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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended: December 31, 1996 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
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None
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
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
As of February 15, 1997 250,000 shares of the registrant's common stock
were outstanding. The registrant is a wholly owned subsidiary and its common
stock is not traded on a public market.
DOCUMENTS INCORPORATED BY REFERENCE
None
The registrant meets the conditions set forth in General Instruction J (1)
(a) and (b) of Form 10-K and is therefore filing this Form with the reduced
disclosure format.
TABLE OF CONTENTS
ITEM PAGE
PART I
1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
3. Legal Proceedings. . . . . . . . . . . . . . . . . . . . . . . . 5
4. Submission of Matters to a Vote of Security Holders. . . . . . . 5
PART II
5. Market for Registrant's Common Equity
and Related Stockholder Matters. . . . . . . . . . . . . . . . 6
6. Selected Financial Data. . . . . . . . . . . . . . . . . . . . . 6
7. Management's Discussion and Analysis of
Results of Operations and Financial Condition. . . . . . . . . 6
8. Financial Statements and Supplementary Data. . . . . . . . . . . 11
9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure . . . . . . . . . . . . 31
PART III
10. Directors and Executive Officers of the Registrant . . . . . . . 32
11. Executive Compensation . . . . . . . . . . . . . . . . . . . . . 32
12. Security Ownership of Certain Beneficial Owners and Management . 32
13. Certain Relationships and Related Transactions . . . . . . . . . 32
PART IV
14. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K . . . . . . . . . . . . . . . . . . . . . . . . . 33
2
PART I
ITEM 1. BUSINESS
(a) GENERAL DEVELOPMENT OF BUSINESS
SBM Certificate Company (the "Company") was incorporated in Minnesota in
June of 1990, to assume the face-amount certificate business of SBM Company
("SBM"). Effective December 31, 1993, SBM transferred all of the Company's
shares of common stock to its wholly owned subsidiary, State Bond and
Mortgage Life Insurance Company ("SBM Life"). On June 14, 1995, the Company
became a wholly owned subsidiary of ARM Financial Group, Inc. ("ARM")
pursuant to ARM's purchase of substantially all of the assets and business
operations of SBM (the "Acquisition"). ARM specializes in the asset
accumulation business, providing retail and institutional customers with
products designed to serve the growing retirement and long-term savings
markets as well as providing other asset management services. At
December 31, 1996 ARM had $7.6 billion of assets under management.
(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS.
The Company has one business segment.
(c) NARRATIVE DESCRIPTION OF BUSINESS
The Company is an issuer of fixed-rate face-amount certificates
registered under the Investment Company Act of 1940 (the "1940 Act"). A
face-amount certificate is an obligation of the Company requiring the
Company to pay certificate holders the original invested amount of the
certificate, plus a three-year fixed-rate return, at a given maturity date.
The Company selects the interest rate offered on the face-amount
certificates based on the short to intermediate term sections of the yield
curve. Face-amount certificates, which are similar to bank certificates of
deposit, generally compete with various types of individual savings
products offered by banks and insurance companies that provide a fixed rate
of return on investors' money. The Company's face-amount certificates are
sold primarily in Minnesota, Iowa, South Dakota and California.
The Company's face-amount certificates are distributed by ARM
Securities Corporation ("ARM Securities"), a wholly owned subsidiary of
ARM, pursuant to an Underwriting Agreement. Prior to November 29, 1996, ARM
Securities operated under the name SBM Financial Services, Inc. ARM
Securities currently uses a network of independent agents to sell and
service the business. The Company continues to investigate opportunities to
expand upon its distribution channels. ARM Securities is registered with
the Securities and Exchange Commission (the "SEC") as a broker-dealer under
the provisions of the Securities Exchange Act of 1934.
The Company's gross margin is derived primarily from the margin
between earnings on investments and amounts paid or credited on its fixed-
rate certificate deposits ("net investment spread"). The Company's net
income is determined by deducting investment and other expenses and federal
income taxes from gross margin. The net investment spread is affected by
general economic conditions, government monetary policy, the policies of
regulatory authorities that
3
influence market interest rates, and the Company's ability to respond to
changes in such rates. Changes in market interest rates may have a negative
impact on the Company's earnings.
The Company's face-amount certificate business competes in general
with various types of individual savings products which offer a fixed rate
of return on investors' money, especially insurance and bank products. Some
of these other products are insured by governmental agencies or funds or
independent third parties. The certificates offered by the Company are not
guaranteed or insured by any governmental agency or fund or independent
third party. The Company's business is highly competitive and the Company
competes with many other companies having greater financial resources,
larger sales forces, and greater access to customers. The Company's ability
to offer competitive interest rates, attractive terms, and efficient
service are the Company's primary basis for meeting competition. The
Company has no employees. Pursuant to an Investment Services Agreement and
an Administrative Services Agreement, the Company's operations are managed
by ARM.
Like many financial services companies which offer investment
opportunities to the public, the Company is subject to regulation and
supervision by federal and state regulators. The 1940 Act and rules issued
by the SEC thereunder specify certain terms for face-amount certificates,
the method for calculating reserve liabilities on outstanding certificates,
the minimum amounts and types of investments to be deposited with a
qualified custodian to support such reserve liabilities, and a variety of
other restrictions on the operation and governance of a face-amount
certificate company. Pursuant to statutory authority, the Minnesota
Department of Commerce ("MDC") and the Illinois Secretary of State exercise
supervisory powers over the Company's face-amount certificate business
similar to those under the 1940 Act. In addition, the MDC conducts
examinations of the Company on a periodic basis. The offer and sale of the
Company's face-amount certificates also are subject to federal and state
securities laws.
(d) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT
SALES
The Company has no foreign operations.
ITEM 2. PROPERTIES
The Company's and ARM's corporate executive offices (the "Corporate
Offices") are located at 515 West Market Street, Louisville, Kentucky. The main
telephone number for the Corporate Offices is (502) 582-7900. The Corporate
Offices are the location of the Company's executive officers and the primary
location for ARM's accounting, legal and marketing activities and various other
support personnel.
The Company's administrative offices are located in New Ulm, Minnesota, at
100 North Minnesota Street, in a building owned by the Company. The building has
a total office space of approximately 49,000 square feet. A significant portion
of the building (approximately 15,000 square feet) is leased exclusively to
State Bank & Trust Company of New Ulm, a former subsidiary of SBM. Parts of the
building are leased to other persons.
4
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to, nor is any of the Company's property the
subject of, any material pending legal proceedings, other than ordinary
litigation routine to the Company's business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
This information is omitted in accordance with Instruction (J)(2)(c) to
Form 10-K.
5
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
There is currently no public market or trading in the common stock of the
Company. All of the Company's 250,000 outstanding shares of common stock are
held by ARM as of December 31, 1996. The Company has never paid cash dividends
on its common stock.
