Edgar Filing: First American Financial Corp

faf-10q_20160630.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2016

1	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 001-34580

FIRST AMERICAN FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

Incorporated in Delaware		26-1911571
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

1 First American Way, Santa Ana, California		92707-5913
(Address of principal executive offices)		(Zip Code)

(714) 250-3000

(Registrant’s telephone number, including area code)

(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 x No 1

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 x No 1

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	x	Accelerated filer	1

Non-accelerated filer	1 (Do not check if a smaller reporting company)	Smaller reporting company	1

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes 1 No x

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY

PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

Indicate by check mark whether the registrant has filed all documents and reports to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes 1 No 1

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

On July 18, 2016, there were 109,717,650 shares of common stock outstanding.

FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

INFORMATION INCLUDED IN REPORT

PART I: FINANCIAL INFORMATION

Item 1.	Financial Statements (unaudited)

	A. Condensed Consolidated Balance Sheets as of June 30, 2016 and December 31, 2015	5

	B. Condensed Consolidated Statements of Income for the three and six months ended June 30, 2016 and 2015	6

	C. Condensed Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2016 and 2015	7

	D. Condensed Consolidated Statement of Stockholders’ Equity for the six months ended June 30, 2016	8

	E. Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2016 and 2015	9

	F. Notes to Condensed Consolidated Financial Statements	10

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	34

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	45

Item 4.	Controls and Procedures	45

PART II: OTHER INFORMATION

Item 1.	Legal Proceedings	46

Item 1A.	Risk Factors	48

Item 6.	Exhibits	54

Items 2 through 5 of Part II have been omitted because they are not applicable with respect to the current reporting period.

THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. THESE FORWARD-LOOKING STATEMENTS CAN BE IDENTIFIED BY THE FACT THAT THEY DO NOT RELATE STRICTLY TO HISTORICAL OR CURRENT FACTS AND MAY CONTAIN THE WORDS “BELIEVE,” “ANTICIPATE,” “EXPECT,” “INTEND,” “PLAN,” “PREDICT,” “ESTIMATE,” “PROJECT,” “WILL BE,” “WILL CONTINUE,” “WILL LIKELY RESULT,” OR OTHER SIMILAR WORDS AND PHRASES OR FUTURE OR CONDITIONAL VERBS SUCH AS “WILL,” “MAY,” “MIGHT,” “SHOULD,” “WOULD,” OR “COULD.” THESE FORWARD-LOOKING STATEMENTS INCLUDE, WITHOUT LIMITATION, STATEMENTS REGARDING FUTURE OPERATIONS, PERFORMANCE, FINANCIAL CONDITION, PROSPECTS, PLANS AND STRATEGIES. THESE FORWARD-LOOKING STATEMENTS ARE BASED ON CURRENT EXPECTATIONS AND ASSUMPTIONS THAT MAY PROVE TO BE INCORRECT.

INTEREST RATE FLUCTUATIONS;

CHANGES IN THE PERFORMANCE OF THE REAL ESTATE MARKETS;

VOLATILITY IN THE CAPITAL MARKETS;

UNFAVORABLE ECONOMIC CONDITIONS;

IMPAIRMENTS IN THE COMPANY’S GOODWILL OR OTHER INTANGIBLE ASSETS;

FAILURES AT FINANCIAL INSTITUTIONS WHERE THE COMPANY DEPOSITS FUNDS;

CHANGES IN APPLICABLE GOVERNMENT REGULATIONS;

HEIGHTENED SCRUTINY BY LEGISLATORS AND REGULATORS OF THE COMPANY’S TITLE INSURANCE AND SERVICES SEGMENT AND CERTAIN OTHER OF THE COMPANY’S BUSINESSES;

THE CONSUMER FINANCIAL PROTECTION BUREAU’S EXERCISE OF ITS BROAD RULEMAKING AND SUPERVISORY POWERS;

REGULATION OF TITLE INSURANCE RATES;

REFORM OF GOVERNMENT-SPONSORED MORTGAGE ENTERPRISES;

LIMITATIONS ON ACCESS TO PUBLIC RECORDS AND OTHER DATA;

CHANGES IN RELATIONSHIPS WITH LARGE MORTGAGE LENDERS AND GOVERNMENT-SPONSORED ENTERPRISES;

CHANGES IN MEASURES OF THE STRENGTH OF THE COMPANY’S TITLE INSURANCE UNDERWRITERS, INCLUDING RATINGS AND STATUTORY CAPITAL AND SURPLUS;

LOSSES IN THE COMPANY’S INVESTMENT PORTFOLIO;

MATERIAL VARIANCE BETWEEN ACTUAL AND EXPECTED CLAIMS EXPERIENCE;

DEFALCATIONS, INCREASED CLAIMS OR OTHER COSTS AND EXPENSES ATTRIBUTABLE TO THE COMPANY’S USE OF TITLE AGENTS;

ANY INADEQUACY IN THE COMPANY’S RISK MITIGATION EFFORTS;

SYSTEMS DAMAGE, FAILURES, INTERRUPTIONS AND INTRUSIONS, OR UNAUTHORIZED DATA DISCLOSURES;

ERRORS AND FRAUD INVOLVING THE TRANSFER OF FUNDS;

INABILITY TO REALIZE THE BENEFITS OF THE COMPANY’S OFFSHORE OPERATIONS;

INABILITY OF THE COMPANY’S SUBSIDIARIES TO PAY DIVIDENDS OR REPAY FUNDS;

INABILITY TO REALIZE THE BENEFITS OF, AND CHALLENGES ARISING FROM, THE COMPANY’S ACQUISITION STRATEGY; AND

OTHER FACTORS DESCRIBED IN THIS QUARTERLY REPORT ON FORM 10-Q, INCLUDING UNDER THE CAPTION “RISK FACTORS” IN ITEM 1A OF PART II.

THE FORWARD-LOOKING STATEMENTS SPEAK ONLY AS OF THE DATE THEY ARE MADE. 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.

PART I: FINANCIAL INFORMATION

Item 1.

Financial Statements.

FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Condensed Consolidated Balance Sheets

(in thousands, except par values)

(unaudited)

	June 30, 2016			December 31, 2015
Assets
Cash and cash equivalents	$	1,241,814		$	1,027,321
Accounts and accrued income receivable, net		285,519			256,731
Income taxes receivable		3,876			1,067
Investments:
Deposits with banks		21,746			23,224
Debt securities, includes pledged securities of $117,647 and $122,441		4,542,421			4,279,347
Equity securities		362,266			321,285
Other investments		160,432			161,177
		5,086,865			4,785,033
Property and equipment, net		413,174			409,973
Title plants and other indexes		562,852			554,923
Deferred income taxes		22,020			22,020
Goodwill		982,834			964,342
Other intangible assets, net		50,932			48,114
Other assets		186,827			180,777
	$	8,836,713		$	8,250,301
Liabilities and Equity
Deposits	$	3,100,365		$	2,699,015
Accounts payable and accrued liabilities		825,130			876,087
Deferred revenue		211,935			207,929
Reserve for known and incurred but not reported claims		994,764			983,880
Income taxes payable		47,976			7,576
Deferred income taxes		133,097			133,097
Notes and contracts payable		579,474			581,052
		5,892,741			5,488,636
Commitments and contingencies (Note 13)
Stockholders’ equity:
Preferred stock, $0.00001 par value; Authorized—500 shares; Outstanding—none		—			—
Common stock, $0.00001 par value; Authorized—300,000 shares; Outstanding—109,699 shares and 109,098 shares		1			1
Additional paid-in capital		2,173,632			2,150,813
Retained earnings		943,198			846,691
Accumulated other comprehensive loss		(175,769	)		(239,003	)
Total stockholders’ equity		2,941,062			2,758,502
Noncontrolling interests		2,910			3,163
Total equity		2,943,972			2,761,665
	$	8,836,713		$	8,250,301

See notes to condensed consolidated financial statements.

FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Condensed Consolidated Statements of Income

(in thousands, except per share amounts)

(unaudited)

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2016		2015		2016		2015
Revenues
Direct premiums and escrow fees	$	623,975	$	609,606	$	1,125,889	$	1,111,018
Agent premiums		515,792		501,613		1,028,037		934,533
Information and other		182,771		180,838		337,848		337,985
Net investment income		30,925		27,864		58,295		48,422
Net realized investment gains		8,070		3,868		13,176		2,915
		1,361,533		1,323,789		2,563,245		2,434,873
Expenses
Personnel costs		417,725		407,452		800,437		773,575
Premiums retained by agents		403,669		395,278		808,708		738,014
Other operating expenses		216,361		211,824		403,036		411,982
Provision for policy losses and other claims		122,360		122,870		229,458		224,424
Depreciation and amortization		23,994		21,463		46,414		42,317
Premium taxes		16,027		16,012		30,404		29,481
Interest		7,790		7,268		15,589		14,510
		1,207,926		1,182,167		2,334,046		2,234,303
Income before income taxes		153,607		141,622		229,199		200,570
Income taxes		51,156		48,043		74,076		69,195
Net income		102,451		93,579		155,123		131,375
Less: Net income attributable to noncontrolling interests		302		232		473		396
Net income attributable to the Company	$	102,149	$	93,347	$	154,650	$	130,979
Net income per share attributable to the Company's stockholders (Note 8):
Basic	$	0.92	$	0.86	$	1.40	$	1.21
Diluted	$	0.92	$	0.85	$	1.40	$	1.19
Cash dividends declared per share	$	0.26	$	0.25	$	0.52	$	0.50
Weighted-average common shares outstanding (Note 8):
Basic		110,480		108,459		110,327		108,102
Diluted		110,978		109,796		110,842		109,586

See notes to condensed consolidated financial statements.

FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Condensed Consolidated Statements of Comprehensive Income

(in thousands)

(unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2016			2015			2016		2015
Net income	$	102,451		$	93,579		$	155,123	$	131,375
Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on securities		17,681			(28,506	)		49,508		(8,432	)
Foreign currency translation adjustment		(5,579	)		4,866			6,525		(13,794	)
Pension benefit adjustment		3,621			4,601			7,217		9,202
Total other comprehensive income (loss), net of tax		15,723			(19,039	)		63,250		(13,024	)
Comprehensive income		118,174			74,540			218,373		118,351
Less: Comprehensive income attributable to noncontrolling interests		272			227			489		390
Comprehensive income attributable to the Company	$	117,902		$	74,313		$	217,884	$	117,961

See notes to condensed consolidated financial statements.

FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Condensed Consolidated Statement of Stockholders’ Equity

(in thousands)

(unaudited)

	First American Financial Corporation Stockholders
	Shares			Common stock		Additional paid-in capital			Retained earnings			Accumulated other comprehensive loss			Total stockholders’ equity			Noncontrolling interests			Total
Balance at December 31, 2015		109,098		$	1	$	2,150,813		$	846,691		$	(239,003	)	$	2,758,502		$	3,163		$	2,761,665
Net income for six months ended June 30, 2016		—			—		—			154,650			—			154,650			473			155,123
Dividends on common shares		—			—		—			(56,897	)		—			(56,897	)		—			(56,897	)
Purchase of Company shares		(14	)		—		(454	)		—			—			(454	)		—			(454	)
Shares issued in connection with share-based compensation plans		615			—		1,331			(1,246	)		—			85			—			85
Share-based compensation		—			—		21,968			—			—			21,968			—			21,968
Net activity related to noncontrolling interests		—			—		(26	)		—			—			(26	)		(742	)		(768	)
Other comprehensive income (Note 12)		—			—		—			—			63,234			63,234			16			63,250
Balance at June 30, 2016		109,699		$	1	$	2,173,632		$	943,198		$	(175,769	)	$	2,941,062		$	2,910		$	2,943,972

See notes to condensed consolidated financial statements.

FIRST AMERICAN FINANCIAL CORPORATION

AND SUBSIDIARY COMPANIES

Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

	Six Months Ended June 30,
	2016			2015
Cash flows from operating activities:
Net income	$	155,123		$	131,375
Adjustments to reconcile net income to cash provided by operating activities:
Provision for policy losses and other claims		229,458			224,424
Depreciation and amortization		46,414			42,317
Amortization of premiums and accretion of discounts on debt securities, net		13,082			14,045
Excess tax benefits from share-based compensation		(3,137	)		(8,417	)
Net realized investment gains		(13,176	)		(2,915	)
Share-based compensation		21,968			15,563
Equity in earnings of affiliates, net		(3,018	)		(4,880	)
Dividends from equity method investments		3,749			5,940
Changes in assets and liabilities excluding effects of acquisitions and noncash transactions:
Claims paid, including assets acquired, net of recoveries		(225,568	)		(251,542	)
Net change in income tax accounts		7,486			37,875
Increase in accounts and accrued income receivable		(24,946	)		(20,961	)
Decrease in accounts payable and accrued liabilities		(60,826	)		(26,188	)
Increase (decrease) in deferred revenue		3,895			(955	)
Other, net		(4,118	)		11,262
Cash provided by operating activities		146,386			166,943
Cash flows from investing activities:
Net cash effect of acquisitions/dispositions		(18,432	)		(25,929	)
Net decrease in deposits with banks		968			2,959
Purchases of debt and equity securities		(899,629	)		(1,207,037	)
Proceeds from sales of debt and equity securities		259,915			344,170
Proceeds from maturities of debt securities		436,125			263,015
Net change in other investments		2,346			4,509
Capital expenditures		(60,939	)		(61,837	)
Proceeds from sales of property and equipment		8,787			16,608
Cash used for investing activities		(270,859	)		(663,542	)
Cash flows from financing activities:
Net change in deposits		401,350			632,579
Repayment of debt		(2,329	)		(2,623	)
Net activity related to noncontrolling interests		(768	)		(679	)
Excess tax benefits from share-based compensation		3,137			8,417
Net payments in connection with share-based compensation plans		(3,052	)		(4,328	)
Purchase of Company shares		(454	)		—
Cash dividends		(56,897	)		(54,121	)
Cash provided by financing activities		340,987			579,245
Effect of exchange rate changes on cash		(2,021	)		(3,066	)
Net increase in cash and cash equivalents		214,493			79,580
Cash and cash equivalents—Beginning of period		1,027,321			1,190,080
Cash and cash equivalents—End of period	$	1,241,814		$	1,269,660
Supplemental information:
Cash paid during the period for:
Interest	$	14,537		$	14,664
Premium taxes	$	40,340		$	34,043
Income taxes, less refunds of $699 and $713	$	66,562		$	30,973

See notes to condensed consolidated financial statements.

