Investors Title Company - 10-Q quarterly report FY

Washington, D.C. 20549

For the quarterly period ended March 31, 2007

OR

Commission File Number: 0-11774

 

(Exact name of registrant as specified in its charter)

 

 

 

(Registrant’s telephone number, including area code)

 

 

 

 

 

 

 

 

 

 

 

March 31, 2007

(Unaudited)

Reference should be made to the "Notes to Consolidated Financial Statements" of Investors Title Company’s (“the Company”) Annual Report to Shareholders for the year ended December 31, 2006 for a complete description of the Company’s significant accounting policies.

 

In the opinion of management, all adjustments considered necessary for a fair presentation of the financial position, results of operations and cash flows in the accompanying unaudited consolidated financial statements have been included. All such adjustments are of a normal recurring nature. Operating results for the quarter ended March 31, 2007 are not necessarily indicative of the results that may be expected for the year ended December 31, 2007.

For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2006.

 

 

The total reserve for all reported and unreported losses the Company incurred through March 31, 2007 is represented by the reserves for claims. The Company's reserves for unpaid losses and loss adjustment expenses are established using estimated amounts required to settle claims for which notice has been received (reported) and the amount estimated to be required to satisfy incurred claims of policyholders which may be reported in the future. Despite the variability of such estimates, management believes that the reserves are adequate to cover claim losses which might result from pending and future claims for policies issued through March 31, 2007. The Company continually reviews and adjusts its reserve estimates to reflect its loss experience and any new information that becomes available. Adjustments resulting from such reviews may be significant.

Claims and losses paid are charged to the reserves for claims. Although claims losses are typically paid in cash, occasionally claims are settled by purchasing the interest of the insured or the claimant in the real property. When this event occurs, the Company carries assets at the lower of cost or estimated realizable value, net of any indebtedness on the property.

Total comprehensive income for the three months ended March 31, 2007 and 2006 was $2,217,546 and $2,410,923, respectively. Other comprehensive income is comprised of unrealized gains or losses on the Company’s available-for-sale securities, net of tax.

Basic earnings per common share is computed by dividing net income by the weighted-average number of common shares outstanding during the reporting period. Diluted earnings per common share is computed by dividing net income by the combination of dilutive common share equivalents, comprised of shares issuable under the Company’s share-based compensation plans and the weighted-average number of common shares outstanding during the reporting period. Dilutive common share equivalents include the dilutive effect of in-the-money shares, which is calculated based on the average share price for each period using the treasury stock method. Under the treasury stock method, the exercise price of a share, the amount of compensation cost, if any, for future service that the Company has not yet recognized, and the amount of estimated tax benefits that would be recorded in additional paid-in capital, if any, when the share is exercised are assumed to be used to repurchase shares in the current period. The incremental dilutive common share equivalents, calculated using the treasury stock method were 36,823 and 37,395 for the periods ended March 31, 2007 and 2006, respectively.

 

 

 

Operating revenues represent net premiums written and other revenues.

The Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109,” (“FIN 48”) on January 1, 2007. This interpretation requires that the Company recognize in its financial statements the impact of a tax position if that position is more likely than not of being sustained on an audit, based on the technical merits of the position. As a result of the implementation of FIN 48, the Company made a comprehensive review of its portfolio of uncertain tax positions in accordance with recognition standards established by FIN 48. In this regard, an uncertain tax position represents the Company’s expected treatment of a tax position taken in a filed tax return, or planned to be taken in a future tax return, that has not been reflected in measuring income tax expense for financial reporting purposes. As a result of this review, the Company did not recognize any increase in the liability for unrecognized tax benefits, nor did it reduce the January 1, 2007 balance in retained earnings for any additional liability.

The amount of unrecognized tax benefit or liability may increase or decrease in the future for various reasons, including adding amounts for current tax year positions, expiration of open income tax returns due to the statute of limitation, changes in management’s judgment about the level of uncertainty, status of examinations, litigation and legislative activity and the addition or eliminations of uncertain tax positions.

