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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: June 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 August 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
SBM CERTIFICATE COMPANY
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30,
1999 DECEMBER 31,
(UNAUDITED) 1998
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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, 1999-$34,690,024; December 31, 1998-$34,136,751) $ 33,734,920 $ 34,149,196
Equity securities, at fair value (cost: June 30, 1999-$290,688;
December 31, 1998-$290,688) 384,157 390,776
Certificate loans 122,199 164,209
Cash and cash equivalents 3,058,271 3,279,970
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Total cash and investments 37,299,547 37,984,151
Receivables:
Dividends and interest 249,672 296,013
Receivable for investment securities sold -- 22,249
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Total receivables 249,672 318,262
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Total qualified assets 37,549,219 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 173,098 204,228
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Total assets $ 37,722,317 $ 39,354,476
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</TABLE>
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SBM CERTIFICATE COMPANY
CONDENSED BALANCE SHEETS (CONTINUED)
<TABLE>
<CAPTION>
JUNE 30,
1999 DECEMBER 31,
(UNAUDITED) 1998
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<S> <C> <C>
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities:
Certificate reserves $ 32,785,533 $ 34,067,826
Payable for investment securities purchased 533,082 --
Accounts payable and other liabilities 239,666 231,345
Deferred federal income tax liability 14,394 27,265
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Total liabilities 33,572,675 $ 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 1,711,405 1,657,592
Accumulated other comprehensive income from
net unrealized gains (losses) on available-for-sale securities (861,763) 70,448
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Total shareholder's equity 4,149,642 5,028,040
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Total liabilities and shareholder's equity $ 37,722,317 $ 39,354,476
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SEE ACCOMPANYING NOTES.
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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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1999 1998 1999 1998
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<S> <C> <C> <C> <C>
Investment income:
Interest income from securities $ 561,739 $ 652,231 $ 1,139,363 $ 1,469,564
Other investment income 12,185 46,453 14,782 79,163
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Total investment income 573,924 698,684 1,154,145 1,548,727
Investment and other expenses:
Management and investment advisory fees 15,687 52,659 68,700 106,255
Deferred acquisition cost amortization and
renewal commissions 52,426 75,831 108,367 152,731
Real estate expenses -- 39,670 -- 68,757
Other expenses (income) 9,720 1,419 14,626 (1,645)
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Total investment and other expenses 77,833 169,579 191,693 326,098
Interest credited on certificate reserves 417,101 524,301 850,012 1,143,303
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Net investment income before federal income
taxes 78,990 4,804 112,440 79,326
Income tax expense (25,004) (2,242) (36,729) (28,888)
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Net investment income 53,986 2,562 75,711 50,438
Realized investment gains (losses) -- 57,733 (33,689) (72,503)
Income tax benefit (expense) on realized
investment gains and losses -- (20,706) 11,791 29,876
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Net realized investment gains (losses) -- 37,027 (21,898) (42,627)
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Net income $ 53,986 $ 39,589 $ 53,813 $ 7,811
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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, 1999 AND 1998
<TABLE>
<CAPTION>
1999 1998
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<S> <C> <C>
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES $ 1,062,413 $ 1,298,641
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:
Fixed maturity investments available-for-sale:
Purchases (5,777,188) (27,107,416)
Maturities and redemptions 3,899,986 15,083,938
Sales 2,683,159 10,576,558
Proceeds from sales or maturities of other invested assets -- 75,950
Repayments of certificate loans, net 42,010 21,094
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Cash flows provided by (used in) investing activities 847,967 (1,349,876)
CASH FLOWS USED IN FINANCING ACTIVITIES:
Amounts paid to face-amount certificate holders (2,294,503) (8,771,967)
Amounts received from face-amount certificate holders 162,424 125,763
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Cash flows used in financing activities (2,132,079) (8,646,204)
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Net change in cash and cash equivalents (221,699) (8,697,439)
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 $ 3,058,271 $ 4,357,425
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SEE ACCOMPANYING NOTES.
