SECURITY NATIONAL FINANCIAL CORP 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. Overview The Company’s operations over the last several years generally reflect three strategies which the Company expects to continue: (i) increased attention to “niche” insurance products, such as the Company’s funeral plan policies and traditional whole life products; (ii) increased emphasis on the cemetery and mortuary business; and (iii) capitalizing on an improving housing market by originating mortgage loans. Insurance Operations The Company’s life insurance business includes funeral plans and interest-sensitive life insurance, as well as other traditional life, accident and health insurance products. The Company places specific marketing emphasis on funeral plans through pre-need planning. A funeral plan is a small face value life insurance policy that generally has face coverage of up to $30,000. The Company believes that funeral plans represent a marketing niche that is less competitive because most insurance companies do not offer similar coverage. The purpose of the funeral plan policy is to pay the costs and expenses incurred at the time of a person’s death. On a per thousand-dollar cost of insurance basis, these policies can be more expensive to the policyholder than many types of non-burial insurance due to their low face amount, requiring the fixed cost of the policy administration to be distributed over a smaller policy size, and the simplified underwriting practices that result in higher mortality costs. The following table shows the condensed financial results of the insurance operations for three and six month periods ended June 30, 2023, and 2022. See Note 7 to the condensed consolidated financial statements. Three months ended June 30, (in thousands of dollars) Six months ended June 30, (in thousands of dollars) 2023 2022 % Increase (Decrease) 2023 2022 % Increase (Decrease) Revenues from external customers Insurance premiums $ 28,813 $ 25,912 11 % $ 56,781 $ 52,254 9 % Mortgage fee income 22 - 100 % $ 66 $ - 100 % Net investment income 18,420 15,126 22 % 35,175 29,707 18 % Gains on investments and other assets 458 (266 ) 272 % 515 (159 ) 424 % Other 358 394 (9 )% 949 866 10 % Total $ 48,071 $ 41,166 17 % $ 93,486 $ 82,668 13 % Intersegment revenue $ 2,517 $ 2,076 21 % $ 4,028 $ 3,772 7 % Earnings before income taxes $ 9,158 $ 3,932 133 % $ 12,842 $ 4,748 170 % Intersegment revenues are primarily interest income from the warehouse line for loans held for sale provided to SecurityNational Mortgage Company (“SecurityNational Mortgage”). Profitability for the six month period ended June 30, 2023 increased due to (a) a $5,468,000 increase in net investment income, (b) a $4,527,000 increase in insurance premiums and other considerations, (c) a $1,494,000 decrease in selling, general and administrative expenses, (d) a $674,000 increase in gains on investments and other assets, (e) a $256,000 increase in intersegment revenue, (f) a $83,000 increase in other revenues, and (g) a $66,000 increase in mortgage fee income, which were partially offset by (i) a $3,183,000 increase in future policy benefits, (ii) a $732,000 increase in amortization of deferred policy acquisition costs, (iii) a $417,000 increase in interest expense, (iv) a 125,000 increase in intersegment interest expense and other expenses, and (v) a $16,000 increase in death, surrenders and other policy benefits. 58 Cemetery and Mortuary Operations The Company sells mortuary services and products through its nine mortuaries in Utah and three mortuaries in New Mexico. The Company also sells cemetery products and services through its five cemeteries in Utah, one cemetery in San Diego County, California, and one cemetery in Santa Fe, New Mexico. At-need product sales and services are recognized as revenue when the services are performed or when the products are delivered. Pre-need cemetery product sales are deferred until the merchandise is delivered and services performed. Recognition of revenue for cemetery land sales occurs when 10% of the purchase price is received. The following table shows the condensed financial results of the cemetery and mortuary operations for the three and six month periods ended June 30, 2023, and 2022. See Note 7 to the condensed consolidated financial statements. Three months ended June 30, (in thousands of dollars) Six months ended June 30, (in thousands of dollars) 2023 2022 % Increase (Decrease) 2023 2022 % Increase (Decrease) Revenues from external customers Mortuary revenues $ 3,125 $ 3,106 1 % $ 6,400 $ 6,872 (7 )% Cemetery revenues 4,044 4,144 (2 )% 7,240 7,584 (5 )% Net investment income 1,343 739 82 % 1,945 1,236 57 % Gains (losses) on investments and other assets 198 (720 ) 128 % 252 (975 ) 126 % Other 103 21 390 % 174 36 383 % Total $ 8,813 $ 7,290 21 % $ 16,011 $ 14,753 9 % Earnings before income taxes $ 2,828 $ 1,486 90 % $ 4,613 $ 3,506 32 % Profitability in the six month period ended June 30, 2023 increased due to (a) a $1,227,000 increase in gains on investments and other assets, (b) a $709,000 increase in net investment income, (c) a $495,000 increase in cemetery pre-need sales, and (d) a $138,000 increase in other revenues, (e) a $46,000 decrease in amortization of deferred policy acquisition costs, and (f) a $28,000 decrease in intersegment interest expense and other expenses, which were partially offset by (i) an $839,000 decrease in mortuary at-need sales, (ii) a $473,000 decrease in cemetery at-need sales, (iii) a $116,000 increase in selling, general and administrative expenses, (iv) a $99,000 decrease in intersegment revenues, and a (v) 9,000 increase in cost of goods and services sold. Mortgage Operations The Company’s wholly owned subsidiary, SecurityNational Mortgage, is a mortgage lender incorporated under the laws of the State of Utah and approved and regulated by the Federal Housing Administration (FHA), a department of the U.S. Department of Housing and Urban Development (HUD), which originate mortgage loans that qualify for government insurance in the event of default by the borrower, in addition to various conventional mortgage loan products. SecurityNational Mortgage originates and refinances mortgage loans on a retail basis. Mortgage loans originated or refinanced by the SecurityNational Mortgage are funded through loan purchase agreements with Security National Life, Kilpatrick Life and unaffiliated financial institutions. SecurityNational Mortgage receive fees from borrowers that are involved in mortgage loan originations and refinancings, and secondary fees earned from third party investors that purchase the mortgage loans. Mortgage loans are generally sold with mortgage servicing rights (“MSRs”) released to third-party investors or retained by SecurityNational Mortgage. SecurityNational Mortgage currently retains the mortgage servicing rights on approximately 5% of its loan origination volume. These mortgage loans are serviced by either SecurityNational Mortgage or an approved third-party sub-servicer. On October 31, 2022, the Company sold certain of its MSRs. The MSRs related to mortgage loans previously originated by the Company in aggregate unpaid principal amount of approximately $7.02 billion. As a result of the sale, the book value of the Company’s MSRs decreased by $51,185,906. Mortgage rates have followed the US Treasury yields up in response to the higher than expected inflation and the expectation that the Federal Reserve will continue to raise rates in the near term. As expected, the rapid increase in mortgage rates has resulted in a decrease in loan originations classified as ‘refinance.’ Higher mortgage rates have also had a negative effect on loan originations classified as ‘purchases,’ although not as significant as those in the refinance classification. 59 For the six month periods ended June 30, 2023 and 2022, SecurityNational Mortgage originated 3,738 loans ($1,139,735,000 total volume) and 6,419 loans ($2,049,959,000 total volume), respectively. The following table shows the condensed financial results of the mortgage operations for the three and six month periods ended June 30, 2023, and 2022. See Note 7 to the condensed consolidated financial statements. Three months ended June 30, (in thousands of dollars) Six months ended June 30, (in thousands of dollars) 2023 2022 % Increase (Decrease) 2023 2022 % Increase (Decrease) Revenues from external customers Secondary gains from investors $ 19,276 $ 37,161 (48 )% $ 37,193 $ 76,764 (52 )% Income from loan originations 8,334 10,581 (21 )% 14,889 19,393 (23 )% Change in fair value of loans held for sale (1,402 ) (3,464 ) (60 )% (607 ) (6,210 ) (90 )% Change in fair value of loan commitments (151 ) (2,247 ) (93 )% 527 428 23 % Net investment income 409 106 286 % 827 223 271 % Gains on investments and other assets 161 72 124 % 161 391 (59 )% Other 336 4,901 (93 )% 860 9,581 (91 )% Total $ 26,963 $ 47,110 (43 )% $ 53,850 $ 100,570 (46 )% Earnings before income taxes $ (3,837 ) $ (688 ) (458 )% $ (7,720 ) $ 919 (940 )% Included in other revenues is service fee income. Profitability for the six month period ended June 30, 2023 decreased due to (a) a $39,571,000 decrease in secondary gains from investors, (b) a $8,721,000 decrease in other revenues, (c) a $4,504,000 decrease in income from loan originations, (d) a $274,000 increase in rent and rent related expenses, (e) a $230,000 decrease in gains on investments and other assets, and (f) a $167,000 