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, 2002
Commission filed number: 811-6268
SBM CERTIFICATE COMPANY
(Formerly SBM Certificate Company, a Minnesota Corporation)
(Exact name of registrant as specified in its charter)
MARYLAND 52-2250397
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
c/o STATE BOND & MORTGAGE COMPANY, L.L.C.
5101 RIVER ROAD, SUITE 101
BETHESDA, MD 20816
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 301-656-4200
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. / / Yes /X/ No
As of October 15, 2002, 250,000 shares of the registrant's common stock
were outstanding; all of which are privately owned and not traded on a public
market.
Reference is made to the Company's Form 8-K Current Report dated October 3,
2002 ("Form 8-K"). Because of the transactions described in the Form 8-K, the
Company has restated its financial statements for the years ended December 31,
2001 and December 31, 2000, and amended all Form 10-Q's affected since December
31, 2000. In addition, certain narrative disclosures have been revised. The
transactions described in the Form 8-K prevented the Company from filing this
Form 10-Q for the period ended June 30, 2002, on a timely basis.
- 1 -
Table of Contents
Part I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets as of June 30, 2002
(unaudited) and December 31, 2001...............................3
Consolidated Statements of Operations for the three months ended
June 30, 2002 (unaudited) and June 30, 2001 (unaudited).........4
Consolidated Statements of Operations for the six months ended
June 30, 2002(unaudited) and June 30, 2001 (unaudited)..........4
Consolidated Statements of Cash Flows for the six months ended
June 30, 2002 (unaudited) and June 30, 2001 (unaudited).........5
Notes to Consolidated Financial Statements ..........................6
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.............................8
Item 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK...........12
Part II. OTHER INFORMATION...................................................13
Item 1. LEGAL PROCEEDINGS ...................................................13
Item 6. EXHIBITS AND REPORTS ON FORM 8-K REPORTS.............................13
SIGNATURES ...................................................................14
CERTIFICATIONS
- 2 -
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SBM Certificate Company and Subsidiary
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2002 2001
------------ ------------
(unaudited)
ASSETS
Cash and investments
Marketable securities, available-for-sale, at fair value
(amortized cost: $11,931,479 and $6,440,016) $ 10,693,464 $ 6,774,313
Mortgage notes held for sale 7,531,885 5,436,118
Mortgage notes held for investment -- 731,482
Real estate tax lien certificates 3,112,545 2,628,528
Property held for sale 485,102 419,923
Real estate owned 2,500,912 --
Escrows 69,748 608,037
Certificate loans 94,158 98,137
Cash and cash equivalents 2,891,909 5,538,094
------------ ------------
Total cash and investments 27,379,723 22,234,632
------------ ------------
Receivables
Dividends and interest 422,697 372,894
------------ ------------
Total receivables
422,697 372,894
------------ ------------
Total qualified assets
27,802,420 22,607,526
Other assets
Related party receivable 80,037 47,787
Fixed assets, net of accumulated depreciation of $32,720 and $20,657 206,708 204,606
Goodwill 591,463 591,463
Deferred acquisition costs 518,257 420,093
Due from shareholder 868,918 812,218
Allowance - Due from shareholder (868,918) (812,218)
Other assets 42,740 9,219
------------ ------------
TOTAL ASSETS $ 29,241,625 $ 23,880,694
============ ============
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities
Statutory certificate liability 28,044,456 21,311,350
Additional certificate liability 1,508,728 2,509,700
Warehouse line of credit 979,105 --
Accounts payable and other liabilities 136,532 307,463
Related party payable 13,061 23,211
------------ ------------
Total liabilities 30,681,882 24,151,724
------------ ------------
Shareholder's equity
Common stock, $1 par value; 10,000,000 shares
authorized; 250,000 shares issued and outstanding 250,000 250,000
Additional paid-in capital 3,861,818 3,222,591
Accumulated comprehensive income, net of taxes (1,278,277) 217,448
Retained earnings (deficit) (4,273,798) (3,961,069)
------------ ------------
Total shareholder's equity (deficit) (1,440,257) (271,030)
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY $ 29,241,625 $ 23,880,694
============ ============