The Company is subject to two principal restrictions on its ability to pay
dividends in addition to the generally applicable restrictions and requirements
of Minnesota corporate law. First, pursuant to Section 28(b) of the 1940 Act,
the Company is required to establish and maintain qualified assets having a
value not less than the aggregate of certificate reserves plus $250,000. Second,
the MDC has determined that face-amount certificate companies such as the
Company should maintain a ratio of shareholder's equity to total assets of a
minimum of 5%. For purposes of determining compliance with both requirements,
assets are based upon a valuation of available-for-sale securities reflected at
amortized cost. The Company could not pay dividends if it did not meet both of
these two requirements or if payment of a dividend would cause it not to meet
such requirements. As of December 31, 1996, the Company had qualified assets in
excess of certificate reserves plus $250,000 of $4.6 million and assets in
excess of the 5% ratio of $2.1 million.
ITEM 6. SELECTED FINANCIAL DATA
This information is omitted in accordance with Instruction (J)(2)(a) to
Form 10-K.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
GENERAL
The Company was acquired by ARM in connection with ARM's acquisition of
substantially all of the assets and business operations of SBM effective May 31,
1995. The results of operations for the year ended December 31, 1995 represent
the historical results of the Company for the period from January 1, 1995 to May
31, 1995 combined with the results of operations of the Company subsequent to
the Acquisition from June 1, 1995 to December 31, 1995. Historical results of
operations are not completely comparable with results of operations subsequent
to the Acquisition primarily due to differing asset/liability management
strategies and expense allocation methodologies of ARM and SBM management.
Therefore, results of operations for the year ended December 31, 1996, are not
completely comparable with the prior year.
6
RESULTS OF OPERATIONS
1996 COMPARED WITH 1995
During 1996, net income was $731,981 compared to $776,739 in 1995. Net
investment income (net income excluding realized investment gains and losses net
of tax) was $414,670 and $595,354 for 1996 and 1995, respectively. The decrease
in net investment income was primarily attributable to a decrease in net
investment spread, partially offset by lower investment and other expenses and
lower federal income tax expense.
Net investment spread, which is the difference between investment income
and interest credited on certificate reserves, decreased to $1.5 million during
1996 from $2.0 million in 1995. These amounts reflect net investment spread of
2.23% and 2.97% during 1996 and 1995, respectively, between the Company's
investment yield on average cash and investments and the average rate credited
on certificate reserves. The Company's investment income decreased to $4.3
million from $4.9 million for 1996 and 1995, respectively. These amounts
represent investment yields of 7.73% and 8.21% on average cash and investments
of $54.9 million and $56.3 million for 1996 and 1995, respectively. This
decrease in investment yield on cash and investments was primarily attributable
to a reduction in the average duration of the investment portfolio during 1996
and to the December 1995 sale of the Company's mortgage loan portfolio. The
proceeds from the sale of mortgage loans were invested in fixed maturities of a
generally higher quality, but with lower yields.
Interest credited on certificate reserves was $2.8 million and $2.9 million
for 1996 and 1995, respectively. These amounts represent average rates of
interest credited of 5.50% and 5.24% on average certificate reserves of $50.4
million and $52.9 million for 1996 and 1995, 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 adjustment, up or down, on new certificates are made as
the Company deems necessary. New and renewal contracts issued and outstanding
during the past year have crediting rates that are generally higher than
contracts that matured or surrendered during the period, resulting in the
overall increase in the average crediting rate.
Investment and other expenses were $815,094 and $957,593 for 1996 and 1995,
respectively. The decrease in investment and other expenses was primarily
attributable to the decrease in management and investment advisory fees.
Currently, management and investment advisory fees are computed as a percentage
of average certificate reserves and qualified assets. Such fees have been lower
since the Acquisition primarily as a result of ARM's lower marginal operating
cost attributable to greater economies of scale since the Acquisition.
Realized investment gains were $485,135 and $283,885 for 1996 and 1995,
respectively. These realized investment gains were 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) are sold
during rising and falling interest rate environments which can result in period-
to-period swings in realized investment gains and losses.
7
Certificate reserves decreased $2.3 million or 4.3% during 1996, 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 1996 and 1995, 73% and
72%, respectively, were renewed.
1995 COMPARED WITH 1994
During 1995, net income was $776,739 compared to $383,203 in 1994. Net
investment income was $595,354 and $363,420 for 1995 and 1994, respectively.
The increase in net investment income was primarily attributable to a higher net
investment spread and lower investment and other expenses.
Net investment spread increased to $2.0 million during 1995 from $1.8
million in 1994. These amounts reflect net investment spread of 2.97% and 2.10%
during 1995 and 1994, respectively, between the Company's investment yield on
average cash and investments and the average rate credited on certificate
reserves. The Company's investment income decreased to $4.9 million from $5.3
million for 1995 and 1994, respectively. The investment yields for 1995 and 1994
were 8.21% and 7.63% on average cash and investments of $56.3 million and $66.1
million, respectively. This increase in investment yield was attributable to
higher yields attained as a result of a restructuring of the investment
portfolio subsequent to the Acquisition, as well as accretion resulting from
purchase accounting adjustment.
Interest credited on certificate reserves was $2.9 million and $3.6 million
for 1995 and 1994, respectively. These amounts represent average rates of
interest credited of 5.24% and 5.53% on average certificate reserves of $52.9
million and $62.2 million for 1995 and 1994, respectively. This decrease is a
result of new and renewal certificates issued during 1995 accumulating interest
at rates lower than contracts that matured or surrendered.
The decrease in investment and other expenses was primarily attributable to
the decrease in management and investment advisory fees since the Acquisition
and lower amortization of deferred charges.
Realized investment gains were $283,885 and $29,783 for 1995 and 1994,
respectively. Realized investment gains were interest-rate related and
attributable to the asset/liability management strategies of the Company.
8
ASSET PORTFOLIO REVIEW
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 98% investment grade
for the years ended December 31, 1996 and 1995. Investment grade securities are
those classified as 1 or 2 by the National Association of Insurance
Commissioners, or where such classifications are not available, having a rating
on the scale used by Standard & Poor's Corporation of BBB- or above.
Additionally, the Company's investment portfolio has minimal exposure to real
estate, mortgage loans and common equity securities, which represented 1.0% and
1.1% of qualified assets at December 31, 1996 and 1995, respectively. As of
December 31, 1996, 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 and
collateralized mortgage obligations ("CMOs"), totaled $32.6 million at
December 31, 1996, representing 58.9% of total qualified assets (61.4% at
December 31, 1995). The Company's investments in CMOs, which are primarily
backed by the U.S. Government or U.S. Government agencies, represented 52.8% and
47.3% of the Company's qualified assets as of December 31, 1996 and 1995,
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 gains or losses 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. Also, the Company monitors three year cash flow projections 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.
In December 1995, the Company sold virtually all of its mortgage loan
portfolio resulting in a loss of approximately $65,000.
