Price – $37.18 Market Cap – $78m
Net Cash & Investments on B/S – $35.70
2011 EPS estimate = $3.10
2012 Dividend – $0.28
Investors Title Company (NASDAQ: ITIC) is based in Chapel Hill, North Carolina, Investors Title Company is a holding company for Investors Title Insurance Company and National Investors Title Insurance Company which write policies to protect mortgage lenders and homeowners from unforeseen claims made against title to real property.
Our Margin of Safety
- A $78m company which is has a moat around its business, remains profitable and yet has “excess” cash and investments of at least $75m which could potentially be taken out the business without affecting operations or loss reserves. Essentially we are buying a low risk investment portfolio and getting a profitable family run business for free.
- Buying on a low multiple of trough cyclical earnings a company that has demonstrated its resilience across many real estate cycles.
- Customers are legally obliged to buy their product
Investors Title Company was founded in 1972 by current chairman, CEO and patriarch J. Allen Fine. He has grown the business from nothing to a $80-100m business. Allen Fine earned a Bachelor’s Degree in Accounting and Master’s in Business Administration from the University of North Carolina at Chapel Hill. He is a CPA and began his career teaching accounting at UNC-CH School of Business. In the late 1960′s, Allen made the decision to start a business. He identified the need for title insurance, researched the subject, and in 1972 Investors Title first opened its doors.
Two of his sons, one a qualified CPA and one a CFA, are now also in the business as CFO and as Company Secretary respectively. Between the family and other senior execs they own 26% of the common stock.
ITIC isn’t just the Fine family business in that it puts food on the table; this business is the family legacy in the state of North Carolina. It would seem that they really play on the fact that this is more important to them than just insurance. If so, that’s a good intangible to be invested alongside. Highly specialised, passionate owner operators.
Traditionally a North Carolina based business, the company is expanding aggressively into other states particularly Texas, which has gone from a negligible amount to 37% of revenue in the space of a year!
The Business Model
As I said above, customers are legally obliged to buy ITIC’s product. Let me explain, a purchaser of real estate buys title insurance to eliminate their risk of loss due to title defects, encumberances or liens against their property. In fact, mortgage lenders require title insurance before lending – to protect them from having security over bad assets.
Title insurance protects owners and lenders from myriad potential issues after the completion of a real estate purchase including forgeries, tax judgements and incorrectly executed deeds. Such defects could call into question whether the buyer has clear title to the property. Title insurers are responsible for performing an examination of the land records to ensure that the seller has proper standing to convey ownership to the buyer. In the event that the title proves to be defective at a later date, the title insurer is responsible for covering the resulting losses up to the coverage limit of the policy.
Issues of some sort arise in 1 in 3 residential transactions. The job of the title insurer is slightly different to a normal insurer in that they endeavour to head off these problems BEFORE they arise.
Traditional insurance takes a premium, has a small SG&A expense and a very large reserve against claim losses. Title insurance takes a premium, spends a lot on SG&A expense as it investigates and frees the property from potential problems and liabilities – the loss reserve is comparatively small. By far the main expense in the industry is the due diligence and investigation required to make sure titles are free and clear, this constitutes 70-80% of each premium received or 70-80% of revenue whichever way you want to look at it.
Title insurance is not normal insurance. Insurers seek to assume risk and be compensated for doing so; title insurers look to identify risk and then eliminate it before guaranteeing against their own work. It is a service business, they only compensate if they don’t do their job properly.
Title Insurance seems to be a pretty closed industry with no major competitors entering in the last few years. The business is a transactional one built on relationships between people. There is no price competition between companies as the price is set by the state. Buyers usually take advice from their professional service providers on whom to buy title insurance from. So the realtors and lawyers can allocate business on the basis of whom they have a good relationship with; the Fines at ITIC have been around for 40 years, are local specialists and have had as long as anyone to build up a good network of referrers in their business.
