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STEWART INFORMATION SERVICES CORP - Quarter Report: 2017 March (Form 10-Q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 
FORM 10-Q
(Mark One)

þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2017
or
 ¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission file number 001-02658
 STEWART INFORMATION SERVICES CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
 
74-1677330
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
1980 Post Oak Blvd., Houston TX
 
77056
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code: (713) 625-8100
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    
Yes þ  No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes þ    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer  þ
 
Accelerated filer ¨
 
Non-accelerated filer  ¨ 
(Do not check if smaller reporting company)
 
Smaller reporting company  ¨ 
Emerging growth company  ¨ 
 
 
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes      No þ
On April 25, 2017, there were 23,710,234 shares of the issuer's Common Stock, $1 par value per share, outstanding.




FORM 10-Q QUARTERLY REPORT
QUARTER ENDED MARCH 31, 2017
TABLE OF CONTENTS
 
Item
 
Page
 
PART I – FINANCIAL INFORMATION
 
 
 
 
1.
 
 
 
2.
 
 
 
3.
 
 
 
4.
 
PART II – OTHER INFORMATION
 
1.
 
 
 
1A.
 
 
 
2.
 
 
 
5.
 
 
 
6.
 
 
 
 
As used in this report, “we,” “us,” “our,” "Registrant," the “Company” and “Stewart” mean Stewart Information Services Corporation and our subsidiaries, unless the context indicates otherwise.





















2


PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
 
For the Three Months Ended 
 March 31,
 
2017
 
2016
 
($000 omitted, except per share)
Revenues
 
 
 
Title insurance:
 
 
 
Direct operations
187,428

 
186,002

Agency operations
233,349

 
224,635

Ancillary services
17,304

 
22,035

Operating revenues
438,081

 
432,672

Investment income
4,671

 
5,070

Investment and other gains – net
287

 
488

 
443,039

 
438,230

Expenses
 
 
 
Amounts retained by agencies
191,175

 
183,844

Employee costs
139,785

 
150,209

Other operating expenses
78,318

 
87,711

Title losses and related claims
20,701

 
23,093

Depreciation and amortization
6,378

 
8,306

Interest
817

 
779

 
437,174

 
453,942

 
 
 
 
Income (loss) before taxes and noncontrolling interests
5,865

 
(15,712
)
Income tax benefit
(144
)
 
(6,648
)
 
 
 
 
Net income (loss)
6,009

 
(9,064
)
Less net income attributable to noncontrolling interests
1,922

 
2,130

Net income (loss) attributable to Stewart
4,087

 
(11,194
)
 
 
 
 
Net income (loss)
6,009

 
(9,064
)
Other comprehensive income, net of taxes:
 
 
 
Foreign currency translation adjustments
1,325

 
3,295

Change in net unrealized gains on investments
2,467

 
5,789

Reclassification of adjustment for gains included in net income (loss)
(367
)
 
(64
)
Other comprehensive income, net of taxes:
3,425

 
9,020

 
 
 
 
Comprehensive income (loss)
9,434

 
(44
)
Less net income attributable to noncontrolling interests
1,922

 
2,130

Comprehensive income (loss) attributable to Stewart
7,512

 
(2,174
)
 
 
 
 
Basic average shares outstanding (000)
23,433

 
23,348

Basic earnings (loss) per share attributable to Stewart
0.17

 
(0.48
)
 
 
 
 
Diluted average shares outstanding (000)
23,569

 
23,348

Diluted earnings (loss) per share attributable to Stewart
0.17

 
(0.48
)
See notes to condensed consolidated financial statements.

3


CONDENSED CONSOLIDATED BALANCE SHEETS
 
As of 
 March 31, 2017 (Unaudited)
 
As of 
 December 31, 2016
 
($000 omitted)
Assets
 
 
 
Cash and cash equivalents
122,575

 
185,772

Short-term investments
22,836

 
22,239

Investments in debt and equity securities available-for-sale, at fair value:
 
 
 
Statutory reserve funds
484,752

 
485,409

Other
171,447

 
146,094

 
656,199

 
631,503

Receivables:
 
 
 
Premiums from agencies
32,253

 
31,246

Trade and other
42,334

 
41,897

Income taxes
7,008

 
4,878

Notes
3,145

 
3,402

Allowance for uncollectible amounts
(9,691
)
 
(9,647
)
 
75,049

 
71,776

Property and equipment, at cost:
 
 
 
Land
3,991

 
3,991

Buildings
22,688

 
22,529

Furniture and equipment
223,700

 
217,105

Accumulated depreciation
(178,539
)
 
(173,119
)
 
71,840

 
70,506

Title plants, at cost
75,313

 
75,313

Investments in investees, on an equity method basis
9,423

 
9,796

Goodwill
217,094

 
217,094

Intangible assets, net of amortization
9,975

 
10,890

Deferred tax assets
3,863

 
3,860

Other assets
43,801

 
42,975

 
1,307,968

 
1,341,724

Liabilities
 
 
 
Notes payable
100,845

 
106,808

Accounts payable and accrued liabilities
88,401

 
115,640

Estimated title losses
460,142

 
462,572

Deferred tax liabilities
9,480

 
7,856

 
658,868

 
692,876

Contingent liabilities and commitments

 

Stockholders’ equity
 
 
 
Common Stock and additional paid-in capital
181,371

 
180,959

Retained earnings
468,844

 
471,788

Accumulated other comprehensive income (loss):
 
 
 
Unrealized investment gains on investments - net
9,946

 
7,846

Foreign currency translation adjustments
(15,402
)
 
(16,727
)
Treasury stock – 352,161 common shares, at cost
(2,666
)
 
(2,666
)
Stockholders’ equity attributable to Stewart
642,093

 
641,200

Noncontrolling interests
7,007

 
7,648

Total stockholders’ equity (23,710,234 and 23,431,279 shares outstanding)
649,100

 
648,848

 
1,307,968

 
1,341,724

See notes to condensed consolidated financial statements.

4


CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
 
Three Months Ended 
 March 31,
 
2017
 
2016
 
($000 omitted)
Reconciliation of net income (loss) to cash provided by operating activities:
 
 
 
Net income (loss)
6,009

 
(9,064
)
Add (deduct):
 
 
 
Depreciation and amortization
6,378

 
8,306

Provision for bad debt
366

 
711

Investment and other gains – net
(287
)
 
(488
)
Amortization of net premium on investments available-for-sale
1,718

 
1,742

Payments for title losses in excess of provisions
(3,605
)
 
(523
)
Adjustment for insurance recoveries of title losses
409

 
312

Increase in receivables – net
(3,896
)
 
(3,622
)
Increase in other assets – net
(666
)
 
(2,583
)
Decrease in payables and accrued liabilities – net
(27,355
)
 
(26,540
)
Change in net deferred income taxes
136

 
(1,953
)
Net income from equity investees
(197
)
 
(341
)
Dividends received from equity investees
570

 
581

Stock based compensation expense
1,230

 
1,395

Other – net
1

 
226

Cash used by operating activities
(19,189
)
 
(31,841
)
 
 
 
 
Investing activities:
 
 
 
Proceeds from investments available-for-sale sold
15,843

 
11,327

Proceeds from investments available-for-sale matured
14,956

 
260

Purchases of investments available-for-sale
(51,981
)
 
(44,254
)
Net purchases of short-term investments
(597
)
 
(2,302
)
Purchases of property and equipment, title plants and real estate – net
(5,586
)
 
(5,494
)
Other – net
449

 
387

Cash used by investing activities
(26,916
)
 
(40,076
)
 
 
 
 
Financing activities:
 
 
 
Payments on notes payable
(8,382
)
 
(1,307
)
Proceeds from notes payable
875

 
10,000

Distributions to noncontrolling interests
(2,563
)
 
(3,028
)
Cash dividends paid
(7,031
)
 
(6,720
)
Other – net
(818
)
 
(240
)
Cash used by financing activities
(17,919
)
 
(1,295
)
 
 
 
 
Effects of changes in foreign currency exchange rates
827

 
2,898

Decrease in cash and cash equivalents
(63,197
)
 
(70,314
)
 
 
 
 
Cash and cash equivalents at beginning of period
185,772

 
179,067

Cash and cash equivalents at end of period
122,575

 
108,753

 
 
 
 
See notes to condensed consolidated financial statements.