FIRST AMERICAN FINANCIAL CORPORATION
AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements
(unaudited)

Note 1 – Basis of Condensed Consolidated Financial Statements

Basis of Presentation

The condensed consolidated financial information included in this report has been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and Article 10 of Securities and Exchange Commission (“SEC”) Regulation S-X. The principles for condensed interim financial information do not require the inclusion of all the information and footnotes required by GAAP for complete financial statements. Therefore, these financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2015. The condensed consolidated financial statements included herein are unaudited; however, in the opinion of management, they contain all normal recurring adjustments necessary for a fair statement of the consolidated results for the interim periods. All material intercompany transactions and balances have been eliminated upon consolidation.

Reclassifications and revisions

Certain 2015 amounts have been reclassified to conform to the 2016 presentation.

During the fourth quarter of 2015, the Company reclassified certain revenues and expenses related to closing protection letters and temporary labor costs. The impact to the Company’s title insurance and services segment for the three and six months ended June 30, 2015 included decreases to direct premiums and escrow fees and increases to agent premiums of $8.5 million and $15.1 million, increases to personnel costs of $10.5 million and $18.5 million, increases to premiums retained by agents of $0.5 million and $0.7 million and decreases to other operating expenses of $11.0 million and $19.2 million, respectively. The impact to the Company’s specialty insurance segment for the three and six months ended June 30, 2015 included increases to personnel costs and decreases to other operating expenses of $0.3 million and $0.5 million, respectively.

Also, during the fourth quarter of 2015, the Company identified certain non-risk based revenues included within direct premiums and escrow fees that should have been reflected in information and other. To correct for this error, these revenues were reclassified from direct premiums and escrow fees to information and other. The revision to the Company’s title insurance and services segment for the three and six months ended June 30, 2015 resulted in a decrease to direct premiums and escrow fees and an increase to information and other of $10.3 million and $20.8 million, respectively.

The Company does not consider these adjustments to be material, individually or in the aggregate, to any previously issued consolidated financial statements.

Recently Adopted Accounting Pronouncements

In September 2015, the Financial Accounting Standards Board (“FASB”) issued updated guidance intended to simplify the accounting for adjustments made to provisional amounts recognized in a business combination and eliminates the requirement to retrospectively account for those adjustments. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2015 and applies prospectively to adjustments made to provisional amounts that occur after the effective date of this guidance with early adoption permitted for financial statements that have not been issued. The adoption of this guidance had no impact on the Company’s condensed consolidated financial statements.

In August 2015, the FASB issued updated guidance relating to the Securities and Exchange Commission Staff Announcement at the June 18, 2015 Emerging Issues Task Force meeting on the presentation and subsequent measurement of debt issuance costs associated with line-of-credit arrangements. The updated guidance allows for the deferral and presentation of debt issuance costs as an asset which may be amortized ratably over the term of the line-of-credit arrangement, regardless of whether there are any related outstanding borrowings. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2015, with early adoption permitted. The adoption of this guidance had no impact on the Company’s condensed consolidated financial statements.

FIRST AMERICAN FINANCIAL CORPORATION
AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements – (Continued)
(unaudited)

In May 2015, the FASB issued updated guidance intended to eliminate the diversity in practice surrounding how investments measured at net asset value under the practical expedient with future redemption dates have been categorized in the fair value hierarchy. Under the updated guidance, investments for which fair value is measured at net asset value per share using the practical expedient should no longer be categorized in the fair value hierarchy. The updated guidance requires retrospective adoption for all periods presented and is effective for interim and annual reporting periods beginning after December 15, 2015, with early adoption permitted. The adoption of this guidance had no impact on the Company’s condensed consolidated financial statements.

In April 2015, the FASB issued updated guidance intended to clarify the accounting treatment for cloud computing arrangements that include software licenses. Under the updated guidance, if a cloud computing arrangement includes a software license, the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2015, with early adoption permitted. The Company elected to adopt the updated guidance prospectively for all arrangements entered into or materially modified after the effective date. The adoption of this guidance did not have a material impact on the Company’s condensed consolidated financial statements. The financial statement line items impacted by the adoption of the updated guidance include other intangible assets, net and depreciation and amortization. See Note 5 Other Intangible Assets for further information on the Company’s internal-use software licenses.

In April 2015, the FASB issued updated guidance intended to simplify, and provide consistency to, the presentation of debt issuance costs. The new standard requires that debt issuance costs be presented in the balance sheet as a direct deduction from the carrying amount of the debt liability, consistent with debt discounts. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2015, with early adoption permitted. The adoption of this guidance did not have a material impact on the Company’s condensed consolidated financial statements.

In February 2015, the FASB issued updated guidance which changes the analysis that a reporting entity must perform to determine whether it should consolidate certain types of legal entities. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2015, with early adoption permitted. The adoption of this guidance had no impact on the Company’s condensed consolidated financial statements.

In June 2014, the FASB issued updated guidance intended to eliminate the diversity in practice regarding share-based payment awards that include terms which provide for a performance target that affects vesting being achieved after the requisite service period. The new standard requires that a performance target which affects vesting and could be achieved after the requisite service period be treated as a performance condition that affects vesting and should not be reflected in estimating the grant-date fair value. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2015, with early adoption permitted. The adoption of this guidance had no impact on the Company’s condensed consolidated financial statements.

Pending Accounting Pronouncements

In June 2016, the FASB issued updated guidance intended to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The updated guidance replaces the current incurred loss impairment methodology with a methodology that reflects expected credit losses and requires the consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2019, with early adoption permitted. The Company is currently assessing the impact of the new guidance on its condensed consolidated financial statements.

FIRST AMERICAN FINANCIAL CORPORATION
AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements – (Continued)
(unaudited)

In May 2016, the FASB issued updated guidance intended to clarify the guidance previously issued in May 2014 related to the recognition of revenue from contracts with customers. The updated guidance includes narrow-scope improvements intended to address implementation issues and to provide additional practical expedients in the guidance. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2017, with early adoption permitted for interim and annual reporting periods beginning after December 15, 2016. The Company does not expect the adoption of this guidance to have a material impact on its condensed consolidated financial statements.

In April 2016, the FASB issued updated guidance intended to clarify the guidance previously issued in May 2014 related to the recognition of revenue from contracts with customers. The updated guidance is intended to reduce the cost and complexity of applying the guidance on identifying promised goods or services in a contract and to improve the operability and understandability of the implementation guidance regarding the licensing of intellectual property. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2017, with early adoption permitted for interim and annual reporting periods beginning after December 15, 2016. The Company does not expect the adoption of this guidance to have a material impact on its condensed consolidated financial statements.

In March 2016, the FASB issued updated guidance intended to simplify and improve several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of such awards as either equity or liabilities and classification on the statement of cash flows. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2016, with early adoption permitted. The Company is currently assessing the impact of the new guidance on its condensed consolidated financial statements.

In March 2016, the FASB issued updated guidance intended to clarify the guidance previously issued in May 2014 related to the recognition of revenue from contracts with customers. The updated guidance is intended to improve the operability and understandability of the implementation guidance regarding principal versus agent considerations in a contract. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2017, with early adoption permitted for interim and annual reporting periods beginning after December 15, 2016. The Company does not expect the adoption of this guidance to have a material impact on its condensed consolidated financial statements.

In March 2016, the FASB issued updated guidance intended to simplify the accounting treatment for investments that become qualified for the equity method of accounting as a result of an increase in the level of ownership interest or degree of influence. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2016, with early adoption permitted. The Company expects the adoption of this guidance to have no impact on its condensed consolidated financial statements.

In February 2016, the FASB issued updated guidance that requires the rights and obligations associated with leasing arrangements be reflected on the balance sheet in order to increase transparency and comparability among organizations. Under the updated guidance, lessees will be required to recognize a right-of-use asset and a liability to make lease payments and disclose key information about leasing arrangements. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2018, with early adoption permitted. The Company is currently assessing the impact of the new guidance on its condensed consolidated financial statements.

In January 2016, the FASB issued updated guidance intended to enhance the reporting model for financial instruments to provide users of financial statements with more decision-useful information. In addition to making other targeted improvements to current guidance, the updated guidance also requires all equity investments, except those accounted for under the equity method of accounting or those that result in consolidation of the investee, to be measured at fair value with changes in the fair value recognized through net income. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2017, with early adoption permitted in certain circumstances. While the Company expects the adoption of this guidance to impact its condensed consolidated statements of income, the materiality of the impact will depend upon the size of, and level of volatility experienced within, the Company’s equity portfolio.

FIRST AMERICAN FINANCIAL CORPORATION
AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements – (Continued)
(unaudited)

In May 2015, the FASB issued updated disclosure guidance related to short-duration contracts issued by insurance entities. The updated guidance is intended to increase the transparency of significant estimates made in measuring liabilities for unpaid claims and claim adjustment expenses and to provide additional insight into an insurance entity’s ability to underwrite and anticipate costs associated with claims. The updated guidance is effective for annual reporting periods beginning after December 15, 2015 and for interim periods within annual periods beginning after December 15, 2016, with early adoption permitted. Except for the disclosure requirements, the Company does not expect the adoption of this guidance to impact its condensed consolidated financial statements.

In May 2014, the FASB issued updated guidance for recognizing revenue from contracts with customers to provide a single, comprehensive revenue recognition model for all contracts with customers to improve comparability within and across industries, and across capital markets. The new revenue standard contains principles that an entity will apply to determine the measurement of revenue and the timing of recognition. The underlying principle is that an entity will recognize revenue to depict the transfer of goods or services to customers at an amount that the entity expects to be entitled to in exchange for those goods or services. Revenue from insurance contracts is not within the scope of this guidance. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2016, with early adoption prohibited. In August 2015, the FASB issued updated guidance which defers the effective date of this guidance by one year to interim and annual reporting periods beginning after December 15, 2017, with early adoption permitted as of the original effective date. The Company is currently assessing the impact of the new guidance on its condensed consolidated financial statements.

Note 2 – Escrow Deposits, Like-kind Exchange Deposits and Trust Assets

The Company administers escrow deposits and trust assets as a service to its customers. Escrow deposits totaled $8.0 billion and $6.6 billion at June 30, 2016 and December 31, 2015, respectively, of which $3.0 billion and $2.6 billion, respectively, were held at the Company’s federal savings bank subsidiary, First American Trust, FSB. The escrow deposits held at First American Trust, FSB are temporarily invested in cash and cash equivalents and debt securities, with offsetting liabilities included in deposits in the accompanying condensed consolidated balance sheets. The remaining escrow deposits were held at third-party financial institutions.

Trust assets held or managed by First American Trust, FSB totaled $3.1 billion and $3.0 billion at June 30, 2016 and December 31, 2015, respectively. Escrow deposits held at third-party financial institutions and trust assets are not considered assets of the Company and, therefore, are not included in the accompanying condensed consolidated balance sheets. However, the Company could be held contingently liable for the disposition of these assets.

In conducting its operations, the Company often holds customers’ assets in escrow, pending completion of real estate transactions and, as a result, the Company has ongoing programs for realizing economic benefits with various financial institutions. The results from these programs are included in the condensed consolidated financial statements as income or a reduction in expense, as appropriate, based on the nature of the arrangement and benefit received.

The Company facilitates tax-deferred property exchanges for customers pursuant to Section 1031 of the Internal Revenue Code and tax-deferred reverse exchanges pursuant to Revenue Procedure 2000-37. As a facilitator and intermediary, the Company holds the proceeds from sales transactions and takes temporary title to property identified by the customer to be acquired with such proceeds. Upon the completion of each such exchange, the identified property is transferred to the customer or, if the exchange does not take place, an amount equal to the sales proceeds or, in the case of a reverse exchange, title to the property held by the Company is transferred to the customer. Like-kind exchange funds held by the Company totaled $2.2 billion and $2.8 billion at June 30, 2016 and December 31, 2015, respectively. The like-kind exchange deposits are held at third-party financial institutions and, due to the structure utilized to facilitate these transactions, the proceeds and property are not considered assets of the Company and, therefore, are not included in the accompanying condensed consolidated balance sheets. All such amounts are placed in deposit accounts insured, up to applicable limits, by the Federal Deposit Insurance Corporation. The Company could be held contingently liable to the customer for the transfers of property, disbursements of proceeds and the returns on such proceeds.

