2023-04-30 10:53:39 ET
Summary
- Investors Title Company represents a low-risk opportunity with reasonable upside.
- Despite short-term macro headwinds, ITIC has substantial long-term earning power and a rock-solid balance sheet.
- Core title business is cyclical, but this business can actually benefit from rising rates.
- We are recommending a long position in Investors Title Company.
Editor's note: Seeking Alpha is proud to welcome Jonquil Capital as a new contributor. It's easy to become a Seeking Alpha contributor and earn money for your best investment ideas. Active contributors also get free access to SA Premium. Click here to find out more »
Investors Title Company (ITIC) may face significant headwinds in their title business from the macro environment, but their cash-rich balance sheet will generate more profits as rates rise, which can offset the smaller than average earnings in the core business. The strength of the balance sheet provides a strong floor for the business as we wait for any inflection in the housing market. Despite being the best positioned title business in terms of markets and management alignment, ITIC trades a large discount to its peers.
Considering the prevailing headlines of recession risk, rising rates, and the least affordable housing market of all time for buyers, you would assume that housing-related business would be a bad bet right now, right?
In the next few years, the data would incontrovertibly agree with this general sentiment. Let's take a look at residential mortgages as a proxy for overall housing activity:
Mortgage Purchase and Refinancing Index (mortgagenewsdaily.com)
Activity has come to a screeching halt. We are at the lowest point in the past decade. In this market, how can we possibly be bullish on anything related to housing?
Background
Enter Investors Title Insurance. ITIC was founded in 1972 by J. Allen Fine who continues to run the business with his family to this day. Since 1993, ITIC has returned 1,982.76% versus an 814.84% return for the S&P 500 without dividends included at the time of writing. The business has grown revenues, net income, book value, and market share since its inception.
The Business of Title
Before we discuss the most obvious red flag (the current macro environment), let's go over the business in detail.
Title insurance companies write premiums to protect homebuyers and mortgage issuers/holders from any unclean chain of title or any defect in title related to a property. These businesses are fundamentally record-keepers of each and every lien and transaction related to properties in the United States. When the homebuyer and the lender come to the closing table, they need some assurance that the seller owns the home free and clear that they are selling. This sounds incredibly bizarre, but it does happen. A title insurance policy is issued to the buyer and the lender at closing and is charged as a % of the home value that is being insured.
This brings us to the first interesting piece of the title insurance business - natural inflation protection. As inflation rises, housing prices rise. While the recent rises in inflation may seem out of the ordinary, inflation will not be going away. We've always had inflation as evidenced by the time series above going back to 1963 when average home prices were $19,300. Based on today's average price of $516,500, prices have increased 5.6% per year over the past 60 years. Many companies struggle to increase prices in line with inflation, but for title insurers, there is no issue at all with price increases. There are a few key reasons for this:
- When buying a home, the title is not a large part of the overall transaction. When you are purchasing a $516,500 asset, a $2,000 fee in a list of a dozen or so closing fees does not feel as onerous.
- The consumer does not actively shop title policies. Title insurers win by dominating marketing channels such as title agencies, closing attorneys, or realtors.
If you have ever been through the home-buying process, you may not remember there being much of a discussion about title insurance - it was just there when you say down to close. As the title insurer, my biggest expense is not paying for claims (this is actually a very small cost for the insurer). My biggest expense is paying commissions to the people who ensure that my policy is the one in the daunting stack of 40 pages that you sign while overwrought with emotion about your new house.
How Does ITIC Handle Housing Booms and Busts?
As an insurer, regulators require ITIC to have a certain amount of equity on the balance sheet to be able to pay out claims when they do arise. However, claims are very rare and only make up 5-15% of overall premiums in any given year. The result is a business that has an incredibly strong balance sheet without any massive liability position or leverage to speak of.
I think about this Investors Title as two segments that operate together in harmony. The first is the title insurance underwriter, which we have already discussed and the second is the investment side. There are $227 million in investments alone on the balance sheet that are unnecessary for running the business; they exist to satisfy regulators. The composition of the portfolio is very conservative:
- 53.9 million in fixed income securities.
- 51.6 million in equities.
- 103.6 million in short-term investments (money markets and short-term treasuries).
- 18.3 million in other investments such as real estate and interests in title agencies.
The equity securities took a roughly $21 million haircut in 2022, but should participate in any market recovery we see in the coming years. The important component of the portfolio is that it becomes more valuable with rising rates. Income and dividends in 2022 were $4.7 million, but with rising rates, this figure could rise to $8 million this year. Not to mention that the "Other Investments" have delivered strong returns and income averaging $5.35 million in the past two years.
The underwriting business suffers from lower purchase and refinance activity, but this is at least partially offset by rising investment income which drops right to the bottom line. It's a 'heads I win, tails I don't lose much' situation as it relates to housing cycles. Even in 2008/2009 financial crisis, Investors Title only took a small loss due to the impairment of assets, not due to any actual economic losses in my opinion.
Market Position
The Investors Title Company is based in North Carolina and has a very strong position in its home state as well as Texas. They have increased penetration in other markets in the Southeast. Real estate is a local phenomena. While rising interest rates have impacted affordability across all states, some markets have been more resilient than others and may have better long-term prospects.
