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Executives

Craig Barberio – Director, IR

Dennis Gilmore – CEO

Max Valdes – EVP and CFO

Mark Seaton – SVP, Finance

Analysts

Nat Otis – KBW

Brett Huff – Stevens

Jason Deleeuw – Piper Jaffray

First American Financial Corporation (FAF) Q1 2011 Earnings Call April 28, 2011 11:00 AM ET

Operator

Welcome and thank you for standing by. At this time, all participants are on a listen-only mode. (Operator Instructions) A copy of today’s press release is available on First American’s website at www.firstam.com/investor.

Please note that the call is being recorded and will be available for replay from the company’s investor website and for a short time by dialing 203-369-1842.

We will now turn the call over to Craig Barberio, Director of Investor Relations to make an introductory statement.

Craig Barberio

Good morning, everyone, and thank you for joining us for our first quarter 2011 earnings conference call. Joining us on today’s call will be our Chief Executive Officer, Dennis Gilmore, Max Valdes, Executive Vice President and Chief Financial Officer, and Mark Seaton, Senior Vice-President of Finance.

At this time we would like to remind listeners that management’s commentary and responses to your questions may contain forward-looking statements, such as those described on pages four and five of today’s news release and other statements that do not relate strictly to historical or current fact.

The forward-looking statements speak only as of the date they are made, and the company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made. Risks and uncertainties exist that may cause results to differ materially from those set forth in the forward-looking statements. Factors that could cause the anticipated results to differ from those described in the forward-looking statements are also described on pages four and five of the news release.

Management commentary contains and responses to your questions may often contain certain financial measures that are not presented in accounting to generally accounting principles, including an adjusted loss provision rates. The company is presenting these non-GAAP financial measures because they provide the company’s management and investors with additional insight with the operational performance to company relative to earlier periods and relative to the company competitors. The company does not intent for these non-GAAP financial measures to be a substitute for any GAAP financial information, in the Form 8-K that we filed today which is available on our website www.firstam.com. The non-GAAP financial measures disclosed in management commentary are presented with and reconcile to the most directly comparable GAAP financial measures. Investors should use these non-GAAP financial measures only in conjunction with the comparable GAAP financial measures.

I will now turn the call over to Dennis Gilmore.

Dennis Gilmore

Thank you Craig. First American posted a net loss of $15 million or $0.15 per diluted share this quarter. Our results reflect $45 million reserves strengthening charge for our Canadian operations which reduce our EPS by $0.26. This charge is in connection with a guaranteed evaluation product we sell exclusively in Canada. This product which is small from our revenue perspective guarantees the accuracy the valuation of the property as of the date that loan was made. Again, we only guarantee the value of collateral and only as of the date the loan was made.

We sold only on loans with LVVs at 80% or less and it is underwritten using the prominent property risk assessment tool. The product appear to perform well for years, during 2010 we begin to see an increase in claim activity. At the end of the first quarter 2011, we observed the meaningful increase in claim activity which let our internal actuary to determine that the reserve strengthening was necessary. We are disappointed with the products and we are cancelling its current form. And we are looking to reinsure a modified version, but we can’t reinsure all or most of the risk, we will terminate it completely. In addition to the reserve strengthening in Canada, we also strengthened our U.S. reserves by $15 million due to increased claim activity for prior policy year. Our open order accounts were down 17% relative to the fourth quarter primarily due to lower refinance volumes. The impact of the decline was offset by a reduction in personal and other operating expenses totaling $50 million.

Our commercial title business continues to perform well with revenues up 35% of last year. In the first quarter, we had our highest open order accounts since 2008. First American mortgage service, which includes our national vendor and default businesses had a very good quarter. Our national vendor operations are focused on large vendor refinance channels and we believe this business is gaining market share with revenues up 11% compared to last year. In default, our revenues were down 18% in the first quarter of 2010, but on the sequential basis revenues were up 11% in the first quarter of 2011.

Our Specialty Insurance segment generated pre-tax earnings of $12 million this quarter from an 18% margin. Both our home warranty and our property and causality businesses performed well. Regarding capital management, there were two noteworthy developments in the quarter. In March, our board authorized $150 share repurchase program and in April we sold $4 million shares of our investment in CoreLogic, which represents approximately a third of our position. Given the conditions we see in the market, we will continue to maintain a conservative balance sheet. Specific to current market conditions, March open orders were up 4% from February, and April orders are trending slightly down from March. While resale orders are up slightly in April, overall the spring selling activities has been off to a slow start.

Now, looking forward we will continue to manage our expenses and drive efficiencies across our business, now the majority of our future expense reductions will be market driven as we believe that the mortgage and real estate markets are nearing a bottom and we are positioned in the company for future growth.