FIRST AMERICAN FINANCIAL CORPORATION
AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements – (Continued)
(unaudited)

Note 3 – Debt and Equity Securities

Investments in debt securities, classified as available-for-sale, are as follows:

(in thousands)	Amortized cost		Gross unrealized					Estimated fair value
(in thousands)	Amortized cost		Gains		Losses			Estimated fair value
June 30, 2016
U.S. Treasury bonds	$	121,611	$	2,777	$	—		$	124,388
Municipal bonds		743,942		23,407		(434	)		766,915
Foreign government bonds		141,315		2,058		(56	)		143,317
Governmental agency bonds		338,201		3,554		—			341,755
Governmental agency mortgage-backed securities		2,207,589		15,830		(5,607	)		2,217,812
U.S. corporate debt securities		701,935		19,582		(3,135	)		718,382
Foreign corporate debt securities		226,227		4,736		(1,111	)		229,852
	$	4,480,820	$	71,944	$	(10,343	)	$	4,542,421
December 31, 2015
U.S. Treasury bonds	$	130,252	$	421	$	(1,301	)	$	129,372
Municipal bonds		692,000		12,640		(845	)		703,795
Foreign government bonds		129,984		1,132		(1,015	)		130,101
Governmental agency bonds		419,869		1,023		(2,801	)		418,091
Governmental agency mortgage-backed securities		2,065,728		4,984		(15,039	)		2,055,673
U.S. corporate debt securities		642,869		4,297		(12,483	)		634,683
Foreign corporate debt securities		210,162		1,248		(3,778	)		207,632
	$	4,290,864	$	25,745	$	(37,262	)	$	4,279,347

Investments in equity securities, classified as available-for-sale, are as follows:

	Cost		Gross unrealized					Estimated fair value
(in thousands)	Cost		Gains		Losses			Estimated fair value
June 30, 2016
Preferred stocks	$	19,558	$	195	$	(4,584	)	$	15,169
Common stocks		340,638		14,421		(7,962	)		347,097
	$	360,196	$	14,616	$	(12,546	)	$	362,266
December 31, 2015
Preferred stocks	$	18,305	$	420	$	(3,258	)	$	15,467
Common stocks		307,429		13,103		(14,714	)		305,818
	$	325,734	$	13,523	$	(17,972	)	$	321,285

Sales of debt and equity securities resulted in realized gains of $12.2 million and $1.5 million and realized losses of $4.6 million and $0.4 million for the three months ended June 30, 2016 and 2015, respectively, and realized gains of $13.2 million and $5.1 million and realized losses of $7.0 million and $6.6 million for the six months ended June 30, 2016 and 2015, respectively.

FIRST AMERICAN FINANCIAL CORPORATION
AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements – (Continued)
(unaudited)

Gross unrealized losses on investments in debt and equity securities are as follows:

	Less than 12 months					12 months or longer					Total
(in thousands)	Estimated fair value		Unrealized losses			Estimated fair value		Unrealized losses			Estimated fair value		Unrealized losses
June 30, 2016
Debt securities:
Municipal bonds	$	41,605	$	(312	)	$	13,668	$	(122	)	$	55,273	$	(434	)
Foreign government bonds		8,389		(11	)		3,506		(45	)		11,895		(56	)
Governmental agency mortgage-backed securities		749,708		(2,898	)		281,816		(2,709	)		1,031,524		(5,607	)
U.S. corporate debt securities		73,749		(1,192	)		51,399		(1,943	)		125,148		(3,135	)
Foreign corporate debt securities		24,080		(549	)		20,101		(562	)		44,181		(1,111	)
Total debt securities		897,531		(4,962	)		370,490		(5,381	)		1,268,021		(10,343	)
Equity securities		41,343		(1,199	)		72,578		(11,347	)		113,921		(12,546	)
Total	$	938,874	$	(6,161	)	$	443,068	$	(16,728	)	$	1,381,942	$	(22,889	)
December 31, 2015
Debt securities:
U.S. Treasury bonds	$	105,701	$	(1,285	)	$	1,654	$	(16	)	$	107,355	$	(1,301	)
Municipal bonds		133,465		(733	)		13,190		(112	)		146,655		(845	)
Foreign government bonds		13,601		(890	)		267		(125	)		13,868		(1,015	)
Governmental agency bonds		191,035		(2,497	)		18,237		(304	)		209,272		(2,801	)
Governmental agency mortgage-backed securities		1,096,301		(9,424	)		213,020		(5,615	)		1,309,321		(15,039	)
U.S. corporate debt securities		361,842		(11,272	)		13,511		(1,211	)		375,353		(12,483	)
Foreign corporate debt securities		102,801		(2,725	)		11,246		(1,053	)		114,047		(3,778	)
Total debt securities		2,004,746		(28,826	)		271,125		(8,436	)		2,275,871		(37,262	)
Equity securities		191,248		(12,068	)		31,974		(5,904	)		223,222		(17,972	)
Total	$	2,195,994	$	(40,894	)	$	303,099	$	(14,340	)	$	2,499,093	$	(55,234	)

FIRST AMERICAN FINANCIAL CORPORATION
AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements – (Continued)
(unaudited)

Investments in debt securities at June 30, 2016, by contractual maturities, are as follows:

(in thousands)	Due in one year or less		Due after one through five years		Due after five through ten years		Due after ten years		Total
U.S. Treasury bonds
Amortized cost	$	27,855	$	64,029	$	13,800	$	15,927	$	121,611
Estimated fair value	$	27,870	$	64,603	$	14,331	$	17,584	$	124,388
Municipal bonds
Amortized cost	$	44,059	$	326,255	$	223,201	$	150,427	$	743,942
Estimated fair value	$	44,127	$	333,004	$	231,647	$	158,137	$	766,915
Foreign government bonds
Amortized cost	$	12,314	$	109,665	$	10,968	$	8,368	$	141,315
Estimated fair value	$	12,347	$	110,912	$	11,318	$	8,740	$	143,317
Governmental agency bonds
Amortized cost	$	20,842	$	207,230	$	73,135	$	36,994	$	338,201
Estimated fair value	$	20,864	$	207,870	$	73,760	$	39,261	$	341,755
U.S. corporate debt securities
Amortized cost	$	15,137	$	324,828	$	287,199	$	74,771	$	701,935
Estimated fair value	$	15,205	$	331,095	$	292,749	$	79,333	$	718,382
Foreign corporate debt securities
Amortized cost	$	7,109	$	110,605	$	95,282	$	13,231	$	226,227
Estimated fair value	$	7,103	$	111,978	$	96,637	$	14,134	$	229,852
Total debt securities excluding mortgage-backed securities
Amortized cost	$	127,316	$	1,142,612	$	703,585	$	299,718	$	2,273,231
Estimated fair value	$	127,516	$	1,159,462	$	720,442	$	317,189	$	2,324,609
Total mortgage-backed securities
Amortized cost									$	2,207,589
Estimated fair value									$	2,217,812
Total debt securities
Amortized cost									$	4,480,820
Estimated fair value									$	4,542,421

Mortgage-backed securities, which include contractual terms to maturity, are not categorized by contractual maturity because borrowers may have the right to call or prepay obligations with, or without, call or prepayment penalties.

FIRST AMERICAN FINANCIAL CORPORATION
AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements – (Continued)
(unaudited)

The composition of the investment portfolio at June 30, 2016, by credit rating, is as follows:


	A- Ratings or higher			BBB+ to BBB- Ratings			Non-Investment Grade			Total
(in thousands, except percentages)	Estimated fair value		Percentage	Estimated fair value		Percentage	Estimated fair value		Percentage	Estimated fair value		Percentage
June 30, 2016
Debt securities:
U.S. Treasury bonds	$	124,388	100.0	$	—	—	$	—	—	$	124,388	100.0
Municipal bonds		733,263	95.5		27,446	3.5		6,206	1.0		766,915	100.0
Foreign government bonds		129,866	90.6		9,930	6.9		3,521	2.5		143,317	100.0
Governmental agency bonds		341,755	100.0		—	—		—	—		341,755	100.0
Governmental agency mortgage-backed securities		2,217,812	100.0		—	—		—	—		2,217,812	100.0
U.S. corporate debt securities		308,868	43.0		202,157	28.1		207,357	28.9		718,382	100.0
Foreign corporate debt securities		118,692	51.6		74,241	32.3		36,919	16.1		229,852	100.0
Total debt securities		3,974,644	87.5		313,774	6.9		254,003	5.6		4,542,421	100.0
Preferred stocks		—	—		8,866	58.4		6,303	41.6		15,169	100.0
Total	$	3,974,644	87.2	$	322,640	7.1	$	260,306	5.7	$	4,557,590	100.0

As of June 30, 2016, the estimated fair value of total debt securities included $144.2 million of bank loans, of which $134.1 million was non-investment grade; $103.4 million of high yield corporate debt securities, all of which was non-investment grade; and $53.7 million of emerging market debt securities, of which $10.3 million was non-investment grade.

The composition of the investment portfolio in an unrealized loss position at June 30, 2016, by credit rating, is as follows:


	A- Ratings or higher			BBB+ to BBB- Ratings			Non-Investment Grade			Total
(in thousands, except percentages)	Estimated fair value		Percentage	Estimated fair value		Percentage	Estimated fair value		Percentage	Estimated fair value		Percentage
June 30, 2016
Debt securities:
Municipal bonds	$	49,907	90.2	$	1,634	3.0	$	3,732	6.8	$	55,273	100.0
Foreign government bonds		9,435	79.3		1,033	8.7		1,427	12.0		11,895	100.0
Governmental agency mortgage-backed securities		1,031,524	100.0		—	—		—	—		1,031,524	100.0
U.S. corporate debt securities		13,722	11.0		29,183	23.3		82,243	65.7		125,148	100.0
Foreign corporate debt securities		2,898	6.6		18,155	41.1		23,128	52.3		44,181	100.0
Total debt securities		1,107,486	87.4		50,005	3.9		110,530	8.7		1,268,021	100.0
Preferred stocks		—	—		8,866	59.3		6,093	40.7		14,959	100.0
Total	$	1,107,486	86.3	$	58,871	4.6	$	116,623	9.1	$	1,282,980	100.0

As of June 30, 2016, the estimated fair value of total debt securities in an unrealized loss position included $50.8 million of bank loans, of which $46.3 million was non-investment grade; $54.0 million of high yield corporate debt securities, all of which was non-investment grade; and $9.5 million of emerging market debt securities, of which $6.5 million was non-investment grade.

The credit ratings in the above tables reflect published ratings obtained from Standard & Poor’s Rating Services, DBRS, Inc., Fitch Ratings, Inc. and Moody’s Investor Services, Inc. If a security was rated differently among the rating agencies, the lowest rating was selected. Governmental agency mortgage-backed securities are not rated by any of the ratings agencies; however, these securities have been included in the above table in the A- Ratings or higher category because the payments of principal and interest are guaranteed by the governmental agency that issued the security.

FIRST AMERICAN FINANCIAL CORPORATION
AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements – (Continued)
(unaudited)

Note 4 – Goodwill

A summary of the changes in the carrying amount of goodwill, by operating segment, for the six months ended June 30, 2016, is as follows:

(in thousands)	Title Insurance and Services			Specialty Insurance		Total
Balance as of December 31, 2015	$	917,577		$	46,765	$	964,342
Acquisitions		16,992			—		16,992
Foreign currency translation		1,821			—		1,821
Other adjustments		(321	)		—		(321	)
Balance as of June 30, 2016	$	936,069		$	46,765	$	982,834

The Company’s four reporting units for purposes of assessing impairment are title insurance, home warranty, property and casualty insurance and trust and other services. During the six months ended June 30, 2016 there were no triggering events that would require an impairment analysis. There is no accumulated impairment for goodwill as the Company has never recognized impairment to any of its reporting units.

Note 5 – Other Intangible Assets

Other intangible assets consist of the following:

(in thousands)	June 30, 2016			December 31, 2015
Finite-lived intangible assets:
Customer relationships	$	94,265		$	93,572
Noncompete agreements		27,519			26,963
Trademarks		9,376			9,341
Internal-use software licenses		7,905			—
Patents		2,840			2,840
		141,905			132,716
Accumulated amortization		(107,857	)		(101,479	)
		34,048			31,237
Indefinite-lived intangible assets:
Licenses		16,884			16,877
	$	50,932		$	48,114

Amortization expense for finite-lived intangible assets was $3.2 million and $5.6 million for the three and six months ended June 30, 2016, respectively, and $2.4 million and $4.8 million for the three and six months ended June 30, 2015, respectively.

Estimated amortization expense for finite-lived intangible assets for the next five years is as follows:

Year	(in thousands)
Remainder of 2016	$	5,800
2017	$	9,449
2018	$	6,544
2019	$	4,295
2020	$	2,551
2021	$	1,143

FIRST AMERICAN FINANCIAL CORPORATION
AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements – (Continued)
(unaudited)

Note 6 – Reserve for Known and Incurred But Not Reported Claims

A summary of the Company’s loss reserves is as follows:

(in thousands, except percentages)	June 30, 2016				December 31, 2015
Known title claims	$	76,767	7.7	%	$	87,543	8.9	%
Incurred but not reported claims		856,577	86.1	%		844,364	85.8	%
Total title claims		933,344	93.8	%		931,907	94.7	%
Non-title claims		61,420	6.2	%		51,973	5.3	%
Total loss reserves	$	994,764	100.0	%	$	983,880	100.0	%

The provision for title insurance losses, expressed as a percentage of title insurance premiums and escrow fees, was 5.5% for the three and six months ended June 30, 2016 compared to 6.6% for the three and six months ended June 30, 2015. The current quarter rate of 5.5% reflects the ultimate loss rate of 5.0% for the current policy year and a $5.2 million net increase in the loss reserve estimates for prior policy years. The second quarter of 2015 rate of 6.6% reflected the ultimate loss rate of 6.0% for the 2015 policy year and a $5.7 million net increase in the loss reserve estimates for prior policy years.

Note 7 – Income Taxes

The Company’s effective income tax rates (income tax expense as a percentage of income before income taxes) were 33.3% and 32.3% for the three and six months ended June 30, 2016, respectively, and 33.9% and 34.5% for the three and six months ended June 30, 2015, respectively. The effective tax rates differ from the statutory federal rate of 35% primarily due to changes in state and foreign income taxes resulting from fluctuations in the Company’s noninsurance and foreign subsidiaries’ contribution to pretax income and changes in the ratio of permanent differences to income before income taxes. The rates for both the three and six months ended June 30, 2016 include a benefit for the resolution of certain tax authority examinations and tax credits in current and prior years.

In connection with the Company’s June 2010 spin-off from its prior parent, which subsequently assumed the name CoreLogic, Inc. (“CoreLogic”), it entered into a tax sharing agreement which governs the Company’s and CoreLogic’s respective rights, responsibilities and obligations for certain tax related matters. At June 30, 2016 and December 31, 2015, the Company had a net payable to CoreLogic of $37.1 million and $36.5 million, respectively, related to tax matters prior to the spin-off. This amount is included in the Company’s condensed consolidated balance sheets in accounts payable and accrued liabilities. The increase during the current year was primarily the result of an additional accrual for tax matters prior to the spin-off.

