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  1. 1. The First American Financial Corporation 1997 1997 ANNUAL REPORT MAKING NEWS
  2. 2. T H E F I R S T A M E R I C A N F I N A N C I A L C O R P O R AT I O N A N D S U B S I D I A R Y C O M PA N I E S FIRST AMERICAN First American Profile profile The First American Financial Corporation is the leading provider of real estate-related financial and information services to real property buyers and mortgage lenders. The Company’s products and services include title insurance; information services which include tax monitoring, credit reporting, property data services, flood certification, field inspection services, appraisal services, mortgage loan servicing systems and mortgage document preparation; home warranty; and investment, trust and thrift operations. The title insurance and real estate information segments operate through networks of offices nationwide. The Company provides its title services through more than 300 offices and 4,000 agents throughout the United States. It also offers title services abroad in Australia, the Bahama Islands, Canada, Guam, Mexico, Puerto Rico, the U.S. Virgin Islands and the United Kingdom. Home warranty services are available in Arizona, California, Nevada, North Carolina, South Carolina, Texas, Utah and Washington. The investment, trust and thrift businesses operate in Southern California. First American, based in Santa Ana, California, celebrated its centennial in 1989. First American is dedicated to leading our industry — in customer satisfaction by providing consistently high-quality service; in innovation by developing and marketing new systems, products and services; in profitability by demanding efficiency; and in growth by searching out domestic and international opportunities. TA B L E O F contents First American’s accomplishments made news throughout a successful year. 2 Letter to Stockholders 4 Stock Performance 5 The Year in Review 8 Title Insurance 12 Real Estate Information Services 16 Home Warranty 18 Trust and Banking Fulfilling goals and adhering to our growth strategy led to powerful 1997 financial results. Management’s Discussion and Analysis 20 Selected Financial Data 24 Common Stock and Quarterly Data 25 Consolidated Balance Sheets 26 Consolidated Statements of Income 28 Consolidated Statements of Stockholders’ Equity 29 Consolidated Statements of Cash Flows 30 Notes to Consolidated Financial Statements 31 Report of Independent Accountants 37 The company’s people — throughout the nation and the world — were at the helm of our newsworthy success. 38 Board of Directors 39 Officers 40 Primary Companies 41 Shareholder Information
  3. 3. T H E F I R S T A M E R I C A N F I N A N C I A L C O R P O R AT I O N A N D S U B S I D I A R Y C O M PA N I E S FINANCIAL Financial Highlights highlights (in thousands, except percent, per share amounts and employee data) Percent 1997 1996 Change Revenues $1,887,461 $1,597,566 18 Expenses 1,764,348 1,491,701 18 Income before premium and income taxes 123,113 105,865 16 Premium taxes 16,904 16,676 1 Income before income taxes 106,209 89,189 19 Income taxes 41,500 35,600 17 Net income $ 64,709 $ 53,589 21 Stockholders’ equity $ 411,412 $ 352,465 17 Return on average stockholders’ equity 16.9% 16.4% 3 Cash dividends $ 8,818 $ 7,928 11 Per share of common stock (Note A) — Net income: Basic $ 3.73 $ 3.12 20 Diluted $ 3.64 $ 3.09 18 Stockholders’ equity $ 23.68 $ 20.34 16 Cash dividends $ .51 $ .46 11 Number of common shares outstanding (Note A) — Weighted average during the year: Basic 17,362 17,179 1 Diluted 17,785 17,325 3 End of year 17,374 17,331 – Number of employees 12,930 11,611 11 Note A — After adjustment for 3-for-2 stock split effected January 15, 1998, and restatement for the adoption of Statement of Financial Accounting Standards No. 128, “Earnings per Share.” 01 O pe ra t in g Re ve Operating Revenues Pretax Profits nu by Business Segment by Business Segment e s Pr b et ax Title Insurance – 78% Title Insurance – 62% Pr o fit s Real Estate Information – 18% Real Estate Information – 29% Home Warranty – 3% Home Warranty – 6% Trust and Banking – 1% Trust and Banking – 3% Ti tle Ti tle In su Re Is ra R ur al nc ea a E e nc lE st Ho 7 at e H st m e om 62 at e In e % W e
  4. 4. T H E F I R S T A M E R I C A N F I N A N C I A L C O R P O R AT I O N A N D S U B S I D I A R Y C O M PA N I E S D.P. Kennedy, chairman of the board Parker S. Kennedy, president LETTER TO Letter to Stockholders stockholders T his was a record year for our company in every 1. A greater emphasis on information. Customers today respect. The last time we experienced such outstanding growth seek a wide variety of information to support their real estate was 1993, which was a year of extraordinary transaction levels decisions and First American wants to be the company of caused by an unprecedented refinance boom. Strength and choice for these customers. Generally, title insurance balance marked 1997. Our strong performance was enhanced accompanies this information but often, as in the case of by strong and steady markets in lending, real estate brokerage, second mortgage lending, title information (when coupled with home building and commercial development. We continued borrower credit data, a flood zone determination and tax our strategy of providing a full array of informational products information) is enough. To meet this