Investors Title Company (ITIC): A Strong, Consistently Profitable Regional Title Insurer Trading at a Premium to Book Value
This stock was brought to me by Andrew. He wanted to know more about the title insurance industry. ITIC is a publicly traded (it trades on NASDAQ) regional title insurer. There are four large, national title insurers that account for 80-90% of all title insurance market share in the U.S. However, in some states – the leading title insurer is a homegrown operation. These companies are known as “regional” title insurers. ITIC was started by the Fine family in the 1970s (it became operational midway through 1976). By the 1980s, it became the largest title insurer in North Carolina. It has since expanded into other states – mainly Texas, Georgia, and South Carolina. Premiums in North Carolina, Texas, Georgia, and South Carolina account for 75-80% of the company’s premiums. ITIC writes mainly (but not totally) directly in North Carolina and through “issuing agents” (lawyers, bankers, basically anyone originating a real estate purchase or transfer or refinance) in other states. Generally, there is no commission associated with title insurance premiums written directly and slightly under a 70% commission rate for insurance written indirectly.
ITIC is a “primary” insurer. It does own a reinsurance subsidiary. And it both assumes and cedes some insurance each year. However, this has never been a material part of its business. As far as I can tell – and I only read the most recent 10-K from 2019 and the oldest 10-K from the mid-1990s – reinsurance has been less than 1% of revenues. My guess is that the reinsurance business is not for regulatory reasons. It probably has to do with the company’s choice to not retain individual risks in excess of a certain amount. For example – and this is just a hypothetical illustration, it may be close to the truth but is not something the company says explicitly – if someone wants $900,000 of title insurance, the company may take the first $500,000 and retain that risk in the usual insurance subsidiary and then pass the other $400,000 on to the reinsurance subsidiary. As of the 1990s, we know that this was not a requirement that state regulators in North Carolina put on the company. It was a choice the company was making.
ITIC’s financial position is strong. You can see it has an A.M. Best rating of “A” (there are only two notches above this: A+ and A++). In a podcast I did recently with Andrew, I mentioned that investors may want to look for an “A minus” or better rating from A.M. Best to know if there is anything about the company’s financial position that might be a concern in terms of the strength of an insurance subsidiary. Keep in mind that an A.M. Best rating is really an indication of insurance subsidiary strength as an insurer (safety for policyholders, ability to reinsure others, etc.) and not a credit rating. It’s certainly not a rating of the safety of the common stock or its dividend.
Having said that, I wasn’t surprised when I saw the A.M. Best rating. There are several indications in ITIC’s financials that suggest strength. One, the company uses effectively zero underwriting leverage. When you look at the consolidated balance sheet and compare premiums written, reserves for claims, etc. you can see that premiums are roughly in line with tangible shareholder’s equity. In fact, they are often somewhat below. Sometimes, the company may only be writing 80 cents to 90 cents of premiums for every $1 of tangible equity in its business. Another way to look at this is the ratio of investments to equity. They are about the same. So, when you are buying this company at a price-to-book of 1 – you’re getting about the stock price in bonds and common stocks. Many insurers – though not necessarily many title insurers – have far more dollars per share in investments than they do in book value. In other words, you pay $100 a share for a stock with an investment portfolio of far more than $100. That’s not the case here.
How would Buffett look at this company?
He’d think of the stock and bond portfolio as an investment portfolio he was buying. And then he’d value the actual underwriting (and other income – ITIC’s fee-based businesses are significant) as being priced for him at whatever premium he was paying above book. So, if you are paying $300 million in market cap for the whole company and paying a 1.4x price-to-book, you’re really buying a little over $200 million in a bond and stock portfolio and paying the other $100 million or so for the ongoing operations.
What does the investment portfolio consist of? It’s mostly revenue backed municipal bonds. The other one-third is in stocks. I’m not sure this 2/3rds bonds and 1/3rd stocks allocation is exactly what the company consciously targets. You can see that the stock portion of the portfolio is largely the result of unrealized gains in market value. At cost, the stock portfolio was smaller. They just haven’t sold it down.
What are the economics of a title insurer? Do they justify paying a premium over book?
So, title insurance – at least as far as ITIC practices it – is partially an income on “float” business. That’s difficult to see here, because the company has some off-balance sheet float that is big. In fact, off balance sheet float is much, much bigger than on balance sheet float and is a lot bigger than the company’s market cap.
