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, 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 November 19, 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
Condensed Consolidated Balance Sheets as of September 30, 2003
(unaudited) and December 31, 2002.................................................................3
Condensed Consolidated Statements of Operations for the three months ended
September 30, 2003 (unaudited) and September 30, 2002 (unaudited).................................4
Condensed Consolidated Statements of Operations for the nine months ended
September 30, 2003 (unaudited) and September 30, 2002 (unaudited).................................4
Condensed Consolidated Statements of Cash Flows for the nine months ended
September 30, 2003 (unaudited) and September 30, 2002 (unaudited).................................5
Notes to Consolidated Financial Statements ............................................................6
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS...............................................................9
Item 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.............................................18
Item 4 CONTROLS AND PROCEDURES................................................................................19
Part II. OTHER INFORMATION....................................................................................20
Item 1. LEGAL PROCEEDINGS ....................................................................................20
Item 6. EXHIBITS AND REPORTS ON FORM 8-K REPORTS..............................................................20
SIGNATURES ...................................................................................................20
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SBM Certificate Company and Subsidiary
CONSOLIDATED BALANCE SHEETS
September 30, 2003 December 31, 2002
------------------ -----------------
ASSETS (unaudited)
Cash and investments
Available-for-sale securities
(amortized cost: $6,471,538 and $11,245,510) $ 6,375,931 $ 9,190,162
Mortgage notes held for sale 13,153,440 13,163,828
Mortgage notes held for investment 5,571,759 --
Investment in real estate partnership 7,889,667 --
Real estate tax lien certificates 614,229 1,632,437
Real estate owned 2,760,509 2,647,095
Residual mortgage certificate 2,660,465 4,038,607
Property and equipment, net 121,360 124,909
Escrows -- 100,000
Certificate loans 68,575 77,462
Cash and cash equivalents 1,296,365 2,230,886
------------ ------------
Total cash and investments 40,512,300 33,205,386
------------ ------------
Receivables
Dividends and interest 385,857 394,749
------------ ------------
Total qualified assets 40,898,157 33,600,135
Other assets
Related party receivable 135,646 129,351
Fixed assets, net 75,738 90,508
Goodwill 591,463 591,463
Deferred acquisition costs, net 470,996 581,534
Due from shareholder 1,359,573 1,218,181
Allowance - due from shareholder (1,359,573) (1,218,181)
Other assets 218,613 122,069
------------ ------------
TOTAL ASSETS $ 42,390,613 $ 35,115,060
============ ============
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities
Statutory certificate liability 32,518,974 31,418,457
Additional certificate liability 1,248,126 1,770,369
Warehouse line of credit 3,200,400 2,542,600
Deferred revenue 1,417,603 1,640,425
Real estate liabilities -- 870,317
Escrow liability 371,251 --
Notes Payable 5,883,000 --
Accounts payable and other liabilities 527,405 335,882
Related party payable 2,152 117,925
------------ ------------
Total liabilities 45,168,911 38,695,975
------------ ------------
Shareholder's equity (deficit)
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 (538,441) (2,055,348)
Accumulated deficit (6,351,675) (5,637,385)
------------ ------------
Total shareholder's equity (deficit) (2,778,298) (3,580,915)
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY (DEFICIT) $ 42,390,613 $ 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ---------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Investment income
Interest and dividend income $ 140,155 $ 167,301 $ 365,497 $ 506,978
Other investment income 4,784 11,288 50,012 20,362
Loan fee income -- -- 90,173 --
Mortgage interest income 499,217 434,221 1,401,133 1,390,516
------------ ------------ ------------ ------------
Total investment income 644,156 612,810 1,906,815 1,917,856
------------ ------------ ------------ ------------
Investment and other expenses
Administrative services fee 261,500 535,000 625,900 1,407,000
Legal and accounting fees 129,675 -- 242,230 45,004
Deferred acquisition cost amortization and renewal commissions 74,202 41,871 208,620 121,081
Depreciation expense 8,249 6,392 24,448 18,454
Other expenses 64,628 64,262 152,772 543,979
------------ ------------ ------------ ------------
Total investment and other expenses 538,254 647,525 1,253,970 2,135,518
------------ ------------ ------------ ------------
Interest credited on certificate liability 621,544 523,247 1,871,253 764,833
------------ ------------ ------------ ------------
Net investment loss before income taxes
and realized investment gains (losses) (515,642) (557,962) (1,218,408) (982,495)
------------ ------------ ------------ ------------
Realized investment gains (losses) (225,985) 329,472 468,419 473,232
Income tax expense on realized investment gains -- -- -- --
------------ ------------ ------------ ------------
Net investment loss before income taxes (741,627) (228,490) (749,989) (509,263)
------------ ------------ ------------ ------------
Other operating income
