| CAPITAL TITLE GROUP INC Item 1A Risk Factors The risk factors listed in this section and other factors noted herein or incorporated by reference could cause our actual results to differ materially from those contained in any forward-looking statements |
| The following risk factors, in addition to the information discussed elsewhere herein, should be carefully considered in evaluating us and our business: The demand for our title insurance and related services is highly dependent upon the volume of real estate transactions and other general economic conditions, and our future revenues and profits may decline as interest rates stabilize or rise |
| The demand for title insurance and appraisal services depends upon, among other things, the volume of commercial and residential real estate transactions |
| The volume of these transactions has historically been influenced by factors such as mortgage interest rates and the state of the overall economy |
| When mortgage interest rates are increasing or during an economic downturn or recession, real estate activity typically declines and the title insurance and appraisal industries tend to experience lower revenues and profitability |
| For example, stable mortgage interest rates and strength in the real estate market, especially in California and throughout the West Coast, contributed to very positive conditions for the title insurance industry throughout 1997 and 1998 |
| However, during the second half of 1999 and through 2000, steady interest rate increases resulted in a significant decline in refinancing transactions |
| As a result, the market shifted from a refinance-driven market in 1998 to a more traditional market driven by new home purchases and resales in 1999 and 2000 |
| Beginning in 2002 and into 2003, the level of real estate activity increased, including refinancing transactions, new home sales and resales, due in significant part to substantial decreases in mortgage interest rates |
| The volume of refinance activity declined in 2004 as a result of interest rates stabilizing or increasing from 2003 levels, and the favorable industry conditions that existed in 2002 and 2003 may not occur again in the foreseeable future |
| We cannot predict changes in the interest rate environment in future periods and its complete impact on residential resale refinance activity |
| If mortgage interest rates rise quickly and significantly during 2006, it would likely negatively affect opened orders and, in turn, have a negative impact on our revenue levels and profitability, particularly in comparison to our financial performance in recent years, which saw record levels of residential resale activity |
| 13 ______________________________________________________________________ Our success depends on our ability to attract and retain key personnel |
| Competition for personnel in our industry is intense |
| We may have difficulty hiring the necessary sales, marketing and management personnel to support our growth |
| The successful implementation of our business model and growth strategy depends on the continued contributions of our seasoned executives and key managers |
| The loss of any key employee, the failure of any key employee to perform in his or her current position, or the inability of our officers and key managers to expand, train and manage our employee base could prevent us from executing our growth strategy and have a material adverse effect on our business |
| Additionally, competition for personnel varies from region to region and increased costs may hurt our financial performance in certain regions |
| For example, competition for key personnel in California has substantially increased our costs of attracting and retaining personnel |
| Additional personnel cost increases in this or other regions could lower our profits |
| The title insurance industry experiences seasonal fluctuations |
| Historically, residential real estate activity has been generally slower in the winter, when fewer families move, buy or sell homes, with increased volumes in the spring and summer |
| Residential refinancing activity generally is more uniform throughout the year, subject to interest rate stability |
| Demand for our title insurance and related services generally tracks these seasonal demand patterns of the residential real estate market, although acquisitions of other title insurance companies and changes in interest rates may alter these traditional seasonal demand patterns |
| We typically report our lowest revenues and earnings in the first quarter, with revenues and earnings increasing into the second quarter and through the third quarter and declining again in the fourth quarter |
| Our business is highly competitive and increased competition could reduce our revenues and profitability |
| The business of providing real estate transaction products and services is highly competitive, particularly with respect to price, service and expertise |
| Over 40 independent title insurance companies accounted for less than 10prca of the market |
| The number and size of competing companies varies in the different geographic areas in which we conduct our business |
| Companies with significant market share in the local and national markets in which we compete include First American, Old Republic, Stewart Title, Fidelity National Title and LandAmerica |
| All of the top five title insurers have larger distribution networks, greater financial resources, more extensive computerized databases and longer standing relationships than us |
| The number and size of competing companies varies in the different geographic areas in which we conduct our business |
| Also, the removal of regulatory barriers might result in new competitors entering the title insurance business, and those new competitors may include diversified financial services companies that have greater financial resources than we do and possess other competitive advantages |
| Competition with the major title insurance companies, expansion by smaller regional companies and new entrants could adversely affect our business operations and financial condition |
| For example, intense competition in California has resulted in lower profit margins in that region |
| We may not be able to implement successfully our strategy of selectively acquiring other businesses in the title insurance industry and related industries |
| As part of our overall growth strategy, we intend to acquire selectively businesses in our industry and related industries that will allow us to enter new markets, provide services that we currently do not offer or advance our existing technology |
