Once upon a time a group of individuals known as “conveyancers” were responsible for conducting background checks on real property before it was sold in order to give confidence to the purchaser that he was getting a clean title. That system ended thanks to the 1868 decision in Watson v. Muirhead by the Pennsylvania Supreme Court that a buyer could not necessarily win a suit against a conveyor for concealing title defects (what they said was “conduct was not to be judged by the result” and would depend on individual facts and circumstances) and was replaced by the widespread use of title insurance to protect buyers against title defects on purchases.

Basically, under the old system of conveyancers, you could rely on a trusted individual to research title defects on your behalf, but if errors were made the purchaser of the property was still out for his investment rather than the liability fall on the conveyancer. You might think of some parallels under this system with credit agencies today: they publish research based upon their professional opinions but do not have liability should they be wrong. Title insurers, though, would not only thoroughly research the title of a property but also provide insurance in instances where they may have made an error in their research.

The first title insurer was The Real Estate Title Insurance Company of Philadelphia and was incorporated in 1876. Ownership of that company changed hands many times over the years and eventually became Commonwealth Land Title Insurance Company and owned by Fidelity National (FNF), the largest title insurance company in the country.

Title insurance today is written for mortgage holders (and covers the title for the life of the loan) and real estate owners themselves (covering the title for as long as it is owned by that specific owner). Thus, when a home is sold two policies – one for the owner and one for the lender – are generally written and when a refinancing takes place one policy for the lender is generally written. Premiums are distributed either directly or through an agency that may or may not be affiliated with the title insurer.

Obviously, premium volume within the industry is closely tied to the volume of mortgage issuance, as the chart below shows. Policies on home purchases are generally more expensive than policies issued for refinanced mortgages, so shifts in the mortgage mix can be influential in determining the total size of the mortgage premium market.

Source: American Land Title Association and Mortgage Bankers' Association.

Exemplifying the rate difference in new and refinanced mortgage originations, I constructed an index of mortgage activity since 1990 with new mortgages weighted twice as heavily as refinances and compared that index to an index of mortgage premiums.

Does that mean that investors should be pessimistic towards title insurers should mortgage rates rise from record lows? Yes, but with some very large caveats.

30 year conventional mortgage rates, 1972-Present. Source: Freddie Mac and Federal Reserve Bank of St. Louis.

Here is a look at the average 30 year mortgage rates each year since 1990 versus mortgage originations – both purchases and refinances. Both purchase and refi volume have a negative correlation with interest rates (the coefficients I come up with are -0.28 for purchase volume and -0.55 for refinance volume) and it should not take a genius to figure out that higher interest rates are bad for the mortgage market.

Note: Purchase and Refinance volume is in $ billions.

There are some reasons to believe that the relationship between interest rates and mortgage originations are not currently in historical balance. For one, just look at a scatter plot of interest rates and from the data above.

Note: Purchase volume is in billions of dollars.

The data points circled are the most recent years where the correlation is nothing similar to the years prior to 2007. You can draw your own conclusions from the relationship, but I think tighter lending standards from banks as well as a greater reluctance from Americans in general (especially younger ones) to be homeowners is the reason for the changing correlations in the two variables. 

US Homeownership Rate, 1965-Present. Source: US Census Bureau and Federal Reserve Bank of St. Louis.

What does all of this mean for future premium volume from title insurers? Unless a truly unexpected event occurs and interest rates decline further, refinance volume is not likely to increase. But refinance volume is already at a fairly low level and if mortgage holders ever actually believed that mortgage rates would finally rise you could see a one-time bump in refinancing.

Of more importance is what will happen to purchase volume if interest rates rise and secular shifts play out. With mortgage originations already low relative to interest rate levels an argument could be made that originations could in fact rise with modestly higher interest rates because it could encourage banks that would be receiving higher net interest margins to loosen lending standards somewhat. A secular shift towards renting would not alleviate the need for title insurance, but if a larger amount of purchases are made via cash by investors rather owner-occupiers, then title insurers would be hurt by not selling policies to lenders in addition to buyers.

All things considered, the title insurance industry continues to be enormously attractive because of concentration within the industry and the necessity of the industry itself. And even if interest rates rise modestly, one company could actually be a net beneficiary more so than the large title insurers: Investors Title Corporation (ITIC).

Investors Title is the tenth largest title insurer in the United States with less than 1% of the total market. It was founded in the early 1970s in North Carolina by J. Allen Fine. Mr. Fine’s ownership combined with that of his two sons totals 28.7%. Markel Corporation (MKL) is the next larger holder after the Fine family with an 11.0% stake.

The below chart summarizes industry market shares (for 2015) and current valuations for those that are publicly traded. Although Investor’s Title does not have the scale of the large title insurers it trades for very attractive valuations on both an earnings and book value basis.

Source: American Land Title Association and Morningstar.

Further, its size could be an advantage by allowing more opportunities for future organic growth such as the company’s entrance into Texas a few years ago did. Over the last ten years premiums at Investor’s Title have increased by 54% versus an industry decline of 21%. 

Investor's Title Income Statement, 2006 to Present. Source: ITIC SEC Filings.

As would be expected, Investor Title’s investment portfolio has also grown over the last decade, by 44%, from $123.6 million to $178.0 million. But, investment income has remained pretty much flat over that time frame. In 2006 it was $4.3 million and over the last twelve months investment income has been $4.5 million – a decline in the effective yield from 3.5% to 2.6%. Of course, much of that decline has been caused by market conditions, but some of it has also been due to a disciplined investment process.

Investor's Title investment portfolio, 6/30/16 and 12/31/06. Source: ITIC SEC Filings.

The percentage of Investor Title’s investments in fixed maturities that mature in 10 years or longer has declined from 35% of the portfolio at the end of 2006 to just 1% today and the percentage of the portfolio in cash and short term investments has more than doubled from 7% to 15%.

A final point to mention in discussing the company is to take a look at the cash that’s been generated along with how those cash flows have been invested. 

Investor's Title sources and uses of cash, 2006-Present. Source: ITIC SEC Filings.

The company has generated roughly $10 million in cash per year on average and a total of $53 million, or 56% of the total, has gone towards increasing the company’s cash and investments. But a close second has been share repurchases which is where 47% of free cash flow has been dedicated. Average shares outstanding have correspondingly declined by 25% from 2.56 to 1.94 million.

The current market presents so many curve-balls that it can be hard to know which way is up and which way is down. Investor’s Title does not present a valuation today (at 14x earnings) that is so compelling that an investor is going to quickly get rich buying it, but it does represent an attractive way to participate in an industry that has favorable characteristics, whose volume may not suffer from interest rate rises as some fear, and whose conservative investment policies offer offsetting benefits from increases interest rates should they hurt operating profitability.

My best suggestion on Investor’s Title, as it so often is in general, is to have a degree of patience. Over the next couple of years there are bound to be fears and some realities surrounding stock market valuations, recessions, and the health of the housing market. Step in and buy shares at that point if the valuation ever approaches book value again from its current 20% premium; I would be willing to say with a high degree of probability that should that happen, the company itself will.