Based on the provisions of Statement of Financial Accounting Standards
("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," adopted as of January 1, 1994, the Company currently classifies its
fixed maturity and equity securities as available-for-sale. Such securities are
carried at fair value and changes in fair value, net of related deferred income
taxes, are charged or credited directly to shareholder's equity. The decrease in
interest rates after the Acquisition, at which time the Company's invested
assets were restated to fair value in accordance with purchase accounting rules,
and then the subsequent rise in interest rates during the year ended December
31, 1996, have resulted in unrealized gains of $231,541 (net of $124,676 in
deferred income taxes) compared to unrealized gains of $885,878 (net of $477,011
in deferred income taxes)
9
as of December 31, 1995. Volatility in reported shareholder's equity occurs
as a result of SFAS No. 115 which requires some assets to be carried at fair
value while other assets and all liabilities are carried at historical values.
The Company manages assets and liabilities in a closely integrated manner
to minimize the volatility of margins. As a result, adjusting the shareholder's
equity for changes in the fair value of the Company's fixed maturities and
equity securities without reflecting offsetting changes in the value of the
Company's liabilities or other assets creates volatility in reported
shareholder's equity but does not reflect the underlying economics of the
Company's business.
LIQUIDITY AND FINANCIAL RESOURCES
The Company has never paid cash dividends on its common stock in order to
maintain and increase capital resources. The Company will, however, evaluate
this on an ongoing basis.
As of December 31, 1996, the Company had $4.6 million of qualified assets
in excess of the minimum amount required by the 1940 Act and the rules and
regulations promulgated thereunder by the SEC, as computed in accordance with
Section 28(b) of the 1940 Act. In addition, the MDC has certain regulatory
authority over the Company. The MDC 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 reflected at amortized cost for purposes of this
calculation. Under this formula, the Company's capital ratio was 8.7% at
December 31, 1996.
The primary liquidity requirement of the Company relates to its payment of
certificate maturities and surrenders. The principal sources of cash to meet
such liquidity requirements are investment income and proceeds from maturities
and redemptions of investments.
At December 31, 1996, cash and cash equivalents totaled $3.2 million, a
decrease of $0.7 million from December 31, 1995. The Company's aim is to manage
its cash and cash equivalents position so as to satisfy short-term liquidity
needs. In connection with this management of cash and cash equivalents, the
Company may invest idle cash in short duration fixed maturities to capture
additional yield when short-term liquidity requirements permit.
Cash flows of $3.6 million, $4.1 million, and $4.2 million were generated
from operating activities in 1996, 1995, and 1994, respectively. These cash
flows resulted principally from investment income, less management and
investment advisory fees and commissions paid. Proceeds from sales, redemptions
and maturities of investments generated $39.4 million, $51.8 million, and $10.6
million in cash flows during 1996, 1995, and 1994, respectively, which were
offset by purchases of investments of $38.5 million, $44.2 million, and $5.1
million, respectively. The higher purchases and sales of investments during 1995
were a result of the initial restructuring of the Company's investment portfolio
following the Acquisition.
10
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX
FINANCIAL STATEMENTS
Reports of Independent Auditors. . . . . . . . . . . . . . . . . . . . . . 12
Balance Sheets as of December 31, 1996 and 1995. . . . . . . . . . . . . . 14
Statements of Operations for the Years Ended December 31, 1996, 1995,
and 1994 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Statements of Shareholder's Equity for the Years Ended December 31, 1996,
1995 and 1994. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Statements of Cash Flows for the Years Ended December 31, 1996, 1995
and 1994 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Notes to Financial Statements. . . . . . . . . . . . . . . . . . . . . . . 19
SUPPLEMENTARY DATA
None
11
REPORT OF INDEPENDENT AUDITORS
Board of Directors
SBM Certificate Company
We have audited the accompanying balance sheets of SBM Certificate Company as of
December 31, 1996 and 1995, and the related statements of income, shareholder's
equity, and cash flows for the years then ended. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of SBM Certificate Company at
December 31, 1996 and 1995, and the results of its operations and its cash flows
for the years then ended in conformity with generally accepted accounting
principles.
/s/ Ernst & Young LLP
Louisville, Kentucky
February 12, 1997
12
INDEPENDENT AUDITORS' REPORT
Board of Directors
SBM Certificate Company
We have audited the statements of income and of cash flows of SBM Certificate
Company (the "Company") for the year ended December 31, 1994. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the results of SBM Certificate Company's operations and its cash flows
for the year ended December 31, 1994 in conformity with generally accepted
accounting principles.
The financial statements have been prepared on a historical basis and do not
include any purchase accounting or other adjustments resulting from the sale of
the Company as discussed in Note 2 to the financial statements.
As discussed in Note 1 to the financial statements, in 1994 the Company adopted
Statement of Financial Accounting Standards No. 115, ACCOUNTING FOR CERTAIN
INVESTMENTS IN DEBT AND EQUITY SECURITIES.
/s/ Deloitte and Touche LLP
Minneapolis, Minnesota
March 29, 1995
13
SBM CERTIFICATE COMPANY
BALANCE SHEETS
- ----------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------
DECEMBER 31,
1996 1995
- ----------------------------------------------------------------------------------------------------------------
ASSETS
Qualified assets:
Cash and investments:
Investments in securities of unaffiliated issuers:
Fixed maturities available-for-sale, at fair value (amortized cost:
1996-$49,863,826; 1995-$53,076,255) $ 50,169,361 $ 54,388,115
Equity securities, at fair value (cost: 1996-$493,912; 1995-$570,162) 544,594 621,191
Certificate loans 273,368 279,463
Other invested assets 523,083 632,154
Cash and cash equivalents 3,247,192 3,900,494
--------------------------------
Total cash and investments 54,757,598 59,821,417
Receivables:
Dividends and interest 533,958 397,898
Receivable for investment securities sold 122,570 --
--------------------------------
Total receivables 656,528 397,898
--------------------------------
Total qualified assets 55,414,126 60,219,315
Deferred acquisition cost 132,163 113,500
Goodwill 113,095 192,919
Other assets 66,163 54,203
--------------------------------
Total assets $ 55,725,547 $ 60,579,937
--------------------------------
--------------------------------
14
SBM CERTIFICATE COMPANY
BALANCE SHEETS (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------
DECEMBER 31,
1996 1995
- ----------------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities:
Certificate reserves $ 50,186,386 $ 52,459,724
Payable for investment securities purchased -- 2,454,325
Deferred federal income taxes 445,419 619,148
Accounts payable and other liabilities 29,940 60,582
--------------------------------
Total liabilities 50,661,745 55,593,779
Shareholder's equity:
Common stock, $1 par value; 1,000,000 shares authorized;
250,000 shares issued and outstanding 250,000 250,000
Additional paid-in capital 3,050,000 3,050,000
Net unrealized gains on available-for-sale securities 231,541 885,878
Retained earnings 1,532,261 800,280
--------------------------------
Total shareholder's equity 5,063,802 4,986,158
--------------------------------
Total liabilities and shareholder's equity $55,725,547 $60,579,937
--------------------------------
--------------------------------
SEE ACCOMPANYING NOTES.