I’d now like to turn the call over to Max Valdes, who will provide a more detailed review for financial results.

Max Valdes

Thank you, Dennis. The company’s generated total revenues of $932 million for the quarter; up 3% from the same quarter of the prior year. Net loss for the quarter was 15.3 million or $0.15 per share compared with net income of 13.8 million or $0.13 per share for the same quarter of the prior year.

As Dennis mentioned, the results for the current quarter included a $45 million reverse strengthening change in our Canadian operations which totaled 27 million on an active after-tax basis or $0.26 per share.

In the Title Insurance and Services segment, total revenues for the quarter were $861 million; up 3% compared with the same quarter of the prior year. Title premiums and escrow fees were $697 million for the quarter; up 4% compared with the same quarter of last year. Direct revenues were flat, driven by an 8% decline in closed orders, offset by higher average revenues for orders closed.

Average revenues per order closed increased 8%, to $1,337 compared to the same quarter of last year, this increase primarily reflected the strength of our higher premium commercial title business partially offset by the increase of lower premium refinance transactions. Agent premiums were up 7% in the quarter; primarily due to the normal reporting lag of approximately one quarter. As a result, higher agent remittances this quarter were consistent with an increase in the company’s direct premiums and escrow fees in the first quarter of 2010 relative to 2009.

Information and other revenues totaled $149 million for the fourth quarter; up 3% compared to the same quarter of last year. This line item includes title plan information, search products, appraisal and other related revenues. The increase in the fourth quarter was driven by increased demand for title plan information, partially offset by reduced demand for the company’s default and international information products.

Investment income totaled $17 million, down 11% compared with the same quarter of last year. This decrease was primarily due to lower interest earned on the investment portfolio. We incurred net realized investment losses of 1.4 million for the quarter compared with net realized investments gains of 2.7 million for the same quarter of last year. Personnel costs were 264 million for the quarter, up 2.3 million or 1% compared with the same quarter of last year.

This increase primarily reflects higher commissions paid as a result of improved commercial activity that was largely offset by a reduction in U.S. head count and lower healthcare related expenses in the current quarter.

Other operating expenses were 173 million in the quarter, down 4% from the same quarter of last year. Lower office related costs and a decline in bad debt expense in our default business with the primary drivers. These declines were partially offset by increased production related expenses as a result of improved commercial activities and shift to lower margin productions in a company’s default business.

Agent retention was 80.0% of agent premiums compared with 80.6% in the first quarter of 2010. The improvement in agent retention was large due to our large commercial transaction with the favorable agents with that caused in the current quarter. Nonetheless, we continued our efforts and progress on improving agents quit across the number of markets. The provision for title losses was 96 million in the first quarter or 13.% of premium and escrow revenue compared with 5.9% in the same quarter of 2010.

The $45 million reserve strengthening charge for the company’s Canadian operations was by itself 6.5% of premium and escrow revenues for the quarter. The reserve strengthening charge was primarily driven by policy years 2007 and 2008. We based the reserve strengthening adjustment on our internal actuary’s best point estimate which was well above the third party actuary estimate. Excluding the reserve strengthening charge in Candia the loss provision rate in the current quarter was 7.3% of premium an escrow revenue, reflecting an expect ultimate loss rate of 5.2% with 2011 policy year and a net increase in the loss reserve estimate for certain prior policy years primarily 2007. We continue to book to our actuary’s best point estimate.

The company’s Title Insurance segment generated a negative pre-tax margin of 2.2% in the quarter compared to a positive 3.2% for the same quarter of last year.

Switching gears, our Specialty Insurance segment continued to perform well. Total revenue were 69 million, essentially flat compared with the same quarter of last year. Total expenses were down 4%, primarily driven by higher costs in 2010, related to the home warranty’s move to a new call center.

The Specialty Insurance segment pre-tax margin was 17.8% for the current quarter up from 14.0% for the same quarter of the prior year. Finally corporate expenses were 17.5 million in the first quarter. We anticipate that corporate expenses will be at a quarterly run rate of 15 million for the remainder of 2011.

With that, I will turn the call over to Mark.

Mark Seaton

Thank you, Max. I will provide a few comments on our capital and liquidity. Cash used for operations in the first quarter was $50 million, it is typical in our business to have a drain on cash in the first quarter due to seasonality of operations and the timing of certain cash payments. Capital expenditures during the quarter were $13 million which is less than 15 million, we’ve targeted to spend on a quarterly basis.

