Security National Financial Corporation — FY 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. The company operates life insurance, cemetery and mortuary, and mortgage businesses. The 10-K was filed March 31, 2017. Amounts below are in U.S. dollars.
Financial performance and position
| Metric | FY 2016 / Dec. 31, 2016 | Prior comparable period |
|---|---|---|
| Total revenue | $307.2 million | $284.6 million in 2015; up 8.0% |
| Earnings before income taxes | $20.7 million | $21.2 million in 2015; down 2.3% |
| Net earnings | $14.3 million | $13.5 million in 2015; up 5.9% |
| Basic / diluted EPS | $0.96 / $0.94 | $0.93 / $0.90 in 2015 |
| Net cash from operating activities | $43.9 million | Used $15.8 million in 2015 |
| Cash and cash equivalents | $39.0 million | $40.1 million at year-end 2015 |
| Total assets / stockholders’ equity | $854.0 million / $128.2 million | $749.9 million / $111.2 million |
| Bank and other loans payable | $53.7 million | $40.9 million at year-end 2015 |
Net margin was approximately 4.6% versus 4.7% in 2015; total benefits and expenses were 93.2% of revenue versus 93.0%. Total investment income was $37.6 million. Total investments were $561.4 million, excluding separately presented restricted assets.
Segment pretax earnings: Mortgage $11.8 million (essentially unchanged from 2015); life insurance $7.7 million (down 9%); cemetery and mortuary $1.2 million (up 33%). Mortgage operations generated $184.0 million in external customer revenue. The company reported approximately 64% of 2016 revenue from mortgage operations.
Material changes versus 2015
- Mortgage fee income rose 6.1% to $186.4 million, supported by higher originations. SecurityNational Mortgage originated and sold 16,022 loans totaling $3.10 billion, versus 14,976 loans totaling $2.84 billion in 2015.
- Insurance premiums and other considerations increased 14.3% to $64.5 million; net investment income rose 10.5% to $37.6 million. The company attributed premium growth to higher renewal and first-year premiums.
- Realized gains on investments and other assets shifted from a $2.4 million gain to a $0.2 million loss, principally because of the prior-year sale of an office building and 2016 real-estate impairments. This contributed to lower pretax earnings despite revenue growth.
- Expenses rose 8.8% to $286.5 million. Selling, general and administrative expenses increased $16.0 million, primarily from personnel and commission costs. Loan-loss provision expense decreased to $4.7 million from $6.3 million.
- Operating cash flow improved to $43.9 million from cash use of $15.8 million, largely reflecting changes in cash collected on mortgage loans sold to investors. Investing activities used $55.6 million, including increased lending, real-estate investment and the First Guaranty acquisition.
- Debt increased $12.8 million. The company’s equity share of total capitalization (equity plus bank loans and notes payable) declined to 70.5% from 73.1%.
Outlook, risks, contingencies and unusual items
- Outlook: Management described continued emphasis on niche insurance products, cemetery and mortuary operations, and mortgage origination. No quantified earnings or revenue guidance was provided. Management characterized the Dry Creek apartment project as a long-term investment; it was 94% occupied at year-end. Phase one of the 53rd Center corporate campus was expected to be completed in the third quarter of 2017.
- Acquisition: Security National Life acquired First Guaranty Insurance Company on July 11, 2016, for $6.753 million. Its financial statements were included from acquisition; acquisition-date fair values were preliminary. The acquisition added insurance policies, agents and investment assets.
- Mortgage settlement and litigation: SecurityNational Mortgage paid $4.25 million in October 2016 to settle a DOJ/ HUD investigation concerning certain FHA loan originations, without admitting liability; it retained FHA program eligibility. Separately, Utah Lehman/Aurora cases were settled in December 2016, with the combined settlement resulting in $2.125 million more paid to Lehman Holdings. A separate Lehman Holdings proceeding in New York remained pending; the company denied liability and intended to defend itself.
- Reserves and credit exposure: The reserve for investor indemnification claims was $0.63 million at year-end, down from $2.81 million. Management cautioned that future claims could exceed reserves. Mortgage loans more than 90 days delinquent totaled $3.18 million, including $1.83 million in foreclosure; no interest income was recognized on these loans.
- Reporting and controls: The company corrected immaterial prior-period errors in accounting for mortgage loan commitments, moving fair-value changes from other comprehensive income to current earnings. The filing restated 2014 and 2015 and revised the first three 2016 quarters. Management identified two material weaknesses—derivative valuation/accounting and a construction progress bill not timely accrued—and stated remediation measures were implemented. Management concluded internal control over financial reporting was not effective at year-end. The auditor gave an unqualified opinion on the financial statements but did not attest to internal control.
- Liquidity and funding: Year-end mortgage loans pending settlement with third-party investors totaled $181.6 million. Warehouse lines with Wells Fargo and Texas Capital Bank were each increased to $100 million. The company also reported $15.6 million of unfunded residential construction and land-development loan commitments and a separate construction facility of up to $40.7 million, of which $8.8 million had been drawn.
- Other risks: Key exposures include mortgage-market and interest-rate volatility, loan repurchase or indemnification claims, investment valuation and liquidity, insurance mortality and lapse experience, regulatory changes, and real-estate conditions. Insurance subsidiaries exceeded regulatory capital criteria, but dividends to the parent are subject to regulatory approval. The company had never paid cash dividends and did not expect to do so in the foreseeable future; it continued annual 5% stock dividends through 2016.
Important facts for investors to verify
- Review the restated quarterly and annual results, the loan-commitment fair-value treatment, and management’s remediation evidence for the two material weaknesses.
- Assess mortgage-segment dependence, origination volumes, investor settlement timing, warehouse funding capacity, and the adequacy of loan-loss and indemnification reserves.
- Track the remaining Lehman Holdings proceeding and any subsequent investor repurchase or indemnification demands.
- Evaluate debt maturities and financing for the 53rd Center development, as well as the timing and returns on the company’s expanding real-estate investments.
- Confirm First Guaranty’s post-acquisition contribution, insurance subsidiary statutory capital and dividend restrictions, and any changes in risk-based capital or lapse experience.