trend, First American has to these markets and were rewarded with strong revenues continued to expand its control of property data by purchasing and increased profits. Our dedicated team of employees is more than 20 title operations during 1997. Additionally, a huge to be commended. step was taken with the creation of the Experian joint venture. Revenues for the year were $1.887 billion. After-tax profits In combining most of our information services division with were $64.7 million, or $3.64 per diluted share, compared with Experian’s real estate information arm, First American gained an $3.09 per diluted share in 1996. Our stock price improved 80% 80 percent interest in the nation’s most extensive database of over the course of the year. title and property characteristic records as well as a national real estate tax database. This financially strong and valuable INDUSTRY TRENDS partnership has already provided substantial benefits by At the beginning of the decade, we viewed a markedly bringing excellent new people and technological capabilities 02 different landscape when compared with today. There were 10 to First American. national title insurance companies, each offering a very limited The strong profits and potential created by the Experian array of informational products, most relying heavily on data venture have exceeded expectations. Spanning nearly all of our and software owned outside the industry for production of its companies, this venture brings us closer to our goal of primary product. Title searches were produced county-by- operating our divisions as one enterprise. The acquisition county and practices and policy coverages were dictated by strategy of purchasing data bases needed to produce our local customs. Change was inevitable, and First American primary products helps ensure the long-term strength of our changed from a national title insurer to a full service provider company and our industry. of real estate information. 2. Lenders will play a stronger role in shaping our After a period of intense consolidation, there are now six products and product mix. Mortgage originators and national underwriters. Our industry now offers a menu of servicers continue to expand. As they grow and geographically informational products and databases which are, more often diversify, the need for efficient systems and uniform products is than not, controlled by title companies. The searching process is more urgent. Our strong working relationships with our lender becoming much more automated and central processing is clients will become even more important to us. common in several states, as national customers are demanding Our strategy of offering the most extensive array of products uniform policy coverages from state to state. to lender clients helps us strengthen our lender alliances. This process of transformation is far from over. We must Furthering this strategy during the year, First American acquired continue to look into the future and structure our company to Strategic Mortgage Services (SMS), a multiple product provider prosper in the world as it will be. As we look ahead, we see several of real estate information including mortgage credit important trends that will shape the future of First American: information, appraisal data and document preparation. By adding the SMS customers to our existing systems, our profits
  5. 5. were substantially improved in the mortgage credit reporting TRANSITIONS and appraisal businesses and we also were able to add the During the year, First American Records Management (FARM) mortgage document preparation business to our mix. On top of redeemed shares that had been held by The First American this, SMS operated an effective computer software company Financial Corporation. FARM, of which First American previously specializing in escrow closing and title plant systems. This unit is owned 35 percent, continues to be an excellent investment and evolving into the systems and software hub for our title division. we are pleased to retain 71/2 percent of the company. 3. Customers will require that they be able to order and It is with sadness that we report the passing of Robert receive all informational products electronically and McLain, our good friend and longtime board member. Bob was on a single system. An integral part of our strategy is the a homebuilder throughout his very successful career and completion of our ordering and delivery systems. We are enjoyed a reputation for the highest integrity. He was a loyal nearing the completion of a frame relay system allowing for and extremely supportive board member since joining in 1981, very high volume ordering and delivery of mortgage credit guiding us through many years of growth. We will miss Bob’s information, flood certifications, tax monitoring information friendship and wise counsel. and title products. We recently completed an Internet-based We are pleased to add D. Van Skilling to our board. Van order and delivery system for smaller volume users. In most began his career with TRW in 1970, rising to the level of cases, orders are now placed with multiple vendors using mail, executive vice president. When TRW sold its well-known credit fax machines, telephones or separate user interfaces. A single reporting division, Van continued to head the unit now known customer may deal with 20 or more vendors and their systems as Experian, and is now chairman