SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the period ended: September 30, 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
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). |_| Yes |X| No
As of November 20, 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 registrant's Form 8-K Current Report dated
October 3, 2002 ("October Form 8-K"). Because of the transactions described in
the October Form 8-K, the registrant has restated its financial statements for
the years ended December 31, 2001 and December 31, 2000, and amended all of its
Form 10-Q Quarterly Reports affected since December 31, 2000. In addition,
certain narrative disclosures have been revised. The transactions described in
the October Form 8-K prevented the registrant from filing its Form 10-Q for the
period ended September 30, 2002, on a timely basis.
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Table of Contents
Part I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets as of September 30, 2002
(unaudited) and December 31, 2001...................................3
Consolidated Statements of Operations for the three months ended
September 30, 2002 (unaudited) and September 30, 2001 (unaudited)...4
Consolidated Statements of Operations for the nine months ended
September 30, 2002(unaudited) and September 30, 2001 (unaudited)....4
Consolidated Statements of Cash Flows for the nine months ended
September 30, 2002 (unaudited) and September 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...........13
Item 4 CONTROLS AND PROCEDURES..............................................13
Part II. OTHER INFORMATION....................................................14
Item 1. LEGAL PROCEEDINGS ...................................................14
Item 6. EXHIBITS AND REPORTS ON FORM 8-K REPORTS.............................14
SIGNATURES ...................................................................15
CERTIFICATIONS
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SBM CERTIFICATE COMPANY AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2002 2001
------------ ------------
(unaudited)
ASSETS
Cash and investments
Marketable securities, available-for-sale, at fair value
(amortized cost: $10,073,466 and $6,440,016) $ 7,403,493 $ 6,774,313
Mortgage notes held for sale 11,159,106 5,436,118
Mortgage notes held for investment -- 731,482
Real estate tax lien certificates 2,206,560 2,628,528
Property held for sale 503,925 419,923
Real estate owned 2,645,324 --
Residual mortgage certificate 4,178,571 --
Escrows -- 608,037
Certificate loans 76,359 98,137
Cash and cash equivalents 5,082,094 5,538,094
------------ ------------
Total cash and investments 33,255,432 22,234,632
------------ ------------
Receivables
Dividends and interest 343,529 372,894
------------ ------------
Total receivables 343,529 372,894
------------ ------------
Total qualified assets 33,598,961 22,607,526
Other assets
Related party receivable 123,625 47,787
Fixed assets, net of accumulated depreciation
of $39,112 and $20,657 206,583 204,606
Goodwill 591,463 591,463
Deferred acquisition costs 607,672 420,093
Due from shareholder 1,039,721 812,218
Allowance - Due from shareholder (1,039,721) (812,218)
Other assets 51,293 9,219
------------ ------------
TOTAL ASSETS $ 35,179,597 $ 23,880,694
============ ============
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities
Statutory certificate liability 31,078,753 21,311,350
Additional certificate liability 1,892,979 2,509,700
Warehouse line of credit 4,704,400 --
Deferred revenue 446,275 --
Accounts payable and other liabilities 256,861 307,463
Related party payable 56,792 23,211
------------ ------------
Total liabilities 38,436,060 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 (loss), net of taxes (2,669,973) 217,448
Retained earnings (deficit) (4,698,308) (3,961,069)
------------ ------------
Total shareholder's equity (deficit) (3,256,463) (271,030)
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY $ 35,179,597 $ 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ----------------------------
2002 2001 2002 2001
--------- --------- ----------- -----------
Investment income
Interest and dividend income $ 167,301 $ 181,922 $ 506,978 $ 708,090
Other investment income 11,288 1,230 20,362 12,653
Mortgage interest income 434,221 420,758 1,390,516 577,374
--------- --------- ----------- -----------
Total investment income 612,810 603,910 1,917,856 1,298,117
--------- --------- ----------- -----------
Investment and other expenses
Administrative services fee 535,000 434,700 1,407,000 650,839
Deferred acquisition cost amortization 41,871 27,010 121,081 72,740
Amortization of goodwill -- 10,886 -- 32,658
Depreciation expense 6,392 17,497 18,454 18,393
Reserve for losses - shareholder receivable 170,803 232,417 227,503 469,982