Home or Branch Policies
Title insurance companies typically issue their policies directly through branch offices or through title agencies. In the Company’s home and branch operations, the Company issues the insurance policy and retains the entire premium, as no commissions are paid in connection with these policies. All of the Company’s branch offices are located in North Carolina; as a result, the home and branch office premiums written are primarily for North Carolina policies.
When a policy is written through a title agency, agents retain the majority of the title premium collected, with the balance remitted to the title underwriter for bearing the risk of loss in the event that a claim is made under the title insurance policy. The increase in the percentage of total premiums written by agencies in 2011 is primarily due to the Company’s strategy of growth through expansion of its agency base and the influence of local geographic trends. Agency premiums have become 80% of the business, up from 70% just 12 months ago as they achieve scale outside of North Carolina.
The Size of the Addressable Market
ITIC is a tiny player in the broader American title insurance market. There are 4 national insurers that make up 90% of business written nationally. ITIC has a national market share of only 0.6% due to its traditional, specific focus in North Carolina where they now do around a third of their business and which historically was the source of almost all of their revenue.
Within North Carolina however, ITIC is one of the Big Players commanding around a quarter of the market, a share which has held steady for the last decade.
The Total Title Insurance market in the US was worth about $3.5-4bn per annum in the early 1990’s, and north of $16bn as of the mid 2000’s. In 2010 it was $9.6bn, it doesn’t seem unreasonable to imagine that this might tick back up as the real estate market becomes more liquid again.
It is worth noting that ITIC is primarily dependent on real estate volume not pricing. To be an owner of ITIC one doesn’t have to have a rosy outlook on house prices, merely a belief that at some stage there will be increased activity and when there is the delta to ITIC’s profits will be large. The re-financing market (because it involves new mortgage docs) is also an important part of ITIC’s market, given that rates have been ultra low for 3 years now it’s likely that anyone who could refinance, has refinanced.
From the recent management statement;
“In 2010, refinancing activity accounted for 69.9% of all mortgage originations. In 2011, refinancing transactions are projected by the October 11, 2011 MBA Mortgage Finance Forecast to account for 66.2% of mortgage originations. The projected decrease is attributable to the higher levels of refinance volume that occurred in prior years, as well as reduced available equity and more stringent requirements being imposed by lenders. Despite current mortgage rates falling to the lowest levels in decades, the Company believes that many homeowners would need rates to fall even further to justify the closing costs involved with subsequent refinance transactions.”
The point being, I really think we are looking at trough revenue for the industry and for the company. Despite this, it’s a reasonable 12x earnings.
Positive Business Mix
In the 3rd Quarter of 2010, ITIC began writing business in Texas, the second largest title insurance market in the US. This has already had a positive impact on premium growth.
North Carolina is decreasing as a share of the overall business as it expands into other states. NC premiums are less than half the national average and therefore the resulting loss ratio is always higher for NC than for other states, all other things being equal. This should help to improve margins if they can achieve operational scale in alternate, higher premium states.
From the annual report;
“In a cyclical industry such as ours expense management and operating efficiency are critical. We remain focused on managing expenses with an emphasis on staffing and occupancy costs. In 2010, payroll and occupancy costs decreased by 4% YoY even as we continued to make targeted investments in growth opportunities and strategic technology initiatives.”
Remarkably, the company spent the same on SG&A in 2003 as in 2010 despite the fact that it wrote 38% more business in 2003. This demonstrates that it is a relatively high fixed cost business as they are reluctant to cut staff because staff own relationships which are the source of business. This provides a great deal of built in operating leverage which is currently slack but is there, waiting to enhance the bottom line.
Because of the size of their investment portfolio relative to the market cap ($83.6m Fixed Income portfolio) there is a great deal of sensitivity to interest rates. The vast majority of the portfolio is in Treasuries, Muni securities and corporate bonds. Unfortunately, I cannot ascertain the duration of the portfolio beyond a vague statement in the accounts that the “effective maturity of the majority of the bonds is within 10 years.”
Although they clearly bear interest risk and the capital value of the bond portfolio may change due to rising interest rates, it is worth noting that for each 1% rise in interest rates, net income would likely increase by something near $1m on a portfolio of that size.
