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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the period ended: March 31, 2003
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. |X| Yes |_| 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 May 15, 2003, 250,000 shares of the registrant's common stock were
outstanding; all of which are privately owned and not traded on a public market.
Because of the transactions and events described in the registrant's Form
8-K Current Reports dated August 16, 2002, October 3, 2002, and November 12,
2002, 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 were revised.
Table Of Contents
Part I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets as of March 31, 2003
(unaudited) and December 31, 2002...............................3
Consolidated Statements of Operations for the three months ended
March 31, 2003 (unaudited) and March 31, 2002 (unaudited).......4
Consolidated Statements of Cash Flows for the three months ended
March 31, 2003 (unaudited) and March 31, 2002 (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..............................................14
Part II. OTHER INFORMATION...................................................15
Item 1. LEGAL PROCEEDINGS ...................................................15
Item 6. EXHIBITS AND REPORTS ON FORM 8-K REPORTS.............................15
SIGNATURES ...................................................................15
CERTIFICATIONS
- 2 -
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SBM Certificate Company and Subsidiary
CONSOLIDATED BALANCE SHEETS
March 31, 2003 December 31, 2002
-------------- -----------------
(unaudited)
ASSETS
Cash and investments
Available-for-sale securities
(amortized cost: $11,235,134 and $11,245,510) $ 9,167,550 $ 9,190,162
Mortgage notes held for sale 10,374,315 13,163,828
Real estate tax lien certificates 1,342,955 1,632,437
Real estate owned 2,654,426 2,647,095
Residual mortgage certificate 3,973,006 4,038,607
Escrows 100,000 100,000
Certificate loans 77,629 77,462
Cash and cash equivalents 4,551,883 2,230,886
------------ ------------
Total cash and investments 32,241,764 33,080,477
------------ ------------
Receivables
Dividends and interest 428,491 394,749
------------ ------------
Total receivables 428,491 394,749
------------ ------------
Total qualified assets 32,670,255 33,475,226
Other assets
Related party receivable 121,934 129,351
Fixed assets, net of accumulated depreciation
of $54,125 and $46,134 212,491 215,417
Goodwill 591,463 591,463
Deferred acquisition costs, net 549,853 581,534
Due from shareholder 1,356,026 1,218,181
Allowance - due from shareholder (1,356,026) (1,218,181)
Other assets
234,221 122,069
------------ ------------
TOTAL ASSETS $ 34,380,217 $ 35,115,060
============ ============
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities
Statutory certificate liability 31,577,869 31,418,457
Additional certificate liability 1,423,453 1,770,369
Warehouse line of credit 1,788,000 2,542,600
Deferred revenue 2,000,054 1,640,425
Real estate liabilities 870,317 870,317
Accounts payable and other liabilities 275,270 335,882
Related party payable 456 117,925
------------ ------------
Total liabilities 37,935,419 38,695,975
------------ ------------
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 3,861,818
Accumulated comprehensive income (loss), net of taxes (2,067,584) (2,055,348)
Accumulated deficit (5,599,436) (5,637,385)
------------ ------------
Total shareholder's equity (deficit) (3,555,202) (3,580,915)
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY $ 34,380,217 $ 35,115,060
============ ============
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
MARCH 31,
------------------------
2003 2002
--------- ---------
Investment income
Interest and dividend income $ 141,162 $ 157,866
Other investment income 23,261 7,838
Loan fee income 75,173 --
Mortgage interest income 465,983 238,946
--------- ---------
Total investment income 705,579 404,650
--------- ---------
Investment and other expenses
Administrative services fee 113,000 522,000
Deferred acquisition cost amortization and renewal commissions 66,221 43,996
Depreciation expense 7,993 5,911
Other expenses 61,107 211,843
--------- ---------
Total investment and other expenses 248,321 783,750
--------- ---------
Interest credited on certificate liability 384,886 320,140
--------- ---------
Net investment income (loss) before income taxes 72,372 (699,240)
--------- ---------
Other operating income:
Origination fee income 129,147 149,045