increase in intersegment interest expense and other expenses, which were partially offset by (i) a $18,025,000 decrease in commissions, (ii) a $9,849,000 decrease in personnel expenses, (iii) a $7,503,000 decrease in other expenses, (iv) a $5,603,000 increase in the fair value of loans held for sale, (v) a $1,200,000 decrease in costs related to funding mortgage loans, (v) a $1,177,000 decrease in interest expense, (vi) a $661,000 decrease in advertising expenses, (vii) a $604,000 increase in net investment income, (viii) a $107,000 increase in intersegment revenues, and (ix) a $99,000 increase in the fair value of loan commitments. Consolidated Results of Operations Three month period ended June 30, 2023, Compared to Three month period ended June 30, 2022 Total revenues decreased by $11,721,000, or 12.3%, to $83,846,000 for the three month period ended June 30, 2023, from $95,567,000 for the comparable period in 2022. Contributing to this decrease in total revenues was a $15,952,000 decrease in mortgage fee income, a $4,520,000 decrease in other revenues, and an $82,000 decrease in net mortuary and cemetery sales, which were partially offset by a $4,201,000 increase in net investment income, a $1,731,000 increase in gains on investments and other assets, and a $2,901,000 increase in insurance premiums and other considerations. Mortgage fee income decreased by $15,952,000, or 38.0%, to $26,079,000, for the three month period ended June 30, 2023, from $42,031,000 for the comparable period in 2022. This decrease was primarily due to a $17,863,000 decrease in secondary gains from mortgage loans sold to third-party investors into the secondary market due to the decline in origination activity because of increasing interest rates, and a $2,247,000 decrease in loan fees and interest income net of a decrease in the provision for loan loss reserve, which were partially offset by a $2,096,000 increase in the fair value of loan commitments and a $2,062,000 increase in the fair value of loans held for sale. Insurance premiums and other considerations increased by $2,901,000, or 11.2%, to $28,813,000 for the three month period ended June 30, 2023, from $25,912,000 for the comparable period in 2022. This increase was primarily due to an increase of $2,829,000 in first year premiums and an increase of $72,000 in renewal premiums. 60 Net investment income increased by $4,201,000, or 26.3%, to $20,172,000 for the three month period ended June 30, 2023, from $15,971,000 for the comparable period in 2022. This increase was primarily attributable to a $1,332,000 increase in fixed maturity securities income, an $885,000 increase in real estate income, a $672,000 increase in interest on cash and cash equivalents, a $585,000 decrease in investment expenses, a $368,000 increase in insurance assignment income, a $223,000 increase in mortgage loan interest, a $115,000 increase in other investment income, and a $21,000 increase in equity securities income. Net mortuary and cemetery sales decreased by $82,000, or 1.1%, to $7,169,000 for the three month period ended June 30, 2023, from $7,250,000 for the comparable period in 2022. This decrease was primarily due to a $617,000 decrease in cemetery at-need sales, which were partially offset by a $517,000 increase in cemetery pre-need sales and an $18,000 increase in mortuary at-need sales. Gains on investments and other assets increased by $1,731,000, or 189.3%, to $817,000 in net gains for the three month period ended June 30, 2023, from $914,000 in net losses for the comparable period in 2022. This increase in gains on investments and other assets was primarily due to a $2,597,000 increase in gains on equity securities mostly attributable to increases in the fair value of these equity, which were partially offset by securities a $558,000 decrease in gains on other assets, a $199,000 decrease in gains on fixed maturity securities, and a $109,000 decrease in gains on real estate. Other revenues decreased by $4,520,000, or 85.0%, to $797,000 for the three month period ended June 30, 2023, from $5,316,000 for the comparable period in 2022. This decrease was primarily attributable to a decrease in servicing fee revenue as a result of the sale of certain mortgage servicing rights in October 2022. Total benefits and expenses were $75,697,000, or 90.3% of total revenues, for the three month period ended June 30, 2023, as compared to $90,837,000, or 95.1% of total revenues, for the comparable period in 2022. Death benefits, surrenders and other policy benefits, and future policy benefits increased by an aggregate of $2,313,000 or 10.2%, to $24,906,000 for the three month period ended June 30, 2023, from $22,593,000 for the comparable period in 2022. This