“For the nine months ended September 30, 2011, net premiums written increased 50.1% to $63,303,202, investment income decreased 3.3% to $2,665,245, total revenues increased 42.3% to $69,858,103 and net income increased 26.2% to $5,054,477, all compared with the same nine month period in 2010.
Both net income per basic and diluted common share increased from $1.75 for the nine months ended September 30, 2010 to $2.34 and $2.32, respectively, for the comparable period in 2011.”
Get The Business For Free?
ITIC is a nice story and a good business, but it’s not one I can get hugely excited about. However, if you offer it to me for free, I’ll take it. I think you can get the business for free because, as it is currently, ITIC is vastly overcapitalised. Thankfully, it has a very clean balance sheet which makes it easy to identify the value – being conservative (omitting all accounts receivable etc)….
|Investments in Fixed Income||$83.6m|
|Investments in Equities||$17.7m|
|Short Term Investments||$21.7m|
|Cash and Cash Equivalents||$14.7m|
|Property (at book cost)||$3.6m|
|Reserves for Claims||$37.6m|
Shareholder Equity =
This is remarkable relative to a market cap of $78m! On top of this the company had net income of about $5.4m over the last 12 months.
The company could close down today, pay off all liabilities, liquidate their portfolio and return $92.6m/2.12m shares = $43.67 per share to its owners. That’s a 17% premium to today’s price, but it would be madness to shutdown a stable, profitable and growing business – it’s just nice to know!
The value of the real estate seems to be substantially understated too as demonstrated in this article.
This adds another $5-8m to book value depending on how conservative or optimistic you would like to be. Significant, as it adds a few dollars to the intrinsic value of the share.
“The Company purchased 168,516 shares in the first nine months of 2011 and 10,592 for the same period in 2010 at an average per share price of $32.20 and $31.22, respectively.”
There is authority to buy back up to 500,000 shares under the current scheme. The recent purchases shrunk the share count by an impressive 7% indicating management see some serious value and that they are willing to do something about it.
Of course with most equity investments the risk is that the future doesn’t look like the past. In particular to ITIC, the risk that is likely weighing most heavily on the market is the prospect of years of continued depression in housing. A sustained slump would result in low transaction volumes as “underwater” borrowers are unable to sell their houses without wiping out their equity and new construction continues to flat-line the bottom with low levels of housing starts. ITIC has a geographic concentration that does not include the bubble markets of California, Florida, Nevada, and Arizona and is therefore protected from the worst regions. Additionally, the company has proven it’s resiliency, profits in periods of exceptional stress, with the exception of 2008.
Unfortunately, I can’t see a special dividend in the near future but it’s likely that the management will continue to buy back undervalued shares. At the current market cap of $78m you get an owner operated business of long standing and good reputation with $6m of cyclically depressed earnings and a liquidation value of around $100m.
Running this operation you have an experienced and highly incentivised management team with a multi decade track record expanding the business into new higher margin territories. It’s a rare opportunity when a consistently profitable business is available for free. The only reason the stock is this cheap is because it’s unknown, something this article is designed to remedy.
David Merkel said:
Note: title insurance reserving is a dark art. Claims are largely, but not entirely, driven by fraud.
Ask the company to divulge their reserving formula to you, at least in broad. See what they say. I’ve never had a title insurer give me a good answer, and as an actuary, I find that interesting.
This is a really interesting point David, an insight I’ve not come across (or even considered!!). I will have a go at asking but to be honest they are not very responsive to outside investors – its “their” business, i’m just borrowing it!
From my understanding though the reserving is legally mandated in North Carolina and then tapered off over the course of a few years as the probability of a claim is perceived to dissipate with time? Is that correct?
I guess you are right in that it’s a dark art and less obviously calculable than a life expectancy table. However, am I being compensated for that inherent ambiguity in the current valuation?
The Khrom Cap letter that you mentioned said this about reserving in North Carolina:
As discussed at the outset, the main expense in the title insurance business is the work required to make sure the title is free and clear. This work is done either internally by the insurer or through title agents, who retain about 70% to 80% of the insurance premium for their services.
