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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, 1997
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 (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 November 7, 1997, 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
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PART I. FINANCIAL INFORMATION
1. Financial Statements (Unaudited)
Condensed Balance Sheets--September 30, 1997 and
December 31, 1996 . . . . . . . . . . . . . . . . . . . . . . . . . .3
Condensed Statements of Operations--Three and Nine
Months Ended September 30, 1997 and 1996. . . . . . . . . . . . . . .5
Condensed Statements of Cash Flows--Nine Months
Ended September 30, 1997 and 1996. . . . . . . . . . . . . . . . . . .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>
SEPTEMBER 30, DECEMBER 31,
1997 1996
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<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: September 30, 1997-$39,324,933;
December 31, 1996-$49,863,826) $ 39,158,380 $ 50,169,361
Equity securities, at fair value (cost: September 30, 1997-
$493,912; December 31, 1996-$493,912) 567,068 544,594
Certificate loans 186,796 273,368
Other invested assets 484,544 523,083
Cash and cash equivalents 4,644,046 3,247,192
----------------------------
Total cash and investments 45,040,834 54,757,598
Receivables:
Dividends and interest 338,838 533,958
Receivable for investment securities sold 7,369,046 122,570
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Total receivables 7,707,884 656,528
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Total qualified assets 52,748,718 55,414,126
Deferred acquisition costs 142,917 132,163
Goodwill -- 113,095
Other assets 42,947 66,163
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Total assets $ 52,934,582 $ 55,725,547
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</TABLE>
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SBM CERTIFICATE COMPANY
CONDENSED BALANCE SHEETS (CONTINUED)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1997 1996
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<S> <C> <C>
(Unaudited)
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities:
Certificate reserves $ 47,419,714 $ 50,186,386
Deferred federal income taxes 183,255 445,419
Accounts payable and other liabilities 189,890 29,940
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Total liabilities 47,792,859 50,661,745
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 (losses) on available-for-sale securities (60,709) 231,541
Retained earnings 1,902,432 1,532,261
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Total shareholder's equity 5,141,723 5,063,802
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Total liabilities and shareholder's equity $ 52,934,582 $ 55,725,547
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</TABLE>
SEE ACCOMPANYING NOTES.
4
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SBM CERTIFICATE COMPANY
CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------------------------------
1997 1996 1997 1996
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<S> <C> <C> <C> <C>
Investment income:
Interest income from securities $ 994,238 $1,043,839 $2,989,173 $3,067,561
Other investment income 48,741 51,947 144,145 151,094
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Total investment income 1,042,979 1,095,786 3,133,318 3,218,655
Investment and other expenses:
Management and investment advisory
fees 61,617 56,380 184,851 184,872
Deferred acquisition cost amortization
and renewal commissions 72,356 66,132 213,990 177,081
Real estate expenses 33,284 67,713 116,594 172,881
Amortization of goodwill -- 19,956 23,833 59,868
Other expenses 4,806 3,762 16,101 46,867
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Total investment and other expenses 172,063 213,943 555,369 641,569
Interest credited on certificate reserves 697,004 702,960 2,122,030 2,127,124
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Net investment income before federal
income taxes 173,912 178,883 455,919 449,962
Federal income tax expense (58,529) (53,241) (154,863) (160,555)
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Net investment income 115,383 125,642 301,056 289,407
Realized investment gains (losses) 9,875 (97,471) 63,479 (154,640)
Federal income tax benefit on realized
investment gains and losses 26,294 2,032 5,636 12,992
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Net realized investment gains (losses) 36,169 (95,439) 69,115 (141,648)
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Net income $ 151,552 $ 30,203 $ 370,171 $ 147,759
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</TABLE>
SEE ACCOMPANYING NOTES.
5
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SBM CERTIFICATE COMPANY
CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
<TABLE>
<CAPTION>
1997 1996
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<S> <C> <C>
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES $ 3,168,909 $ 2,913,895
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:
Fixed maturity investments available-for-sale:
Purchases (57,489,381) (26,944,692)
Maturities and redemptions 4,548,571 4,720,513
Sales 55,967,691 23,079,773
Proceeds from sale or maturity of other invested assets 2,539 104,816
Repayments of certificate loans, net 86,572 5,605
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Cash flows provided by investing activities 3,115,992 966,015
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:
Amounts paid to face-amount certificate holders (5,187,525) (4,793,339)
Amounts received from face-amount certificate holders 299,478 816,226
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Cash flows used in financing activities (4,888,047) (3,977,113)
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Net change in cash and cash equivalents 1,396,854 (97,203)
Cash and cash equivalents at beginning of period 3,247,192 3,900,494
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Cash and cash equivalents at end of period $ 4,644,046 $ 3,803,291
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</TABLE>
SEE ACCOMPANYING NOTES.
6
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SBM CERTIFICATE COMPANY
NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 1997
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, 1997, are not necessarily indicative of
those to be expected for the year ending December 31, 1997. 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, 1996.