The Company evaluates the realizability of its deferred tax assets by assessing the valuation allowance and adjusts the allowance, if necessary. The factors used to assess the likelihood of realization are the Company’s forecast of future taxable income and available tax planning strategies that could be implemented to realize the net deferred tax assets. The ability or failure to achieve the forecasted taxable income in the applicable taxing jurisdictions could affect the ultimate realization of deferred tax assets. Based on future operating results in certain jurisdictions, it is possible that the current valuation allowance positions of those jurisdictions could be adjusted in the next 12 months.

As of June 30, 2016 and December 31, 2015, the liability for income taxes associated with uncertain tax positions was $26.3 million and $23.8 million, respectively. The net increase in the liability during 2016 was primarily attributable to reserves for tax positions taken by the Company. As of June 30, 2016 and December 31, 2015, the liabilities could be reduced by $3.4 million of offsetting tax benefits associated with the correlative effects of potential adjustments, including timing adjustments and state income taxes. The net amounts of $22.9 million and $20.4 million as of June 30, 2016 and December 31, 2015, respectively, if recognized, would favorably affect the Company’s effective tax rate.

FIRST AMERICAN FINANCIAL CORPORATION
AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements – (Continued)
(unaudited)

The Company’s continuing practice is to recognize interest and penalties, if any, related to uncertain tax positions in income tax expense. As of June 30, 2016 and December 31, 2015, the Company had accrued $9.3 million and $9.7 million, respectively, of interest and penalties (net of tax benefits of $4.3 million and $4.1 million, respectively) related to uncertain tax positions.

It is reasonably possible that the amount of the unrecognized benefit with respect to certain of the Company’s unrecognized tax positions may significantly decrease within the next 12 months. This change may be the result of ongoing audits or the expiration of federal and state statutes of limitations for the assessment of taxes.

The Company, or one of its subsidiaries, files income tax returns in the U.S. federal jurisdiction, various state jurisdictions, and various non-U.S. jurisdictions. The primary non-federal jurisdictions are California, Canada, India and the United Kingdom. The Company is generally no longer subject to U.S. federal, state and non-U.S. income tax examinations by taxing authorities for years prior to 2005.

Note 8 – Earnings Per Share

The computation of basic and diluted earnings per share is as follows:

	Three Months Ended June 30,				Six Months Ended June 30,
(in thousands, except per share amounts)	2016		2015		2016		2015
Numerator
Net income attributable to the Company	$	102,149	$	93,347	$	154,650	$	130,979
Less: dividends and undistributed earnings allocated to unvested restricted stock units (“RSUs”)		—		88		—		150
Net income allocated to common stockholders	$	102,149	$	93,259	$	154,650	$	130,829
Denominator
Basic weighted-average shares		110,480		108,459		110,327		108,102
Effect of dilutive employee stock options and RSUs		498		1,337		515		1,484
Diluted weighted-average shares		110,978		109,796		110,842		109,586
Net income per share attributable to the Company’s stockholders
Basic	$	0.92	$	0.86	$	1.40	$	1.21
Diluted	$	0.92	$	0.85	$	1.40	$	1.19

For the three and six months ended June 30, 2016, 2 thousand and 1 thousand, respectively, of RSUs were excluded from weighted-average diluted common shares outstanding due to their antidilutive effect. For the three and six months ended June 30, 2015, 4 thousand and 2 thousand, respectively, of RSUs were excluded from weighted-average diluted common shares outstanding due to their antidilutive effect.

FIRST AMERICAN FINANCIAL CORPORATION
AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements – (Continued)
(unaudited)

Note 9 – Employee Benefit Plans

Net periodic cost related to the Company’s funded defined benefit pension and unfunded supplemental benefit plans includes the following components:

	Three Months Ended June 30,						Six Months Ended June 30,
(in thousands)	2016			2015			2016			2015
Expense:
Service costs	$	260		$	390		$	521		$	780
Interest costs		6,037			7,009			12,001			14,018
Expected return on plan assets		(3,073	)		(5,448	)		(6,167	)		(10,896	)
Amortization of net actuarial loss		7,073			8,492			14,110			16,984
Amortization of prior service credit		(1,211	)		(1,041	)		(2,422	)		(2,082	)
	$	9,086		$	9,402		$	18,043		$	18,804

Pension termination and settlement

In May 2016, the Company’s board of directors terminated the Company’s funded defined benefit pension plan known as the First American Financial Corporation Pension Plan (the “Pension Plan”) effective as of July 31, 2016. The Pension Plan was closed to new entrants effective December 31, 2001 and amended to “freeze” all benefit accruals as of April 30, 2008. Also, in May 2016, a subsidiary of the Company terminated its small regional funded defined benefit pension plan effective as of August 31, 2016. The Company expects the termination of both pension plans to occur over a similar timeframe. Upon completion of these terminations, the Company will have no remaining funded defined benefit pension plan obligations. All financial impacts discussed below reflect the termination of both pension plans.

The Pension Plan offers participants annuity payments based on a number of factors. The Pension Plan will also offer an alternative lump sum distribution to certain participants. After certain regulatory approvals are obtained, the Company will provide additional cash contributions to the Pension Plan to ensure that sufficient assets are available to make lump sum distribution payments, purchase group annuity contracts from one or more highly rated insurance companies to pay and administer future benefit payments, and complete other transactions required to terminate the Pension Plan in a manner that fully meets its obligations to all participants. The total amount of additional cash contributions required to be provided by the Company will depend upon changes in interest rates, Pension Plan asset returns, the lump sum election rate, and other factors. To sufficiently fund the Pension Plan, the Company expects to make additional cash contributions totaling approximately $100 million, in addition to paying other termination related expenses.

As of December 31, 2015, the Company reported net unrealized losses of $197 million, before tax, in accumulated other comprehensive loss on its consolidated balance sheet related to the Pension Plan. These net unrealized losses, as well as other expenses estimated to be approximately $15 million, before tax, will be recognized in the Company’s consolidated statement of income in two separate quarters as payments are made, initially to settle lump sum elections, and later to purchase group annuity contracts. The Company expects to make distributions to participants electing lump sum payouts and to recognize approximately $81 million in net unrealized losses during the fourth quarter of 2016. The Company expects to complete the transfer of all remaining liabilities and administrative responsibilities related to the Pension Plan to one or more highly rated insurance companies and to recognize approximately $131 million in net unrealized losses and other expenses by the end of the third quarter of 2017. The preceding information related to the expected amounts and timing of pension termination expenses to be recognized are estimates based on net unrealized losses as of December 31, 2015 and actual amounts recognized may differ due to changes in interest rates, Pension Plan asset returns, the lump sum election rate, and other factors.

Certain aspects of the transactions required to terminate the Pension Plan and settle its obligations are subject to regulatory review.

FIRST AMERICAN FINANCIAL CORPORATION
AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements – (Continued)
(unaudited)

Note 10 – Fair Value Measurements

Certain of the Company’s assets are carried at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

The Company categorizes its assets and liabilities carried at fair value using a three-level hierarchy for fair value measurements that distinguishes between market participant assumptions developed based on market data obtained from sources independent of the Company (observable inputs) and the Company’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The hierarchy for inputs used in determining fair value maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available. The hierarchy level assigned to the assets and liabilities is based on management’s assessment of the transparency and reliability of the inputs used to estimate the fair values at the measurement date. The three hierarchy levels are defined as follows:

Level 1—Valuations based on unadjusted quoted market prices in active markets for identical assets or liabilities.

Level 2—Valuations based on observable inputs (other than Level 1 prices), such as quoted prices for similar assets or liabilities at the measurement date; quoted prices in markets that are not active; or other inputs that are observable, either directly or indirectly.

Level 3—Valuations based on inputs that are unobservable and significant to the overall fair value measurement, and involve management judgment.

If the inputs used to measure fair value fall into different levels of the fair value hierarchy, the hierarchy level assigned is based upon the lowest level of input that is significant to the fair value measurement.

Assets measured at fair value on a recurring basis

The valuation techniques and inputs used by the Company to estimate the fair value of assets measured on a recurring basis are summarized as follows:

Debt securities

The fair values of debt securities were based on the market values obtained from independent pricing services that were evaluated using pricing models that vary by asset class and incorporate available trade, bid and other market information and price quotes from well-established independent broker-dealers. The independent pricing services monitor market indicators, industry and economic events, and for broker-quoted only securities, obtain quotes from market makers or broker-dealers that they recognize to be market participants. The pricing services utilize the market approach in determining the fair value of the debt securities held by the Company. The Company obtains an understanding of the valuation models and assumptions utilized by the services and has controls in place to determine that the values provided represent fair value. The Company’s validation procedures include comparing prices received from the pricing services to quotes received from other third party sources for certain securities with market prices that are readily verifiable. If the price comparison results in differences over a predefined threshold, the Company will assess the reasonableness of the changes relative to prior periods given the prevailing market conditions and assess changes in the issuers’ credit worthiness, performance of any underlying collateral and prices of the instrument relative to similar issuances. To date, the Company has not made any material adjustments to the fair value measurements provided by the pricing services.

Typical inputs and assumptions to pricing models used to value the Company’s U.S. Treasury bonds, municipal bonds, foreign government bonds, governmental agency bonds, governmental agency mortgage-backed securities and U.S. and foreign corporate debt securities include, but are not limited to, benchmark yields, reported trades, broker-dealer quotes, credit spreads, credit ratings, bond insurance (if applicable), benchmark securities, bids, offers, reference data and industry and economic events. For mortgage-backed securities, inputs and assumptions may also include the structure of issuance, characteristics of the issuer, collateral attributes and prepayment speeds. Non-agency mortgage-backed securities and certain corporate debt securities were not actively traded and there were fewer observable inputs available requiring the use of more judgment in determining their fair values, which resulted in their classification as Level 3.

FIRST AMERICAN FINANCIAL CORPORATION
AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements – (Continued)
(unaudited)

Equity securities

The fair values of equity securities, including preferred and common stocks, were based on quoted market prices for identical assets that are readily and regularly available in an active market.

The following tables present the fair values of the Company’s assets, measured on a recurring basis, as of June 30, 2016 and December 31, 2015:

(in thousands)	Total		Level 1		Level 2		Level 3
June 30, 2016
Assets:
Debt securities:
U.S. Treasury bonds	$	124,388	$	—	$	124,388	$	—
Municipal bonds		766,915		—		766,915		—
Foreign government bonds		143,317		—		143,317		—
Governmental agency bonds		341,755		—		341,755		—
Governmental agency mortgage-backed securities		2,217,812		—		2,217,812		—
U.S. corporate debt securities		718,382		—		703,889		14,493
Foreign corporate debt securities		229,852		—		229,129		723
		4,542,421		—		4,527,205		15,216
Equity securities:
Preferred stocks		15,169		15,169		—		—
Common stocks		347,097		347,097		—		—
		362,266		362,266		—		—
Total assets	$	4,904,687	$	362,266	$	4,527,205	$	15,216

(in thousands)	Total		Level 1		Level 2		Level 3
December 31, 2015
Assets:
Debt securities:
U.S. Treasury bonds	$	129,372	$	—	$	129,372	$	—
Municipal bonds		703,795		—		703,795		—
Foreign government bonds		130,101		—		130,101		—
Governmental agency bonds		418,091		—		418,091		—
Governmental agency mortgage-backed securities		2,055,673		—		2,055,673		—
U.S. corporate debt securities		634,683		—		591,116		43,567
Foreign corporate debt securities		207,632		—		201,060		6,572
		4,279,347		—		4,229,208		50,139
Equity securities:
Preferred stocks		15,467		15,467		—		—
Common stocks		305,818		305,818		—		—
		321,285		321,285		—		—
Total assets	$	4,600,632	$	321,285	$	4,229,208	$	50,139

There were no transfers between Levels 1 and 2 during the three and six months ended June 30, 2016 and 2015. Transfers into or out of the Level 3 category occur when unobservable inputs become more or less significant to the fair value measurement. For the three and six months ended June 30, 2016 and 2015, transfers between Level 2 and Level 3 were based on market liquidity and related transparency of pricing and associated observable inputs for certain of the Company’s corporate debt securities. The Company’s policy is to recognize transfers between levels in the fair value hierarchy at the end of the reporting period.