5


CONDENSED CONSOLIDATED STATEMENT OF EQUITY (UNAUDITED)

 
Common Stock ($1 par value)
 
Additional paid-in capital
 
Retained earnings
 
Accumulated other comprehensive (loss) income
 
Treasury stock
 
Noncontrolling interests
 
Total
 
($000 omitted)
 
 
 
 
 
 
 
 
 
 
 
 
Balances at December 31, 2016
23,783

 
157,176

 
471,788

 
(8,881
)
 
(2,666
)
 
7,648

 
648,848

Net income attributable to Stewart

 

 
4,087

 

 

 

 
4,087

Cash dividends on Common Stock ($0.30 per share)

 

 
(7,031
)
 

 

 

 
(7,031
)
Stock based compensation and other
279

 
951

 

 

 

 

 
1,230

Purchase of remaining interest in consolidated subsidiary

 
(818
)
 

 

 

 

 
(818
)
Net change in unrealized gains and losses on investments

 

 

 
2,467

 

 

 
2,467

Net realized gain reclassification

 

 

 
(367
)
 

 

 
(367
)
Foreign currency translation adjustments

 

 

 
1,325

 

 

 
1,325

Net income attributable to noncontrolling interests

 

 

 

 

 
1,922

 
1,922

Subsidiary dividends paid to noncontrolling interests

 

 

 

 

 
(2,563
)
 
(2,563
)
Balances at March 31, 2017
24,062

 
157,309

 
468,844

 
(5,456
)
 
(2,666
)
 
7,007

 
649,100

See notes to condensed consolidated financial statements.


6


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1
Interim financial statements. The financial information contained in this report for the three months ended March 31, 2017 and 2016, and as of March 31, 2017, is unaudited. This report should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.
A. Management’s responsibility. The accompanying interim financial statements were prepared by management, who is responsible for their integrity and objectivity. These financial statements have been prepared in conformity with U.S. generally accepted accounting principles (GAAP), including management’s best judgments and estimates. In the opinion of management, all adjustments necessary for a fair presentation of this information for all interim periods, consisting only of normal recurring accruals, have been made. The Company’s results of operations for interim periods are not necessarily indicative of results for a full year and actual results could differ.
B. Consolidation. The condensed consolidated financial statements include all subsidiaries in which the Company owns more than 50% voting rights in electing directors. All significant intercompany amounts and transactions have been eliminated and provisions have been made for noncontrolling interests. Unconsolidated investees, in which the Company typically owns 20% through 50% of the equity, are accounted for by the equity method.
C. Reclassifications. Certain amounts in the 2016 interim financial statements have been reclassified for comparative purposes. Net loss attributable to Stewart, as previously reported, was not affected.
D. Restrictions on cash and investments. The Company maintains investments in accordance with certain statutory requirements for the funding of statutory premium reserves. Statutory reserve funds, which approximated $484.8 million and $485.4 million at March 31, 2017 and December 31, 2016, respectively, are required to be fully funded and invested in high-quality securities and short-term investments. In addition, included within cash and cash equivalents are statutory reserve funds of approximately $18.7 million and $13.9 million at March 31, 2017 and December 31, 2016, respectively. Although these cash statutory reserve funds are not restricted or segregated in depository accounts, they are required to be held pursuant to state statutes. If the Company fails to maintain minimum investments or cash and cash equivalents to meet statutory requirements, the Company may be subject to fines or other penalties, including potential revocation of its business license. These funds are not available for any other purpose. In the event that insurance regulators adjust the determination of the statutory premium reserves of the Company’s title insurers, these restricted funds as well as statutory surplus would correspondingly increase or decrease.
E. Recently adopted accounting pronouncements. In January 2017, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2017-01, Business Combination: Clarifying the Definition of a Business. The amendments in this ASU change the definition of a business to assist with evaluating when a set of transferred assets and activities is a business. This ASU is effective for annual and interim periods beginning after December 15, 2017 and early adoption is allowed. The Company early adopted ASU 2017-01 effective January 1, 2017.
Also in January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other: Simplifying the Test for Goodwill Impairment. To simplify the subsequent measurement of goodwill, the amendments in this ASU eliminate Step 2 from the two-step quantitative goodwill impairment test. Under this new guidance, the annual, or interim, goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount. An impairment charge, if determined applicable, should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. In addition, income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit should be considered when measuring the goodwill impairment loss. This ASU does not amend the optional qualitative assessment of goodwill impairment. This ASU is effective for annual and interim periods beginning after December 15, 2019 and early adoption is allowed. The Company early adopted ASU 2017-04 effective January 1, 2017.


7


NOTE 2
Investments in debt and equity securities available-for-sale. The amortized costs and fair values follow:
 
March 31, 2017
 
December 31, 2016
 
Amortized
costs
 
Fair
values
 
Amortized
costs
 
Fair
values
 
($000 omitted)
Debt securities:
 
 
 
 
 
 
 
Municipal
72,236

 
72,918

 
72,284

 
72,432

Corporate
334,887

 
341,283

 
338,365

 
343,047

Foreign
190,366

 
192,663

 
165,735

 
167,027

U.S. Treasury Bonds
12,795

 
12,635

 
12,795

 
12,613

Equity securities
30,616

 
36,700

 
30,255

 
36,384

 
640,900

 
656,199

 
619,434

 
631,503

Foreign debt securities consist primarily of Canadian government and corporate bonds, United Kingdom treasury bonds, and Mexican government bonds. Equity securities consist of common stocks and master limited partnership interests.
Gross unrealized gains and losses were:
 
March 31, 2017
 
December 31, 2016
 
Gains
 
Losses
 
Gains
 
Losses
 
($000 omitted)
Debt securities:
 
 
 
 
 
 
 
Municipal
1,111

 
429

 
723

 
575

Corporate
7,612

 
1,216

 
6,871

 
2,189

Foreign
3,414

 
1,117

 
2,912

 
1,620

U.S. Treasury Bonds
5

 
165

 
4

 
186

Equity securities
6,902

 
818

 
6,800

 
671

 
19,044

 
3,745

 
17,310

 
5,241

Debt securities as of March 31, 2017 mature, according to their contractual terms, as follows (actual maturities may differ due to call or prepayment rights):
 
 
Amortized
costs
 
Fair
values
 
($000 omitted)
In one year or less
41,967

 
42,258

After one year through five years
260,428

 
266,216

After five years through ten years
230,514

 
232,252

After ten years
77,375

 
78,773

 
610,284

 
619,499



8


Gross unrealized losses on investments and the fair values of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at March 31, 2017, were:
 
 
Less than 12 months
 
More than 12 months
 
Total
 
Losses
 
Fair values
 
Losses
 
Fair values
 
Losses
 
Fair values
 
($000 omitted)
Debt securities:
 
 
 
 
 
 
 
Municipal
429

 
12,503

 

 

 
429

 
12,503

Corporate
1,216

 
98,998

 

 

 
1,216

 
98,998

Foreign
1,095

 
72,071

 
22

 
1,550

 
1,117

 
73,621

U.S. Treasury Bonds
165

 
11,867

 

 

 
165

 
11,867

Equity securities
592

 
8,413

 
226

 
1,473

 
818

 
9,886

 
3,497

 
203,852

 
248

 
3,023

 
3,745

 
206,875

The number of investment securities in an unrealized loss position as of March 31, 2017 was 164, 10 securities of which were in unrealized loss positions for more than 12 months. Since the Company does not intend to sell and will more-likely-than-not maintain each investment security until its maturity or anticipated recovery, and no significant credit risk is deemed to exist, these investments are not considered other-than-temporarily impaired.
Gross unrealized losses on investments and the fair values of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2016, were:
 
