If you've ever bought a house on credit -- chances are good, since most of us finance a home purchase that way -- and if you really, really bothered to read all the fine print and work the numbers on the settlement statement before closing, then you'd have noticed at least one item labeled "title insurance." And if you asked the closing attorney about it, he probably told you without even looking up from his legal pad that it's just "something the bank requires." Pushed, he might have regurgitated from his first-year law school property textbook that it's meant to protect the lender or buyer against loss arising from a dispute over ownership of a piece of property or any errors in the title.
The required lender's insurance protects the lender up to the amount of the mortgage, but it doesn't protect your equity in the property. For that, you need an owner's title policy for the full value of the home. (Count 'em: that's two title insurance policies that someone's paying for at closing.) In many areas of the country, sellers pay for owner policies as part of their contractual obligation to deliver a good title to the buyer. In other areas, borrowers must buy it as an add-on to the lender policy. The lawyer will wisely counsel you to make this one-time insurance payment, since the cost is relatively small and the value of what's at stake -- your fabulous new home -- is rather large. So you cough up the 300 to 600 bucks -- depending on the price of the property and various state laws -- and sign.
Multiply that transaction by sales of 6 million previously owned homes and 1.2 million new homes last year, add to it all of the refinancing business -- which also requires new titles -- and that, my friends, is the basis for the title insurance industry. It's a business dominated by Fidelity National Financial
The place to be
Is the title insurance business profitable? Yep. Even if it seems like a rip-off to some consumers (an assertion that is certainly debatable) and certain regulators (more on that later), it's still a terrific business to be in, despite the end of the refinancing boom.
Despite my upbeat outlook for the company, Fidelity National's just-announced second-quarter earnings fell 14% on a revenue increase of 10.4% from the previous year -- a phenomenon driven mainly by June's being a big open-order month, generating expenses against revenue that won't be realized until the third quarter. The market prospects for both the industry and Fidelity National nonetheless look very cheery indeed. The Mortgage Bankers Association estimates a 6% increase in the mortgage origination market for 2005, making this year the third-strongest mortgage origination market ever, behind only 2003 and 2002. A forecasted decline from 2005 of $2.7 trillion to $2.5 trillion in loan originations in both 2006 and 2007 is caused only by an expected moderate slowdown in refinance transactions, offset somewhat by the increase in anticipated purchase transactions in each of those years.
Tale of the tape
Like many of its competitors, Fidelity National's core title and escrow segment -- accounting for 73% of total pre-tax earnings -- is complemented by several other related businesses that both contribute to its bottom line and help insulate it to some extent from all the volatility of the interest-rate hypersensitivity of the mortgage refinancing market. A good example is its information services segment, which operates the computer systems processing for nearly 50% of all U.S. mortgages. The financial institutions segment -- contributing 15% to total pre-tax earnings -- has processing and technology relationships with 45 of the top 50 U.S. banks. As with its title business, the information-services segment enjoys huge economies of scale that give its competitors a real pain in the neck. Many of Fidelity National's mortgage-lender customers have signed long-term contracts. When those contracts come up for renewal, the costs of switching to another vendor are often prohibitive.
Fidelity National has continually delivered dividends to shareholders while maintaining a healthy balance sheet. Currently, it has cash on hand of $350 million.
Fidelity National's management does acknowledge, however, that the company is carrying a heavy debt load. Debt-to-capital ratios at the company have increased significantly in 2005, primarily because of the payment of an extraordinary one-time $10-per-share shareholder dividend, a gift to investors intended by management to get the market to recognize the company's value. (The market quickly deducted the same amount from the share price value, so the move didn't immediately work, though the share price has recovered since then, leaving shareholders with an extra $10 per share in their pockets.) Analysts generally agree, however, that FNF has shown good experience in managing debt, so this should not be a negative factor dampening future share growth.
Fidelity National recently made news -- and not the kind that corporate media-relations officers enjoy. The company reached a settlement on the California Department of Insurance's inquiry into captive reinsurance practices in the title insurance industry and now must refund $7.7 million to consumers whose California property was subject to a captive reinsurance arrangement. This is in addition to a penalty of $5.6 million. As part of the settlement, FNF denied any wrongdoing.
Fidelity National over First American on points
The California insurance commissioner has been investigating Fidelity National, along with other large title insurance companies and banks, in an alleged kickback scheme in which builders, lenders, and real-estate agents referred all of their title-insurance business to a specific title company, as long as that company reinsured the title policy to the builder, lender, or agent. Other companies under investigation include First American Title Insurance, a unit of FirstAmerican
Fidelity National appears to be a better investment now than is its rival, Motley Fool Inside Value selection First American. A quick look at the share-price history reveals that Fidelity National has outperformed First American over the past two years if you consider the one-time $10-per-share dividend paid out in March. Although First American is also a great company to consider for your portfolio, I want to own the market leader that has enough muscle to weather the next cyclical slowdown better than its rivals will.
For related Foolishness, see "First American: A Stock I'd Love to Own."
Philip Durell of Motley Fool Inside Value is always on the hunt for undervalued companies in the financial sector. Click here to see his latest recommendations.