and chief executive officer and the informational products are received in many forms. First of Experian’s North American operations. We welcome Van American’s systems, coupled with our extensive product mix, to our board. will lead to incredible efficiencies by allowing order entry and OUTLOOK delivery on a single system. This is First American’s primary New orders during the early part of 1998 are extremely initiative for 1998. strong. Mortgage rates are low and the national economy is In addition to completing these systems, another important robust, leading to record order levels in many parts of the initiative is to expand our national capability to produce title country. Many experts look for these conditions to continue. evidence, and then link our operations electronically. We We look to the future with confidence as we integrate and envision a day when policies are delivered electronically improve our real estate products and services. throughout the country. Each First American branch and agent 03 We will continue to expand into new businesses and work will be linked to the customer through a wide area network. diligently to improve our market shares and margins in all of This network is well underway, linking over 250 First American our divisions. offices. When complete, our major nationwide lender clients In December 1997, the board approved a three-for-two will receive policies electronically from all parts of the country. stock split which was effective in January 1998, increasing the 4. Cost efficiencies will become increasingly important. shares outstanding to 17.4 million. At its February 1998 Our customers, and indeed our own companies, strongly resist meeting, the board increased the quarterly dividend from price increases. This trend will continue, underscoring the need 131/3 cents a share to 15 cents a share. for efficiency. To facilitate a complete re-engineering of the title On behalf of the officers and directors of First American, searching and closing process, First American has been developing we thank you for your support. its FAST Title and Escrow system which will integrate and revolutionize our production processes. This system will be completed during 1998 and rolled out in 1999. Our ongoing effort to improve higher-margin businesses was realized during 1997. Our emphasis on commercial title D.P. Kennedy insurance, a primary company initiative for several years, has Chairman of the Board resulted in strong market share growth. A strong commercial market together with increases in market share in Dallas and Los Angeles, the acquisition of Settlers Abstract in Philadelphia, and continued strength in New York City and in our National Accounts Department, led to excellent results in 1997. Parker S. Kennedy President
  6. 6. S U B S I D I A R Y C O M PA N I E S S U B S I D I A R Y C O M PA N I E S STOCK THE Stock Performance T h e Ye a r i n R e v i e w performance year in review AND AND FIRST AMERICAN STOCK RISES AMID CONTINUED CORPORATE IT FIRST AMERICAN, WAS A SUCCESSFUL YEAR FOR AS OUR CORPORATION T H E F I R S T A M E R I C A N F I N A N C I A L C O R P O R AT I O N T H E F I R S T A M E R I C A N F I N A N C I A L C O R P O R AT I O N GROWTH AND STRONG FINANCIAL PERFORMANCE — AND ITS OPERATING GROUPS MADE SOLID, STRATEGIC MOVES MOVES THAT FURTHERED OUR LEADERSHIP POSITION, AND OFTEN MADE NEWS. 1997 was a banner year for First American’s shareholders. The stock price ended the year 80 percent higher than in 1996. This substantial gain signals a recognition of the company’s successful expansion and initial integration of its real estate-related software and information businesses. It also reflects the achievements made by our operating groups individually. And, of course, First American’s financial performance contributed too, as our revenues and net income reached a historical high, exceeding analysts’ consensus estimates. Outside factors affected our company’s success during the year, as well. Low interest rates spurred increased real estate activity, benefiting many of our operations. Continuing consolidation within our industry also led to increased interest in our stock. Adherence to our growth plans, however, played the leading role in helping us to realize our 1997 financial accomplishments. We acquired, and formed alliances with, major information companies during the year. We continued our geographic expansion, increasing our company’s presence both nationally and internationally. And, we offered new products and services that allow us to increase business with our present customers and establish relationships with new ones. MAY Duff & Phelps Credit OCT A state-of-the-art call JAN First American opens a APR First American Financial SEP First American Home Buyers DEC A joint venture between Since First American became a public company in 1964, the stock has provided shareholders with a compound annual return that has consistently outperformed the S&P. It rose nearly 400 percent in the Rating Co., (DCR), reaffirms First center is opened by the home title office in Australia, becoming issues and sells $100 million of trust Protection Corporation is licensed to First American and Experian is formed. last five years. In 1997, our stock performance continued this history with exceptional results. Many of American Title’s ‘A-’ rating, implying warranty group, staffed with that nation’s first title insurer. preferred securities through First sell its services in Utah, expanding its The merged operations join the our activities during the year, noted here and in the following pages, made news. All of them 04 high claims-paying ability. additional customer service American Capital Trust I. reach to eight states. nation’s largest provider of real estate- contributed to our success. representatives trained to respond related data with the leading provider FEB The title company introduces rapidly to customer requests. OCT Property Financial Appraisal of real estate-related financial and JUL First American Financial APR First American Financial’s the EAGLE Policy. The policy, benefiting information services. 