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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 1996
Commission file number: 811-6268
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SBM CERTIFICATE COMPANY
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1671595
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
C/O ARM FINANCIAL GROUP, INC.
515 WEST MARKET STREET
LOUISVILLE, KENTUCKY 40202
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (502) 582-7900
Indicate by check mark whether the registrant (i) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (ii) has been subject to such
filing requirements for the past 90 days. [X] Yes [_] No
As of November 12, 1996, 250,000 shares of the registrant's common
stock were outstanding, all of which are privately owned and not traded on a
public market.
The registrant meets the conditions set forth in General Instruction
H(1) (a) and (b) of Form 10-Q and is therefore filing this Form with the reduced
disclosure format.
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TABLE OF CONTENTS
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Item Page
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<C> <S> <C>
PART I. FINANCIAL INFORMATION
1. Financial Statements (Unaudited)
Condensed Balance Sheets--September 30, 1996 and
December 31, 1995................................................ 3
Condensed Statements of Operations--Nine and Three
Months Ended September 30, 1996 and 1995......................... 5
Condensed Statements of Cash Flows--Nine
Months Ended September 30, 1996 and 1995......................... 6
Notes to Condensed Financial Statements............................ 7
2. Management's Analysis of Results of Operations....................... 8
PART II. OTHER INFORMATION
1. Legal Proceedings.................................................... 12
6. Exhibits and Reports on Form 8-K..................................... 12
Signatures........................................................... 13
</TABLE>
2
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SBM CERTIFICATE COMPANY
CONDENSED BALANCE SHEETS
<TABLE>
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SEPTEMBER 30, DECEMBER 31,
1996 1995
- -------------------------------------------------------------------------------------------------------
(Unaudited)
<S> <C> <C>
ASSETS
Qualified assets:
Cash and investments:
Investments in securities of unaffiliated issuers:
Fixed maturities available-for-sale, at fair value (amortized cost:
September 30, 1996--$50,355,615; December 31,
1995--$53,166,600) $50,419,472 $54,486,378
Equity securities, at fair value (cost: September 30,
1996--$435,317; December 31, 1995--$479,817) 414,870 522,928
Certificate loans 273,858 279,463
Other invested assets 535,909 632,154
Cash and cash equivalents 3,803,291 3,900,494
--------------------------
Total cash and investments 55,447,400 59,821,417
Receivables:
Dividends and interest 435,687 397,898
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Total qualified assets 55,883,087 60,219,315
Deferred acquisition costs 130,708 113,500
Goodwill 133,051 192,919
Other assets 36,526 54,203
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Total assets $56,183,372 $60,579,937
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</TABLE>
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SBM CERTIFICATE COMPANY
CONDENSED BALANCE SHEETS (CONTINUED)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
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(Unaudited)
<S> <C> <C>
Liabilities and shareholder's equity
Liabilities:
Certificate reserves $50,610,674 $52,459,724
Payable for investment securities purchased 969,728 2,454,325
Deferred federal income taxes 63,751 619,148
Payable to affiliates 201,659 58,312
Accounts payable and other liabilities 46,111 2,270
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Total liabilities 51,891,923 55,593,779
Shareholder's equity:
Common stock, 250,000 shares issued 250,000 250,000
Additional paid-in capital 3,050,000 3,050,000
Net unrealized gains on available-for-sale securities 43,410 885,878
Retained earnings 948,039 800,280
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Total shareholder's equity 4,291,449 4,986,158
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Total liabilities and shareholder's equity $56,183,372 $60,579,937
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</TABLE>
See accompanying notes.
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SBM CERTIFICATE COMPANY
CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1996 1995 1996 1995
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<S> <C> <C> <C> <C>
Investment income:
Interest income from securities $ 3,067,561 $ 3,197,029 $ 1,043,839 $ 1,103,910
Other investment income 151,094 492,234 51,947 163,195
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Total investment income 3,218,655 3,689,263 1,095,786 1,267,105
Investment and other expenses:
Management and investment advisory fees 184,872 294,813 56,380 65,715
Deferred acquisition cost amortization and
renewal commissions 177,081 245,400 66,132 42,846
Real estate expenses 172,881 82,060 67,713 28,590
Amortization of goodwill 59,868 21,448 19,956 16,086
Other expenses 46,867 73,877 3,762 18,899
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Total investment and other expenses 641,569 717,598 213,943 172,136
Interest credited on certificate reserves 2,127,124 2,215,583 702,960 734,220
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Net investment income before federal income taxes 449,962 756,082 178,883 360,749
Federal income tax expense (160,555) (141,324) (53,241) (47,324)
------------------------- --------------------------
Net investment income 289,407 614,758 125,642 313,425
Realized investment gains (losses) (154,640) 194,177 (97,471) 463,722
Federal income tax benefit (expense) on realized
investment gains and losses 12,992 (71,102) 2,032 (177,862)
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Net realized investment gains (losses) (141,648) 123,075 (95,439) 285,860
------------------------- --------------------------
Net income $ 147,759 $ 737,833 $ 30,203 $ 599,285
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</TABLE>
See accompanying notes.