FIRST AMERICAN FINANCIAL CORPORATION
AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements – (Continued)
(unaudited)

The following table presents a summary of the changes in the fair values of Level 3 assets, measured on a recurring basis, for the three months ended June 30, 2016 and 2015:

	June 30, 2016									June 30, 2015
(in thousands)	U.S. corporate debt securities			Foreign corporate debt securities			Total			U.S. corporate debt securities			Foreign corporate debt securities			Total
Fair value at beginning of period	$	14,993		$	1,332		$	16,325		$	30,031		$	2,535		$	32,566
Transfers into Level 3		2,948			—			2,948			1,030			1,474			2,504
Transfers out of Level 3		(5,840	)		(762	)		(6,602	)		(24,063	)		(2,020	)		(26,083	)
Net realized and unrealized gains (losses):
Included in earnings		(36	)		—			(36	)		(43	)		—			(43	)
Included in other comprehensive income (loss)		179			55			234			(193	)		(12	)		(205	)
Purchases		4,640			100			4,740			4,415			73			4,488
Sales		(1,446	)		—			(1,446	)		(481	)		—			(481	)
Settlements		(945	)		(2	)		(947	)		(1,382	)		(6	)		(1,388	)
Fair value at end of period	$	14,493		$	723		$	15,216		$	9,314		$	2,044		$	11,358
Unrealized gains (losses) included in earnings for the period relating to Level 3 assets that were still held at the end of the period:
Net realized investment gains (losses)	$	—		$	—		$	—		$	—		$	—		$	—

The following table presents a summary of the changes in the fair values of Level 3 assets, measured on a recurring basis, for the six months ended June 30, 2016 and 2015:

	June 30, 2016									June 30, 2015
(in thousands)	U.S. corporate debt securities			Foreign corporate debt securities			Total			U.S. corporate debt securities			Foreign corporate debt securities			Non-agency mortgage-backed securities			Total
Fair value at beginning of period	$	43,567		$	6,572		$	50,139		$	—		$	—		$	16,538		$	16,538
Transfers into Level 3		857			—			857			1,030			1,474			—			2,504
Transfers out of Level 3		(33,372	)		(3,773	)		(37,145	)		(24,063	)		(2,020	)		—			(26,083	)
Net realized and unrealized gains (losses):
Included in earnings		(111	)		(35	)		(146	)		(41	)		—			(1,015	)		(1,056	)
Included in other comprehensive income (loss)		667			(9	)		658			37			7			(589	)		(545	)
Purchases		7,993			100			8,093			34,454			2,591			—			37,045
Sales		(3,473	)		(1,049	)		(4,522	)		(653	)		—			(14,934	)		(15,587	)
Settlements		(1,635	)		(1,083	)		(2,718	)		(1,450	)		(8	)		—			(1,458	)
Fair value at end of period	$	14,493		$	723		$	15,216		$	9,314		$	2,044		$	—		$	11,358
Unrealized gains (losses) included in earnings for the period relating to Level 3 assets that were still held at the end of the period:
Net realized investment gains (losses)	$	(5	)	$	—		$	(5	)	$	—		$	—		$	—		$	—

FIRST AMERICAN FINANCIAL CORPORATION
AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements – (Continued)
(unaudited)

Financial instruments not measured at fair value

In estimating the fair values of its financial instruments not measured at fair value, the Company used the following methods and assumptions:

Cash and cash equivalents

The carrying amount for cash and cash equivalents is a reasonable estimate of fair value due to the short-term maturity of these investments.

Deposits with banks

The fair value of deposits with banks is estimated based on rates currently offered for deposits of similar remaining maturities, where applicable.

Notes receivable, net

The fair value of notes receivable, net is estimated based on current market rates being offered for notes with similar maturities and credit quality.

Deposits

The carrying value of escrow and other deposit accounts approximates fair value due to the short-term nature of these liabilities.

Notes and contracts payable

The fair value of notes and contracts payable is estimated based on current rates offered to the Company for debt of similar remaining maturities.

The following table presents the carrying amounts and estimated fair values of the Company’s financial instruments not measured at fair value as of June 30, 2016 and December 31, 2015:

	Carrying		Estimated fair value
(in thousands)	Amount		Total		Level 1		Level 2		Level 3
June 30, 2016
Assets:
Cash and cash equivalents	$	1,241,814	$	1,241,814	$	1,241,814	$	—	$	—
Deposits with banks	$	21,746	$	21,733	$	721	$	21,012	$	—
Notes receivable, net	$	7,159	$	6,897	$	—	$	—	$	6,897
Liabilities:
Deposits	$	3,100,365	$	3,100,365	$	3,100,365	$	—	$	—
Notes and contracts payable	$	579,474	$	607,757	$	—	$	601,049	$	6,708

	Carrying		Estimated fair value
(in thousands)	Amount		Total		Level 1		Level 2		Level 3
December 31, 2015
Assets:
Cash and cash equivalents	$	1,027,321	$	1,027,321	$	1,027,321	$	—	$	—
Deposits with banks	$	23,224	$	23,211	$	1,103	$	22,108	$	—
Notes receivable, net	$	5,866	$	5,791	$	—	$	—	$	5,791
Liabilities:
Deposits	$	2,699,015	$	2,699,015	$	2,699,015	$	—	$	—
Notes and contracts payable	$	581,052	$	590,970	$	—	$	583,893	$	7,077

FIRST AMERICAN FINANCIAL CORPORATION
AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements – (Continued)
(unaudited)

Note 11 – Share-Based Compensation

The following table presents compensation expense associated with the Company’s share-based compensation plans:

	Three Months Ended June 30,				Six Months Ended June 30,
(in thousands)	2016		2015		2016		2015
Expense:
RSUs	$	5,384	$	4,117	$	20,365	$	14,219
Stock options		68		68		135		135
Employee stock purchase plan		658		520		1,468		1,209
	$	6,110	$	4,705	$	21,968	$	15,563

The following table summarizes RSU activity for the six months ended June 30, 2016:

(in thousands, except weighted-average grant-date fair value)	Shares			Weighted-average grant-date fair value
RSUs unvested at December 31, 2015		1,354		$	29.20
Granted during 2016		925		$	36.79
Vested during 2016		(703	)	$	30.78
Forfeited during 2016		(12	)	$	30.57
RSUs unvested at June 30, 2016		1,564		$	32.97

The following table summarizes stock option activity for the six months ended June 30, 2016:

(in thousands, except weighted-average exercise price and contractual term)	Number outstanding		Weighted- average exercise price		Weighted- average remaining contractual term		Aggregate intrinsic value
Balance at December 31, 2015		132	$	27.66
Exercised during 2016		—	$	—
Balance at June 30, 2016		132	$	27.66		7.5 years	$	1,662
Vested and expected to vest at June 30, 2016		132	$	27.66		7.5 years	$	1,662
Exercisable at June 30, 2016		66	$	27.66		7.5 years	$	831

FIRST AMERICAN FINANCIAL CORPORATION
AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements – (Continued)
(unaudited)

Note 12 – Accumulated Other Comprehensive Income (Loss) (“AOCI”)

The following table presents a summary of the changes in each component of AOCI for the six months ended June 30, 2016:

(in thousands)	Unrealized gains (losses) on securities			Foreign currency translation adjustment			Pension benefit adjustment			Accumulated other comprehensive income (loss)
Balance at December 31, 2015	$	(16,401	)	$	(57,242	)	$	(165,357	)	$	(239,000	)
Change in unrealized gains (losses) on securities		79,638			—			—			79,638
Change in foreign currency translation adjustment		—			6,525			—			6,525
Amortization of net actuarial loss		—			—			14,110			14,110
Amortization of prior service cost		—			—			(2,422	)		(2,422	)
Tax effect		(30,130	)		—			(4,471	)		(34,601	)
Balance at June 30, 2016	$	33,107		$	(50,717	)	$	(158,140	)	$	(175,750	)
Allocated to the Company	$	33,088		$	(50,717	)	$	(158,140	)	$	(175,769	)
Allocated to noncontrolling interests		19			—			—			19
Balance at June 30, 2016	$	33,107		$	(50,717	)	$	(158,140	)	$	(175,750	)

The following table presents the other comprehensive income (loss) reclassification adjustments for the three months ended June 30, 2016 and 2015:

(in thousands)	Unrealized gains (losses) on securities			Foreign currency translation adjustment			Pension benefit adjustment			Total other comprehensive income (loss)
Three Months Ended June 30, 2016
Pretax change before reclassifications	$	34,987		$	(5,579	)	$	—		$	29,408
Reclassifications out of AOCI		(7,242	)		—			5,862			(1,380	)
Tax effect		(10,064	)		—			(2,241	)		(12,305	)
Total other comprehensive income (loss), net of tax	$	17,681		$	(5,579	)	$	3,621		$	15,723
Three Months Ended June 30, 2015
Pretax change before reclassifications	$	(42,784	)	$	4,866		$	—		$	(37,918	)
Reclassifications out of AOCI		(1,039	)		—			7,451			6,412
Tax effect		15,317			—			(2,850	)		12,467
Total other comprehensive income (loss), net of tax	$	(28,506	)	$	4,866		$	4,601		$	(19,039	)

FIRST AMERICAN FINANCIAL CORPORATION
AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements – (Continued)
(unaudited)

The following table presents the other comprehensive income (loss) reclassification adjustments for the six months ended June 30, 2016 and 2015:

(in thousands)	Unrealized gains (losses) on securities			Foreign currency translation adjustment			Pension benefit adjustment			Total other comprehensive income (loss)
Six Months Ended June 30, 2016
Pretax change before reclassifications	$	84,781		$	6,525		$	—		$	91,306
Reclassifications out of AOCI		(5,143	)		—			11,688			6,545
Tax effect		(30,130	)		—			(4,471	)		(34,601	)
Total other comprehensive income (loss), net of tax	$	49,508		$	6,525		$	7,217		$	63,250
Six Months Ended June 30, 2015
Pretax change before reclassifications	$	(14,351	)	$	(13,794	)	$	—		$	(28,145	)
Reclassifications out of AOCI		1,652			—			14,902			16,554
Tax effect		4,267			—			(5,700	)		(1,433	)
Total other comprehensive income (loss), net of tax	$	(8,432	)	$	(13,794	)	$	9,202		$	(13,024	)

The following table presents the effect of the reclassifications out of AOCI on the respective line items in the condensed consolidated statements of income:

		Amounts reclassified from accumulated other comprehensive income (loss)
(in thousands)		Three Months Ended June 30,						Six Months Ended June 30,					Affected line items in the condensed
(in thousands)		2016			2015			2016			2015		consolidated statements of income
Unrealized gains (losses) on securities:
Net realized gains (losses) on sales of securities	$	7,242		$	1,039		$	5,628		$	(1,652	)	Net realized investment gains
Net other-than-temporary impairment losses		—			—			(485	)		—		Net realized investment gains
Pretax total	$	7,242		$	1,039		$	5,143		$	(1,652	)
Tax effect	$	(2,740	)	$	(363	)	$	(1,967	)	$	555
Pension benefit adjustment:
Amortization of employee benefit plan items:
Net actuarial loss	$	(7,073	)	$	(8,492	)	$	(14,110	)	$	(16,984	)	(1)
Prior service credit		1,211			1,041			2,422			2,082		(1)
Pretax total	$	(5,862	)	$	(7,451	)	$	(11,688	)	$	(14,902	)
Tax effect	$	2,241		$	2,850		$	4,471		$	5,700

(1)	These components of AOCI are included in the computation of net periodic cost. See Note 9 Employee Benefit Plans for additional details.

FIRST AMERICAN FINANCIAL CORPORATION
AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements – (Continued)
(unaudited)

Note 13 – Litigation and Regulatory Contingencies

The Company and its subsidiaries are parties to a number of non-ordinary course lawsuits. These lawsuits frequently are similar in nature to other lawsuits pending against the Company’s competitors.

For those non-ordinary course lawsuits where the Company has determined that a loss is both probable and reasonably estimable, a liability representing the best estimate of the Company’s financial exposure based on known facts has been recorded. Actual losses may materially differ from the amounts recorded.

For a substantial majority of these lawsuits, however, it is not possible to assess the probability of loss. Most of these lawsuits are putative class actions which require a plaintiff to satisfy a number of procedural requirements before proceeding to trial. These requirements include, among others, demonstration to a court that the law proscribes in some manner the Company’s activities, the making of factual allegations sufficient to suggest that the Company’s activities exceeded the limits of the law and a determination by the court—known as class certification—that the law permits a group of individuals to pursue the case together as a class. In certain instances the Company may also be able to compel the plaintiff to arbitrate its claim on an individual basis. If these procedural requirements are not met, either the lawsuit cannot proceed or, as is the case with class certification or compelled arbitration, the plaintiffs lose the financial incentive to proceed with the case (or the amount at issue effectively becomes de minimis). Frequently, a court’s determination as to these procedural requirements is subject to appeal to a higher court. As a result of, among other factors, ambiguities and inconsistencies in the myriad laws applicable to the Company’s business and the uniqueness of the factual issues presented in any given lawsuit, the Company often cannot determine the probability of loss until a court has finally determined that a plaintiff has satisfied applicable procedural requirements.

Furthermore, because most of these lawsuits are putative class actions, it is often impossible to estimate the possible loss or a range of loss amounts, even where the Company has determined that a loss is reasonably possible. Generally class actions involve a large number of people and the effort to determine which people satisfy the requirements to become plaintiffs—or class members—is often time consuming and burdensome. Moreover, these lawsuits raise complex factual issues which result in uncertainty as to their outcome and, ultimately, make it difficult for the Company to estimate the amount of damages which a plaintiff might successfully prove. In addition, many of the Company’s businesses are regulated by various federal, state, local and foreign governmental agencies and are subject to numerous statutory guidelines. These regulations and statutory guidelines often are complex, inconsistent or ambiguous, which results in additional uncertainty as to the outcome of a given lawsuit—including the amount of damages a plaintiff might be afforded—or makes it difficult to analogize experience in one case or jurisdiction to another case or jurisdiction.

Most of the non-ordinary course lawsuits to which the Company and its subsidiaries are parties challenge practices in the Company’s title insurance business, though a limited number of cases also pertain to the Company’s other businesses. These lawsuits include, among others, cases alleging, among other assertions, that the Company, one of its subsidiaries and/or one of its agents:

charged an improper rate for title insurance in a refinance transaction, including

Lewis v. First American Title Insurance Company, filed on November 28, 2006 and pending in the United States District Court for the District of Idaho.

A court has granted class certification in Lewis. For the reasons stated above, the Company has been unable to assess the probability of loss or estimate the possible loss or the range of loss.

purchased minority interests in title insurance agents as an inducement to refer title insurance underwriting business to the Company or gave items of value to title insurance agents and others for referrals of business in violation of the Real Estate Settlement Procedures Act, including

Edwards v. First American Financial Corporation, filed on June 12, 2007 and pending in the United States District Court for the Central District of California.

FIRST AMERICAN FINANCIAL CORPORATION
AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements – (Continued)
(unaudited)

In Edwards the court has preliminarily approved a settlement. The anticipated loss, for which a liability has been previously recorded, is not material to the condensed consolidated financial statements as a whole.

misclassified certain employees, including

Cruz v. First American Financial Corporation, et al., filed on November 25, 2015 and pending in the Superior Court of the State of California, County of Orange,

Sager v. Interthinx, Inc., filed on January 23, 2015 and pending in the Superior Court of the State of California, County of Los Angeles, and

Weber v. Interthinx, Inc., et al., filed on April 17, 2015 and pending in the United States District Court for the Eastern District of Missouri.