Origination fee income 129,807 102,732 400,025 476,788
Gain on sale to investor 309,925 452,146 1,633,885 866,640
Other loan fee income 118,865 113,010 417,321 225,870
------------ ------------ ------------ ------------
Total other operating income 558,597 667,888 2,451,231 1,569,298
------------ ------------ ------------ ------------
Other operating expenses
Salaries and commissions 462,362 369,045 1,729,478 901,594
Other expenses 183,810 324,058 482,180 596,055
Warehouse interest expense and charges, net 8,747 -- 62,482 --
------------ ------------ ------------ ------------
Total other operating expenses 654,919 693,103 2,274,140 1,497,649
------------ ------------ ------------ ------------
Net other operating income (loss) before income taxes (96,322) (25,215) 177,091 71,649
------------ ------------ ------------ ------------
Net investment and other operating income (loss) before income taxes (837,949) (253,705) (572,898) (437,614)
Income tax and deferred tax asset valuation allowance expense -- -- -- (72,123)
------------ ------------ ------------ ------------
Net investment and other operating loss (837,949) (253,705) (572,898) (509,737)
------------ ------------ ------------ ------------
Non operating expense:
Reserve for losses - shareholder receivable -- (170,803) (141,392) (227,503)
------------ ------------ ------------ ------------
Net loss $ (837,949) $ (424,508) $ (714,290) $ (737,240)
============ ============ ============ ============
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)
2003 2002
------------ ------------
Cash flows provided by (used in) operating activities
Net loss $ (714,290) $ (737,240)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities
Interest credited on certificate liability 1,871,253 764,833
Reserve for losses - shareholder receivable 141,392 227,503
Realized investment gains (468,419) (473,232)
Deferral of revenue 719,530 446,275
Income tax and deferred tax asset valuation allowance -- 72,123
Deferral of acquisition costs (98,082) (229,450)
Amortization of deferred acquisition costs and renewal commissions 208,620 41,871
Depreciation 24,448 18,454
(Increase)Decrease in dividends and interest receivable 8,892 (87,154)
Decrease in mortgage notes held for sale 49,910 --
Increase in shareholder receivable (141,392) (227,503)
Changes in other assets and liabilities 52,843 255,805
------------ ------------
Net cash provided by (used in) operating activities 1,654,705 72,285
------------ ------------
Cash flows from investing activities
Sales and redemptions of available-for-sale securities 6,164,691 4,730,061
Purchases of available-for-sale securities (2,193,422) (7,773,430)
Purchase of mortgage notes receivable (10,620,840) (8,325,950)
Principal payments received on mortgage notes receivable 5,009,559 2,208,250
Closing costs and real estate liabilities paid on sale of real estate (713,143) --
Purchase of real estate tax lien certificates -- (2,245,527)
Proceeds from redemptions of real estate tax lien certificates 1,018,208 1,965,286
Purchase of residual mortgage certificate -- (4,500,000)
Principal payments received on residual mortgage certificate 1,378,142 321,429
Investment in real estate partnership (2,000,000) --
Purchase of fixed assets (6,129) (20,431)
Repayment of certificate loans, net 8,887 21,778
------------ ------------
Net cash provided by (used in) investing activities (1,954,047) (13,618,534)
------------ ------------
Cash flows from financing activities
Amounts paid to face-amount certificate holders (1,292,979) (1,462,757)
Amounts received from face-amount certificate holders -- 9,848,606
Warehouse line of credit borrowings, net 657,800 4,704,400
------------ ------------
Net cash provided by (used in) financing activities (635,179) 13,090,249
------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (934,521) (456,000)
Cash and cash equivalents, beginning 2,230,886 5,538,094
------------ ------------
Cash and cash equivalents, end $ 1,296,365 $ 5,082,094
============ ============
Supplemental disclosure of significant noncash investing
and financing activities:
Contribution of assets from State Bond $ -- $ 639,227
============ ============
Transfer of mortgage notes and tax certificates to REO $ -- $ 2,500,912
============ ============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- 5 -
SBM CERTIFICATE COMPANY AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
September 30, 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 nine months ended September 30,
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 then 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 has been 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 September 30, 2003, these amounts totaled $1,359,573. 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, 2003, the allowance totaled $1,359,573. 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 ($32.7 million and $31.6 million at September 30,
2003 and December 31, 2002, respectively). The Company had qualified assets (at
amortized cost) of $32.3 million at those respective dates. As of September 30,
2003, the Company's qualified assets were insufficient to meet its reserve
requirements by $415,776. Immediately upon discovery of this shortfall, cash was
advanced to the Company by Geneva Capital Partners, LLC ("Geneva") in the amount
of $425,000. This advance replenished the qualified assets to exceed the
required reserves. Geneva is wholly owned by the Company's President, Eric M.
Westbury.
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 September 30, 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.