Other expenses 64,262 156,119 588,983 469,744
--------- --------- ----------- -----------
Total investment and other expenses 818,328 878,629 2,363,021 1,714,356
Interest credited on certificate liabilities 523,247 250,672 764,833 967,532
--------- --------- ----------- -----------
Net investment loss before income tax (728,765) (525,391) (1,209,998) (1,383,771)
--------- --------- ----------- -----------
Other operating income:
Origination fee income 102,732 227,399 476,788 535,739
Gain on sale of mortgage notes 452,146 -- 866,640 --
Other loan fee income 113,010 68,741 225,870 130,974
--------- --------- ----------- -----------
Total other operating income 667,888 296,140 1,569,298 666,713
--------- --------- ----------- -----------
Other operating expenses:
Salaries and commissions 369,045 189,470 901,594 448,018
Other expenses 324,058 44,021 596,055 149,558
--------- --------- ----------- -----------
Total other operating expenses 693,103 233,491 1,497,649 597,576
--------- --------- ----------- -----------
Net other operating income (loss) before income tax (25,215) 62,649 71,649 69,137
--------- --------- ----------- -----------
Net investment and other operating loss before income tax (753,980) (462,742) (1,138,349) (1,314,634)
Deferred tax asset valuation allowance benefit (expense) -- 206,107 (72,123) 267,317
--------- --------- ----------- -----------
Net investment and other operating loss (753,980) (256,635) (1,210,472) (1,047,317)
--------- --------- ----------- -----------
Realized investment gains 329,472 14,617 473,232 73,350
Income tax expense on realized investment gains -- -- -- --
--------- --------- ----------- -----------
Net realized investment gains 329,472 14,617 473,232 73,750
--------- --------- ----------- -----------
Net loss $(424,508) $(242,018) $ (737,240) $ (973,967)
========= ========= =========== ===========
SEE ACCOMPANYING NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
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SBM CERTIFICATE COMPANY AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, (Unaudited)
2002 2001
------------ -----------
Cash flows provided by (used in) operating activities
Net loss $ (737,240) $ (973,967)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities
Provision for certificate liability 764,833 967,532
Reserve for losses - shareholder receivable 227,503 469,982
Realized investment gains (473,232) (73,350)
Deferral of revenue 446,275 --
Deferred tax asset valuation allowance 72,123 (267,317)
Deferral of acquisition costs (229,450) (361,595)
Amortization of deferred acquisition costs 41,871 72,740
Amortization and depreciation 18,454 51,051
Increase in dividends and interest receivable (87,154) (210,212)
Changes in other assets and liabilities 28,302 (1,140,481)
------------ -----------
Net cash used in operating activities (72,285) (1,465,617)
------------ -----------
Cash flows from investing activities
Marketable securities:
Purchases (7,773,430) --
Sales and redemptions 4,730,061 4,876,805
Purchase of mortgage notes held for sale (8,325,950) (2,193,225)
Principal payments received on mortgage notes receivable 2,208,250 893,231
Investment in mortgage notes held for investment -- (15,000)
Real estate tax lien certificates:
Purchases (2,245,527) (4,162,810)
Repayments of tax certificates 1,965,286 813,036
Purchase of fixed assets (20,431) (148,227)
Repayment of certificate loans, net 21,778 354
------------ -----------
Net cash provided by (used in) investing activities (9,439,963) 64,164
------------ -----------
Cash flows from financing activities
Amounts paid to face-amount certificate holders (1,462,757) (4,089,402)
Amounts received from face-amount certificate holders 9,848,606 4,202,826
Proceeds from (repayment of) warehouse line borrowings, net 4,704,400 --
Net dividends paid -- (579,934)
------------ -----------
Net cash provided by (used in) financing activities 13,090,249 (466,510)
------------ -----------
NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS (456,000) (1,867,963)
Cash and cash equivalents, beginning 5,538,094 3,716,393
------------ -----------
Cash and cash equivalents, end $ 5,082,094 $ 1,848,430
============ ===========
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
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SBM CERTIFICATE COMPANY AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
September 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") and State Bond
is a wholly owned subsidiary of 1st Atlantic Guaranty Corporation ("1st
Atlantic"), a Maryland corporation. 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
$1,000,000 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 nine months ended September 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 1940 Act.
