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ITIC > SEC Filings for ITIC > Form 10-Q on 8-Aug-2013All Recent SEC Filings

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Form 10-Q for INVESTORS TITLE CO


8-Aug-2013

Quarterly Report


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

The Company's 2012 Annual Report on Form l0-K should be read in conjunction with the following discussion since it contains important information for evaluating the Company's operating results and financial condition. Forward-looking statements are based on certain assumptions and expectations of future events that are subject to a number of risks and uncertainties. Actual results may vary.

Overview

Investors Title Company (the "Company") is a holding company that engages primarily in issuing title insurance through two subsidiaries, Investors Title Insurance Company ("ITIC") and National Investors Title Insurance Company ("NITIC"). Revenues from the title segment accounted for 96.3% of the Company's insurance and other services revenues in the first six months of 2013. Through ITIC and NITIC, the Company underwrites land title insurance for owners and mortgagees as a primary insurer. Title insurance protects against loss or damage resulting from title defects that affect real property.

There are two basic types of title insurance policies - one for the mortgage lender and one for the real estate owner. A lender often requires property owners to purchase title insurance to protect its position as a holder of a mortgage loan, but the lender's title insurance policy does not protect the property owner. The property owner has to purchase a separate owner's title insurance policy to protect their investment. When real property is conveyed from one party to another, occasionally there is an undisclosed defect in the title or a mistake or omission in a prior deed, will or mortgage that may give a third party a legal claim against such property. If a claim is made against real property, title insurance provides indemnification against insured defects.

The Company issues title insurance policies through issuing agencies and also directly through home and branch offices. Issuing agents are typically real estate attorneys or subsidiaries of community and regional mortgage lending institutions, depending on local customs and regulations and the Company's marketing strategy in a particular territory. The ability to attract and retain issuing agents is a key determinant of the Company's growth in premiums written.

Revenues for this segment result from purchases of new and existing residential and commercial real estate, refinance activity and certain other types of mortgage lending such as home equity lines of credit.

Volume is a factor in the Company's profitability due to fixed operating costs which are incurred by the Company regardless of premium volume. The resulting operating leverage tends to amplify the impact of changes in volume on the Company's profitability. The Company's profitability also depends, in part, upon its ability to manage its investment portfolio to maximize investment returns and minimize risks such as interest rate changes, defaults and impairments of assets.

The Company's volume of title insurance premiums is affected by the overall level of residential and commercial real estate activity, which includes sales, mortgage financing and mortgage refinancing. In turn, real estate activity is affected by a number of factors, including the availability of mortgage credit, the cost of real estate, consumer confidence, employment and family income levels and general United States economic conditions. Interest rate volatility is also an important factor in the level of residential and commercial real estate activity.

The cyclical nature of the residential and commercial real estate markets, and consequently, the land title industry, has historically caused fluctuations in revenues and profitability, and it is expected to continue to do so in the future. Additionally, there are seasonal influences in real estate activity and accordingly in revenue levels for title insurers.

Services other than title insurance provided by operating divisions of the Company that are not required to be reported separately are reported in a category called "All Other." These other services include those offered by the Company and by its wholly owned subsidiaries, Investors Title Exchange Corporation ("ITEC"), Investors Title Accommodation Corporation ("ITAC"), Investors Trust Company ("Investors Trust"), Investors Capital Management Company ("ICMC") and Investors Title Management Services, Inc. ("ITMS").

The Company's exchange services division, ITEC and ITAC, provides customer services in connection with tax-deferred real property exchanges. ITEC serves as a qualified intermediary in like-kind exchanges of real or personal property under Section 1031 of the Internal Revenue Code of 1986, as amended. In its role as qualified intermediary, ITEC coordinates the exchange aspects of the real estate transaction, and its duties include drafting standard exchange documents, holding the exchange funds between the sale of the old property and the purchase of the new property, and accepting the formal identification of the replacement property within the required identification period. ITAC serves as exchange accommodation titleholder in reverse exchanges. An exchange accommodation offers a vehicle for accommodating a reverse exchange when the taxpayer must acquire replacement property before selling the relinquished property.


In conjunction with Investors Trust, ICMC provides investment management and trust services to individuals, companies, banks and trusts. ITMS offers various consulting services to provide clients with the technical expertise to start and successfully operate a title insurance agency.

