INVESTORS TITLE CO quarterly report, Q1 FY2012

Business Context and Reporting Period

Investors Title Company filed this unaudited Form 10-Q for the three months ended March 31, 2012. The company primarily underwrites title insurance through its subsidiaries; title insurance accounted for 95.4% of operating revenues. Results are seasonal and sensitive to real estate transactions, mortgage activity, and investment markets.

Financial Results and Position

After-tax profit margin was 6.4%, compared with 5.1%. Total operating expenses rose 9.6% to $20.47 million. The claims provision was $1.63 million, or 8.3% of net premiums written, versus $721,626, or 4.0%, a year earlier. Management attributed the higher ratio to business mix in states with higher loss ratios and unusually low prior-year claims expense.

At March 31, 2012, total assets were $158.92 million, liabilities $50.39 million, and stockholders’ equity $108.53 million. Cash and cash equivalents were $16.47 million, down from $18.04 million at year-end; short-term investments were $8.57 million. The filing lists no borrowing balance on the balance sheet. Claims reserves totaled $38.29 million, including $31.93 million for incurred-but-not-reported claims. The company paid a $0.07-per-share dividend and repurchased 12,317 shares for $509,711.

Changes Versus the Prior Comparable Period

• Title orders increased 24.6%, to 54,230. Management cited higher refinance and purchase activity amid low mortgage rates.
• Home and branch premiums increased 30.5%; agency premiums increased 4.8%. North Carolina premiums rose, while Texas and Michigan premiums declined.
• Net income increased approximately 40.5%, supported by premium growth and a swing to realized investment gains from a prior-year loss that included impairment charges.
• Claims provision increased by approximately $910,000 year over year. Management estimated the higher claims provision rate added about $837,000 to reserves compared with using the prior-year rate.
• Cash from operations moved from positive to negative, primarily reflecting increased receivables and payments of accounts payable and accrued liabilities.
• Other comprehensive income was $1.18 million, largely reflecting unrealized investment gains; accumulated other comprehensive income rose to $8.69 million.

Outlook, Commentary, Risks, and Unusual Items

The company provided no specific earnings or revenue guidance. Management described the real estate outlook as uncertain and expected a sluggish market for the balance of 2012. The filing cites an MBA forecast of 2012 mortgage originations falling 15.4% from 2011, with purchase activity up 2.0% and refinancing down 23.5%; this is an industry forecast, not company guidance. Management expected refinancing to remain strong in the first half of 2012 and decline in the second half.

• Claims and reserves: Estimates may change as claims experience develops; reserve adjustments could be significant. The company considers its reserves adequate, but actual losses may differ.
• Investments: The portfolio includes $3.70 million of Level 3 auction-rate securities at fair value; auctions have failed and valuations rely on significant unobservable inputs. Unrealized losses and market or credit changes could affect future results. No investment impairment charges were recorded in Q1 2012.
• Legal matter: A title-insurance rate-related class action is pending in West Virginia and is inactive pending resolution of a bankruptcy. The company intends to defend the case, but says it cannot reasonably estimate potential losses.
• Agency acquisition: The company executed an agreement on April 2, 2012 to acquire a majority interest in an agency. The majority-interest price is capped at $1,041,250, payable over two years; $350,000 had already been paid. Options provide for acquiring the remaining interest, with a stated minimum whole-agency purchase price of $1 million; actual cost may differ.
• Off-balance-sheet responsibilities: The company administers customer escrow and trust funds and like-kind exchange proceeds and property, which are excluded from its balance sheet but carry contingent responsibilities. Like-kind exchange deposits and reverse-exchange property totaled approximately $41.92 million. About $1 million par value of those funds was invested in an auction-rate security.
• Liquidity and regulation: Management believes operating cash flows and liquid investments should meet foreseeable needs. Insurance-subsidiary distributions are subject to regulatory limits and prior approvals; adverse results, reserve charges, or investment losses could constrain transfers.

Important Facts for Investors to Verify

• Whether premium and title-order growth persists if refinance activity weakens, and how geographic mix affects premiums and claims.
• How claims experience develops and whether the $38.29 million reserve remains adequate, particularly the IBNR component.
• The recoverability, valuation assumptions, and liquidity of auction-rate securities and other investment holdings.
• The terms, final cost, and financial contribution of the agency acquisition, including any purchase of the remaining interest.
• Cash-flow conversion and the ability of regulated insurance subsidiaries to provide funds to the parent while maintaining required capital and ratings.
• Developments in the rate-related class action and any changes in the company’s ability to estimate a potential loss.