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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 period ended: March 31, 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.
239 S. FIFTH STREET, 12TH FLOOR
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 (1) 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 (2) has been subject to such
filing requirements for the past 90 days. [X] Yes [_] No
As of March 31, 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
Item Page
- ---- ----
PART I. FINANCIAL INFORMATION
1. Financial Statements (Unaudited)
Condensed Balance Sheets--March 31, 1996 and
December 31, 1995................................................. 3
Condensed Statements of Operations--Three
Months Ended March 31, 1996 and 1995.............................. 5
Condensed Statements of Cash Flows--Three
Months Ended March 31, 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..................................................... 10
6. Exhibits and Reports on Form 8-K...................................... 10
Signatures............................................................ 11
2
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SBM CERTIFICATE COMPANY
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1996 1995
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C>
(Unaudited)
ASSETS
Qualified assets:
Cash and investments:
Investments in securities of unaffiliated issuers:
Fixed maturities available-for-sale at fair value (amortized cost:
March 31, 1996-$52,754,700; December 31, 1995-$53,166,600) $52,934,526 $54,486,378
Equity securities at fair value (cost: March 31, 1996-$479,817;
December 31, 1995-$479,817) 477,566 522,928
Certificate loans 276,015 279,463
Other invested assets 565,117 632,154
Cash and cash equivalents 1,377,905 3,900,494
-----------------------------
Total cash and investments 55,631,129 59,821,417
Receivables:
Dividends and interest 456,740 397,898
Receivable for investment securities sold 34,122 --
-----------------------------
Total receivables 490,862 397,898
-----------------------------
Total qualified assets 56,121,991 60,219,315
Deferred acquisition costs 121,006 113,500
Goodwill 172,963 192,919
Other assets 42,948 54,203
-----------------------------
Total assets $56,458,908 $60,579,937
=============================
</TABLE>
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SBM CERTIFICATE COMPANY
CONDENSED BALANCE SHEETS (CONTINUED)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1996 1995
- --------------------------------------------------------------------------------------
(Unaudited)
<S> <C> <C>
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities:
Certificate reserves $51,842,209 $52,459,724
Payable for investment securities purchased -- 2,454,325
Deferred federal income taxes 193,597 619,148
Accounts payable and other liabilities 164,076 60,582
------------------------------
Total liabilities 52,199,882 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 115,424 885,878
Retained earnings 843,602 800,280
------------------------------
Total shareholder's equity 4,259,026 4,986,158
------------------------------
Total liabilities and shareholder's equity $56,458,908 $60,579,937
==============================
</TABLE>
See accompanying notes.
4
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SBM CERTIFICATE COMPANY
CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED)
FOR THE THREE MONTHS ENDED MARCH 31, 1996 AND 1995
<TABLE>
<CAPTION>
1996 1995
- -----------------------------------------------------------------------------------------
<S> <C> <C>
Investment income:
Interest income from securities $1,000,064 $1,045,590
Other investment income 49,519 167,404
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Total investment income 1,049,583 1,212,994
Investment and other expenses:
Management and investment advisory fees 65,586 129,000
Deferred acquisition cost amortization and renewal commissions 50,978 128,235
Real estate expenses 47,621 31,111
Amortization of goodwill 19,956 --
Other expenses 42,268 16,506
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Total investment and other expenses 226,409 304,852
Provision for certificate reserves 717,060 735,938
---------------------------
Net investment income before federal income taxes 106,114 172,204
Federal income tax expense (40,859) (53,000)
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Net investment income 65,255 119,204
Realized investment losses (27,333) (314,000)
Federal income tax benefit on realized investment losses 5,400 107,000
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Net realized investment losses (21,933) (207,000)
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Net income (loss) $ 43,322 $ (87,796)
===========================
</TABLE>
See accompanying notes.
5
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SBM CERTIFICATE COMPANY
CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE THREE MONTHS ENDED MARCH 31, 1996 AND 1995
<TABLE>
<CAPTION>
1996 1995
- --------------------------------------------------------------------------------------
<S> <C> <C>
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES $ 873,050 $ 854,830
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:
Fixed maturity investments:
Purchases (13,555,339) --
Maturities and redemptions 1,420,987 419,914
Sales 10,021,776 5,090,839
Additions to other invested assets -- (35,773)
Proceeds from sale of other invested assets 49,379 280,471
Repayments of certificate loans, net 3,448 45,286
------------------------------
Cash flows provided by (used in) investing activities (2,059,749) 5,800,737
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:
Amounts paid to face-amount certificate holders (1,689,159) (4,685,511)
Amounts received from face-amount certificate holders 353,269 819,470
Capital contribution -- 1,500,000
------------------------------
Cash flows used in financing activities (1,335,890) (2,366,041)
------------------------------
Net change in cash and cash equivalents (2,522,589) 4,289,526
Cash and cash equivalents at beginning of period 3,900,494 1,530,899
------------------------------
Cash and cash equivalents at end of period $ 1,377,905 $ 5,820,425
==============================
</TABLE>
See accompanying notes.