SEE ACCOMPANYING NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
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SBM Certificate Company and Subsidiary
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ------------------------
2002 2001 2002 2001
--------- --------- ----------- ---------
Investment income
Interest and dividend income $ 176,829 $ 227,194 $ 335,226 $ 525,764
Other investment income 6,683 3,614 17,833 11,209
Mortgage interest income 720,891 163,081 955,995 145,406
--------- --------- ----------- ---------
Total investment income 904,403 393,889 1,309,054 682,379
--------- --------- ----------- ---------
Investment and other expenses
Management and investment advisory fees 350,000 112,779 872,000 216,139
Deferred acquisition cost amortization 35,214 28,575 79,210 45,730
Amortization of goodwill -- 12,378 -- 21,772
Depreciation expense 6,151 896 12,062 896
Reserve for losses - shareholder receivable 16,500 -- 56,700 237,565
Other expenses 312,877 270,230 524,720 313,625
--------- --------- ----------- ---------
Total investment and other expenses 720,742 424,858 1,544,692 835,727
Interest credited on certificate liabilities (78,555) 417,852 241,585 705,437
--------- --------- ----------- ---------
Net investment income (loss) before income tax 262,216 (448,821) (477,223) (858,785)
--------- --------- ----------- ---------
Other operating income:
Origination fee income 223,567 126,982 372,611 308,340
Gain on sale to investor 168,803 -- 414,494 --
Other loan fee income 48,577 16,569 113,347 62,233
--------- --------- ----------- ---------
Total other operating income 440,947 143,551 900,452 370,573
--------- --------- ----------- ---------
Other operating expenses:
Salaries and commissions 228,580 108,692 532,549 255,286
Other expenses 146,767 76,211 275,046 108,394
--------- --------- ----------- ---------
Total other operating expenses 375,347 184,903 807,595 363,680
--------- --------- ----------- ---------
Net other operating income (loss) before income tax 65,600 (41,352) 92,857 6,893
--------- --------- ----------- ---------
Net investment and other operating income (loss) before income tax 327,816 (490,173) (384,366) (851,892)
Deferred tax asset valuation allowance expense -- 61,210 (72,123) 61,210
--------- --------- ----------- ---------
Net investment and other operating income (loss) 327,816 (428,963) (456,489) (790,682)
--------- --------- ----------- ---------
Realized investment gains 46,572 64,884 143,760 58,733
Income tax expense on realized investment gains -- -- -- --
--------- --------- ----------- ---------
Net realized investment gains 46,572 64,884 143,760 58,733
--------- --------- ----------- ---------
Net income (loss) $ 374,388 $(364,079) $ (312,729) $(731,949)
========= ========= =========== =========
SEE ACCOMPANYING NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
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SBM Certificate Company and Subsidiary
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, (Unaudited)
2002 2001
----------- -----------
Cash flows provided by (used in) operating activities
Net loss $ (312,729) $ (731,949)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities
Provision for certificate liability 241,585 705,437
Reserve for losses - shareholder receivable 16,500 237,565
Realized investment gains (143,760) (58,733)
Deferred tax asset valuation allowance expense 72,123 --
Deferral of acquisition costs (177,374) (278,585)
Amortization of deferred acquisition costs 79,210 45,730
Amortization and depreciation 12,062 22,668
Increase in dividends and interest receivable (87,154) (120,763)
Changes in other assets and liabilities (270,281) (392,888)
----------- -----------
Net cash provided by (used in) operating activities (569,818) (571,518)
----------- -----------
Cash flows from investing activities
Marketable securities:
Purchases (7,773,430) --
Sales and redemptions 2,430,191 4,666,175
Purchase of mortgage notes held for sale (2,713,850) (2,045,725)
Principal payments received on mortgage notes receivable 1,686,584 422,804
Investment in mortgage notes held for investment -- (15,000)
Real estate tax certificate pools:
Purchases (2,245,527) (3,154,517)
Repayments of tax certificates 1,059,301 252,343
Purchase of fixed assets (14,164) (123,263)
Repayment of certificate loans, net 3,979 20
----------- -----------
Net cash provided by (used in) investing activities (7,566,916) 2,837
----------- -----------
Cash flows from financing activities
Amounts paid to face-amount certificate holders (901,584) (3,432,375)
Amounts received from face-amount certificate holders 6,392,133 3,295,798