15
SBM CERTIFICATE COMPANY
STATEMENTS OF OPERATIONS
- --------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
-----------------------------------------------
1996 1995 1994
- --------------------------------------------------------------------------------------------------
Investment income:
Interest income from securities $ 4,089,948 $ 4,276,460 $ 4,590,206
Interest income from mortgage loans -- 366,321 439,709
Other investment income 200,127 246,597 296,010
-----------------------------------------------
Total investment income 4,290,075 4,889,378 5,325,925
Investment and other expenses:
Management and investment advisory fees 246,468 358,486 516,000
Deferred acquisition cost amortization and renewal
commissions 245,126 289,875 518,782
Real estate expenses 205,029 137,777 112,772
Amortization of goodwill 79,824 92,248 --
Other expenses 38,647 79,207 77,876
-----------------------------------------------
Total investment and other expenses 815,094 957,593 1,225,430
Interest credited on certificate reserves 2,821,912 2,929,357 3,575,075
-----------------------------------------------
Net investment income before federal
income taxes 653,069 1,002,428 525,420
Federal income tax expense (238,399) (407,074) (162,000)
-----------------------------------------------
Net investment income 414,670 595,354 363,420
Realized investment gains 485,135 283,885 29,783
Federal income tax expense on realized investment
gains (167,824) (102,500) (10,000)
-----------------------------------------------
Net realized investment gains 317,311 181,385 19,783
-----------------------------------------------
Net income $ 731,981 $ 776,739 $ 383,203
-----------------------------------------------
-----------------------------------------------
SEE ACCOMPANYING NOTES.
16
SBM CERTIFICATE COMPANY
STATEMENTS OF SHAREHOLDER'S EQUITY
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
NET
UNREALIZED
GAINS (LOSSES)
ADDITIONAL ON AVAILABLE- TOTAL
COMMON PAID-IN FOR-SALE RETAINED SHAREHOLDER'S
STOCK CAPITAL SECURITIES EARNINGS EQUITY
- ----------------------------------------------------------------------------------------------------------------------
Balance, January 1, 1994 $ 250,000 $ 3,740,006 $(165,742) $ 56,373 $ 3,880,637
Adjustment to beginning balance for
change in accounting method, net
of income taxes of $403,000 782,000 782,000
Net income 383,203 383,203
Change in net unrealized losses on
available-for-sale securities (4,858,917) (4,858,917)
-----------------------------------------------------------------------------
Balance, December 31, 1994 250,000 3,740,006 (4,242,659) 439,576 186,923
Net income 776,739 776,739
Capital contribution from SBM Life 1,500,000 1,500,000
Purchase accounting adjustment
(NOTE 2) (2,190,006) 1,066,442 (416,035) (1,539,599)
Change in net unrealized gains
(losses) on available-for-sale
securities 4,062,095 4,062,095
-----------------------------------------------------------------------------
Balance, December 31, 1995 250,000 3,050,000 885,878 800,280 4,986,158
Net income 731,981 731,981
Change in net unrealized gains on
available-for-sale securities (654,337) (654,337)
-----------------------------------------------------------------------------
Balance, December 31, 1996 $ 250,000 $ 3,050,000 $ 231,541 $ 1,532,261 $ 5,063,802
-----------------------------------------------------------------------------
-----------------------------------------------------------------------------
SEE ACCOMPANYING NOTES.
17
SBM CERTIFICATE COMPANY
STATEMENTS OF CASH FLOWS
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
---------------------------------------------
1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------
CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES:
Net income $ 731,981 $ 776,739 $ 383,203
Adjustments to reconcile net income to cash flows provided
by operating activities:
Provision for certificate reserves 2,821,912 2,929,357 3,575,075
Realized investment gains (485,135) (283,885) (29,783)
Deferral of acquisition costs (263,788) (430,852) (507,996)
Amortization of deferred acquisition costs and
renewal commissions 245,126 289,875 518,782
Other amortization and depreciation 530,429 228,861 (75,111)
Deferred tax expense 178,606 295,464 20,000
(Increase) decrease in dividends and interest receivable (136,060) 34,571 30,851
Changes in other assets and liabilities (40,816) 250,559 236,812
---------------------------------------------
Cash flows provided by operating activities 3,582,255 4,090,689 4,151,833
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:
Fixed maturity investments available-for-sale:
Purchases (38,523,432) (44,224,876) (3,922,397)
Maturities and redemptions 5,642,891 2,627,400 7,563,300
Sales 33,578,496 44,977,473 --
Fixed maturity investments held-to-maturity:
Purchases -- -- (1,180,893)
Maturities and redemptions -- 51,500 2,761,816
Sales, maturities and redemptions--mortgage loans 155,643 4,192,459 144,109
Additions to other invested assets -- (81,200) --
Proceeds from sale of other invested assets -- -- 156,453
Repayment of certificate loans, net 6,095 59,416 11,494
---------------------------------------------
Cash flows provided by investing activities 859,693 7,602,172 5,533,882
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:
Amounts paid to face-amount certificate holders (6,063,787) (13,322,027) (13,973,106)
Amounts received from face-amount certificate holders 968,537 2,498,761 3,689,960
Capital contribution -- 1,500,000 --
---------------------------------------------
Cash flows used in financing activities (5,095,250) (9,323,266) (10,283,146)
---------------------------------------------
Net change in cash and cash equivalents (653,302) 2,369,595 (597,431)
Cash and cash equivalents at beginning of year 3,900,494 1,530,899 2,128,330
---------------------------------------------
Cash and cash equivalents at end of year $ 3,247,192 $ 3,900,494 $ 1,530,899
---------------------------------------------
---------------------------------------------
SEE ACCOMPANYING NOTES.
18
SBM CERTIFICATE COMPANY
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
SBM Certificate Company (the "Company") was incorporated in 1990 for the
purpose of acquiring the face-amount certificate business of SBM Company
("SBM"). Effective December 31, 1993, SBM transferred all of the Company's
shares of common stock to its wholly owned subsidiary, State Bond and Mortgage
Life Insurance Company ("SBM Life"), and the Company became a wholly owned
subsidiary of SBM Life.
On June 14, 1995, ARM Financial Group, Inc. ("ARM"), completed the
acquisition of substantially all of the assets and business operations of SBM,
including all of the issued and outstanding common stock of SBM's subsidiaries,
SBM Life and SBM Financial Services, Inc (the "Acquisition"). On November 29,
1996, SBM Financial Services, Inc. changed its name to ARM Securities
Corporation ("ARM Securities"). By virtue of the Acquisition, ARM acquired
control of the Company, a wholly owned subsidiary of SBM Life. Concurrent with
the Acquisition, ARM acquired all outstanding shares of the authorized common
stock of the Company from SBM Life for a purchase price of $3.3 million.