Business Trends and Recent Conditions

Beginning in 2008, the United States economy experienced one of the worst economic downturns in history. Events leading to the recession were primarily the collapse of the housing market and frozen credit markets, prompting the federal government to take unprecedented monetary and fiscal action in an attempt to slow the economic rate of decline and instill consumer confidence. The economy has been slowly recovering from this downturn with the Dow Jones Industrial Average closing and remaining near an all-time high, housing values rebounding and the unemployment rate lowering.

The Mortgage Bankers Association's ("MBA") June 20, 2013 Mortgage Finance Forecast (the "MBA Forecast") projects 2013 mortgage originations to decrease 10.2% from 2012 levels to $1,572 billion, with purchasing activity increasing 19.3% to $600 billion and refinancing activity decreasing 22.1% to $972 billion. In 2012, refinancing activity accounted for 71.3% of all mortgage originations and is projected to represent 61.8% of mortgage originations in 2013.

According to data published by Freddie Mac, the average 30-year fixed mortgage interest rate in the United States was 3.6% and 3.9% for the six months ended June 30, 2013 and 2012, respectively. According to the MBA Forecast, refinancing is expected to decline through 2013 as interest rates climb to a projected 4.2% in the fourth quarter of 2013.

In September 2012, the Federal Reserve (the "Fed") announced Quantitative Easing, "QE 3," in which it will purchase mortgage backed securities at a rate of $40 billion per month and longer-term Treasury securities at a rate of $45 billion per month. Federal Reserve Chairman Bernanke indicated that the level of asset purchases in the months ahead may vary in response to changing economic conditions, noting after the June 2013 meeting that the Fed may begin to slow the level of asset purchases in 2013 and phase out all purchases in 2014. However, there is no stated end date associated with this round of Quantitative Easing and the program will continue as deemed necessary by the Federal Reserve. The Federal Open Market Committee ("FOMC") of the Federal Reserve is also issuing disclosures on a periodic basis that include projections of the federal funds rate and expected actions. In June 2013, the FOMC stated that they intend to keep the federal funds rate exceptionally low, between 0% and 0.25%, until targets of 6.5% for unemployment and 2.5% for inflation are reached.

According to the MBA June 2013 Economic and Mortgage Finance Commentary (the "MBA Commentary,"), 2013 should experience growth relative to 2012. Economic expectations in 2013 include increases in housing starts and stronger home sales. In 2013, the real gross domestic product is expected to increase by 2.1% and the unemployment rate is expected to decrease to 7.5%.

On January 10, 2013, the Consumer Financial Protection Bureau, ("CFPB"), which, among other responsibilities, enforces the Real Estate Settlement Procedures Act ("RESPA"), the primary federal regulatory guidance covering the real estate settlement industry, released final rules requiring a lender to assess each borrower's ability to meet the obligations of the prospective mortgage. Within this rule, there is also a provision that requires the lender to determine if the mortgage is a "Qualified Mortgage" and includes all fees paid to an affiliate of the lender in the points and fees calculation. The key features of a Qualified Mortgage are that it not have excessive upfront points and fees; does not have toxic loan features such as interest only, negative amortization or balloon payment provisions; and that there are limits on the borrower's debt-to-income ratio. The Company and its subsidiaries are not involved in mortgage lending, however, this rule could have an adverse impact on mortgage lending activity and potentially reduce premium volume. This new rule takes effect in January 2014.

The CFPB has also issued a memorandum to banks which has heightened their focus on vetting third party settlement providers which could impact the Company's agents and approved providers. They may propose additional rules which could potentially impact the business of the Company. Further proposals to change regulations governing insurance holding companies and the title insurance industry are often introduced in Congress, in the state legislatures and before the various insurance regulatory agencies. The Company regularly monitors such proposals, but their likelihood and timing, and the impact they may have on the Company and its subsidiaries cannot be determined at this time.

Historically, activity in real estate markets has varied over the course of market cycles by geographic region and in response to evolving economic factors. Operating results can vary from year to year based on cyclical market conditions and do not necessarily indicate the Company's future operating results and cash flows.