The Company’s policy is to report interest and penalties, if any, related to unrecognized tax benefits or liabilities in income tax expense in the Consolidated Statements of Income.

The Company, or one of its subsidiaries, files income tax returns in the U.S. federal jurisdiction and various states. With few exceptions, the Company is no longer subject to U.S. federal or state and local examinations by taxing authorities for years before 2003.

The Company and its subsidiaries are involved in various routine legal proceedings that are incidental to their business. In the Company’s opinion, based on the present status of these proceedings, any potential liability of the Company or its subsidiaries with respect to these legal proceedings will not, in the aggregate, be material to the Company’s consolidated financial condition or operations.

The Company’s 2006 Annual Report on Form 10-K and 2006 Annual Report to Shareholders should be read in conjunction with the following discussion since they contain important information for evaluating the Company's operating results and financial condition.

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 title insurer has the option to retain counsel and pay the legal expenses to eliminate or defend against any title defects, pay any third party claims arising from errors in title examination and recording or pay the insured’s actual losses, up to policy limits, arising from defects in title as defined in the policy.

The Company's overall level of premiums written in the land title insurance industry is affected by real estate activity. In turn, real estate activity is affected by a number of factors, including the level of interest rates, the availability of mortgage funds, the level of real estate transactions and mortgage refinance activity, the cost of real estate, employment levels, family income levels and general economic conditions. Generally, real estate activity declines as a result of higher interest rates or an economic downturn, thus leading to a corresponding decline in title insurance premiums written and profitability of the Company. The cyclical nature of the land title insurance industry has historically caused fluctuations in revenues and profitability and it is expected to continue to do so in the future. The Company’s title business also experiences seasonality in addition to cyclicality.

 

Volume is a key factor in the Company's profitability due to the existence of fixed costs such as personnel and occupancy expenses associated with the support of the issuance of title insurance policies and of general corporate operations. These expenses will be incurred by the Company regardless of the level of premiums written. The resulting operating leverage has historically tended to amplify the impact of changes in volume on the Company’s profitability.

Since the title insurance business generally is closely related to the overall level of real estate activity, and title insurance volumes generally fluctuate based on the effect changes in interest rates have on the level of real estate activity, any substantial increases in interest rates will likely have a negative impact on mortgage originations. Operating results for the quarter ended March 31, 2007, therefore, should not be viewed as indicative of the Company's future operating results. The Company continues to monitor and strives to manage operating expenses to offset the cyclical nature of the real estate market and with knowledge of the potential for further declines in title insurance revenues if interest rates continue to rise or the economy slows.

While timing and content are uncertain, the Department of Housing and Urban Development (“HUD”) continues to indicate that it would like to revise Real Estate Settlement Procedures Act regulations. In April 2007, the Government Accountability Office released a report on a study undertaken on the title insurance industry in which it recommended that HUD and state insurance regulators take actions to improve consumers’ ability to comparison shop for title insurance and strengthen the regulation and oversight of the title insurance market, among other measures. Based on the information known to management at this time, it is not possible to predict the outcome of any of the currently pending governmental recommendations for the title insurance industry’s market and other matters, or the market’s response to them. However, any material change in the Company’s regulatory environment may have an adverse effect on its business.

Factors that influence the title insurance industry will also generally affect the exchange services industry. In addition, the services provided by the Company’s exchange services are pursuant to provisions in the Internal Revenue Code. From time to time, these exchange provisions are subject to review and proposed changes.

