ITEM 1. BUSINESS
(a) GENERAL DEVELOPMENT OF BUSINESS
SBM Certificate Company (the "Company"), was incorporated in Maryland on May 24, 2000. It is a wholly-owned subsidiary of State Bond & Mortgage Company, L.L.C. ("State Bond"), a Maryland limited liability company. The Company's executive offices are located at 5101 River Road, Suite 101, Bethesda, Maryland 20816; its telephone number is 301-656-4200.
On July 19, 2000, State Bond completed the purchase of all of the issued and outstanding shares of common stock of SBM Certificate Company a Minnesota corporation ("SBM MN"), from ARM Financial Group, Inc. ("ARM"), a Delaware corporation (the "Acquisition"). State Bond effected the Acquisition as assignee under a Stock Purchase Agreement, dated March 28, 2000, by and among 1st Atlantic Guaranty Corporation ("1st Atlantic"), a Maryland corporation, and ARM ("Stock Purchase Agreement"). State Bond is wholly-owned by 1st Atlantic. The Company and 1st Atlantic are face-amount certificate companies registered as such under the Investment Company Act of 1940 ("1940 Act").
As part of the Acquisition transactions, SBM MN was merged into the Company. The Company was formed for purposes of redomestication from Minnesota to Maryland and had nominal assets when organized. The Company has succeeded SBM MN, which was a registered face-amount certificate company, as the "registrant" in all filings made by SBM MN under the Securities Act of 1933 ("1933 Act"), Securities Exchange Act of 1934 ("1934 Act") and the 1940 Act.
The Company has assumed the face-amount certificate business of SBM MN. The Company's predecessors have issued various series of face-amount certificates of the fully paid and installment type since 1914. The Company has assumed the obligations under SBM MN's outstanding face-amount certificates as a result of the Acquisition.
On December 17, 2000, 1st Atlantic contributed its 100% ownership of Atlantic Capital Funding Corporation ("ACFC") to the Company. ACFC is a mortgage broker and lender in conventional and HUD mortgage programs as well as commercial lending.
(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
The Company has two business segments, the investment company segment of SBM and the mortgage company segment of ACFC. The consolidating financial statements of the Company presented in Item 14 present the detailed financial information of each separate business segment.
(c) NARRATIVE DESCRIPTION OF BUSINESS
General
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 currently offers 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 is automatically renewed for another guarantee period of the same duration until the certificate's maturity date. The certificates mature no later than 33 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.
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. When a certificate is renewed, 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.
SBM Certificate Company's gross income is derived primarily from the margin between earnings on its investments and amounts paid or credited on its fixed rate certificate liability ("investment spread"). The Company's net income is determined by deducting investment and other expenses and federal income taxes. 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. See "Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition".
The Company accrues liabilities, for which it maintains reserves for its certificate obligations in accordance with the 1940 Act. In general, the Company establishes its certificate liability monthly in an amount equal to the certificates' surrender value. Under provisions of the 1940 Act, the Company is permitted to invest its reserves only in assets that constitute "qualified investments" and such other assets as the Securities and Exchange Commission ("SEC") may permit under the 1940 Act.
ACFC principally originates and brokers single-family residential mortgages (conventional and FHA) for sale to investors. Loan underwriting approval from investors is generally obtained, before closing with the borrower, to fund the loans. ACFC is approved as a nonsupervised lender under the HUD Title II program which has a required net worth based on a prescribed calculation. ACFC performs underwriting and closing services for the Company, which acquires mortgage notes from ACFC. ACFC may originate and process real estate loans directly as well as offer its loan programs to outside mortgage brokers and bankers on a wholesale basis. In the latter case, outside brokers will originate and process loans and ACFC will underwrite and close the loans that meet its investment requirements. ACFC may enter into agreements with selected outside mortgage brokers, bankers and mortgage loan servicing companies to service certain types of mortgages that may require special treatment because of various factors, such as the unique features of the underlying real estate or the credit quality of the borrowers.
Management of Investments
Subject to the oversight of the Board of Directors, the Company's management is responsible for selecting and managing the Company's securities investments to ensure that the Company has, in cash or qualified investments, assets having an aggregate value not less than that required by applicable law. Qualified investments are defined as investments of a kind which life insurance companies are permitted to invest in or hold under provisions of the Insurance Code of the District of Columbia. Management also is responsible for placing orders for the purchase and sale of the Company's securities investments with brokers and dealers. The Company may in the future engage one or more investment advisers to assist the Company in the management of its securities investments.
Sale of Certificates and Competition
The Company sells its certificates directly and through broker-dealers who have entered into selling agreements with the Company. Sales also may be made to members of affinity groups, including service organizations, non-profit associations and other types of member organizations.
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. The Company's certificates are not guaranteed or insured by any governmental agency or fund or independent third party but are supported by reserves required by law. The Company's ability to offer competitive interest rates, attractive terms, and efficient service are its primary basis for meeting competition. American Express Certificate Company (formerly IDS Certificate Company) is the Company's main competitor in the issuance of face-amount certificates.
Relationship with State Bond
The Company is an independent operating entity, but relies upon State Bond and its affiliates to provide it with management, marketing and administrative services, as well as personnel, for the conduct of the Company's business. See "Item 13. Certain Relationships and Related Transactions."
Regulation
Like many financial service companies which offer investment opportunities to the public, the Company is subject to governmental regulation. In particular, the 1940 Act and rules issued by the SEC specify certain terms for face-amount certificates, the method for calculating reserve liabilities on outstanding certificates, the minimum amounts and types of investments to be deposited with a qualified custodian to support such reserve liabilities, and a variety of other restrictions. See Note B and Note M of Notes to Consolidating Financial Statements of the Company for more detail on the policies of the Company related to these regulations.