NATURE OF OPERATIONS
The Company is an issuer of face-amount certificates and is registered
under the Investment Company Act of 1940 (the "1940 Act"). A face-amount
certificate is an obligation of the Company requiring the Company to pay
certificate holders the original invested amount of the certificate, plus a
three-year fixed-rate return, at a given maturity date. The Company's face-
amount certificates are sold primarily in Minnesota, Iowa, South Dakota and
California. Face-amount certificates, which are similar to bank certificates of
deposit, generally compete with various types of individual savings products
offered by banks and insurance companies that provide a fixed rate of return on
investors' money.
BASIS OF PRESENTATION
The financial statements are prepared in accordance with generally accepted
accounting principles. The 1995 financial statements reflect purchase accounting
adjustments related to the Acquisition (see Note 2). For periods prior to the
Acquisition, the financial statements reflect the historical basis of
accounting. Certain amounts from prior years have been reclassified to conform
to the current year's presentation. These reclassifications had no effect on
previously reported net income or shareholder's equity.
INVESTMENTS
Fixed maturities and equity securities are classified as available-for-
sale. Available-for-sale securities are stated at fair value, with the
unrealized gains and losses, net of taxes, reported as a separate component of
shareholder's equity in accordance with Statement of Financial Accounting
Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and
Equity Securities." The amortized cost of fixed maturities classified as
available-for-sale is adjusted for amortization
19
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
of premiums and accretion of discounts to maturity, or in the case of
mortgage-backed securities, over the estimated life of the security. Such
amortization or accretion is computed using the interest method and is
included in investment income. Anticipated prepayments on mortgage-backed
securities are considered in determining the effective yield on such
securities. If a difference arises between anticipated and actual
prepayments, the carrying value of the investment is adjusted with a
corresponding charge or credit to investment income. Interest and dividends
are included in investment income. Certificate loans are carried at their
unpaid principal balances. Cash and cash equivalents consist of highly liquid
investments with maturities of three months or less from the time of
purchase. Security transactions are accounted for on the date the order to
buy or sell is executed. Realized gains and losses on the sale of investments
are determined based upon the specific identification method.
Other invested assets includes real estate, which is recorded at cost, less
accumulated depreciation since the Acquisition.
The Company adopted the provisions of SFAS No. 115 for investments held as
of or acquired after January 1, 1994. The adoption of SFAS No. 115 had no effect
on net income. Upon the date of the Acquisition, the Company classified all
fixed maturities classified as held-to-maturity to the available-for-sale
category.
DEFERRED ACQUISITION COSTS
Costs of issuing new face-amount certificates, principally commissions,
have been deferred. These costs are amortized on a straight-line basis over the
initial maturity period of the certificates which is three years.
FACE-AMOUNT CERTIFICATE RESERVES
Face-amount certificates issued by the Company entitle certificate holders,
who have made either single or installment payments, to receive a definite sum
of money at maturity. Certificate reserves accrue interest, and cash surrender
values are less than accumulated certificate reserves prior to maturity dates.
The reserve accumulation rates, cash surrender values, and certificate reserves,
among other matters, are governed by the 1940 Act.
INCOME TAXES
In accordance with SFAS No. 109, "Accounting for Income Taxes", the
Company uses the liability method of accounting for income taxes. The
Company's taxable income or loss is included in the consolidated federal
income tax return of ARM. The Company provides for income taxes based on a
proportionate share of consolidated taxable income. Additionally, tax
benefits are recognized for losses to the extent they can be used in the
consolidated return. It is the Company's and ARM's policy that any tax
benefit recorded by one entity will be reimbursed by the benefitted entity.
20
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
USE OF ESTIMATES
The preparation of financial statements in conformity
with generally accepted accounting principles requires management of the
Company to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Actual results could differ
from those estimates.
2. ACQUISITION OF THE COMPANY
The Acquisition has been accounted for using the purchase method of
accounting. Under purchase accounting, assets and liabilities are adjusted to
their estimated fair value and reflect an allocation of the Company's portion of
the cost of the Acquisition, commonly referred to as "push-down accounting."
The purchase accounting adjustment reflected in the accompanying statement
of shareholder's equity for the year ended December 31, 1995 was recorded on May
31, 1995, the effective date of the Acquisition. The adjustment restated
shareholder's equity on that date to $3.3 million, the purchase price allocated
to the Company by ARM. The December 31, 1995, balances for "retained earnings"
and "net unrealized gains on available-for-sale securities" reflect net income
and the change in the fair value of fixed maturities and equity securities
subsequent to the Acquisition.
The following combined condensed statements of operations and cash flows
present results for the five months ended May 31, 1995, prior to the
Acquisition, and the seven months ended December 31, 1995, following the
Acquisition. The combined amounts agree to the accompanying statements of
operations and cash flows for the year ended December 31, 1995. The operating
results subsequent to the Acquisition include the effect of new accounting
values assigned to invested assets and intangibles and differing asset/liability
management strategies and expense allocation methodologies of ARM and SBM
management.
