Security National Financial Corporation — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Unaudited consolidated results cover life insurance, cemetery and mortuary, and mortgage operations.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $67.2 million | $71.8 million | $218.2 million | $216.0 million |
| Earnings before taxes | $2.2 million | $1.1 million | $27.6 million | $8.0 million |
| Net earnings | $2.0 million | $1.1 million | $22.2 million | $5.4 million |
| Diluted earnings per share | $0.12 | $0.07 | $1.35 | $0.33 |
| Benefits and expenses as a share of revenue | 96.7% | 98.4% | 87.4% | 96.3% |
Net margin was approximately 3.0% in Q3 2018 versus 1.5% in Q3 2017, and approximately 10.2% for the first nine months versus 2.5% a year earlier. The nine-month earnings comparison benefited substantially from property-sale gains.
- Cash flow: Operating activities used $10.3 million in the first nine months, versus $6.0 million provided in 2017. Investing activities provided $67.0 million and financing activities provided $36.1 million. Cash, cash equivalents and restricted cash totaled $147.4 million at period-end; balance-sheet cash and equivalents alone were $137.1 million.
- Debt and liquidity: Bank and other loans payable were $196.4 million, up from $157.5 million at December 31, 2017. The company reported $40 million owed to the Federal Home Loan Bank at quarter-end and paid it in October 2018. Total assets were $1.064 billion, liabilities $892.2 million, and stockholders’ equity $172.0 million. Equity represented 46.7% of total capitalization, versus 48.5% at year-end 2017.
- Other balances: Loans held for sale were $165.5 million; mortgage servicing rights, net, were $20.9 million. Mortgage loans held for investment were $181.4 million, including $4.2 million non-performing loans (defined as at least 90 days delinquent or on non-accrual).
Material changes versus prior periods
- Q3 revenue declined 6.4%, primarily because mortgage fee income fell $9.9 million (23.9%). Nine-month revenue increased 1.0%, as higher investment gains, insurance premiums, investment income, and cemetery/mortuary sales largely offset lower mortgage income.
- Mortgage operations reported a pretax loss of $0.8 million in Q3 and $5.0 million for the first nine months, compared with profits in both 2017 periods. Nine-month mortgage fee income declined 27.2%. SecurityNational Mortgage originated 7,953 loans totaling $1.169 billion in the first nine months, down from 9,773 loans totaling $1.913 billion in 2017. Management attributed the industry slowdown to limited housing availability and higher mortgage rates reducing refinancings.
- Insurance premiums grew 6.6% in Q3 and 8.2% year to date, which management attributed mainly to renewal premiums and growth in whole-life business. Net investment income rose 17.3% in Q3 and 15.3% year to date.
- Gains on investments and other assets included a $22.252 million gain on the March sale of Dry Creek apartments and a $1.603 million gain on the sale of Deseret Mortuary assets. The Dry Creek sale price was $57 million; proceeds included repayment of a $26.8 million loan. These gains materially lifted nine-month earnings.
- Bank and other loans payable rose while mortgage warehouse-line and real-estate borrowing costs increased. Operating cash flow turned negative, primarily because of cash used to fund mortgage loans held for sale.
Outlook, commentary, risks and unusual items
- Management described ongoing emphasis on niche insurance products, cemetery and mortuary operations, and mortgage lending. It considered cash-flow sources adequate to meet policyholder obligations, operating needs, and debt service; the filing provides no quantified earnings or revenue guidance.
- Management seeks to match investment duration to long-term insurance and cemetery/mortuary liabilities. Life-insurance subsidiaries were reported in compliance with risk-based capital criteria; statutory capital and surplus was $56.7 million. Dividends to the parent require regulatory approval.
- Investment and credit risks include real-estate values, mortgage collateral and borrower concentration (51% of held-for-investment mortgage loans were associated with Utah borrowers), construction-loan execution, interest-rate exposure, and estimates for reserves and mortgage servicing rights. Held-to-maturity securities had $4.1 million in unrealized losses at September 30, 2018, primarily attributed to interest-rate changes; no other-than-temporary fixed-income impairment was recorded in 2018 to date.
- Mortgage repurchase/indemnification reserves were $3.5 million, versus $2.6 million at year-end. Lehman Brothers Holdings litigation concerns alleged indemnification claims involving approximately 136 Fannie Mae/Freddie Mac-related loans; proposed amended claims added approximately 577 RMBS loans. The company denied liability and said it would defend itself. The filing does not quantify potential exposure clearly.
- The company adopted accounting guidance that moved equity-security fair-value changes into earnings, increasing earnings volatility. It also adopted restricted-cash and customer-revenue guidance. New credit-loss guidance was expected to take effect in 2020; lease accounting in 2019 was not expected to materially affect results but would change balance-sheet presentation; long-duration insurance accounting changes were expected in 2021. Management noted estimates are subject to uncertainty.
- The company acquired Beta Capital, a funeral-home and mortuary factoring business, for stated consideration of $3.406 million, including a receivables component and escrow holdback. The filing contains inconsistent transaction dates: the financial-statement note says June 1, while the later transaction discussion refers to September 1.
- Management reported effective disclosure controls and no material change in internal control over financial reporting. The company, as a smaller reporting company, did not provide the customary Item 1A risk-factor discussion or Item 3 market-risk disclosures.
Most important facts for investors to verify
- Whether mortgage origination volumes and profitability stabilized after the reported year-to-date decline, and how higher rates and housing supply affected subsequent results.
- How much of nine-month earnings depended on Dry Creek, Deseret Mortuary, and other asset-sale gains, and how proceeds were redeployed.
- Debt composition, warehouse-line requirements, post-quarter repayment of the $40 million FHLB balance, and the company’s ability to sustain operating cash flow.
- Developments and possible exposure in Lehman-related litigation and mortgage repurchase claims; adequacy of the $3.5 million reserve.
- Credit quality of construction and residential mortgage loans, concentrated geographic exposures, and assumptions underlying loan-loss and real-estate valuations.
- The correct closing date and final terms of the Beta Capital acquisition, given the dates stated inconsistently in the filing.