------------------ -----------------
September 30, 2003 December 31, 2002
------------------ -----------------
Total qualified assets on deposit $ 41,368,023 $ 35,453,112
Less: Qualified assets reserved by Provident warehouse line $ (3,200,400) $ (2,547,954)
Less: Qualified assets reserved for real estate liens and notes (5,883,000) (590,000)
------------------ -----------------
Total qualified assets $ 32,284,623 $ 32,315,158
------------------ -----------------
Certificate reserve under Section 28(a) $ 32,518,974 $ 31,418,457
Less: Certificate loans (68,575) (77,462)
Plus: Base capital requirement 250,000 250,000
------------------ -----------------
Required deposits $ 32,700,399 $ 31,590,995
------------------ -----------------
6. SUBSEQUENT EVENTS
On November 7, 2003, 1st Atlantic, Geneva, the Trustee of John Lawbaugh's
Bankruptcy Estate (the "Trustee") and certain creditors of the Bankruptcy Estate
agreed to a settlement proposal and filed an emergency motion in the United
States Bankruptcy Court for the District of Maryland ("Bankruptcy Court"). Under
the terms of the settlement agreement, Geneva shall purchase 7.5 million shares
of 1st Atlantic common stock (the "Sale"), the majority of issued and
outstanding shares, from the Trustee for $2,532,981. The proceeds from the sale
of the Shares are to be distributed to 1st Atlantic and the Company in the
amounts of $1,175,955 and $1,357,026, respectively, to repay the amounts due
from Mr. Lawbaugh. See Note 4 of the Notes to the Consolidated Financial
Statements for further description of the amounts due from shareholder. In
addition, Geneva shall contribute $3,200,000 as additional paid in capital to
1st Atlantic to resolve the SEC's concerns regarding 1st Atlantic's compliance
with the reserve requirements of Section 28 of the 1940 Act. In connection with
the sale of the Shares, State Bond will issue debt instruments secured by the
common stock of the Company totaling $1,616,772 to certain creditors of the
Bankruptcy Estate. The debt matures ten years from the date of issuance and has
principal and interest payments due semi-annually with interest accruing at the
rate of 1.5% per annum. Legal fees of $125,000 will also be paid by Geneva to
the Trustee and certain other creditors of the Bankruptcy Estate. A hearing for
the approval of the Sale has been scheduled for December 1, 2003 in Bankruptcy
Court. The sale of the Shares to Geneva is subject to the approval of the
Bankruptcy Court.
The Sale will be accounted for in accordance with SFAS 141: Business
Combinations using the purchase method of accounting. See the "Proforma
Post-Acquisition Balance Sheet" under "Certain Significant Events" in "Item 2:
Management Discussion and Analysis of Financial Condition and Results of
Operations" for further disclosure of the Company's projected financial position
as a result of the Sale.
- 8 -
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 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.
- 9 -
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
$490,656 as of September 30, 2003, constitute the amounts due from shareholder
totaling $1,359,573 on the September 30, 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 expense.
As a result of the Questioned Transactions, on August 16, 2002, as
reported in the Company's Form 8-K of that date, 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 investigation into
the Questioned Transactions. In addition, the Company suspended the sale of its
face-amount certificates on August 16, 2002 and has not yet resumed sales at
this time. 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.
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 following summarizes the impact of the Questioned Transactions on the
Company for the respective periods indicated:
NINE MONTHS
ENDED YEAR ENDED YEAR ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31, DECEMBER 31, DECEMBER 31,
2003 2002 2001 2000 TOTAL
------------- ------------ ------------ ------------ -----------
Qualified Assets $ (141,392) $ (56,700) $(1,396,907) $ (292,236) $(1,887,235)
Additional Paid in Capital $ -- $ -- $ (707,550) $ -- $ (707,550)
Shareholder's Equity $ (141,392) $ (265,762) $(1,146,957) $ (292,236) $(1,846,347)
Net Loss $ (141,392) $ (365,763) $ (439,407) $ (292,236) $(1,238,798)
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 7,500,000
shares of 1st Atlantic capital stock ("the Shares"), representing majority
ownership of 1st Atlantic, into escrow and transferred his voting rights
associated with the shares to 1st Atlantic's Board of Directors. The Company
filed a Form 8-K Current Report dated November 12, 2002, with the SEC on
- 10 -
November 27, 2002. That Form 8-K Current Report describes the terms and
conditions of the Escrow Agreement.
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 understood 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 held 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 disagreed with 1st
Atlantic's position. At the same time, the Company had been actively seeking a
buyer for Mr. Lawbaugh's majority ownership of 1st Atlantic common stock.
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 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 had 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 (the "District Court") alleging that 1st Atlantic was in
violation of Sections 28(a) and 28(b) of the 1940 Act because it was not
maintaining sufficient certificate reserves (the "Complaint"). The Complaint
contended that from approximately September 2001 to November 19, 2003, as a
result of the transfer of certain assets held by 1st Atlantic to the Company,
1st Atlantic had been operating with certificate reserves below the minimum
required by the 1940 Act. Specifically, the complaint contended that 1st
Atlantic had improperly counted the value of its investment in its subsidiary
State Bond, the Company's parent, as a "qualified investment" for purposes of
the 1940 Act.