These lawsuits are putative class actions for which a class has not been certified. For the reasons described above, as well as the applicability of certain indemnification rights the Company may have, the Company has not yet been able to assess the probability of loss or estimate the possible loss or the range of loss or, where the Company has been able to make an estimate, the Company believes the amount is not material to the condensed consolidated financial statements as a whole.

overcharged or improperly charged fees for products and services, denied home warranty claims, failed to timely file certain documents, and gave items of value to developers, builders, brokers and others as inducements to refer business in violation of certain laws, such as consumer protection laws and laws generally prohibiting unfair business practices, and certain obligations, including

Chassen v. First American Financial Corporation, et al., filed on January 22, 2009 and pending in the United States District Court of New Jersey,

Kaufman v. First American Financial Corporation, et al., filed on December 21, 2007 and pending in the Superior Court of the State of California, County of Los Angeles,

Kirk v. First American Financial Corporation, et al., filed on June 15, 2006 and pending in the Superior Court of the State of California, County of Los Angeles,

Lennen v. First American Financial Corporation, et al., filed on May 19, 2016 and pending in the United States District court for the Middle District of Florida,

McCormick v. First American Real Estate Services, Inc., et al., filed on December 31, 2015 and pending in the Superior Court of the State of California, County of Orange,

Nichols v. First American Financial Corporation, et al., filed on February 26, 2016 and pending in the United States District Court for the Eastern District of California,

Sjobring v. First American Financial Corporation, et al., filed on February 25, 2005 and pending in the Superior Court of the State of California, County of Los Angeles,

Wilmot v. First American Financial Corporation, et al., filed on April 20, 2007 and pending in the Superior Court of the State of California, County of Los Angeles, and

In re First American Home Buyers Protection Corporation, consolidated on October 9, 2014 and pending in the United States District Court for the Southern District of California.

All of these lawsuits, except Kaufman and Kirk, are putative class actions for which a class has not been certified. In Kaufman a class was certified but that certification was subsequently vacated. A trial of the Kirk matter has concluded and the judgment has been affirmed on appeal. For the reasons described above, the Company has not yet been able to assess the probability of loss or estimate the possible loss or the range of loss or, where the Company has been able to make an estimate, the Company believes the amount is not material to the condensed consolidated financial statements as a whole.

FIRST AMERICAN FINANCIAL CORPORATION
AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements – (Continued)
(unaudited)

While some of the lawsuits described above may be material to the Company’s operating results in any particular period if an unfavorable outcome results, the Company does not believe that any of these lawsuits will have a material adverse effect on the Company’s overall financial condition or liquidity.

The Company also is a party to non-ordinary course lawsuits other than those described above. With respect to these lawsuits, the Company has determined either that a loss is not reasonably possible or that the estimated loss or range of loss, if any, is not material to the condensed consolidated financial statements as a whole.

The Company’s title insurance, property and casualty insurance, home warranty, banking, thrift, trust and investment advisory businesses are regulated by various federal, state and local governmental agencies. Many of the Company’s other businesses operate within statutory guidelines. Consequently, the Company may from time to time be subject to examination or investigation by such governmental agencies. Currently, governmental agencies are examining or investigating certain of the Company’s operations. These exams or investigations include inquiries into, among other matters, pricing and rate setting practices in the title insurance industry, competition in the title insurance industry, real estate settlement service customer acquisition and retention practices and agency relationships. With respect to matters where the Company has determined that a loss is both probable and reasonably estimable, the Company has recorded a liability representing its best estimate of the financial exposure based on known facts. While the ultimate disposition of each such exam or investigation is not yet determinable, the Company does not believe that individually or in the aggregate they will have a material adverse effect on the Company’s financial condition, results of operations or cash flows. These exams or investigations could, however, result in changes to the Company’s business practices which could ultimately have a material adverse impact on the Company’s financial condition, results of operations or cash flows.

The Company’s Canadian operations provide certain services to lenders which it believes to be exempt from excise tax under applicable Canadian tax laws. However, in October 2014, the Canadian taxing authority provided internal guidance that the services in question should be subject to the excise tax. While discussions with the taxing authority are ongoing, the Company believes that the guidance may result in an assessment. The amount, if any, of such assessment is not currently known, and any such assessment would be subject to negotiation. In the event that the Company disagrees with the ultimate assessment, the Company intends to avail itself of avenues of appeal. While the Company believes it is reasonably likely that the Company would prevail on the merits, a loss associated with the matter is possible. In light of the foregoing, the Company is not currently able to reasonably estimate a loss or range of loss associated with the matter. While such a loss could be material to the Company’s operating results in any particular period if an unfavorable outcome results, the Company does not believe that this matter will have a material adverse effect on the Company’s overall financial condition or liquidity.

The Company and its subsidiaries also are involved in numerous ongoing routine legal and regulatory proceedings related to their operations. With respect to each of these proceedings, the Company has determined either that a loss is not reasonably possible or that the estimated loss or range of loss, if any, is not material to the condensed consolidated financial statements as a whole.

FIRST AMERICAN FINANCIAL CORPORATION
AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements – (Continued)
(unaudited)

Note 14 – Segment Information

The Company consists of the following reportable segments and a corporate function:

The Company’s title insurance and services segment issues title insurance policies on residential and commercial property in the United States and offers similar or related products and services internationally. This segment also provides closing and/or escrow services; accommodates tax-deferred exchanges of real estate; provides products, services and solutions involving the use of real property related data designed to mitigate risk or otherwise facilitate real estate transactions; maintains, manages and provides access to title plant records and images; and provides banking, trust and investment advisory services. The Company, through its principal title insurance subsidiary and such subsidiary’s affiliates, transacts its title insurance business through a network of direct operations and agents. Through this network, the Company issues policies in the 49 states that permit the issuance of title insurance policies and the District of Columbia. The Company also offers title insurance and other insurance and guarantee products, as well as related settlement services in foreign countries, including Canada, the United Kingdom, Australia and various other established and emerging markets.

The Company’s specialty insurance segment issues property and casualty insurance policies and sells home warranty products. The property and casualty insurance business provides insurance coverage to residential homeowners and renters for liability losses and typical hazards such as fire, theft, vandalism and other types of property damage. This business is licensed to issue policies in all 50 states and the District of Columbia and actively issues policies in 46 states. In certain markets it also offers preferred risk auto insurance to better compete with other carriers offering bundled home and auto insurance. The home warranty business provides residential service contracts that cover residential systems, such as heating and air conditioning systems, and appliances against failures that occur as the result of normal usage during the coverage period. This business currently operates in 39 states and the District of Columbia.

The corporate function consists primarily of certain financing facilities as well as the corporate services that support the Company’s business operations. Eliminations consist of inter-segment revenues and related expenses included in the results of the operating segments.

Selected financial information about the Company’s operations, by segment, is as follows:

For the three months ended June 30, 2016:

(in thousands)	Revenues			Income (loss) before income taxes			Depreciation and amortization		Capital expenditures
Title Insurance and Services	$	1,255,922		$	172,437		$	22,439	$	29,696
Specialty Insurance		104,424			4,718			1,459		1,468
Corporate		1,202			(23,548	)		96		—
Eliminations		(15	)		—			—		—
	$	1,361,533		$	153,607		$	23,994	$	31,164

For the three months ended June 30, 2015:

(in thousands)	Revenues			Income (loss) before income taxes			Depreciation and amortization		Capital expenditures
Title Insurance and Services	$	1,227,058		$	154,738		$	20,164	$	28,841
Specialty Insurance		97,653			10,590			1,177		1,123
Corporate		(893	)		(23,706	)		122		—
Eliminations		(29	)		—			—		—
	$	1,323,789		$	141,622		$	21,463	$	29,964

FIRST AMERICAN FINANCIAL CORPORATION
AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements – (Continued)
(unaudited)

For the six months ended June 30, 2016:

(in thousands)	Revenues			Income (loss) before income taxes			Depreciation and amortization		Capital expenditures
Title Insurance and Services	$	2,354,391		$	260,111		$	43,515	$	57,939
Specialty Insurance		207,465			16,962			2,707		3,083
Corporate		1,410			(47,874	)		192		—
Eliminations		(21	)		—			—		—
	$	2,563,245		$	229,199		$	46,414	$	61,022

For the six months ended June 30, 2015:

(in thousands)	Revenues			Income (loss) before income taxes			Depreciation and amortization		Capital expenditures
Title Insurance and Services	$	2,246,830		$	224,238		$	39,690	$	60,159
Specialty Insurance		192,189			27,764			2,382		1,877
Corporate		(3,720	)		(51,432	)		245		—
Eliminations		(426	)		—			—		—
	$	2,434,873		$	200,570		$	42,317	$	62,036

Item 2.

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

RISKS AND UNCERTAINTIES EXIST THAT MAY CAUSE RESULTS TO DIFFER MATERIALLY FROM THOSE SET FORTH IN THESE FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD CAUSE THE ANTICIPATED RESULTS TO DIFFER FROM THOSE DESCRIBED IN THE FORWARD-LOOKING STATEMENTS INCLUDE THE FACTORS SET FORTH ON PAGES 3-4 OF THIS QUARTERLY REPORT. THE FORWARD-LOOKING STATEMENTS SPEAK ONLY AS OF THE DATE THEY ARE MADE. 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.

This Management’s Discussion and Analysis contains certain financial measures that are not presented in accordance with U.S. generally accepted accounting principles (“GAAP”), including adjusted information and other revenues, adjusted personnel costs and adjusted other operating expenses, in each case excluding the effects of recent acquisitions. The Company is presenting these non-GAAP financial measures because they provide the Company’s management and readers of this Quarterly Report on Form 10-Q with additional insight into the operational performance of the Company relative to earlier periods. The Company does not intend for these non-GAAP financial measures to be a substitute for any GAAP financial information. In this Quarterly Report on Form 10-Q, these non-GAAP financial measures have been presented with, and reconciled to, the most directly comparable GAAP financial measures. Readers of this Quarterly Report on Form 10-Q should use these non-GAAP financial measures only in conjunction with the comparable GAAP financial measures.

CRITICAL ACCOUNTING ESTIMATES

There have been no material changes to the Company’s critical accounting estimates since the filing of its Annual Report on Form 10-K for the year ended December 31, 2015. A summary of the Company’s accounting policies that it considers to be the most dependent on the application of estimates and assumptions can be found in the Management’s Discussion and Analysis section of the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.

Recently Adopted Accounting Pronouncements

In April 2015, the FASB issued updated guidance intended to clarify the accounting treatment for cloud computing arrangements that include software licenses. Under the updated guidance, if a cloud computing arrangement includes a software license, the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2015, with early adoption permitted. The Company elected to adopt the updated guidance prospectively for all arrangements entered into or materially modified after the effective date. The adoption of this guidance did not have a material impact on the Company’s condensed consolidated financial statements. The financial statement line items impacted by the adoption of the updated guidance include other intangible assets, net and depreciation and amortization. See Note 5 Other Intangible Assets to the condensed consolidated financial statements for further information on the Company’s internal-use software licenses.

Pending Accounting Pronouncements

Results of Operations

Summary of Second Quarter

A substantial portion of the revenues for the Company’s title insurance and services segment results from the sale and refinancing of residential and commercial real estate. In the Company’s specialty insurance segment, revenues associated with the initial year of coverage in both the home warranty and property and casualty operations are impacted by volatility in residential purchase transactions. Traditionally, the greatest volume of real estate activity, particularly residential purchase activity, has occurred in the spring and summer months. However, changes in interest rates, as well as other changes in general economic conditions in the United States and abroad, can cause fluctuations in the traditional pattern of real estate activity.

The Company’s total revenues increased $37.7 million, or 2.9%, in the second quarter of 2016 when compared with the second quarter of 2015. This increase was primarily attributable to an increase in agent premiums and, to a lesser extent, an increase in direct premiums and escrow fees from residential purchase transactions in the title insurance and services segment. Agent premiums increased $14.2 million, or 2.8%, and direct premiums and escrow fees from residential purchase transactions increased $9.9 million, or 4.5%, in the second quarter of 2016 when compared to the second quarter of 2015.

According to the Mortgage Bankers Association’s July 14, 2016 Mortgage Finance Forecast (the “MBA Forecast”), residential mortgage originations in the United States (based on the total dollar value of the transactions) increased 10.6% in the second quarter of 2016 when compared with the second quarter of 2015. According to the MBA Forecast, the dollar amount of purchase originations increased 13.2% and refinance originations increased 7.8%. This volume of domestic residential mortgage origination activity contributed to a 4.5% increase in direct premiums and escrow fees from domestic residential purchase transactions and a 2.2% increase in direct premiums and escrow fees from domestic refinance transactions in the second quarter of 2016 when compared to the second quarter of 2015.

During the second quarter of 2016, the level of domestic title orders opened per day by the Company’s direct title operations increased by 3.7% when compared with the second quarter of 2015. Refinance orders opened per day increased by 21.0% and residential purchase and commercial orders opened per day decreased by 2.2% and 7.9%, respectively.

In May 2016, the Company’s board of directors terminated the Company’s funded defined benefit pension plan effective as of July 31, 2016. Once the termination process is complete, the Company estimates an annual reduction of approximately $22 million in personnel costs related to the pension plan within the corporate segment, based on the level of these expenses in the first half of 2016. For further discussion of the pension termination and the expected amounts and timing of pension termination expenses to be recognized, see Note 9 Employee Benefit Plans to the condensed consolidated financial statements.

The Company recorded certain reclassifications and revisions to its condensed consolidated statements of income for the three and six months ended June 30, 2015. For further discussion of these reclassifications and revisions, see Note 1 Basis of Condensed Consolidated Financial Statements.