I would like to take a moment to explain our thinking around our investment in CoreLogic. At the time of the spin-off we owned 12.9 million shares at CoreLogic. 5.2 million This year were held at our holding company and the remaining 7.7 million shares were held at a regulated insurance company.

We consider the shares that are holding company to be excess capital as we do not need them to operate our business. However we do not consider the shares at the insurance company to be excess capital as their admitted assets were statutory surplus purposes. We wanted to reduce the risk of the insurance company given that we had such a highly concentrated position in one common stock.

On April 5 we agreed to sell, 4 million shares at CoreLogic out of the insurance company, two CoreLogic at a spot market price of $18.95, which resulted in proceeds to us of $76 million. We do not have any future tax payments related to the sale. This action enhances the cash – cash position and improves the surplus quality of the insurance company. We will look to unwind the remaining 8.9 million shares stake in CoreLogic within the next four years as required in connection with our sale.

In March, our board approved $150 million share repurchase authorization. We believe repurchasing shares can be an effective way to return capital for our shareholders; however, while we will be opportunistic, we intend to remain conservative with respect to buy-back until we see recovery in the purchase market and operating margins improvement. In terms of liquidity, we had 51 million of cash at our holding company at the end of March. In addition to this cash, we have 6 million of our 8.9 million shares of CoreLogic as holding company.

Based on yesterday’s closing price, our stake in CoreLogic was valued at $162 million, a 109 million of which is held as a holding company. We also have 200 million available on our $400 million line of credit, so liquidity remains very strong. Our cash and investment portfolio totaled 3.5 billion as of March 31st. which includes 1.6 billion of fiduciary funds. The portfolio is comprised of debt security of 2.1 billion, cash and short-term deposits of 829 million, equity securities of 307 million and 197 million in less liquid long-term investments.

Overall, we have a high quality portfolio with 72% of our debt securities rated AAA and only 2% rated below investment rates. Debt on our balance sheet totaled 291 million as of March 31st. Our debt consists of 200 million funded on our credit facility, 47 million of trustee notes, and 43 million of other notes. Our debt-to-capital ratio as of March 31st was 12.8%. I would now like to turn the call back over to the operator to take your questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions) and our first question comes from Mark (inaudible). Please state your company name.

Unidentified Analyst

Yeah, thanks, from Morgan’s Capital. First, could you give us a little more detail on kind of what you observed in the adverse loss of elements in the 2007 year block and what the risk is of future addition to reserves.

Max Valdes

Sure Mark, this is Max. Let me just start by saying that we haven’t really seen a significant deterioration in claims. Really what’s going on is our policy is that we pulled to our actually best point estimate and we do that, it is considered best accounting practice and it provides transparency, but it does create volatility. So, really what happened in the quarter and it really mostly happened in March. We’re expecting roughly $57 million in claims and we’ve received 67 million, so that’s what came in. so our actuary takes that and developed that number to $15 million and added that to its best estimate. So, we pulled to its best estimate and upped our overall reserve. It’s very minor; I mean it’s less than a 2% adjustment to our balance and again we don’t think it’s a significant deterioration or anything, it’s just our regular policy. In April we’re back down to claim counts; today April to date we are right back to claim counts we were forecasting.

Unidentified Analyst

And what are the risks of future reserve adjustments for the Canadian operations.

Dennis Gilmore

Sure Mark, this is Dennis. You know we have taken the situation obviously very seriously and here’s what we have done in Canada. This product performed well for number of years, but then we clearly had deterioration, and that deterioration started in 2010 and we reflected that in IBNR and by the time we got through quarter of 2011, we have seen a material increase in our claims and we took a position just like an access point in the U.S. Internal actuary took a look at it and decided that needed to take a reserve adjustment and we booked to his best point estimate.

And I want to make sure everybody is clear that was higher than our external actuary’s range. So we want to make sure we do this appropriately. We think we have taken a conservative approach to this. I can’t be 100% sure that we won’t have to come back here but we want to make sure that we have taken conservative approach and put the problem behind this.

Unidentified Analyst

Okay, and Dennis, I just wanted to feel (inaudible) in your comment about how future expense reductions will be market driven? In a scenario in which volumes just kind of bouncer on the bottom here, would you expect any kind of additional incremental process to the plan?

Dennis Gilmore

Thanks for the question, we have done a few things in the quarter, we were relatively aggressive actually. We lowered our employee counts in the U.S. by 275, we eliminated a 160 plus temps in the business, and we’re going to continue to size the business for the market we are operating in, and we are pretty comfortable. We are pretty comfortable, we’re down to the size we need to be for this market. And which really what I’m employing here is that we think we’re narrowing a bottom obviously we can’t make the call that we think we are narrowing bottom and we’re going to make market adjustments and also we’re very focused on growth right now. We think there are good opportunities for others to grow when we look at over the year, next few years.