ITIC reports deposits it holds in trust for others as a footnote to its financials. Actually, it appears in two different categories in two different places. Income that appears to be fee-based for its other businesses – the 10% of revenues that are not premiums – may be largely investment income on float. The company holds several hundred million dollars (not shown on the balance sheet) for others. Even at like a 1% average overnight interest rate, $500 million in average daily balance held for others would produce like $5 million in EBIT. If we assume that actual fees only cover actual expenses, the profit we are seeing for the other business units is probably largely float. On the other hand, a lot of it could actually be additional fees for professional type services associated with selling out of one piece of property and putting the proceeds in another.
The income on the actual insurance business is coming from the assets that are “on balance sheet”. That’s the only investment portfolio we actually see. Title insurance generates a lot of float. To explain how much, I’ll need to explain what title insurance is.
Title insurance – in the U.S., most other countries don’t need and don’t use title insurance – comes in two flavors: 1) Protection for a lender against title defects and other risks where the mortgage lenders lien could be made more junior (or be worthless) than they expected and 2) Protection for the property owner.
I believe a major reason for the existence of title insurance has to do with the marketability of the loan. In the U.S., there is a big secondary market for both residential mortgages (driven mostly by the GSEs: Fannie and Freddie) and for commercial real estate. Lenders can make a loan and then sell it. The entity they are selling to wants to know the loan conforms to certain standards and also has title insurance. So, title insurance is like a one-time tacked on fee necessary to ensure the marketability of the loan. There are other purposes to title insurance. But, the reason the market is so big is probably what I just described.
Title insurance is paid as a one-time non-recurring lump sum premium at the time of closing. Risks in writing title insurance involve: fraud, a title defect you could have found in your database, and a title defect that you can’t find in your database.
There are large economies of scale in the business. Other than commissions, the business is largely fixed cost in nature and yet premium volume – because premiums are paid once up front at closing and not received monthly, annually, etc. – is highly variable. In fact, it’s cyclical (and seasonal) in the same way mortgage loan originations are. Two, you need a database to consult for determining who really has title to land. The bigger the database the better. Having done business in North Carolina for over 40 years is probably a plus when it comes to having a good database. The other major risk here is fraud of some sort. Incentives are high for the issuing agent to close a deal and get you your premium – they keep most of the premium, and they get it upfront. You may need to be somewhat careful – especially in speculative times – with who you are getting your business sourced through.
Why is there so much float in this business? ITIC’s reserves are 90% incurred but not reported (IBNR). Right now, the company has claims reserves of about $33 million with $4 million of that being stuff actually reported to them – but not yet paid out – and $30 million being claims that (based on their own past experience and that of the industry generally) ITIC expects to already exist but be unknown to the insured and to themselves. In some insurance businesses, IBNR is a small item. It’s usually a much, much smaller item than 90% of claims. For example, auto insurers have IBNR (incurred but not reported) reserves that are small, because the time between when an accident occurs and when someone reports the event is really short. Here, it’s long. The title defect existed at the time the insurance was written. But, no one will discover it and file a claim till some future event leads to its discovery.
About 40% of ITIC’s claims are expected to be paid out in 5 or more years from today. Only about 20% are expected to be paid this year. I think that the “half-life” of the current reserves might be in like the 4-year timeframe. In other words, if you set up a fund to pay claims and invested all of the reserve to pay these claims in bonds where half the principal would turn to cash within 4 years, you could probably pay claims just from that fund without ever selling a bond (just letting them mature). This is a pretty substantial amount of “float” on your reserves.
ITIC is actually so liquid it doesn’t need to do that. It has very short-term investments – basically, cash on hand – sufficient to meet all claims likely in the next 5 years or so right now. In fact, the investment portfolio I’m describing – I exclude truly short-term bonds like very near-term Treasuries from my calculation of “investments” – is really backed by shareholder money, not money that’ll eventually be paid out in claims.
The “other” business generates a lot of float. It is tied to 1031 “like kind” exchanges and other escrow type businesses. You can either think of this segment as float generating or not. Since the assets associated with it are off balance sheet, I think analysts will tend to view this as a purely fee based non-insurance business. However, one warning is that if the income really is coming from some sort of float – and not just from fees – this doesn’t quite work like an actual fee-based business. If overnight type lending rates are persistently negative, this business might not do well. “Other” possibly adds up to a significant amount of profit – despite just being 10% of revenue – for ITIC. It is difficult for me to know how much of this is really true fee-based revenue that doesn’t depend at all on interest rates and how much is due to large amounts of float being invested at very low short-term interest rates. Remember, the “investment income” that comes off the “other” business is not booked as investment income. This is because the assets associated with this business are off balance sheet. It just appears on the revenue line for that segment. Everything else about it is described in footnotes.