increase was primarily the result of a $1,899,000 increase in future policy benefits and a $616,000 increase in death benefits, which were partially offset by a $203,000 decrease in surrender and other policy benefits. Amortization of deferred policy and pre-need acquisition costs and value of business acquired increased by $198,000, or 4.9%, to $4,251,000 for the three month period ended June 30, 2023, from $4,053,000 for the comparable period in 2022. This increase was primarily due to an increase in the average outstanding balance of deferred policy and pre-need acquisition costs. Selling, general and administrative expenses decreased by $17,174,000, or 28.1%, to $43,873,000 for the three month period ended June 30, 2023, from $61,047,000 for the comparable period in 2022. This decrease was primarily the result of a $7,661,000 decrease in commissions, a $4,997,000 decrease in personnel expenses, a $3,771,000 decrease in other expenses, a $630,000 decrease in advertising expense, a $203,000 decrease in costs related to funding mortgage loans, and a $41,000 decrease in depreciation on property and equipment, which were partially offset by a $129,000 increase in rent and rent related expenses. Interest expense decreased by $485,000, or 25.5%, to $1,415,000 for the three month period ended June 30, 2023, from $1,900,000 for the comparable period in 2022. This decrease was primarily due to a decrease of $776,000 in interest expense on mortgage warehouse lines for loans held for sale, which was partially offset by an increase of $291,000 in interest expense on bank loans. Six month period ended June 30, 2023, Compared to Six month period ended June 30, 2022 Total revenues decreased by $34,646,000, or 17.5%, to $163,347,000 for the six month period ended June 30, 2023, from $197,993,000 for the comparable period in 2022. Contributing to this decrease in total revenues was a $38,308,000 decrease in mortgage fee income, a $8,500,000 decrease in other revenues, and an $816,000 decrease in net mortuary and cemetery sales, which were partially offset by a $6,781,000 increase in net investment income, a $4,527,000 increase in insurance premiums and other considerations, and a $1,670,000 increase in gains on investments and other assets. 61 Mortgage fee income decreased by $38,308,000, or 42.4%, to $52,068,000, for the six month period ended June 30, 2023, from $90,375,000 for the comparable period in 2022. This decrease was primarily due to a $39,504,000 decrease in secondary gains from mortgage loans sold to third-party investors into the secondary market due to the decline in origination activity because of increasing interest rates and a $4,505,000 decrease in loan fees and interest income net of a decrease in the provision for loan loss reserve, which were partially offset by a $5,603,000 increase in the fair value of loans held for sale and a $98,000 increase in the fair value of loan commitments. Insurance premiums and other considerations increased by $4,527,000, or 8.7%, to $56,781,000 for the six month period ended June 30, 2023, from $52,254,000 for the comparable period in 2022. This increase was primarily due to an increase of $4,018,000 in first year premiums and an increase of $509,000 in renewal premiums. Net investment income increased by $6,781,000, or 21.8%, to $37,947,000 for the six month period ended June 30, 2023, from $31,165,000 for the comparable period in 2022. This increase was primarily attributable to a $2,709,000 increase in fixed maturity securities income, a $1,384,000 increase in interest on cash and cash equivalents, a $1,210,000 increase in real estate income, an $883,000 decrease in investment expenses, a $750,000 increase in mortgage loan interest, a $173,000 increase in income from other investments, and a $39,000 increase in equity securities income, which were partially offset by a $261,000 decrease in insurance assignment income and a $106,000 decrease in policy loan income. Net mortuary and cemetery sales decreased by $816,000, or 5.6%, to $13,640,000 for the six month period ended June 30, 2023, from $14,456,000 for the comparable period in 2022. This decrease was primarily due to an $839,000 decrease in cemetery at-need sales and a $472,000 decrease in mortuary at-need sales, which were partially offset by a $495,000 increase in cemetery pre-need sales. Gains on investments and other assets increased by $1,670,000, or 225.00%, to $928,000 in gains for the six month period ended June 30, 2023, from $742,000 in losses for the comparable period in 2022. This increase in gains on investments and other assets was primarily due to a $3,493,000 increase in gains on equity securities mostly attributable to increases in the fair value of these