Net dividends paid -- (579,934)
----------- -----------
Net cash provided by (used in) financing activities 5,490,549 (716,511)
----------- -----------
NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS (2,646,185) (1,285,192)
Cash and cash equivalents, beginning 5,538,094 3,716,393
----------- -----------
Cash and cash equivalents, end $ 2,891,909 $ 2,431,201
=========== ===========
Supplemental disclosure of significant noncash investing
and financing activities:
Contribution of assets from State Bond $ 639,227 $ --
=========== ===========
Transfer of mortgage notes and tax certificates to REO $ 2,500,912 $ --
=========== ===========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- 5 -
SBM CERTIFICATE COMPANY AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
June 30, 2002
1. ORGANIZATION AND BASIS OF PRESENTATION
SBM Certificate Company (the "Company" or "SBM-MD") was formed on May 24,
2000 under the laws of the State of Maryland. The Company is a wholly owned
subsidiary of State Bond & Mortgage Company, LLC ("State Bond"). The Company is
an issuer of face-amount certificates and is registered under the Investment
Company Act of 1940 (the "1940 Act"). Face-amount certificates issued by the
Company entitle the certificate holder to receive, at maturity, the principal
investment and accrued interest. The accompanying unaudited consolidated
financial statements have been prepared in accordance with generally accepted
accounting principles in the United States for interim financial information and
with the instructions to Form 10-Q.
On July 19, 2000, SBM-MD completed a merger transaction with SBM
Certificate Company, a Minnesota corporation ("SBM-MN"), whereby the Company
became the surviving corporation (See note 2). In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation have been included.
On December 17, 2000, 1st Atlantic contributed, its 100% ownership
interest in Atlantic Capital Funding Corporation ("ACFC") by assigning its
10,000 shares of ACFC Common Stock to SBM-MD, along with two mortgage notes (the
"Contribution"). The Contribution resulted in additional paid-in capital to
SBM-MD for the investment in ACFC, which totaled $573,957. SBM-MD also invested
$1 million into ACFC on this date. ACFC was formed under the laws of the state
of Maryland on March 27, 1997 and is a wholly-owned subsidiary of SBM-MD. ACFC
is a mortgage broker and lender that originates and sells residential and
commercial real estate loans.
Operating results for the Company for the six months ended June 30, 2002,
are not necessarily indicative of those to be expected for the year ending
December 31, 2002. For further information, refer to the financial statements
and footnotes thereto included in the Company's annual report on Form 10-K/A
No.1 for the year ended December 31, 2001.
2. ACQUISITION OF COMPANY BY STATE BOND & MORTGAGE COMPANY, L.L.C.
On July 19, 2000, State Bond completed the purchase of 100% of the issued
and outstanding shares of common stock of SBM-MN, from ARM Financial Group
("ARM"), a Delaware corporation (the "Acquisition"). SBM-MN was a wholly owned
subsidiary of ARM and an issuer of face-amount certificates under the Investment
Company Act of 1940.
State Bond effected the Acquisition as assignee under a Stock Purchase
Agreement, dated March 28, 2000, by and among 1st Atlantic Guaranty Corporation
("1st Atlantic"), a Maryland corporation, SBM-MN and ARM. State Bond is a 100%
owned subsidiary of 1st Atlantic.
The Stock Purchase Agreement provided for a purchase price of $1,400,000,
which allowed for an adjustment to the purchase price based on actual asset
value at the date of the Acquisition. As a result, the purchase price was
reduced to $1,350,000, of which $950,000 was paid directly to ARM and $400,000
is being held by an escrow agent for 18 months as security for certain
post-closing obligations and liabilities of ARM under the Stock Purchase
Agreement. The transaction was accounted for as a reverse merger using the
purchase method of accounting, whereby SBM-MD became the surviving corporation.
The Acquisition was financed by a short-term bank loan made to State Bond,
in the amount of $1,500,000. The loan provided for a floating and fluctuating
rate of interest equal to the prime rate. State Bond's President, his wife and
other officers also personally guaranteed this loan.
- 6 -
On July 19, 2000, upon completion of the Acquisition, the Company declared
and paid a cash dividend in the amount of $1,500,000 to its parent, State Bond,
which used these proceeds to repay the bank borrowing described above.