Critical Accounting Estimates and Policies

The preparation of the Company's Consolidated Financial Statements requires management to make estimates and judgments that affect the reported amounts of certain assets, liabilities, revenues, expenses and related disclosures surrounding contingencies and commitments. Actual results could differ from these estimates. During the six months ended June 30, 2013, the Company made no material changes in its critical accounting policies as previously disclosed in Management's Discussion and Analysis in the Company's Annual Report on Form 10-K for the year ended December 31, 2012 as filed with the Securities and Exchange Commission.

Results of Operations

For the quarter ended June 30, 2013, net premiums written increased 30.9% to $30,429,761, other income increased 29.5% to $2,283,320, total revenues increased 29.2% to $33,693,400 and net income attributable to the Company increased approximately 19.6% to $4,005,675, all compared with the same quarter in 2012. Net income per basic common share increased from $1.60 for the quarter ended June 30, 2012 to $1.94 in the same quarter of 2013. Net income per diluted common share increased from $1.57 for the quarter ended June 30, 2012 to $1.92 for the same quarter of 2013.

For the six months ended June 30, 2013, net premiums written increased 26.7% to $54,355,758, other income increased 27.8% to $4,268,757, total revenues increased 24.8% to $60,451,673 and net income attributable to the Company increased approximately 54.4% to $7,382,405, all compared with the period in 2012. Net income per basic common share increased from $2.28 for the six months ended June 30, 2012 to $3.59 compared with the same period in 2013. Net income per diluted common share increased from $2.24 for the six months ended June 30, 2012 to $3.54 compared with the same period in 2013.

Insurance and Other Services Revenues

Insurance and other services revenues include net premiums written plus other fee income, trust income, management services income and exchange services income. Investment income and realized investment gains and losses are not included in insurance and other services revenues and are discussed separately under "Investment Related Revenues" below.

Title Orders: The volume of title orders issued increased 10.6% in the first six months of 2013 to 122,992 compared with 111,254 title orders in the same period in 2012. The increase in title orders from 2012 is primarily attributable to higher levels of purchase transactions. Title orders did not increase proportionally with premiums due to a higher proportion of purchase transactions. Purchase transactions typically have higher premium rates than refinance transactions.

Title insurance companies typically issue title insurance policies directly through home and branch offices or through title agencies. Following is a breakdown of net premiums generated by home and branch offices and agency operations for the three and six months ended June 30, 2013 and 2012:

                                 Three Months Ended June 30,                            Six Months Ended June 30,
                          2013           %           2012           %           2013           %           2012           %
Home and Branch      $  7,332,764      24.1     $  6,164,038      26.5     $ 13,116,393      24.1     $ 10,986,830      25.6
Agency                 23,096,997      75.9       17,077,532      73.5       41,239,365      75.9       31,922,160      74.4
Total                $ 30,429,761     100.0     $ 23,241,570     100.0     $ 54,355,758     100.0     $ 42,908,990     100.0

Home and Branch Office Net Premiums: 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. Net premiums written from home and branch operations increased 19.0% and 19.4% for the three and six months ended June 30, 2013, compared with the prior year periods. The increase in 2013 net premiums for home and branch operations primarily reflects increases in purchase transactions, new industry-wide premium charges in the State of North Carolina that became effective March 1, 2012, and increases in average home values. All of the Company's home office operations and the majority of its branch offices are located in North Carolina; as a result, the home and branch office net premiums written are primarily for North Carolina policies.

Agency Net Premiums: 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. Agency net premiums written increased 35.2% and 29.2% for the three and six months ended June 30, 2013, compared with the prior year periods. The increase in 2013 net agency premiums reflects increases in purchase transactions, new industry-wide premium charges in certain markets, and increases in average home values in many parts of the nation.

Following is a schedule of net premiums written for the three and six months ended June 30, 2013 and 2012 in select states in which the Company's two insurance subsidiaries ITIC and NITIC currently write insurance:


                          Three Months Ended June 30,         Six Months Ended June 30,
State                        2013              2012             2013             2012
North Carolina         $    9,590,855     $  8,054,389     $ 17,125,721     $ 14,390,654
Texas                       6,378,120        4,615,051       11,299,109        8,825,896
South Carolina              2,354,504        2,167,404        4,675,554        3,702,433
Michigan                    1,727,908        1,183,595        3,047,453        2,155,867
Virginia                    1,465,820        1,333,365        2,732,715        2,552,178
All Others                  8,974,071        5,970,729       15,568,413       11,382,120
  Premiums                 30,491,278       23,324,533       54,448,965       43,009,148
Reinsurance Assumed             2,970            9,905            3,470           15,659
Reinsurance Ceded             (64,487 )        (92,868 )        (96,677 )       (115,817 )
Net Premiums Written   $   30,429,761     $ 23,241,570     $ 54,355,758     $ 42,908,990