21
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
SEVEN
MONTHS
FIVE MONTHS ENDED YEAR ENDED
ENDED DECEMBER 31, DECEMBER 31,
MAY 31, 1995 1995 1995
---------------------------------------------
COMBINED CONDENSED STATEMENT OF OPERATIONS:
Total investment income $ 2,013,780 $ 2,875,598 $ 4,889,378
Total investment and other expenses 511,343 446,250 957,593
Interest credited on certificate reserves 1,224,738 1,704,619 2,929,357
---------------------------------------------
Net investment income before federal income taxes 277,699 724,729 1,002,428
Federal income tax expense (94,000) (313,074) (407,074)
---------------------------------------------
Net investment income 183,699 411,655 595,354
Realized investment gains (losses) (314,000) 597,885 283,885
Federal income tax benefit (expense) on realized
investment gains and losses 106,760 (209,260) (102,500)
---------------------------------------------
Net income (loss) $ (23,541) $ 800,280 $ 776,739
---------------------------------------------
---------------------------------------------
COMBINED CONDENSED STATEMENT OF CASH FLOWS:
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES $ 1,462,487 $ 2,628,202 $ 4,090,689
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:
Fixed maturity investments:
Purchases (21,615) (44,203,261) (44,224,876)
Maturities and redemptions 903,084 1,775,816 2,678,900
Sales 5,090,653 39,886,820 44,977,473
Sales, maturities and redemptions -- mortgage loans 392,947 3,799,512 4,192,459
Additions to other invested assets, net (81,200) -- (81,200)
Repayments of certificate loans, net 66,731 (7,315) 59,416
---------------------------------------------
Cash flows provided by investing activities 6,350,600 1,251,572 7,602,172
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:
Amounts paid to face-amount certificate holders (7,066,042) (6,255,985) (13,322,027)
Amounts received from face-amount certificate
holders 1,926,095 572,666 2,498,761
Capital contribution from SBM Life 1,500,000 -- 1,500,000
---------------------------------------------
Cash flows used in financing activities (3,639,947) (5,683,319) (9,323,266)
---------------------------------------------
Net change in cash and cash equivalents 4,173,140 (1,803,545) 2,369,595
Cash and cash equivalents at beginning of period 1,530,899 5,704,039 1,530,899
---------------------------------------------
Cash and cash equivalents at end of period $ 5,704,039 $ 3,900,494 $ 3,900,494
---------------------------------------------
---------------------------------------------
22
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
3. Investments
The amortized cost and estimated fair values of available-for-sale
securities were as follows:
AVAILABLE-FOR-SALE-SECURITIES
-------------------------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
- ----------------------------------------------------------------------------------------------------------------
DECEMBER 31, 1996:
Fixed maturities:
U.S. treasury securities and obligations
of U.S. government agencies $ 3,467,777 $ -- $ 38,359 $ 3,429,418
Obligations of state and political subdivisions 456,112 3,498 8,838 450,772
Foreign governments 951,123 13,000 5,893 958,230
Corporate securities 7,569,178 63,776 15,206 7,617,748
Asset-backed securities 5,131,230 3,763 35,468 5,099,525
Mortgage-backed securities 32,288,406 498,888 173,626 32,613,668
-------------------------------------------------------------
Total fixed maturities 49,863,826 582,925 277,390 50,169,361
Equity securities 493,912 53,270 2,588 544,594
-------------------------------------------------------------
Total available-for-sale securities $ 50,357,738 $ 636,195 $ 279,978 $ 50,713,955
-------------------------------------------------------------
-------------------------------------------------------------
DECEMBER 31, 1995:
Fixed maturities:
U.S. treasury securities and obligations
of U.S. government agencies $ 6,319,243 $ 25,950 $ -- $ 6,345,193
Obligations of state and political subdivisions 560,292 4,243 6,927 557,608
Foreign governments 500,000 8,125 -- 508,125
Corporate securities 4,777,934 88,765 173 4,866,526
Asset-backed securities 5,108,721 33,383 -- 5,142,104
Mortgage-backed securities 35,810,065 1,169,583 11,089 36,968,559
-------------------------------------------------------------
Total fixed maturities 53,076,255 1,330,049 18,189 54,388,115
Equity securities 570,162 51,074 45 621,191
-------------------------------------------------------------
Total available-for-sale securities $ 53,646,417 $ 1,381,123 $ 18,234 $ 55,009,306
-------------------------------------------------------------
-------------------------------------------------------------
23
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
The amortized cost and estimated fair value of securities by contractual
maturity are shown below. Expected maturities will differ from contractual
maturities because borrowers may have the right to call or repay obligations
with or without call or prepayment penalties and because mortgage-backed and
asset-backed securities provide for periodic payments throughout their life.
DECEMBER 31, 1996
------------------------------------
ESTIMATED
FAIR
COST VALUE
- -----------------------------------------------------------------------------
AVAILABLE-FOR-SALE:
Due in one year or less $ 1,260,417 $ 1,271,617
Due after one year through five years 5,749,018 5,760,012
Due after five years through ten years 4,375,305 4,352,148
Due after ten years 1,059,450 1,072,391
Asset-backed securities 5,131,230 5,099,525
Mortgage-backed securities 32,288,406 32,613,668
Equity securities 493,912 544,594
------------------------------------
Total available-for-sale securities $ 50,357,738 $ 50,713,955
------------------------------------
------------------------------------
Gross gains of $642,039, $815,733 and $7,399 and gross losses of $175,226,
$148,041 and $321,399 were realized on sales of fixed maturities classified as
available-for-sale for the year ended December 31, 1996, the seven months ended
December 31, 1995 and the five months ended May 31, 1995, respectively.
Gross gains of $23,980 and zero and gross losses of zero and $5,075 were
recognized on equity securities sold during 1996 and 1995, respectively. Gross
losses of $64,732 were realized on the sale of substantially all mortgage loans
in December 1995.
24
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
4. CERTIFICATE RESERVES
Total certificate reserves at December 31 are summarized as follows:
MINIMUM ADDITIONAL
1996 1995 INTEREST INTEREST
--------------------------------------------------------------------
Fully-paid certificates:
Single-payment series 503 $ 46,302,625 $ 48,440,527 2.50% 1.85% to 4.60%
Installment 2,270,515 2,267,503 2.50% to 3.50% 1.50% to 2.75%
Optional settlement 592,513 618,419 2.50% to 3.00% 2.00% to 2.75%
Due to unlocated certificate
holders 2,878 2,813 None
-------------------------------
49,168,531 51,329,262
Installment certificates:
Reserves to mature, by series:
120, 215, and 220 424,651 447,033 3.25% 1.75% to 2.00%
315 296,064 364,368 3.50% 1.50% to 1.75%
Advance payments 297,140 319,061 * *
-------------------------------
1,017,855 1,130,462
-------------------------------
Total certificate reserves $ 50,186,386 $ 52,459,724
-------------------------------
-------------------------------
* Minimum interest rates on advance payments are generally the same as
the rates on scheduled installment payments. Interest credited on
advance payments, however, is accruing at 5.00% and will continue at
that rate through 1997.
5. FAIR VALUES OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair values of financial
instruments is made in accordance with the requirements of SFAS No. 107,
"Disclosures About Fair Value of Financial Instruments." The estimated fair
value amounts have been determined using available market information and
appropriate valuation methodologies. However, considerable judgement was
required to develop these estimates. Accordingly, the estimates are not
necessarily indicative of the amounts which could be realized in a current
market exchange. The use of different market assumptions or estimation
methodologies may have a material effect on the estimated fair value amounts.
25
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
--------------------------------------------------------------
DECEMBER 31, 1996 DECEMBER 31, 1995
CARRYING ESTIMATED CARRYING ESTIMATED
VALUE FAIR VALUE VALUE FAIR VALUE
- -----------------------------------------------------------------------------------------------------------
Assets:
Investments in securities of unaffiliated
issuers:
Fixed maturities available-for-sale $ 50,169,361 $ 50,169,361 $ 54,388,115 $ 54,388,115
Equity securities 544,594 544,594 621,191 621,191
Certificate loans 273,368 273,368 279,463 279,463
Other invested assets 523,083 523,083 632,154 632,154
Cash and cash equivalents 3,247,192 3,247,192 3,900,494 3,900,494
Other assets 66,163 66,163 54,203 54,203
Liabilities:
Certificate reserves 50,186,386 50,767,396 52,459,724 52,758,441
Accounts payable and other liabilities 29,940 29,940 60,582 60,582
The following methods and assumptions were used in estimating fair values:
INVESTMENTS IN SECURITIES OF UNAFFILIATED ISSUERS
Fair values for investments in securities of unaffiliated issuers are based
on quoted market prices, where available. For investments in securities of
unaffiliated issuers for which a quoted market price is not available, fair
values are estimated using internally calculated estimates or quoted market
prices of comparable instruments.