Earnings per share are misleading in this business. They should be ignored. Starting a few years ago, accounting rules changed for investments. This caused insurers to start passing unrealized gains and losses on investments through the income statement and incorporating them in EPS.
What should you use instead to determine normal earnings?
The best way to analyze a company like this is usually to break it into 3 parts:
- Fee-based profits
- Underwriting profits
- Investment returns
You then value each of the three parts separately and add them up. Here, the “fee-based businesses” are probably worth at least $25 a share. Again, I’m not sure if some of the stuff that appears to be fees are really off-balance sheet sourced investment income. In normal times, it wouldn’t matter. But, if rates were negative for a while – it would.
Underwriting profits can be analyzed based on past results. We have 35-40 years of underwriting data for this company. You can go back through all the EDGAR filings and come up with what you think is a normalized level of EBIT. Outside of a housing crash, this company has not had meaningful and prolonged underwriting losses. Therefore, it should trade at some premium to the value of its investment portfolio. If investment performance of an insurer is in line with investment portfolios generally – then, the premium or discount to book the insurance stock should trade it would be theoretically determined by the expected underwriting profits (premium to book) or losses (discount to book). It does not make sense for an insurer to trade below the value of its investment portfolio if that insurer normally reports underwriting profits (a combined ratio below 100).
Like I said, the investment portfolio is similar to the book value here. So, this stock shouldn’t trade below book. It has traded below book before. And some title insurers do. But, that’s probably a mistake on the market’s part.
And then you would value the portfolio (which is by far the biggest part of this company) based on expected future portfolio returns….
Or: you could value the portfolio on an asset basis.
The portfolio is carried on the books at the fair market value of the bonds and stocks. These are marked-to-market and disclosed to investors in every quarterly earnings release. So, my guess is that analysts value the portfolio based on its fair market value instead of trying to predict future returns. I’m not sure if this is a good idea.
In fact, it’s here where I see the problem in liking this stock at today’s price.
What if the fair market value of the bonds and stocks this company owns is unusually high today?
We know asset values are high today for financial assets. So, either way you analyze it – trying to figure out the intrinsic value of the portfolio or trying to predict future returns – you get a low number. The most dangerous way to evaluate this stock – the one most likely to make you think it’s cheap when it’s really expensive – is the shortcut approach of assuming intrinsic value and fair market value as of today are exactly the same.
But…
Personally: I wouldn’t want to pay 100 cents on the dollar for any 2/3rds bonds and 1/3rd stocks mix of investment assets quoted at today’s prices.
For that reason, the premium to book value (about 40% in this case) might be fully justified in times of low valuations for stocks and bonds but not be justified in today’s environment.
What about dividends, future earnings, etc.?
This company has grown nicely over time while paying dividends. Cumulatively, dividends have often been as high as 50% of reported earnings. They’ve been uneven. This is due to special dividends and cyclicality. But, you can expect like half of earnings will be paid as a dividend.
Growth has also been fine. Over the last 35 years, I think premiums have grown around 7% a year. They moved into some other states. So, it’s unlikely they grew in any one state by much more than the underlying nominal GDP of that state. Long-term, we should expect that real estate values move about at nominal GDP. And the total market for title insurance should do the same.
So, growth in the 5% to 9% a year range is okay for premiums. Double-digits might be concerning. And less than 5% a year might suggest loss of market share.
Knowing if dividends will grow faster or slower than earnings and premiums is really a question of whether the company is overcapitalized, undercapitalized, etc. and what it intends to do about that. This company may be overcapitalized. But, I expect it to be run at about these capital levels. So, dividends shouldn’t race ahead of earnings for the long-run. For that reason, premium growth plus dividend yield might be a good proxy for your likely future return in this stock. The only other variable of real significance would be the ratio of exit price multiple vs. entry price multiple. So, your return in ITIC would likely be driven by 3 things:
- P/B (P/E, P/S, etc.) multiple expansion or contraction
- Premium volume CAGR
- Dividend yield
ITIC is a family company. The top 3 positions at the company are family members. So, it is family run not just family controlled. The family here – the Fine family – seems to own at least 30% of the company divided equally between the 3 members of the family who are the CEO, CFO, etc. The board is probably pretty cozy with the family. As you’d expect with a NASDAQ listed stock, family members don’t sit on any of the board committees. But, many of the people who do sit on these committees and the lead independent director have been with the company from pretty much the start.