(d) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES
The Company has no foreign operations.
ITEM 2.
ITEM 2. PROPERTIES
The Company's executive offices are located at 5101 River Road, Suite 101, Bethesda, Maryland. The executive offices are the primary location for State Bond's and the Company's investment, accounting, corporate accounting, marketing activities and various support personnel. These offices are leased by State Bond which makes them available to the Company under the Administrative Services Agreement. The Company also maintains administrative offices at 125 Minnesota Street, New Ulm, Minnesota.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to, nor is any of its property the subject of, any material pending legal proceedings, other than ordinary litigation routine to its business.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
There is no public market or trading in the common stock of the Company. All of the Company's 250,000 outstanding shares of common stock are owned by State Bond.
Subject to its obligation to maintain investments in qualified assets as required under Section 28(b) of the 1940 Act, the Company may pay dividends to its parent as declared by the Company's Board of Directors. The Company, including its predecessor, paid total dividends in 2001 and 2000 of $579,934 and $6,513,805, respectively. The dividends in 2000 were primarily in connection with the Acquisition, as discussed in Note A of the Notes to Consolidating Financial Statements.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table contains selected financial data of the Company for the five years ended December 31, 2001. The financial data was derived from the Company's audited financial statements. The reports of Reznick Fedder & Silverman, independent auditors, with respect to the years ended December 31, 2001 and 2000, and of Ernst & Young LLP, independent auditors, with respect to the year ended December 31, 1999, appear at page and, respectively of this Annual Report. The data should be read in conjunction with "Item 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
The Company's predecessor, SBN MN, was incorporated 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 through SBM MN, then a wholly-owned subsidiary of ARM. As a result of the Acquisition, the Company has assumed the obligations of SBM MN's outstanding face-amount certificates and currently offers various series of single-payment face-amount certificates. The Company issues and services fixed rate face-amount certificates and provides related services to holders of the certificates. ACFC performs underwriting and closing services for the Company, as well as other such services to outside brokers and bankers.
Financial Condition, Changes in Financial Condition and Results Of Operations
2001 compared with 2000
During 2001, total assets increased $3,018,243 from $22.3 million in 2000 to $25.3 million in 2001, while certificate liability increased $2,894,422 from $20.9 million in 2000 to $23.8 million in 2001. The increase in total assets and certificate liability is primarily due to certificate sales exceeding 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 expenses and interest credited on certificate reserve liability. Net other operating income is income earned from the origination of loans in the mortgage broker business less operating expenses. Changes in net investment income are largely due to changes in the rate of return on investments. Changes in net other operating income is attributable to changes in the volume of loans originated.
The Company had a net loss of $1,242,405 and $290,643 for the years ended December 31, 2001 and 2000, respectively. The increase in net loss for 2001 stemmed mainly from the net investment loss before income tax of $1,530,959 for the period ended December 31, 2001 as compared to net investment loss before income tax of $483,116 for the period ended December 31, 2000. The increase in net investment loss before income tax for 2001 was due mainly to an increase in investment and other expenses.
Investment income (excluding realized investment gains and losses) in 2001 was $1,515,128 compared to investment income of $1,567,929 for 2000. Investment income plus realized investment gains less realized investment losses represents annualized investment yields of 8.17% and 4.10% on average cash and investments of $19.4 million and $27.8 million for 2001 and 2000, respectively. The decrease in investment income is attributable to a decrease 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 $342,576 for 2001 compared to $44,760 in 2000. On an annualized yield basis, these amounts reflect net investment spread for 2001 and 2000 of 1.53% and .18%, respectively.
Interest credited on certificate reserves for 2001 and 2000 was $1,172,552 and $1,523,169, respectively. These amounts represent annualized average rates of interest credited of 5.24% and 5.97% on average certificate liability of $22.4 million and $25.5 million for 2001 and 2000, 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, resulting in the overall decrease in the average crediting rate.
Investment and other expenses were $1,873,535 and $527,876 for 2001 and 2000, respectively. The increase in investment and other expenses was mainly the result of an increase in the management fee paid to the Company's parent, State Bond, and other expenses. The increase in the management fee was due to a majority of the payment to State Bond in 2001 being made in the form of a management fee, whereas, in 2000 the payment to State Bond was in the form of both a management fee and dividends. Total dividends paid to cover management services and management fee expense combined for 2001 and 2000 was $1,658,773 and $1,486,344, respectively. The increase in other expenses from $178,365 in 2000 to $605,073 in 2001 was mainly due to a new policy implemented after the Acquisition as to the payment of certain direct expenses by the Company. Prior to Acquisition, certain expenses that are currently paid by the Company were paid by ARM.
Net other operating loss before income tax of $68,407 consists of the mortgage broker operations of ACFC, which became a subsidiary of the Company in December 2000. Other operating income of $866,901 is derived from loan origination fees, gain on sale to investor and other processing and underwriting loan fees relating to originating and brokering loans. Other operating expenses of $935,308 consist of salaries and commissions paid in relation to originating and brokering loans and other costs in operating the mortgage company.
Realized investment gains (losses) were $68,697 and ($428,582) for 2001 and 2000, respectively. Realized investment gains and losses are primarily interest-rate related and attributable to the asset/liability management strategies of the Company. Realized investment losses in 2000 were due to the sale of securities as required of SBM MN in the Acquisition transaction. The Company invests in a mixture of investments ranging from securities with fixed maturities, mortgage notes and real estate tax lien certificates. The objective of each investment is to provide reasonable returns while limiting liquidity and credit risks.