CERTIFICATE LOANS
The carrying value of certificate loans approximates their fair value.
CASH AND CASH EQUIVALENTS
The carrying amounts of cash and cash equivalents approximate their fair
value given the short-term nature of these assets.
CERTIFICATE RESERVES
The fair value of certificate reserves is based on a discounted cashflow
analysis, using the current interest rate offered on new certificates of 5.25%
and 5.60% at December 31, 1996 and 1995, respectively.
OTHER INVESTED ASSETS, OTHER ASSETS, ACCOUNTS PAYABLE AND OTHER LIABILITIES
The financial statement carrying amounts of other invested assets, other
assets, accounts payable and other liabilities are deemed to be a reasonable
approximation of their fair value.
26
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
6. FEDERAL INCOME TAXES
Deferred federal income taxes reflect the net tax effects of (i) temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes, and (ii)
operating and capital losses. Significant components of the deferred tax
liabilities and assets as of December 31, 1996 and December 31, 1995 were:
DECEMBER 31,
----------------------------
1996 1995
- -------------------------------------------------------------------------------------------------
Deferred tax liabilities:
Real estate limited partnership $ 178,736 $ 172,851
Net unrealized gains on available-for-sale securities 124,676 477,011
Other -- 39,725
----------------------------
Total deferred tax liabilities 303,412 689,587
Deferred tax assets:
Fixed maturities 45,524 196,991
Other investments 93,789 108,143
Fixed assets 38,149 39,030
Capital loss carryover 363,267 420,357
Other 31,785 20,439
----------------------------
Total deferred tax assets 572,514 784,960
Valuation allowance for deferred tax assets (714,521) (714,521)
----------------------------
Net deferred tax assets (142,007) 70,439
----------------------------
Deferred tax liabilities shown on the accompanying balance sheets $ 445,419 $ 619,148
----------------------------
----------------------------
The components of the provision for federal income tax expense consist of the
following:
YEAR ENDED DECEMBER 31,
-------------------------------------------
1996 1995 1994
-------------------------------------------
Current $ 227,617 $ 214,110 $ 152,000
Deferred 178,606 295,464 20,000
-------------------------------------------
Total federal income tax expense $ 406,223 $ 509,574 $ 172,000
-------------------------------------------
-------------------------------------------
Current and deferred federal income tax expenses for the seven months ended
December 31, 1995 were $233,870 and $288,464, respectively. For the five months
ended May 31, 1995 the current tax benefit was $19,760 and the deferred tax
expense was $7,000.
27
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
In the event that future tax assets are recognized on deductible
temporary differences for which a valuation allowance was provided at the
Acquisition date, such benefits will be applied to first reduce the balance
of goodwill. No such benefits were realized in 1996. During 1995, goodwill
was reduced by $189,251 as a result of realizing such benefits. Goodwill,
with an unamortized balance of $113,095 at December 31, 1996, is being
amortized straight-line over the three year period subsequent to the
Acquisition.
Federal income tax expense differs from that computed by using the federal
income tax rate of 35%. The sources of the differences were:
SEVEN MONTHS FIVE MONTHS
YEAR ENDED DECEMBER 31, ENDED ENDED YEAR ENDED
---------------------------- DECEMBER 31, MAY 31, DECEMBER 31,
1996 1995 1995 1995 1994
-------------------------------------------------------------------------
Income tax expense (benefit) at
statutory rate $ 398,371 $ 450,209 $ 462,915 $ (12,706) $ 194,321
Tax-exempt interest (7,283) (7,256) (3,350) (3,906) (10,000)
Dividend received deduction (12,577) (14,379) (8,000) (6,379) (15,000)
Goodwill amortization 27,938 32,287 32,287 -- --
Taxable proceeds from life
insurance -- 38,482 38,482 -- --
Other (226) 10,231 -- 10,231 2,679
-------------------------------------------------------------------------
Total federal income tax expense
(benefit) $ 406,223 $ 509,574 $ 522,334 $(12,760) $172,000
-------------------------------------------------------------------------
-------------------------------------------------------------------------
7. RELATED PARTY TRANSACTIONS
For the periods presented, management and investment advisory fee expenses
reflected in the accompanying financial statements represent allocations of
expenses from SBM and ARM for the respective periods prior and subsequent to the
Acquisition. These allocations include amounts for administrative and investment
services, including use of property, equipment and facilities. The allocations
are currently based on the proportion which such business and assets managed
represents of all of ARM's and its subsidiaries business activities. Prior to
the Acquisition, the allocations were primarily based on the amount of time
spent by SBM employees on the face-amount certificate business and on the
proportion which such business represents of all of SBM's and its subsidiaries'
business activities. The allocations were $246,468, $151,967, $206,519 and
$516,000 for the year ended December 31, 1996, the seven months ended December
31, 1995, the five months ended May 31, 1995 and for the year ended December 31,
1994, respectively. The Company owns and pays operating expenses for a building
used by SBM (prior to the Acquisition) and its affiliates. The total rent and
utilities reimbursement paid to the Company in 1994 by SBM and affiliates was
$146,554. Management believes the foregoing allocations were made on a
reasonable basis; however, they do
28
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
not necessarily equal the costs which would have been or will be incurred by
the Company on a stand-alone basis.
The Company has paid ARM Securities, an affiliate, $263,089, $443,579 and
$507,995 for the years ended 1996, 1995 and 1994, respectively, for sales
commissions and other issuance, underwriting, and sales expenses.
8. SHAREHOLDER'S EQUITY AND REGULATORY MATTERS
The Company is subject to two principal restrictions relating to its
regulatory capital requirements. First, under 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 ($50.4 million and $52.7 million at December 31, 1996 and
1995, respectively). The Company had qualified assets of $55.1 million and $58.9
million at those respective dates (before addition of $0.4 million and $1.4
million, respectively, for net unrealized pretax gains on fixed maturities and
equity securities classified as available-for-sale).
For purposes of determining compliance with the foregoing provisions,
qualified assets are valued in accordance with 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 securities classified as
available-for-sale are valued at amortized cost and equity securities are valued
at cost.
Second, the Minnesota Department of Commerce ("MDC") 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 reflected at amortized
cost for purposes of this calculation. Under this formula, the Company's capital
ratio was 8.7% and 6.9% at December 31, 1996 and 1995, respectively. In November
1994, based on the decline in the value of the Company's investment portfolio,
resulting from increasing interest rates in 1994 and the Company's decreasing
liquidity resulting from reduced principal payments on the Company's
collateralized mortgage obligations portfolio, the MDC recommended that the
Company increase its capital level. The MDC's concern was influenced by the
Company's capital ratio, calculated including the effects of unrealized
investment losses. Therefore, on March 29, 1995, SBM Life, the former parent
company of the Company, made a $1.5 million capital contribution to the Company.