Gain on sale to investor 640,743 245,691
Other loan fee income 131,261 64,770
--------- ---------
Total other operating income 901,151 459,506
--------- ---------
Other operating expenses:
Salaries and commissions 588,945 332,619
Other expenses 173,197 99,629
Warehouse interest expense and charges, net 35,498 --
--------- ---------
Total other operating expenses 797,640 432,248
--------- ---------
Net other operating income before income taxes 103,511 27,258
--------- ---------
Net investment and other operating income (loss) before income taxes 175,883 (671,982)
Deferred tax asset valuation allowance expense -- (72,123)
--------- ---------
Net investment and other operating income (loss) 175,883 (744,105)
Net realized investment gains (losses) (89) 97,188
--------- ---------
Net operating income (loss) 175,794 (646,917)
--------- ---------
Non operating expense:
Reserve for losses - shareholder receivable (137,845) (40,200)
--------- ---------
Net income (loss) $ 37,949 $(687,117)
========= =========
SEE ACCOMPANYING NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
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SBM Certificate Company and Subsidiary
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, (Unaudited)
2003 2002
----------- -----------
Cash flows provided by (used in) operating activities
Net income (loss) $ 37,949 $ (687,117)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities
Interest credited on certificate liability 384,886 320,140
Reserve for losses - shareholder receivable 137,845 40,200
Realized investment (gains) losses 89 (97,188)
Deferral of revenue 359,629 --
Deferred tax asset valuation allowance -- 72,123
Deferral of acquisition costs (13,273) (65,870)
Amortization of deferred acquisition costs and renewal
commissions 44,954 43,996
Depreciation 7,993 5,911
Increase in dividends and interest receivable (33,742) (81,770)
Decrease in mortgage notes held for sale 2,403,374 --
Increase in shareholder receivable (137,845) --
Changes in other assets and liabilities (309,180) 355,099
----------- -----------
Net cash provided by (used in) operating activities 2,882,679 (94,476)
----------- -----------
Cash flows from investing activities
Sales and redemptions of available-for-sale securities 10,287 395,086
Purchase of mortgage notes receivable (937,146) (99,000)
Principal payments received on mortgage notes receivable 1,342,317 340,792
Principal payments received on residual mortgage certificate 65,601 --
Repayments of real estate tax lien certificates 289,482 289,008
Purchase of fixed assets (5,066) (14,165)
Repayment of certificate loans, net (167) 5,230
----------- -----------
Net cash provided by investing activities 765,308 916,951
----------- -----------
Cash flows from financing activities
Amounts paid to face-amount certificate holders (572,390) (311,141)
Amounts received from face-amount certificate holders -- 2,069,418
Warehouse line of credit borrowings, net (754,600) --
----------- -----------
Net cash provided by (used in) financing activities (1,326,990) 1,758,277
----------- -----------
NET INCREASE IN CASH
AND CASH EQUIVALENTS 2,320,997 2,580,752
Cash and cash equivalents, beginning 2,230,886 5,538,094
----------- -----------
Cash and cash equivalents, end $ 4,551,883 $ 8,118,846
=========== ===========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- 5 -
SBM Certificate Company and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
March 31, 2003
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 three months ended March 31,
2003, are not necessarily indicative of those to be expected for the year ending
December 31, 2003. For further information, refer to the financial statements
and footnotes thereto included in the Company's annual report on Form 10-K for
the year ended December 31, 2002.
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.
- 6 -
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, SBM-MN paid a dividend to ARM in
an amount equal to SBM-MN'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
annually 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
majority 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 March 31, 2003, these amounts totaled $1,356,026. An allowance
for uncollectible amounts due from shareholder has been recorded for the full
amount due with a corresponding charge to operations. As of March 31, 2003, the
allowance totaled $1,356,026. See "Certain Significant Events" in "Item 2:
Management's Discussion and Analysis of Financial Condition and Results of
Operations" for further description of due from shareholder.
