Security National Financial Corporation — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. Unaudited consolidated financial statements. The company operates life insurance, cemetery and mortuary, and mortgage businesses.
Key financial results
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Total revenue | $59.4 million | $61.3 million | $104.5 million | $116.2 million |
| Earnings before tax | $4.19 million | $4.47 million | $4.35 million | $7.70 million |
| Net earnings | $2.62 million | $2.80 million | $2.76 million | $4.83 million |
| Diluted earnings per share | $0.21 | $0.22 | $0.23 | $0.38 |
| Net cash from operations | — | $40.51 million | $38.83 million |
Q2 revenue declined 3.1% and net earnings declined 6.3% year over year. For the first half, revenue fell 10.1% and net earnings fell 42.8%. Benefits and expenses were 93.0% of revenue in Q2 (92.7% in 2013) and 95.8% for the first half (93.4% in 2013).
At June 30, total assets were $643.0 million, total liabilities $551.0 million, and stockholders’ equity $92.0 million. Cash and cash equivalents were $31.2 million; short-term investments were $20.3 million. Bank and other loans payable were $17.1 million. The company reported total capitalization of $109.1 million, with equity representing 84.3%.
Six-month investing cash outflow was $43.9 million, including $3.0 million paid for a subsidiary acquisition; financing cash outflow was $3.6 million. Cash declined by $7.0 million from year-end 2013. Operating cash flow included a reduction in mortgage loans sold to investors and an increase in future policy benefits.
Material changes and business drivers
- Mortgage: Q2 segment revenue was $36.1 million, down 12%; pretax earnings were $2.5 million, down 36%. First-half revenue was $59.6 million, down 21%; pretax earnings were $1.2 million, down 82%. Management attributed the declines to lower secondary gains and reduced refinancing as mortgage rates rose. SecurityNational Mortgage originated and sold 5,021 loans totaling $937.8 million in the first half, versus 6,292 loans totaling $1.18 billion in 2013.
- Life insurance: Q2 segment revenue rose 18% to $19.8 million and pretax earnings rose to $1.5 million from $0.4 million. First-half revenue rose 12% to $38.3 million and pretax earnings rose to $2.8 million. Management cited higher investment income, loan-origination income, and premiums.
- Cemetery and mortuary: Q2 revenue increased 5% to $3.5 million and pretax earnings increased 56% to $0.17 million. First-half revenue increased 3% to $6.6 million and pretax earnings increased 91% to $0.35 million.
- Net investment income increased 33.5% in Q2 and 23.2% in the first half, supported mainly by rental income and mortgage-loan interest. Mortgage fee income fell 12.0% in Q2 and 21.2% in the first half.
- On June 4, the company acquired American Funeral Financial, a factoring business serving funeral homes and mortuaries. Consideration included $3.0 million cash, $12.0 million for good-standing receivables, and a variable three-year earn-out. The acquired business reported 2013 revenue of $5.0 million and net income of $0.16 million.
Liquidity, outlook, risks and contingencies
- Management stated that operating cash flows and invested assets were expected to support policyholder and cemetery obligations, debt service, and operating needs. The company seeks to match investment duration to liabilities; it reported compliance with life-insurance risk-based capital criteria.
- Management expects its focus on niche insurance products, cemetery and mortuary operations, and mortgage origination to continue. No quantified earnings or revenue guidance was provided; management cautioned that interim results are not necessarily indicative of full-year results.
- Mortgage credit exposure is geographically concentrated, including 35% of mortgage loans in Utah, 19% in California, 13% in Texas, 11% in Florida, and 5% in Nevada. Nonperforming mortgage loans declined to $6.2 million from $12.4 million at year-end 2013. The allowance for mortgage loan losses was $1.7 million.
- The company accrued approximately $6.2 million for claims by mortgage-loan investors seeking repurchase or indemnification. Management said the reserve may not cover all claims; adverse litigation outcomes could require the mortgage subsidiary to curtail or cease operations.
- In the Lehman/Aurora litigation, a May 2014 summary judgment favored SecurityNational Mortgage in one action. A motion for reconsideration and determination of amounts due remained pending; related claims by Lehman Holdings also remained unresolved. The filing reports Lehman Holdings’ claimed damages in excess of $5 million and the company’s claim for approximately $4 million in affirmative relief.
- JPMorgan Chase/EMC had asserted an indemnification claim relating to 21 loans; the company said it had defenses and intended to defend against any legal action. Under the Wells Fargo settlement, the mortgage subsidiary continues to remit 10 basis points on loan-sale proceeds through March 2017 and 50% of net proceeds from specified property sales.
- Commitments to fund residential construction loans totaled $36.1 million, of which $20.4 million had been funded as of June 30. Interest-rate movements, mortgage refinancing activity, loan performance, investor demands, and valuation estimates for investments and servicing rights are material sensitivities.
- Shareholders approved a 1-for-10 reverse split of Class C shares and changes giving each Class C share ten votes and one-for-one conversion into Class A shares. The changes became effective August 1, 2014.
Most important facts for investors to verify
- Whether mortgage origination volumes, secondary gains, and refinancing activity stabilize after the reported decline.
- Whether the $6.2 million investor-claim reserve is adequate and how pending Lehman and JPMorgan/EMC matters develop.
- Cash generation and liquidity, including the movement in mortgage loans sold to investors and the funding of construction-loan commitments.
- Performance and receivable collections from American Funeral Financial, including any earn-out payments and acquisition-related results.
- Insurance subsidiary statutory capital, dividend restrictions, and investment quality; non-investment-grade bonds were 5.5% of bond investments at June 30, 2014.