 
Less than 12 months
 
More than 12 months
 
Total
 
Losses
 
Fair values
 
Losses
 
Fair values
 
Losses
 
Fair values
 
($000 omitted)
Debt securities:
 
 
 
 
 
 
 
Municipal
575

 
32,038

 

 

 
575

 
32,038

Corporate
2,189

 
119,965

 

 

 
2,189

 
119,965

Foreign
1,427

 
70,012

 
193

 
3,160

 
1,620

 
73,172

U.S. Treasury Bonds
186

 
11,847

 

 

 
186

 
11,847

Equity securities
424

 
5,950

 
247

 
2,250

 
671

 
8,200

 
4,801

 
239,812

 
440

 
5,410

 
5,241

 
245,222

The Company believes its investment portfolio is diversified and expects no material loss to result from the failure to perform by issuers of the debt securities it holds. Investments made by the Company are not collateralized.
NOTE 3
Fair value measurements. The Fair Value Measurements and Disclosures Topic (Topic 820) of the FASB Accounting Standards Codification (ASC) defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal, or most advantageous, market for the asset or liability in an orderly transaction between market participants at the measurement date. Topic 820 establishes a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. This hierarchy requires entities to maximize the use of observable inputs when possible. The three levels of inputs used to measure fair value are as follows:
 
Level 1 – quoted prices in active markets for identical assets or liabilities;
Level 2 – observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data; and

9


Level 3 – unobservable inputs that are supported by little or no market activity and that are significant to the fair values of the assets or liabilities, including certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.
As of March 31, 2017, financial instruments measured at fair value on a recurring basis are summarized below:
 
Level 1
 
Level 2
 
Fair value
measurements
 
($000 omitted)
Investments available-for-sale:
 
 
 
 
 
Debt securities:
 
 
 
 
 
Municipal

 
72,918

 
72,918

Corporate

 
341,283

 
341,283

Foreign

 
192,663

 
192,663

U.S. Treasury Bonds

 
12,635

 
12,635

Equity securities
36,700

 

 
36,700

 
36,700

 
619,499

 
656,199

As of December 31, 2016, financial instruments measured at fair value on a recurring basis are summarized below:
 
Level 1
 
Level 2
 
Fair value
measurements
 
($000 omitted)
Investments available-for-sale:
 
 
 
 
 
Debt securities:
 
 
 
 
 
Municipal

 
72,432

 
72,432

Corporate

 
343,047

 
343,047

Foreign

 
167,027

 
167,027

U.S. Treasury Bonds

 
12,613

 
12,613

Equity securities
36,384

 

 
36,384

 
36,384

 
595,119

 
631,503

As of March 31, 2017, Level 1 financial instruments consist of equity securities. Level 2 financial instruments consist of municipal, governmental and corporate bonds, both U.S. and foreign. In accordance with the Company’s policies and guidelines which incorporate relevant statutory requirements, the Company’s third-party registered investment manager invests only in securities rated as investment grade or higher by the major rating services, where observable valuation inputs are significant. All municipal, foreign, and U.S. Treasury bonds are valued using a third-party pricing service, and the corporate bonds are valued using the market approach, which includes three to ten inputs from relevant market sources, including Financial Industry Regulatory Authority’s (FINRA) Trade Reporting and Compliance Engine (TRACE) and independent broker/dealer quotes, bids and offerings, as well as other relevant market data, such as securities with similar characteristics (i.e. sector, rating, maturity, etc.). Broker/dealer quotes, bids and offerings mentioned above are gathered (typically three to ten) and a consensus risk premium spread (credit spread) over risk-free Treasury yields is developed from the inputs obtained, which is then used to calculate the resulting fair value.
There were no transfers of investments between levels during the three months ended March 31, 2017 and 2016.


10


NOTE 4
Investment income and other gains and losses. Gross realized investment and other gains and losses follows:
 
For the Three Months Ended 
 March 31,
 
2017
 
2016
 
($000 omitted)
Realized gains
566

 
3,937

Realized losses
(279
)
 
(3,449
)
 
287

 
488

Expenses assignable to investment income were insignificant. There were no significant investments as of March 31, 2017 that did not produce income during the year.
 
For the three months ended March 31, 2017, investment and other gains – net included $0.4 million of net realized gains from the sale of investments available-for-sale. For the three months ended March 31, 2016, investments and other gains - net included $1.6 million of net realized gains due to changes in the fair values of contingent consideration liabilities associated with certain prior year acquisitions, partially offset by $1.4 million of office closure costs.

Proceeds from sales of investments available-for-sale are as follows: 
 
For the Three Months Ended 
 March 31,
 
2017
 
2016
 
($000 omitted)
Proceeds from sales of investments available-for-sale
15,843

 
11,327



NOTE 5
Estimated title losses. A summary of estimated title losses for the three months ended March 31 is as follows:
 
2017
 
2016
 
($000 omitted)
Balances at January 1
462,572

 
462,622

Provisions:
 
 
 
Current year
20,537

 
22,991

Previous policy years
164

 
102

Total provisions
20,701

 
23,093

Payments, net of recoveries:
 
 
 
Current year
(2,988
)
 
(3,762
)
Previous policy years
(20,909
)
 
(19,542
)
Total payments, net of recoveries
(23,897
)
 
(23,304
)
Effects of changes in foreign currency exchange rates
766

 
3,998

Balances at March 31
460,142

 
466,409

Loss ratios as a percentage of title operating revenues:
 
 
 
Current year provisions
4.9
%
 
5.6
%
Total provisions
4.9
%
 
5.6
%



11


NOTE 6
Earnings per share. The Company’s basic earnings per share (EPS) attributable to Stewart is calculated by dividing net income attributable to Stewart by the weighted-average number of shares of Common Stock outstanding during the reporting periods. Outstanding shares of Common Stock granted to employees that are not yet vested (restricted shares) are excluded from the calculation of the weighted-average number of shares outstanding for calculating basic EPS. To calculate diluted EPS, the number of shares is adjusted for the effects of any dilutive shares. The treasury stock method is used to calculate the dilutive number of shares related to the Company’s long term incentive and stock option plans. In periods of loss, dilutive shares are excluded from the calculation of the diluted EPS and diluted EPS is computed in the same manner as basic EPS.

The calculation of the basic and diluted EPS is as follows:
 
For the Three Months Ended 
 March 31,
 
2017
2016
 
($000 omitted, except per share)
Numerator:
 
 
Net income (loss) attributable to Stewart
4,087

(11,194
)
 
 
 
Denominator (000):
 
 
Basic average shares outstanding
23,433

23,348

Average number of dilutive shares relating to grants of restricted shares
136


Diluted average shares outstanding
23,569

23,348

 
 
 
Basic earnings (loss) per share attributable to Stewart
0.17

(0.48
)
 
 
 
Diluted earnings (loss) per share attributable to Stewart
0.17

(0.48
)


NOTE 7
Share-based payments. During the first quarters 2017 and 2016, the Company granted executives and senior management shares of restricted common stock, consisting of time-based shares, which vest on each of the first three anniversaries of the grant date, and performance-based shares, which vest upon achievement of certain financial objectives over the period of three years. The aggregate fair values of these awards at the grant date in the first quarters 2017 and 2016 were $3.0 million (69,000 shares with an average grant price per share of $43.87) and $3.9 million (105,000 shares with an average grant price per share of $37.33), respectively. Awards were made pursuant to the Company’s employee incentive compensation plans and the compensation expense associated with restricted stock awards is recognized over the corresponding vesting period.
In April 2017, the Company granted certain senior management 19,000 shares of restricted common stock with aggregate fair value of $0.8 million and an average grant price per share of $44.45. Similar grants were made by the Company in 2016 and were included in the above shares granted during the first quarter 2016.