| Our ability to implement our selective acquisition strategy will depend on our success in identifying and consummating acquisitions of businesses on favorable terms |
| Although we also are actively seeking other acquisition candidates, we can give no assurance that we will be successful in these efforts |
| If we are unable to acquire appropriate businesses on favorable economic terms, or at all, or are unable to introduce new products and services successfully, our business could be materially adversely affected |
| 14 ______________________________________________________________________ We may encounter difficulties managing and integrating our acquisitions |
| Part of our continued growth strategy is to pursue additional opportunities to diversify and expand our operations by acquiring other companies |
| The success of each acquisition will depend upon our ability: • to integrate the acquired businesses’ operations, products and personnel to achieve synergies and economies of scale; • to retain key personnel of the acquired businesses; • to maintain the customers and goodwill of the acquired businesses; • manage any unexpected costs or unforeseen liabilities associated with the acquired businesses; and • to expand our financial and management controls and reporting systems and procedures |
| In addition, our growth strategy of providing a comprehensive suite of services subjects us to associated risks, including lack of experience in operating such businesses |
| Our inability to successfully integrate acquired businesses and manage our growth strategy could have a material adverse effect on our business |
| Security breaches and computer viruses could harm our business by disrupting our delivery of services and damaging our reputation |
| We electronically receive, process, store and transmit sensitive business information of our customers |
| Unauthorized access to our computer systems could result in the theft or publication of confidential information, the deletion or modification of records or otherwise cause interruptions in our operations |
| These concerns about security are increased when we transmit information over the Internet |
| Computer viruses have also been distributed and have rapidly spread over the Internet |
| Computer viruses could infiltrate our systems, disrupting our delivery of services and making our products unavailable |
| Any inability to prevent security breaches or computer viruses could cause existing customers to lose confidence in our systems and terminate their agreements with us, and could inhibit our ability to attract new customers |
| We may experience significant claims relating to our title insurance operations and losses resulting from fraud, defalcation or misconduct |
| A significant component of our revenue arises from issuing title insurance policies which typically provides coverage for the real property mortgage lender and the buyer of the real property |
| We may also be subject to a legal claim arising from the handling of escrow transactions |
| We carry errors and omissions insurance coverage for errors made during the real estate settlement process of up to dlra10dtta0 million per occurrence, dlra10dtta0 million in the aggregate, subject to a deductible of dlra250cmam000 per occurrence |
| The occurrence of a significant title or escrow claim in any given period could have a material adverse effect on our financial condition and results of operations during the period |
| Fraud, defalcation and misconduct by employees are also risks inherent in our business |
| As of December 31, 2005, we were the custodian of dlra980dtta4 million of cash deposited by customers with specific instructions as to its disbursement from escrow, trust and account servicing files |
| To the extent that any loss or theft of funds substantially exceeded our insurance coverage, our business could be materially adversely affected |
| 15 ______________________________________________________________________ Insurance regulations limit the ability of our insurance subsidiary to pay cash dividends to us |
| Our insurance subsidiary is subject to regulations that limit its ability to pay dividends or make loans or advances to us, principally to protect policy holders |
| Generally, these regulations limit the total amount of dividends and distributions to the greater of 10prca of our insurance subsidiary’s surplus, which amount was dlra21dtta4 million as of December 31, 2005, or 100prca of net income for the previous calendar year, which was dlra4dtta5 million for the year ended December 31, 2005 |
| At December 31, 2005, dlra42dtta8 million of cash, short-term investments, fixed maturity bonds and equity securities were subject to this dividend restriction |
| These restrictions could limit our ability to pay dividends to our stockholders, repay our indebtedness, make acquisitions or otherwise grow our business |
| We are subject to substantial government regulation which could have the effect of delaying or preventing a change of control of our insurance subsidiary or our company |
| Many state insurance regulatory laws intended primarily for the protection of policyholders contain provisions that require advance approval by state agencies of any change in control of an insurance company or an insurance holding company that is domiciled (or, in some cases, doing business) in that state |
| Any future transaction that would constitute a change of control of our insurance underwriting subsidiary or us may require regulatory approval by the state insurance agencies of the states in which we are currently licensed |
| In addition, any person or group that beneficially owns more than a particular threshold percentage of our issued and outstanding common stock may be required to obtain approval from various state insurance departments |
| All states where we are currently subject to regulation have laws that impose filing requirements on persons who beneficially own 10prca or more of our voting shares |
| Such regulatory requirements could have the effect of delaying or preventing transactions affecting the control of us or the ownership of our common stock, including transactions that could be advantageous to our common stockholders |
| Our insurance subsidiary is subject to substantial government regulation |
| State authorities regulate our insurance subsidiary in the states in which it does business |
| These regulations generally are intended for the protection of policyholders rather than stockholders |