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.
2000 compared with 1999
The Company's earnings are derived primarily from the after tax-yield on invested assets less investment expenses and interest credited on certificate reserve liabilities. Changes in earnings' trends occur largely due to changes in the rates of return on investments and the rates of interest credited to the accounts of certificate holder. Likewise, changes in the make-up of taxable and tax-advantaged investments will impact the Company's investment portfolio.
During 2000, total assets decreased $12,025,541, while certificate liability decreased $9,190,058 and the deferred tax liability increased $305,209. The decrease in total assets and the certificate liability is primarily due to maturities, redemptions, early surrenders of certificates exceeding certificate sales, and the certificate liability release. (See the discussion in the last paragraph of this discussion of the results of operation for 2000 compared to 1999 in this connection and Note B to the consolidating financial statements of SBM Certificate Company and Subsidiary.) The $6,513,805 of dividends paid by SBM MN and SBM MD, resulting primarily from the Acquisition, also significantly impacted total assets. The increase in the deferred tax liability was mainly attributable to the new methodology for calculating the certificate liability subsequent to the Acquisition offset by the net operating loss carryforward deferred tax asset.
The Company had net income (loss) of ($290,643) and $36,143 for the years ended December 31, 2000 and 1999, respectively. Net loss for 2000 stemmed from the net investment income of $137,939 and net realized investment loss of $428,582. Net income for 1999 consisted of net investment income of $408,623 and net realized investment losses of $372,530.
Net investment income (excluding net realized investment gains and losses) in 2000 was $137,939 compared to net investment income of $408,673 for 1999. The net investment income in 2000 of $137,939 is comprised of net investment losses before income taxes of $483,116 and a deferred income tax benefit of $621,055. The net investment income in 1999 of $408,673 consists of net investment income before income taxes of $306,660 and an income tax benefit of $102,013. The decrease in net investment income before income taxes was a result of materially diminished certificate sales and a decrease in investments held as a result of redemptions of certain investments. Certificate sales generate the funds needed to purchase various investments that can generate excess investment income over expenses, as well as to serve as qualified investments.
Net investment spread, which is the difference between investment income and interest credited on certificate liability, decreased to $43,761 during 2000 from $0.7 million in 1999. These amounts reflect net investment spread of 0.18% and 1.20% during 2000 and 1999, respectively, between the Company's investment yield on average cash and investments and the average rate credited on certificate reserves.
The Company's investment income decreased to $1.6 million from $2.3 million for 2000 and 1999, respectively. These amounts represent investment yields of 4.10% and 6.20% on average cash and investments of $27.8 million and $36.9 million for 2000 and 1999, respectively. The decrease in investment income is primarily attributable to a lower amount of securities investments in 2000 as compared to 1999.
Interest credited on certificate liability was $1.5 million and $1.6 million for 2000 and 1999, respectively. These amounts represent average rates of 5.97% and 5.00% on average certificate liability of $25.5 million and $32.3 million for 2000 and 1999, respectively. The majority of the Company's outstanding face-amount certificates are fixed-rate three-year contracts.
The Company monitors credited interest rates for new and renewal issues against competitive products, mainly bank certificates of deposit. Credited interest rate adjustments (up or down) on new certificates are made as the Company deems necessary. New and renewal contracts issued during 2000 have crediting rates that are generally lower than contracts that matured during that period, resulting in the overall decrease in the average crediting rate.
Investment and other expenses were $527,876 and $369,825 for 2000 and 1999, respectively. The increase in investment and other expenses is primarily attributable to the costs relating to the Acquisition.
Net realized investment losses (net of gains) were $428,582 and $372,530 for 2000 and 1999, respectively. Realized investment losses for 2000 are due to the sale of securities as required of SBM MN in the Acquisition transaction. Other realized investment gains and losses were primarily interest-rate related and attributable to the asset/liability management strategies of the Company. Fixed maturities and equity securities (i.e., non-redeemable preferred stock) classified as available-for-sale are sold during rising and falling interest rate environments which can result in period-to-period swings in interest-rate related realized investment gains and losses as well.
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.
Certificate liabilities decreased $9.2 million or 30.5% during 2000, as maturities and surrenders exceeded sales and renewals. The decrease is attributable to SBM MD's policy not to renew outstanding Certificates during 2000 and its inability to sell new Certificates after April 30, 2000. This was due to SBM MN's decision not to update its prospectus for use in continuing the offer and sale of Certificates after that date. The Acquisition did not close until July 19, 2000, after which the Company filed amendments to the registration statement that required review by the SEC. The Company began the resumption of certificate sales in early 2001. For certificates reaching their maturity date during 2000 and 1999, 34% and 66%, respectively, were renewed.
Asset Portfolio Review
The Company invests its assets in accordance with the provisions of the 1940 Act, which permits the investment of reserves only in cash or "qualified investments." Qualified investments are investments of a kind which life insurance companies may hold under the Insurance Code of the District of Columbia, and other such assets as the SEC may permit under the 1940 Act. The Company's investment policy is to invest reserves in a variety of investments that diversify risk, provide a reasonable return on investment and allow for liquidity consistent with the cash requirements of the Company. The Company's three principal investment types as of December 31, 2001 are fixed maturity securities, mortgage notes and real estate tax lien certificates. The Company monitors its short-term liquidity needs to ensure that cash flow from investments allows for the payment of all of its obligations due, including expected cash outflow to certificate holders, with the goal of maintaining an adequate level of liquidity for maturing face-amount certificates. In addition, the investment strategy also is designed to provide protection of the investment portfolio from adverse changes in interest rates.