State Bond effected the Acquisition as assignee under a Stock Purchase
Agreement, dated March 28, 2000, by and among 1st Atlantic, SBM-MN and ARM.
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
was held by an escrow agent as security for certain post-closing obligations and
liabilities of ARM under the Stock Purchase Agreement. In October 2001, a final
settlement was reached with ARM relating to these post-closing obligations,
whereby, the Company received $278,333 and the remainder of the escrow monies
was released to ARM. The Acquisition was accounted for as a reverse merger using
the purchase method of accounting, whereby SBM-MD became the surviving
corporation.
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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.
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 (the "1933 Act"), Securities Exchange Act of 1934 (the "1934 Act") and the
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. DUE FROM SHAREHOLDER
Due from shareholder represents amounts paid to John J. Lawbaugh, the
controlling shareholder of 1st Atlantic, directly or through companies
affiliated with Mr. Lawbaugh and other costs incurred by the Company as a result
of these payments. As of September 30, 2002, these amounts totaled $1,039,721.
An allowance for uncollectible amounts due from shareholder has been recorded
for the full amount due with a corresponding charge to operations. As of
September 30, 2002, the allowance totaled $1,039,721.
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 ($31.3 million and $21.5 million at September 30,
2002 and December 31, 2001, respectively). The Company had qualified assets (at
amortized cost) of $31.5 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 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.
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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 September 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.
------------ ------------
September 30, December 31,
2002 2001
------------ ------------
Total qualified assets at amortized cost $ 31,488,175 $ 22,175,092
------------ ------------
Certificate reserve under Section 28(a) $ 31,078,753 $ 21,311,350
Less: Certificate loans $ (76,359) $ (98,137)
Plus: Base capital requirement $ 250,000 $ 250,000
------------ ------------
Required deposits $ 31,252,394 $ 21,463,213
------------ ------------
Excess qualified assets $ 235,781 $ 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.
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
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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. 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.
Certain Significant Events
Recently, management of the Company discovered facts that came to its
attention regarding several transactions (the "Questioned Transactions")
involving the Company. The Questioned 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 1933 Act and the 1934 Act,
caused the Company to improperly report asset balances, and diverted cash assets
of the Company to himself directly or indirectly during 2000, 2001 and 2002
totaling $1,768,917, of which $900,000 was repaid by Mr. Lawbaugh to the
Company. The balance of $868,417, together with legal and accounting costs
incurred by the Company because of these matters, which totaled $170,804 as of
September 30, 2002, constitute the due from shareholder on the Consolidated
Balance Sheet of the Company as of September 30, 2002 of $1,039,721. An
allowance for uncollectible amounts due from shareholder has been recorded for
the full amount due from the shareholder with a corresponding charge to
operations.
The following summarizes the impact of the Questioned Transactions on the
Company for the respective periods:
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NINE MONTHS ENDED YEAR ENDED YEAR ENDED
SEPTEMBER 30, 2002 DECEMBER 31, 2001 DECEMEBR 31, 2000 TOTAL
------------------ ----------------- ----------------- ------------
Qualified Assets $ (56,700) $(1,396,907) $ (292,236) $(1,745,843)
Additional Paid in Capital $ -- $ (707,550) $ -- $ (707,550)
Shareholder's Equity $ (227,503) $(1,146,957) $ (292,236) $(1,666,696)
Net Loss $ (227,503) $ (439,407) $ (292,236) $ (959,646)
Due to the discovery of the Questioned Transactions, the Company suspended
the sale of its face-amount certificates on August 16, 2002. The Company
restated its financial statements and added disclosure to its Form 10-Q
Quarterly Reports and Form 10-K Annual Reports filed with the SEC for the
periods affected to properly reflect the nature and affects of these
transactions. The Company has not yet resumed sales. An amendment to the
Company's 1933 Act registration statement for its face-amount certificates is
pending at the SEC.
As a result of the Questioned Transactions, 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.
Further, on November 12, 2002, Mr. Lawbaugh resigned from the Board of
Directors of the Company and on November 14, 2002, entered into a Stock Escrow
Agreement ("Escrow Agreement"). The Escrow Agreement places Mr. Lawbaugh's
shares of 1st Atlantic capital stock into escrow and removes his voting rights
associated with the shares.
