Security National Financial Corporation — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018; unaudited. The company operates life insurance, cemetery and mortuary, and mortgage businesses. Financial amounts below are in millions of dollars unless noted.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total revenue | $68.865 | $73.313 | $150.941 | $144.142 |
| Earnings before tax | $4.162 | $3.994 | $25.349 | $6.892 |
| Net earnings | $3.238 | $2.486 | $20.164 | $4.346 |
| Diluted earnings per share | $0.20 | $0.15 | $1.23 | $0.27 |
| Benefits and expenses as % of revenue | 94.0% | 94.6% | 83.2% | 95.2% |
Q2 revenue fell 6.1%, primarily as mortgage fee income declined 23.6% to $31.709 million. Six-month revenue increased 4.7%; net margin, calculated from reported revenue and net earnings, was approximately 13.4% versus 3.0% a year earlier, substantially reflecting property-sale gains rather than comparable recurring growth.
- Revenue drivers: Q2 insurance premiums rose 9.7% to $19.191 million and net investment income rose 17.1% to $9.742 million. For six months, those lines increased 9.0% and 14.3%, respectively.
- Mortgage segment: External revenue was $34.214 million in Q2 and $61.653 million for six months, down 22% and 28%. Pretax losses were $0.846 million and $4.232 million, respectively, versus profits in both 2017 periods.
- Other segments: Six-month pretax income was $26.649 million in life insurance and $2.932 million in cemetery/mortuary. These results included substantial asset-sale gains.
- Cash flow: Operating activities used $27.787 million in the first half, versus $20.042 million provided in 2017, primarily due to funding mortgage loans held for sale. Investing activities provided $52.063 million and financing activities provided $49.333 million. Cash, cash equivalents and restricted cash totaled $128.111 million at period-end; unrestricted cash and equivalents were $118.706 million.
- Balance sheet and debt: Total assets were $1.068 billion, up from $982.173 million at year-end 2017; liabilities were $898.164 million and equity was $169.586 million. Bank and other loans payable rose to $208.778 million from $157.451 million. Equity represented 44.9% of total capitalization, versus 48.5% at year-end.
- Investment and credit exposures: Total investments were $590.899 million. Mortgage loans held for investment were $193.069 million net; $5.598 million were non-performing. Held-to-maturity securities had $3.536 million of unrealized losses, attributed primarily to interest-rate movements.
Material changes and unusual items
- The first-half results 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. Dry Creek sold for $57.0 million; proceeds included repayment of a $26.803 million secured loan. The company said proceeds may be reinvested in real estate, potentially through a Section 1031 exchange.
- Mortgage fee income fell 29.0% for the first half. Management cited lower originations and refinancing, a national shortage of available new housing, and higher mortgage rates; mortgage originations also declined year over year.
- The company adopted accounting guidance requiring fair-value changes in certain equity securities to flow through earnings, increasing potential earnings volatility. It also adopted restricted-cash cash-flow presentation guidance.
- Effective tax rates were 22.2% for Q2 and 20.5% for the first half, compared with 37.8% and 36.9% in 2017. Management attributed the lower rates largely to the federal tax-rate reduction from 35% to 21%.
- On June 1, the company acquired funeral-home factoring business Beta Capital for $3.406 million, including $0.890 million cash and $2.516 million of receivables. A $0.175 million holdback is subject to an 18-month escrow arrangement.
Outlook, risks and contingencies
- No numerical earnings or revenue guidance is provided. Management said cash-flow sources are considered adequate to meet policyholder and cemetery/mortuary obligations, debt service, and operating needs; it cautioned that first-half results are not necessarily indicative of full-year results.
- The company reported $94.866 million of construction and land-development loan commitments, of which $64.961 million had been funded. Mortgage lending is exposed to housing-market and interest-rate conditions, borrower performance, collateral values, and geographic concentration; 48% of held-for-investment mortgage loans were to Utah borrowers.
- Mortgage investors may seek indemnification or repurchase payments on previously sold loans. The related reserve was $3.180 million, up from $2.572 million at year-end. Management noted actual claims could differ from estimates.
- SecurityNational Mortgage is involved in Lehman Brothers Holdings litigation concerning alleged indemnification on approximately 136 loans. A motion challenging jurisdiction and venue was heard in June 2018 and remained under advisement; the company denies liability and intends to defend its position.
- The insurer is responsible for reinsured amounts if reinsurers fail to pay. Life subsidiaries were reported in compliance with risk-based capital requirements; statutory capital and surplus was $55.063 million. Dividends to the parent require regulatory approval.
Investor verification priorities
- Separate recurring operating performance from the $22.252 million Dry Creek gain and $1.603 million Deseret Mortuary gain when assessing first-half earnings.
- Track mortgage originations, secondary-market gains, segment losses, and the effects of housing supply and interest rates.
- Reconcile negative operating cash flow with mortgage-loan funding, warehouse borrowings, and the reported increase in cash and debt.
- Review mortgage loan delinquencies, construction-loan commitments, collateral concentrations, and the adequacy of loan-loss and indemnification reserves.
- Monitor the Lehman litigation, Beta Capital receivable collections and escrow, and the company’s planned use of Dry Creek sale proceeds.