equity securities, which were partially offset by a $980,000 decrease in gains on real estate, a $464,000 decrease in gains on fixed maturity securities, and $379,000 decrease in gains on other assets. Other revenues decreased by $8,500,000, or 81.1%, to $1,984,000 for the six month period ended June 30, 2023, from $10,484,000 for the comparable period in 2022. This decrease was primarily attributable to a decrease in servicing fee revenue as a result of the sale of certain mortgage servicing rights in October 2022. Total benefits and expenses were $153,613,000, or 94.0% of total revenues, for the six month period ended June 30, 2023, as compared to $188,819,000, or 95.4% of total revenues, for the comparable period in 2022. Death benefits, surrenders and other policy benefits, and future policy benefits increased by an aggregate of $3,200,000 or 6.7%, to $50,772,000 for the six month period ended June 30, 2023, from $47,572,000 for the comparable period in 2022. This increase was primarily the result of a $3,183,000 increase in future policy benefits and a $410,000 increase in death benefits, which was partially offset by a $393,000 decrease in surrender and other policy benefits. Amortization of deferred policy and pre-need acquisition costs and value of business acquired increased by $685,000, or 8.1%, to $9,135,000 for the six month period ended June 30, 2023, from $8,450,000 for the comparable period in 2022. This increase was primarily due to an increase in the average outstanding balance of deferred policy and pre-need acquisition costs. Selling, general and administrative expenses decreased by $38,341,000, or 30.3%, to $88,401,000 for the six month period ended June 30, 2023, from $126,742,000 for the comparable period in 2022. This decrease was primarily the result of a $17,890,000 decrease in commissions, a $9,909,000 decrease in personnel expenses, a $8,082,000 decrease in other expenses, a $1,438,000 decrease in advertising expense, a $1,200,000 decrease in costs related to funding mortgage loans, and a $68,000 decrease in depreciation on property and equipment, which were partially offset by a $246,000 increase in rent and rent related expenses. 62 Interest expense decreased by $759,000, or 20.9%, to $2,868,000 for the six month period ended June 30, 2023, from $3,627,000 for the comparable period in 2022. This decrease was primarily due to a decrease of $1,177,000 in interest expense on mortgage warehouse lines for loans held for sale, which was partially offset by an increase of $418,000 in interest expense on bank loans. Liquidity and Capital Resources The Company’s life insurance subsidiaries and cemetery and mortuary subsidiaries realize cash flow from premiums, contract payments and sales on personal services rendered for cemetery and mortuary business, from interest and dividends on invested assets, and from the proceeds from the sale or maturity of investments. The mortgage subsidiaries realize cash flow from fees generated by originating and refinancing mortgage loans and fees from mortgage loans held for sale that are sold to investors into the secondary market. It should be noted that current conditions in the financial markets and economy may affect the realization of these expected cash flows. The Company considers these sources of cash flow to be adequate to fund future policyholder and cemetery and mortuary liabilities, which generally are long-term, and adequate to pay current policyholder claims, annuity payments, expenses related to the issuance of new policies, the maintenance of existing policies, debt service, and to meet current operating expenses. As of June 30, 2023, the Company was not in compliance with the net income covenant and has received or is in the process of receiving waivers from the warehouse banks. In the unlikely event the Company is required to repay the outstanding advances of approximately $7,100,000 on the warehouse line that has not provided a covenant waiver, the Company has sufficient cash and borrowing capacity on the warehouse lines that have provided covenant waivers to fund its origination activities. The Company has done an internal analysis of its funding capacities of both internal and external sources and has determined that there are sufficient funds to continue its business model. The Company continues to negotiate other warehouse lines with other lenders. During the six month periods ended June 30, 2023 and 2022, the Company’s operations provided cash of $2,181,000 and $97,639,000, respectively. The decrease in cash provided by operations was due primarily to decreased proceeds from the sale of mortgage loans held for sale. The Company’s liability for future policy benefits is expected to be paid out