tax rate based on domestic and international operating results. A valuation allowance against certain foreign tax credit carryforwards, which may not be utilized in the future, remains at March 31, 2013.

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 March 31, 2013, our cash and investments, including amounts reserved pursuant to statutory requirements, aggregated $733.9 million.

A substantial majority of our consolidated cash and investments as of March 31, 2013 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.

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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, 2012, the maximum dividend that could be paid in 2013 after such approval in 2013 is $85.8 million. Guaranty did not pay a dividend in the three months ended March 31, 2013 or 2012. 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.

Cash held at the parent company totaled $8.8 million at March 31, 2013. As noted above, as a holding company, the parent is funded principally by cash from its subsidiaries in the form of dividends, operating and other administrative expense reimbursements, and pursuant to intercompany tax sharing agreements. The expense reimbursements are paid in accordance with 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 Three Months
                                                      Ended March 31,
                                                    2013             2012
                                                   (dollars in millions)
         Net cash used by operating activities          (3.4 )        (20.3 )
         Net cash used by investing activities         (25.2 )         (0.5 )
         Net cash used by financing activities          (3.7 )         (6.0 )

Operating activities

Our principal sources of cash from operations are premiums on title policies and revenue from title service-related transactions, and mortgage servicing support 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 used by operations for the first quarter 2013 was $3.4 million, an improvement of $16.9 million from the $20.3 million used by operations in 2012. This improvement is primarily related to the $15.6 million increase in net earnings when comparing the same periods, along with a $15.0 million decrease in receivables for those periods. This improvement is partially offset by a $10.3 million increase in cash used to settle accounts payable and accrued liabilities and a $6.8 million increase in claims paid compared to loss provisions.

Although our business is labor intensive, we are focused on a cost-effective, scalable business model which includes utilization of technology, centralization of back and middle office functions and business process outsourcing. Our approach allows us to adjust more easily to fluctuations in transaction volumes.

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 March 31, 2013, cash and investments funding the statutory premium reserve aggregated $455.8 million and our statutory estimate of claims that may be reported in the future totaled $389.6 million. In addition to this restricted cash and investments, we had unrestricted cash and investments (excluding equity method investments) of $142.5 million, which are available for underwriter operations, including claims payments.

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Investing activities

Cash from investing activities was generated principally by proceeds from investments matured and sold in the amounts of $15.3 million and $39.6 million for the first quarters of 2013 and 2012, respectively. We used cash for the purchases of investments in the amounts of $36.3 million and $38.7 million for the first quarters of 2013 and 2012, respectively.

Capital expenditures were $4.3 million and $4.7 million for the first quarters of 2013 and 2012, respectively. We maintain investment in capital expenditures at a level that enables us to implement technologies for increasing our operational and back-office efficiencies. We sold assets and subsidiaries resulting in cash receipts of $0.1 million and $3.4 million for the first quarters of 2013 and 2012, respectively.

Financing activities and capital resources

Total debt and stockholders' equity were $34.2 million and $621.1 million, respectively, as of March 31, 2013. In the first quarter 2013 and 2012, we repaid $0.5 million and $4.3 million, respectively, of debt in accordance with the underlying terms of the debt instruments. Included in total debt is $27.8 million of Notes. In the first quarter 2013, we exchanged an aggregate of $37.1 million of Notes for an aggregate of 3,037,430 shares of common stock plus cash for accrued and unpaid interest. We also have available a $10.0 million bank line of credit commitment, which expires in June 2013, under which no borrowings were outstanding at March 31, 2013.

Effect of changes in foreign currency rates

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 $0.8 million for the first quarter 2013 compared to a net increase of $1.1 million for the first quarter 2012. Our principal foreign operating unit is in Canada, and, on average, the value of the U.S. dollar relative to the Canadian dollar decreased during the first quarter 2013.

***********

We believe we have sufficient liquidity and capital resources to meet the cash needs of our ongoing operations. However, if we determine that supplemental debt, including additional convertible debentures, or equity funding is warranted to provide additional liquidity for unforeseen circumstances or strategic acquisitions, we may pursue those sources of cash. Other than scheduled maturities of debt, operating lease payments, purchase agreements and anticipated claims payments, we have no material commitments. We expect that cash flows from operations and cash available from our underwriters, subject to regulatory restrictions, will be sufficient to fund our operations, including claims payments. However, to the extent that these funds are not sufficient, we . . .

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