Immediately prior to the closing of the sale, the Company paid a dividend to ARM
in an amount equal to the Company's shareholders' equity less (i) $450,000 and
(ii) estimated deferred acquisition cost net of income taxes. The dividend,
totaling $3,708,384 was in the form of a transfer of certain securities,
in-kind, and the balance, in cash and cash equivalents.
As a result of the Acquisition transactions, SBM-MD has succeeded SBM-MN
as the "registrant" in all filings made by SBM-MN under the Securities Act of
1933, Securities Exchange Act of 1934 and Investment Act of 1940 ("1940 Act).
3. GOODWILL AND PURCHASED INTANGIBLE ASSETS
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets" ("SFAS 142"). SFAS 142 requires goodwill to be tested for
impairment under certain circumstances, and written down when impaired, rather
than being amortized as previous standards required. Furthermore, SFAS 142
requires purchased intangible assets other than goodwill to be amortized over
their useful lives unless these lives are determined to be indefinite.
SFAS 142 is effective for fiscal years beginning after December 15, 2001.
In accordance with SFAS 142, the Company ceased amortizing goodwill, which
totaled $591,463 as of the beginning of fiscal year 2002, and there was no
charge to goodwill as a result of the implementation of SFAS 142. The goodwill
was initially derived from the Acquisition.
4. SUBSEQUENT EVENTS
Recently, management of the Company confirmed facts that came to its
attention regarding several transactions involving the Company. Those
transactions raised concerns that the Company's Chairman of the Board and Chief
Executive Officer, John J. Lawbaugh, failed to comply with provisions of the
1940 Act prohibiting transactions with affiliated persons of registered
investment companies, caused the Company to fail to comply with disclosure
requirements of the Securities Act of 1933 and the Securities Exchange Act of
1934, and diverted cash assets of the Company to himself directly or indirectly.
As a result, on August 16, 2002, the Company's Board of Directors removed
Mr. Lawbaugh from his position as Chairman of the Board and Chief Executive
Officer and suspended his authority to act for or bind the Company with respect
to any transactions. The Company filed its Form 8-K Current Report dated October
3, 2002, with the SEC on October 4, 2002. That Form 8-K Current Report describes
the findings of the Special Committee created by the Board of Directors to
oversee the investigation of Mr. Lawbaugh's transactions, summarizes the nature
of the transactions and discusses various related matters.
5. REGULATORY MATTERS
The Company is subject to restrictions relating to its regulatory reserve
requirements 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 (as calculated under
Section 28(a)) plus $250,000 ($28.2 million and $21.5 million at June 30, 2002
and December 31, 2001, respectively). The Company had qualified assets (at
amortized cost) of $28.9 million and $22.2 million at those respective dates.
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 SEC. These values are the
same as the financial statement carrying values, except that for financial
statement purposes, fixed maturities and equity securities
- 7 -
classified as available-for-sale are carried at fair value. For qualified asset
purposes, fixed maturities classified as available-for-sale are valued at
amortized cost and equity securities are valued at cost.
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 and invested in certain
investments to meet certificate liability requirements as of June 30, 2002 and
December 31, 2001, as shown in the following table. Certificate loans, secured
by applicable certificate liabilities, are deducted from certificate reserves in
computing deposit requirements.
----------------------------
June 30, December 31,
2002 2001
------------ ------------
Total qualified assets at amortized cost $ 28,946,277 $ 22,175,092
------------ ------------
Certificate reserve under Section 28(a) $ 28,044,456 $ 21,311,350
Less: Certificate loans (94,158) (98,137)
Plus: Base capital requirement 250,000 250,000
------------ ------------
Required deposits $ 28,200,298 $ 213
------------ ------------
Excess qualified assets $ 745,979 $ 711,879
------------ ------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
SBM MN was incorporated in (Minnesota) in June 1990 to assume the
face-amount certificate business of SBM Company ("SBM"), which began in 1914.
ARM purchased most of the assets of SBM in June 1995 and continued the issuance
of face-amount certificates. The Company was formed on May 24, 2000 under the
laws of the State of Maryland. The Company is a wholly-owned subsidiary of State
Bond. The Company is an issuer of face-amount certificates and is registered
under the 1940 Act. Face-amount certificates issued by the Company entitle the
certificate holder to receive, at maturity, the principal investment and accrued
interest. As a result of the Acquisition, the Company has assumed the
obligations of SBM MN's outstanding face-amount certificates and now is the
issuer of face-amount certificates that trace their origin to the early 1900s.