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SBM CERTIFICATE COMPANY
CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995
<TABLE>
<CAPTION>
1996 1995
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<S> <C> <C>
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES $ 2,913,895 $ 2,932,974
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:
Fixed maturity investments:
Purchases (26,944,692) (29,436,747)
Maturities and redemptions 4,720,513 1,799,645
Sales 23,079,773 30,677,072
Additions to other invested assets -- (81,200)
Proceeds from sale of other invested assets 104,816 414,296
Repayments of certificate loans, net 5,605 58,635
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Cash flows provided by investing activities 966,015 3,431,701
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:
Amounts paid to face-amount certificate holders (4,793,339) (11,326,133)
Amounts received from face-amount certificate holders 816,226 2,190,766
Capital contribution -- 1,500,000
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Cash flows used in financing activities (3,977,113) (7,635,367)
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Net change in cash and cash equivalents (97,203) (1,270,692)
Cash and cash equivalents at beginning of period 3,900,494 1,530,899
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Cash and cash equivalents at end of period $ 3,803,291 $ 260,207
===========================
</TABLE>
See accompanying notes.
6
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SBM CERTIFICATE COMPANY
NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 1996
1. BASIS OF PRESENTATION
The accompanying unaudited condensed financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for SBM Certificate Company (the "Company") for
the nine months ended September 30, 1996, are not necessarily indicative of
those to be expected for the year ending December 31, 1996. For further
information, refer to the financial statements and footnotes thereto included in
the Company's annual report on Form 10-K for the year ended December 31, 1995.
Certain amounts from prior periods have been reclassified to conform to the
current period presentation. These reclassifications had no effect on previously
reported net income or shareholder's equity.
2. SHAREHOLDER'S EQUITY AND REGULATORY CAPITAL
The Company is subject to two principal restrictions relating to its
regulatory capital requirements. First, under the Investment Company Act of
1940, as amended (the "1940 Act"), the Company is required to establish and
maintain qualified assets (as defined in Section 28(b) of the 1940 Act) having a
value not less than the aggregate of certificate reserves plus $250,000 ($50.9
million as of September 30, 1996). The Company had qualified assets of $55.8
million at September 30, 1996 (which excludes $43,410 of unrealized pretax gains
on fixed maturities and equity securities classified as available-for-sale).
For purposes of determining compliance with the foregoing provisions,
qualified assets are valued in accordance with the District of Columbia
Insurance Laws (the "D.C. Laws") as required by the 1940 Act. Qualified assets
for which no provision for valuation is made in the D.C. Laws are valued in
accordance with rules, regulations, or orders prescribed by the Securities and
Exchange Commission. These values are the same as the financial statement
carrying values, except that for financial statement purposes, fixed maturities
and equity securities classified as available-for-sale are carried at fair
value. For qualified asset purposes, fixed maturities classified as available-
for-sale are valued at amortized cost and equity securities are valued at cost.
Second, the Minnesota Department of Commerce has historically recommended
to the Company that face-amount certificate companies should maintain a ratio of
shareholder's equity to total assets
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of a minimum of 5% based upon a valuation of available-for-sale securities
reflected at amortized cost for purposes of this calculation. Under this
formula, the Company's capital ratio was 7.6% at September 30, 1996.
3. FEDERAL INCOME TAXES
Federal income taxes are different from the amount determined by
multiplying pretax earnings by the expected federal income tax rate of 35%. The
differences are primarily attributable to non-deductible goodwill amortization
and changes in valuation allowances related to deferred tax assets.
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ITEM 2. MANAGEMENT'S ANALYSIS OF RESULTS OF OPERATIONS
The Company was acquired by ARM Financial Group, Inc. ("ARM") in connection
with ARM's acquisition of substantially all of the assets and business
operations of SBM Company effective May 31, 1995 (the "Acquisition"). The
results of operations for the nine months ended September 30, 1995 represent the
historical results of the Company for the period from January 1, 1995 to May 31,
1995 combined with the results of operations of the Company subsequent to the
Acquisition from June 1, 1995 to September 30, 1995. Historical results of
operations are not completely comparable with results of operations subsequent
to the Acquisition primarily due to differing asset/liability management
strategies and expense allocation methodologies of ARM and SBM Company
management. Therefore, results of operations of the current year to date period
are not completely comparable with the corresponding prior period.
Net income for the nine months ended September 30, 1996 was $147,759
compared to $737,833 for the same period in 1995. Net investment income (net
income excluding realized investment gains and losses net of taxes) was $289,407
and $614,758 for the nine months ended September 30, 1996 and 1995,
respectively. The decrease in net investment income was primarily attributable
to a decrease in net investment spread, partially offset by lower investment and
other expenses.