There is a poison pill. The board is also classified – meaning you only elect 1/3rd of the board each year, thus delaying a takeover. There are also some change of control payments. It’s not an obvious takeover target. It’s very well protected from any takeover the family doesn’t want.
Markel owns a bit over 11% of the stock. I believe they bought a bit less than 10% a long time ago and then just keep holding indefinitely. There have been some share buybacks over time that would’ve upped Markel’s percentage stake. Technically, the bought back shares are held by a subsidiary (I assume an insurance subsidiary) and not the parent company. As a result, while shares outstanding are listed in some places as 2.2 million – there are really only 1.9 million shares out.
Some of the investment assets are held at the parent company (this is unusual for an insurance company and again shows the insurance subsidiary is very well capitalized). I don’t think this is relevant. I just mention it because the consolidated entity has significantly more capital than would be required for regulatory reasons. If there were any concerns about capital levels, you’d definitely keep all your investments at the insurance subsidiary level. Here, the consolidated company is even a bit stronger than suggested by the regulatory capital situation at the subsidiary (in some insurance holding companies, the reverse is true – the consolidated situation is a bit weaker than the insurance subsidiary’s financial position).
Obviously, we’re in a boom time for real estate and therefore a boom time for title insurance. Might next year’s earnings be amazing – especially if stock and bond prices continue to do well? Yes. But, I don’t think a one year EPS pop is a good reason to own the stock for the long-term. And if you’re not willing to own it for the long-term – you shouldn’t buy it just gambling on a one-year EPS pop and then selling to someone else when that pop happens.
ITIC doesn’t look cheap versus publicly traded peers. I haven’t analyzed the other title insurers you can buy shares in – so, I can’t get into why this is the case and whether it is justified. In fact, by some measures, ITIC is actually a bit more expensive than some peers.
Could it be a better business than its peers?
That’s possible. It’s probably the leader in North Carolina even though the national title insurers have the leading national share.
Of course, some people will wonder if this thing would be sold to a bigger title insurer when the family decides to sell. That’s possible. As of now, it’s a founder led company.
Overall, this has been a consistent and profitable grower. It has shown it could move from a just direct business in one state to a mostly agency business in several Southern states. The states the company is in are good states to be in long-term.
I also have to stress that the capital position, low levels of underwriting leverage, etc. here are really notable. Even just looking at a surface level at peers – the financial strength here vs. the volume of business being done does stand out.
So, at the same price-to-book and P/E ratio and so on – would I rather buy the underleveraged member of the group? Yes. I don’t get the feeling the family would shift to a very different level of underwriting volume vs. capital. If they did, you could make more money as an investor. I mean, we can do some comparisons with some other title insurers and see that the “earning power” of ITIC at an equal level of leverage as these other title insurers would be quite a bit higher.
Due to the past history here, the continuity provided by family management, and the financial position versus amount of underwriting – I’d keep an eye on ITIC. This might be the title insurer you’d choose to own if you could buy any title insurer at the same price multiple.
However, like I said, the company – although smaller and less well known – doesn’t trade at a discount to peers. Adjusted for capitalization levels – it might be cheap. But, I’m not sure if a potential shareholder should really adjust for capitalization ratios. What we have here might just be a lower risk title insurer stock – not necessarily a higher return one.
Of course, when a potential buyer analyzes a company like ITIC – he thinks in terms of how much leverage he’d be using, not how much it’s using now. To an acquirer, ITIC probably looks a lot cheaper (and would be worth a lot more) than it does as a stand-alone public company. So, maybe the “private market value” here is above the public market value. And maybe I should be thinking of the value to an insurance company acquiring ITIC instead of thinking in terms of ITIC staying independent indefinitely.
My next step in analyzing this one would be to do a comparison between ITIC and each of the other more-or-less “pure play” title insurers with publicly traded shares. You can’t buy ITIC without first analyzing the other title insurers as your opportunity cost.