12


NOTE 8
Contingent liabilities and commitments. In the ordinary course of business, the Company guarantees the third-party indebtedness of certain of its consolidated subsidiaries. As of March 31, 2017, the maximum potential future payments on the guarantees are not more than the related notes payable recorded in the condensed consolidated balance sheets. The Company also guarantees the indebtedness related to lease obligations of certain of its consolidated subsidiaries. The maximum future obligations arising from these lease-related guarantees are not more than the Company’s future minimum lease payments. As of March 31, 2017, the Company also had unused letters of credit aggregating $5.6 million related to workers’ compensation and other insurance. The Company does not expect to make any payments on these guarantees.

NOTE 9
Regulatory and legal developments. The Company is subject to claims and lawsuits arising in the ordinary course of its business, most of which involve disputed policy claims. In some of these lawsuits, the plaintiff seeks exemplary or treble damages in excess of policy limits. The Company does not expect that any of these ordinary course proceedings will have a material adverse effect on its consolidated financial condition or results of operations. In addition, along with the other major title insurance companies, the Company is party to class action lawsuits concerning the title insurance industry. The Company believes that it has adequate reserves for the various litigation matters and contingencies discussed in this paragraph and that the likely resolution of these matters will not materially affect its consolidated financial condition or results of operations.

The Company is subject to administrative actions and litigation relating to the basis on which premium taxes are paid in certain states. Additionally, the Company receives from time to time various other inquiries from governmental regulators concerning practices in the insurance industry. Many of these practices do not concern title insurance. To the extent the Company is in receipt of such inquiries, it believes that it has adequately reserved for these matters and does not anticipate that the outcome of these inquiries will materially affect its consolidated financial condition or results of operations.

The Company is subject to various other administrative actions and inquiries into its business conduct in certain of the states in which it operates. While the Company cannot predict the outcome of the various regulatory and administrative matters, it believes that it has adequately reserved for these matters and does not anticipate that the outcome of any of these matters will materially affect its consolidated financial condition or results of operations.

NOTE 10
Segment information. The Company reports two operating segments: title and ancillary services and corporate. The title segment provides services needed to transfer title to property in a real estate transaction and includes services such as searching, examining, closing and insuring the condition of the title to the property. In addition, the title segment includes centralized title services, home and personal insurance services and Internal Revenue Code Section 1031 tax-deferred exchanges. The ancillary services and corporate segment historically provided appraisal and valuation services, document management, recording and call center-related services offered to large mortgage lenders and servicers, mortgage brokers and mortgage investors. Beginning in 2017, the principal offerings of ancillary services are appraisal and valuation services. Also included in the ancillary services and corporate segment are expenses of the parent holding company and certain other enterprise-wide overhead costs, net of centralized administrative services costs allocated to respective operating businesses.

13


Selected statement of income information related to these segments is as follows:
 
For the Three Months Ended 
 March 31,
 
2017
 
2016
 
($000 omitted)
Title segment:
 
 
 
Revenues
425,795

 
413,540

Depreciation and amortization
5,226

 
5,158

Income (loss) before taxes and noncontrolling interest
12,276

 
(618
)
 
 
 
 
Ancillary services and corporate segment:
 
 
 
Revenues
17,244

 
24,690

Depreciation and amortization
1,152

 
3,148

Loss before taxes and noncontrolling interest
(6,411
)
 
(15,094
)
 
 
 
 
Consolidated Stewart:
 
 
 
Revenues
443,039

 
438,230

Depreciation and amortization
6,378

 
8,306

Income (loss) before taxes and noncontrolling interest
5,865

 
(15,712
)

The Company does not provide asset information by reportable operating segment as it does not routinely evaluate the asset position by segment.

Revenues generated in the United States and all international operations are as follows:
 
For the Three Months Ended 
 March 31,
 
2017
 
2016
 
($000 omitted)
United States
419,251

 
417,589

International
23,788

 
20,641

 
443,039

 
438,230

NOTE 11
Other comprehensive income. Changes in the balances of each component of other comprehensive income and the related tax effects are as follows:
 
For the Three Months Ended 
 March 31, 2017
 
For the Three Months Ended 
 March 31, 2016
 
Before-Tax Amount
Tax Expense (Benefit)
Net-of-Tax Amount
 
Before-Tax Amount
Tax Expense (Benefit)
Net-of-Tax Amount
 
($000 omitted)
 
($000 omitted)
Unrealized investment gains on investments - net:
 
 
 
 
 
 
 
Change in net unrealized gains on investments
3,795

1,328

2,467

 
8,906

3,117

5,789

Less: reclassification adjustment for net gains included in net income (loss)
(565
)
(198
)
(367
)
 
(98
)
(34
)
(64
)
 Net unrealized gains
3,230

1,130

2,100

 
8,808

3,083

5,725

 
 
 
 
 
 
 
 
Foreign currency translation adjustments
1,680

355

1,325

 
5,357

2,062

3,295

 
 
 
 
 
 
 
 
Other comprehensive income
4,910

1,485

3,425

 
14,165

5,145

9,020


14


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

MANAGEMENT’S OVERVIEW

We reported net income attributable to Stewart of $4.1 million ($0.17 per diluted share) for the first quarter 2017 compared to a net loss attributable to Stewart of $11.2 million ($0.48 per diluted share) for the first quarter 2016. Pretax income before noncontrolling interests for the first quarter 2017 was $5.9 million compared to a pretax loss before noncontrolling interests of $15.7 million for the first quarter 2016.

First quarter 2017 results included a $1.7 million ($0.07 per diluted share) net income tax benefit related to previously unrecognized tax credits.

First quarter 2016 results included:
$2.8 million of charges recorded in the ancillary services and corporate segment relating to our exit of the delinquent loan servicing operations (including a $1.3 million realized loss associated with early lease termination costs),
$2.2 million of expenses recorded in the ancillary services and corporate segment associated primarily with a life insurance settlement with a former Class B shareholder,
$3.6 million of litigation-related accrual recorded in the ancillary services and corporate segment, and
$1.8 million of other net realized gains composed of $3.8 million of net realized gains recorded within the ancillary services and corporate segment, offset by $2.0 million of net realized losses recorded within the title segment.

Summary results of the title segment are as follows ($ in millions, except pretax margin):
 
For the Three Months
Ended March 31,
 
2017
 
2016
 
% Change
 
 
 
 
 
 
Total revenues
425.8

 
413.5

 
3.0
%
Pretax income (loss)
12.3

 
(0.6
)
 
2,086.4
%
Pretax margin
2.9
%
 
(0.1
)%
 



The first quarter 2017 results included $0.4 million of net realized gains, compared with $2.0 million of net realized losses during the first quarter 2016, primarily related to additional contingent consideration expenses in connection with a prior year acquisition.

Non-commercial domestic revenue, as shown under the Results of Operations - Title revenues section, includes revenues from purchase transactions and centralized title operations. Revenues from purchase transactions decreased 2.2% in the first quarter 2017 compared to the prior year quarter, while centralized title revenues declined 17.6%, primarily due to decreased refinancing transactions. Total international revenues increased 20.7% in the first quarter 2017 compared to the prior year quarter, mainly due to transaction volume growth from our Canada operations. Revenues from independent agency operations in the first quarter 2017 increased 3.9% compared to the first quarter 2016. The independent agency remittance rate was 18.1% in the first quarter 2017 compared to 18.2% in the first quarter 2016; while revenues from independent agencies, net of retention, increased 3.4% from the prior year quarter.

Summary results of the ancillary services and corporate segment are as follows ($ in millions):
 
For the Three Months
Ended March 31,
 
2017
 
2016
 
% Change
 
 
 
 
 
 
Total revenues
17.2

 
24.7

 
(30.2
)%
Pretax loss
(6.4
)
 
(15.1
)
 
57.5
 %

The decline in the segment’s revenues in the first quarter 2017 compared to the prior year quarter was primarily due to our exit of the delinquent loan servicing operations completed in the first quarter 2016 and the divestitures of the loan file review, quality control services and government services lines of business at the end of 2016.