Unidentified Analyst

Okay, great. And is there any guidance you can provide on the earnings impact in the sale of the CoreLogic on your second quarter results.

Mark Seaton

Yes, Mark, this is Mark Seaton we are going to have abutted almost 800,000 realized gain in the second quarter because of the 4 million shares (inaudible) so, I would say is immaterial.

Unidentified Analyst

Okay, thanks.

Operator

And our next question comes from Nat Otis. Please state your company name.

Nat Otis – KBW

Okay, KBW. Good morning. Just maybe to follow-up on Canada, you’ve given – talked about that it was relatively small revenue component. If you thought you had the exit that business completely once you kind of looked at it, can you tell us what type of impact that would be on say a percentage basis of your overall international revenues.

Dennis Gilmore

Sure. It’s a material. The product in Canada has been – that was introduced in 2003, and to 2010, our revenues were never higher than 15 million and the average between 5 and 10.

Nat Otis – KBW

So, you’ve taken the material portion, you’ve reserved against the material portion of that business itself right now. Would you say like 50% or something like that?

Dennis Gilmore

I’m not going to give a percentage, but we have taken I think the right approach and we follow our actuary’s guidance since book to midpoint, is keeping its best estimate. You know, there is one other comments I would like to make, it’s an important comment for us and that is we need to learn a lessons from the process number one. Number two, we’re in the risk assumption business and we need to continue to innovate, both in the U.S. and international. This is just a case that we mispriced our risk.

And so the lesson we’re going to learn from this is that only innovates across our product offerings; we’re going to make sure that we balance that risk with steps that we’re going to put to re-ensure in early years

Nat Otis – KBW

All right. I guess then you’re shifting over to kind of what you’re seeing from a volume standpoint. You gave commentary that you – possibly hop to be close to a bottom but on – Is there any way to gauge that assuming the trends that you’re seeing in April, where you think originations are going for full year? I mean are they trending given what you’re seeing April to 11 or sub one trillion market or is it just kind of still within the range of what you expected when you started the year?

Dennis Gilmore

Yeah, it’s absolutely in the range of what we expected. The NBA just recently re-forecasted, made their forecast of 107 trillion and we don’t see any reasons and not believe that forecast at this point, but what actually happened is that we are seeing a little higher refinancing, a little lower purchases. We would like to see a reverse of that and what’s actually happened was what the NBA has forecasted right now. And so we think that the forecast is accurate. We started off with a slow spring buying season, no question. We have some optimism that it may grow in May or June, but regardless, which side the business for the turnover count.

Nat Otis – KBW

All right, fair enough. And then just last question. Just on looking forward into May and June, every year is certainly different, but is – could you argue that May or what month is typically the best month that you would have from seasonal selling standpoint as things would start to trend upward?

Dennis Gilmore

It changes by year, but it’s typically is April or May.

Nat Otis – KBW

Okay, fair enough. Thank you very much.

Dennis Gilmore

You are welcome.

Operator

(Operator Instructions) Our next question comes from Brett Huff. Please state your company name.

Brett Huff – Stevens

Good morning Brett Huff from Stevens good morning everybody, just a couple of follow-up questions. I wanted to – the $50 million sequential decline in cost was seemed very good and I want to make sure that we understood all the components of that I am guessing that the FTE culture part of it. But, is there anything else in particular that should be called out that will continue on or might be onetime?

Mark Seaton

Hey, Brett, this is Mark. A lot of the expense reductions between Q4 and Q1 were just variable in nature and we accrue less bonuses, we accrue that 401(k) match. We did have some real cost cut, like we closed 30 offices, we have reduced about 275 people as Dennis said, but a lot of it was because of seasonal accruals because of the first quarter.

Brett Huff – Stevens

Okay, but the office cuts in the people obviously are ongoing the others sound like they’re just seasonal?

Dennis Gilmore

Correct.

Brett Huff – Stevens

Okay. And then second question any update on the Bank of America situation anything you can share with us on that?

Dennis Gilmore

Brett, there really is until the process continues on I am going to say with our policy, I’m not commenting on active litigation other than stuff that I’ve been saying over the last few quarter Bank of America continues to be a very good customer barrowers and we continue to deal with Bank of America and by serving (inaudible) space.

Brett Huff – Stevens

Okay. And then in terms of the agent retention I want to make sure I get that, the agent retention was driven largely just by a mix of a particular large transaction that’s one met to a little big lower level than it’s typical and that will go back to sort of the mid 80, 81 level?

