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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the period ended: September 30, 1999
Commission file number: 811-6268
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 12, 1999, 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
<TABLE>
<CAPTION>
SBM CERTIFICATE COMPANY
CONDENSED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
1999 1998
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(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, 1999-$25,892,664; December 31, 1998-$34,136,751) $ 25,178,627 $ 34,149,196
Equity securities, at fair value (cost: September 30, 1999-$290,688;
December 31, 1998-$290,688) 373,739 390,776
Certificate loans 122,726 164,209
Cash and cash equivalents 9,263,081 3,279,970
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Total cash and investments 34,938,173 37,984,151
Receivables:
Dividends and interest 297,101 296,013
Receivable for investment securities sold 26,875 22,249
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Total receivables 323,976 318,262
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Total qualified assets 35,262,149 38,302,413
Other fixed maturities, available-for-sale, at fair value (amortized
cost: December 31, 1998-$851,978) (unaffiliated issuer) -- 847,835
Deferred acquisition costs 162,020 204,228
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Total assets $ 35,424,169 $ 39,354,476
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</TABLE>
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<TABLE>
<CAPTION>
SBM CERTIFICATE COMPANY
CONDENSED BALANCE SHEETS (CONTINUED)
SEPTEMBER 30, DECEMBER 31,
1999 1998
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(UNAUDITED)
<S> <C> <C>
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities:
Certificate reserves $ 31,081,900 $ 34,067,826
Accounts payable and other liabilities 52,527 231,345
Deferred federal income tax liability -- 27,265
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Total liabilities 31,134,427 34,326,436
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 1,548,066 1,657,592
Accumulated other comprehensive income from
net unrealized gains (losses) on available-for-sale securities (558,324) 70,448
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Total shareholder's equity 4,289,742 5,028,040
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Total liabilities and shareholder's equity $ 35,424,169 $ 39,354,476
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</TABLE>
SEE ACCOMPANYING NOTES.
3
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<TABLE>
<CAPTION>
SBM CERTIFICATE COMPANY
CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
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1999 1998 1999 1998
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<S> <C> <C> <C> <C>
Investment income:
Interest income from securities $566,034 $627,001 $1,705,397 $2,096,565
Other investment income 4,971 36,734 19,753 115,897
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Total investment income 571,005 663,735 1,725,150 2,212,462
Investment and other expenses:
Management and investment advisory fees 30,774 50,925 99,474 157,180
Deferred acquisition cost amortization and
renewal commissions 55,425 68,123 163,792 220,853
Real estate expenses -- 14,284 -- 83,041
Other expenses (income) 458 309 15,084 (1,337)
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Total investment and other expenses 86,657 133,641 278,350 459,737
Interest credited on certificate reserves 397,407 472,485 1,247,419 1,615,791
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Net investment income before federal
income taxes 86,941 57,609 199,381 136,934
Income tax benefit 173,636 29,091 136,907 203
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Net investment income 260,577 86,700 336,288 137,137
Realized investment losses (436,818) (35,012) (470,507) (107,514)
Income tax benefit (expense) on realized
investment gains and losses 12,902 (33,076) 24,693 (3,200)
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Net realized investment losses (423,916) (68,088) (445,814) (110,714)
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Net income (loss) $ (163,339) $ 18,612 $(109,526) $ 26,423
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</TABLE>
SEE ACCOMPANYING NOTES.
4
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<TABLE>
<CAPTION>
SBM CERTIFICATE COMPANY
CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
1999 1998
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<S> <C> <C>
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES $ 1,507,477 $ 1,670,384
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:
Fixed maturity investments available-for-sale:
Purchases (21,473,925) (39,375,067)
Maturities and redemptions 21,409,990 19,731,543
Sales 8,731,243 20,875,666
Proceeds from sales or maturities of other invested assets -- 260,296
Repayments of certificate loans, net 41,483 21,172
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Cash flows provided by investing activities 8,708,791 1,513,610
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:
Amounts paid to face-amount certificate holders (4,397,769) (11,970,481)
Amounts received from face-amount certificate holders 164,612 163,684
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Cash flows used in financing activities (4,233,157) (11,806,797)
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Net change in cash and cash equivalents 5,983,111 (8,622,803)
Cash and cash equivalents at beginning of period 3,279,970 13,054,864
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Cash and cash equivalents at end of period $ 9,263,081 $ 4,432,061
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</TABLE>
SEE ACCOMPANYING NOTES.
