Security National Financial Corporation — FY 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017; comparisons are primarily with restated FY 2016 results. The company operates life insurance, cemetery and mortuary, and mortgage businesses. Its audited financial statements received an unmodified opinion; the auditor did not provide an opinion on internal control over financial reporting.
Financial performance and condition
| Metric | FY 2017 | FY 2016 | Change / context |
|---|---|---|---|
| Total revenue | $276.9 million | $304.3 million | Down 9.0% |
| Benefits and expenses | $269.4 million | $284.6 million | Down 5.4%; 97.3% of revenue versus 93.5% |
| Earnings before tax | $7.5 million | $19.7 million | Down 61.8%; pretax margin about 2.7% |
| Income tax benefit (expense) | $6.6 million benefit | $7.5 million expense | 2017 included a $9.0 million Tax Act-related benefit |
| Net earnings | $14.1 million | $12.2 million | Up 15.8%; net margin about 5.1% |
| Diluted earnings per equivalent Class A share | $0.87 | $0.77 | Up from restated 2016 |
| Cash from operating activities | $44.3 million | $35.5 million | Management attributed the increase primarily to cash collected on loans held for sale |
| Cash and cash equivalents | $45.3 million | $39.0 million | At year-end |
| Bank and other loans payable | $157.5 million | $152.1 million | Up $5.3 million; $88.4 million due in 2018 |
| Stockholders’ equity | $148.6 million | $132.6 million | Equity was 46.9% of equity plus loans, versus 46.6% |
Segment results
- Life insurance: External revenue was $100.7 million, up 5%; pretax earnings were $4.7 million, down 40%. Premiums increased 9.2% to $70.4 million, while realized investment losses and impairments increased.
- Cemetery and mortuary: External revenue was $13.4 million, up 4%; pretax earnings rose 39% to $1.7 million, reflecting lower expenses and higher pre-need sales.
- Mortgage: External revenue was $153.8 million, down 19%; pretax earnings fell 89% to $1.1 million. SecurityNational Mortgage originated 12,877 loans totaling $2.53 billion, compared with 16,022 loans totaling $3.10 billion in 2016. Results included a one-time $4.18 million fair-value gain on loans held for sale.
Material changes and unusual items
- The company elected fair-value accounting for mortgage loans held for sale originated after July 1, 2017. It recorded a $4.18 million unrealized gain at year-end; the election changed the timing of revenue and cost recognition.
- FY 2017 net earnings benefited from the Tax Act, including remeasurement of deferred tax balances. Without the Act’s impact, management reported an estimated effective tax rate of 31.8%.
- The company restated 2016 financial statements after identifying material errors in accounting for mortgage repurchase agreements and a tax valuation allowance, as well as other corrections. Restated 2016 net earnings were $12.2 million, versus $14.3 million originally reported.
- Commercial real estate impairment losses were $5.35 million in 2017, versus $0.9 million in 2016; total realized investment and other-asset losses were $2.95 million, versus $0.18 million.
- In March 2018, the company completed the sale of its Dry Creek apartment complex for $57 million. The filing identifies this as a subsequent event.
Outlook, risks and contingencies
- No quantified earnings or revenue guidance is provided. Management describes continued emphasis on niche insurance products, cemetery and mortuary operations, mortgage lending, and real estate development.
- Management cited a limited supply of new housing and higher mortgage rates as factors reducing mortgage originations and refinancing. Mortgage results remain exposed to interest rates, housing and credit-market conditions, and investors’ willingness to purchase loans.
- Mortgage investors may require loan repurchases or indemnification for alleged defects, misrepresentations, or early payment defaults. The company accrued $2.57 million for indemnification losses at year-end, compared with $0.63 million in 2016, and noted actual claims could exceed reserves.
- A Lehman Brothers Holdings dispute involving alleged indemnification obligations on approximately 136 loans remained pending. SecurityNational Mortgage denied liability and said it would defend its position; the filing does not specify a clear maximum exposure.
- Mortgage loans held for investment more than 90 days delinquent totaled $5.39 million, including $1.33 million in foreclosure. The company reported no interest income on these loans.
- Insurance operations face mortality, persistency, investment-spread, reinsurance, regulatory, and capital risks. Insurance subsidiaries’ statutory capital and surplus totaled $44.0 million; dividends to the parent are subject to regulatory limits and approvals.
- Interest-rate sensitivity, real estate valuations, estimates of policy liabilities and acquisition costs, and loan-loss reserves are significant judgment areas. Life insurance guaranteed interest rates range from 1% to 6.5%.
- The company disclosed that management had identified two material weaknesses in internal controls as of 2016, restated prior periods, and implemented remediation measures. Management concluded controls were effective as of December 31, 2017; the auditor was not engaged to attest to that conclusion.
- There were $28.8 million of unfunded residential construction and land-development loan commitments reported in MD&A; the notes separately describe approximately $79.0 million of total commitments, of which $50.2 million had been funded. Investors should reconcile these disclosures.
Important facts for investors to verify
- Whether mortgage production, secondary-market gains, and mortgage segment profitability stabilize after the 2017 decline.
- The adequacy of the $2.57 million mortgage indemnification reserve and the eventual outcome and exposure in the Lehman litigation and other investor claims.
- The sustainability of reported net earnings excluding the $9.0 million Tax Act benefit and the $4.18 million fair-value gain.
- The company’s debt refinancing and liquidity position, including the $88.4 million of debt due in 2018 and warehouse-line maturities.
- The results of ongoing state insurance examinations, statutory capital requirements, and restrictions on subsidiary dividends.
- The effects of the Dry Creek sale and related proceeds on debt, investment strategy, and future rental income.
- The restatement disclosures and remediation of previously identified control weaknesses; also note that management’s internal-control assessment was not auditor-attested.