Results of Operations
For the three months ended September 30, 2002 compared with the three months
ended September 30, 2001
The Company had a net loss of $424,508 and $242,018 for the three months
ended September 30, 2002 and 2001, respectively. The net loss for the three
months ended September 30, 2002 and September 30, 2001, respectively, stemmed
mainly from net investment loss of $728,765 and $525,391. The increase in net
investment loss was due to an increase in the interest credited on certificate
liabilities.
Net investment spread, which is the difference between investment income
and interest credited on certificate liability, was $89,563 during the three
months ended September 30, 2002 compared to $353,238 for the three month period
ended September 30, 2001. On an annualized yield basis, these amounts reflect
net investment spread of 1.26% and 6.58% for the three months ended September
30, 2002 and 2001, respectively. The Company's investment income increased to
$612,810 from $603,910 for the three months ended September 30, 2002 and 2001,
respectively. The investment income represents annualized investment yields of
13.41% and 11.62% on average cash and investments of $28.1 million and $21.3
million for the three months ended September 30, 2002 and 2001, respectively.
Investment and other expenses were $818,328 and $878,629 for the three
months ended September 30, 2002 and 2001, respectively. Investment and other
expenses is comprised mainly of the administrative services fee paid to State
Bond, reserve for losses on the shareholder receivable and other expenses. The
losses on the shareholder receivable relate to an allowance established on
uncollectible amounts due from
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shareholder (see Note 4 of the Notes to Consolidated Financial Statements).
Other expenses consists mainly of legal fees, accounting fees and advertising
costs.
Net other operating income (loss) for the three months ended September 30,
2002 and 2001, was ($25,215) and $62,649, respectively. This consists of the
mortgage lender operations of ACFC. Other operating income for the three months
ended September 30, 2002 and 2001 was $667,888 and $296,140, respectively. The
income is derived from loan origination fees, gain on sale of mortgage notes 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 September
30, 2002 and 2001 were $693,103 and $233,491, respectively. The increase was
mainly due to more commissions paid from an increase in loan origination volume
for the three months ended September 30, 2002 as compared to the three months
ended September 30, 2001.
Realized investment gains were $329,472 and $14,617 for the three months
ended September 30, 2002 and 2001, respectively. Realized investment gains are
primarily interest-rate related and attributable to the asset/liability
management strategies of the Company. The Company invests in various 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 securities totaled $7,403,493 at
September 30, 2002, 22.26% of the investment portfolio. Marketable securities
consist of fixed maturity securities and equity securities. As of September 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 real estate mortgage notes
receivable totaled $11,159,106 at September 30, 2002, 33.56% 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. 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 real estate owned ("REO") of $2,645,324, 7.95%
of the investment portfolio at September 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 $503,925 is the cost basis of a property held by the
Company. The property is currently under contract for sale for $2.3 million. The
sale is scheduled to close in December 2002.
In July 2002, the Company purchased an interest in a residual mortgage
certificate for $4,500,000. The residual interest represents a right to receive
excess cash flow, if any, from a securitization trust, or REMIC. The assets of
the securitization trust consist of single-family residential first mortgages
with maturity dates through 2026. Although maturity dates extend through 2026,
due to prepayment risk, management estimates a much shorter life of the trust's
underlying mortgages. As of September 30, 2002, the residual mortgage
certificate had a balance of $4,178,571, 12.44% of the investment portfolio.
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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, are payable by the property owner 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 September 30, 2002, the tax lien certificates had a balance of
$2,206,560, 6.64% 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 $3,418,540 or 11.57% for the three months
ended September 30, 2002, as compared to the period ended June 30, 2002, as
sales and renewals exceeded maturities and surrenders. Of the face-amount
certificates reaching their maturity date during the three month ended September
30, 2002 and 2001, 84% and 73%, respectively, were renewed.
For the nine months ended September 30, 2002 compared with the nine months ended
September 30, 2001
The Company had net loss of $737,240 and $973,967 for the nine months
ended September 30, 2002 and 2001, respectively. The net loss for the nine
months ended September 30, 2002 stemmed mainly from the net investment loss of
$1,209,998 as compared to the net investment loss of $1,383,771 for the nine
months ended September 30, 2001. The decrease in net investment loss was due to
an increase in total investment income for the nine months ended September 30,
2002, as compared to the nine months ended September 30, 2001.