6
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SBM CERTIFICATE COMPANY
NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 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 three months ended March 31, 1996, are not necessarily indicative of those
to be expected for the year ended 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
(the "1940 Act"), as amended, 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 ($52.1 million
as of March 31, 1996). The Company had qualified assets of $55.9 million at
March 31, 1996 (before addition of $0.2 million 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.
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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 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 7.4% at
March 31, 1996.
ITEM 2. MANAGEMENT'S ANALYSIS OF RESULTS OF OPERATIONS
Three Months Ended March 31, 1996 Compared with Three Months Ended
March 31, 1995
The Company was acquired by ARM Financial Group, Inc. ("ARM") effective May
31, 1995 (the "Acquisition"). The results of operations for the three months
ended March 31, 1995, were prepared on a historical basis and do not include the
effect of purchase accounting and other adjustments resulting from the
Acquisition. Therefore, 1996 results are not necessarily comparable with 1995.
Net income for the first quarter of 1996 was $43,322 compared to a net loss
of $87,796 for the first quarter of 1995. The improvement in net income was
primarily attributable to 1996 net realized investment losses of $21,933,
compared to 1995 net realized investment losses of $207,000. This decrease in
realized investment losses was partially offset by a decrease in net investment
income in 1996.
Net investment income for the three months ended March 31, 1996 was $65,255
compared to $119,204 for the same period in 1995. The decrease in net investment
income is primarily attributable to a lower net investment spread, partially
offset by lower investment and other expenses (principally as a result of lower
amortization of deferred charges and lower management fees charged since the
Acquisition).
Net investment spread, which is the difference between income earned on
investments and interest credited on certificate reserves, decreased to $332,523
during the first three months of 1996 from $477,056 during the same period in
1995. These amounts represent the difference of 2.03% and 2.65% for the three
months ended March 31, 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 $1.0 million from $1.2 million for the three months ended March 31,
1996 and 1995, respectively. These amounts represent annualized investment
yields of 7.53% and 7.66% on average cash and investments of $55.7 million and
$63.4 million for the three months ended March 31,1996 and 1995, respectively.
This decrease in average annualized investment yield is primarily attributable
to the removal from the Company's investment portfolio of $4.5 million in higher
yielding collateralized mortgage obligation ("CMO") securities that were sold in
December 1995 and the proceeds reinvested in lower yielding U.S. Treasury bonds.
These U.S. Treasury bonds were ultimately sold and the proceeds reinvested in
higher yielding CMOs during March 1996. Interest credited on certificate
reserves was $717,060 and $735,938 for the three months ended March 31, 1996 and
1995, respectively. These amounts represent annualized average rates of interest
credited of 5.50% and 5.01% on average
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certificate reserves of $52.2 million and $58.8 million for the three months
ended March 31, 1996 and 1995, respectively. This increase in annualized average
credited rates is a result of new and renewal certificates issued during 1996
and 1995 accumulating interest at rates higher than those certificates issued
during 1994. 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.
The decrease in investment and other expenses is primarily attributable to
the decrease in management and investment advisory fees. Currently, these fees
are computed as a percentage of average certificate reserves and qualified
assets. Such fees have been lower since the Acquisition primarily due to ARM's
lower marginal operating cost attributable to greater economies of scale.
Amortization of deferred acquisition costs is lower in the first quarter of 1996
compared to the same period in 1995 as a result of the elimination of the
historical deferred acquisition cost asset due to purchase accounting
adjustments made in connection with the Acquisition.
Realized investment losses were $27,333 and $314,000 during the three
months ended March 31, 1996 and 1995, respectively. Realized investment losses
for the first quarter of 1996 were interest-rate related and attributable to the
on-going management of the Company's fixed maturities classified as available-
for-sale which can result in period-to-period swings in realized investment
gains and losses since securities are sold during rising and falling interest
rate environments. In order to improve liquidity during the three months ended
March 31, 1995, the Company sold fixed maturity securities for proceeds of $5.0
million which resulted in $314,000 of realized investment losses. The proceeds
were used to increase the Company's short-term investment position in
anticipation of certificate maturities.
