Security National Financial Corporation — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017. The company operates life insurance, cemetery and mortuary, and mortgage businesses. Financial statements are unaudited; the company notes that 2017 interim results are not necessarily indicative of full-year results. Certain 2016 amounts were reclassified without affecting net earnings or equity; the December 31, 2016 balance sheet is identified as restated.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $72.0 million | $82.9 million | $216.0 million | $232.5 million |
| Pretax earnings | $1.14 million | $6.57 million | $8.03 million | $18.63 million |
| Net earnings | $1.10 million | $4.18 million | $5.44 million | $11.74 million |
| Diluted earnings per share | $0.07 | $0.27 | $0.35 | $0.77 |
| Operating cash flow | Not separately provided for the quarter | $6.03 million | $17.64 million |
Q3 revenue fell 13.2%; nine-month revenue fell 7.1%. Mortgage fee income was the principal drag, down 21.8% in Q3 and 16.9% for the nine months. Management attributed weaker mortgage activity to lower originations and refinancing, including limited new housing supply and higher mortgage rates. Nine-month mortgage originations by SecurityNational Mortgage were 9,773 loans totaling $1.91 billion, versus 11,720 loans totaling $2.25 billion a year earlier.
Life insurance premiums and considerations rose 1.9% in Q3 and 10.2% year to date; net investment income increased 3.4% and 8.8%, respectively. Cemetery and mortuary revenue was broadly flat. Mortgage segment pretax earnings declined to $0.38 million in Q3 from $4.38 million and to $1.87 million for the nine months from $11.56 million. Total benefits and expenses were 98.4% of revenue in Q3, compared with 92.1%; for the nine months the ratio was 96.3%, compared with 92.0%.
Financial position and liquidity
- At September 30, 2017, total assets were $1.008 billion, total liabilities $868.6 million, and stockholders’ equity $139.3 million. Equity was $132.6 million at December 31, 2016.
- Bank and other loans payable were $182.8 million, up from $152.1 million at year-end. Cash and cash equivalents were $38.6 million, approximately unchanged from $39.0 million. Cash from operations for the nine months declined to $6.0 million from $17.6 million; management attributed the decrease mainly to lower collections on loans held for sale. Financing provided $28.4 million, while investing used $34.8 million.
- Loans held for sale totaled $201.9 million on the balance sheet, including $167.0 million measured at fair value. The fair-valued loans had $161.2 million unpaid principal and a reported $5.8 million unrealized gain. The company elected fair value accounting for loans originated after July 1, 2017.
- Future policy benefits and unpaid claims were $600.6 million. The company reported total capitalization of $322.1 million, of which stockholders’ equity represented 43.3%, down from 46.6% at year-end. Life insurance subsidiaries reported statutory capital and surplus of $42.6 million and were in compliance with risk-based capital requirements.
Material changes, outlook, and risks
- Mortgage fee income declined amid reduced loan volume and secondary-market gains. Q3 secondary gains were $28.6 million, down from $41.3 million. The company also reported a $4.8 million adverse Q3 change in fair value of loan commitments.
- Net earnings were additionally affected by higher policy benefits and investment expenses. Nine-month death benefits, surrenders, and future policy benefits increased in aggregate by $6.0 million year over year. Interest expense rose 13.8% for the nine months, largely reflecting mortgage warehouse lines and real-estate borrowing.
- Mortgage loans past due totaled $7.4 million; $5.6 million were non-performing, up from $3.2 million at December 31, 2016. The allowance for mortgage-loan losses was $2.1 million. Geographic concentration and construction-loan repayment depend on local economic conditions, collateral values, and project completion.
- Investment impairments were $0.6 million for the first nine months, versus $0.1 million in 2016. The company reported $1.76 million of unrealized losses on held-to-maturity fixed-income securities at quarter-end, primarily related to interest-rate movements.
- Mortgage repurchase and indemnification exposure remains uncertain. The related reserve was $2.17 million, versus $0.63 million at year-end. SecurityNational Mortgage is involved in Lehman Brothers Holdings litigation relating to approximately 136 loans and alleged indemnification claims described as involving millions of dollars; it denies liability and intends to defend its position. The filing does not state a clear quantified potential loss.
- The company had approximately $69.6 million of commitments for construction and land-development loans, of which $41.3 million had been funded. Reinsurance also leaves the company liable if reinsurers cannot meet their share of claims. Management said cash sources are adequate for expected obligations and operations; no specific earnings or revenue guidance was provided.
- Management concluded disclosure controls and procedures were not effective as of September 30, 2017, citing previously identified material weaknesses. Remediation included reviewing accounting staffing and processes and engaging an outside specialist for complex mortgage accounting.
Important facts for investors to verify
- Whether mortgage originations, refinancing activity, secondary gains, and mortgage-segment profitability stabilize.
- Further development of the Lehman litigation and mortgage repurchase claims, and whether the $2.17 million reserve proves adequate.
- Performance of delinquent and non-performing mortgage loans, construction exposures, and real-estate collateral.
- Cash generation, warehouse-line and other borrowing levels, and the effect of the lower equity share of capitalization.
- Progress in remediating material weaknesses and whether disclosure controls become effective.
- Impact of forthcoming accounting standards, including the expected earnings volatility from adopting the equity-investment fair-value standard in 2018.