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STC > SEC Filings for STC > Form 10-Q on 1-May-2014All Recent SEC Filings




Quarterly Report

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


In the first quarter 2014, the industry experienced the lowest level of mortgage originations in 17 years with existing home sales falling 6.6% year over year and refinancing loans falling 70%. The decline can be attributed to harsh winter weather conditions, rising interest rates and new Qualified Residential Mortgage rules that went into effect on January 1, 2014. Also, specific to the Company, we experienced a decline in revenues in our Mortgage Services business compared to the year ago period.

We reported net loss attributable to Stewart of $12.1 million, or $0.54 per diluted share, for the first quarter 2014, compared to earnings of $3.2 million, or $0.15 per diluted share, for the first quarter 2013. The pretax loss for the first quarter 2014 was $18.6 million, representing a decrease of $25.7 million when compared to pretax earnings of $7.1 million for the first quarter 2013. The decline is attributable to decreases in earnings from our title and mortgage services segments of $12.7 million and $11.4 million, respectively. In addition, we incurred approximately $3.6 million of aggregate costs related to a shareholder settlement as well as legal and other due diligence costs related to acquisitions, both of which were previously announced.

Total revenues for the first quarter 2014 were $391.4 million, a decrease of $32.3 million, or 7.6%, from $423.7 million for the first quarter 2013. Operating revenues decreased 8.5% to $387.4 million in the first quarter 2014 compared to $423.4 million in the first quarter 2013. Compared to the first quarter 2013, title revenues decreased 6.2% in the first quarter 2014, while mortgage services revenues decreased 33.2%.

Revenues from our title segment decreased 5.6% and 14.0% from the first quarter 2013 and fourth quarter 2013, respectively. In the first quarter 2014, the title segment generated a pretax margin of 4.9%, a decrease of 300 basis points from first quarter 2013 and, sequentially, a decrease of 620 basis points from the fourth quarter 2013. Revenues from direct operations for the first quarter 2014 decreased 6.2% compared to the same quarter last year and 16.6% sequentially from the fourth quarter 2013. 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 23.4% to $32.7 million from the first quarter 2013. International operating revenues (including foreign-sourced commercial revenues) increased 10.5% to $22.0 million from the first quarter 2013 and decreased sequentially by 21.4% from the fourth quarter 2013.

Revenues from our mortgage services segment were $26.6 million for the first quarter 2014, declining 35.4% when compared to $41.2 million in the first quarter 2013, but increasing 3.9% sequentially from the fourth quarter 2013 as recently signed contracts began generating revenues. Many of these contracts require several months to reach steady-state revenues and normalized margins. Given that we maintained much of the existing operational infrastructure to support new contracts that are ramping up to their full revenue potential, any incremental costs to service those contracts should be minimal. The segment reported a pretax loss of $1.6 million in the first quarter 2014 compared to pretax earnings of $9.8 million and a pretax loss of $1.6 million for the first quarter 2013 and fourth quarter 2013, respectively.

As previously disclosed, the board of directors approved the repurchase of $70.0 million of Common Stock during 2014 and 2015 which we expect to fund with cash flow from operations. The timing and amount of repurchases under the program will depend on market conditions, share price, our capital and liquidity relative to internal and rating agency targets, legal requirements which include approval of dividends from the insurance underwriter by our regulators, corporate considerations and other factors. In addition, we expect to reduce our operating expenses on a run-rate basis by $25.0 million by the end of 2015.

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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, 2014, 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, 2013.

Title loss reserves

Our most critical accounting estimate is providing for title loss reserves.

Provisions for title losses, as a percentage of title operating revenues, were 6.3%, 6.1% and 6.2% for the quarters ended March 31, 2014, March 31, 2013 and December 31, 2013, 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 operating results approximately $3.6 million for the quarter ended March 31, 2014.

                                               For the Three Months
                                                 Ended Months 31,
                                                2014            2013
                                                  ($ in millions)
               Provisions - Known Claims:
               Current year                         4.6            1.8
               Prior policy years                  13.9           13.1

                                                   18.5           14.9

               Provisions - IBNR
               Current year                        18.1           21.6
               Prior policy years                   0.1            0.2

                                                   18.2           21.8

               Transferred to Known Claims        (13.9 )        (13.1 )

               Total provisions                    22.8           23.6

Provisions for known claims arise primarily from prior policy years as claims are not typically reported until several years after policies are issued. Provisions - Incurred But Not Reported (IBNR) are estimates of claims expected to be incurred over the next 20 years; therefore, it is not unusual or unexpected to experience adjustments to the provisions in both current and prior policy years as new loss development of policy years occurs. This loss development experience may result in changes to our estimate of total ultimate losses expected (i.e., the IBNR policy loss reserve). As claims become known, provisions are reclassified from IBNR to known claims. Adjustments relating to large losses may impact provisions for either known claims or IBNR.