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SBM CERTIFICATE COMPANY
NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 1999
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, 1999 are not necessarily indicative of those
to be expected for the year ending December 31, 1999. 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, 1998.
2. COMPREHENSIVE INCOME
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income," 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 and nine months ended September 30, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
Three Months Ended September 30,
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1999 1998
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<S> <C> <C>
Net income (loss) $(163,339) $ 18,612
Change in net unrealized gains and losses on available-for-sale securities 303,439 227,785
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Comprehensive income $ 140,100 $ 246,397
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<CAPTION>
Nine Months Ended September 30,
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1999 1998
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<S> <C> <C>
Net income (loss) $(109,526) $ 26,423
Change in net unrealized gains and losses on available-for-sale securities (628,772) 211,548
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Comprehensive income (loss) $(738,298) $ 237,971
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</TABLE>
6
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ITEM 2. MANAGEMENT'S ANALYSIS OF RESULTS OF OPERATIONS
RELATIONSHIP WITH ARM FINANCIAL GROUP, INC.
The Company is a wholly owned subsidiary of ARM Financial Group, Inc.
("ARM"). Pursuant to an Investment Services Agreement and an Administrative
Services Agreement, the Company's operations are administered and managed by
ARM.
On July 29, 1999, ARM announced that it was restructuring its
institutional business and positioning its retail business and technology
operations for sale. To date, ARM's efforts to find a buyer have been
unsuccessful. As a result, ARM requested protection with respect to its
insurance subsidiary, Integrity Life Insurance Company ("Integrity"), from
the Ohio Department of Insurance, its domiciliary regulator. On August 20,
1999, Integrity consented to a Supervision Order issued by the Ohio
Department of Insurance, effective for a period of 60 days. Unless the Ohio
Department of Insurance begins proceedings for the appointment of a
rehabilitator or liquidator, the Supervision Order is automatically extended
for successive 60-day periods until written notice is given to Integrity
ending the supervision. On October 30, 1999, the Supervision Order was
automatically extended. ARM's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1999 (filed on November 19, 1999) states that "regardless
of whether [ARM] is able to find a suitable buyer for its insurance
subsidiaries or its businesses or assets, [ARM] is likely to cease doing
business as a going concern." If ARM were to liquidate under federal or state
bankruptcy laws, there can be no assurance that ARM would be able to provide
services under the agreements mentioned above.
NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED WITH NINE MONTHS ENDED
SEPTEMBER 30, 1998
Net investment income (net income excluding net realized investment gains
and losses) was $336,288 and $137,137 for the nine months ended September 30,
1999 and 1998, respectively. The increase in net investment income is primarily
attributable to lower investment and other expenses and a one-time income tax
benefit, partially offset by a decrease in net investment spread.
Net investment spread, which is the difference between investment income
and interest credited on certificate reserves, was $477,731 during the first
nine months of 1999 compared to $596,671 during the same period in 1998. These
amounts reflect net investment spread of 1.19% and 1.15% for the nine months
ended September 30, 1999 and 1998, 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 $1.7 million from $2.2 million for the nine months ended
September 30, 1999 and 1998, respectively. These amounts represent annualized
investment yields of 6.26% and 6.56% on average cash and investments of $36.7
million and $45.0 million for the nine months ended September 30, 1999 and 1998,
respectively. This decrease in annualized investment yield on cash and
investments was primarily attributable to the Company investing in lower
yielding securities during 1999 compared to 1998.
Interest credited on certificate reserves was $1.2 million and $1.6 million
for the nine months ended September 30, 1999 and 1998, respectively. These
amounts represent annualized average rates
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of interest credited of 5.07% and 5.41% on average certificate reserves of $32.8
million and $39.8 million for the nine months ended September 30, 1999 and 1998,
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, such as 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 lower than
contracts that matured during that period, resulting in the overall decrease in
the average crediting rate.
Investment and other expenses were $278,350 and $459,737 for the nine
months ended September 30, 1999 and 1998, respectively. The decrease in
investment and other expenses is partially attributable to zero real estate
expenses during the nine months ended September 30, 1999 compared to $83,041
during the same period in 1998. The Company sold its investment in real estate
during 1998. Also, certain expenses that are directly proportional to the level
of customer deposits declined due to the decrease of those deposits during the
period.