15



The first quarter 2016 results included $2.5 million of net realized gains (composed primarily of a $3.6 million gain due to a reduction in estimated contingent consideration associated with a prior year acquisition, offset by $1.3 million of early lease termination costs related to our exit of the delinquent loan servicing operations) and $7.3 million of other charges, for a total of $4.8 million of net charges.

CRITICAL ACCOUNTING ESTIMATES
The preparation of the Company’s condensed 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, 2017, we made no material changes to our 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, 2016.
Operations. 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, agencies and centralized title services centers. Our ancillary services and corporate segment includes our parent holding company expenses and certain enterprise-wide overhead costs, along with our remaining ancillary services operations, principally appraisal and valuation services.
Factors affecting revenues. The principal factors that contribute to changes in operating revenues for our title and ancillary services and corporate segments include:
 
mortgage interest rates;
availability of mortgage loans;
number and average value of mortgage loan originations;
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;
consumer confidence, including employment trends;
demand by buyers;
number of households;
premium rates;
foreign currency exchange rates;
market share;
ability to attract and retain highly productive sales associates;
independent agency remittance rates;
opening of new offices and acquisitions;
number and value of commercial transactions, which typically yield higher premiums;
government or regulatory initiatives, including tax incentives and the implementation of the new integrated disclosure requirements;
acquisitions or divestitures of businesses;
volume of distressed property transactions; and
seasonality and/or weather.


16


Premiums are determined in part by the 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. As an overall guideline, a 5% increase in median home prices results in an approximate 3.5% increase in title premiums. Home price changes 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 months. Our second and third quarters are the most active as the summer is the traditional home buying season, and while commercial transaction closings are skewed to the end of the year, individually large commercial transactions can occur any time of year.

RESULTS OF OPERATIONS
Comparisons of our results of operations for the three months ended March 31, 2017 with the three months ended March 31, 2016 are set forth below. 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. Segment results 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 Realtors®, the Mortgage Bankers Association and Freddie Mac. We also use information from our direct operations.
Operating environment. Actual existing home sales in the first quarter 2017 increased approximately 5.1% from the first quarter 2016. March 2017 existing home sales totaled 456,000, which was up 8.3% from a year ago, and, following the usual seasonal pattern, up 44.8% from February 2017. Further, March 2017 median and average home prices rose 6.8% and 5.3%, respectively, as compared to March 2016 prices. March 2017 housing starts declined 6.8% sequentially from February, but increased 9.2% from a year ago. Newly issued building permits in March 2017 were up 3.6% sequentially from February and increased 17.0% from a year ago. According to Fannie Mae, one-to-four family residential lending declined from $363 billion in the first quarter 2016 to $355 billion in the first quarter 2017, driven primarily by a decrease of approximately $12 billion, or 6.9%, in refinance originations, partially offset by an increase in purchase lending of approximately $4 billion, or 2.1%. On average, refinance title premium rates are 60% of the premium rates for a similarly priced sale transaction.
Title revenues. Direct revenue information is presented below:
 
For the Three Months
Ended March 31,
 
2017
 
2016
 
% Change
 
($ in millions)
 
 
Commercial:
 
 
 
 
 
Domestic
41.6

 
38.7

 
7.5
 %
International
4.4

 
4.0

 
10.0
 %
 
46.0

 
42.7

 
7.7
 %
Non-commercial
 
 
 
 
 
Domestic
123.1

 
128.5

 
(4.2
)%
International
18.3

 
14.8

 
23.6
 %
 
141.4

 
143.3

 
(1.3
)%
Total direct revenues
187.4

 
186.0

 
0.8
 %
Revenues from direct title operations, which include residential, commercial, international and centralized title services transactions, increased $1.4 million, or approximately 1.0%, in the first quarter 2017 compared to the same period in 2016, due to revenue increases from our international and commercial operations, partially offset by revenue declines in centralized title operations and residential transactions. Revenues from our centralized title operations, which primarily process refinancing and default title orders, decreased $2.9 million, or 17.6%, in the first quarter 2017 compared to the first quarter 2016 primarily due to decreased refinancing orders and lower demand for default services. Our residential revenues, which make up the majority of direct revenue, decreased $2.5 million, or 2.2%, in the first quarter 2017 compared to the same period in 2016.

17


Our direct operations include local offices and international operations, and we generate commercial revenues both domestically and internationally. U.S. commercial revenues increased $2.9 million, or 7.5%, in the first quarter 2017 over the prior year quarter primarily due to improvement in our commercial revenue per file. Total international revenues increased $3.9 million, or 20.7%, in the first quarter 2017 over the prior year quarter as a result of increased transaction volume from our Canada operations. Direct revenues constituted 44.5% and 45.3% of our total title revenues in the first quarters 2017 and 2016, respectively.

Orders information for the first quarter ended March 31 is as follows:
 
2017
 
2016
Opened Orders:
 
 
 
Commercial
11,450

 
11,331

Purchase
61,242

 
59,081

Refinance
23,456

 
33,467

Other
4,596

 
3,447

Total
100,744

 
107,326

 
 
 
 
Closed Orders:
 
 
 
Commercial
7,326

 
7,618

Purchase
40,202

 
38,709

Refinance
19,208

 
24,531

Other
3,198

 
3,785

Total
69,934

 
74,643


Total orders closed decreased by approximately 4,700, or 6.3%, in the first quarter 2017 compared to the first quarter 2016 primarily due to the declines in refinancing orders mentioned earlier. Compared to first quarter 2016, refinancing orders closed decreased in the first quarter 2017 by approximately 5,300, or 21.7%, while commercial orders decreased by approximately 300, or 3.8%. These order declines were partially offset by increased purchase orders of approximately 1,500, or 3.9%, in the first quarter 2017 compared to the prior year quarter.

In the first quarter 2017 compared to the first quarter 2016, revenues from independent agency operations increased $8.7 million, or 3.9%; net of agency retention, independent agency revenues increased $1.4 million, or 3.4%. The increase in gross agency revenues in the first quarter 2017 over the prior year quarter was primarily driven by revenue increases from New Jersey, Texas, Minnesota and Pennsylvania, partially offset by a revenue decrease from New York. We continue to focus on increasing profit margins in every state, increasing premium revenue in states where remittance rates are above 20%, and maintaining the quality of our agency network, which we believe to be the industry’s best, in order to mitigate claims risk and drive consistent future performance. While market share is important in our agency operations channel, it is not as important as margins, risk mitigation and profitability.
Ancillary services revenues. Ancillary services operating revenues decreased $4.7 million, or 21.5%, in the first quarter 2017 compared to the first quarter 2016, primarily due to our exit of the delinquent loan servicing operations completed in the first quarter 2016 and the divestitures of the loan file review, quality control services and government services lines of business at the end of 2016.
Investment income. Investment income decreased $0.4 million, or 7.9%, in the first quarter 2017 compared to the first quarter 2016 mainly due to lower interest income as a result of decreased cash and investments balances.

Investment and other gains - net. For the three months ended March 31, 2017, investment and other gains – net included $0.4 million of net realized gains from the sale of investments available-for-sale. For the three months ended March 31, 2016, investments and other gains - net included $1.6 million of net realized gains due to changes in the fair values of contingent consideration liabilities associated with certain prior year acquisitions, partially offset by $1.4 million of office closure costs.