Known claims provisions increased for the period ended March 31, 2014 to $18.5 million from $14.9 million in the prior year, primarily as a result of adjustments to existing claims relating to policies issued in previous years as well as increased losses in our direct operations. Current year provisions - IBNR are recorded on policies issued in the current year as a percentage of premiums realized (provisioning rate). For the three months ended March 31, 2014, current year provisions - IBNR decreased $3.5 million to $18.1 million compared to 2013. As a percentage of title operating revenues, provisions - IBNR for the current policy year decreased from 5.6% in 2013 to 5.0% in 2014 due to a 3% decrease in the provisioning rate as a consequence of favorable loss development relative to actuarial expectations of losses. Provisions - IBNR relating to prior policy years were consistent with the prior year due to continued lower incurred losses as the claims environment continues to improve.

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In addition to title policy claims, we incur losses in our direct operations from escrow, closing and disbursement functions. These escrow losses typically relate to errors or other miscalculations of amounts to be paid at closing, including timing or amount of mortgage payoff, payment of property or other taxes and payment of homeowners' association fees. Escrow losses also arise in cases of mortgage fraud, and in those cases the title insurer incurs the loss under its obligation to ensure that an unencumbered title is conveyed. Escrow losses are typically paid less than 12 months after the loss is discovered. During the first quarter ended March 31, 2014, we accrued approximately $2.4 million of policy loss reserves relating to legacy escrow losses arising from mortgage fraud.

We consider our actual claims payments and incurred loss experience, including consideration of the frequency and severity of claims, compared to our actuarial estimates of claims payments and incurred losses in determining whether our overall loss experience has improved or worsened compared to the prior periods. We also consider the impact of economic or market factors on particular policy years to determine whether the results of those policy years are indicative of future expectations. In addition, we evaluate the frequency and severity of large losses in determining whether our experience has improved or worsened. The loss provision rate is applied to current premium revenues resulting in the title loss expense for the period. This loss provision rate is set to provide for losses on current year premiums and is determined using moving average ratios of recent actual policy loss payment experience (net of recoveries) to premium revenues. 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 premium revenues resulting in a title loss expense for the period.

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 necessary to provide for future title losses. 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 (+/- 4.0%) of our actuarially-based reserve calculation and the actuary's point estimate, 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 since the independent agency is often able, over time, to conceal misappropriation of escrow funds relating to more than one transaction through the constant volume of funds moving through its escrow accounts. As long as new funds continue to flow into escrow accounts, an independent agency 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.

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Internal controls relating to independent agencies include, but are not limited to, pre-signing and 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, the scope of our review is limited by attorney agencies that cite client confidentiality. Certain states have mandated annual reviews of all agencies by their underwriter. We also determine whether our independent agencies have appropriate internal controls as defined by the American Land Title Association and us. However, even with adequate internal controls in place, their effectiveness can be circumvented by collusion or improper override of the controls by management at the independent agencies. To aid in the selection of independent agencies to review, we have developed an agency risk model that aggregates data from different areas to identify possible problems. This is not a guarantee that all independent agencies with deficiencies will be identified. In addition, we are typically not the only underwriter for which an independent agency issues policies and independent 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 calculated estimate.

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; loan due diligence; compliance solutions; service performance management; 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;

• availability of mortgage loans;

• ability of potential purchasers to qualify for loans;

• inventory of existing homes available for sale;

• ratio of purchase transactions compared with refinance transactions;

• ratio of closed orders to open orders;

• home prices;

• volume of distressed property transactions;

• consumer confidence, including employment trends;

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• 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;

• number of REO and foreclosed properties and related debt; and

• acquisitions or divestitures of businesses.

Premiums are determined in part by the insured values of the transactions we handle. To the extent inflation or market conditions cause 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. Historically, our first quarter is the least active in terms of title insurance revenues as home buying is generally depressed during winter month. Our third and fourth quarters are the most active as the summer is the traditional home buying season, while commercial transaction closings are skewed to the end of the year.

On a 12-month moving average seasonally adjusted basis, median home prices increased 11.3% from the first quarter 2013 and sequentially 2.1% from the fourth quarter 2013. A 5% increase in home prices results in an approximately 3.6% increase in title premiums.