The Company's investments in fixed maturity securities totaled $6,774,313 at December 31, 2001, 28.22% of the investment portfolio (60.58% at December 31, 2000). Fixed maturity investments were 100% investment grade at December 31, 2001. Investment grade securities are those classified as 1 or 2 by the National Association of Insurance Commissioners, or where such classifications are not available, securities are classified by a nationally recognized statistical rating organization (i.e., Standard & Poor's Corporation's rating of BBB- or above). As of December 31, 2001, the Company held no fixed maturity securities that had defaulted on principal or interest payments. Fixed maturities include mortgage-backed securities ("MBSs"), collateralized mortgage obligations ("CMOs") and asset-backed securities, which include pass-through securities. MBSs and CMOs are subject to risks associated with prepayments of the underlying mortgage loans. Prepayments cause these securities to have actual maturities different from those expected at the time of purchase. The degree to which a security is susceptible to either an increase or decrease in yield due to prepayment speed adjustments is influenced by the difference between its amortized cost and par, the relative sensitivity of the underlying mortgages backing the assets to prepayments in a changing interest rate environment and the repayment priority of the securities in the overall securitization structure. Prepayment sensitivity is evaluated and monitored, giving full consideration to the collateral characteristics such as weighted average coupon rate, weighted average maturity and the prepayment history of the specific loan pool.
Based on the provisions of Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities," the Company currently classifies its fixed maturity securities as available-for-sale. Such securities are carried at fair value and changes in fair value, net of deferred income taxes, are charged or credited directly to shareholder's equity. During 2001, the change in unrealized gains, net of tax increased by $4,657 resulting in an unrealized gain, net of tax at December 31, 2001 of $217,448. Unrealized gain net of tax at December 31, 2000 was $212,791. Volatility in reported shareholder's equity occurs as a result of the application of SFAS No. 115, which requires some assets to be carried at fair value while other assets and all liabilities are carried at historical values. As a result, adjusting the shareholder's equity for changes in the fair value of the Company's fixed maturity securities without reflecting offsetting changes in the value of the Company's liabilities or other assets creates volatility in reported shareholder's equity but does not reflect the underlying economics of the Company's business.
The Company's investments in residential and commercial real estate mortgage notes receivable totaled $7,695,895 at December 31, 2001, 32.06% of the investment portfolio. These real estate mortgage notes consist of $6,964,413 of mortgage notes held for sale and $731,482 of mortgage notes held for investment. The notes accrue interest at rates ranging from 8.0% to 14.5% per annum and are secured by the underlying real property. The Company's intention is to sell the mortgage notes held for sale to a buyer under certain favorable market conditions and to hold the mortgage notes held for investment as a long-term investment.
The Company's other significant investments are real estate tax lien certificates. These certificates are comprised of delinquent real estate tax bills purchased from municipalities. They accrue interest at the rate of 20% per annum and are secured by a first lien on the property on which the tax is owed. In all cases, the certificates are significantly over-collateralized by the underlying property. As of December 31, 2001, the real estate tax lien certificates had a balance of $2,917,063, 12.15% of the investment portfolio.
Liquidity and Financial Resources
As of December 31, 2001, the Company had $2.1 million of qualified assets in excess of the minimum amount required by the 1940 Act and the rules and regulations promulgated thereunder by the SEC, as computed in accordance with the 1940 Act.
The primary liquidity requirement of the Company relates to its payment of certificate maturities and surrenders and payment of its management fee. The principal sources of cash to meet such liquidity requirements are investment income and proceeds from maturities and redemptions of investments.
At December 31, 2001, cash and cash equivalents totaled $5.5 million, an increase of $1.8 million from December 31, 2000. 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 ($1.2) million, $1.6 million, and $2.1 million were generated from (used in) operating activities in 2001, 2000, and 1999, respectively. These cash flows resulted principally from investment income, less management fees, and commissions paid. Proceeds from sales, redemptions and maturities of investments generated $9.5 million, $6.4 million, and $37.0 million in cash flows during 2001, 2000, and 1999, respectively, which were offset by purchases of investments of $7.4 million, $3.5 million, and $22.5 million, respectively.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Most of the Company's investments are represented by fixed maturity securities (comprised of government and corporate bonds and mortgage-backed securities), mortgage notes 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.
Presently, the Company has a portion of its portfolio invested in real estate loans, which includes $6.96 million of mortgage notes held for sale and $.7 million of mortgage notes held for investment. Over time, it anticipates increasing this segment of its investment portfolio with the view to enhancing the Company's return on investment. Fluctuations in the value of the underlying real estate represent the greatest risk factor for this investment strategy. However, the Company will invest only in those loans that have a history of producing income, are of high quality by
industry standards or have underlying properties that represent excellent values and safety relative to the market. The mortgage notes must have a loan to value ratio no 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 $2.9 million at December 31, 2001. The greatest risk associated with this investment is the time and costs of a foreclosure process when amounts remain unpaid beyond the Company's aging policy. The risk is mitigated by the Company's first priority lien on the property on which the tax is owed, and the Company's general policy of securing these investments only with properties in which the amount advanced by the Company to acquire the certificates is less than 5% of the market value of the property that secures the investment.