Net investment spread, which is the difference between investment income
and interest credited on certificate reserves, decreased to $1,091,531 during
the nine months ended September 30, 1996 from $1,473,680 during the same period
in 1995. These amounts reflect net investment spread of 2.20% and 2.93% during
the nine months ended September 30, 1996 and 1995, respectively, between the
Company's annualized investment yield on average cash and investments and the
annualized average rate credited on certificate reserves. The Company's
investment income decreased to $3.2 million from $3.7 million for the nine
months ended September 30, 1996 and 1995, respectively. These amounts represent
annualized investment yields of 7.70% and 8.14% on average cash and investments
of $55.7 million and $60.4 million for the nine months ended September 30, 1996
and 1995, respectively. This decrease in annualized investment yield on cash and
investments was primarily attributable to a reduction in the average duration of
the investment portfolio and the December 1995 sale of the Company's mortgage
loan portfolio. The proceeds from the sale were invested in fixed maturities
with lower yields.
Interest credited on certificate reserves was $2.1 million and $2.2 million
for the nine months ended September 30, 1996 and 1995, respectively. These
amounts represent annualized average rates of interest credited of 5.50% and
5.21% on average certificate reserves of $50.6 million and $56.7 million for the
nine months ended September 30, 1996 and 1995, respectively. The majority of the
Company's outstanding face-amount certificates are fixed-rate three year
contracts. The Company monitors credited interest rates for new and renewal
issues against competitive products, mainly bank certificates of deposit.
Credited interest rate adjustments (up or down) on new certificates are made as
the Company deems necessary. New and renewal contracts issued during the past
year have crediting rates that are generally higher than contracts that matured
during that period, resulting in the overall increase in the average crediting
rate.
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The decrease in investment and other expenses was primarily attributable to
the decrease in management and investment advisory fees. Currently, management
and investment advisory fees are computed as a percentage of average certificate
reserves and qualified assets. Such fees have been lower since the Acquisition
primarily as a result of ARM's lower marginal operating cost attributable to
greater economies of scale since the Acquisition.
Realized investment losses were $154,640 for the nine months ended
September 30, 1996 compared to realized investment gains of $194,177 during the
nine months ended September 30, 1995. Realized investment gains and losses were
interest-rate related and attributable to the asset/liability management
strategies of the Company. Fixed maturities classified as available-for-sale are
sold during rising and falling interest rate environments which can result in
period-to-period swings in realized investment gains and losses.
The Company primarily invests in securities with fixed maturities with the
objective of providing reasonable returns while limiting credit and liquidity
risks. The Company's investments in fixed maturities were 98% investment grade
as of September 30, 1996 and December 31, 1995. Investment grade securities are
those classified as 1 or 2 by the National Association of Insurance
Commissioners, or where such classifications are not available, having a rating
on a scale used by Standard & Poor's Corporation of BBB- or above. Additionally,
the Company's investment portfolio has minimal exposure to real estate, mortgage
loans and common equity securities, which represented 1% of qualified assets at
September 30, 1996.
Fixed maturities include mortgage-backed and asset-backed securities,
corporate securities, and U.S. Treasury securities. Mortgage-backed securities
("MBSs"), which include pass-through securities and collateralized mortgage
obligations ("CMOs"), totaled $34.3 million at September 30, 1996, representing
61.4% of total qualified assets (also 61.4% at December 31, 1995). The Company's
investments in CMOs, which are primarily backed by the U.S. government or U.S.
government agencies, represented 48.3% and 47.3% of the Company's qualified
assets as of September 30, 1996 and December 31, 1995, respectively. MBSs
(including CMOs) are subject to risks associated with prepayments of the
underlying mortgage loans. Prepayments cause these securities to have actual
maturities different from those expected at the time of purchase. The degree to
which a security is susceptible to either gains or losses due to prepayment
speed adjustments is influenced by the difference between its amortized cost and
par, the relative sensitivity of the underlying mortgages backing the assets to
prepayments in a changing interest rate environment and the repayment priority
of the securities in the overall securitization structure. Prepayment
sensitivity is evaluated and monitored, giving full consideration to the
collateral characteristics such as weighted average coupon rate, weighted
average maturity and the prepayment history of the specific loan pool. Also, the
Company monitors three year cash flow projections with the goal of maintaining
an adequate level of liquidity for maturing face-amount certificates. The
Company's asset/liability management strategy not only allows the Company to
monitor its short-term liquidity needs but also aims to provide protection to
the investment portfolio from adverse changes in interest rates.
Certificate reserves decreased $1.8 million or 3.5% during the first nine
months of 1996, as maturities and surrenders exceeded sales and renewals. The
Company believes a significant factor
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leading to the decrease was the certificate of deposit marketplace currently
being very competitive, as many financial institutions are offering special high
rates to induce customers to open new accounts. For face-amount certificates
reaching their maturity date during the nine months ended September 30, 1996 and
1995, 72% were renewed in each period.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is currently involved in no material legal or administrative
proceedings.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Reports on Form 8-K
The Company did not file any reports on Form 8-K during the three months
ended September 30, 1996.
Exhibits
No exhibits are filed herewith.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on November 12, 1996.
SBM CERTIFICATE COMPANY
By: /s/ EDWARD L. ZEMAN
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Edward L. Zeman
Executive Vice President-Chief
Financial Officer (Principal Financial
Officer)
By: /s/ BARRY G. WARD
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Barry G. Ward
Controller (Principal Accounting
Officer)
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