18


Expenses. An analysis of expenses is shown below:
 
For the Three Months
Ended March 31,
 
2017
 
2016
 
% Change
 
($ in millions)
 
 
 
 
 
 
 
 
Amounts retained by agencies
191.2

 
183.8

 
4.0
 %
As a % of agency revenues
81.9
%
 
81.8
%
 
 
Employee costs
139.8

 
150.2

 
(6.9
)%
As a % of operating revenues
31.9
%
 
34.7
%
 
 
Other operating expenses
78.3

 
87.7

 
(10.7
)%
As a % of operating revenues
17.9
%
 
20.3
%
 
 
Title losses and related claims
20.7

 
23.1

 
(10.4
)%
As a % of title revenues
4.9
%
 
5.6
%
 



Retention by agencies. Amounts retained by title agencies are based on agreements between agencies and our title underwriters. Average independent agency remittance rates (i.e., inverse of retention rates, representing the amount paid to us relative to the amount collected by agents at the closing of the transaction) in the first quarter 2017 was 18.1%, comparable to the 18.2% from the prior year quarter. The increase of $7.3 million, or 4.0%, in agency retention in the first quarter 2017 compared to the prior year quarter was primarily driven by the increase in gross agency revenues as earlier discussed. We continue to evaluate independent agency relationships with a focus on states that provide higher remittance rates. The average retention percentage may vary from quarter-to-quarter due to the geographic 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. In addition, a high proportion of our independent agencies are in states with retention rates greater than 80%. Consequently, we expect our average annual retention percentage to remain in the 81% - 82% range over the near to medium term.

Employee costs. Total employee costs decreased $10.4 million, or 6.9%, in the first quarter 2017 compared to the first quarter 2016, as a result of ongoing cost management efforts, as well as a reduction in employee counts tied to volume declines, primarily in our ancillary services and centralized title operations. Average employee counts for the first quarter 2017 decreased approximately 9.1% from the first quarter 2016, while as a percentage of total operating revenues, employee costs for the first quarter 2017 were 31.9%, compared to 34.7% in the prior year quarter.

Employee costs in the title segment decreased $2.9 million, or 2.2%, in the first quarter 2017 compared to the prior year quarter primarily due to decreased salaries and incentives as a result of reduced employee counts, partially offset by increased commissions from higher direct and agency title revenues. In the ancillary services and corporate segment, employee costs decreased $7.5 million, or 39.4%, in the first quarter 2017 compared to the prior year quarter primarily as a result of the reduction in average employee count resulting from the discontinued lines of the ancillary services business mentioned above.
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 and professional fees, third-party-outsourcing provider fees, equipment rental, insurance, rent and other occupancy expenses, repairs and maintenance, technology costs, telephone and title plant expenses. Costs that follow, to varying degrees, changes in transaction volumes and revenues include fee attorney splits, bad debt expenses, ancillary services cost of sales expenses, copy supplies, delivery fees, outside search fees, postage, premium taxes and title plant maintenance expenses. Costs that fluctuate independently of revenues include general supplies, litigation defense, business promotion and marketing and travel.

19


Consolidated other operating expenses decreased $9.4 million, or 10.7%, in the first quarter 2017 compared to the same period last year. As a percentage of total operating revenues, other operating expenses were 17.9% and 20.3% in the first quarters 2017 and 2016, respectively. During the first quarter 2016, we incurred other operating expenses of $3.6 million for a litigation-related accrual and $2.2 million of expenses associated primarily with a life insurance settlement with a former Class B shareholder. Excluding these litigation-related accrual and charges, other operating expenses as a percentage of operating revenues in the first quarter 2016 were 18.9%.

Costs that follow, to varying degrees, changes in transaction volumes and revenues in the first quarter 2017 amounted to $35.8 million, which was comparable to the first quarter 2016. Excluding the litigation-related accrual mentioned above, costs that fluctuate independently of revenues decreased $0.6 million, or 6.9%, in the first quarter 2017 compared to the prior year quarter due to reduced general supplies and legal expenses. Excluding the charges mentioned above and compared to the similar period in the prior year, costs that are fixed in nature decreased $3.1 million, or 8.3%, in the first quarter 2017 mainly due to lower attorney and professional fees.
Title losses. Provisions for title losses, as a percentage of title revenues and including adjustments for certain large claims and escrow losses, were 4.9% and 5.6% for the first quarters 2017 and 2016, respectively. Title loss expense in the first quarter 2017 decreased $2.4 million, or 10.4%, from $23.1 million in the first quarter 2016, primarily as a result of favorable loss experience. The title loss ratio in any given quarter can be significantly influenced by changes in new large claims incurred, escrow losses and adjustments to reserves for existing large claims.
Cash claim payments in the first quarter 2017 compared to the prior year quarter increased 2.5%, primarily due to payments on existing claims. We continue to manage and resolve large claims prudently and in keeping with our commitments to our policyholders.

The composition of title policy loss expense is as follows:
 
For the Three Months
Ended March 31,
 
2017
 
2016
 
($ in millions)
Provisions – known claims:
 
 
 
Current year
2.2

 
2.9

Prior policy years
18.7

 
16.3

 
20.9

 
19.2

Provisions – IBNR
 
 
 
Current year
18.3

 
20.1

Prior policy years
0.2

 
0.1

 
18.5

 
20.2

Transferred to known claims
(18.7
)
 
(16.3
)
Total provisions
20.7

 
23.1


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 additional loss experience on policy years is obtained. This loss experience may result in changes to our estimate of total ultimate losses expected (i.e., the IBNR policy loss reserve). Current year provisions - IBNR are recorded on policies issued in the current year as a percentage of premiums realized (provisioning rate). As claims become known, provisions are reclassified from IBNR to known claims. Adjustments relating to large losses (those individually in excess of $1.0 million) may impact provisions either for known claims or for IBNR.

Known claims provisions increased $1.7 million, or 8.9%, in the first quarter 2017 compared to the same quarter in 2016 primarily as a result of adjustments to existing claims related to prior year policies. Compared to the same period in 2016, total provisions - IBNR decreased $1.7 million, or 8.4%, in the first quarter 2017 mainly due to a decrease in provisions for large claims. As a percentage of title operating revenues, provisions - IBNR for the current policy year decreased to 4.3% in the first quarter 2017 from 4.9% in the first quarter 2016.

20


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 a 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 recognized as expense when discovered or when contingencies associated with them (such as litigation) are resolved and are typically paid less than 12 months after the loss is recognized. During the three months ended March 31, 2017 and 2016, we recorded approximately $1.1 million and $1.5 million, respectively, for policy loss reserves relating to escrow losses arising from mortgage fraud.

Total title policy loss reserve balances:
 
March 31, 2017
 
December 31,
2016
 
($ in millions)
Known claims
73.5

 
76.5

IBNR
386.6

 
386.1

Total estimated title losses
460.1

 
462.6


The amount of the reserve represents the aggregate, non-discounted future payments (net of recoveries) that we expect to incur on policy and escrow losses and in costs to settle claims. Title claims are generally incurred three to five years after policy issuance and the timing of payments on these claims can significantly impact the balance of known claims. In many cases, claims may be open for several years before the resolution and payment of the claims occur; as a result, the estimate of the ultimate amount to be paid may be modified over that time period.

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 estimates.

Depreciation and amortization. Depreciation and amortization expenses decreased to $6.4 million in the first quarter 2017 compared to $8.3 million in the first quarter 2016, primarily due to the higher depreciation expense recorded in the first quarter 2016 resulting from accelerated depreciation charges relating to our exit from the delinquent loan servicing operations, and the lower amortization expense in the first quarter 2017 as a result of the fourth quarter 2016 disposal of certain intangible assets in connection with the divestitures of several lines of the ancillary services business.

Income taxes. Our effective tax rates were (3.7)% and 37.3% for the first quarters 2017 and 2016, respectively, based on income (loss) before taxes, after deducting income attributable to noncontrolling interests, of $3.9 million and ($17.8) million for the first quarters 2017 and 2016, respectively. For the first quarter 2017, a discrete net income tax benefit of $1.7 million was recorded relating to previously unrecognized research and development tax credits. Excluding the effect of the first quarter 2017 discrete tax items, which included the $1.7 million income tax benefit, our effective tax rate for the first quarter 2017 was 36.7%.