Business
The Company issues and services fixed rate face-amount certificates. A
face-amount certificate is an obligation of the issuer to pay a face, or
principal, amount, plus specified interest, to the holder of the certificate.
Under the certificates, the face amount may be paid at the end of a
certificate's guarantee period or at its maturity date. Lesser amounts are paid
at such times if all or part of an investment in the certificate is withdrawn
prior to maturity or the end of any guarantee period. Interest, as described
above, may be paid quarterly or annually, or may be compounded.
The Company currently offers various series of single-payment investment
certificates. The Company's face-amount certificate operations include issuance
of single-payment certificates and the servicing of outstanding single-payment
and installment certificates, the investment of related funds, and other related
service activities.
- 8 -
SBM Certificate Company's gross income is derived primarily from the
margin between earnings on its investments and amounts paid or credited on its
fixed rate certificate deposits ("investment spread"). The Company's net
investment income is determined by deducting investment and other expenses from
its investment spread. The investment spread is affected principally by the
Company's investment decisions, general economic conditions, government monetary
policy, the policies of regulatory authorities that 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 its earnings.
The Company accrues liabilities, for which it maintains reserves for its
certificate obligations in accordance with the 1940 Act. In general, the Company
establishes its certificate liability monthly in an amount equal to the
certificates' surrender value. Under provisions of the 1940 Act, the Company is
permitted to invest its reserves only in assets that constitute "qualified
investments" and such other assets as the Securities and Exchange Commission
("SEC") may permit under the 1940 Act.
ACFC is principally a mortgage broker and lender for single-family
residential mortgages (conventional and FHA) for sale to investors. Loan
underwriting approval from investors is generally obtained, before closing with
the borrower to fund the loans. ACFC is approved as a nonsupervised lender under
the HUD Title II program, which has a required net worth based on a prescribed
calculation. ACFC also performs underwriting and closing services for the
Company, which acquires mortgage notes from ACFC. ACFC may originate and process
real estate loans directly to the Company as well as offer its loan programs to
outside mortgage brokers and bankers on a wholesale basis.
In the latter case, outside brokers will originate and process loans and
ACFC will underwrite and close the loans that meet its investment requirements.
ACFC may enter into agreements with selected outside mortgage brokers, bankers
and mortgage loan servicing companies to service certain types of mortgages that
may require special treatment because of various factors, such as the unique
features of the underlying real estate or the credit quality of the borrowers.
Competition
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, bank and thrift products. Some of
these other products are insured by governmental agencies or funds or private
third parties. For example, banks and thrifts typically have federal deposit
insurance covering monies deposited with them. The Company's certificates are
not guaranteed or insured by any governmental agency or fund or independent
third party. The Company's ability to offer competitive interest rates,
attractive terms, and efficient service are its primary basis for meeting
competition. American Express Certificate Company (formerly IDS Certificate
Company) is the Company's main competitor in the issuance of face-amount
certificates.
Results of Operations
For the three months ended June 30, 2002 compared with the three months ended
June 30, 2001
The Company had net income (loss) of $374,388 and ($364,079) for the three
months ended June 30, 2002 and 2001, respectively. The net income for the three
months ended June 30, 2002 stemmed mainly from net investment income of $262,216
as compared to the net investment loss of $448,821 for the three months ended
June 30, 2001. The increase in net investment income was due to an increase in
total investment income.
Net investment spread, which is the difference between investment income
and interest credited on certificate liability, was $982,958 during the three
months ended June 30, 2002 compared to ($23,963) for the three month period
ended June 30, 2001. On an annualized yield basis, these amounts reflect net
investment spread of 14.73% and (0.45%) for the three months ended June 30, 2002
and 2001, respectively. The Company's investment income increased to $904,403
from $393,889 for the three months ended June 30, 2002 and 2001, respectively.
The investment income represents annualized investment yields of 15.09%
- 9 -
and 8.93% on average cash and investments of $25.2 million and $20.6 million for
the three months ended June 30, 2002 and 2001, respectively. The increase in
investment income is mainly attributable to mortgage interest income earned on a
property transferred to real estate owned ("REO") and mortgage interest income
being recognized on a delinquent loan that was paid off during the three months
ended June 30, 2002. In addition, there was a higher overall yield on the
mortgage note portfolio for the three months ended June 30, 2002 as compared to
the three months ended June 30, 2001. The increase in yield was mainly due to
the Company investing in several new mortgage notes with a higher rate of
return.
