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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: June 30, 1998
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 August 10, 1998, 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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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SBM CERTIFICATE COMPANY
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30,
1998 DECEMBER 31,
(UNAUDITED) 1997
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<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:
June 30, 1998-$37,182,933; December 31, 1997-$45,602,442) $ 37,141,701 $ 45,614,870
Equity securities, at fair value (cost: June 30, 1998-$290,688;
December 31, 1997-$340,473) 391,137 412,234
Certificate loans 165,198 186,292
Other invested assets 225,000 471,992
Cash and cash equivalents 4,357,425 13,054,864
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Total cash and investments 42,280,461 59,740,252
Receivables:
Dividends and interest 308,823 328,516
Receivable for investment securities 202,622 --
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Total receivables 511,445 328,516
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Total qualified assets 42,791,906 60,068,768
Deferred acquisition costs 209,611 157,994
Other assets -- 42,948
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Total assets $ 43,001,517 $ 60,269,710
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</TABLE>
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SBM CERTIFICATE COMPANY
CONDENSED BALANCE SHEETS (CONTINUED)
<TABLE>
<CAPTION>
JUNE 30,
1998 DECEMBER 31,
(UNAUDITED) 1997
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<S> <C> <C>
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities:
Certificate reserves $ 37,623,420 $ 45,127,084
Payable for investment securities purchased -- 9,731,948
Deferred federal income taxes 57,970 98,320
Accounts payable and other liabilities 346,881 330,686
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Total liabilities 38,028,271 55,288,038
Shareholder's equity:
Common stock, 250,000 shares issued 250,000 250,000
Additional paid-in capital 3,050,000 3,050,000
Retained earnings 1,634,760 1,626,949
Accumulated other comprehensive income from net unrealized
gains on available-for-sale securities 38,486 54,723
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Total shareholder's equity 4,973,246 4,981,672
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Total liabilities and shareholder's equity $ 43,001,517 $ 60,269,710
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</TABLE>
SEE ACCOMPANYING NOTES.
3
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SBM CERTIFICATE COMPANY
CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
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1998 1997 1998 1997
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<S> <C> <C> <C> <C>
Investment income:
Interest income from securities $ 652,231 $ 961,687 $1,469,564 $1,994,935
Other investment income 46,453 51,891 79,163 95,404
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Total investment income 698,684 1,013,578 1,548,727 2,090,339
Investment and other expenses:
Management and investment advisory fees 52,659 61,617 106,255 123,234
Deferred acquisition cost amortization and
renewal commissions 75,831 71,337 152,731 141,634
Real estate expenses 39,670 51,193 68,757 83,310
Amortization of goodwill -- 3,877 -- 23,833
Other (income) expenses 1,419 5,300 (1,645) 11,295
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Total investment and other expenses 169,579 193,324 326,098 383,306
Interest credited on certificate reserves 524,301 725,039 1,143,303 1,425,026
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Net investment income before federal income
taxes 4,804 95,215 79,326 282,007
Income tax expense (2,242) (32,328) (28,888) (96,334)
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Net investment income 2,562 62,887 50,438 185,673
Realized investment gains (losses) 57,733 58,976 (72,503) 53,604
Federal income tax benefit (expense) on
realized investment gains and losses (20,706) (21,220) 29,876 (20,658)
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Net realized investment gains (losses) 37,027 37,756 (42,627) 32,946
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Net income $ 39,589 $ 100,643 $ 7,811 $ 218,619
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</TABLE>
SEE ACCOMPANYING NOTES.
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SBM CERTIFICATE COMPANY
CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
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<S> <C> <C>
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES $ 1,298,641 $ 2,038,696
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:
Fixed maturity investments available-for-sale:
Purchases (27,107,416) (25,876,935)
Maturities and redemptions 15,083,938 2,257,083
Sales 10,576,558 23,283,764
Proceeds from sale or maturity of other invested assets 75,950 1,677
Repayments of certificate loans, net 21,094 86,765
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Cash flows provided by (used in) investing activities (1,349,876) (247,646)
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:
Amounts paid to face-amount certificate holders (8,771,967) (3,265,132)
Amounts received from face-amount certificate holders 125,763 240,694
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Cash flows used in financing activities (8,646,204) (3,024,438)
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Net change in cash and cash equivalents (8,697,439) (1,233,388)
Cash and cash equivalents at beginning of period 13,054,864 3,247,192
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Cash and cash equivalents at end of period $ 4,357,425 $ 2,013,804
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</TABLE>
SEE ACCOMPANYING NOTES.
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SBM CERTIFICATE COMPANY
NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 1998
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 six months ended June 30, 1998, are not necessarily indicative of those to
be expected for the year ending December 31, 1998. 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, 1997.
2. COMPREHENSIVE INCOME
As of January 1, 1998, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 130, "Reporting Comprehensive Income." SFAS No. 130
establishes new rules for the reporting and display of comprehensive income and
its components; however, the adoption of this Statement had no impact on the
Company's net income or total shareholder's equity. SFAS No. 130 requires
unrealized gains or losses on the Company's available-for-sale securities to be
included in other comprehensive income.