5. REGULATORY MATTERS
The Company is subject to restrictions relating to its regulatory capital
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 ($31.8 million and $31.6 million at March 31, 2003
and December 31, 2002, respectively). The Company had qualified assets (at
amortized cost) of $32.3 million and $32.3 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, available-for-sale securities are carried at fair value. For
qualified asset purposes, available-for-sale securities are valued at amortized
cost.
- 7 -
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 March 31, 2003 and
December 31, 2002, as shown in the following table. Certain assets on deposit
are not considered qualified assets for the purposes of this calculation because
they are reserved for the repayment of existing liabilities. Certificate loans,
secured by applicable certificate liabilities, are deducted from certificate
reserves in computing deposit requirements.
March 31, 2003 December 31, 2002
-------------- -----------------
Total qualified assets on deposit $ 34,653,497 $ 35,453,112
Less: Qualified assets reserved by Provident warehouse line $ (1,788,000) $ (2,547,954)
Less: Qualifies assets reserved for real estate liens (590,000) (590,000)
------------ ------------
Total qualified assets $ 32,275,497 $ 32,315,158
------------ ------------
Certificate reserve under Section 28(a) $ 31,577,869 $ 31,418,457
Less: Certificate loans (77,629) (77,462)
Plus: Base capital requirement 250,000 250,000
------------ ------------
Required deposits $ 31,750,240 $ 31,590,995
------------ ------------
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 is a face-amount certificate company registered under the 1940
Act that 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. 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 may be paid quarterly or annually, or may be compounded.
The Company issues various series of single-payment investment
certificates with guarantee periods of three, five, seven and ten years,
respectively. Unless otherwise instructed by the holder, a certificate, by its
terms, automatically continues for another guarantee period of the same duration
until the certificate's maturity date. The certificates mature no later than 30
years from the date they are issued. 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. As indicated below under
"Certain Significant Events," the Company
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suspended the sale of its certificates on August 16, 2002. Any use in this Form
10-Q Annual Report of the term "offer," "sale" or "issues" and any discussion in
that context, is qualified by such suspension.
The Company periodically declares the interest rates payable for a
certificate's guarantee period. The interest rate declared is applicable for the
entire guarantee period. The prevailing interest rates available on
interest-bearing instruments are a primary consideration in deciding upon the
interest rates declared by the Company. However, the Company has complete
discretion as to what interest rates it declares for the certificates. At the
end of a guarantee period, the interest rates in effect for the succeeding
guarantee period may be greater or lesser than the rates in effect for the
expiring guarantee period.
The 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 liability ("investment spread"). The Company's net income is
determined by deducting investment and other expenses and federal income taxes
from the 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 SEC may permit under the 1940 Act.
ACFC principally is a mortgage lender and mortgage broker of single-family
residential mortgages (conventional and FHA), which are sold to investors. ACFC
is approved as a nonsupervised lender under the HUD Title II program, which has
a required net worth based on a prescribed calculation.
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.
Certain Significant Events
In 2002, 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 former 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 $868,917, together with legal and
accounting costs incurred by the Company because of these matters, which totaled
$487,109 as of March 31, 2003, constitute the amounts due from shareholder
totaling $1,356,026 on the March 31, 2003 Consolidated Balance Sheet of the
Company. 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.
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 and authorized an
- 9 -
investigation into the Questioned Transactions. The investigation was performed
by the Company's management under the supervision of two directors of the Board
(the "Special Committee") and the Company's independent auditors. 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. In addition, the Company suspended the sale of its
face-amount certificates on August 16, 2002. The Company restated its financial
statements and amended its Form 10-Q Quarterly Reports and Form 10-K Annual
Reports filed with the Securities and Exchange Commission (the "SEC") for the
periods affected to properly reflect the nature and effect of these
transactions. The Company has not yet resumed the sale of its face-amount
certificates and cannot, at this time, state when the sale of its certificates
will resume.
