<PAGE>
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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, 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 May 6, 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>
MARCH 31,
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:
March 31, 1998-$40,960,554; December 31, 1997-$45,602,442) $41,029,070 $45,614,870
Equity securities, at fair value (cost: March 31, 1998-$327,903;
December 31, 1997-$340,473) 408,513 412,234
Certificate loans 187,272 186,292
Other invested assets 225,415 471,992
Cash and cash equivalents 7,657,517 13,054,864
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Total cash and investments 49,507,787 59,740,252
Receivables:
Dividends and interest 357,668 328,516
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Total qualified assets 49,865,455 60,068,768
Deferred acquisition costs 189,614 157,994
Other assets -- 42,948
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Total assets $50,055,069 $60,269,710
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-------------------------------
</TABLE>
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SBM CERTIFICATE COMPANY
CONDENSED BALANCE SHEETS (CONTINUED)
<TABLE>
<CAPTION>
MARCH 31,
1998 DECEMBER 31,
(UNAUDITED) 1997
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<S> <C> <C>
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities:
Certificate reserves $41,613,062 $45,127,084
Payable for investment securities purchased 2,939,014 9,731,948
Deferred federal income taxes 91,269 98,320
Accounts payable and other liabilities 417,951 330,686
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Total liabilities 45,061,296 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 1,595,176 1,626,949
Accumulated other comprehensive income from
net unrealized gains on available-for-sale securities 98,597 54,723
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Total shareholder's equity 4,993,773 4,981,672
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Total liabilities and shareholder's equity $50,055,069 $60,269,710
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</TABLE>
SEE ACCOMPANYING NOTES.
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SBM CERTIFICATE COMPANY
CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED)
FOR THE THREE MONTHS ENDED MARCH 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
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<S> <C> <C>
Investment income:
Interest income from securities $ 817,334 $ 1,033,248
Other investment income 32,711 43,513
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Total investment income 850,045 1,076,761
Investment and other expenses:
Management and investment advisory fees 53,596 61,617
Deferred acquisition cost amortization and renewal commissions 76,899 70,297
Real estate expenses 29,087 32,117
Amortization of goodwill -- 19,956
Other (income) expenses (3,065) 5,995
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Total investment and other expenses 156,517 189,982
Interest credited on certificate reserves 619,002 699,987
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Net investment income before federal income taxes 74,526 186,792
Income tax expense (26,646) (64,006)
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Net investment income 47,880 122,786
Realized investment losses (130,235) (5,372)
Income tax benefit on realized investment losses 50,582 562
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Net realized investment losses (79,653) (4,810)
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Net income (loss) $ (31,773) $ 117,976
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</TABLE>
SEE ACCOMPANYING NOTES.
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SBM CERTIFICATE COMPANY
CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE THREE MONTHS ENDED MARCH 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
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<S> <C> <C>
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES $ 782,873 $ 1,146,506
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:
Fixed maturity investments available-for-sale:
Purchases (17,165,758) (4,327,458)
Maturities and redemptions 9,330,719 1,051,350
Sales 5,713,288 4,698,847
Proceeds from sales or maturities of other invested assets 75,535 839
Repayments (issuance) of certificate loans, net (980) 26,553
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Cash flows provided by (used in) investing activities (2,047,196) 1,450,131
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:
Amounts paid to face-amount certificate holders (4,169,737) (1,430,187)
Amounts received from face-amount certificate holders 36,713 93,538
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Cash flows used in financing activities (4,133,024) (1,336,649)
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Net change in cash and cash equivalents (5,397,347) 1,259,988
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 $ 7,657,517 $ 4,507,180
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</TABLE>
SEE ACCOMPANYING NOTES.
5
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SBM CERTIFICATE COMPANY
NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
March 31, 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 three months ended March 31, 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
three months ended March 31, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
Three Months Ended March 31,
----------------------------
(IN THOUSANDS) 1998 1997
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<S> <C> <C>
Net income (loss) $ (31,773) $ 117,976
Net unrealized gains (losses) on available-for-sale securities 43,874 (316,736)
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Comprehensive income (loss) $ 12,101 $ (198,760)
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</TABLE>
ITEM 2. MANAGEMENT'S ANALYSIS OF RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1998 COMPARED WITH THREE MONTHS ENDED MARCH 31,
1997
Net investment income (net income excluding net realized investment gains
and losses) was $47,880 and $122,786 for the three months ended March 31, 1998
and 1997, respectively. The
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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 $231,043 during the
first three months of 1998 from $376,774 during the same period in 1997. These
amounts reflect net investment spread of 0.91% and 2.31% for the three months
ended March 31, 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
$0.9 million from $1.1 million for the three months ended March 31, 1998 and
1997, respectively. These amounts represent annualized investment yields of
6.62% and 7.92% on average cash and investments of $51.4 million and $54.8
million for the three months ended March 31, 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. In addition, above normal cash balances were
held, further depressing the investment yield.
Interest credited on certificate reserves was $619,002 and $699,987 for the
three months ended March 31, 1998 and 1997, respectively. These amounts
represent annualized average rates of interest credited of 5.71% and 5.61% on
average certificate reserves of $43.4 million and $49.9 million for the three
months ended March 31, 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 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 $156,517 and $189,982 for the three
months ended March 31, 1998 and 1997, respectively. The decrease in investment
and other expenses is primarily attributable to zero goodwill amortization
during the first quarter of 1998 compared to $19,956 during the first quarter of
1997. The goodwill asset became fully amortized during the second quarter of
1997.
Realized investment losses were $130,235 and $5,372 for the three months
ended March 31, 1998 and 1997, respectively. 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.
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Net income (loss) during the first quarter of 1998 and 1997 was $(31,773)
and $117,976, 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 March 31, 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, mortgage
loans and common equity securities, which represented less than 1% of qualified
assets at March 31, 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 $23.2
million at March 31, 1998, representing 46.5% 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 44.8%
and 52.4% of the Company's qualified assets, net of unsettled securities trades,
as of March 31, 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.
Certificate reserves decreased $3.5 million or 7.8% during the first three
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 three months ended March 31, 1998 and 1997, 61% and 64%,
respectively, were renewed.
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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 March 31, 1998.
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 May 13, 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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