Net investment spread, which is the difference between investment income
and interest credited on certificate liability, was $1,153,023 during the nine
months ended September 30, 2002 compared to $330,585 for the nine months ended
September 30, 2001. On an annualized yield basis, these amounts reflect net
investment spread of 5.41% and 2.05% for the nine months ended September 30,
2002 and 2001, respectively. The Company's investment income increased to
$1,917,856 from $1,298,117 for the nine months ended September 30, 2002 and
2001, respectively. The investment income represents annualized investment
yields of 11.34% and 8.59% on average cash and investments of $28.1 million and
$21.3 million for the nine months ended September 30, 2002 and 2001,
respectively. The increase in investment income is mainly attributable to a
higher overall yield on the mortgage note portfolio for the nine months ended
September 30, 2002 as compared to the nine months ended September 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 $2,363,021 and $1,714,356 for the
nine months ended September 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 nine months ended September 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 nine months ended September 30,
2001 was $1,230,773 ($650,839 of administrative services fee and $579,934 of
dividends) compared to $1,407,000 of an administrative services fee for the nine
months ended September 30, 2002. The increase in other expenses from $469,744
for the nine months ended September 30, 2001 to $588,983 for the nine months
ended September 30, 2002 was mainly due to an increase in the advertising
expense of the Company.
Net other operating income for the nine months ended September 30, 2002
and 2001, was $71,649 and $69,137, respectively. This consists of the mortgage
lender operations of ACFC and revenue recognized from a deferred origination fee
on a loan held by SBM. Other operating income for the nine months ended
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September 30, 2002 and 2001 was $1,569,298 and $666,713, respectively. The
income is derived from loan origination fees, gain on sale of mortgage notes 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 and the recognition of a deferred origination fee by SBM. Other
operating expenses for the nine months ended September 30, 2002 and 2001 were
$1,497,649 and $597,576, respectively. The increase was mainly due to more
commissions paid from an increase in loan origination volume for the nine months
ended September 30, 2002 as compared to the nine months ended September 30,
2001.
Realized investment gains were $473,232 and $73,350 for the nine months
ended September 30, 2002 and 2001, respectively.
ITEM 3. 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, interest in a
residual mortgage certificate 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 September 30, 2002, the Company has $7.4 million invested in marketable
securities, which consists of fixed maturity securities and equity securities.
Fixed maturity securities consist of US Treasuries, municipal bonds,
mortgage-backed securities 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 $14.3 million of its portfolio invested in real estate and
real estate loans, which includes $11.2 million of mortgage notes held for sale,
$.5 million of property held for sale and $2.6 million of REO. 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 $2.2 million at September 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.
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.
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ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Within 90 days prior to the filing date of this Quarterly Report on Form
10-Q (the "Evaluation Date"), the Company's chief executive officer and chief
financial officer evaluated the effectiveness of the Company's disclosure
controls and procedures. Based on this evaluation, the Company's chief executive
officer and chief financial officer concluded that the disclosure controls and
procedures are effective to ensure that information required to be disclosed in
reports that are filed or submitted under the 1934 Act is adequately disclosed
and accurately reported. There were no significant changes in internal controls
or in other factors that significantly affect internal controls subsequent to
the Evaluation Date.
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
(a) EXHIBITS
(99.1) Written Statement of the Chief Executive Officer.
(99.2) Written Statement of the Chief Financial Officer.
(b) REPORTS ON FORM 8-K
The Company filed one report on Form 8-K during the three months
ended September 30, 2002. The Company's Form 8-K Report dated
August 16, 2002 was filed by the Company on August 20, 2002.
-14-
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on November 25, 2002.
Date: November 25, 2002 SBM CERTIFICATE COMPANY
/s/ Eric M. Westbury
----------------------------
President
Date: November 25, 2002 /s/ Trey Stafford
----------------------------
Chief Financial and Accounting
Officer
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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 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 quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this 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 quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report is
being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: November 25, 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 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 quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this 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 quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report is
being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: November 25, 2002
/s/Trey Stafford
---------------------------------
Trey Stafford
Chief Financial and Accounting Officer
(Principal Financial Officer)