| The nature and extent of these regulations vary from jurisdiction to jurisdiction, but typically involve: • approval of premium rates for insurance; • standards of solvency and minimum amounts of statutory capital surplus that must be maintained; • limitations on types and amounts of investments; • establishing reserves, including statutory premium reserves, for losses and loss adjustment expenses; • regulation of dividend payments and other transactions between affiliates; • prior approval of the acquisition and control of an insurance company or of any company controlling an insurance company; • licensing of insurers and agents; • regulation of reinsurance; • restrictions on the size of risks that may be insured by a single company; • regulation of underwriting and marketing practices; • deposits of securities for the benefit of policyholders; • approval of policy forms; • methods of accounting; and • filing of annual and other reports with respect to financial condition and other matters |
| These regulations may impede or impose burdensome conditions on rate increases or other actions that we might want to take to implement our business strategy and enhance our operating results |
| Additionally, as a result of having operations within an industry that is governed by various regulatory authorities, the sometimes fast-changing regulatory environment could impact the way we operate and compete in the markets we serve |
| 16 ______________________________________________________________________ If we fail to comply with privacy regulations imposed on providers of services to financial institutions, our business could be harmed |
| As a provider of services to financial institutions, we are bound by the same limitations on disclosure of the information we receive from our customers as apply to the financial institutions themselves |
| If we fail to comply with these regulations, we could be exposed to suits for breach of contract or to governmental proceedings, damage our customer relationships, harm our reputation and inhibit our ability to obtain new customers |
| In addition, if more restrictive privacy laws or rules are adopted in the future on the federal or state level, or, with respect to our international operations, by authorities in foreign jurisdictions on the national, provincial, state or other level, then it could have an adverse impact on us |
| If rating agencies downgrade our insurance subsidiary, our results of operations and competitive position in the industry may suffer |
| Ratings have become an increasingly important factor in establishing the competitive position of insurance companies |
| Our insurance company subsidiary is rated by Lace Financial Corporation and Demotech, Inc, whose ratings are designed to indicate the insurance company’s financial condition and/or claims paying ability |
| These ratings are not evaluations directed to investors |
| Our ratings are subject to periodic review by those entities and the continued retention of those ratings cannot be assured |
| If our ratings are reduced from their current levels by those entities, our results of operations could be adversely affected |
| Our stock price might be volatile and you might not be able to resell your shares at or above the price you have paid |
| If you purchase shares of common stock, you might not be able to resell those shares at or above the price you have paid |
| The market price of our common stock might fluctuate significantly in response to many factors, some of which are beyond our control, including the following: • actual or anticipated fluctuations in our annual and quarterly results of operations; • changes in securities analysts’ expectations; • variations in our operating results, which could cause us to fail to meet analysts’ or investors’ expectations; • announcements by our competitors or us of significant technical innovations, contracts, acquisitions, strategic partnerships, joint ventures or capital commitments; • conditions and trends in the title insurance and real estate business; • general market, economic, industry and political conditions; • changes in market values of comparable companies; • additions or departures of key personnel; • stock market price and volume fluctuations attributable to inconsistent trading volume levels; and • future sales of equity or debt securities, including sales which dilute existing investors |
| In addition, the stock market has experienced extreme volatility that often has been unrelated to the performance of its listed companies |
| These market fluctuations might cause our stock price to fall regardless of our performance |
| In the past, companies that have experienced volatility in the market price of their stock have been the objects of securities class action litigation |
| If we were involved in securities class action litigation, it could result in substantial costs and a diversion of our attention and resources and have a material adverse effect on our business |
| Certain provisions of our certificate of incorporation, granting our board of directors broad discretion to issue shares of preferred stock, may adversely affect your rights as a common stockholder |
| Our board of directors may, without further action by our common stockholders, from time to time, issue shares of our authorized but unissued preferred stock, and determine the rights, preferences and limitations of each series of preferred stock |
| Upon the vote of a majority of the directors then in office, our 17 ______________________________________________________________________ board of directors, without stockholder approval, may issue shares of preferred stock with dividend, liquidation, voting, conversion and other rights superior to the rights of our common stockholders |
| Satisfaction of any dividend preferences of our outstanding redeemable preferred stock and future issuances of preferred stock would reduce the amount of funds available for the payment of dividends on shares of common stock |
| Holders of shares of preferred stock may be entitled to receive a preference payment in the event of any liquidation, dissolution or winding-up of our company before any payment to our common stockholders |
| Under some circumstances, the issuances of shares of preferred stock may make a merger, tender offer or proxy contest or the assumption of control by a holder of a large block of our securities or the removal of incumbent management more difficult |
| Any issuances of our preferred stock thus may have a material adverse effect on your rights as a common stockholder |