Security National Financial Corporation — Q1 2016 Form 10-Q
Business context and period. Unaudited results cover the three months ended March 31, 2016, compared with Q1 2015. The company operates life insurance, cemetery and mortuary, and mortgage businesses. Its stated strategic focus includes niche insurance products, cemetery and mortuary operations, and mortgage lending.
Financial performance
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Revenue | $66.0 million | $64.0 million | +3.1% |
| Income before taxes | $2.85 million | $3.00 million | -4.9% |
| Net earnings | $1.79 million | $1.86 million | Down about 4% |
| Basic / diluted EPS | $0.13 / $0.12 | $0.14 / $0.13 | Down $0.01 each |
| Operating cash flow | $25.86 million | $0.71 million | Up substantially |
- Revenue mix and drivers: Net investment income rose 14.9% to $9.0 million, premiums and other considerations increased 4.3% to $14.5 million, and mortuary and cemetery sales increased 13.0% to $3.25 million. Mortgage fee income was nearly flat at $37.8 million. Realized gains on investments and other assets fell 76.7% to $98,000.
- Profit and margins: Benefits and expenses rose 3.5% to $63.2 million, outpacing revenue growth. Expenses were 95.7% of revenue versus 95.3%; pretax margin was approximately 4.3% versus 4.7%, and net margin approximately 2.7% versus 2.9%.
- Segment results: Life insurance pretax income fell 24% to $1.07 million, despite 5% revenue growth, mainly reflecting higher SG&A and lower realized gains. Cemetery/mortuary pretax income rose 15% to $469,000. Mortgage pretax income increased 11% to $1.32 million, supported by higher secondary gains on loans sold.
- Balance sheet and liquidity: At March 31, total assets were $757.3 million, cash and cash equivalents $46.7 million, total liabilities $642.8 million, and stockholders’ equity $114.6 million. Bank and other loans payable were $41.3 million. Cash increased $6.65 million from year-end. Operating cash flow was driven primarily by a $21.99 million decrease in mortgage loans sold to investors; investing activities used $19.11 million.
- Capital and investments: Equity was 73.5% of total capitalization, compared with 73.1% at year-end. The company reported compliance with life-insurance subsidiary risk-based capital criteria. Non-investment-grade bonds represented 9.98% of total bond investments, up from 8.3% at year-end.
Material changes and management commentary
- Mortgage origination and sale volume at SecurityNational Mortgage declined to 3,139 loans totaling $586.6 million from 3,275 loans totaling $640.1 million. EverLEND reported no originations, versus 78 loans totaling $17.75 million in Q1 2015.
- Higher personnel costs, acquisition-cost amortization, rent, and interest expense contributed to expense growth. Personnel expense increased $2.88 million; commissions declined $1.72 million.
- Operating cash generation rose sharply year over year, but the filing attributes much of the increase to movements in mortgage loans sold to investors, rather than presenting it as a change in recurring earnings.
- Management said its cash sources were adequate for expected policyholder and cemetery/mortuary obligations, operating needs, and debt service. It emphasized matching investment duration to long-term liabilities. No specific earnings or revenue guidance was provided; management cautioned that quarterly results are not necessarily indicative of full-year results.
- On March 5, 2016, the company agreed to acquire all shares of Reppond Holding, parent of First Guaranty Insurance Company, for $6.753 million. The filing describes an agreement, not a completed acquisition.
Risks, contingencies, and unusual items
- FHA investigation: SecurityNational Mortgage was cooperating with a DOJ and HUD Inspector General civil investigation into FHA loan compliance. No FHA demand had been made, and no liability was recorded because management could not estimate a reasonably possible loss. The review covered approximately 45,900 loans originated from 2006 through May 2013, with original principal of about $7.9 billion.
- Mortgage repurchase/indemnification exposure: The loan loss reserve increased to $3.35 million from $2.81 million at year-end. Management noted that actual claims could differ from estimates and that unresolved investor claims could result in litigation.
- Lehman-related litigation: In a Utah action, SecurityNational Mortgage had obtained a 2014 summary judgment award of approximately $3.89 million plus interest against Lehman Bank and Aurora Loan Services, but reserve replenishment and offset issues remained under advisement. Its separate motion against Lehman Holdings was denied in March 2016. Related Delaware and New York bankruptcy litigation concerning alleged indemnification claims was ongoing; the company denied liability and said it would defend its position.
- Credit and valuation risks: Nonperforming mortgage loans increased to $5.88 million from $5.46 million at year-end; total past-due loans were $6.39 million. Mortgage exposure was concentrated geographically, including 53% in Utah. Investment values, mortgage servicing rights, benefit liabilities, and loan-loss allowances depend on estimates and assumptions.
- Fixed-maturity securities had $5.17 million of unrealized losses at March 31, primarily attributed to interest-rate fluctuations. Equity securities had $1.41 million of unrealized losses, primarily attributed to market declines. The company recorded $73,630 of investment impairments during the quarter.
Investor verification priorities
- Track progress, purchase completion, and integration costs for the proposed $6.753 million First Guaranty acquisition.
- Seek updates on the FHA investigation, possible exposure, and the Lehman/Aurora and Lehman Holdings proceedings; no FHA liability was recorded and litigation outcomes remain uncertain.
- Assess the quality and repeatability of operating cash flow, particularly the effect of mortgage loans sold to investors and related balance movements.
- Monitor mortgage origination volumes, nonperforming and past-due loans, indemnification reserves, and the geographic concentration of mortgage credit.
- Compare investment income growth with investment expenses, unrealized losses, and the increased share of non-investment-grade bonds.
- Reconcile small internal inconsistencies in the filing: Q1 2015 net earnings are reported as both $1,863,803 and $1,863,703 in different statements, and segment pretax income differs slightly from the consolidated amount.