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 placed Mr. Lawbaugh's shares of 1st
Atlantic capital stock, representing majority ownership of 1st Atlantic, into
escrow and removed his voting rights associated with the shares. The Company
filed a Form 8-K Current Report dated November 12, 2002, with the SEC on
November 27, 2002. That Form 8-K Current Report describes the terms and
conditions of the Escrow Agreement, which, among other things, provides for the
sale of all of Mr. Lawbaugh's shares of 1st Atlantic capital stock.
The following summarizes the impact of the Questioned Transactions on the
Company for the respective periods indicated:
THREE MONTHS
ENDED YEAR ENDED YEAR ENDED YEAR ENDED
MARCH 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
2003 2002 2001 2000 TOTAL
----------- ----------- ----------- ----------- -----------
Qualified Assets $ (137,845) $ (56,700) $(1,396,907) $ (292,236) $(1,883,688)
Additional Paid in Capital $ -- $ -- $ (707,550) $ -- $ (707,550)
Shareholder's Equity $ (137,845) $ (265,762) $(1,146,957) $ (292,236) $(1,842,800)
Net Loss $ (137,845) $ (365,763) $ (439,407) $ (292,236) $(1,235,251)
Potential Impact of Certain Regulatory Concerns
Since the filing of its Form 8-K dated August 16, 2002, the Company has
been engaged in ongoing discussions with staff members (the "Staff") of the SEC
concerning the Questioned Transactions, the results of the Special Committee's
investigation and various related matters such as are referred to above. In
addition, the Staff initiated a regulatory examination of 1st Atlantic in
October 2002. In January 2003, the Staff advised 1st Atlantic that it believed
the reserves required to be maintained by 1st Atlantic under the 1940 Act to
support 1st Atlantic's outstanding face-amount certificates were inadequate. The
Company understands that the Staff's position is that certain transfers of 1st
Atlantic's assets to the Company were made without consideration resulting in a
reduction in 1st Atlantic's reserves materially below the minimum amount
required by the 1940 Act.
1st Atlantic has taken the position that the common stock of the Company
that it owns, through State Bond, and that it owned at the time of the above
transfers, may be treated as a qualified asset for purposes of the certificate
reserve requirements of the 1940 Act. Members of the Staff have stated that they
disagree with 1st Atlantic's position. At the same time, the Company has been
actively seeking a buyer for Mr. Lawbaugh's majority ownership of 1st Atlantic
common stock. The Company's President, Eric M. Westbury and certain
non-affiliated investors have formed a partnership that has submitted a proposal
to the Board of Directors of 1st Atlantic for the purchase of the majority of
1st Atlantic's shares, now held in escrow. The Company believes that under this
proposal the Commission's concerns regarding 1st Atlantic's compliance with the
reserve requirements of the 1940 Act would be resolved. The Company cannot, of
course, provide any assurances in that regard.
On March 17, 2003, the Staff advised 1st Atlantic, through its counsel,
that in the absence of satisfactory evidence of an imminent transaction that
would restore 1st Atlantic's reserves, the Staff would
- 10 -
recommend to the
Commission that a civil injunctive action be brought against 1st Atlantic
seeking emergency relief, including among other things, the appointment of a
receiver. 1st Atlantic has been actively engaged in discussions with the Staff
regarding this issue and a possible resolution. Nevertheless, on April 23, 2003,
the Commission filed a complaint in the United States District Court for the
District of Maryland alleging that 1st Atlantic is in violation of Sections
28(a) and 28(b) of the 1940 Act because it is not maintaining sufficient
certificate reserves. The complaint contends that from approximately September
2001, as a result of the transfer of certain assets held by 1st Atlantic to the
Company, 1st Atlantic has been and is operating with certificate reserves below
the minimum required by the 1940 Act. Specifically, the complaint contends that
1st Atlantic has improperly counted the value of the common stock of its
subsidiary State Bond, the Company's parent, as a "qualified investment" for
purposes of the 1940 Act.