On February 3, 2006, the IRS proposed new regulations which, if adopted, may negatively affect the ability of qualified intermediaries to retain a portion of the interest earned on exchange funds held during exchange transactions. If passed as proposed, these regulations would have a materially adverse impact on the exchange services segment and the Company’s net income, since a significant portion of the exchange segment’s revenues are based on retaining a portion of the interest income earned on deposits held by the Company. A public hearing on the proposed regulations was held on June 6, 2006, and as a result the IRS agreed to revise its initial regulatory flexibility analysis on the impact of the proposed regulations to small businesses. In March, 2007, the IRS issued a revised regulatory flexibility analysis and requested more specific information to help in determining the impact the rules would have on small businesses.

 

The preparation of the Company’s financial statements requires management to make estimates and judgments that affect the reported amounts of certain assets, liabilities, revenue, expenses and related disclosures surrounding contingencies and commitments. During the quarter ended March 31, 2007, 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, 2006 as filed with the Securities and Exchange Commission. Actual results could differ from these estimates.

For the quarter ended March 31, 2007, net premiums written increased 1.0% to $16,792,542, investment income increased 21.7% to $1,209,607, total revenues increased 0.8% to $20,333,769 and net income decreased 19.2% to $2,322,214, all compared with the same quarter in 2006. Net income per basic and diluted common share decreased 17.7% and 17.1%, respectively, to $0.93 and $0.92, compared with the same prior year period.

Total revenues slightly exceeded the prior year period primarily due to an increase in the exchange services income, an increase in investment income and a slight increase in net premiums written. Offsetting these increases was a decrease in net realized gain on sales of investments. Profit margin declined as overall operating expenses increased.

 

 

Following is a breakdown of branch and agency premiums for the quarter ended March 31:

 

Total premiums written were positively impacted by an increase in the Company’s agency business. Agency net premiums written increased 8.5% and decreased 9.7% for the three months ended March 31, 2007 and 2006, respectively, compared with the prior years.

 

Following is a schedule of premiums written for the three months ended March 31, 2007 and 2006 in all states in which the Company’s two insurance subsidiaries currently underwrite insurance:

 

 

According to data published by Freddie Mac, the quarterly average 30-year fixed mortgage interest rates in the United States decreased to 6.22% for the quarter ended March 31, 2007, compared with 6.24% for the quarter ended March 31, 2006. Although net premiums written in the first quarter of 2007 increased slightly over the same period in 2006, the total number of policies and commitments issued declined in the first quarter of 2007 to 57,009, which is a decrease of 6.7% compared with 61,097 policies and commitments issued in the same period in 2006. Title insurance volumes fluctuate based on the effect that changes in interest rates have on the level of real estate activity. The softening housing market due to higher sustained rates was the primary reason for the decline in volume. In addition, premium rates vary by the state in which the policies are written.

Operating revenues from the Company’s two subsidiaries that provide tax-deferred exchange services (ITEC and ITAC) increased 21.2% compared with the first quarter of 2006. The increase in 2007 was primarily due to higher levels of interest income earned on exchange fund deposits held by the Company, resulting from higher current interest rates. The Company has also focused on increased marketing and education efforts. Also, see Overview section for discussion of proposed IRS rules.

Other revenues primarily include investment management fee income and agency service fees, as well as search fee and other ancillary fees and income related to the Company’s other equity method investments. Other revenues decreased 4.5% in 2007 compared with the first quarter of the prior year, primarily due to declines in closing and search fee income.

Investment income increased 21.7% to $1,209,607 in the first quarter of 2007, compared with $994,054 in the same period in 2006. The increase was principally attributable to increases in the average investment portfolio balance and, to a lesser extent, to an increase in investments in taxable securities and higher rates of interest earned on short-term investments and cash balances.

Net realized gain on the sales of investment securities totaled $166,180 for the three months ended March 31, 2007, compared with net realized gain of $561,647 for the corresponding period in 2006. The decrease in net realized investment gain in 2007 was primarily the result of capital gains realized on several equity securities sold during the first quarter of 2006 primarily due to a repositioning of the Company’s investment portfolio.

 

 

On a combined basis, profit margins were 11.4% and 14.2% in 2007 and 2006, respectively. Total revenues increased 0.8% in 2007, while operating expenses increased 5.8%, contributing to a less favorable combined profit margin for 2007.