Capital Allocation
The Fine family owns a significant portion of the business and has a vested interest in seeing value created. They have recently been issuing special dividends of excess capital each year, which allows them to invest where they see high ROIC opportunities. This strategy allows them to be flexible with cash returned to shareholders and does not have baggage and expectations associated with a high regular quarterly dividend.
Year Over Year Housing Inventory (zillow.com/research/data/)
While inventory is up 23% year-over-year across the entire country, certain markets such as Texas and North Carolina have larger inventory buildups in anticipation of future demand. Certain West Coast markets, where Investors Title has no exposure, are bringing down the nation-wide average. The data supports the popular narrative that remote workers from high cost of living areas are moving from New York and California to lower cost of living areas such as Texas and Florida.
Valuation
Sum Of the Parts
The valuation of this business requires the assumption that the investment side of the business is truly surplus capital. History shows us that the investment side of the balance sheet indeed is not necessary for operations, nor is it encumbered by substantial liabilities. As we discussed above, taking a sum of all of the non-core assets on the balance sheet, the portfolio can be valued at $227 million.
Valuing ITIC, the underwriter, is much more difficult. After taking some liberties valuing the assets of ITIC, we try to use a much more conservative approach to value the underwriting business:
1. After backing out income from investment activities, the underwriting side of the house has delivered 10.41% pre-tax income margins in the past two decades, which comes out to 8.3% Net Income Margins.
2. Premiums have come down in 2022 to $248 million from an all-time high of $273 million in 2021. Let's assume that due to stagnation in the housing market premiums retreat to 2020 levels of $205 million per annum and then to be extremely conservative, let's assume no growth in premiums from here on out (historically, premiums have grown on average by 7% per year).
3. So we on average can expect 8.3% Net Income Margins on $205 million of annual premiums. What we are left with is $17 million in expected net income per year from the underwriting operation over the long term.
4. We value the conservative long-term average expected net income of $17 million as an annuity at a 10% discount rate to get a ~$170 million value for the underwriting business.
SOTP Valuation (Author's representation)
Taking the sum of the parts (the underwriting business and the portfolio), we find the value of the equity of the business to be $397.5 million. Dividing this by the number of shares outstanding, the fair value per share of ITIC would be $209.46 , implying a 43% upside from market price.
Comparables Valuation
Tangible Book Value (Author's representation)
While many title insurers trade in a similar range of price to book value, the composition of that book value is significantly different. We use tangible book ((TB)) value to value title insurers. The tangible book value tells you how much of the company's equity are hard assets such as cash or property compared to intangible assets such as goodwill. The reason we care more about tangible assets is that in a liquidation scenario, I cannot typically sell the goodwill on my balance sheet. Focusing on hard assets and tangible book value helps you as an investor protect your downside.
Fidelity National Financial (FNF) and Stewart Information Services (STC) have negative or near-zero tangible book value making it difficult to compare these businesses. Old Republic International (ORI) has a substantial property casual insurance business which drags the P/B down for that business. First American Financial (FAF), which trades at 1.93x Price-to-Tangible Book is the best comp for ITIC and there is some warranted premium for FAF due to higher historical average returns on equity for that business. That being said, even in today's somewhat depressed market, ITIC should trade for at least 1.7x Price-to-Tangible Book versus 1.25x today.
Risks
Rising Mortgage Rates
It's not all rosy for the Investors Title Company. Premiums written by ITIC decreased by 32.1% in Q4 of 2022 relative to the prior-year quarter. Rising rates will slow purchase activity and all but stop refinance activity. As a result, less and less title policies are being written. There is a chance that ITIC will have much lower earnings or even negative earnings in the short term.
As we discussed earlier, even in the worst markets, title insurers can still produce positive net income. Let's look to the worst housing market in recent memory - the 2008/2009 Financial Crisis. In 2008, the company reported the worst earnings figure in the past 20 years which was a loss of ($0.50) per share or a $1.18 million loss. While this may not look great, ITIC also took a non-economic impairment charge of $1.2 million in the same year. If we back out the impairment charge, Investors Title Company was still profitable in what may be one of the worst housing markets imaginable. Every market is different and this current slowdown in housing could be even more harmful to the title insurance industry.
Regulatory Risk and Alternatives to Title Insurance
The United States is unique in how they manage real estate transactions and many people argue that the process is inefficient and imposes too many frictional costs. Regulatory agencies want to find ways to limit the costs imposed by consumers and have in some cases targeted title insurance.
As an alternative to title insurance, consumers can now get an 'Attorney Title Opinion Letter' stating that a home has a clean title. This practice is widely unknown, but is still very new. Time will tell if opinion letters become more mainstream in the closing process. Our view is that title insurance has existed in its current state for 50 years and this is unlikely to change much in the future.
Conclusion
For any business that derives its revenue through housing activity, there are storm clouds on the horizon. However, opportunities are best found in periods of distress. The key to understanding the Investors Title Company is that they are built to withstand the stress of housing market fluctuations with a profitable operating model and an overcapitalized balance sheet. With general recession risks about and the overall market still at close to frothy levels, we recommend preserving capital and earning reasonable returns through an investment in ITIC.
For further details see:
Investors Title Company: Providing Stability In An Unstable Market