First American Financial: A Play On Housing Recovery

As the housing market goes, so go title insurance companies.

Every time a home is sold or refinanced, they get a piece of the action.

Title insurers are "probably the best pure-play way" for investors to get exposure to a broad housing recovery, Keefe, Bruyette & Woods analysts told their clients in a recent report.

The refinancing wave, fueled by low interest rates and government programs, has been a boon for the industry after a long downturn.

Santa Ana, Calif.-basedFirst American Financial ( FAF ) is among the prime beneficiaries.

The company dates back to 1889 when Orange County was newly formed. It's the second-largest title insurance firm afterFidelity National Financial ( FNF ).

It has operations nationwide and some business overseas. It holds a 27% share of the U.S. title market to Fidelity National's 34% share, according to KBW.

Top states by market share include Arizona, Ohio, Pennsylvania and California.

Shares of both companies climbed in 2012 as their financials improved, but First American's more so with shares up 85% to Fidelity National's 44%.

Four Quarterly Gains

First American is on track to post its fourth straight quarter of revenue and earnings gains. Third-quarter revenue jumped 25% over the prior year to $1.2 billion, driven mostly by refinance volume.

Refis made up 65% of its mix of closed orders, up from 60% in the second quarter.

Though home purchase volume has picked up, that part of the market is still seen in early recovery. But it'll likely provide the next leg of growth, analysts say, though they are unclear on the timing.

"Purchases generate twice the revenue and twice as much or more of profits (than refinance volume)," said Stephens Inc. analyst Brett Huff in an interview.

Even with only a partial home-purchase recovery, First American's 2012 earnings are expected to rise 245% over 2011 to $2.52 a share.

But they're seen edging down in 2013 and 2014 as refi activity fades from current high levels and purchase volume doesn't yet fully pick up the slack.

Some analysts, notably those at Barclays Capital, think that the refi wave will remain relatively strong in 2013 and 2014.

They also note that the government's Home Affordable Refinancing Program, or HARP, could keep refi volume elevated through at least 2013.

Therefore, "the gap between a refi-driven and purchase-driven market could be a manageable one," the Barclays analysts wrote in a recent report.

Title companies perform more work on a home purchase than on a refi, and so they charge more. And often they get escrow fees, something they don't typically get on a refi transaction.

First American's average revenue per closed order in Q3 was $1,502, down slightly from the same quarter a year earlier.

While low interest rates are important in the refi market, a strong economy with good job growth is more reflective of a healthy home-purchase market, Huff says.

"Refis at some point will start to taper off in 2013," Huff said. "The question is will purchase volume be enough to offset the refi decrease?"

KBW analysts note that First American's management considers Mortgage Bankers Association forecasts of a 15% uptick in purchase volume in 2013 and a 35% fall-off in refinancing volume as "reasonable."

While under that scenario, total mortgage volume would fall by more than 20%, they note, First American's revenue would drop by only half that because purchase-related fees are about double refi's.

Barclays figures U.S. refi volume in 2013 will fall only 2% from 2012's level, to $1.3 trillion. Its analysts expect purchase transactions to go up 11% to $575 billion, for a total of $1.9 trillion in mortgage originations, but falling to $1.4 trillion in 2014.

Barclays based estimates on models from the firm's securitized products team and says estimates are more than 20% above the average of three forecasts from the MBA,Fannie Mae ( FNMA ) andFreddie Mac ( FMCC ).

Even so, the analysts wrote that their above-consensus estimates "are more likely to be too low than too high."

Conservative Estimates

They reason that purchase-volume estimates are conservative based on 2013 outlooks for total home sales growth of 6% to 7% and home-price appreciation of 5% to 6%.

Barclays pegs First American earnings in 2013 at $2.30 a share and $2.08 in 2014. In contrast, Wall Street's consensus calls for $1.90 in 2013 and $1.83 in 2014, according to Thomson Reuters.

First American's earnings have grown at a faster pace than revenue, as fixed costs, which were trimmed during the downturn, stayed relatively stable on higher volumes.

In Q3, profit jumped 375% to 95 cents a share.

First American has only modestly increased hiring to handle higher volumes in 2012.

First American's Q3 also benefited from $47.3 million in net investment gains from the sale of its remaining stake inCoreLogic ( CLGX ), a research arm it spun off in 2010.

Claims were also down. Management expects the trend to continue as claims recede from the high-loss-policy years of 2005 to 2008.

"They still have the capacity to handle new revenue without doing much hiring," Huff said. "However, there will come a time when their capacity to handle new volume will require hiring."

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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