 

Agent commissions represent the portion of premiums retained by agents pursuant to the terms of their respective agency contracts. Commissions to agents increased 8.9% from the prior year first quarter primarily due to increased premiums from agency operations in 2007 as noted previously. Commission expense as a percentage of net premiums written by agents was 70.9 % and 70.6% for the first quarter 2007 and 2006, respectively. Commission rates vary by the geographic area in which the commission is paid and may be influenced by state regulations.

 

The provision for claims as a percentage of net premiums written was 10.8% for the three months ended March 31, 2007, versus 11.2% for the same period in 2006. Loss provision rates are subject to variability and are reviewed and adjusted as experience develops. Declining economic conditions and/or declines in transaction volumes have historically been factors in increased claim expenses due to increased mechanics liens, defalcations and other matters which may be discovered during property foreclosures. Title claims are typically reported and paid within the first several years of policy issuance. The provision 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.

 

At March 31, 2007, the total reserves for claims were $37,133,000. Of that total, $4,919,601 was reserved for specific claims and $32,213,399 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.

On a consolidated basis, salaries, employee benefits and payroll taxes as a percentage of total revenues were 25.9% and 24.8% for the three months ended March 31, 2007 and 2006, respectively. The increase in salary and employee benefit costs in 2007 was primarily related to salary increases. The title insurance segment’s total salaries, employee benefits and payroll taxes accounted for 84.7% and 87.2% of the total consolidated amount for the three months ended March 31, 2007 and 2006, respectively.

Overall office occupancy and operations as a percentage of total revenues was 7.1% and 7.3% for the three months ended March 31, 2007 and 2006, respectively. The decrease in office occupancy and operations expense in 2007 compared with 2006 was due to a decrease in various items, including office supplies, partially offset by an increase in depreciation expense and maintenance services.

 

Title insurance companies are generally not subject to state income or franchise taxes. However, in most states they are subject to premium and retaliatory taxes. Premium and retaliatory taxes as a percentage of premiums written were 2.6% and 2.1% for the three months ended March 31, 2007 and 2006, respectively.

Professional and contract labor fees for the three months ended March 31, 2007 compared with the same period in 2006 increased primarily due to an increase in contract labor fees incurred related to investments in infrastructure and technology.

Other expenses primarily include miscellaneous operating expenses of the Trust division and other miscellaneous expenses of the title segment.

 

 

The total reserve for all reported and unreported losses the Company incurred through March 31, 2007 is represented by the reserves for claims. Information regarding the claims reserves can be found in Note 2 to the consolidated financial statements of this Form 10-Q. Further information on contractual obligations related to the reserves for claims can be found in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006 as filed with the Securities and Exchange Commission.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). This statement, which is expected to expand fair value measurement, permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company is currently assessing the impact of SFAS No. 159 on its consolidated financial position and results of operations.

No material changes in the Company’s market risk or market strategy occurred during the current period. A detailed discussion of market risk is provided in the Company’s 2006 Annual Report on Form 10-K for the period ended December 31, 2006.

 

 

The Company's disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 (the "Act") was recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission's rules and forms. Pursuant to Rule 13a-15b under the Act, an evaluation was performed under the supervision and with the participation of the Company's management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based on that evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective as of March 31, 2007. In reaching this conclusion, the Company's Chief Executive Officer and Chief Financial Officer determined that the Company's disclosure controls and procedures were effective in ensuring that such information was accumulated and communicated to the Company's management as appropriate to allow timely decisions regarding required disclosure.

During the quarter ended March 31, 2007, the Company implemented new general ledger, accounts payable and fixed assets systems to record and report financial transactions. Other than the items described above, there were no other changes in the Company's internal control over financial reporting that occurred during the quarter ended March 31, 2007 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.

 

 

 

 

 

 

 

Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

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