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 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's financial statements begin on page. Reference is made to the Index to Financial Statements on page of this Annual Report. The Company's supplementary financial information as required per regulation S-X begins on page S-01.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Certain information about the Company's directors and officers, including their principal occupations for the past five years, is set out below. Members of the Board who are considered "interested persons" of the Company under the 1940 Act are indicated by an asterisk (*). The Company's directors and officers, other than directors who are not interested persons of the Company, serve in such capacities without compensation. Officers are appointed annually at the annual meeting of the Company's Board of Directors.
The individuals named below became officers and directors of the Company in May 2000, upon the organization of the Company, except that Donald N. Briggs became a director in August 2000, Eric M. Westbury became President of the Company in December 2000, and Trey Stafford became an officer of the Company in July 2001. Name and Age Principal Occupations During the Past Five Years
Board of Directors
The Board of Directors is responsible for the overall management of the Company's business. Directors are elected annually at the Company's meeting of shareholders. Each Director who is not an interested person of the Company receives an annual retainer of $500, plus a $750 fee for each regular or special Board meeting he or she attends. The Directors also receive reimbursement for their expenses incurred in attending any meeting of the Board. The Board generally meets semi-annually.
Committees of the Board of Directors
The Company has an Audit Committee. The duties of the Audit Committee and its present membership are as follows:
Audit Committee: The members of the Audit Committee consult with the Company's independent auditors as the auditors deem it desirable, and meet with the Company's independent auditors at least once annually to discuss the scope and results of the annual audit of the Company and such other matters as the Committee members deem appropriate or desirable. Directors Barnes, Barve and Williams are members of the Audit Committee.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The Company's directors and officers, other than directors who are not interested persons of the Company, serve in such capacities without compensation. See "Item 13. Certain Relationships and Related Transactions," below.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The Company is a wholly-owned subsidiary of State Bond, which, in turn, is wholly-owned by 1st Atlantic. John J. Lawbaugh, an officer and director of the Company, is the controlling shareholder of 1st Atlantic.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Pursuant to an Amended and Restated Administrative Services Agreement dated as of July 1, 2001 (the "Administrative Services Agreement"), State Bond provides various administrative services to the Company. Under the terms of that Agreement, State Bond makes available certain of its property, equipment and facilities to the Company for use in its business operations. State Bond also provides the Company with certain administrative and special services, including personnel and furnishes or otherwise makes available accounting services to the Company. The annual charge to the Company for the services and facilities provided by State Bond is 1% of the Company's average certificate liability balances, or an amount not to exceed $2.5 million. The charge will be determined monthly by State Bond and Company management. At no time, however, may the charge cause the Company to have assets of less than the total of the qualified investments and capital stock required under the 1940 Act. State Bond waived its fees due under the original Administrative Services Agreement dated July 1, 2000 through September 30, 2000. For the last quarter of 2000 a fee of $112,223 was charged to the Company, of which $40,289 remained payable at December 31, 2000. During 2001, a fee totaling $1,078,839 was charged and $1,119,128 was paid by the Company to State Bond. State Bond's parent, 1st Atlantic, is controlled by John J. Lawbaugh.
In connection with the Acquisition, certain dividend payments were made by the Company to its former, and to its current, parent as described in Note A of the Notes to Consolidating Financial Statements. Also, from time-to-time the Company makes dividend payments to State Bond, which, in turn, may make dividend payments to 1st Atlantic, State Bond's parent. During 2001, the Company paid $579,934 of cash dividends to State Bond.
See Note L of Notes to Consolidating Financial Statements with respect to the contribution of two mortgage notes as additional paid-in capital made by State Bond to the Company on September 30, 2001.
ITEM 14
ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) DOCUMENTS FILED AS PART OF THIS REPORT
1. FINANCIAL STATEMENTS.
See financial statements index on page for a listing of financial statements and related reports of independent auditors included in this report.
2. FINANCIAL STATEMENT SCHEDULES
The following financial statement schedules of the Company and the related Report of Independent Auditors are incorporated herein as follows:
Report of Independent Auditors
Schedule I Investment in Securities of Unaffiliated Issuers-December 31, 2001
Schedule II Investments in and Advances to Affiliates and Income Thereon - December 31, 2001
Schedule III Mortgage loans on real estate and interest earned on mortgages - December 31, 2001
Schedule V Qualified Assets on Deposit-December 31, 2001
Schedule VI Certificate Reserves-Year Ended December 31, 2001
Schedule VII Valuation and Qualifying Accounts-December 31, 2001
Schedules required by Article 6 of Regulation S-X for face-amount certificate investment companies other than those listed are omitted because they are not required, are not applicable, or equivalent information has been included in the financial statements and notes thereto, or elsewhere herein.
3. EXHIBITS
NUMBER DESCRIPTION
(2) Stock Purchase Agreement dated March 28, 2000 by and among 1st Atlantic Guaranty Corporation, SBM Certificate Company, and ARM Financial Group Exhibits omitted), incorporated by reference to Exhibit (2) to form 8-K dated March 28, 2000 of 1st Atlantic Guaranty Corporation (File No. 333-41361).
(3)(a) Articles of Incorporation of the Company, incorporated by reference to Exhibit (3)(a) of Post-effective Amendment No. 11 to Registration Statement No. 33-38066 filed on September 28, 2000.
(3)(a) (i) Certificate of Correction of Articles of Incorporation of the Company incorporated by reference to Exhibit (3)(a) of Post-effective Amendment No. 13 to Registration Statement No. 33-38066 filed on January 2, 2001.
(3)(b) By-Laws of the Company incorporated by reference to Exhibit (3)(b) of Post-effective Amendment No. 11 to Registration Statement No. 33-38066 filed on September 28, 2000.