Investment and other expenses were $720,742 and $424,858 for the three
months ended June 30, 2002 and 2001, respectively. The increase was due to an
increase in the administrative services fee and an increase in other expenses.
The increase in the administrative services fee was due to the payment to State
Bond in 2002 for the fee being made in the form of an administrative services
fee, whereas, for the three months ended June 30, 2001 the payment to State Bond
was in the form of both an administrative services fee and dividends. Total
dividends paid to cover the management costs and the administrative services fee
combined for the three months ended June 30, 2001 was $270,398 ($112,779 of
administrative services fee and $157,619 of dividends) compared to $350,000 of
an administrative services fee for the three months ended June 30, 2002. The
increase in other expenses from $270,230 for the three months ended June 30,
2001 to $312,877 for the three months ended June 30, 2002 was mainly due to an
increase in the advertising expense of the Company.
Net other operating income (loss) for the three months ended June 30, 2002
and 2001, was $65,600 and ($41,352), respectively. This consists of the mortgage
lender operations of ACFC. Other operating income for the three months ended
June 30, 2002 and 2001 was $440,947 and $143,551, respectively. The income is
derived from loan origination fees, gain on sale to investor and other
processing and underwriting loan fees relating to originating, selling and
brokering loans. The increase in revenue was due to an increase in the volume of
loan origination. Other operating expenses for the three months ended June 30,
2002 and 2001 were $375,347 and $184,903, respectively. The increase was mainly
due to higher commissions paid on an increased loan origination volume for the
three months ended June 30, 2002 as compared to the three months ended June 30,
2001.
Realized investment gains were $46,572 and $64,884 for the three months
ended June 30, 2002 and 2001, respectively. Realized investment gains are
primarily interest-rate related and attributable to he asset/liability
management strategies of the Company. The Company invests in a mixture of types
of investments ranging from fixed maturity securities, equity securities,
mortgage notes (originated by ACFC) and real estate tax lien certificates. The
objective of each investment is to provide a reasonable return while limiting
liquidity and credit risks.
The Company's investments in marketable maturities totaled $10,693,464 at
June 30, 2002, 39.06% of the investment portfolio. Marketable securities consist
of fixed maturity securities and equity securities. As of June 30, 2002, the
Company held no securities that had defaulted on principal or interest payments.
Fixed maturities include corporate debt, mortgage-backed securities ("MBSs") and
asset-backed securities, which include pass-through securities. MBSs are subject
to risks associated with prepayments of the underlying mortgage loans.
Prepayments cause these securities to have actual maturities different from
those expected at the time of purchase. The degree to which a security is
susceptible to either an increase or decrease in yield due to prepayment speed
adjustments is influenced by the difference between its amortized cost and par,
the relative sensitivity of the underlying mortgages backing the assets to
prepayments in a changing interest rate environment and the repayment priority
of the securities in the overall securitization structure. Prepayment
sensitivity is evaluated and monitored, giving full consideration to the
collateral characteristics such as weighted average coupon rate, weighted
average maturity and the prepayment history of the specific loan pool.
The Company's investments in residential and commercial real estate
mortgage notes receivable totaled $7,531,885 at June 30, 2002, 27.5% of the
investment portfolio. The notes accrue interest at rates ranging from 6.25% to
14.5% per annum and are secured by the underlying real property. The loan to
value ratio on all notes is no greater than 75%, which is in accordance with the
guidelines of the DC Insurance Code.
- 10 -
The Company's intention is to sell the mortgage notes held for sale to buyers
under certain favorable market conditions.
The Company's investment in REO of $2,500,912, 9.13% of the investment
portfolio at June 30, 2002, is a result of non-performing mortgage notes on
which the Company foreclosed. REO consists of two properties and the Company is
currently negotiating sale agreements on the properties. Property held for sale
of $485,102 is the cost basis of a property held by the Company. The property is
currently under contract for sale for $1,911,000. The sale is scheduled to close
in December 2002.