LIQUIDITY AND CAPITAL RESOURCES
Our liquidity and capital resources reflect our ability to generate cash flow to meet our obligations to stockholders, customers (payments to satisfy claims on title policies), vendors, employees, lenders and others. As of March 31, 2017, our cash and investments, including amounts reserved pursuant to statutory requirements, aggregated $801.6 million ($298.2 million, net of statutory reserves on cash and investments). Of our total cash and investments at March 31, 2017, $577.0 million ($217.2 million, net of statutory reserves) was held in the United States and the rest internationally, principally Canada.


21


Cash held at the parent company totaled $3.7 million at March 31, 2017. As a holding company, the parent company 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, approved by the Texas Department of Insurance (TDI), among us and our subsidiaries. In addition to funding operating expenses, cash held at the parent company is used for dividend payments to common stockholders and for stock repurchases, if any. To the extent such uses exceed cash available, the parent company is dependent on distributions from its regulated title insurance underwriter, Stewart Title Guaranty Company (Guaranty).

A substantial majority of our consolidated cash and investments as of March 31, 2017 was held by Guaranty and its subsidiaries. The use and investment of these funds, dividends to the parent company, and cash transfers between Guaranty and its subsidiaries and the parent 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 and ancillary services operations) for their operating and debt service needs.

We maintain investments in accordance with certain statutory requirements in the states of domicile of our underwriters for the funding of statutory premium reserves. Statutory premium reserves, which approximated $484.8 million and $485.4 million at March 31, 2017 and December 31, 2016, respectively, are required to be fully funded and invested in high-quality securities and short-term investments. In addition, included within cash and cash equivalents are statutory reserve funds of approximately $18.7 million and $13.9 million at March 31, 2017 and December 31, 2016, respectively. Although these cash statutory reserve funds are not restricted or segregated in depository accounts, they are required to be held pursuant to state statutes. If the Company fails to maintain minimum investments or cash and cash equivalents sufficient to meet statutory requirements, the Company may be subject to fines or other penalties, including potential revocation of its business license. As of March 31, 2017, our known claims reserve totaled $73.5 million and our estimate of claims that may be reported in the future totaled $386.6 million. In addition to this, we had cash and investments (excluding equity method investments) of $208.9 million which are available for underwriter operations, including claims payments.

The ability of Guaranty to pay dividends to its parent is governed by Texas insurance law. The TDI must be notified of any dividend declared, and any dividend in excess of the statutory maximum of 20% of surplus (approximately $102.0 million as of December 31, 2016) would be, by regulation, considered extraordinary and subject to pre-approval by the TDI. Also, the Texas Insurance Commissioner may raise an objection to a planned distribution during the notification period. Guaranty’s actual ability or intent to pay dividends to its parent may be constrained by business and regulatory considerations, such as the impact of dividends on surplus and the liquidity ratio, which could affect its ratings and competitive position, the amount of insurance it can write and its ability to pay future dividends. As of December 31, 2016, our statutory liquidity ratio for our principal underwriter was 106%. Our internal objective is to maintain a ratio of at least 100%, as we believe that ratio is crucial to our competitiveness in the market and our insurer financial strength ratings. On an ongoing basis, this ratio will largely guide our decisions as to frequency and magnitude of dividends from Guaranty to the parent company. 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 economic environment operating conditions or changes in interpretation of statutory accounting requirements by regulators. No dividend was paid by Guaranty to its parent during the three months ended March 31, 2017 and 2016.

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,
 
2017
 
2016
 
(dollars in millions)
Net cash used by operating activities
(19.2
)
 
(31.8
)
Net cash used by investing activities
(26.9
)
 
(40.1
)
Net cash used by financing activities
(17.9
)
 
(1.3
)

22


Operating activities. Our principal sources of cash from operations are premiums on title policies and revenue from title service-related transactions and ancillary services and other operations. 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 was $19.2 million in the first quarter 2017 compared to $31.8 million for the same period in 2016. The improvement in the cash flows from operations was primarily due to the increase in net income generated during the first quarter 2017, partially offset by higher payments of claims.

Although our business is labor intensive, we are focused on a cost-effective, scalable business model which includes utilization of technology, centralized back and middle office functions and business process outsourcing. Our approach allows us to adjust more easily to seasonal and cyclical fluctuations in transaction volumes. We are continuing our focus on cost management, specifically lowering unit costs of production, which will result in improved margins. Our plans to improve margins also include further outsourcing, additional automation of manual processes, and further consolidation of our various systems and production operations. We are currently investing in the technology necessary to accomplish these goals.

Investing activities. Cash used by investing activities was primarily driven by purchases of investments, capital expenditures and acquisition of subsidiaries, offset by proceeds from matured and sold investments. Total proceeds from available-for-sale investments sold and matured approximated $30.8 million and $11.6 million, while cash used for purchases of available-for-sale investments approximated $52.0 million and $44.3 million for the first quarters 2017 and 2016, respectively. Our purchases of short-term investments, net of sales, amounted to $0.6 million for the first quarter 2017 compared to net purchases of $2.3 million in the same period in 2016.

Capital expenditures were $5.6 million and $5.5 million for the first quarters 2017 and 2016, respectively. We maintain investment in capital expenditures at a level that enables us to implement technologies for increasing our operational and back-office efficiencies and to pursue growth in key markets.

Financing activities and capital resources. Total debt and stockholders’ equity were $100.8 million and $649.1 million, respectively, as of March 31, 2017. During the first quarters 2017 and 2016, we borrowed $0.9 million and $10.0 million, and repaid $8.4 million and $1.3 million, respectively, of debt in accordance with the underlying terms of the debt instruments. Of the total debt activity, $0.9 million of additions during the first quarter 2017 and $7.3 million and $0.4 million of payments during the first quarters 2017 and 2016, respectively, were related to short-term loan agreements in connection with our Section 1031 tax-deferred property exchange business. Our debt-to-equity ratio at March 31, 2017 was approximately 15.5%, below the 20% we have set as our unofficial internal limit on leverage. At March 31, 2017, the outstanding balance of our $125.0 million line of credit was $92.9 million, while the remaining balance of the line of credit available for use was $29.6 million, net of an unused $2.5 million letter of credit.

During the first quarters 2017 and 2016, we declared and paid dividends of $0.30 per common share.

Effect of changes in foreign currency exchange rates. The effect of changes in foreign currency exchange rates on our cash and cash equivalents on the consolidated statements of cash flows was a net increase of $0.8 million and $2.9 million in the first quarters 2017 and 2016, respectively. Our principal foreign operating unit is in Canada, and, on average, the value of the Canadian dollar relative to the U.S. dollar appreciated during the three months ended March 31, 2017 and 2016.
***********

We believe we have sufficient liquidity and capital resources to meet the cash needs of our ongoing operations. However, we may determine that additional debt or equity funding is warranted to provide liquidity for achievement of strategic goals or acquisitions or for unforeseen circumstances. Other than scheduled maturities of debt, operating lease payments and anticipated claims payments, we have no material contractual 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 may be required to borrow funds on terms less favorable than we currently have or seek funding from the equity market, which may not be successful or may be on terms that are dilutive to existing stockholders.


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Contingent liabilities and commitments. See discussion of contingent liabilities and commitments in Note 8 to the condensed consolidated financial statements included in Item 1 of Part I of this Report.

Other comprehensive income. Unrealized gains and losses on investments and changes in foreign currency exchange rates are reported net of deferred taxes in accumulated other comprehensive income (loss), a component of stockholders’ equity, until realized. For the three months ended March 31, 2017, net unrealized investment gains of $2.1 million, which increased our other comprehensive income, were primarily related to temporary increases in the fair values over costs of our corporate and foreign bond securities available-for-sale investments, net of taxes. For the three months ended March 31, 2016, net unrealized investment gains of $5.7 million, which increased our other comprehensive income, were primarily related to temporary increases in the fair values over costs of our corporate and municipal bond and equity securities available-for-sale investments, net of taxes. Changes in foreign currency exchange rates, primarily related to our Canadian operations, increased our other comprehensive income, net of taxes, by $1.3 million and $3.3 million for the three months ended March 31, 2017 and 2016, respectively.