(4)(a) Form of Application, incorporated by reference to Exhibit (4)(a) of Post-effective Amendment No. 11 to Registration Statement No. 33-38066 filed on September 28, 2000
(4)(b) Form of Account Statement, incorporated by reference to Exhibit (4)(a) of Post-effective Amendment No. 11 to Registration Statement No. 33-38066 filed on September 28, 2000.
(10)(a) Amended and Restated Administrative Services Agreement dated as of the 1st day of July, 2001, by and between the Company and State Bond & Mortgage Company, L.L.C.
(10)(b) Custody Agreement, as amended and supplemented, between the Company (as successor to SBM Certificate Company (Minnesota)) and First Trust National Association (now U.S. Bank Trust N.A.) dated December 20, 1990, incorporated by reference to Exhibit 10(b) to Form S-1 Registration Statement No. 33-38066 filed on January 2, 1991.
(21) Subsidiary
(24) Powers of Attorney
(b) REPORTS ON FORM 8-K
No Current Report on Form 8-K was filed by the Company covering an event during 2001. No amendments to previously filed Form 8-K were filed during 2001.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this amended report to be signed on its behalf by the undersigned, thereunto duly authorized, in Bethesda, Maryland, on this 11th day of April, 2002.
SBM Certificate Company
By: /s/ Eric M. Westbury ----------------------- Eric M. Westbury President
Pursuant to the requirements of the Securities Exchange Act of 1934, this amended report has been signed by the following persons in the capacities and on the dates indicated:
* - ---------------------- Director Nancy Hopkinson
* - ---------------------- Director Brian Murphy
* - ---------------------- Director Marialice B. Williams
*By /s/ John L. Lawbaugh -------------------- John L. Lawbaugh Attorney-in-fact April 11, 2002
INDEPENDENT AUDITORS' REPORT
To the Shareholder and Board of Directors SBM Certificate Company
We have audited the accompanying consolidating balance sheets of SBM Certificate Company and Subsidiary as of December 31, 2001 and 2000, and the related consolidating statements of operations and comprehensive income (loss), shareholder's equity, and cash flows for the years then ended. These consolidating financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidating financial statements based on our audit. The financial statements of SBM Certificate Company (formerly SBM Certificate Company, a Minnesota Corporation) as of December 31, 1999, were audited by other auditors whose report, dated March 31, 2000, except for the last paragraph of note A, as to which the date is July 19, 2000, expressed an unqualified opinion.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidating financial statements referred to above present fairly, in all material respects, the financial position of SBM Certificate Company and Subsidiary at December 31, 2001 and 2000, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the supplemental financial statement schedules, when considered in relation to the basic consolidating financial statements taken as a whole, present fairly in all material respects the information set forth therein.
/s/ Reznick Fedder & Silverman
Bethesda, Maryland February 28, 2002
REPORT OF INDEPENDENT AUDITORS
Board of Directors SBM Certificate Company (Minnesota)
We have audited the accompanying statement of operations, shareholder's equity and cash flows of SBM Certificate Company (Minnesota) for the year ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the results of SBM Certificate Company's (Minnesota) operations and its cash flows for the year ended December 31, 1999, in conformity with accounting principles generally accepted in the United States.
/s/ Ernst & Young LLP
Louisville, Kentucky March 31, 2000 Except for the second paragraph of Note A, as to which the date is July 19, 2000
SBM Certificate Company and Subsidiary
CONSOLIDATING BALANCE SHEET
December 31, 2001
See accompanying summary of accounting policies and notes to consolidating financial statements
SBM Certificate Company and Subsidiary
CONSOLIDATING BALANCE SHEET
December 31, 2000
See accompanying summary of accounting policies and notes to consolidating financial statements
SBM Certificate Company and Subsidiary
CONSOLIDATING STATEMENT OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
Year ended December 31, 2001
See accompanying summary of accounting policies and notes to consolidating financial statements
SBM Certificate Company and Subsidiary
CONSOLIDATING STATEMENT OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
Year ended December 31, 2000
See accompanying summary of accounting policies and notes to consolidating financial statements
SBM Certificate Company
STATEMENT OF OPERATIONS AND COMPREHENSIVE LOSS
Year ended December 31, 1999
Investment income Interest income from securities $ 2,261,957 Other investment income 29,602 -----------
Total investment income 2,291,559 -----------
Investment and other expenses Management and investment advisory fees 154,042 Deferred acquisition cost amortization and renewal commissions 193,973 Real estate expenses 2,610 Other expenses 19,200 -----------
Total investment and other expenses 369,825 -----------
Interest credited on certificate liability 1,615,074 -----------
Net investment income before income taxes 306,660
Income tax benefit 102,013 -----------
Net investment income 408,673 -----------
Realized investment losses (470,507) Income tax benefit on realized investment losses 97,977 -----------
Net realized investment losses (372,530) -----------
Net income $ 36,143 ===========
Other comprehensive loss: Unrealized loss on available-for-sale securities Unrealized holding loss in current year $ (895,970) Income tax -- -----------
Net unrealized loss during period (895,970) -----------
Net other comprehensive loss $ (859,827) ===========
See accompanying summary of accounting policies and notes to consolidating financial statements
SBM Certificate Company and Subsidiary
CONSOLIDATING STATEMENTS OF SHAREHOLDER'S EQUITY
