Security National Financial Corporation — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; unaudited. The company operates life insurance, cemetery and mortuary, and mortgage businesses. Comparisons are with Q1 2019 unless otherwise noted.
Financial performance and position
| Metric | Q1 2020 / March 31, 2020 | Prior comparable / period-end |
|---|---|---|
| Total revenue | $79.6 million | $61.5 million; up 29.5% |
| Pre-tax earnings | $1.47 million | $2.43 million |
| Net earnings | $1.42 million; $0.08 per diluted equivalent share | $1.93 million; $0.11 per diluted equivalent share |
| Benefits and expenses / revenue | 98.1% | 96.0% |
| Net margin | Approximately 1.8% | Approximately 3.1% |
| Net cash from operating activities | $(63.8) million | $19.5 million provided |
| Cash, cash equivalents and restricted cash | $120.4 million | $139.5 million at March 31, 2019 |
| Total assets | $1.376 billion | $1.334 billion at December 31, 2019 |
| Bank and other loans payable | $254.0 million | $217.6 million at December 31, 2019 |
| Stockholders’ equity | $189.7 million | $196.7 million at December 31, 2019 |
Comprehensive loss was $7.43 million, largely reflecting $8.85 million of after-tax other comprehensive losses, including unrealized losses on available-for-sale fixed-maturity securities. Total investments were $766.7 million, including $329.1 million of fixed-maturity securities. The fixed-maturity portfolio’s gross unrealized losses rose to $8.95 million from $0.74 million at year-end 2019; the filing attributes these mainly to interest-rate fluctuations and reported no recognized credit losses in the quarter.
Material changes and business drivers
- Mortgage: External segment revenue rose to $42.4 million from $26.6 million; pre-tax profit was $4.44 million versus a loss of $0.84 million. Mortgage fee income increased 64.6% to $40.3 million, mainly on higher loan volume and secondary-market gains. Mortgage originations totaled approximately $792.2 million versus $428.5 million.
- Life insurance: External revenue increased 9% to $33.2 million, but the segment swung to a $3.07 million pre-tax loss from $2.09 million profit. Investment losses, higher policy benefits and expenses weighed on results. The December 2019 Kilpatrick Life acquisition contributed to higher premiums, investment income, benefits and expenses.
- Cemetery and mortuary: External revenue declined 8% to $4.01 million and pre-tax earnings fell to $0.10 million from $1.18 million, principally due to investment losses and lower real-estate gains.
- Net investment income increased 33.4% to $13.4 million. Gains and losses on investments and other assets moved from a $1.81 million gain to a $3.21 million loss, mainly reflecting lower equity-security values and option-related results during market disruption.
- Stockholders’ equity declined during the quarter, principally reflecting the other comprehensive loss, partly offset by net earnings and other equity activity.
Liquidity, debt and risk
- Operating cash use of $63.8 million was attributed primarily to mortgage-loan originations held for sale. Investing activities provided $12.2 million and financing activities provided $34.2 million; cash, cash equivalents and restricted cash declined by $17.3 million during the quarter.
- Loans held for sale were $281.1 million at fair value. Their rapid growth increased funding needs; the company reported $253.97 million of bank and other loans payable overall.
- SecurityNational Mortgage had approximately $98.1 million outstanding on its $100 million Wells Fargo warehouse line and $75.0 million on its $100 million Texas Capital Bank line at March 31. It had not received requested waivers for covenant violations associated with the indebtedness-to-adjusted-tangible-net-worth ratio and cross-default provisions. The Wells Fargo line was due to mature June 16, 2020 and the Texas Capital line September 9, 2020. Management said the company had sufficient cash and borrowing capacity to repay both lines in the unlikely event repayment was required.
- Mortgage loans held for investment totaled $250.4 million net; the allowance for loan losses increased to $2.09 million from $1.45 million at year-end. Non-performing loans were $5.40 million, down from $8.90 million. The portfolio has significant geographic concentration, including 49% in Utah.
- The company had approximately $135.9 million of commitments for construction and land-development loans, of which $94.8 million had been funded.
- Life insurance subsidiaries reported $70.6 million of statutory capital and surplus and were in compliance with risk-based capital criteria. Dividends from those subsidiaries require regulatory approval.
Outlook, contingencies and unusual items
- Management said COVID-19 began significantly affecting operations in March and would likely adversely affect nearly all operations in Q2. The duration and longer-term financial effects could not be reasonably estimated; management warned that estimates for investments, mortgage loans, servicing rights, policy benefits, credit allowances and taxes may require significant future adjustment. No quantitative earnings or revenue guidance was provided.
- The company reported that its existing business-continuity measures, including remote work and travel restrictions, enabled continued operations. Management said it might temporarily adjust strategy in response to changing economic conditions.
- The company recorded a $433,000 tax benefit related primarily to CARES Act net operating loss carrybacks; the reported effective tax rate was 3.4%, compared with 20.6% in Q1 2019.
- SecurityNational Mortgage is defending Lehman Brothers Holdings litigation concerning alleged indemnification for mortgage loans, including approximately 136 Fannie Mae/Freddie Mac-related loans and approximately 577 additional RMBS loans. The filing describes the claims as disputed and does not provide a clear amount of potential exposure; no amount was accrued for these claims.
- The loan-loss reserve for mortgage loans previously sold was $3.43 million, including an estimated $3.0 million for unresolved claims on loans originated in 2005–2007. Management noted that actual losses could differ and that legal action may follow if claims cannot be resolved.
- Management concluded disclosure controls and procedures were not effective as of March 31, 2020. A material weakness at acquired Kilpatrick Life involving policy-system change management and segregation of duties remained unremediated; remediation steps and additional testing were underway.
- The company adopted ASU 2018-13 in 2020 without material financial-statement impact. It was evaluating the potential effects of expected credit-loss accounting and long-duration insurance-contract accounting standards.
Investor facts to verify
- Whether the Wells Fargo and Texas Capital warehouse-line waivers or covenant amendments were obtained, and the status of renewals and maturities.
- Subsequent-quarter mortgage volume, gain-on-sale margins, warehouse funding requirements and operating cash flow.
- COVID-19 effects on insurance claims and premiums, cemetery and mortuary activity, investment valuations, mortgage credit performance and liquidity.
- Changes in the available-for-sale securities portfolio, unrealized losses, mortgage-loan allowances and loan-loss reserve adequacy.
- Developments and potential exposure in the Lehman litigation, and progress remediating Kilpatrick Life’s material weakness.