over the long-term due to the Company’s market niche of selling funeral plans. Funeral plans are small face value life insurance policies that payout upon a person’s death to cover funeral burial costs. Policyholders generally keep these policies in force and do not surrender them prior to death. Because of the long-term nature of these liabilities, the Company is able to hold to maturity its bonds, real estate, and mortgage loans thus reducing the risk of liquidating these long-term investments as a result of any sudden changes in their fair values. The Company attempts to match the duration of invested assets with its policyholder and cemetery and mortuary liabilities. The Company may sell investments other than those held to maturity in the portfolio to help in this timing matching. The Company purchases short-term investments on a temporary basis to meet the expectations of short-term requirements of the Company’s products. The Company’s investment philosophy is intended to provide a rate of return, which will persist during the expected duration of policyholder and cemetery and mortuary liabilities regardless of future interest rate movements. The Company’s investment policy is also to invest predominantly in fixed maturity securities, real estate, mortgage loans, and warehousing of mortgage loans held for sale on a short-term basis before selling the loans to investors in accordance with the requirements and laws governing the life insurance subsidiaries. Bonds owned by the insurance subsidiaries amounted to $340,331,000 (at estimated fair value) and $345,598,000 (at estimated fair value) as of June 30, 2023 and December 31, 2022, respectively. This represented 38.0% and 36.4% of the total investments as of June 30, 2023, and December 31, 2022, respectively. Generally, all bonds owned by the life insurance subsidiaries are rated by the National Association of Insurance Commissioners. Under this rating system, there are six categories used for rating bonds. At June 30, 2023, 2.0% (or $6,932,000) and at December 31, 2022, 2.2% (or $7,833,000) of the Company’s total bond investments were invested in bonds in rating categories three through six, which are considered non-investment grade. 63 The Company is subject to risk-based capital guidelines established by statutory regulators requiring minimum capital levels based on the perceived risk of assets, liabilities, disintermediation, and business risk. At June 30, 2023 and December 31, 2022, the life insurance subsidiaries were in compliance with the regulatory criteria. The Company’s total capitalization of stockholders’ equity, bank and other loans payable was $402,064,000 as of June 30, 2023, as compared to $454,499,000 as of December 31, 2022. Stockholders’ equity as a percent of total capitalization was 74.3% and 64.4% as of June 30, 2023, and December 31, 2022, respectively. Bank loans and other loans payable decreased by $58,411,000 as of June 30, 2023, as compared to December 31, 2022, which was partially offset by an increase in stockholders’ equity of $5,976,000 as of June 30, 2023 as compared to December 31, 2022, thus causing the increase in the stockholders’ equity percentage. Lapse rates measure the amount of insurance terminated during a particular period. The Company’s lapse rate for life insurance in 2022 was 4.3% as compared to a rate of 4.8% for 2021. The 2023 lapse rate to date has been approximately the same as 2022. The combined statutory capital and surplus of the Company’s life insurance subsidiaries was $99,865,000 and $94,254,000 as of June 30, 2023, and December 31, 2022, respectively. The life insurance subsidiaries cannot pay a dividend to their parent company without the approval of state insurance regulatory authorities. Banking Environment On March 10, 2023 and March 12, 2023, Silicon Valley Bank and Signature Bank were placed in receivership with the Federal Deposit Insurance Corporation (“FDIC”). Normal banking activities resumed shortly thereafter. On May 1, 2023, First Republic bank was placed in receivership with the FDIC and was immediately purchased by a national bank. The Company does not maintain any deposit or other accounts or credit facilities with Silicon Valley Bank, Signature Bank or First Republic Bank. The Company may periodically transfer funds to these banks to pay for services rendered by third party vendors that continue to maintain banking relationships with these banks. The Company continues to monitor the banking industry and its relationships with regional and community banks. Item 3. Quantitative and Qualitative Disclosures About Market Risk. As a smaller reporting company, the Company is not required to provide information typically disclosed under this item. 64