Comparisons of our results of operations for the three months ended March 31, 2014 with the three months ended March 31, 2013 follow. 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. 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. Existing home sales in the first quarter of 2014 fell 6.6% from the first quarter 2013, as harsh winter weather conditions across many major metropolitan markets made home purchasing difficult. In addition, the new "qualified mortgage" rules became effective at the beginning of the year, resulting in processing delays by lenders as they acclimated to new regulations. Altogether, mortgage originations for the quarter were estimated to be the lowest of any quarter in the past 17 years. According to Fannie Mae, one-to-four family residential lending decreased from an estimated $532 billion in the first quarter 2013 to $246 billion in the first quarter 2014, primarily driven by an estimated $270 billion decrease in refinance originations from the first quarter 2013 to the first quarter 2014. Sequentially, residential lending for home purchase volumes decreased from $173 billion in the fourth quarter of 2013 to $128 billion in the first quarter of 2014. Residential refinance lending volumes decreased from $184 billion in the fourth quarter 2013 to $118 billion in the first quarter 2014. 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 decreased $10.0 million, or 6.2%, in the first quarter 2014 compared to the first quarter 2013. Revenues in the first quarter 2014 decreased primarily due to declining transaction volume. The largest decreases in revenues were in California, Canada and Washington, partially offset by increases in New York, Texas and other international. Revenues from commercial and other large transactions increased $6.2 million, or 23.4%. Direct operating revenues, excluding commercial and other large transactions, decreased 11.9%, while the average revenue per closing increased 23.7% in the first quarter 2014 compared to the first quarter 2013.

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Direct orders closed decreased 28.7% and were the lowest in at least the last 15 years, while the average revenue per file closed (including large commercial policies) increased 32.2% in the first quarter 2014 compared to the first quarter 2013 due to a shift in mix to more resale and commercial orders combined with the decline in refinancing orders. The closing ratio of 62.3% was the lowest since the first quarter 2011. Had the closing ratio for the first quarter 2014 been equivalent to first quarter 2013, closed orders would have been about 6,100 higher. This is significant since much of the cost to process the orders not yet closed has been incurred, and the carry-over impact into the second quarter should be positive.

Total opened orders for the first quarter 2014 fell 20.4% over the prior year quarter, driven mainly by a fall-off in refinancings, but increased 9.3% sequentially from the fourth quarter 2013. Refinancings fell from almost a third of opened orders in the first quarter 2013 to slightly less than 17% of the total in the first quarter 2014. Opened orders per workday increased 12% in March from February's depressed level, and increased 17% in total.

Revenues from independent agencies decreased $14.0 million, or 6.1%, in the first quarter 2014 compared to the first quarter 2013. The largest decreases in revenues from independent agencies in the first quarter 2014 were in Pennsylvania, California and New York, partially offset by increases in Texas and Massachusetts. Revenues from independent agencies net of amounts retained by those agencies decreased 3.9% in the first quarter 2014 compared to the first quarter 2013. We continue to be pleased with the performance of our independent agency network, and we will continue to emphasize quality of the network while partnering with them to get ready for changes in the industry brought about by CFPB regulations as well as implementing ALTA Best Practices.

Mortgage services revenues.Mortgage services operating revenues decreased $12.0 million, or 33.2%, in the first quarter 2014 compared to the first quarter 2013, as demand for default and distressed property-related services continued to fall sharply due to the improved housing market in 2013. However, revenues increased sequentially almost 4% from the fourth quarter 2013 due to new contracts beginning to generate revenue. Many of these contracts require several months to reach steady-state revenues and normalized margins.

We continue to see opportunity through the mortgage value chain and were able to take advantage of the shifting market to make attractive acquisitions to expand our offerings to mortgage lenders. Subsequent to quarter end, we announced the acquisitions of Wetzel Trott, Inc. and the title and collateral valuation business lines of DataQuick Lending Solutions, as well as an agreement to acquire LandSafe Title. These acquisitions will close in the second or third quarter 2014 and will take several quarters to become fully integrated into our operations.

As noted in our fourth quarter 2013 results, our objective for this segment is to transition from its historical service offerings for the management of defaulted and distressed loans to a more sustainable suite of service offerings to support the ongoing loan origination and servicing support needs of lenders in a more demanding regulatory environment. The acquisitions discussed previously, in combination with existing Stewart Lender Services offerings, will allow us to deliver a comprehensive solution set and position us as one of the strongest providers of outsourcing solutions to the mortgage lending market.

Investment income. Investment income increased $0.2 million, or 5.9%, in the first quarter 2014 compared to the first quarter 2013. Investment income increased primarily due to increases in average balances, partially offset by decreases in 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 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 81.8% and 82.2% in the first quarters of 2014 and 2013, respectively. The decrease in the average retention percentage was due primarily to a shift in geographical revenue mix, as agency revenues in high retention states either declined or did not increase as fast as agency revenues in relatively lower retention states. 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 continue to improve 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 81% - 82% 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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