Realized investment losses were $470,507 and $107,514 for the nine months
ended September 30, 1999 and 1998, respectively. Realized investment losses for
1998 included an estimated loss of $268,960 related to the write-down to fair
value and subsequent sale 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.
In the event that the Company experiences higher than historical levels of
certificate surrenders, the Company might need to liquidate investments other
than in accordance with its normal asset/liability management strategy and, as a
result, the Company could experience substantial realized investment losses. If
the Company requires additional capital, there is no assurance that such capital
would be available from ARM. (See "-Relationship with ARM Financial Group,
Inc.")
Net loss during the nine months ended September 30, 1999 was $109,526
compared to net income of $26,423 for the same period in 1998. The decrease in
net income was primarily attributable to increased realized investment losses
partially offset by lower investment and other expenses.
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 97%
investment grade at September 30, 1999 and December 31, 1998, 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's Corporation's rating of BBB- or
above). Additionally, the Company's investment portfolio has no exposure to real
estate,
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mortgage loans and common equity securities. As of September 30, 1999, the
Company held no securities which had defaulted on principal or interest
payments.
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 but
are primarily collateralized mortgage obligations ("CMOs"), totaled $10.7
million at September 30, 1999, representing 30.4% of total qualified assets
(48.0% at December 31, 1998). 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 projects
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 $3.0 million or 8.8% during the first nine
months of 1999, as maturities and surrenders exceeded sales and renewals. The
Company believes a factor leading to the decrease was the modest increase in
intermediate-term market interest rates in 1999 which enhanced the
attractiveness of competing products, such as money market funds and bank
certificates of deposit. For face-amount certificates reaching their maturity
date during the nine months ended September 30, 1999 and 1998, 65% and 59%,
respectively, were renewed.
YEAR 2000
ARM has undertaken a Year 2000 project that includes all of its
subsidiaries, including the Company. ARM's Year 2000 compliance project, as it
relates to the Company, is provided for under the Investment Services Agreement
and Administrative Services Agreement between ARM and the Company. Pursuant to
the agreements, the Company's operations are administered and managed by ARM.
The cost of ARM's Year 2000 initiatives is not expected to be material to ARM's
results of operations or financial condition. Likewise, any cost to the Company
related to Year 2000 compliance is not expected to be material to the Company's
results of operations or financial condition.
ARM's Year 2000 project is on schedule and is currently 95% complete.
During the assessment phase of the project, ARM assessed all production
applications, hardware (personal computers and servers), system software,
vendors, facilities and business partners. Where Year 2000 problems were found,
the necessary upgrades and repairs have been completed. Although ARM is still
assessing various logistic concerns with its facilities, ARM's production
systems are now substantially Year
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2000 compliant. Specifically, in regards to the Company, during the third
quarter of 1999 management replaced the face-amount certificate administrative
system with an application that is Year 2000 compliant and converted the
business to that application.
The Company has also completed certification testing. Certification testing
serves to verify the results of the assessment and repairs. The few problems
that were discovered in this phase have been repaired and re-tested.
As a precaution, ARM is in the process of developing a contingency and
business resumption plan. Preparations to implement the contingency and business
resumption plan will continue through December 31, 1999.
Although ARM anticipates no major interruption of business activities, that
will be dependent, in part, upon the activity of third parties. Even though ARM
has assessed and continues to assess third party issues, it has no direct
ability to influence the compliance actions of such parties. Accordingly, while
ARM believes its actions in this regard should have the effect of reducing Year
2000 risks, it is unable to eliminate them or to estimate the ultimate effect
Year 2000 risks will have on ARM's operations.
The estimated date on which ARM believes it will complete its Year 2000
compliance efforts, and the expenses related to ARM's Year 2000 compliance
efforts are based upon management's best estimates, which were based on
assumptions of future events, including the availability of certain resources,
third party modification plans and other factors. There can be no assurances
that these results and estimates will be achieved and the actual results could
materially differ from those anticipated.
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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, 1999.
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 November 12, 1999.
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/ JOHN R. MCGEENEY
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John R. McGeeney
President
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