As indicated above, 1st Atlantic has taken the position that the common
stock of the Company, owned through State Bond, and that 1st Atlantic owned at
the time of the above transfers, may be treated as a qualified asset for
purposes of the certificate reserve requirements of the 1940 Act. 1st Atlantic,
however, without admitting or denying the allegations of the complaint, agreed
to the entry of a temporary restraining order enjoining 1st Atlantic from
violating Sections 28(a) and 28(b) of the 1940 Act. In addition, 1st Atlantic
agreed to be temporarily enjoined from making any payments to 1st Atlantic
certificate holders. An order of the United States District Court for Maryland
set a hearing date of May 5, 2003 to hear the Commission's motion for
appointment of a receiver. This hearing date was subsequently changed to May 20,
2003. The Company does not believe that the appointment of a receiver for 1st
Atlantic is necessary due to the potential transaction for the purchase of Mr.
Lawbaugh's Shares, as described above. The Company believes that under this
proposal, which would include a contribution of additional capital to 1st
Atlantic, the Commission's concerns regarding 1st Atlantic's compliance with the
reserve requirements of the 1940 Act would be resolved. The Company, however,
cannot provide any assurances in this regard. The Company filed a Form 8-K
Current Report dated April 23, 2003, with the SEC on April 28, 2003. That Form
8-K Current Report describes, in detail, the complaint filed by the Commission.
Financial Condition, Changes IN Financial ConditioN And Results OF Operations
For THE THREE MONTHS ENDED March 31, 2003 COMPARED WITH THE THREE MONTHS ENDED
March 31, 2002
As of March 31, 2003, total assets decreased $0.7 million from $35.1
million as of December 31, 2002 to $34.4 million as of March 31, 2003, while
certificate liability decreased $0.2 million from $33.2 million as of December
31, 2002 to $33.0 million as of March 31, 2003. The decrease in total assets is
primarily due to a lesser amount of mortgage notes held for sale funded from the
warehouse line of credit. The decrease in certificate liability is primarily due
to certificate maturities, redemptions and early surrenders.
The Company's earnings are derived primarily from net investment income
and net other operating income. Net investment income is income earned from
invested assets less investment and other expenses and interest credited on
certificate reserve liability. Net other operating income is income earned from
the origination of loans in the mortgage lender/broker business less operating
expenses. Changes in net investment income are largely due to changes in the
rate of return on investments and changes in operating costs. Changes in net
other operating income is attributable to changes in the volume and pricing of
loans originated.
The Company had a net income (loss) of $37,949 and ($687,117) for the
three months ended March 31, 2003 and 2002, respectively. The net income for the
three months ended March 31, 2003 stemmed mainly from net investment income of
$72,372 and net other operating income of $103,511 less reserve for
losses-shareholder receivable of $137,845. The net loss for the three months
ended March 31, 2002 stemmed mainly from the net investment loss before income
tax of $699,240. The net investment loss before income tax for the three months
ended March 31, 2002 was due mainly to the combination of investment and other
expenses and interest credited on certificate liability exceeding the income
generated from the investment portfolio. During 2002, the Company held several
non-revenue producing assets, which had a negative impact on the income
generated from the investment portfolio. In addition, high operational costs
related to the administrative services fee, legal fees and advertising resulted
in an
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operating loss. The reserve for losses - shareholder receivable contributed
further to the net loss for the three months ended March 31, 2002.
Investment income (excluding realized investment gains and losses) for the
three months ended March 31, 2003 was $705,579 compared to investment income of
$404,650 for the three months ended March 31, 2003. Investment income plus
realized investment gains represents annualized investment yields of 8.53% and
8.66% on average cash and investments of $33.1 million and $23.2 million for the
three months ended March 31, 2003 and 2002, respectively. The increase in
investment income is attributable to an increase in cash and investments being
held by the Company.
Net investment spread, which is the difference between investment income
and interest credited on certificate liability, was $320,693 for the three
months ended March 31, 2003 compared to $84,510 for the three months ended March
31, 2002. On an annualized yield basis, these amounts reflect net investment
spread the three months ended March 31, 2003 and 2002 of 3.88% and 1.36%,
respectively.