As indicated above, 1st Atlantic had 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, could 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 District Court set a hearing date of May 5,
2003 to hear the Commission's motion for appointment of a receiver. On May 5,
2003 the District Court entered an order extending the temporary restraining
order and freeze of payments to 1st Atlantic certificate holders to May 20,
2003, and set a hearing date of May 20, 2003 to hear the Commission's motion for
a receiver and motion for a preliminary injunction. At the hearing on May 20,
2003, an additional order extending the temporary restraining order and freeze
of payments to 1st Atlantic certificate holders to June 3, 2003 was entered by
the District Court. In addition, a new hearing for the Commission's motion for
appointment of a receiver and its motion for preliminary injunction was
scheduled for June 3, 2003.
On May 29, 2003, John Lawbaugh, 1st Atlantic's majority shareholder, filed
a petition for relief under Chapter 11 of the United States Bankruptcy Code in
the United States Bankruptcy Court for the District of Maryland. 1st Atlantic
has filed an adversary proceeding in Mr. Lawbaugh's bankruptcy proceeding
seeking a declaration that the Escrow Agreement, described in the Company's Form
8-K Current Report dated November 12, 2002, is enforceable despite Mr.
Lawbaugh's bankruptcy.
At the hearing on June 3, 2003, the District Court entered an order
extending the temporary restraining order and freeze of payments to 1st Atlantic
certificate holders to June 17, 2003, but did not grant the SEC's motion for a
preliminary injunction and for appointment of a receiver for 1st Atlantic. A
telephone status conference was also scheduled for June 17, 2003 to discuss the
status of a proposed sale of a majority of the outstanding shares of 1st
Atlantic common stock and other matters related to 1st Atlantic. During the
telephone status conference on June 17, 2003, the District Court was updated on
the status of the proposed sale of 1st Atlantic's common stock and was advised
of the filing by 1st Atlantic of an adversary complaint in the
- 11 -
Bankruptcy Court relating to Mr. Lawbaugh's petition. The District Court entered
an order further extending the temporary restraining order and freeze of
payments to 1st Atlantic certificate holders to July 8, 2003, and scheduled a
telephone status conference for that date. During the telephone status
conference on July 8, 2003, the District Court entered an order further
extending the temporary restraining order and freeze of payments to 1st Atlantic
certificate holders indefinitely. In addition, on July 11, 2003, the District
Court entered an order transferring 1st Atlantic's adversary proceeding filed in
Mr. Lawbaugh's bankruptcy case from Bankruptcy Court to the United States
District Court for the District of Maryland. 1st Atlantic moved for summary
judgment on its claims against Mr. Lawbaugh in the adversary proceeding in his
bankruptcy case. On August 20, 2003, a hearing was held on the motion for
summary judgment and the District Court entered an order granting 1st Atlantic
summary judgment and declaring the Escrow Agreement is an enforceable express
trust. As such, the Shares would be subject to the terms of the Escrow Agreement
and would not be property of Lawbuagh's bankruptcy estate (the "Estate"). As
such, the Shares could be sold free and clear of all claims, liens and interest
of the Estate. However, the Trustee filed an emergency motion for a stay of the
Shares to prevent their sale and a motion to include the Shares as part of Mr.
Lawbaugh's bankruptcy case. The District Court granted the motion to stay the
sale of the Shares until October 9, 2003 and include the Shares as part of the
Bankruptcy Estate. At a hearing on October 9, 2003 in the Bankruptcy Court, the
Trustee filed a motion for an approval of the sale procedures and a motion for a
temporary restraining order prohibiting the escrow agent from selling and
releasing the Shares. Mr. Lawbaugh filed a motion to reconsider the denial of
his attempt to reject the Escrow Agreement. The Bankruptcy Court granted the
temporary restraining order through October 20, 2003 and continued the motion
for approval of sale procedures until October 20, 2003. Mr. Lawbaugh's motion
for reconsideration was also continued until October 20, 2003. All motions
granted through October 20, 2003 were then further continued until November 19,
2003.
Change in Control of 1st Atlantic
On November 7, 2003, 1st Atlantic, Geneva, the Trustee and certain
creditors of the Bankruptcy Estate agreed to a settlement proposal and filed an
emergency motion in Bankruptcy Court on November 10, 2003 for the approval of
the sale of the Shares to Geneva under such proposal. Under the terms of the
settlement proposal, the Trustee is to sell the Shares to Geneva for $2,532,981.
The proceeds from the sale of the Shares will be distributed to 1st Atlantic and
the Company in the amounts of $1,175,955 and $1,357,026, respectively, to repay
the amounts due from Mr. Lawbaugh. See Note 4 of the Notes to the Consolidated
Financial Statements for further description of the amounts due from
shareholder. In addition, Geneva shall contribute $3,200,000 as additional paid
in capital to 1st Atlantic to resolve the SEC's concerns regarding 1st
Atlantic's compliance with the reserve requirements of Section 28 of the 1940
Act. Further, State Bond shall issue debt instruments secured by the common
stock of the Company totaling $1,616,772 to certain creditors of the Estate. The
debt matures ten years from the date of issuance and has principal and interest
payments due semi-annually with interest accruing at the rate of 1.5% per annum.