1,300 Services (PFS) is acquired, greatly reports record-breaking second first quarter operating profits exceed homeowners and lenders, is the first of OCT First American Financial 1,200 expanding First American’s appraisal quarter revenues. analysts’ consensus expectations. its type in the nation. 1,100 DEC First American Financial 1,000 Comparison of Cumulative reports record-breaking third quarter service presence in the Northeast. Total Return 900 Dollar Growth 800 revenues and net income. FEB First American Trust MAY First American acquires declares a 3-for-2 stock split. AUG First American Financial The First American 700 Financial Corporation OCT The purchase of Settlers 600 Company becomes a direct Strategic Mortgage Services (SMS), increases its dividend by 11 percent. 500 Custom Peer Group NOV An independent customer DEC First American becomes 400 participant with the Federal Reserve a leading provider of real estate Abstract in Philadelphia by First S&P Financial Index 300 200 S&P 500 Composite Index survey, commissioned by First American, Bank, enabling the group to wire information services to the mortgage American Title strengthens the the first to establish title insurance 100 prompts the Real Estate Information money directly into the bank’s system and title industries. The acquisition company’s commercial business. operations in the Republic of Ireland. 0 90 91 92 93 94 95 96 97 Services group to establish marketing while saving money for the company brings with it more than 800 employees In all, 22 offices nationwide are systems that mirror the way customers and its customers. and an $85 million revenue base. added by the title group in 1997. First Am. Financial use their services. Custom Peer Group S&P Financial S&P 500 Index
  7. 7. T H E F I R S T A M E R I C A N F I N A N C I A L C O R P O R AT I O N A N D S U B S I D I A R Y C O M PA N I E S Parker S. Kennedy, president The First American Financial Corporation First American Title Insurance Company Gary L. Kermott, chief operating officer First American Title Insurance Company TITLE Title Insurance insurance Af fordable interest rates, low unemployment and high consumer confidence created a strong housing market in 1997, helping to set the pace for our title company’s profitable year. Pretax profit for 1997 totaled $95.6 million, a 45 percent increase over 1996. The title group ended the first quarter, a traditionally slow period for real estate activity, with a 9 percent increase in revenue over first quarter 1996. The year’s first quarter profits were less than half that of last year’s due to the cost of increased staffing needed to service the high level of orders opened during the last quarter of 1996 and the first quarter of 1997. Many of those orders then closed during the second quarter, helping the title division to realize a 9 percent gain in pretax income over the second quarter 1996. And, despite the Federal Reserve Board’s rate increase in March, orders opened during the second quarter increased to 306,000 from 259,000 in second quarter 1996. By the third quarter, stabilized interest rates spurred increased home sales and prompted a rise in refinance activity. This translated into increased title orders and an 86 percent jump in pretax income over the same period in 1996. The resurgence of resales and refinancing was especially evident by the end of the year, as the orders opened during the last quarter were nearly 25 percent higher than in the last quarter of 1996. The title company ended 1997 with $1.46 billion in revenues, up from $1.27 billion in 1996. 08 { } The title company‘s claims-paying ability continued to be highly regarded by independent rating firms. Our title company’s ‘A-’ rating was reaffirmed in 1997 by Duff & Phelps Credit Rating Co. (DCR). The rating implies high claims-paying ability and is based on the strength of our title and related services, continued favorable operating results, adequate capitalization and loss reserves, and conservative investment portfolio. Our title company has also received strong rankings from rating services including A.M. Best Company, which gave us an A (Excellent) rating, Demotech, Inc., which assigned an A’ (Unsurpassed) rating, and Moody’s Investors Service which credited us with an A3 (Exceptional) rating. The title company introduced the nation to a new title insurance product in 1997 when it debuted the EAGLE Policy. The policy was developed to offer customers additional coverages, many of which had never been issued through any standard policy. By year’s end, the EAGLE Policy was available in 29 states. Efforts by our underwriting team should result in adoption of the policy in more states throughout 1998.