Off-balance sheet arrangements. We do not have any material source of liquidity or financing that involves off-balance sheet arrangements, other than our contractual obligations under operating leases. We also routinely hold funds in segregated escrow accounts pending the closing of real estate transactions and have qualified intermediaries in tax-deferred property exchanges for customers pursuant to Section 1031 of the Internal Revenue Code. The Company holds the proceeds from these transactions until a qualifying exchange can occur. In accordance with industry practice, these segregated accounts are not included on the balance sheet. See Note 17 in our Annual Report on Form 10-K for the year ended December 31, 2016.

Forward-looking statements. Certain statements in this report are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements relate to future, not past, events and often address our expected future business and financial performance.  These statements often contain words such as "expect," "anticipate," "intend," "plan," "believe," "seek," "will," "foresee" or other similar words. Forward-looking statements by their nature are subject to various risks and uncertainties that could cause our actual results to be materially different than those expressed in the forward-looking statements. These risks and uncertainties include, among other things, the challenging economic conditions; adverse changes in the level of real estate activity; changes in mortgage interest rates, existing and new home sales, and availability of mortgage financing; our ability to respond to and implement technology changes, including the completion of the implementation of our enterprise systems; the impact of unanticipated title losses or the need to strengthen our policy loss reserves; any effect of title losses on our cash flows and financial condition; the impact of vetting our agency operations for quality and profitability; changes to the participants in the secondary mortgage market and the rate of refinancing that affects the demand for title insurance products; regulatory non-compliance, fraud or defalcations by our title insurance agencies or employees; our ability to timely and cost-effectively respond to significant industry changes and introduce new products and services; the outcome of pending litigation; the impact of changes in governmental and insurance regulations, including any future reductions in the pricing of title insurance products and services; our dependence on our operating subsidiaries as a source of cash flow; the continued realization of expense savings from our cost management program; our ability to successfully integrate acquired businesses; our ability to access the equity and debt financing markets when and if needed; our ability to grow our international operations; and our ability to respond to the actions of our competitors. These risks and uncertainties, as well as others, are discussed in more detail in our documents filed with the Securities and Exchange Commission, including our Annual Report on Form 10-K for the year ended December 31, 2016, and if applicable, our Quarterly Reports on Form 10-Q, and our Current Reports on Form 8-K. All forward-looking statements included in this report are expressly qualified in their entirety by such cautionary statements. We expressly disclaim any obligation to update, amend or clarify any forward-looking statements contained in this report to reflect events or circumstances that may arise after the date hereof, except as may be required by applicable law.


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Item 3. Quantitative and Qualitative Disclosures About Market Risk
There have been no material changes during the quarter ended March 31, 2017 in our investment strategies, types of financial instruments held or the risks associated with such instruments that would materially alter the market risk disclosures made in our Annual Report on Form 10-K for the year ended December 31, 2016.
Item 4. Controls and Procedures
Our principal executive officer and principal financial officer are responsible for establishing and maintaining disclosure controls and procedures. They evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of March 31, 2017, and have concluded that, as of such date, our disclosure controls and procedures are adequate and effective to ensure that information we are required to disclose in the reports that we file or submit under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (ii) accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f) and 15d-15(f)). Our internal control over financial reporting is a process, under the supervision of our principal executive officer and principal financial officer, designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our management, with the participation of our principal executive officer and principal financial officer, assessed the effectiveness of our internal control over financial reporting as of March 31, 2017. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework (2013). Based on this assessment, management believes that, as of March 31, 2017, our internal control over financial reporting is effective based on those criteria.

All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Due to such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk.
There has been no change in our internal control over financial reporting during the quarter ended March 31, 2017 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. As a result, no corrective actions were required or undertaken.

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PART II – OTHER INFORMATION
 
Item 1. Legal Proceedings
See discussion of legal proceedings in Note 9 to the condensed consolidated financial statements included in Item 1 of Part I of this Report, which is incorporated by reference into this Part II, Item 1, as well as Item 3. Legal Proceedings, in our Annual Report on Form 10-K for the year ended December 31, 2016.

Item 1A. Risk Factors

There have been no changes during the first nine months ended March 31, 2017 to our risk factors as listed in our Annual Report on Form 10-K for the year ended December 31, 2016.


Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

There were no repurchases of our Common Stock during the quarter ended March 31, 2017.

Item 5. Other Information
Our book value per share was $27.38 and $27.69 as of March 31, 2017 and December 31, 2016, respectively. As of March 31, 2017, our book value per share was based on approximately $649.1 million in stockholders’ equity and 23,710,234 shares of Common Stock outstanding. As of December 31, 2016, our book value per share was based on approximately $648.8 million in stockholders’ equity and 23,431,279 shares of Common Stock outstanding.
Item 6. Exhibits
Those exhibits required to be filed by Item 601 of Regulation S-K are listed in the Index to Exhibits immediately preceding the exhibits filed herewith and such listing is incorporated herein by reference.


SIGNATURE
Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
April 28, 2017
Date
 
 
Stewart Information Services Corporation
 
 
Registrant
 
 
By:
 
/s/ J. Allen Berryman
 
 
J. Allen Berryman, Chief Financial Officer, Secretary and Treasurer

26


Index to Exhibits
Exhibit
 
 
  
 
 
 
 
3.1
 
-
  
Restated Certificate of Incorporation of the Registrant, dated April 28, 2016 (incorporated by reference in this report from Exhibit 3.1 of the Current Report on Form 8-K filed April 29, 2016)
 
 
 
3.2
 
-
  
Third Amended and Restated By-Laws of the Registrant, as of April 27, 2016 (incorporated by reference in this report from Exhibit 3.2 of the Current Report on Form 8-K filed April 28, 2016)
 
 
 
10.1 †
 
-
  
Addendum, entered into as of March 30, 2017 and effective as of January 1, 2017, to Employment Agreement entered into as of March 31, 2016 and effective as of January 1, 2016, by and between Stewart Information Services Corporation and Matthew W. Morris (incorporated by reference in this report from Exhibit 10.1 of the Current Report on Form 8-K filed March 31, 2017)
 
 
 
 
 
10.2 †
 
-
  
Addendum, entered into as of March 30, 2017 and effective as of January 1, 2017, to Employment Agreement entered into as of March 31, 2016 and effective as of January 1, 2016, by and between Stewart Information Services Corporation and John L. Killea (incorporated by reference in this report from Exhibit 10.2 of the Current Report on Form 8-K filed March 31, 2017)
 
 
 
 
 
10.3 †
 
-
  
Amended and Restated Employment Agreement, entered into as of January 1, 2016, and effective as of January 1, 2016, by and between Stewart Information Services Corporation and David A. Fauth (incorporated by reference in this report from Exhibit 10.3 of the Current Report on Form 8-K filed March 31, 2017)
 
 
 
 
 
10.4 †
 
-
  
Addendum, entered into as of March 30, 2017 and effective as of January 1, 2017, to the Amended and Restated Employment Agreement entered into as of January 1, 2016 and effective as of January 1, 2016, by and between Stewart Information Services Corporation and David A. Fauth (incorporated by reference in this report from Exhibit 10.4 of the Current Report on Form 8-K filed March 31, 2017)
31.1*
 
-
  
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
31.2*
 
-
  
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
32.1*
 
-
  
Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
 
 
 
32.2*
 
-
  
Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS*
 
-
  
XBRL Instance Document
 
 
 
101.SCH*
 
-
  
XBRL Taxonomy Extension Schema Document
 
 
 
101.CAL*
 
-
  
XBRL Taxonomy Extension Calculation Linkbase Document
 
 
 
101.DEF*
 
-
  
XBRL Taxonomy Extension Definition Linkbase Document
 
 
 
101.LAB*
 
-
  
XBRL Taxonomy Extension Label Linkbase Document
 
 
 
101.PRE*
 
-
  
XBRL Taxonomy Extension Presentation Linkbase Document
*
Filed herewith
Management contract or compensatory plan




27