Pursuant to the required calculations of various states, the provisions of
the certificates, depository agreements, and the 1940 Act, qualified assets of
the Company were deposited with independent custodians to meet certificate
liability requirements as of December 31, 1996 and 1995 as shown in
29
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
the following table. Certificate loans, secured by applicable certificate
reserves, are deducted from certificate reserves in computing deposit
requirements.
1996 1995
-------------------------------
Assets on deposit with:
Central depositary $ 51,522,592 $ 57,278,134
State governmental authorities 245,102 193,756
-------------------------------
Total deposits $ 51,767,694 $ 57,471,890
-------------------------------
-------------------------------
Required deposits (certificate reserves less certificate loans plus $250,000) $ 50,163,018 $ 52,430,261
-------------------------------
-------------------------------
Assets on deposit consisted of the following at December 31:
1996 1995
-------------------------------
Investment securities, at cost plus accrued interest $ 51,244,584 $ 56,839,655
First mortgage loans 4,068 13,472
Other assets on deposit, at cost 519,042 618,763
-------------------------------
$ 51,767,694 $ 57,471,890
-------------------------------
-------------------------------
30
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There have been no changes in or disagreements with accountants on
accounting, auditing, or financial reporting matters.
31
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
This information is omitted in accordance with Instruction (J)(2)(c)
to Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION
This information is omitted in accordance with Instruction (J)(2)(c)
to Form 10-K.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
This information is omitted in accordance with Instruction (J)(2)(c)
to Form 10-K.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
This information is omitted in accordance with Instruction (J)(2)(c)
to Form 10-K.
32
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) DOCUMENTS FILED AS PART OF THIS REPORT
1. FINANCIAL STATEMENTS.
See financial statements index on page 11 of this document for a
listing of financial statements and reports of independent auditors
included in this report.
2. FINANCIAL STATEMENT SCHEDULES
The following financial statement schedules of the Company and
the related Report of Independent Auditors are incorporated herein by
reference and were previously filed as Part II Item 16(b) to Post
Effective Amendment No. 8 to Registration Statement on Form S-1 of the
Company filed February 28, 1997 (File No. 33-38066):
Report of Independent Auditors
Schedule I Investments in Securities of Unaffiliated
Issuers--December 31, 1996
Schedule V Qualified Assets on Deposit--December 31, 1996
Schedule VI Certificate Reserves--Year Ended December 31, 1996
Schedules I, III, V and VI as of or for the year ended December
31, 1995, and related Report of Independent Auditors, included in the
Company's Post Effective Amendment No. 7 to Registration Statement on
Form S-1 filed March 5, 1996, Schedules III and VI for the year ended
December 31, 1994, and related Independent Auditors' Report, included
in the Company's Post Effective Amendment No. 6 to Registrant
Statement on Form S-1 filed March 31, 1995, (File No. 33-38066), are
incorporated herein by reference.
Schedules required by Article 6 of Regulation S-X for face-amount
certificate investment companies other than those listed are omitted
because they are not required, are not applicable, or equivalent
information has been included in the financial statements and notes
thereto, or elsewhere herein.
3. EXHIBITS
See Exhibit Index on page 36 of this report.
33
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed by the Company during the fourth
quarter of 1996.
34
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) 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 February 26, 1997.
SBM Certificate Company
By: /S/ JOHN R. MCGEENEY
------------------------------------
John R. McGeeney
Chairman of the Board of Directors
and President
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant in the capacities indicated on the 26th day of February 1997.
Name Title
---- -----
/s/ JOHN R. McGEENEY Chairman of the Board of Directors
- ------------------------------------- and President (Principal Executive
John R. McGeeney Officer)
/s/ EDWARD L. ZEMAN Executive Vice President-Chief
- ------------------------------------- Financial Officer (Principal
Edward L. Zeman Financial Officer)
/s/ BARRY G. WARD Controller (Principal Accounting
- ------------------------------------- Officer)
Barry G. Ward
/s/ STEVEN B. BING Director
- -------------------------------------
Steven B. Bing
/s/ THEODORE S. ROSKY Director
- -------------------------------------
Theodore S. Rosky
/s/ MARTIN R. SNYDER Director
- -------------------------------------
Martin R. Snyder
35
SBM CERTIFICATE COMPANY
EXHIBIT INDEX
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
EXHIBIT
NUMBER DESCRIPTION
- --------------------------------------------------------------------------------
3.1 Articles of Incorporation-filed as Exhibit 3(a) to Registration
Statement No. 33-38066 dated December 4, 1990.*
3.2 By-laws-filed as Exhibit 3(b) to Registration Statement No. 33-38066
dated December 4, 1990.*
4 Instruments defining the rights of security holders-Form of Series 503
Certificate filed as Exhibit 4 to Registration Statement on Form N-8B-
4, File No. 811-6268, filed April 1, 1991.*
10.1 Underwriting Agreement by and between the Company and SBM Financial
Services, Inc. dated June 14, 1995, filed as Exhibit 10(b) to
Amendment No. 7 to Registration Statement No. 33-38066 of the Company
dated March 5, 1996.*
10.2 Administrative Services Agreement by and between the Company and ARM
Financial Group, Inc. dated as of June 14, 1995, filed as Exhibit
10(c) to Amendment No. 7 to Registration Statement No. 33-38066 of the
Company dated March 5, 1996.*
10.3 Investment Services Agreement by and between the Company and ARM
Financial Group, Inc. dated as of June 14, 1995, filed as Exhibit
10(d) to Amendment No. 7 to Registration Statement No. 33-38066 of the
Company dated March 5, 1996.*
10.4 Custody Agreement, as amended and supplemented, between the Company
and First Bank National Association dated December 20, 1990, filed as
Exhibit 10(b) to Amendment No. 1 to Registration Statement No. 33-
38066 of the Company dated January 2, 1991.*
10.5 Lease between the Company and State Bank & Trust Company of New Ulm
dated August 13, 1992, filed as Exhibit 10A to Form 10-K of SBM
Company filed March 31, 1993 (File No. 811-407).*
10.6 Form of Tax Allocation Agreement by and among the Company, ARM
Financial Group, Inc. and certain ARM subsidiaries dated March 21,
1996, filed as Exhibit 10.1 to Form 10-Q of the Company, File No.
811-6268, filed May 14, 1996.*
23.1 Consent of Ernst & Young LLP, filed herewith.
23.2 Consent of Deloitte & Touche LLP, filed herewith.
27 Not applicable.
* Previously filed as indicated and incorporated herein by reference.
36