Mark Seaton

Hey, Brett this is Mark again yeah the this quarter was 80.0. We did have a large commercial transaction, we had about 4 million of premium that swung it, if you exclude that our split would have been about 80.5, but we are really pushing hard to reduce that overtime. And so we think that it’s going to trend down more towards the 80.0 and hopefully less than 80.0 by the end of the year. We have done a lot to change our splits New York, which we have talked about in the past we just announced that we are going from 8515 to 8317 towards as of today as of April 1st were the split of 8317 in New York, we want to get that down to 8020 within an year. So that will again help us. We moved the split materially in a lot of smaller states, Oregon we moved at 400 basis points, Montana we moved at 400 basis points, Colorado we moved at 100 basis points and there is also some larger states like California, it’s typically our company has always been 1910. Today, it’s 88.5 and we want to move that down a little more. So we are really focusing hard on the splits, and we think we’ll see some movement there going forward.

Brett Huff – Stevens

Okay, that’s I had. Thanks for your time.

Operator

The last question comes from Jason Deleeuw. Please state your company name.

Jason Deleeuw – Piper Jaffray

Yeah Piper Jaffray thank and good morning.

Dennis Gilmore

Good morning.

Jason Deleeuw – Piper Jaffray

Going back to the Canada product, are you guys started seeing an increase in the claim activity in 2010, can you just give us a little bit of color on what was driving that and just an idea what customers were using this product?

Dennis Gilmore

Sure. Again, we introduced the product in 2003 and had very good performance in the early years and in 2009, 2010, we started to see a slight uptick in the Canadian default rate and that is where we started to identify some deficiencies in our product. And those deficiencies really fall under three categories; number one at the highest level we just took too high an underwriting risk and we weren’t adequately compensated for it, and we dealt without or dealing with that issue.

Second issue is the model we used to make determinations on assurability, which is we think is the best model available had some weaknesses that we accept and not the model. So, we accepted and that is we took risk on for example rural properties that probably in retrospect we should know. And then the last component that drove that is we have one of our key customers up there, one of our best customers has launched specific channel that has performed poorly and we’re taking steps to deal with that channel right now.

Jason Deleeuw – Piper Jaffray

Where these big or small mortgage lenders in Canada? Can you just give a little bit of sense of that?

Dennis Gilmore

Sure, sure. Our top three customers represent over 95% of the volume.

Jason Deleeuw – Piper Jaffray

Okay. Then in the U.S business with the claims deterioration that we saw, you guys – it sounds like April it sort of normalized. You just saw the spike up in the March and the claims. Can you give us a sense and the regions in this – under regional level or type of mortgage products? Where were you seeing the increased claims?

Max Valdes

Jason, it’s Max. It is really across the board. It is really – it is across residential, commercial, it is across direct agent channels and is really not one type of claims of costs – higher claims you will just – like I said across the board.

Jason Deleeuw – Piper Jaffray

Okay, and then just getting back to your – the margins and managing expenses for the volumes but also being positioned before turnaround or your near bottom in the volumes. I guess what the current – it seems like you guys are somewhat comfortable with the expenses right now given the volumes that you are seeing. Can you still hit your margin targets that you guys are looking internally to hit, can you still hit those with the current expense levels with the volumes that we are seeing or we are going to have to see an increase in volumes?

Dennis Gilmore

Well, we’ve set an objective for this year, let me answer this. In the first quarter when I take the results strengthening and put it off beside, I don’t mean that not – accounts when I put it off beside we actually had a strong operating performance in our business, we hit or exceeded all our expense ratios and our key operating ratios, number one. Number two, we’ve set an objective for the business to try to match our performance of 2010 and that will be very difficult by the way in the current revenue environment or in. We are comfortable with right size right now. Towards the longer term margin we are not back in off in our commitment at all of an eight to 10 margin. Now we are going to need some help in the market. We are going to need some stability and ultimately some growth, that is absolutely our long-term objective.

Jason Deleeuw – Piper Jaffray

Okay. And then could you just give us sense of the purchase refi mix in April?

Dennis Gilmore

Yeah. In April, we opened up the 4,600 per day and 46% of those re-price.

Jason Deleeuw – Piper Jaffray

Thank you very much.

Dennis Gilmore

Definitely trend it down in January with 55% refi, February with 51%, March with 50% and April with 46% but we’re seeing the mix of refi circled down throughout the year.

Jason Deleeuw – Piper Jaffray

Thank you.

Operator

And that’s all the time we have for questions today. That concludes this morning’s call we’d like to remind listeners that today’s call will be available for replay on the company’s website or by dialing 203-369-1842. The company would like to thank you for your participation and this concludes today’s conference call, you may now disconnect.

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