Other Revenues

Other revenues primarily include other fee income, trust income, management services income, exchange services income, and income related to the Company's equity method investments. Other revenues were $2,283,320 and $4,268,767 for the three and six month periods ended June 30, 2013, respectively, compared with $1,763,689 and $3,340,401 in the prior year periods. The increase in 2013 was primarily related to increases in other fee income, earnings of unconsolidated affiliates and income from trust and investment management services.

Investment Related Revenues

Investment income and realized gains and losses from investments are included in investment related revenues.

Investment Income: The Company derives a substantial portion of its income from investments in municipal and corporate bonds and equity securities. The Company's title insurance subsidiaries are required by statute to maintain minimum levels of investments in order to protect the interests of policyholders.

In formulating its investment strategy, the Company has emphasized after-tax income. The Company's investments are primarily in bonds and, to a lesser extent, equity securities. The effective maturity of the majority of the bonds is within 10 years. The Company's invested assets are managed to fund its obligations and evaluated to ensure long-term stability of capital accounts.

As the Company generates cash from operations, it is invested in accordance with the Company's investment policy and corporate goals. The Company's investment policy has been designed to balance multiple goals, including the assurance of a stable source of income from interest and dividends, the preservation of principal and the provision of liquidity sufficient to meet insurance underwriting and other obligations as they become payable in the future. Securities purchased may include a combination of taxable bonds, tax-exempt bonds and equity securities. The Company strives to maintain a high quality investment portfolio. Interest and investment income levels are primarily a function of general market performance, interest rates and the amount of cash available for investment.

Investment income was $925,047 and $1,845,532 for the three and six months ended June 30, 2013, respectively, compared with $1,009,918 and $1,987,179 for the same period in 2012. The decrease in investment income in 2013 was due primarily to a decrease in the portfolio of fixed maturities coupled with lower levels of interest earned on fixed maturities and short-term funds, partially offset by a slight increase in dividends associated with an increase in the portfolio of equity securities. See Note 7 in the accompanying Consolidated Financial Statements for the major categories of investments, scheduled maturities, amortized cost, fair values of investment securities and earnings by security category.

Net Realized Gain (Loss) on Investments: Dispositions of equity securities at a realized gain or loss reflect such factors as industry sector allocation decisions, ongoing assessments of issuers' business prospects and tax planning considerations. Additionally, the amounts of net realized investment gains and losses are affected by assessments of securities' valuation for other-than-temporary impairment. As a result of the interaction of these factors and considerations, net realized investment gains or losses can vary significantly from period to period.

Net realized gain on investments was $55,272 and $71,616 for the three and six months ended June 30, 2013 compared with $65,148 and $258,029 for the same period in 2012. The 2013 year-to-date gain includes impairment charges of $34,070 on certain investments that were deemed to be other-than-temporarily impaired, offset by net realized gains on the sales of investments and other assets of $105,686. The 2012 year-to-date gain includes impairment charges of $76,539 on certain investments that were deemed to


be other-than-temporarily impaired, offset by net realized gains on the sales of investments, other assets and property acquired in the settlement of claims of $334,568. Management believes unrealized losses on remaining fixed income and equity securities at June 30, 2013 are temporary in nature.

The securities in the Company's portfolio are subject to economic conditions and market risks. The Company considers relevant facts and circumstances in evaluating whether a credit or interest-related impairment of a security is other-than-temporary. Relevant facts and circumstances include the extent and length of time the fair value of an investment has been below cost.

There are a number of risks and uncertainties inherent in the process of monitoring impairments and determining if an impairment is other-than-temporary. These risks and uncertainties include the risk that the economic outlook will be worse than expected or have more of an impact on the issuer than anticipated, the risk that the Company's assessment of an issuer's ability to meet all of its contractual obligations will change based on changes in the characteristics of that issuer, the risk that information obtained by the Company or changes in other facts and circumstances leads management to change its intent to hold the equity security until it recovers in value or its intent to sell the debt security, and the risk that management is making decisions based on misstated information in the financial statements provided by issuers.