A total of $125,000 will also be paid by Geneva to the Trustee and certain other
creditors of the Estate. A hearing for the approval of the Sale has been
scheduled for December 1, 2003 in Bankruptcy Court. The sale of the Shares to
Geneva is subject to the approval of the Bankruptcy Court. The Company
anticipates the Sale to occur on December 1, 2003, upon approval by the
Bankruptcy Court. Immediately after closing, Geneva will also make an additional
cash and non-cash contribution to the Company of $1 million cash and a $500,000
investment in a real estate partnership investment fund, which will be treated
as additional paid in capital. The Proforma Post-Acquisition Balance Sheet of
the Company reflects the projected financial position of the Company as a result
of the Sale.
The following reflects the proforma balance sheet as of September 30, 2003
of the Company and its qualified assets giving effect to the acquisition of the
7.5 million 1st Atlantic shares by Geneva.
- 12 -
Consolidated Proforma Post-Acquisition Balance Sheet
Acquisition Post-Acquisition
September 30, 2003 Adjustments Ending Balance
------------------- ------------ ----------------
(unaudited) (unaudited) (unaudited)
Qualified assets
Available-for-sale securities $ 6,375,931 $ 296,003 1 $ 6,671,934
Mortgage notes held for sale 13,153,440 47,142 1 13,200,582
Mortgage notes held for investment 5,571,759 120,866 1 5,692,625
Warehouse line of credit receivable -- -- --
Investment in real estate partnership 7,889,667 500,000 3 8,389,667
Real estate tax lien certificates 614,229 -- 614,229
Residual mortgage certificate 2,660,465 -- 2,660,465
Real estate owned 2,760,509 (475,000) 1 2,285,509
Property and equipment 121,360 -- 121,360
Certificate loans 68,575 -- 68,575
Cash and cash equivalents 1,296,365 1,357,026 2
1,000,000 3 3,653,391
------------ ------------ ------------
Total cash and investments 40,512,300 2,846,037 43,358,337
------------ ------------ ------------
Dividends and interest 385,857 -- 385,857
------------ ------------ ------------
Total qualified assets 40,898,157 2,846,037 43,744,194
Other assets
Related party receivable 135,646 -- 135,646
Fixed assets 75,738 -- 75,738
Investment in subsidiaries -- -- --
Goodwill 591,463 (591,463) 1 --
Goodwill and intangibles -- 2,444,143 4 --
5,822,237 5 8,266,380
Deferred acquisition costs 470,996 (470,996) 1 --
Due from shareholder 1,359,573 (1,359,573) 2 --
Allowance - due from shareholder (1,359,573) 1,359,573 1 --
Other assets 218,613 (10,000) 1 208,613
------------ ------------ ------------
Total assets $ 42,390,613 $ 10,039,958 $ 52,430,571
============ ============ ============
Liabilities
Statutory certificate liability $ 32,518,974 $ -- $ 32,518,974
Additional certificate liability 1,248,126 -- 1,248,126
Warehouse line of credit 3,200,400 -- 3,200,400
Deferred revenue 1,417,603 (1,417,603) 1 --
Escrow liability 371,251 -- 371,251
Notes payable 5,883,000 -- 5,883,000
Accounts payable and other liabilities 527,405 -- 527,405
Related party payable 2,152 -- 2,152
------------ ------------ ------------
Total liabilities 45,168,911 (1,417,603) 43,751,308
------------ ------------ ------------
Shareholder's equity (deficit)
Common stock, $1 par value; 10,000,000 shares
authorized; 250,000 shares issued and outstanding 250,000 (250,000) 1
250,000 2 250,000
Common stock, $2 par value; 10,000 shares
authorized; 10,000 shares issued and outstanding -- -- --
Additional paid-in capital 3,861,818 (3,861,818) 1 --
1,107,026 2
1,500,000 3
5,822,237 5 8,429,263
Accumulated comprehensive income (loss), net of taxes (538,441) 538,441 1 --
Accumulated deficit (6,351,675) 6,351,675 1 --
------------ ------------ ------------
Total shareholder's equity (deficit) (2,778,298) 11,457,561 8,679,263
------------ ------------ ------------
Total liabilities and shareholder's equity (deficit) $ 42,390,613 $ 10,039,958 $ 52,430,571
============ ============ ============
- 13 -
Footnotes to Acquisition Journal Entries:
1 - Adjust assets and laibilities to fair value in accrodance with FAS 141. Fair
value for available for sale securities is as of November 10, 2003
2 - Record receipt of cash for repayment of due from shareholder
3 - To record a cash and non-cash conribution made by Geneva at closing of a
$500,000 interest in a real estate fund and $1 million cash
4 - To record unallocated purchase price to goodwill and intangibles in
accordance with FAS 141
5 - To push down unallocated purchase price to reporting unit of value, SBM
SBM CERTIFICATE COMPANY
REGULATORY CERTIFICATE RESERVE CALCULATION
Acquisition Post-Acquisition
September 30, 2003 Adjusments Ending Balance
------------------ ------------ -----------------
(unaudited) (unaudited) (unaudited)
Total qualified assets on deposit $ 41,368,023 $ 2,307,596 $ 43,675,619
Less: Qualified assests reserved by Provident warehouse line $ (3,200,400) -- (3,200,400)
Less: Qualified assests reserved for real estate liens and notes (5,883,000) -- (5,883,000)
------------ ------------ ------------
Total qualified assets $ 32,284,623 $ 2,782,596 $ 34,592,219
------------ ------------ ------------
Certificate reserve under Section 28(a) $ 32,518,974 $ -- $ 32,518,974
Less: Certificate loans (68,575) -- (68,575)