The Company's other significant investment type are real estate tax lien
certificates. These certificates are comprised of delinquent real estate tax
bills purchased from municipalities. They accrue interest at the rate of 20% per
annum on the outstanding taxes due and are secured by a first lien on the
property on which the tax is owed. In all cases, the certificates are
significantly over-collateralized by the underlying property. As of June 30,
2002, the tax lien certificates had a balance of $3,112,545, 11.37% of the
investment portfolio.
The Company's asset/liability management strategies seek to maximize
returns while limiting risk and allowing the Company to meet its obligations to
pay its liabilities. The Company monitors its short-term liquidity needs to
ensure that cash flow from investments allows for the payment of all of its
obligations due, including expected cash outflow to certificate holders, with
the goal of maintaining an adequate level of liquidity for maturing face-amount
certificates. In addition, the investment strategy also provides protection of
the investment portfolio from adverse changes in interest rates.
Certificate liability increased $5,732,134 or 24.06% for the six months
ended June 30, 2002, as compared to the period ended December 31, 2001, as sales
and renewals exceeded maturities and surrenders. Of the face-amount certificates
reaching their maturity date during the three month ended June 30, 2002 and
2001, 84% and 71%, respectively, were renewed.
For the six months ended June 30, 2002 compared with the six months ended June
30, 2001
The Company had net loss of $312,729 and $731,949 for the six months ended
June 30, 2002 and 2001, respectively. The net loss for the six months ended June
30, 2002 stemmed mainly from the net investment loss of $477,223 as compared to
the net investment loss of $858,785 for the six months ended June 30, 2001. The
decrease in net investment loss was due to a greater increase in total
investment income than the increase in total investment and other expenses.
Net investment spread, which is the difference between investment income
and interest credited on certificate liability, was $1,067,469 during the six
months ended June 30, 2002 compared to ($23,058) for the six months ended June
30, 2001. On an annualized yield basis, these amounts reflect net investment
spread of 8.0% and (0.43)% for the six months ended June 30, 2002 and 2001,
respectively. The Company's investment income increased to $1,309,054 from
$682,379 for the six months ended June 30, 2002 and 2001, respectively. The
investment income represents annualized investment yields of 11.53% and 7.21% on
average cash and investments of $25.2 million and $20.6 million for the six
months ended June 30, 2002 and 2001, respectively. The increase in investment
income is mainly attributable to mortgage interest income earned on a property
transferred to REO and mortgage interest income being recognized on a delinquent
loan that was paid off during the six months ended June 30, 2002. In addition,
there was a higher overall yield on the mortgage note portfolio for the six
months ended June 30, 2002 as compared to the six months ended June 30, 2001.
The increase in yield was mainly due to the Company investing in several new
mortgage notes with a higher rate of return.
Investment and other expenses were $1,544,692 and $835,727 for the six
months ended June 30, 2002 and 2001, respectively. The increase was due to an
increase in the administrative services fee and an increase in other expenses.
The increase in the administrative services fee was due to the payment to State
Bond in 2002 for the fee being made in the form of an administrative services
fee, whereas, for the six months ended June 30, 2001 the payment to State Bond
was in the form of both an administrative services fee and dividends. Total
dividends paid to cover the management costs and the administrative services fee
- 11 -
combined for the six months ended June 30, 2001 was $796,073 ($216,139 of
administrative services fee and $579,934 of dividends) compared to $872,000 of
an administrative services fee for the six months ended June 30, 2002. The
increase in other expenses from $313,625 for the six months ended June 30, 2001
to $524,720 for the six months ended June 30, 2002 was mainly due to an increase
in the advertising expense of the Company.
Net other operating income (loss) for the six months ended June 30, 2002
and 2001, was $92,857 and $6,893, respectively. This consists of the mortgage
lender operations of ACFC. Other operating income for the six months ended June
30, 2002 and 2001 was $900,452 and $370,573, respectively. The income is derived
from loan origination fees, gain on sale to investor and other processing and
underwriting loan fees relating to originating, selling and brokering loans. The
increase in revenue was due to an increase in the volume of loan origination.
Other operating expenses for the six months ended June 30, 2002 and 2001 were
$807,595 and $363,680, respectively. The increase was mainly due to higher
commissions paid on an increased loan origination volume for the six months
ended June 30, 2002 as compared to the six months ended June 30, 2001.
