Business Context and Reporting Period
Security National Financial Corporation filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2015. Its three reportable businesses are life insurance, cemetery and mortuary services, and mortgage lending. Management describes a continuing focus on niche insurance products, cemetery and mortuary operations, and mortgage originations. Green Street Mortgage ceased operations effective March 31, 2015.
Financial Performance and Position
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Revenue | $75.5 million | $61.7 million | $215.6 million | $166.2 million |
| Earnings before tax | $7.8 million | $3.4 million | $17.0 million | $7.7 million |
| Net earnings | $4.9 million | $2.1 million | $10.6 million | $4.9 million |
| Diluted earnings per share | $0.35 | $0.17 | $0.78 | $0.38 |
| Benefits and expenses as a share of revenue | 89.7% | 94.5% | 92.1% | 95.3% |
Q3 revenue increased 22.3% year over year and net earnings rose about 129%. Nine-month revenue increased 29.7% and net earnings rose about 116%. Mortgage fee income was the largest growth driver: $46.9 million for Q3 and $133.5 million year to date, increases of 29.5% and 42.7%, respectively. Nine-month net investment income increased 21.0% to $24.8 million. Mortgage growth also raised commissions, personnel costs, and other operating expenses.
- Segment pretax earnings, nine months: Mortgage $9.0 million (2014: $2.7 million); life insurance $7.2 million (2014: $4.8 million); cemetery and mortuary $0.8 million (2014: $0.2 million).
- Cash flow: Operating activities used $3.7 million in the first nine months, compared with $36.4 million provided in 2014. The filing attributes the 2015 use primarily to a $34.7 million increase in mortgage loans sold to investors. Investing activities provided $35.6 million and financing activities provided $9.1 million.
- Liquidity and balance sheet: Cash and cash equivalents were $71.9 million at September 30, 2015, versus $30.9 million at December 31, 2014. Total assets were $749.4 million, liabilities $640.1 million, and stockholders’ equity $109.3 million. Bank and other loans payable were $39.5 million, up from $29.0 million.
- Capital: Stockholders’ equity was 73.4% of total capitalization, versus 77.0% at year-end 2014. The life insurance subsidiary was reported in compliance with risk-based capital requirements. Statutory equity of $36.6 million held by insurance subsidiaries cannot be distributed to the parent without regulatory approval.
Material Changes, Outlook, and Risks
- Mortgage originations increased substantially: SecurityNational Mortgage originated and sold 11,689 loans totaling $2.19 billion in the first nine months of 2015, versus 7,981 loans totaling $1.50 billion in 2014. Mortgage segment growth reflected higher production and secondary gains on loans sold.
- SecurityNational Mortgage entered a new $30 million warehouse credit agreement with Texas Capital Bank, expiring August 14, 2016 unless renewed. $8.0 million was outstanding at quarter-end. Consolidated interest expense increased 58.6% year over year for the nine-month period, primarily due to higher warehouse borrowing.
- The mortgage loan indemnification reserve rose to $5.75 million from $1.72 million at year-end 2014. The company faces investor demands to repurchase or indemnify allegedly defective loans; management considers its reserve reasonable but says actual losses may differ and litigation could follow.
- A DOJ and HUD civil investigation concerns FHA-insured loans originated from 2006 through May 2013—approximately 45,900 loans with original principal of $7.9 billion. No demand has been made; the company recorded no liability because it could not estimate a reasonably possible loss range.
- In the Lehman/Aurora litigation, a court awarded SecurityNational Mortgage $3.9 million plus prejudgment interest on a reserve-account claim; disputes over offsets and reserve replenishment remained unresolved. A separate Lehman Holdings case and an indemnification notice involving 21 loans also remained matters to monitor.
- Mortgage loan credit exposure remains relevant: $5.3 million of held-for-investment mortgage loans was nonperforming at quarter-end, down from $7.5 million at year-end. Mortgage loans are geographically concentrated, including 44% in Utah. Management identifies loan-loss estimates and mortgage investor claims as uncertain.
- Other notable items include a sale of an office building that contributed to realized gains, and reinsurance transactions that transferred policy obligations and related assets to Security National Life. Management gave no specific earnings guidance; it cautions that nine-month results are not necessarily indicative of full-year results. It considers cash sources adequate for expected obligations and expenses.
The company reported no significant change in market-risk disclosures from its 2014 Form 10-K and concluded disclosure controls were effective as of September 30, 2015.
Important Facts for Investors to Verify
- Whether mortgage production, secondary gains, and margins are sustainable, and how results respond to changes in mortgage rates and refinancing activity.
- Whether the $5.75 million mortgage indemnification reserve adequately covers investor demands, including any developments in the FHA investigation and Lehman-related matters.
- The reasons operating cash flow turned negative and whether mortgage-loan sale timing or warehouse funding requirements create additional liquidity needs.
- The quality and geographic concentration of held-for-investment mortgage loans, the adequacy of loss allowances, and the performance of loans currently delinquent or nonperforming.
- Debt balances, warehouse-line availability and renewal, and restrictions on upstreaming insurance-subsidiary capital.