Years ended December 31, 2001 and 2000
*On July 9, 2000 SBM Certificate Company of Maryland purchased SBM Certificate of Minnesota (see note A)
See accompanying summary of accounting policies and notes to consolidating financial statements
SBM Certificate Company
STATEMENT OF SHAREHOLDER'S EQUITY
Year ended December 31, 1999
See accompanying summary of accounting policies and notes to consolidating financial statements
SBM Certificate Company and Subsidiary
CONSOLIDATING STATEMENT OF CASH FLOWS
Year ended December 31, 2001
See accompanying summary of accounting policies and notes to consolidating financial statements
SBM Certificate Company and Subsidiary
CONSOLIDATING STATEMENT OF CASH FLOWS
Year ended December 31, 2000
(continued)
SBM Certificate Company and Subsidiary
CONSOLIDATING STATEMENT OF CASH FLOWS - CONTINUED
Year ended December 31, 2000
Supplemental disclosure of significant noncash investing and financing activities: Release of cerfificate liability, net of tax $ 1,259,530 ============
Acquisition of SBM-MN: Assets acquired $ 27,390,982 Liabilities assumed (26,557,263) Legal acquisiton costs (136,868) Goodwill 653,149 ------------ Total purchase price $ 1,350,000 ============
Contribution of 1st Atlantic ownership to SBM-MD $ 573,957 ============
See accompanying summary of accounting policies and notes to consolidating financial statements
SBM Certificate Company
STATEMENT OF CASH FLOWS
Year ended December 31, 1999
Cash flows from operating activities Net income $ 36,143 Adjustments to reconcile net income to net cash provided by operating activities Provision for certificate liability 1,615,074 Realized investment losses 470,507 Deferral of acquisition costs (140,145) Amortization of deferred acquisition costs and renewal commissions 193,973 Other amortization and depreciation 23,711 Deferred tax expense 11,513 Decrease in dividends and interest receivable 115,051 Changes in other assets and liabilities (247,085) ------------
Net cash provided by operating activities 2,078,742 ------------
Cash flows from investing activities Fixed maturity investments: Purchases (22,469,407) Maturities and redemptions 26,873,872 Sales 10,171,240 Repayment of certificate loans, net 39,276 ------------
Net cash provided by investing activities 14,614,981 ------------
Cash flows from financing activities Amounts paid to face-amount certificate holders (5,737,826) Amounts received from face-amount certificate holders 171,612 ------------
Net cash used in financing activities (5,566,214) ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 11,127,509
Cash and cash equivalents, beginning 3,279,970 ------------
Cash and cash equivalents, end $ 14,407,479 ============
See accompanying summary of accounting policies and notes to consolidating financial statements
SBM Certificate Company and Subsidiary
NOTES TO CONSOLIDATING FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
NOTE A - ORGANIZATION AND BUSINESS
Organization and Acquisitions
SBM Certificate Company and Subsidiary (the "Company") consists of SBM Certificate Company, a Maryland Corporation ("SBM-MD"), and Atlantic Capital Funding Corporation, a Maryland Corporation ("ACFC"). SBM-MD was formed on May 24, 2000 under the laws of the State of Maryland. SBM-MD is a wholly-owned subsidiary of State Bond and Mortgage Company, LLC ("State Bond"). 1st Atlantic Guaranty Corporation ("1st Atlantic"), a Maryland Corporation, is the sole member of State Bond. SBM-MD is an issuer of face-amount certificates and is registered under the Investment Company Act of 1940 (the "1940 Act").
On July 19, 2000, State Bond completed the purchase of 100% of the issued and outstanding shares of common stock of SBM Certificate Company, a Minnesota Corporation ("SBM-MN") (the "Acquisition"), from ARM Financial Group, Inc. ("ARM"), a Delaware corporation. SBM-MN was a wholly-owned subsidiary of ARM and an issuer of face-amount certificates under the Investment Company Act of 1940.
State Bond effected the Acquisition as assignee under a Stock Purchase Agreement, dated March 28, 2000, by and among 1st Atlantic, SBM-MN and ARM. State Bond is a 100% owned subsidiary of 1st Atlantic.
The Stock Purchase Agreement provided for a purchase price of $1,400,000, which allowed for an adjustment to the purchase price based on actual asset values 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 were 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.
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.
SBM Certificate Company and Subsidiary
NOTES TO CONSOLIDATING FINANCIAL STATEMENTS - CONTINUED
December 31, 2001, 2000 and 1999
NOTE A - ORGANIZATION AND BUSINESS (Continued)
Organization and Acquisitions (Continued)
On July 19, 2000, upon completion of the Acquisition, SBM-MD 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, Securities Exchange Act of 1934 and Investment Act of 1940 (the "1940 Act").
On December 17, 2000, 1st Atlantic contributed its 100% ownership interest in ACFC by assigning its 10,000 shares of ACFC common stock to SBM-MD (the "Contribution"). The Contribution resulted in additional paid-in capital to SBM-MD for the investment in ACFC, which totaled $573,957. SBM-MD also invested $1 million into ACFC on this date. ACFC was formed under the laws of the State of Maryland on March 27, 1997 and is a wholly-owned subsidiary of SBM-MD.
Nature of Operations
SBM-MD is engaged in the business of issuing and servicing face-amount certificates. A face-amount certificate is an obligation of the issuer to pay a face, or principal amount, plus specified interest, to the holder of the certificate. Under the certificates, the face-amount may be paid at the end of a certificate's Guarantee Period or at its Maturity Date. Lesser amounts are paid at such times if all or part of an investment in the Certificate is withdrawn prior to maturity or the end of any Guarantee Period. Interest, as described above, may be paid quarterly or annually, or compounded.