</TABLE>
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SBM CERTIFICATE COMPANY
NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 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 six months ended June 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 loss, net of related tax, for the three and
six months ended June 30, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
Three Months Ended June 30,
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1999 1998
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<S> <C> <C>
Net income $ 53,986 $ 39,589
Change in net unrealized gains and losses on available-for-sale securities (731,865) (60,111)
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Comprehensive loss $ (677,879) $ (20,522)
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Six Months Ended June 30,
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1999 1998
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Net income $ 53,813 $ 7,811
Change in net unrealized gains and losses on available-for-sale securities (932,211) (16,237)
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Comprehensive loss $ (878,398) $ (8,426)
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</TABLE>
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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 the
sale of ARM. Following the July 29, 1999 announcement, certain of ARM's
insurance subsidiaries' ratings were lowered by four significant rating
agencies. ARM's Quarterly Report on Form 10-Q for the quarter ended June 30,
1999 (filed on August 23, 1999) states that if ARM "is unable to find a
suitable buyer for its subsidiaries or its businesses or receive a
significant infusion of capital from an investor or investors, then [its]
ability to continue as a going concern is in substantial doubt." 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.
SIX MONTHS ENDED JUNE 30, 1999 COMPARED WITH SIX MONTHS ENDED JUNE 30, 1998
Net investment income (net income excluding net realized investment gains
and losses) was $75,711 and $50,438 for the six months ended June 30, 1999 and
1998, respectively. The increase in net investment income is primarily
attributable to lower investment and other expenses, 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 $304,133 during the first six
months of 1999 compared to $405,424 during the same period in 1998. These
amounts reflect net investment spread of 1.06% and 1.15% for the six months
ended June 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
$1.2 million from $1.5 million for the six months ended June 30, 1999 and 1998,
respectively. These amounts represent annualized investment yields of 6.16% and
6.67% on average cash and investments of $36.8 million and $46.5 million for the
six months ended June 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 $0.9 million and $1.1 million
for the six months ended June 30, 1999 and 1998, respectively. These amounts
represent annualized average rates of interest credited of 5.09% and 5.52% on
average certificate reserves of $33.1 million and $41.5 million for the six
months ended June 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
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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 $191,693 and $326,098 for the six months
ended June 30, 1999 and 1998, respectively. The decrease in investment and other
expenses is partially attributable to zero real estate expenses during the six
months ended June 30, 1999 compared to $68,757 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 $33,689 and $72,503 for the six months
ended June 30, 1999 and 1998, respectively. Realized investment losses for 1998
included 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.
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 income during the six months ended June 30, 1999 and 1998 was $53,813
and $7,811, respectively. The increase in net income was primarily attributable
to a decrease in investment and other expenses partially offset by a decrease in
net investment spread.
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% investment grade
at both June 30, 1999 and December 31, 1998. 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, mortgage loans
and common equity securities. As of June 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 $18.1
million at June 30, 1999, representing 48.1% of total qualified assets (48.0% at
December 31, 1998). MBSs, including CMOs, are subject to risks associated with
prepayments of
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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 $1.3 million or 3.8% during the first six
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 six months ended June 30, 1999 and 1998, 68% 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 has completed the assessment phase of the project for all production
applications, hardware (personal computers and servers), system software,
vendors, facilities and business partners. Although ARM is still receiving
information from a few vendors and business partners and assessing various
logistic concerns with its facilities, ARM's major production systems are
substantially Year 2000 compliant. However, the administrative system which
processes face-amount certificate transactions can not correctly process data in
the Year 2000 due to a two digit year field. Where Year 2000 problems were
found, as in the case of the face-amount certificate administration system, the
necessary upgrades, repairs or conversions are either complete or in progress
and are scheduled for completion no later than September 30, 1999. Specifically,
in regards to the Company, management plans to replace the face-amount
certificate administrative system with an application that is Year 2000
compliant and then convert the business to that application.
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The Company is also conducting certification testing. Certification
testing, which serves to verify the results of repairs and assessments, has been
completed for all mission critical production systems and the few problems that
were discovered have been repaired and re-tested.
ARM's Year 2000 project is well underway and management believes that it
will be Year 2000 compliant by September 30, 1999, however, as a precaution ARM
is 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 June 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 August 20, 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/BARRY G. WARD
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Barry G. Ward
Controller (Principal Accounting
Officer)
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