Realized investment gains were $143,760 and $58,733 for the six months
ended June 30, 2002 and 2001, respectively.
ITEM 3A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Most of the Company's qualified assets are represented by marketable
securities, real estate mortgage notes, property held for sale and real estate
tax lien certificates. The management of interest rates between those earned on
the Company's investments and those paid under the face-amount certificates is
fundamental to the Company's investment decisions. Both rates are sensitive to
changes in the general level of interest rates in the economy, as well as to
competitive factors in the case of the certificates.
At June 30, 2002, the Company has $10.7 million invested in marketable
securities, which consists of fixed maturity securities and equity securities.
Fixed maturity securities consist of US Treasuries, municipal bonds, MBS's and
corporate debt. The market value of these investments fluctuates with changing
economic conditions. All are influenced greatly by market interest rates.
Corporate debt market value is also weighed by the performance of the Company
that issued the debt. Upgrades or downgrades in the rating of a corporate bond
will increase or decrease the market value of such investment. The Company's
investments in equity securities are subject to market risk and fluctuations in
the market value of the securities. Fluctuations in market value of marketable
securities affect the yield on the investment and could result in a reduction in
the principal amount invested in the security. The Company takes into account
the current and expected future market environment in evaluating investment risk
and investment yields.
The Company has $10.5 million of its portfolio invested in real estate and
real estate loans, which includes $7.5 million of mortgage notes held for sale,
$.5 million of property held for sale and $2.5 million of REO. Over time, it
anticipates increasing this segment of its investment portfolio to enhance the
Company's return on investment. Fluctuations in the value of the underlying real
estate represent the greatest risk factor for this investment strategy. However,
the Company will invest only in those loans that have a history of producing
income, are of high quality by industry standards or have underlying properties
that represent excellent values and safety relative to the market. The mortgage
notes must have a loan to value ratio no greater than 75% for the investment to
be a qualified asset as defined by the provisions of the Insurance Code at the
District of Columbia.
The Company also invests in real estate tax lien certificates, which have
a balance of $3.1 million at June 30, 2002. The greatest risk associated with
this investment is the time and costs of a foreclosure process when amounts
remain unpaid beyond the Company's aging policy. The risk is mitigated by the
Company's first priority lien on the property on which the tax is owed, and the
Company's general policy of securing these investments only with properties in
which the amount advanced by the Company to acquire the certificates is less
than 5% of the market value of the property that secures the investment.
- 12 -
In addition to standard methods used to analyze interest rate sensitivity,
the Company regularly analyzes the potential impact of a range of different
interest rate models. These provide "benchmarks" for assessing the impact on
Company earnings if rates moved higher or lower than the expected targets set in
our investment guidelines. The Company will continue to formulate strategies
directed at protecting earnings from the potential negative effects of changes
in interest rates.
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 six months ended
June 30, 2002.
EXHIBITS
(99.1) Form 8-K Current Report of the Company, incorporated by
reference to Form 8-K dated October 3, 2002 (File No.
811-06268).
(99.2) Written Statement of the Chief Executive Officer.
(99.3) Written Statement of the Chief Financial Officer.
- 13 -
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Company has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on November 1, 2002.
SBM CERTIFICATE COMPANY
By: /s/ Eric M. Westbury
----------------------------
President
By: /s/ Trey Stafford
----------------------------
Chief Financial and Accounting Officer
- 14 -
CERTIFICATION
I, Eric M. Westbury, certify that:
1. I have reviewed this quarterly report on Form 10-Q of the registrant, SBM
Certificate Company;
2. Based on my knowledge, this amended quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
amended quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this amended quarterly report, fairly present in all
material respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this amended
quarterly report;
Date: November 1, 2002
/s/ Eric M. Westbury
---------------------------------
Eric M. Westbury
President
(Principal Executive Officer)
CERTIFICATION
I, Trey Stafford, certify that:
1. I have reviewed this quarterly report on Form 10-Q of the registrant, SBM
Certificate Company;
2. Based on my knowledge, this amended quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
amended quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this amended quarterly report, fairly present in all
material respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this amended
quarterly report;
Date: November 1, 2002
/s/ Trey Stafford
-------------------------------------------
Trey Stafford
Chief Financial and Accounting Officer
(Principal Financial Officer)