Interest credited on certificate liability for the three months ended
March 31, 2003 and 2002 was $384,886 and $320,140, respectively. These amounts
represent annualized average rates of interest credited of 4.65% and 5.15% on
average certificate liability of $33.1 million and $24.9 million for the three
months ended March 31, 2003 and 2002, respectively. The Company monitors
credited interest rates for new and renewal issues against competitive products,
such as bank certificates of deposit. Credited interest rate adjustments (up or
down) on new face-amount certificates are made by the Company periodically. In
addition, there are surrender charges on new face-amount certificates resulting
in the overall decrease in the average crediting rate.
Investment and other expenses were $248,321 and $783,750 for three months
ended March 31, 2003 and 2002, respectively. The decrease in investment and
other expenses was the result of a decrease in the administrative services fee
to the Company's parent, State Bond, and a decrease in other operating expenses.
The administrative services fee for the three months ended March 31, 2003 was
$113,000 as compared to $522,000 for the three months ended March 31, 2002. The
decrease in the administrative services fee was due to lower operational costs
for State Bond. State Bond's operational costs are funded through the
administrative services fee. Investment and other expenses were further
decreased by lower advertising costs for the three months ended March 31, 2003
as compared to the three months ended March 31, 2002. There was no advertising
expense for the three months ended March 31, 2003 as compared to $170,881 for
the three months ended March 31, 2002. The decrease in advertising expense in
2003 was due to the halting of advertising as certificate sales were suspended.
Net other operating income before income tax for the three months ended
March 31, 2003 and 2002, was $103,511 and $27,258, respectively. This consists
of the mortgage lender/broker operations of ACFC. For the three months ended
March 31, 2003 and 2002, other operating income was $901,151 and $459,506,
respectively. This income is derived from loan origination fees, gain on sale to
investor and other processing and underwriting loan fees relating to originating
and brokering loans. The increase in other operating income for the three months
ended March 31, 2003 as compared to the three months ended March 31, 2002 was
due to an increase in the volume of loans originated and higher yields generated
on those loans. For the three months ended March 31, 2003 and 2002, other
operating expenses were $797,640 and $432,248, respectively. These expenses
consist of salaries and commissions paid in relation to originating and
brokering loans and other costs in operating the mortgage company. The increase
in other operating expenses for the three months ended March 31, 2003 as
compared to the three months ended March 31, 2002, was mainly due to higher
commissions paid on the increased revenues generated.
Realized investment losses were $89 and realized investment gains were
$97,188 for the three months ended March 31, 2003 and 2002, respectively. The
decrease in realized investment gains was due to the sale of certain
available-for-sale securities for the three months ended March 31, 2002, which
had significant increases in their market value over their original cost.
Realized investment gains and losses are primarily interest-rate related and
attributable to the asset/liability management strategies of the Company. The
Company invests in a mixture of investments ranging from fixed maturity
securities, equity securities, mortgage notes, real estate, and real estate tax
lien certificates. The objective of each investment is to provide reasonable
returns while limiting liquidity and credit risks.
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In the event that the Company experiences higher than historical levels of
certificate surrenders, the Company might need to liquidate investments other
than in accordance with its normal asset/liability management strategy and, as a
result, the Company could experience substantial realized investment losses.
For the three months ended March 31, 2003 and 2002, reserve for losses -
shareholder receivable was $137,845 and $40,200, respectively. See "Item 2:
Certain Significant Events" to this Form 10-Q for further descriptions of this
item.
Liquidity and Financial Resources
As of March 31, 2003, the Company had $525,257 of qualified assets in
excess of the minimum amount required by the 1940 Act and the rules and
regulations promulgated thereunder by the SEC, as computed in accordance with
the 1940 Act.
The primary liquidity requirement of the Company relates to its payment of
certificate maturities and surrenders and payment of its legal costs and
administrative services fee. The principal sources of cash to meet such
liquidity requirements are investment income and proceeds from maturities and
redemptions of investments. The Company's certificates may be surrendered by the
certificateholder at any time prior to maturity. Certificates mature 28 or 30
years after their issuance, depending on the interest guarantee period, or
series, selected. Surrenders at the end of any interest guarantee period may be
made by the certificateholder without a withdrawal charge that would otherwise
apply. The Company has $138,033 of certificate obligations under interest
guarantee periods expiring during the nine months ending December 31, 2003. The
Company can make no representation as to the amount of certificates that may be
surrendered for payment with or without a withdrawal charge during such period.
