Security National Financial Corporation — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020; unaudited. The company operates life insurance, cemetery and mortuary, and mortgage businesses. Results reflect the COVID-19 pandemic and the December 2019 acquisition of Kilpatrick Life.
Financial performance
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Total revenue | $118.7m | $68.4m | $198.3m | $129.9m |
| Earnings before tax | $27.2m | $4.6m | $28.7m | $7.1m |
| Net earnings | $20.6m | $3.5m | $22.0m | $5.4m |
| Diluted earnings per Class A equivalent share | $1.07 | $0.19 | $1.15 | $0.29 |
- Q2 revenue rose 73.4%; six-month revenue rose 52.6%. Mortgage fee income was the largest driver, increasing 122.7% in Q2 and 97.9% year to date, primarily from higher originations, secondary-market gains, and fair-value changes.
- Net investment income increased 23.0% in Q2 and 28.1% for the six-month period. Six-month gains and losses on investments and other assets shifted from a $0.8m gain to a $1.0m loss, with management citing equity-security fair-value declines amid COVID-19.
- Benefits and expenses were 77.1% of revenue in Q2 versus 93.2% a year earlier, and 85.5% for the first half versus 94.6%. Q2 net margin was approximately 17.3%, compared with 5.1%; six-month net margin was approximately 11.1%, compared with 4.2%.
Segments and material changes
- Mortgage: Pretax income was $22.0m in Q2 and $26.4m for the first half, versus $2.4m and $1.5m, respectively, in 2019. SecurityNational Mortgage originated 8,105 loans totaling $2.04bn in the first half, compared with 4,605 loans totaling $1.02bn a year earlier; EverLEND originated $67.2m versus $28.8m.
- Life insurance: Pretax income was $3.7m in Q2 versus $1.2m; first-half pretax income declined to $0.6m from $3.3m. Kilpatrick Life contributed to higher premiums and investment income, but also higher benefits and expenses. Management attributed $1.15m of increased Q2 and first-half death benefits to COVID-19-related deaths.
- Cemetery and mortuary: Pretax income was $1.5m in Q2 versus $1.0m; first-half pretax income was $1.7m versus $2.2m. Management said COVID-related service limits reduced average funeral case size; cemetery and mortuary sales nevertheless increased.
Financial position, cash flow, and liquidity
- At June 30, total assets were $1.52bn, versus $1.33bn at December 31, 2019. Stockholders’ equity was $222.6m, up from $196.7m.
- Cash and cash equivalents were $117.0m, down from $127.8m. Loans held for sale increased to $356.9m from $213.5m; mortgage loans held for investment were $260.4m, up from $236.7m.
- Bank and other loans payable rose to $347.1m from $217.6m. Stockholders’ equity as a share of total capitalization (equity plus bank and other loans) declined to 39.1% from 47.5%.
- Operating activities used $109.6m of cash in the first half, versus $40.7m used in 2019; management attributed the use primarily to mortgage-loan originations held for sale. Investing activities used $24.4m, while financing activities provided $125.2m. Cash, cash equivalents, and restricted cash totaled $129.0m at period-end.
- The company reported $79.0m owed to the Federal Home Loan Bank and $19.6m of estimated remaining borrowing capacity. Management stated it was in compliance with debt covenants at June 30. Warehouse facilities include cross-default provisions; disclosed maturities included September 2020 and June 2021.
Outlook, risks, contingencies, and unusual items
- No formal earnings or revenue guidance is provided. Management said COVID-19’s duration and longer-term effects cannot be reasonably estimated; it expected effects to continue into Q3 and identified potential impacts on demand, operations, cash flows, credit quality, and asset valuations. Mortgage demand had remained strong, but processing capacity was a constraint.
- Mortgage fee income includes substantial secondary gains and fair-value changes. The first-half reserve provision for mortgage-loan indemnification losses was $2.1m; the reserve balance was $4.8m. Management said approximately $3.0m related to 2004–2007 originations and that a July 30 settlement covered remaining anticipated claims; reserves were considered sufficient and expected to be reduced in Q3.
- Mortgage loans held for investment included $9.5m of non-performing loans at June 30, up from $8.9m at year-end; the related allowance for loan losses rose to $2.4m from $1.5m. The portfolio was concentrated geographically, including 54% of loans in Utah.
- SecurityNational Mortgage is defending Lehman Brothers Holdings litigation involving alleged indemnification claims on mortgage loans. The company denies liability and intends to defend its position. Management reported no accrual for the litigation and said other ordinary-course legal actions were not expected to have a material effect.
- Disclosure controls and procedures were deemed ineffective at June 30 because of an unremediated material weakness in Kilpatrick Life’s policy-administration system change management and segregation of duties. The company described remediation steps, but said testing and assessment were ongoing; it also stated known deficiencies had been remediated by August 14 to the extent they no longer constituted a material weakness.
- Fixed-maturity unrealized losses were attributed primarily to interest-rate fluctuations and COVID-related uncertainty. The company reported 3.3% of total bond investments in NAIC rating categories three through six, versus 2.2% at year-end. Life insurance subsidiaries were reported in compliance with risk-based capital criteria.
Important facts for investors to verify
- How much of mortgage-segment earnings depends on elevated loan volume, secondary gains, and fair-value movements, and whether processing capacity can keep pace.
- Trends in mortgage delinquencies, non-performing loans, loss allowances, geographic concentration, and repurchase or indemnification claims.
- Debt levels, warehouse-line availability and refinancing at upcoming maturities, covenant compliance, and the effect of cross-default provisions.
- Progress and independent validation of Kilpatrick Life’s control remediation and the status of the Lehman litigation and July 2020 settlement.
- COVID-19 effects on insurance claims, funeral-service demand, investment valuations, credit losses, and cash flows.