Security National Financial Corporation — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. The company operates life insurance, cemetery and mortuary, and mortgage businesses. Financial statements are unaudited. Results reflect substantial growth in mortgage origination and sales, as well as the December 2019 acquisition of Kilpatrick Life.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Total revenue | $146.2M | $75.4M | $344.5M | $205.3M |
| Earnings before tax | $38.6M | $4.8M | $67.3M | $11.8M |
| Net earnings | $29.3M | $3.6M | $51.3M | $9.0M |
| Diluted earnings per share | $1.51 | $0.19 | $2.68 | $0.48 |
| Net investment income | $14.7M | $10.5M | $41.1M | $31.1M |
| Mortgage fee income | $98.6M | $39.7M | $212.2M | $97.2M |
Revenue increased 94% in Q3 and 68% year to date. The mortgage segment drove most of the improvement: its pretax profit was $32.5M in Q3 and $58.9M for the first nine months, compared with $3.3M and $4.8M, respectively, in 2019. Nine-month pretax profit was $5.4M in life insurance and $3.0M in cemetery and mortuary. Consolidated net margin was approximately 20.0% in Q3 and 14.9% year to date, versus 4.8% and 4.4% in the comparable 2019 periods.
Mortgage fee income growth reflected higher loan origination volume and secondary-market gains. For the first nine months, the mortgage subsidiaries originated 14,862 loans totaling approximately $3.82B, versus 8,002 loans totaling approximately $1.84B in 2019. Insurance premiums also grew, partly due to Kilpatrick Life and renewal business. Cemetery and mortuary sales increased, although management reported pandemic-related restrictions on funeral services and a lower average case size.
Cash flow, balance sheet and liquidity
- At September 30, 2020, total assets were $1.65B, compared with $1.33B at year-end 2019. Cash and cash equivalents were $151.7M; cash, cash equivalents and restricted cash totaled $161.5M.
- Loans held for sale were $445.9M, up from $213.5M at year-end. The fair-value balance exceeded unpaid principal by $17.0M.
- Bank and other loans payable were $424.9M, up from $217.6M. Stockholders’ equity was $256.0M, versus $196.7M. Equity represented 37.7% of equity plus bank and other loans, compared with 47.5% at year-end.
- Operating activities used $164.6M of cash in the first nine months, versus $62.9M used in 2019; investing activities used $12.7M and financing activities provided $201.0M. Management attributed the operating cash use primarily to mortgage loan originations held for sale.
- The company reported compliance with debt covenants at September 30. Mortgage warehouse facilities include cross-default provisions. Separately, the company owed $88.0M to the Federal Home Loan Bank and reported only $0.384M of remaining maximum borrowing capacity there.
Changes, outlook and risks
- Benefits and expenses were 73.6% of revenue in Q3 and 80.5% year to date, down from 93.7% and 94.2% in 2019. Higher mortgage-related commissions and personnel expenses accompanied the increase in lending volume.
- COVID-19 contributed to higher death benefits: management attributed $2.0M of Q3 and $3.3M of nine-month increases to COVID-19-related deaths. Management said the pandemic’s duration and longer-term effects on demand, credit quality, earnings and cash flows could not be reliably estimated.
- Mortgage repurchase and indemnification risks remain. The loan-loss reserve for loans sold was $3.0M at quarter-end, after a $3.0M settlement paid in Q3 relating to loans originated in 2004–2007; the company said it holds no further reserve for that vintage. Management planned to use an 8-basis-point reserve on Q4 originations, while continuing to monitor conditions.
- SecurityNational Mortgage is defending Lehman Brothers Holdings litigation involving alleged indemnification obligations on mortgage loans, including approximately 136 loans in one matter and approximately 577 RMBS loans in another. The filing describes claims for amounts to be determined and the company denies liability; the ultimate exposure is not stated as a clear value.
- The company recorded $0.8M of commercial real estate held-for-sale impairment in Q3 and $0.8M for the first nine months. It also reported $7.8M of mortgage loans more than 90 days past due and $1.4M in foreclosure at quarter-end; total non-performing mortgage loans were $9.2M.
- No formal earnings guidance is provided. Management said mortgage demand remained steady but processing capacity was a challenge. It expected marketed commercial and residential properties held for sale to sell within 12 months.
- Management judged disclosure controls effective. Kilpatrick Life control deficiencies related to system change management and segregation of duties were remediated to the extent they no longer constituted a material weakness, but testing of the acquired business’s controls was still in progress.
Investor verification points
- Assess how sustainable mortgage origination volumes, secondary gains and the unusually strong mortgage-segment earnings are, and whether processing capacity constrains growth.
- Review the quality and valuation sensitivity of loans held for sale, mortgage servicing rights, mortgage commitments and fair-value gains, including the assumptions used for servicing and loan fallout.
- Track mortgage delinquencies, construction-loan exposure, allowance adequacy and the effects of COVID-19 on borrowers and repurchase claims.
- Evaluate increased debt and warehouse-line usage, operating cash outflows, cross-default terms, covenant headroom and available liquidity.
- Follow developments in the Lehman litigation and confirm whether reserves or disclosures change; the filing does not quantify a clear maximum exposure.
- Verify the ongoing impact of COVID-19 on insurance claims, funeral operations, investment values and the effectiveness of Kilpatrick Life’s internal controls.