SNFCA

Business Context and Reporting Period

Company: Security National Financial Corp (SNFC)
Reporting Period: Fiscal Year Ended December 31, 2007
Business Segments: The Company operates three integrated segments: Life Insurance (funeral plans, annuities, higher education products), Cemetery and Mortuary (pre-need and at-need services), and Mortgage Loans (residential and commercial origination). The segments are designed to cross-sell products, with insurance assets often invested in mortgage loans originated by the mortgage subsidiary.

Key Financial Metrics

Note: Revenue includes significant mortgage fee income ($130.47 million in 2007 vs $85.11 million in 2006). Net investment income increased to $31.96 million.

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 37.5% to $209.75 million, driven primarily by a $45.36 million increase in mortgage fee income due to higher loan origination volume.
• Profitability Decline: Despite revenue growth, Net Earnings decreased 55.8% to $2.27 million. This was caused by a disproportionate rise in expenses, particularly commissions and interest expense.
• Expense Increases: Selling, general, and administrative expenses rose 47.1% to $155.50 million. Commission expenses increased $33.28 million due to mortgage volume. Interest expense more than doubled to $13.27 million due to increased warehouse lines of credit.
• Mortgage Segment Loss: The mortgage subsidiary (SNMC) reported a pre-tax loss of approximately $1.48 million for the year, attributed to the collapse of the secondary market for "Alt A" loans and subprime volatility. The Company ceased funding subprime loans and significantly reduced Alt A production by year-end.
• Loan Losses: The Company experienced loan losses of $5.47 million in 2007, charging this amount against the provision for loan losses. The reserve for loan losses stood at $2.36 million at year-end.

Guidance, Outlook, Risks, and Contingencies

• Outlook: Management expects significant industry challenges to continue through 2008. Profitability is difficult to predict due to potential volume reductions, margin compression, and increased borrowing costs in the mortgage sector.
• Regulatory Risk (Florida): The Florida Office of Insurance Regulation issued a proposed consent order regarding the "New Success Life Program" (higher education product). The order alleges misrepresentation of benefits. If enforced, it could require refunds of approximately $8.2 million to policyholders, plus a $100,000 penalty. The Company disputes the order and is negotiating.
• Acquisition Contingencies:
  • Capital Reserve Life: Acquired in December 2007. $2.1 million of the purchase price is held in escrow to cover potential liabilities from pending litigation (Russell Litigation) involving unpaid bonuses to a former employee.
  • C & J Financial: Acquired in July 2007 to expand fast-funding operations for funeral homes.
• Liquidity: The Company maintains a $40 million revolving line of credit (secured by commercial mortgages) with $6.5 million outstanding as of year-end. Warehouse lines of credit total $450 million. Management believes liquidity is adequate to carry unsold Alt A loans if the secondary market remains frozen.

Investor Verification Checklist

• Florida Consent Order: Verify the status of negotiations with the Florida Office of Insurance Regulation regarding the potential $8.2 million refund liability.
• Alt A Loan Exposure: Confirm the current status of the $24.59 million in Alt A loans held for sale as of December 31, 2007, and any subsequent sales or write-downs.
• Loan Loss Reserves: Assess the adequacy of the $2.36 million loan loss reserve given the $5.47 million in losses incurred during the year and the volatile mortgage market.
• Capital Reserve Litigation: Monitor the resolution of the "Russell Litigation" to determine if the $2.1 million escrow is sufficient or if additional indemnification from sellers is required.
• Mortgage Segment Viability: Evaluate the sustainability of the mortgage segment's profitability given the shift away from Alt A and subprime products and the associated increase in interest expense.