Business context and reporting period
Security National Financial Corporation filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2016. Its three reportable segments are life insurance, cemetery and mortuary, and mortgage operations. Comparisons below are with the corresponding 2015 periods unless otherwise noted.
Key financial results
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Revenue | $81.74 million, up 7.5% | $147.75 million, up 5.5% |
| Earnings before income taxes | $7.98 million, versus $6.23 million | $10.83 million, versus $9.23 million |
| Net earnings | $5.36 million, versus $3.85 million | $7.15 million, versus $5.72 million |
| Diluted earnings per share | $0.37, versus $0.27 | $0.50, versus $0.40 |
| Operating cash flow | $17.23 million provided in the first half, versus $18.84 million used in first-half 2015 |
Second-quarter net margin was approximately 6.6% versus 5.1%; first-half net margin was approximately 4.8% versus 4.1% (calculated as net earnings divided by revenue). Benefits and expenses were 90.2% of revenue in the quarter and 92.7% for the first half, compared with 91.8% and 93.4%, respectively.
At June 30, 2016, total assets were $769.67 million and stockholders’ equity was $120.14 million, compared with $749.93 million and $111.25 million at year-end 2015. Cash and cash equivalents were $36.80 million, down from $40.05 million; total investments were $461.47 million. Bank and other loans payable were $42.60 million, up from $40.91 million. Management reported total capitalization of $162.74 million, with equity equal to 73.8% of capitalization. Future life, annuity and other benefits liabilities were $523.19 million.
Material changes and operating performance
- Mortgage: First-half segment pre-tax earnings increased 17% to $6.03 million. The company originated and sold 7,413 loans totaling $1.414 billion, versus 7,636 loans totaling $1.446 billion a year earlier. Management attributed stronger earnings to higher service-release premiums and origination fees. Mortgage fee income increased 3.1% to $89.25 million.
- Life insurance: First-half segment pre-tax earnings were $3.57 million, up 1%. Insurance premiums and other considerations rose 9.3% to $30.35 million; management cited higher renewal and first-year premiums and increased sales.
- Cemetery and mortuary: First-half segment pre-tax earnings increased to $1.23 million from $0.56 million. External revenue rose 13% to $7.14 million, with management citing higher at-need and pre-need sales.
- First-half investment income increased 10.4% to $18.13 million, driven principally by higher real estate rental income, insurance-assignment income, and mortgage-loan interest. Realized gains on investments and other assets declined to $0.22 million from $0.92 million.
- First-half total benefits and expenses rose 4.6% to $136.92 million. Personnel expenses and acquisition-cost amortization increased; provision for mortgage repurchase losses declined year over year.
First-half investing activities used $21.19 million and financing activities provided $0.71 million. Cash declined by $3.25 million during the period. Mortgage loans held for investment, net of allowances, increased to $131.38 million from $112.55 million; the allowance for loan losses rose to $2.20 million from $1.85 million. Mortgage servicing rights increased to $15.42 million from $12.68 million.
Outlook, risks, contingencies and unusual items
- The filing provides no quantified earnings or revenue guidance. Management says operating results for the first six months are not necessarily indicative of full-year results. Its stated business emphasis remains niche insurance products, cemetery and mortuary operations, and mortgage origination.
- The company reported $5.64 million of nonperforming mortgage loans at June 30. Mortgage credit exposure is geographically concentrated: 52% of mortgage loans were to borrowers in Utah. Management notes that borrower performance depends in part on regional economic conditions.
- Mortgage repurchase and indemnification loss reserves were $4.06 million, up from $2.81 million at year-end. SecurityNational Mortgage is cooperating with a DOJ/HUD investigation concerning FHA-insured loans originated from 2006 through May 2013 (about 45,900 loans and $7.9 billion original principal). No FHA demand has been made; no liability was recorded because potential loss could not be reasonably estimated.
- Lehman-related litigation remains unresolved. In one Utah case, the company obtained a summary judgment award of approximately $3.89 million plus interest against Aurora parties, with reserve-account and offset issues still pending. A separate Lehman Holdings case was set for trial beginning December 12, 2016. Related Delaware and bankruptcy-court matters were also pending; the company denies liability and says it will defend itself.
- The company had $65.93 million of commitments to fund residential construction loans, of which $44.83 million had been funded. It disclosed $619,076 of reserves for certain casualty, workers’ compensation and liability programs.
- On July 11, 2016, after quarter-end, the company completed its acquisition of Reppond Holding, parent of First Guaranty Insurance Company, for $6.753 million. First Guaranty reported 2015 revenue of $8.10 million and a net loss of $0.72 million. Stockholders also approved increasing authorized Class C shares from 2 million to 3 million.
- Management stated that the life insurance subsidiary complied with risk-based capital requirements. The filing says market-risk disclosures had no significant changes from the 2015 Form 10-K, and that disclosure controls were effective.
Most important facts for investors to verify
- Whether mortgage origination volumes, fee income and service-release premiums can be sustained, particularly given the lower first-half loan count and dependence on the mortgage market.
- Potential exposure from the FHA investigation and Lehman-related claims, including whether demands, rulings or settlements change the estimated $4.06 million mortgage loss reserve.
- Credit quality and collateral values in the growing mortgage-loan portfolio, including nonperforming loans, allowance adequacy and geographic concentration.
- Liquidity and investment risks, including the increase in bank debt, unrealized investment losses, and the proportion of bond investments rated non-investment grade (9.9% at June 30).
- The financial and statutory-capital effects of the First Guaranty acquisition and its integration, given First Guaranty’s reported 2015 net loss and capital and surplus of $3.85 million.