Plus: Base capital requirement 250,000 -- 250,000
------------ ------------ ------------
Required deposits $ 32,700,399 $ -- $ 32,700,399
------------ ------------ ------------
Reserve excess (shortfall) $ (415,776) $ 2,307,596 $ 1,891,820
------------ ------------ ------------
- 14 -
Financial Condition, Changes in Financial Condition and Results of Operations
For the three months ended September 30, 2003 compared with the three months
ended September 30, 2002
As of September 30, 2003, total qualified assets remained unchanged from
December 31, 2003 at $32.3 million, while required certificate reserves
increased $1.1 million from $31.6 million as of December 31, 2002 to $32.7
million as of September 30, 2003.
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 and gains and losses from the sale of investments less
investment and other expenses and interest credited on certificate reserve
liability. Net investment income is related to the operations of the face-amount
certificate company. 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 loss of $837,949 and $424,508 for the three months
ended September 30, 2003 and 2002, respectively. The net loss for the three
months ended September 30, 2003 stemmed mainly from net investment loss of
$741,627 from the investment company operations. The net loss for the three
months ended September 30, 2002 resulted from the net investment loss of
$228,490 related to the investment company operations and the reserve for losses
on the shareholder receivable of $170,803. The net investment losses before
income tax for the three months ended September 30, 2003 and 2002 were mainly
due to investment and other expenses and interest credited on certificate
liability exceeding investment income.
Investment income (excluding realized investment gains and losses) for the
three months ended September 30, 2003 was $644,156 compared to investment income
of $612,810 for the three months ended September 30, 2002. Investment income
plus realized investment gains (losses) represents annualized investment yields
of 5.18% and 14.05% on average cash and investments of $32.3 million and $26.8
million for the three months ended September 30, 2003 and 2002, respectively.
The decrease in investment yield for the three months ended September 30, 2003
is mainly attributable to realized losses from the sale of real estate in the
amount of $271,239 as compared to realized investment gains of $329,472 from the
sale of available for sale securities for the three months ended September 30,
2002.
Net investment spread, which is the difference between investment income
and interest credited on certificate liability, was $22,612 for the three months
ended September 30, 2003 compared to $89,563 for the three months ended
September 30, 2002. On an annualized yield basis, these amounts reflect net
investment spread for the three months ended September 30, 2003 and 2002 of
0.27% and 1.26%, respectively.
Interest credited on certificate liability for the three months ended
September 30, 2003 and 2002 was $621,544 and $523,247, respectively. These
amounts represent annualized average rates of interest credited of 7.43% and
7.37% on average certificate liability of $33.5 million and $28.4 million for
the three months ended September 30, 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.
Investment and other expenses were $538,254 and $647,525 for three months
ended September 30, 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. The administrative services fee for the
three months ended September 30, 2003 was $261,500 as compared to $535,000 for
the three months ended September 30, 2002. This decrease was due to lower
operational costs for State Bond. State Bond's operational costs are funded
through the administrative services fee. For the three months ended September
30, 2003 legal and accounting costs were $129,675. For the three months ended
September 30, 2002 there were no legal and accounting costs. The absence of
legal and accounting expenses for the three months ended September 30, 2002 was
due to the Company charging $170,804 of legal and accounting costs to reserve
for losses - shareholder receivable. These were legal and accounting expenses
incurred related to the Questioned Transactions described in "Certain
Significant Events" above and charged to Mr. Lawbaugh by the Company. Legal and
accounting costs for the three months ended September 30, 2003 were considerably
higher than what the Company had
- 15 -
historically incurred. This increase was due to legal costs associated with the
Questioned Transactions noted above. Management does not expect legal and
accounting costs to continue at this level since a sale of the Shares and a
Settlement with the SEC is expected to occur in 2003.
Realized investment gains (losses) for the three months ended September
30, 2003 and 2002 were ($225,985) and $329,472, respectively. The realized
losses for the three months ended September 30, 2003 resulted from losses of
$271,239 from the sale of real estate as compared to realized investment gains
for the three months ended September 30, 2002 of $329,472 which resulted from
the sale of available for sale securities. 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.