Title Insurance and Services

	Three Months Ended June 30,												Six Months Ended June 30,
(in thousands, except percentages)	2016			2015			$ Change			% Change			2016			2015			$ Change			% Change
Revenues
Direct premiums and escrow fees	$	522,871		$	515,292		$	7,579			1.5	%	$	926,911		$	926,551		$	360			—	%
Agent premiums		515,792			501,613			14,179			2.8			1,028,037			934,533			93,504			10.0
Information and other		181,958			179,989			1,969			1.1			336,220			336,371			(151	)		—
Net investment income		27,478			25,996			1,482			5.7			52,404			47,770			4,634			9.7
Net realized investment gains		7,823			4,168			3,655			87.7			10,819			1,605			9,214			NM	¹
		1,255,922			1,227,058			28,864			2.4			2,354,391			2,246,830			107,561			4.8
Expenses
Personnel costs		389,799			381,038			8,761			2.3			744,879			720,277			24,602			3.4
Premiums retained by agents		403,669			395,278			8,391			2.1			808,708			738,014			70,694			9.6
Other operating expenses		195,495			194,285			1,210			0.6			360,993			374,883			(13,890	)		(3.7	)
Provision for policy losses and other claims		57,126			66,735			(9,609	)		(14.4	)		107,642			122,286			(14,644	)		(12.0	)
Depreciation and amortization		22,439			20,164			2,275			11.3			43,515			39,690			3,825			9.6
Premium taxes		14,246			14,194			52			0.4			27,187			26,225			962			3.7
Interest		711			626			85			13.6			1,356			1,217			139			11.4
		1,083,485			1,072,320			11,165			1.0			2,094,280			2,022,592			71,688			3.5
Income before income taxes	$	172,437		$	154,738		$	17,699			11.4	%	$	260,111		$	224,238		$	35,873			16.0	%
Margins		13.7	%		12.6	%		1.1	%		8.7	%		11.0	%		10.0	%		1.0	%		10.0	%

(1)	Not meaningful

Direct premiums and escrow fees were $522.9 million and $926.9 million for the three and six months ended June 30, 2016, respectively, increases of $7.6 million, or 1.5%, and $0.4 million, or essentially flat, when compared with the respective periods of the prior year. The increase for the three months ended June 30, 2016 was primarily due to an increase in average revenues per order closed, partially offset by a decrease in domestic title orders closed. The six months ended June 30, 2016 was essentially flat due to the increase in average revenues per order closed being offset by a decrease in domestic title orders closed. The average revenues per order closed were $1,972 and $1,959 for the three and six months ended June 30, 2016, respectively, increases of 2.8% and 4.2% when compared with $1,918 and $1,880 for the respective periods of the prior year. The increases in average revenues per order closed for the three and six months ended June 30, 2016 were primarily attributable to higher residential real estate values. Average revenues per order closed for the six months ended June 30, 2016 also benefited from a shift in mix of direct revenues generated from lower premium refinance products to higher premium commercial products. The Company’s direct title operations closed 244,200 and 437,300 title orders during the three and six months ended June 30, 2016, respectively, decreases of 0.9% and 3.7% when compared with 246,500 and 454,100 title orders closed during the respective periods of the prior year.

Agent premiums were $515.8 million and $1.0 billion for the three and six months ended June 30, 2016, respectively, increases of $14.2 million, or 2.8%, and $93.5 million, or 10.0%, when compared with the respective periods of the prior year. Agent premiums are recorded when notice of issuance is received from the agent, which is generally when cash payment is received by the Company. As a result, there is generally a delay between the agent’s issuance of a title policy and the Company’s recognition of agent premiums. Therefore, current quarter agent premiums typically reflect prior quarter mortgage origination activity. The increase in agent premiums quarter over quarter was generally consistent with the 1.8% decrease in the Company’s direct premiums and escrow fees in the first quarter of 2016 as compared with the first quarter of 2015.

Information and other revenues primarily consist of revenues generated from fees associated with title search and related reports, title and other real property records and images, other non-insured settlement services, and risk mitigation products and services. These revenues generally trend with direct premiums and escrow fees but are typically less volatile since a portion of the revenues are subscription based and do not fluctuate with transaction volumes.

Information and other revenues were $182.0 million and $336.2 million for the three and six months ended June 30, 2016, respectively, an increase of $2.0 million, or 1.1%, and a decrease of $0.2 million, or essentially flat, when compared with the respective periods of the prior year. Excluding the $8.4 million and $10.5 million impact of new acquisitions for the three and six months ended June 30, 2016, respectively, information and other revenues decreased $6.4 million, or 3.6%, and $10.7 million, or 3.2%, when compared with the respective periods of the prior year. The decreases in information and other revenues for the three and six months ended June 30, 2016, adjusted for the impact of acquisitions, were due to lower demand for the Company’s default information products as a result of lower loss mitigation activities when compared with the same periods of the prior year and lower revenue in our Australian operations due to the loss of a large customer.

Net investment income totaled $27.5 million and $52.4 million for the three and six months ended June 30, 2016, respectively, increases of $1.5 million, or 5.7%, and $4.6 million, or 9.7%, when compared with the respective periods of the prior year. The increases were primarily attributable to higher interest income from the investment portfolio due to higher average balances in the title insurance and services segment’s debt securities portfolio, partially offset by lower income from investments accounted for using the equity method when compared to the same periods of the prior year.

Net realized investment gains totaled $7.8 million and $10.8 million for the three and six months ended June 30, 2016, respectively, and were primarily from the sales of equity securities. Net realized investment gains for the six months ended June 30, 2016 also included gains from the sales of real estate and certain regional operations. Net realized investment gains totaled $4.2 million and $1.6 million for the three and six months ended June 30, 2015, respectively, and included gains from the sales of real estate of $8.1 million and $9.1 million, respectively, partially offset by impairment on internally developed software of $6.6 million recorded in the three months ended June 30, 2015.

The title insurance and services segment (primarily direct operations) is labor intensive; accordingly, a major expense component is personnel costs. This expense component is affected by two primary factors: the need to monitor personnel changes to match the level of corresponding or anticipated new orders and the need to provide quality service.

Personnel costs were $389.8 million and $744.9 million for the three and six months ended June 30, 2016, respectively, increases of $8.8 million, or 2.3%, and $24.6 million, or 3.4%, when compared with the respective periods of the prior year. Excluding the $6.1 million and $8.6 million impact of new acquisitions for the three and six months ended June 30, 2016, respectively, personnel costs increased $2.7 million, or 0.7%, and $16.0 million, or 2.2%, when compared with the respective periods of the prior year. The increases in personnel costs for the three and six months ended June 30, 2016, adjusted for the impact of new acquisitions, were primarily attributable to higher salary and share based compensation costs, partially offset by lower incentive compensation expense due to lower expected 401(k) savings plan matches. The higher salary costs were due to an increase in average salaries and higher average headcount. The higher share based compensation costs were due to increased restricted stock units granted to employees during the first quarter of 2016 associated with 2015 performance. The increase in personnel costs for the six months ended June 30, 2016, adjusted for the impact of new acquisitions, was also attributable to higher employee benefit costs primarily due to higher paid medical claims in the first quarter of 2016 when compared to the same period of the prior year.

Agents retained $403.7 million and $808.7 million of title premiums generated by agency operations for the three and six months ended June 30, 2016, respectively, which compares with $395.3 million and $738.0 million for the respective periods of the prior year. The percentage of title premiums retained by agents was 78.3% and 78.7% for the three and six months ended June 30, 2016, respectively, compared to 78.8% and 79.0% for the respective periods of the prior year. The decreases in the percentage of title premiums retained by agents for the three and six months ended June 30, 2016 were due to a change in the geographic mix of agency revenues towards lower agent-retention geographies.

Other operating expenses for the title insurance and services segment were $195.5 million and $361.0 million for the three and six months ended June 30, 2016, respectively, an increase of $1.2 million, or 0.6%, and a decrease of $13.9 million, or 3.7%, when compared with the respective periods of the prior year. Excluding the $1.3 million and $2.8 million impact of new acquisitions for the three and six months ended June 30, 2016, respectively, other operating expenses decreased $0.1 million, or essentially flat, and $16.7 million, or 4.5%, when compared with the respective periods of the prior year. The slight decrease in other operating expenses for the three months ended June 30, 2016, adjusted for the impact of new acquisitions, was primarily attributable to lower production related costs and lower bad debt expense, offset by increased professional services costs. The decrease in other operating expenses for the six months ended June 30, 2016, adjusted for the impact of new acquisitions, was primarily attributable to lower production related costs, lower bad debt expense and a recovery on an insurance claim. Production related costs for the three and six months ended June 30, 2016 declined due to lower order volumes and an increase in the mix of revenues generated from products with lower production related expenses as a percentage of revenue.

The provision for policy losses and other claims, expressed as a percentage of title insurance premiums and escrow fees, was 5.5% for the three and six months ended June 30, 2016 compared to 6.6% for the three and six months ended June 30, 2015. The current quarter rate of 5.5% reflects the ultimate loss rate of 5.0% for the current policy year and a $5.2 million net increase in the loss reserve estimates for prior policy years. The second quarter of 2015 rate of 6.6% reflected the ultimate loss rate of 6.0% for the 2015 policy year and a $5.7 million net increase in the loss reserve estimates for prior policy years.

Depreciation and amortization expense was $22.4 million and $43.5 million for the three and six months ended June 30, 2016, respectively, increases of $2.3 million, or 11.3%, and $3.8 million, or 9.6%, when compared with the respective periods of the prior year. The increases in depreciation and amortization for the three and six months ended June 30, 2016 were primarily attributable to the amortization expense associated with internally developed technology and purchased software licenses.

Premium taxes were $14.2 million and $27.2 million for the three and six months ended June 30, 2016, respectively, increases of $52 thousand, or essentially flat, and $1.0 million, or 3.7%, respectively, compared to $14.2 million and $26.2 million for the same periods of the prior year. Premium taxes as a percentage of title insurance premiums and escrow fees were 1.4% for the three and six months ended June 30, 2016 and 2015.

The profit margins for the title insurance business reflect the high cost of performing the essential services required before insuring title, whereas the corresponding revenues are subject to regulatory and competitive pricing restraints. Due to this relatively high proportion of fixed costs, title insurance profit margins generally improve as closed order volumes increase. Title insurance profit margins are affected by the composition (residential or commercial) and type (resale, refinancing or new construction) of real estate activity. Title insurance profit margins are also affected by the percentage of title insurance premiums generated by agency operations. Profit margins from direct operations are generally higher than from agency operations due primarily to the large portion of the premium that is retained by the agent. Pre-tax margins for the three and six months ended June 30, 2016 were 13.7% and 11.0%, respectively, compared with 12.6% and 10.0% in the respective periods of the prior year.

Specialty Insurance

	Three Months Ended June 30,												Six Months Ended June 30,
(in thousands, except percentages)	2016			2015			$ Change			% Change			2016			2015			$ Change			% Change
Revenues
Direct premiums	$	101,104		$	94,314		$	6,790			7.2	%	$	198,978		$	184,467		$	14,511			7.9	%
Information and other		819			856			(37	)		(4.3	)		1,640			1,628			12			0.7
Net investment income		2,254			2,215			39			1.8			4,490			4,216			274			6.5
Net realized investment gains		247			268			(21	)		(7.8	)		2,357			1,878			479			25.5
		104,424			97,653			6,771			6.9			207,465			192,189			15,276			7.9
Expenses
Personnel costs		17,023			16,817			206			1.2			33,802			32,441			1,361			4.2
Other operating expenses		14,209			11,116			3,093			27.8			28,961			24,208			4,753			19.6
Provision for policy losses and other claims		65,234			56,135			9,099			16.2			121,816			102,138			19,678			19.3
Depreciation and amortization		1,459			1,177			282			24.0			2,707			2,382			325			13.6
Premium taxes		1,781			1,818			(37	)		(2.0	)		3,217			3,256			(39	)		(1.2	)
		99,706			87,063			12,643			14.5			190,503			164,425			26,078			15.9
Income before income taxes	$	4,718		$	10,590		$	(5,872	)		(55.4	)%	$	16,962		$	27,764		$	(10,802	)		(38.9	)%
Margins		4.5	%		10.8	%		(6.3	)%		(58.3	)%		8.2	%		14.4	%		(6.2	)%		(43.1	)%

Direct premiums were $101.1 million and $199.0 million for the three and six months ended June 30, 2016, respectively, increases of $6.8 million, or 7.2%, and $14.5 million, or 7.9%, when compared with the respective periods of the prior year. The increases in direct premiums for the three and six months ended June 30, 2016 were attributable to higher premiums earned in the home warranty business driven by an increase in the price charged for home warranty residential service contracts and an increase in the number of contracts issued.

Net realized investment gains totaled $0.2 million and $2.4 million for the three and six months ended June 30, 2016, respectively, and $0.3 million and $1.9 million for the three and six months ended June 30, 2015, respectively. The net realized gains for the three months ended June 30, 2016 were from the sales of debt securities. The net realized gains for the six months ended June 30, 2016 were primarily from the sale of real estate. The net realized gains for the three and six months ended June 30, 2015 were from the sales of debt and equity securities.

Personnel costs and other operating expenses were $31.2 million and $62.8 million for the three and six months ended June 30, 2016, respectively, increases of $3.3 million, or 11.8%, and $6.1 million, or 10.8%, when compared with the respective periods of the prior year. The increases were primarily related to higher advertising expense in the home warranty business, higher offshore labor expense related to increased customer support activities associated with the increased volume in the home warranty business, and higher salary expense due to higher average salaries.