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 ($47.7
million as of September 30, 1997). The Company had qualified assets of $52.8
million at September 30, 1997 (which excludes a $93,397 unrealized pretax loss
on fixed maturities and equity securities classified as available-for-sale).
For purposes of determining compliance with the foregoing provision,
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 of a minimum of 5% based upon a valuation
of available-for-sale securities at amortized cost for purposes of this
calculation. Under this formula, the Company's capital ratio was 9.8% at
September 30, 1997.
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3. FEDERAL INCOME TAXES
Federal income taxes are different from the amount determined by
multiplying pretax earnings by the federal income tax rate of 35%. The
differences are primarily attributable to changes in valuation allowances
related to deferred federal income tax assets.
Future tax assets were recognized on deductible temporary differences for
which a valuation allowance was provided at the date of the acquisition of the
Company. Such benefits were used to first reduce the balance of goodwill. During
the nine months ended September 30, 1997, goodwill was reduced by $89,262 as a
result of realizing such benefits.
ITEM 2. MANAGEMENT'S ANALYSIS OF RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED WITH NINE MONTHS ENDED
SEPTEMBER 30, 1996
Net income for the nine months ended September 30, 1997 was $370,171
compared to $147,759 for the nine months ended September 30, 1996. The increase
was primarily attributable to realized investment gains and losses. Net
investment income (net income excluding realized investment gains and losses,
net of tax) was $301,056 and $289,407 for the nine months ended September 30,
1997 and 1996, respectively.
Net investment spread, which is the difference between investment income
and interest credited on certificate reserves, decreased to $1.0 million during
the first nine months of 1997 from $1.1 million during the same period in 1996.
These amounts reflect net investment spread of 1.98% and 2.26% for the nine
months ended September 30, 1997 and 1996, 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 $3.1 million for the nine months ended September 30, 1997, from
$3.2 million for the same period in 1996. These amounts reflect annualized
investment yields of 7.79% and 7.76% on average cash and investments of $53.7
million and $55.3 million for the nine months ended September 30, 1997 and 1996,
respectively.
Interest credited on certificate reserves was $2.1 million for both the
nine month periods ended September 30, 1997 and 1996, reflecting annualized
average rates of interest credited of 5.78% and 5.50% on average certificate
reserves of $48.9 million and $51.6 million for the nine months ended September
30, 1997 and 1996, 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.
Investment and other expenses were $555,369 and $641,569 for the nine
months ended September 30, 1997 and 1996, respectively. The decrease in
investment and other expenses is
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primarily attributable to (i) a decrease in real estate expenses at the
Company's Minnesota facility, (ii) a decrease in other expenses which included
decreases in annual regulatory examination expenses and franchise taxes and
(iii) a decrease in goodwill amortization. Such decreases were partially offset
by an increase in renewal commissions.
Realized investment gains were $63,479 for the nine months ended September
30, 1997 compared to realized investment losses of $154,640 for the nine months
ended September 30, 1996. Such realized investment gains and losses were
interest-rate related and attributable to the asset/liability management
strategies of the Company. Fixed maturities and equity securities 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 liquidity and credit
risks. The Company's investments in fixed maturities were 100% and 98%
investment grade as of September 30, 1997 and December 31, 1996, 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, securities are classified by a nationally recognized statistical
rating organization (i.e., Standard & Poor Corporation's rating of BBB- or
above). Additionally, the Company's investment portfolio has minimal exposure to
real estate, mortgage loans and common equity securities, which represented
approximately 1% of qualified assets at September 30, 1997 and December 31,
1996.
Fixed maturities include mortgage-backed and asset-backed securities,
corporate securities, U.S. Treasury securities and other government
obligations. Mortgage-backed securities ("MBSs"), which include pass-through
securities and collateralized mortgage obligations ("CMOs"), totaled $28.5
million at September 30, 1997, representing 54.0% of total qualified assets
(58.9% at December 31, 1996). The Company's investments in CMOs represented
52.2% and 52.8% of the Company's qualified assets as of September 30, 1997 and
December 31, 1996, respectively. Currently, 90.8% of the CMOs are backed by the
U.S. Government or U.S. Government agencies. 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 an increase or decrease in yield 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.
Additionally, the Company routinely reprojects three year liability and asset
cash flows with the goal of maintaining an adequate level of liquidity for
maturing face-amount certificates. The Company's asset/liability management
strategies not only allow the Company to monitor its short-term liquidity needs,
but also aim to provide protection to the investment portfolio from adverse
changes in interest rates.
Certificate reserves decreased $2.8 million or 5.5% during the first nine
months of 1997, as maturities and surrenders exceeded sales and renewals. The
Company believes a significant factor
9
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leading to the decrease is that the certificate of deposit marketplace is
currently very competitive. For certificates reaching their maturity date during
the nine months ended September 30, 1997 and 1996, 65% and 72%, 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
The Company did not file any reports on Form 8-K during the three months
ended September 30, 1997.
EXHIBITS
No exhibits are 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 November 10, 1997.
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