Net other operating loss before income tax for the three months ended
September 30, 2003 and 2002, was $96,322 and $25,215, respectively. This
consists of the mortgage lender/broker operations of ACFC. For the three months
ended September 30, 2003 and 2002, other operating income was $558,597 and
$667,888, 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 decrease in other operating income for the
three months ended September 30, 2003 as compared to the three months ended
September 30, 2002 was due to a decrease in the volume of loans originated. Loan
volume origination decreased as a result of an increase in market interest rates
and the departure of a significant number of loan sales employees. Management
expects the loan origination volume to increase in the near term as management
has begun active recruitment of loan sales employees to replace those previously
departed. For the three months ended September 30, 2003 and 2002, other
operating expenses were $654,919 and $693,103, 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 decrease
in other operating expenses for the three months ended September 30, 2003 as
compared to the three months ended September 30, 2002, was mainly due to lower
commissions paid because of the decrease in revenues generated.
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 September 30, 2002, reserve for losses -
shareholder receivable was $170,803. See "Certain Significant Events" under Item
2 to this Form 10-Q for further descriptions of this item.
For the nine months ended September 30, 2003 compared with the nine months ended
September 30, 2002
The Company had a net loss of $714,290 and $737,240 for the nine months
ended September 30, 2003 and 2002, respectively. The net loss for the nine
months ended September 30, 2003 stemmed mainly from net investment loss before
income taxes of $749,989. The net loss for the nine months ended September 30,
2002 resulted mainly from the net investment loss before income tax of $509,263
and the reserve for losses - shareholder receivable of $227,503. The net
investment loss before income tax for the nine months ended September 30, 2003
and 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.
Investment income (excluding realized investment gains and losses) for the
nine months ended September 30, 2003 was $1,906,815 compared to investment
income of $1,917,856 for the nine months ended September 30, 2002. Investment
income plus realized investment gains for the nine months ended September 30,
2003 and 2002 was $2,375,234 and $2,391,088, respectively. Investment income
plus realized investment gains represents annualized investment yields of 9.80%
and 11.88% on average cash and investments of $32.3 million and $26.8 million
for the nine months ended September 30, 2003 and 2002, respectively. Realized
gains for the nine months ended September 30, 2003 are primarily attributable to
gains related to the sale of real estate. Realized gains for the nine months
ended September 30, 2002 are the result of the sale of available for sale
securities.
Net investment spread, which is the difference between investment income
and interest credited on certificate liability, was $35,562 for the nine months
ended September 30, 2003 compared to $1,153,023 for the nine months ended
September 30, 2002. On an annualized yield basis, these amounts reflect net
investment spread for the nine months ended September 30, 2003 and 2002 of 0.42%
and 5.41%, respectively.
- 16 -
Interest credited on certificate liability for the nine months ended
September 30, 2003 and 2002 was $1,871,253 and $764,833, respectively. These
amounts represent annualized average rates of interest credited of 7.45% and
3.59% on average certificate liability of $33.5 million and $28.4 million for
the nine months ended September 30, 2003 and 2002, respectively.
Investment and other expenses were $1,253,970 and $2,135,518 for the nine
months ended September 30, 2003 and 2002, respectively. The decrease in
investment and other expenses was mainly the result of a decrease in the
administrative services fee to the Company's parent, State Bond, and a decrease
in other expenses. The administrative services fee for the nine months ended
September 30, 2003 was $625,900 as compared to $1,407,000 for the nine months
ended September 30, 2002. The decrease in the administrative services fee was
due to State Bond having lower operational costs, which are funded through the
administrative services fee. Other expenses decreased due to lower advertising
costs for the nine months ended September 30, 2003 as compared to the nine
months ended September 30, 2002. There was no advertising expense for the nine
months ended September 30, 2003 as compared to $357,968 for the nine months
ended September 30, 2002. The decrease in advertising expense in 2003 was due to
the halting of advertising as certificate sales were suspended. For the nine
months ended September 30, 2003 and 2002 legal and accounting costs were
$242,230 and $45,004, respectively. Legal and accounting expenses were higher
for the 2003 period due to the Company charging $170,804 of legal and accounting
costs for the nine months ended September 30, 2002 to reserve for losses -
shareholder receivable. These were legal and accounting expenses incurred
related to the Questioned Transactions described in "Certain Significant Events"
above and charged to Mr. Lawbaugh.