The provision for home warranty claims, expressed as a percentage of home warranty premiums, was 66.6% and 60.0% for the three and six months ended June 30, 2016, respectively, compared with 59.6% and 53.4% for the respective periods of the prior year. The increases in the claims rates for the three and six months ended June 30, 2016 were primarily attributable to higher contract servicing costs and, to a lesser extent, increased claims frequency. The provision for property and casualty claims, expressed as a percentage of property and casualty insurance premiums, was 60.0% and 63.9% for the three and six months ended June 30, 2016, respectively, compared with 59.3% and 59.2% for the respective periods of the prior year. The increases in the claims rates for the three and six months ended June 30, 2016 were primarily attributable to increases in the severity of claims, partially offset by lower claims frequency.

Premium taxes were $1.8 million and $3.2 million for the three and six months ended June 30, 2016, respectively, compared with $1.8 million and $3.3 million for the respective periods of the prior year. Premium taxes as a percentage of specialty insurance segment premiums were 1.8% and 1.6% for the three and six months ended June 30, 2016, respectively, and 1.9% and 1.8% for the three and six months ended June 30, 2015, respectively.

A large part of the revenues for the specialty insurance businesses are generated by renewals and are not dependent on the level of real estate activity in the year of renewal. With the exception of loss expense, the majority of the expenses for this segment are variable in nature and therefore generally fluctuate consistent with revenue fluctuations. Accordingly, profit margins for this segment (before loss expense) are relatively constant, although as a result of some fixed expenses, profit margins (before loss expense) should nominally improve as premium revenues increase. Pre-tax margins for the three and six months ended June 30, 2016 were 4.5% and 8.2%, respectively, compared with 10.8% and 14.4% in the respective periods of the prior year.

Corporate

	Three Months Ended June 30,												Six Months Ended June 30,
(in thousands, except percentages)	2016			2015			$ Change			% Change			2016			2015			$ Change			% Change
Revenues
Net investment income (losses)	$	1,202		$	(325	)	$	1,527			NM	¹%	$	1,410		$	(3,152	)	$	4,562			144.7	%
Net realized investment losses		—			(568	)		568			100.0			—			(568	)		568			100.0
		1,202			(893	)		2,095			234.6			1,410			(3,720	)		5,130			137.9
Expenses
Personnel costs		10,903			9,597			1,306			13.6			21,756			20,857			899			4.3
Other operating expenses		6,663			6,430			233			3.6			13,094			12,905			189			1.5
Depreciation and amortization		96			122			(26	)		(21.3	)		192			245			(53	)		(21.6	)
Interest		7,088			6,664			424			6.4			14,242			13,705			537			3.9
		24,750			22,813			1,937			8.5			49,284			47,712			1,572			3.3
Loss before income taxes	$	(23,548	)	$	(23,706	)	$	158			0.7	%	$	(47,874	)	$	(51,432	)	$	3,558			6.9	%

(1)	Not meaningful

Net investment income totaled $1.2 million and $1.4 million for the three and six months ended June 30, 2016, respectively, compared with losses of $0.3 million and $3.2 million for the respective periods of the prior year. The increases in net investment income for the three and six months ended June 30, 2016 were primarily attributable to higher earnings on investments associated with the Company’s deferred compensation plan when compared to the same periods of 2015. Net investment losses for the six months ended June 30, 2015 was also impacted by a one-time non-cash expense of $4.0 million, recorded during the first quarter of 2015, related to the investments associated with the Company’s deferred compensation plan.

Corporate personnel costs and other operating expenses were $17.6 million and $34.9 million for the three and six months ended June 30, 2016, respectively, compared with $16.0 million and $33.8 million for the respective periods of the prior year. The increases in personnel costs and other operating expenses for the three and six months ended June 30, 2016 were primarily attributable to increased expense related to the Company’s deferred compensation plan.

Eliminations

The Company’s inter-segment eliminations were not material for the three and six months ended June 30, 2016 and 2015.

INCOME TAXES

The Company’s effective income tax rates (income tax expense as a percentage of income before income taxes) were 33.3% and 32.3% for the three and six months ended June 30, 2016, respectively, compared with 33.9% and 34.5% for the respective periods of the prior year. The differences in the effective tax rates were primarily due to changes in state and foreign income taxes resulting from fluctuations in the Company’s noninsurance and foreign subsidiaries’ contribution to pretax income and changes in the ratio of permanent differences to income before income taxes. The rates for both the three and six months ended June 30, 2016 include a benefit for the resolution of certain tax authority examinations and tax credits in current and prior years.

NET INCOME AND NET INCOME ATTRIBUTABLE TO THE COMPANY

Net income for the three and six months ended June 30, 2016 was $102.5 million and $155.1 million, respectively, compared with $93.6 million and $131.4 million for the respective periods of the prior year. Net income attributable to the Company for the three and six months ended June 30, 2016 was $102.1 million, or $0.92 per diluted share, and $154.7 million, or $1.40 per diluted share, respectively, compared with $93.3 million, or $0.85 per diluted share, and $131.0 million, or $1.19 per diluted share, for the respective periods of the prior year.

LIQUIDITY AND CAPITAL RESOURCES

Cash requirements. The Company generates cash primarily from the sale of its products and services and investment income. The Company’s current cash requirements include operating expenses, taxes, payments of principal and interest on its debt, capital expenditures and dividends on its common stock, and may include business acquisitions and repurchases of its common stock. Additionally, in May 2016, the Company’s board of directors terminated the Company’s funded defined benefit pension plan effective as of July 31, 2016. In connection with the termination, to sufficiently fund the pension plan, the Company expects to make additional cash contributions totaling approximately $100 million, in addition to paying other termination related expenses. For further discussion of the pension termination and expected additional cash contributions, see Note 9 Employee Benefit Plans to the condensed consolidated financial statements. Management forecasts the cash needs of the holding company and its primary subsidiaries and regularly reviews their short-term and long-term projected sources and uses of funds, as well as the asset, liability, investment and cash flow assumptions underlying such forecasts. Due to the Company’s ability to generate cash flows from operations, its liquid-asset position and amounts available on its revolving credit facility, management believes that its resources are sufficient to satisfy its anticipated operational cash requirements and obligations for at least the next twelve months.

The substantial majority of the Company’s business is dependent upon activity in the real estate and mortgage markets, which are cyclical and seasonal. Periods of increasing interest rates and reduced mortgage financing availability generally have an adverse effect on residential real estate activity and therefore typically decrease the Company’s revenues. In contrast, periods of declining interest rates and increased mortgage financing availability generally have a positive effect on residential real estate activity which typically increases the Company’s revenues. Residential purchase activity is typically slower in the winter months with increased volumes in the spring and summer months. Residential refinance activity is typically more volatile than purchase activity and is highly impacted by changes in interest rates. Commercial real estate volumes are less sensitive to changes in interest rates, but fluctuate based on local supply and demand conditions for space and mortgage financing availability.

Cash provided by operating activities amounted to $146.4 million and $166.9 million for the six months ended June 30, 2016 and 2015, respectively, after claim payments, net of recoveries, of $225.6 million and $251.5 million, respectively. The principal nonoperating uses of cash and cash equivalents for the six months ended June 30, 2016 and 2015 were purchases of debt and equity securities, capital expenditures, dividends to common stockholders and business acquisitions. The most significant nonoperating sources of cash and cash equivalents for the six months ended June 30, 2016 and 2015 were proceeds from the sales and maturities of debt and equity securities and increases in the deposit balances at the Company’s banking operations. The net effect of all activities on total cash and cash equivalents were increases of $214.5 million and $79.6 million for the six months ended June 30, 2016 and 2015, respectively.

The Company continually assesses its capital allocation strategy, including decisions relating to dividends, stock repurchases, capital expenditures, acquisitions and investments. In May 2016, the Company’s board of directors approved a second quarter cash dividend of 26 cents per common share. Management expects that the Company will continue to pay quarterly cash dividends at or above the current level. The timing, declaration and payment of future dividends, however, falls within the discretion of the Company’s board of directors and will depend upon many factors, including the Company’s financial condition and earnings, the capital requirements of the Company’s businesses, industry practice, restrictions imposed by applicable law and any other factors the board of directors deems relevant from time to time.

In March 2014, the Company’s board of directors approved an increase in the size of the Company’s stock repurchase plan from $150.0 million to $250.0 million, of which $182.4 million remained as of June 30, 2016. Purchases may be made from time to time by the Company in the open market at prevailing market prices or in privately negotiated transactions. During the six months ended June 30, 2016, the Company repurchased and retired 14 thousand shares of its common stock for a total purchase price of $454 thousand and as of June 30, 2016, had repurchased and retired 3.2 million shares of its common stock under the current authorization for a total purchase price of $67.6 million.

Holding Company. First American Financial Corporation is a holding company that conducts all of its operations through its subsidiaries. The holding company’s current cash requirements include payments of principal and interest on its debt, taxes, payments in connection with employee benefit plans, dividends on its common stock and other expenses. The holding company is dependent upon dividends and other payments from its operating subsidiaries to meet its cash requirements. The Company’s target is to maintain a cash balance at the holding company equal to at least twelve months of estimated cash requirements. At certain points in time, the actual cash balance at the holding company may vary from this target due to, among other factors, the timing and amount of cash payments made and dividend payments received. Pursuant to insurance and other regulations under which the Company’s insurance subsidiaries operate, the amount of dividends, loans and advances available to the holding company is limited, principally for the protection of policyholders. As of June 30, 2016, under such regulations, the maximum amount of dividends, loans and advances available to the holding company from its insurance subsidiaries for the remainder of 2016, without prior approval from applicable regulators, was $554.0 million. However, the timing and amount of dividends paid by the Company’s insurance subsidiaries to the holding company falls within the discretion of each insurance subsidiary’s board of directors and will depend upon many factors, including the level of total statutory capital and surplus required to support minimum financial strength ratings by certain rating agencies. Such restrictions have not had, nor are they expected to have, an impact on the holding company’s ability to meet its cash obligations.

As of June 30, 2016, the holding company’s sources of liquidity included $231.0 million of cash and cash equivalents and $700.0 million available on the Company’s revolving credit facility. Management believes that liquidity at the holding company is sufficient to satisfy anticipated cash requirements and obligations for at least the next twelve months.

Financing. The Company maintains a credit agreement with JPMorgan Chase Bank, N.A. in its capacity as administrative agent and the lenders party thereto. The credit agreement is comprised of a $700.0 million revolving credit facility. Unless terminated earlier, the revolving loan commitments under the credit agreement will terminate on May 14, 2019. The obligations of the Company under the credit agreement are neither secured nor guaranteed. Proceeds under the credit agreement may be used for general corporate purposes. At June 30, 2016, the Company had no outstanding borrowings under the facility and was in compliance with the financial covenants under the credit agreement.

In addition to amounts available under its credit facility, certain subsidiaries of the Company are parties to master repurchase agreements which are used as part of the Company’s liquidity management activities and to support its risk management activities. In particular, securities loaned or sold under repurchase agreements may be used as short-term funding sources. During the six months ended June 30, 2016, the Company financed securities for funds received totaling $24.5 million under these agreements. As of June 30, 2016, no amounts remained outstanding under these agreements.

Notes and contracts payable as a percentage of total capitalization was 16.4% and 17.5% at June 30, 2016 and December 31, 2015, respectively.

Investment Portfolio. The Company maintains a high quality, liquid investment portfolio that is primarily held at its insurance and banking subsidiaries. As of June 30, 2016, 93% of the Company’s investment portfolio consisted of fixed income securities, of which 63% were United States government-backed or rated AAA and 94% were rated or classified as investment grade. Percentages are based on the estimated fair values of the securities. Credit ratings reflect published ratings obtained from Standard & Poor’s Rating Services, DBRS, Inc., Fitch Ratings, Inc. and Moody’s Investor Service, Inc. If a security was rated differently among the rating agencies, the lowest rating was selected. For further information on the credit quality of the Company’s investment portfolio at June 30, 2016, see Note 3 Debt and Equity Securities to the condensed consolidated financial statements.

In addition to its debt and equity securities portfolio, the Company maintains certain money-market and other short-term investments.

Off-balance sheet arrangements. The Company administers escrow deposits and trust assets as a service to its customers. Escrow deposits totaled $8.0 billion and $6.6 billion at June 30, 2016 and December 31, 2015, respectively, of which $3.0 billion and $2.6 billion, respectively, were held at the Company’s federal savings bank subsidiary, First American Trust, FSB. The escrow deposits held at First American Trust, FSB are temporarily invested in cash and cash equivalents and debt securities, with offsetting liabilities included in deposits in the accompanying condensed consolidated balance sheets. The remaining escrow deposits were held at third-party financial institutions.

At June 30, 2016 and December 31, 2015, the Company was contingently liable for guarantees of indebtedness owed by affiliates and third parties to banks and others totaling $7.4 million and $8.2 million, respectively. The guarantee arrangements relate to promissory notes and other contracts that contingently require the Company to make payments to the guaranteed party upon the failure of debtors to make scheduled payments according to the terms of the notes and contracts. The Company’s maximum potential obligation under these guarantees totaled $7.4 million and $8.2 million at June 30, 2016 and December 31, 2015, respectively, and is limited in duration to the terms of the underlying indebtedness. The Company has not incurred any costs as a result of these guarantees and has not recorded a liability on its condensed consolidated balance sheets related to these guarantees at June 30, 2016 and December 31, 2015.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk.

The Company’s primary exposure to market risk relates to interest rate risk associated with certain financial instruments. Although the Company monitors its risk associated with fluctuations in interest rates, it does not currently use derivative financial instruments on any significant scale to hedge these risks.

There have been no material changes in the Company’s market risks since the filing of its Annual Report on Form 10-K for the year ended December 31, 2015.

Item 4.

Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

The Company’s chief executive officer and chief financial officer have concluded that, as of June 30, 2016, the end of the quarterly period covered by this Quarterly Report on Form 10-Q, the Company’s disclosure controls and procedures, as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended, were effective, based on the evaluation of these controls and procedures required by Rule 13a-15(b) thereunder.

Changes in Internal Control Over Financial Reporting

There was no change in the Company’s internal control over financial reporting during the quarter ended June 30, 2016, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II: OTHER INFORMATION

Item 1.

Legal Proceedings.