The components of comprehensive income (loss), net of related tax, for the
six months ended June 30, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
Six Months Ended June 30,
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(IN THOUSANDS) 1998 1997
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<S> <C> <C>
Net income $ 7,811 $ 218,619
Net unrealized losses on available-for-sale securities (16,237) (129,477)
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Comprehensive income (loss) $ (8,426) $ 89,142
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</TABLE>
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ITEM 2. MANAGEMENT'S ANALYSIS OF RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 1998 COMPARED WITH SIX MONTHS ENDED JUNE 30, 1997
Net investment income (net income excluding net realized investment gains and
losses) was $50,438 and $185,673 for the six months ended June 30, 1998 and
1997, respectively. The decrease in net investment income is 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 $405,424 during the
first six months of 1998 from $665,313 during the same period in 1997. These
amounts reflect net investment spread of 1.15% and 1.98% for the six months
ended June 30, 1998 and 1997, 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
$1.5 million from $2.1 million for the six months ended June 30, 1998 and 1997,
respectively. These amounts represent annualized investment yields of 6.67% and
7.74% on average cash and investments of $46.5 million and $54.0 million for the
six months ended June 30, 1998 and 1997, respectively. This decrease in
annualized investment yield on cash and investments was primarily attributable
to the Company selling its mortgage-backed derivative securities during the last
half of 1997 and reinvesting the proceeds when generally lower reinvestment
rates were available. Further depressing the investment yield, above normal
cash balances were held to provide necessary liquidity for maturing face-amount
certificates.
Interest credited on certificate reserves was $1.1 million and $1.4 million
for the six months ended June 30, 1998 and 1997, respectively. These amounts
represent annualized average rates of interest credited of 5.52% and 5.76% on
average certificate reserves of $41.5 million and $49.4 million for the six
months ended June 30, 1998 and 1997, 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 and renewal certificates are made as the
Company deems necessary. New and renewal contracts issued during the past year
have crediting rates that are generally lower than contracts that matured during
that period, resulting in the overall decrease in the average crediting rate.
Investment and other expenses were $326,098 and $383,306 for the six months
ended June 30, 1998 and 1997, respectively. The decrease in investment and other
expenses is attributable to zero goodwill amortization during the six months
ended June 30, 1998 compared to $23,833 for the six months ended June 30, 1997.
The goodwill asset became fully amortized during the second quarter of 1997. In
addition, management and investment advisory fees and real estate expenses for
the six months ended June 30, 1998 decreased $16,979 and $14,553, respectively,
compared to the same period in 1997.
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Realized investment losses were $72,503 for the six months ended June 30,
1998 compared to realized investment gains of $53,604 for the six months ended
June 30, 1997. Realized investment losses for 1998 include an estimated loss of
$138,042 related to the write-down to fair value of the Company's real estate
investment. Other realized investment gains and losses were primarily
interest-rate related and attributable to the asset/liability management
strategies of the Company. Fixed maturities and equity securities (i.e.,
non-redeemable preferred stock) classified as available-for-sale are sold during
rising and falling interest rate environments which can result in
period-to-period swings in interest-rate related realized investment gains and
losses.
Net income during the six months ended June 30, 1998 and 1997 was $7,811 and
$218,619, respectively. The decrease in net income was primarily attributable to
the decrease in net investment spread and the increase in realized investment
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 99% investment grade
as of June 30, 1998 and December 31, 1997. 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, and common equity securities,
which represented less than 1% of qualified assets at June 30, 1998 and
December 31, 1997.
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 $20.0
million at June 30, 1998, representing 47.0% of total qualified assets, net of
unsettled securities trades (54.2% at December 31, 1997). The Company's
investments in CMOs, which are primarily backed by the U.S. Government, U.S.
Government agencies or triple-A rated corporate securities, represented 43.1%
and 52.4% of the Company's qualified assets, net of unsettled securities trades,
as of June 30, 1998 and December 31, 1997, 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 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.
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Certificate reserves decreased $7.5 million or 16.6% during the first six
months of 1998, as maturities and surrenders exceeded sales and renewals. The
Company believes a significant factor 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 six months ended June 30, 1998 and 1997, 59% and 64%, respectively,
were renewed.
YEAR 2000
ARM Financial Group, Inc. ("ARM"), the Company's parent company, has a Year
2000 project which includes all of its subsidiaries. ARM has completed the
assessment phase of the project. It was determined that the administration
system which processes face-amount certificate transactions could not accept
Year 2000 data, because it uses a two digit year field. The necessary
upgrades and repairs are scheduled for completion no later than March 31,
1999. The Year 2000 project, as it relates to the Company, is provided for
under the Administration Services Agreement between ARM and the Company.
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 June 30, 1998.
EXHIBITS
No exhibits are filed herewith.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Company has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on August 12, 1998.
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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