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Spring Housing Strength Boosts First American Financial

If you're looking to buy a home, then most mortgage lenders will require that you get title insurance protection. First American Financial (NYSE: FAF) is a provider of title services, and the recent boom in the housing market has kept its policy volumes high and its business looking good throughout the past several years.

Coming into Thursday's second-quarter financial report, First American investors expected those good times to continue, with higher revenue helping to lift profit levels. First American did even better than most had foreseen, and its efforts to streamline its internal operations have paid off with improvements that bode well for its long-term outlook. Let's take a closer look at First American Financial and what its latest results mean for the future.

Image source: First American Financial.

Spring home sales lift First American's results

First American Financial's second-quarter results maintained the forward momentum that the stock has generated lately. Revenue was up 7% to $1.45 billion, doubling the growth rate that most investors had expected to see from the title company. Net income jumped by a fifth to $122.3 million, and the resulting earnings of $1.09 per share was well above the consensus forecast among those following the stock for $0.93 per share.

Taking a closer look at First American's report, the company saw good results across its business segments. The key title insurance and services division produced higher revenue by more than 6%, and pre-tax income climbed at an even healthier 14% rate. As we saw in Q1, the number of direct orders was down about 12% from the year-ago quarter, but a shift to higher-premium residential purchase and commercial transactions boosted the per-order average revenue by 16%. In particular, commercial activity was strong, with modest order gains and a 7% rise in revenue. At $8,600, average revenue per commercial order remained well above the roughly $2,300 overall average for the segment, reflecting the lower-margin nature of residential title insurance. Recent acquisitions also helped boost First American's revenue from information services by 9%.

The specialty insurance business bounced back from recent difficulties. Revenue climbed 10%, and pre-tax income more than doubled from year-ago levels. Headwinds from poor loss experience in the home warranty business finally gave way to more normal conditions, and even though the property and casualty business saw higher numbers of claims, improving loss ratios lifted the unit's overall performance.

CEO Dennis Gilmore celebrated the results for First American. "Our continued operating discipline is reflected in the record title margin we achieved in the second quarter," Gilmore said. "The declining refinance market stabilized in the second quarter, and we continued to adjust the cost structure in our related businesses to reflect the lower activity level." He also pointed to higher rates as lifting the company's investment income, adding further to profits.

Can First American Financial keep improving?

First American believes that good times will continue. As Gilmore put it, "Our longer-term outlook remains optimistic, as we believe that ongoing improvement in the housing market will drive further growth in our revenue, margins, and profitability."

One thing that First American won't have to worry about going forward is its pension plan obligations. The company successfully terminated the plan in July, and First American said that investors should expect a charge of $153 million related to the termination. By eliminating the plan, First American believes it can cut annual expenses by enough to pay for the charge within about the first seven years.

First American has done a good job of weathering changing interest rate conditions in the financing market, and that should help it going forward. Even though refinancing activity has dried up with rising rates, the ability to take advantage of various niches throughout the residential and commercial real estate industry gives First American the ability to find replacement revenue from multiple sources.

Shareholders were happy with First American Financial's report, and the stock was up 2% during the morning market session following the announcement. The title insurer should continue to see gains for its fundamental business metrics as long as the real estate industry more broadly remains solid.

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Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends First American Financial. The Motley Fool has a disclosure policy.