Security National Financial Corporation — Q2 2017 Form 10-Q
Business context and reporting period. This unaudited quarterly report covers the three and six months ended June 30, 2017. The company operates life insurance, cemetery and mortuary, and mortgage businesses. Its insurance strategy emphasizes funeral-plan and traditional life products; mortgage operations originate residential loans; cemetery and mortuary operations are concentrated in Utah, with a cemetery in California. Comparisons below are to the corresponding 2016 periods unless otherwise noted.
Financial results and condition
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Revenue | $73.2 million, down 8.6% | $144.0 million, down 3.7% |
| Earnings before income taxes | $4.0 million, versus $8.0 million | $6.9 million, versus $12.1 million |
| Net earnings | $2.5 million, versus $5.0 million | $4.3 million, versus $7.6 million |
| Diluted earnings per share | $0.16, versus $0.33 | $0.28, versus $0.50 |
| Benefits and expenses as a share of revenue | 94.3%, versus 90.0% | 95.1%, versus 91.9% |
Mortgage fee income was $39.9 million for Q2 (down 19.8%) and $78.4 million for the half-year (down 13.9%). Insurance premiums and other considerations increased 10.1% in Q2 and 14.8% year to date. Net investment income rose 6.7% in Q2 and 6.5% year to date. Mortgage segment pre-tax earnings fell 82% in Q2 and 79% for the half-year; life insurance pre-tax earnings increased, while cemetery and mortuary earnings declined.
For the six months, operating cash flow was positive $20.0 million, compared with negative $11.7 million in 2016. Investing activities provided $13.6 million, compared with using $21.2 million; financing activities provided $9.6 million, compared with $29.6 million. Cash and cash equivalents were $82.3 million at June 30, up from $39.0 million at year-end 2016.
At June 30, total assets were $976.5 million and stockholders’ equity was $137.6 million, compared with $951.7 million and $132.6 million, respectively, at December 31, 2016. Bank and other loans payable were $163.6 million, up from $152.1 million. Total capitalization was $301.2 million; equity represented 45.7%, versus 46.6% at year-end. The company reported $172.8 million in loans held for sale and $23.4 million in short-term investments. These balances are not necessarily all freely available liquidity.
Material changes and management commentary
- Management attributed weaker mortgage results to lower originations, citing limited housing available for purchase and reduced refinancing as mortgage rates rose. SecurityNational Mortgage originated 6,551 loans totaling $1.272 billion in the first half of 2017, versus 7,413 loans totaling $1.414 billion a year earlier.
- Higher insurance premiums and investment income partly offset lower mortgage revenue. Realized gains also increased, in part from sales of commercial and residential real estate.
- Nonperforming mortgage loans increased to $6.7 million from $3.2 million at year-end 2016. Total past-due mortgage loans were $9.9 million, versus $5.1 million. The allowance for mortgage loan losses rose to $1.9 million from $1.7 million.
- The company reported $52.6 million of commitments for construction and land-development loans, of which $34.5 million was funded at quarter-end. It also reported a $1.135 million reserve for mortgage-loan indemnification losses, up from $628,000.
- Management said operating cash sources were adequate for policyholder obligations, debt service, and operating expenses. Life insurance subsidiaries had $43.5 million of statutory capital and surplus and were in compliance with risk-based capital requirements. Dividends from those subsidiaries require regulatory approval.
Outlook, risks and unusual items
The filing provides no specific earnings or revenue guidance. Management expects its focus on niche insurance products, cemetery and mortuary business, and mortgage lending to continue, but cautions that first-half results are not necessarily indicative of full-year results.
- Controls: Management concluded disclosure controls and procedures were not effective as of June 30, 2017. The company was addressing material weaknesses identified in its 2016 annual filing through accounting-staff and process reviews.
- Legal contingency: SecurityNational Mortgage is involved in Lehman Brothers Holdings litigation concerning alleged mortgage-loan indemnification obligations tied to approximately 136 loans. The company denies liability and intends to defend itself. The filing does not provide a clear estimate of potential exposure.
- Credit and investment risk: Mortgage lending is geographically concentrated, with 42% of mortgage loans in Utah. The company recorded $318,000 of fixed-maturity investment impairments in the first half, versus $60,000 in 2016. Management identifies significant estimation judgments in loan-loss reserves, policy liabilities, mortgage servicing rights, and other valuations.
- Auditor change: Eide Bailly resigned on May 15, 2017; Deloitte & Touche was engaged on June 1 to audit the 2017 financial statements. The filing reports no disagreements or reportable events with the former auditor.
- Accounting and presentation: The December 31, 2016 balance-sheet figures are identified as restated. The filing refers readers to the 2016 Form 10-K/A for corrections of prior errors. The company also noted that adopting new accounting rules for equity investments could increase earnings volatility.
Important facts for investors to verify
- Whether mortgage originations and mortgage-segment profitability stabilize, and how higher rates affect refinancing, loan sales, and warehouse-line costs.
- Trends in mortgage delinquencies, nonaccrual loans, loan-loss allowances, and investor repurchase or indemnification claims.
- Progress in remediating the disclosed material weaknesses and whether future filings report effective controls.
- Developments in the Lehman litigation and any change in the company’s assessment or reserve for potential exposure.
- The 2016 restatements and auditor transition, including any implications for financial-statement reliability or comparability.
- Available liquidity and borrowing needs, taking into account that cash, short-term investments, loans held for sale, and insurance assets have different availability and purposes.