The Company primarily invests in securities with fixed maturities with the
objective of providing reasonable returns while limiting liquidity and credit
risks. The Company's investments in fixed maturities were 97% and 98% investment
grade as of March 31, 1996 and December 31, 1995 (at amortized cost),
respectively. 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 represent 1.9% of the amortized cost of qualified assets at
March 31, 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 CMOs, totaled $40.4 million
at March 31, 1996 (at amortized cost), representing 72.2% of total qualified
assets (61.3% 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 58.1% and 46.6% of the Company's qualified assets (at amortized
cost) as of March 31, 1996 and December 31, 1995, respectively. All mortgage-
backed securities (including CMOs) are subject to the risk that a changing
interest rate environment might cause prepayment of the underlying obligations
at speeds slower or faster than anticipated at the time of their purchase;
however, the prepayment risk associated with individual CMO structures may vary
significantly.
9
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Since the Acquisition in June 1995, a restructuring of the investment portfolio
was performed to better match the duration of the investment portfolio and
related certificate reserves. In addition, the Company repositioned its mix of
CMO holdings to reduce positions in more volatile or highly leveraged securities
in favor of the more stable or less leveraged CMO tranches. The Company monitors
three year cash flow projections with the goal of maintaining an adequate level
of liquidity for maturing certificates. The Company's asset/liability 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 $617,515 or 1.2% during the first three
months of 1996, as maturities and surrenders exceeded sales and renewals. The
Company believes a significant factor leading to the decrease is 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 certificates reaching their maturity date during the three months
ended March 31, 1996 and 1995, 62% and 63%, respectively, were renewed.
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
On February 23, 1996, the Company filed on Form 8-K to report the change in
the Company's certifying accountant from Deloitte & Touche LLP to Ernst & Young
LLP.
Exhibits
10.1 Tax allocation agreement by and among the Company, ARM and certain ARM
subsidiaries dated March 21, 1996 (filed herewith).
10
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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 May 10, 1996.
SBM CERTIFICATE COMPANY
By: /s/ EDWARD L. ZEMAN
-------------------------------
Edward L. Zeman
Executive Vice President-Chief
Financial Officer (Principal
Financial Officer
By: /s/ BARRY G. WARD
-------------------------------
Barry G. Ward
Controller (Principal
Accounting Officer)
11
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Exhibit 10.1
TAX ALLOCATION AGREEMENT
This Agreement, dated March 21, 1996, is entered into by and among ARM
Financial Group, Inc. ("ARM"), Integrity Holdings, Inc. ("Integrity Holdings"),
SBM Certificate Company ("SBM Cert"), ARM Capital Advisors, Inc. ("ARMCAP"), SBM
Financial Services, Inc. ("SBMFS"), and ARM Transfer Agency, Inc. ("ARM TA"),
(collectively the "Consolidated Companies").
WHEREAS, Integrity Holdings, SBM Cert, ARMCAP, SBMFS, and ARM TA (the
"Subsidiaries") are wholly-owned subsidiaries of ARM; and
WHEREAS, the Consolidated Companies are includible corporations of an
affiliated group within the meaning of Section 1504 of the Internal Revenue
Code of 1986 as amended (the "Code"), qualified to file federal income tax
returns on a consolidated basis pursuant to Section 1501 of the Code; and
WHEREAS, ARM and the Subsidiaries desire to file a consolidated federal
income tax return and, where permissible, consolidated state income tax returns
(a "Consolidated Return"); and
WHEREAS, the Consolidated Companies desire to enter into this Agreement to
provide for the allocation of consolidated tax liabilities among the parties
hereto, for reimbursing ARM for payment of such tax liability, for compensating
any party hereto for use of its losses or tax credits, and to provide for the
allocation and payment of any refund arising from a carryback of losses or tax
credits from subsequent tax years;
NOW, THEREFORE, in consideration of the premises and of the mutual promises
set forth herein, and intending to be legally bound hereby, the Consolidated
Companies agree as follows:
I. EFFECTIVE DATE/TAX YEARS
This Agreement shall be in effect for the taxable period beginning January
1, 1995, and for any taxable period thereafter for which ARM is required or
permitted to file a Consolidated Return, except that no Subsidiary shall be
considered to be a member of the Consolidated Companies for any period that it
would not qualify as a member thereof pursuant to the Code.
II. ALLOCATION
For each taxable period, consolidated income tax liabilities shall be
apportioned among the Consolidated Companies based upon each members'
proportionate share of taxable income determined in accordance with Section
1552(a)(1) of the Code and Regulation 1.552-1(a)(1) thereunder. Additional
amounts will be allocated among the Consolidated Companies in accordance with
Regulation 1.1502-33(d)(3) by assuming a 100% allocation of any decreased tax
liability.