  8. 8. First American Title Adds 22 Offices Nationwide, Continuing Growth Strategy * * * SANTA ANA, Calif. — Continuing a newsworthy pattern of national expansion that started more than 40 years ago, our company added title offices in 22 counties in 1997. The majority of these were acquired by First American, chosen for their strength in their communities or their prominence in specialized fields. Geographically, our 1997 acquisitions let us reach new customers in several population centers. Many brought us great financial and organizational benefits, as well, such as those we are already realizing with our acquisition of Long & Melone in Hawaii. Geographic expansion also strengthened our position as one of the select title companies that can service large clients on a national basis. Our national presence and revenues also grew in the commercial market. Of special importance was our purchase of Settlers Abstract in Philadelphia. This acquisition added significantly to our burgeoning commercial effort. Our continued commitment to expand our presence in this field led First American to increase its share of the commercial business within the nation’s major markets by more than 2 percent in 1997. * * *
  9. 9. Expanded Title Coverage Introduced by First American Is First in the Nation * * * SANTA ANA, Calif. — First American made news early in the year with the introduction of the EAGLE Policy, a title product never before offered in our industry. We created the policy to give homeowners and lenders the benefit of additional title protection. We did that by including more coverage automatically than any other policy in history. While the EAGLE Policy contains all of the protection of traditional policies, it also includes coverages that previously were available only by endorsement, and only when specifically requested. It also adds several completely new coverages, including some that protect homeowners in situations that occur after the policy is written — coverage unheard of before the introduction of the EAGLE Policy. And for all of this, our customers are charged an additional fee that is proving to be very reasonable. By developing a policy that better meets the needs of our customers, First American is continuing its role as industry leader and innovator. The policy was first offered in California alone, and by year’s end it was available in 29 states. We look forward to increasing enthusiasm for the EAGLE Policy by homeowners and lenders throughout the country in 1998. * * *
  10. 10. T H E F I R S T A M E R I C A N F I N A N C I A L C O R P O R AT I O N A N D S U B S I D I A R Y C O M PA N I E S Our international expansion continued in 1997 as First American became the first title insurer in Australia. We still do extremely well in Canada as well, where we hold more than a 90 percent share of the market. We remain the leading title company in England, and began offering our services in Ireland and Scotland during the year. Title office additions within the U.S. flourished in 1997, continuing four decades of strategic national expansion. Our commercial market presence was strengthened with our purchase of Settlers Title Insurance Abstract in Philadelphia, a leader in commercial activity. Our acquisition of Hillam Title Agency gave us two new offices in Utah. We purchased Klamath County Title Company, a presence in the Oregon market since 1905. In September we announced the acquisition of Illini Title Services, Inc., Pekin Abstract & Title Company and Woodford County Abstract & Title, enhancing our services throughout central Illinois. Operations in the Midwest were expanded with our acquisition of 140-year-old Miller Abstract in Share of Total U.S. Market Kansas City. Two new offices in Texas came to us through our ($ in millions) acquisition of Donegan Abstract. First American expanded its business in the U.S. Virgin Islands with the purchase of Service Standard, which 25 serves the islands of St. Thomas, St. John and St. Croix. We also acquired operations in California, Hawaii, Ohio and South Carolina. 20 In all, First American added 22 title offices nationally throughout the year. First American divested its 17 percent interest in North American 15 Asset Development when Lennar Homes bought that company 92 93 94 95 96 in 1997. We retained a 50 percent interest in North American Share of US Market { } Plans for 1998 include the integration of several of our systems with those of SMS and Experian. 