The remaining amount of the premium is not yet profits, since a portion must still go towards loss reserves for the few claims that still arise. Dependent on the state, that loss reserve from 3-15% of the premium. This range of 3%-15% exists more so due to differences in premium of different states rather than loss costs. (E.g., say that in NY, title insurers are allowed to charge an $800 premium on a house that they can only charge a $400 premium for in NC. The claim frequency and severity in both states is probably the same, and so $50 of the premium would go towards reserves. Given the difference in the premium price, however, that would equal a loss ratio of 6% on the NY policy and 12% on the NC policy.)
(For those interested in the technicals, North Carolina loss reserves are regulated by statute, which dictates a title insurer shall initially reserve 10% of the direct premium written. Then, th reserves are allowed to be reduced annually, over a period of 20 years, pursuant to the following: 20% the first year; 10% for years two and three; 5% for years four through ten; 3% for years eleven through fifteen; and 2% for years sixteen through twenty.) “
El Toro said:
Do you have a position in ITIC? This is a great blog and you have a lot of talent. Why the FTSE hedge? If you believe GMO’s numbers the FTSE probably has an expected real return north of 5% per year. If you were running a fund and needed to smooth volatility for your investors it may make sense but for a personal account why bother?
El Toro, thanks for the compliment. I am really enjoying the blog – I think it forces me to refine my thinking and holds me to account. No Hiding!
Yeh I look at the GMO numbers and I’ve been amazed by their historical predictive power. However, I don’t want “north of 5%” real returns, I want “near 10%” real returns. I think that can only be achieved by good stockpicking and making sure that you preserve enough capital to be around to swing for the fences when valuations are extra cheap. Mid Month I actually went considerably more short/hedged and have only just started trimming that back this afternoon.
Also, I don’t like volatility, I’m of a nervous disposition!
Interesting post, however it seems to me that everyone is overestimating the amount by which they’re over-reserved. If you look at their last 10K, they explicitly note that the amount they’re currently required to hold by regulators is ~$65M of consolidated equity. It seems they could ask to take more out of their subs, buy would require regulatory approval (see below). Thus, there’s no reason to believe anything beyond ~$38M is excess capital. Furthermore, they note that $41.89M of this is for “required statutory premium reserve”. I’m not well-versed in insurance companies by my understanding is that this is basically a reserve for unearned premiums which could not be taken out of the company at this point.
I’m not sure I understand why you think ITIC has “at least $75M which could be taken out of the business”?
My calculations show that excluding the “excess capital” portion of interest-income, the business can earn in the low $2/per share range. Excess capital = ~$18/share.
10 P/E for earnings of $2.3/share + $18 excess capital = $41/share. Not a huge bargain, though not expensive.
“As of December 31, 2010 and 2009 approximately $65,297,000 and $62,822,000, respectively, of consolidated stockholders’ equity represents net assets of the Company’s subsidiaries that cannot be transferred in the form of dividends, loans or advances to the parent company under statutory regulations without prior insurance department approval.”
Sagitta, thanks for the reply. Some good points you made. I struggle to get my head around the insurance industry too which is part of the reason that I posted about – so people like you could tell me where/why I’m wrong!
I’ll need to go back and look at the 10K’s when I get a chance to fully address your points. Not the complete answer you are looking for! I’m sorry!
The reserve capital they are required to hold may be in a state of flux as the business mix changes. Reserve requirements were mandated by the NC state law however I have no idea what the situation is in Texas, an increasingly large part of the business.
They might not be able to take excess capital out of the business as easily as I suggested, but as long as it’s still there and they continue to earn decent returns on it – I remain a reasonably satisfied owner of that capital.
What I would say is that the low $2 earnings per share you calculate excluding any excess capital is correct – but misleading. Their income derives in large part from two extremely depressed factors; real estate transaction volume and interest income from a bond portfolio. At some point, these will both increase substantially, and we are paying a reasonable multiple on the depressed earnings.