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Each Subsidiary shall reimburse ARM for the Subsidiary's proportion of any
tax liability, and for the dollar amount of any tax benefit it received by
virtue of the filing of a Consolidated Return regardless of whether or not the
benefit resulted in a tax liability on a consolidated return basis. Any
payments received by ARM for reimbursement of tax benefits shall be allocated
among the Consolidated Companies pursuant to this Agreement.
ARM shall reimburse each Subsidiary having a loss for the Subsidiary's
proportion of any tax credit utilized to reduce the tax liability on a
consolidated return basis.
For purposes of this Agreement, the consolidated tax liability shall
include any liability for alternative minimum tax.
III. CONSENTS
The Consolidated Companies agree to file such consents, elections, and
other documents, and to take such other action as may be necessary or
appropriate to carry out the purpose of this Agreement.
IV. PAYMENTS
Within 30 days after completion of a Consolidated Return, each Subsidiary
shall pay to ARM the amount of any tax liability and any tax benefit allocated
to the Subsidiary. At least five business days prior to the due date of any
consolidated estimated tax payments which ARM determines to be payable, each
Subsidiary shall advance to ARM that portion of such estimated tax payment
attributable to the Subsidiary as determined equitably by ARM. Such advances
shall reduce any amount payable to ARM following completion of the next
subsequent federal Consolidated Return and any negative balance resulting from
such reduction shall be refunded by ARM to the Subsidiary.
Within 60 days after completion of a Consolidated Return, ARM shall pay to
each Subsidiary the amount of any tax credit and any tax benefit reimbursement
allocated to the Subsidiary.
All payments between the Consolidated Companies pursuant to this Agreement
shall be made in cash.
V. TAX ADJUSTMENTS
In the event of any adjustment to any consolidated income tax liability
determined in accordance with this Agreement, whether by reason of an amended
return, claim for refund, or an audit by the Internal Revenue Service, the
allocations under Section II shall be redetermined to give effect to any such
adjustment, including statutory interest and penalties thereon, as if it had
been made as part of the original computation of consolidated income tax
liability. Payments between the Consolidated Companies as a result of such
redetermination shall be made within 60 days after
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any such payments are made or refunds are received, or, in the case of protested
proceedings, within 120 days after final resolution of the matter.
VI. NEW MEMBERS
The Consolidated Companies recognize that from time to time other companies
may become members of the Consolidated Companies and be required to be included
in the Consolidated Return. ARM and the Subsidiaries hereby agree that such new
members become parties to and be bound by this Agreement.
VII. TERMINATION
This Agreement shall be terminated as to any Subsidiary as of the date that
the Subsidiary does not qualify as a member of the Consolidated Companies
pursuant to the Code. This Agreement may be terminated in its entirety by
written agreement of the then existing Consolidated Companies. Notwithstanding
such termination, this Agreement shall continue in effect with respect to any
payment or refunds due for all taxable periods prior to termination.
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IN WITNESS WHEREOF the parties have caused this Agreement to be executed by
their officers duly authorized to do so, as of the date first written above.
ARM FINANCIAL GROUP, INC.
- -------------------------
BY: /S/JOHN FRANCO
TITLE: CO-CHIEF EXECUTIVE OFFICER AND CO-CHAIRMAN OF THE BOARD
BY: /S/MARTIN H. RUBY
TITLE: CO-CHIEF EXECUTIVE OFFICER AND CO-CHAIRMAN OF THE BOARD
INTEGRITY HOLDINGS, INC.
- ------------------------
BY: /S/JOHN FRANCO
TITLE: CO-CHIEF EXECUTIVE OFFICER AND CO-CHAIRMAN OF THE BOARD
BY: /S/MARTIN H. RUBY
TITLE: CO-CHIEF EXECUTIVE OFFICER AND CO-CHAIRMAN OF THE BOARD
SBM CERTIFICATE COMPANY
- -----------------------
BY: /S/JOHN MCGEENEY
TITLE: CHAIRMAN OF THE BOARD AND PRESIDENT
ARM CAPITAL ADVISORS, INC.
- --------------------------
BY: /S/JOHN FRANCO
TITLE: CO-CHIEF EXECUTIVE OFFICER
BY: /S/MARTIN H. RUBY
TITLE: CO-CHIEF EXECUTIVE OFFICER
SBM FINANCIAL SERVICES, INC.
- ---------------------------
BY: /S/ E J HAINES
TITLE: PRESIDENT
ARM TRANSFER AGENCY, INC.
- ------------------------
BY: /S/DAVID E. FERGUSON
TITLE: PRESIDENT
15
