Thursday, July 17, 2008

National Western Life Insurance (NWLIA)

Last week, I said that I would be reviewing selected Financial Stocks that I believe have sold off below a price level that is justified based on fundamentals, as fear and panic reach what we all hope is a crescendo in the market. I recently established a small position in a company called National Western Life Insurance (NWLIA).

NWLIA is a life insurance company headquartered in Austin, TX. It sells a wide variety of life insurance products including annuities, universal life insurance, fixed indexed annuities, fixed indexed universal life, and term and whole life products. Most of its domestic sales are annuities. It also has a large international life insurance business marketed to high socioeconomic classes in Central America and the Pacific Rim. Brazil and Taiwan are the largest markets with 50% of its international insurance in those two countries.

The company is controlled by the Moody family, which maintains voting control with class B shares.

The chart below shows its performance the last two years:



The businesses that NWLIA operates in are very sensitive to the spreads between yields earned on investments less rates credited to policies. The company states it best in its annual 10-K, so I will reproduce its statement here:

“A decline in interest rates could expose the Company to reduced profitability due to minimum interest rate guarantees that are required in our products by regulation. A key component of profitability is investment spread, or the difference between the yield on our investments and the rates we credit to policyholders on our products.”

“A rise in interest rates will increase the net unrealized loss position of our investment portfolio and may subject the Company to disintermediation risk. Disintermediation risk is the risk that policyholders may surrender their contracts in a rising interest rate environment, requiring the Company to liquidate investments in an unrealized loss position.”

After reading this, you might wonder why anyone would even be in the annuity business, but the boilerplate risks listed above are offset by hedging, and new business that is written every year.

Reasons to Buy

NWLIA has an excellent long term record of increasing book value per share, which is the method that Value Investors tend to use to judge insurance companies. Book value was $172.26 at 12/31/2002 and increased to $283.27 at 3/31/2008. NWLIA has traded from 0.5 to 1.0 times book value, and is trading at 0.72 times book value currently. While this is not at rock bottom valuation, it does give us some margin of safety.

As of March 31, 2008, the company reported only $8.8 million in Level 3 assets in its investment portfolio totaling $1.9 billion. The company also reported no holdings in collateralized bond obligations (CBOs), collateralized debt obligations (CDOs), or collateralized loan obligations (CLOs).

NWLIA has a strong position internationally, which provides a hedge against the economic slowdown in the U.S. and the weak dollar.

NWLIA has traditionally sold below book value as the market discounts its value due to its control by the Moody family. There is a possibility one day that if the family should decide to sell out, its businesses would sell for more than book value, which is where most publicly traded insurers are valued in a normal market environment.

NWLIA also holds a common stock investment totaling approximately 9.4% of the issued and outstanding shares of Moody Bancshares, Inc. This is a bank that is also controlled by the Moody family. Although banking is a potential danger zone in the current environment, the bank is well capitalized, as seen below, and the ratio of noncurrent loans to total loans is only 0.48%. (All data as of 3/31/2008)

Equity capital to assets - 9.84%
Core capital (leverage) ratio - 9.05%
Tier 1 risk-based capital ratio - 16.61%
Total risk-based capital ratio - 17.36%

As its competitors stumble, this bank may gain market share and business, which would accrue to NWLIA through its ownership.

NWLIA can be difficult to buy due to liquidity issues. It trades infrequently and with a wide spread between the bid and ask, so be careful with this one.



This article was written by The Stock Market Prognosticator. You may email questions or comments to me at info@brittaincapitalmanagement.com.

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