Net other operating income before income tax for the nine months ended
September 30, 2003 and 2002 was $177,091 and $71,649, respectively. This
consists of the mortgage lender/broker operations of ACFC. For the nine months
ended September 30, 2003 and 2002, other operating income was $2,451,231 and
$1,569,298, 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 nine months ended September 30, 2003 as compared to the nine
months ended September 30, 2002 was due to an increase in the volume of loans
originated and higher yields generated on those loans. The loan origination
volume increased due to residential mortgage lending rates falling in the first
half of 2003. This led to an influx of mortgage refinances along with a strong
market for new purchases of residential housing. For the nine months ended
September 30, 2003 and 2002, other operating expenses were $2,274,140 and
$1,497,649, 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 nine
months ended September 30, 2003 as compared to the nine months ended September
30, 2002, was mainly due to higher commissions paid on the increased revenues
generated.
Realized investment gains were $468,419 and $473,232 for the nine months
ended September 30, 2003 and 2002, respectively. Realized gains for the nine
months ended September 30, 2003 are primarily attributable to gains related to
the sale of real estate. Realized gains for the nine months ended September 30,
2002 are the result of the sale of available for sale securities.
For the nine months ended September 30, 2003 and 2002, reserve for losses
- - shareholder receivable was $141,392 and $227,503, respectively. See "Certain
Significant Events" under Item 2 to this Form 10-Q for further descriptions of
this item.
Liquidity and Financial Resources
As of September 30, 2003, the Company's qualified assets were insufficient
to meet its reserve requirements by $415,776. Immediately upon discovery of this
shortfall, cash was advanced to the Company by Geneva in the amount of $425,000.
This advance replenished the qualified assets to exceed the required reserves.
Upon the sale of the Shares to Geneva, the Company shall receive $1,357,026 of
cash for the repayment of the due from shareholder (Mr. Lawbaugh) and
immediately following the sale the Company projects qualified assets in excess
of reserves to be $1,891,820. See The Consolidated Pro-Forma Post-Acquisition
Balance Sheet and Reserve Calculation under "Certain Significant Events" above
for further disclosure.
- 17 -
The primary liquidity requirement of the Company relates to its payment of
certificate holder interest, certificate maturities and surrenders, 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 $77,483 of scheduled interest disbursements and $45,913
of certificate obligations under interest guarantee periods expiring during the
three 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 September 30, 2003, cash and cash equivalents totaled $1.3 million, an
increase of $0.9 million from December 31, 2002. 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 $1,654,705 and $72,285 were generated from operating
activities for the nine months ended September 30, 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. Cash
proceeds (uses) from investing activities generated ($1,954,047) and
($13,618,534) for the nine months September 30, 2003 and 2002, respectively. The
cash used in investing activities for the nine months ended September 30, 2003
were mainly attributable to the purchase of available-for-sale securities,
mortgage notes and real estate exceeding the sales of available for sale
securities. The cash outflow from investing activities for the nine months ended
September 30, 2002 resulted from the purchase of investments exceeding sales and
repayments.
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
$6,375,931 at September 30, 2003, 19.75% of the investment portfolio (28.44% 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 September 30, 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
securities market value is also weighed by the performance of the company that
issues 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 directly in
real estate and real estate loans, which includes $18.7 million of mortgage
notes, $2.0 million of investment in a real estate development partnership and
$2.8 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
80% for the investment to be a qualified asset as defined by the provisions of
the Insurance Code at the District of Columbia.
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The Company also invests in real estate tax lien certificates, which have
a balance of $614,229 at September 30, 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 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 10% of the market value of the property that secures
the investment.
The Company's ownership of the residual mortgage certificate, which is
valued at $2,660,465 at September 30, 2003, 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 from the potential negative effects of changes in interest
rates.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures.
Our management evaluated, with the participation of our Chief Executive
Officer and our Chief Financial Officer, the effectiveness of our disclosure
controls and procedures as of the end of the period covered by the Quarterly
Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and
our Chief Financial Officer have concluded that our disclosure controls and
procedures are effective to ensure that information we are required to disclose
in reports that we file or submit under the Securities Exchange Act of 1934 is
recorded, processed, summarized and reported within the time periods specified
in Securities and Exchange Commission rules and forms.
Changes in internal control over financial reporting.
There was no change in our internal control over financial reporting that
occurred during the period covered by this Quarterly Report on Form 10-Q that
has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is currently involved in no material legal or administrative
proceedings.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
(31.1) Certification of Chief Executive Officer
(31.2) Certification of Chief Financial Officer
(32.0) Written Statement of the Chief Executive Officer and
Chief Financial Officer pursuant to 18 U.S.C. Section
1350
(99.1) Term Sheet for the Sale of John Lawbaugh's 7.5 Million
Shares of Common Stock of 1st Atlantic Guaranty
Corporation by Bankruptcy Trustee to Geneva Capital
Partners, LLC
(b) REPORTS ON FORM 8-K
The Company filed reports on Form 8-K dated July 8, 2003 and August
20, 2003 during the three months ended September 30, 2003, in each
case providing information under Item 5.
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 19, 2003.
Date: November 19, 2003 SBM CERTIFICATE COMPANY
/s/ Eric M. Westbury
--------------------------------------
Chief Executive Officer
Date: November 19, 2003 /s/ Trey Stafford
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Chief Financial and Accounting Officer
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