11 Title Insurance Company, which was owned by North American Asset Development. The other 50 percent is now owned by Lennar. North American Title Company, which operates throughout California and in Arizona and Colorado, is the primary agent for Title Revenues North American Title Insurance Company. This has been a ($ in millions) successful venture for all concerned. 1,600 Plans for 1998 include the integration of several of our systems 1,400 with those of SMS and Experian, two new members of the First 1,200 American team. The title company’s ability to deliver its products 1,000 800 more efficiently, for example, will be enhanced as we directly access 600 Experian’s title plant and image document capabilities. The title 400 and closing operations of SMS will also merge with those of 200 0 First American. 88 89 90 91 92 93 94 95 96 97 Title Revenues
  11. 11. T H E F I R S T A M E R I C A N F I N A N C I A L C O R P O R AT I O N A N D S U B S I D I A R Y C O M PA N I E S John W. Long, president First American Real Estate Information Services, Inc. R E A L E S TAT E Real Estate Information Services information services F irst American Real Estate Information Services was built primarily through the acquisition of leading information service companies. The group plays a key role in First American’s efforts to offer our customers integrated services through a single source. In 1997, its operations were enhanced as First American acquired Strategic Mortgage Services (SMS) and announced our joint venture with Experian. SMS, our ninth major Information Services acquisition since 1995, had operations in fields similar to ours, including mortgage credit information, title, appraisal and escrow and title system software. By integrating these operations, we expanded our customer base and increased our efficiency. The SMS acquisition also brought us the nation’s largest mortgage document preparation service business. Previously, First American had no operations in this vital portion of the mortgage process. Joseph R. Reppert, former chairman of SMS, now acts as vice chairman of First American Real Estate Information Services. Our joint venture with Experian, which became effective in January of 1998, added the services of the nation’s largest provider of real estate-related data to our group. The efficiencies of having immediate access to this supply of raw data — information we use in many of our operations — will be enormous. Property Financial Appraisal Services (PFS) was also acquired by First American in 1997. The group has been integrated into First American Appraisal Services, a fast-growing division which uses technology and qualified appraisers to provide lenders with property value assessments 12 needed to measure loan risk. Prominent for many years in the New England area, PFS has expanded our appraisal service presence in the Northeast. { } Streamlining the deliver y of our ser vices should benefit our customers today and well into the future. First American Real Estate Information Services’ Excelis division completed its conversion of GMAC’s $54 billion portfolio onto its system in 1997. Excelis, the nation’s only commercially available real-time, on-line loan servicing system, was developed to handle the nation’s largest loan portfolios. During the second half of the year, First American Real Estate Information Services set out to further strengthen its efficiency and client satisfaction by learning more about its customers’ specific needs. The results of a customer survey, conducted by an independent research firm, led First American to structure the delivery of its services in a way that mirrors the way customers access them. To do so, the
  12. 12. First American and Experian Create Industry Powerhouse by Merging Substantial Operations * * * SANTA ANA, Calif. — The biggest news of the year, and perhaps of our history, came when we formed our joint venture with Experian Group. The agreement teamed Experian Real Estate Solutions, the nation’s largest provider of real estate-related data, with First American, the nation’s leading provider of real estate-related financial and information services. We have joined the industry’s biggest supplier of raw data with its biggest user of this information. The efficiencies, already being realized, will be substantial. This venture, which will begin operating under an independent name during 1998, will take the company in new directions. With the Experian resources, we will be able to greatly accelerate the pace of title searching innovation — integrating and automating a process which is currently very fragmented. The door to further acquisitions is open as we seek to integrate additional data and software. * * *