Expenses

The Company's operating expenses consist primarily of commissions to agents, salaries, employee benefits and payroll taxes, provision for claims and office occupancy and operations. Operating expenses increased 29.6% and 19.1% for the three and six months ended June 30, 2013, respectively, compared with the same period in 2012. For the three months ended June 30, 2013, expenses increased primarily due to increases in commissions to agents and salaries, employee benefits and payroll taxes and the provision for claims. For the six months ended June 30, 2013 expenses increased primarily due to commissions to agents and salaries, employee benefits and payroll taxes, offset by a decline in the provision for claims.

Following is a summary of the Company's operating expenses for the three and six months ended June 30, 2013 and 2012. Inter-segment eliminations have been netted; therefore, the individual segment amounts will not agree to Note 4 in the accompanying Consolidated Financial Statements.

                             Three Months Ended June 30,                           Six Months Ended June 30,
                        2013          %          2012          %             2013          %          2012          %
Title Insurance    $ 26,244,237     94.3    $ 20,099,098     93.7       $ 46,802,408     93.8    $ 39,161,010     93.4
All Other             1,579,113      5.7       1,361,526      6.3          3,117,797      6.2       2,768,749      6.6
Total              $ 27,823,350     100.0   $ 21,460,624     100.0      $ 49,920,205     100.0   $ 41,929,759     100.0

On a combined basis, after-tax profit margins were 11.9% and 12.2% for the three and six months ended June 30, 2013, and 12.8% and 9.9% for the three and six months ended June 30, 2012.

Commissions: Agent commissions represent the portion of premiums retained by agents pursuant to the terms of their respective agency contracts. Commissions to agents increased 39.2% and 30.4% for the three and six months ended June 30, 2013 compared with the prior year period. This increase was primarily due to increased real estate activity. Commission expense as a percentage of net premiums written by agents was 76.2% and 75.4% for the three and six months ended June 30, 2013, respectively, compared with 74.1% and 74.7% for the same period in 2012. Commission rates may vary due to geographic locations, different levels of premium rate structures and state regulations.

Provision for Claims: The provision for claims as a percentage of net premiums written was 3.3% and 1.1% for the three and six months ended June 30, 2013, respectively, compared with 1.6% and 4.6% for the same periods in 2012. The claims provision rates in all periods were abnormally low due to adjustments for favorable loss development. Recent improvements in the claims provision rate were impacted by the absence of large defalcations claims in recent years as well as an increase in business in states with historically lower loss provision rates.

The decrease in the loss provision rate for the six months ended June 30, 2013 from the 2012 level resulted in approximately $1,916,000 less in reserves than would have been recorded at the higher 2012 level. Loss provision ratios are subject to variability and are reviewed and adjusted as experience develops.

Title claims are typically reported and paid within the first several years of policy issuance. The provision for claims reflects actual payments of claims, net of recovery amounts, plus adjustments to the specific and incurred but not reported claims reserves, the latter of which are actuarially determined based on historical claims experience. Actual payments of claims, net of recoveries, were $918,812 and $2,441,466 for the six months ended June 30, 2013 and 2012, respectively.


Reserves for Claims: At June 30, 2013, the total reserve for claims was $38,767,000. Of that total, approximately $4,439,000 was reserved for specific claims, and approximately $34,328,000 was reserved for claims for which the Company had no notice. Because of the uncertainty of future claims, changes in economic conditions and the fact that many claims do not materialize for several years, reserve estimates are subject to variability.

Changes from prior periods in the expected liability for claims reflect the uncertainty of the claims environment, as well as the limited predictive power of historical data. The Company continually updates and refines its reserve estimates as current experience develops and credible data emerges. Adjustments may be required as new information develops which often varies from past experience.

Movements in the reserves related to prior periods were primarily the result of changes to estimates to better reflect the latest reported loss data, rather than as a result of material changes to underlying key actuarial assumptions or methodologies. Such changes include payments on claims closed during the quarter, new details that emerge on still-open cases that cause claims adjusters to increase or decrease the case reserves and the impact that these types of changes have on the Company's total loss provision.

Salaries, Employee Benefits and Payroll Taxes: Personnel costs include base . . .

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