At March 31, 2003, cash and cash equivalents totaled $4.5 million, an
increase of $2.3 million from December 31, 2002. The increase was primarily due
to the payment of outstanding principal on certain mortgage notes held for sale.
The Company's aim is to manage its cash and cash equivalents position so as to
satisfy short-term liquidity needs. In connection with this management of cash
and cash equivalents, the Company may invest idle cash in short duration fixed
maturities to capture additional yield when short-term liquidity requirements
permit.
Cash flows of $2,882,679 and ($94,476) were generated from (used in) operating
activities for the three months ended three months ended March 31, 2003 and
2002, respectively. These cash flows resulted principally from investment
income, less management fees, changes in mortgage notes held for sale, and
commissions paid. Proceeds from investing activities generated $1,707,520 and
$1,045,116 for the three months ended March 31, 2003 and 2002, respectively,
which were offset by purchases of investments of $942,212 and $128,165,
respectively.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's investments are represented by a mixture of
available-for-sale securities (comprised of government and corporate bonds,
mortgage-backed securities, and equity securities), mortgage notes, real estate,
and real estate tax lien certificates. Managing 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.
The Company's investments in available-for-sale securities totaled
$9,167,550 at March 31, 2003, 28.06% of the investment portfolio (27.45% at
December 31, 2002). Available-for-sale securities consist of fixed maturity
securities and equity securities. Fixed maturity securities consist of US
Treasuries, municipal bonds, mortgage-backed securities and corporate debt. As
of March 31, 2003, the Company held one fixed maturity security that had
defaulted on interest payments. The market value of available-for-sale
securities fluctuates with changing economic conditions. Fixed maturity
securities are influenced greatly by market interest rates. Corporate debt
market value is also weighed by the performance of the company that issues
- 13 -
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 equity 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.
Presently, the Company has a portion of its portfolio invested in real
estate and real estate loans, which includes $10.4 million of mortgage notes
held for sale and $2.7 million of real estate owned. Defaults by the borrower on
payments due and fluctuations in the value of the underlying real estate
represent the greatest risk factor for this investment strategy. However, the
Company mitigates the risk associated with the mortgage notes by investing 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 higher 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 $1.3 million at March 31, 2003. The greatest risk associated with
this investment is the time and costs of the 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 in most circumstances
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.
The Company's ownership of the residual mortgage certificate represents a
subordinate ownership interest in a securitization trust (the "Trust"). The
assets of the Trust consist of mortgage loans secured by first liens on
residential real properties. The Company's ownership interest represents a
subordinate right to receive excess cash flow, if any, generated by the mortgage
loans of the Trust. The Company assumes the risk of default on the mortgages
held within the Trust. Defaults of principal and interest by borrowers will
adversely affect the Company's return on this investment. A reserve for defaults
was calculated into the original purchase price to mitigate the risk of loss on
the investment. In addition, risk of loss is lessened by the weighted average
loan to value ratio on the underlying mortgage notes as compared to the real
estate securing the note being approximately 60%.
The Company regularly analyzes interest rate sensitivity and the potential
impact of interest rate fluctuations based on 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 for the potential negative effects of changes in interest
rates.
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.
- 14 -
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 did not file any reports on Form 8-K during the three
months ended March 31, 2003.
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 May 15, 2003.
Date: May 15, 2003 SBM CERTIFICATE COMPANY
/s/ Eric M. Westbury
----------------------------
President
Date: May 15, 2003 /s/ Trey Stafford
----------------------------
Chief Financial and Accounting Officer
- 15 -
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: May 15, 2003
/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: May 15, 2003
/s/Trey Stafford
----------------
Trey Stafford
Chief Financial and Accounting Officer
(Principal Financial Officer)