The Company currently offers various series of single-payment investment certificates. The Company's face-amount certificate operations include issuance of single-payment certificates and the servicing of outstanding single-payment and installment certificates, the investment of related funds, and other related service activities.
SBM Certificate Company and Subsidiary
NOTES TO CONSOLIDATING FINANCIAL STATEMENTS - CONTINUED
December 31, 2001, 2000 and 1999
NOTE A - ORGANIZATION AND BUSINESS (Continued)
Nature of Operations (Continued)
ACFC is a mortgage broker that originates residential and commercial loans and assigns certain loans to SBM-MD at closing. SBM-MD purchases these loans at ACFC's cost.
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The preparation of consolidating financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ from those estimates.
Principles of Consolidating
The consolidating financial statements include the accounts of SBM-MD and its wholly-owned subsidiary, ACFC. All significant intercompany balances and transactions have been eliminated.
Cash and Fixed Maturity Investments
Fixed maturities and equity securities are classified as available-for-sale. Available-for-sale securities are stated at fair value, with the unrealized gains and losses, net of taxes, reported as a separate component of shareholder's equity in accordance with Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities." The amortized cost of fixed maturities classified as available-for-sale is adjusted for amortization of premiums and accretion of discounts to maturity, or in the case of mortgage-backed securities, over the estimated life of the security. Such amortization or accretion is computed using the interest method and is included in investment income. Anticipated prepayments on mortgage-backed securities are considered in determining the effective yield on such securities. If a difference arises between anticipated and actual prepayments, the carrying value of the investment is adjusted with a corresponding charge or credit to investment income. Interest and dividends are included in investment income.
SBM Certificate Company and Subsidiary
NOTES TO CONSOLIDATING FINANCIAL STATEMENTS - CONTINUED
December 31, 2001, 2000 and 1999
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Cash and Fixed Maturity Investments (Continued)
Certificate loans are carried at their unpaid principal balances. Cash and cash equivalents consist of highly liquid investments with maturities of three months or less from the time of purchase. Security transactions are accounted for on the date the order to buy or sell is executed. Realized gains and losses on the sale of investments are determined based upon the specific identification method.
Mortgage Notes Held for Sale
Mortgage notes receivable held for sale are carried at the lower of cost or market value. Loan origination fees and discount points paid by borrowers and the incremental direct costs of originating the loans are capitalized until the loans are sold or paid off. The market value is determined by evaluating, on a loan by loan basis, the note receivable expected loan payments and the market value of the real estate securing the loan.
Mortgage Notes Held for Investment
Mortgage notes held for investment are carried at amortized cost net of loan origination fees and discount points paid by borrowers and the incremental direct costs of originating the loans. These fees and costs are capitalized and amortized through maturity. If necessary, a loan loss reserve is recognized for management's estimate of unrecoverable amounts. Unrecoverable balances are determined by management based on an evaluation of the borrower and the value of the real estate securing the loan.
Real Estate Tax Lien Certificates
Real estate tax lien certificates are investments comprised of delinquent real estate tax bills purchased from municipalities. The investments are secured by a first lien on the respective properties on which the tax is owed. They are carried at cost and, if necessary, a reserve is recognized for management's estimate of unrecoverable amounts.
Deferred Acquisition Costs
Costs of issuing new face-amount certificates, principally commissions, have been deferred. These costs are amortized on a straight-line basis over the initial maturity period of the certificates.
Certificate Liability
Face-amount certificates issued by the Company entitle certificate holders, who have made either single or installment payments, to receive a definite sum of money at maturity. The certificate liability accrues interest, and cash surrender values are less than the accumulated certificate liability prior to maturity dates. The certificate liability accumulation rates, cash surrender values, certificate liability and certificate reserves, among other matters, are governed by the 1940 Act.
SBM Certificate Company and Subsidiary
NOTES TO CONSOLIDATING FINANCIAL STATEMENTS - CONTINUED
December 31, 2001, 2000 and 1999
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Certificate Liability (Continued)
Following the Acquisition, a methodology for calculating the certificate liability was adopted and implemented, whereby the certificate liability is carried at the certificate's surrender value. This methodology is in accordance with Section 28 of the Investment Company Act of 1940. Application of this method of calculating the liability resulted in a reduction of the certificate liability net of tax of $1,259,530 at Acquisition. This amount is reflected as an adjustment to the accumulated deficit in the statement of shareholder's equity.
Income Taxes
The Company accounts for income taxes using the asset and liability approach, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying and tax bases of assets and liabilities. A valuation allowance is recorded if, based upon the evidence available, it is more likely than not that some portion or all of the deferred tax assets will not be realized.
Goodwill
Goodwill resulted from the Acquisition transaction and is being amortized over 15 years. Upon the adoption of SFAS No. 142, goodwill and intangible assets that have indefinite useful lives will not be amortized but rather will be tested at least annually for impairment. The statement is applicable starting with fiscal years beginning after December 15, 2001. The Company will adopt the provisions of SFAS No. 142 on January 1, 2002. Under the new rules, goodwill will no longer be amortized but will be subject to annual impairment tests in accordance with the Statements. During 2002, the Company will perform the first of the required impairment tests of goodwill as of January 1, 2002 and has not yet determined what the effect of these tests will be on the earnings and financial position of the Company.
Fixed Assets
Fixed assets are carried at cost and depreciated using the straight-line method over the estimated useful lives of the assets.
Revenue Recognition
The Company recognizes interest and dividend income on investments when earned on an accrual basis. Revenue earned from the origination and brokering of loans is recognized upon the sale of the loan to an investor or third party. Gains and losses from the sales of investments are recognized at the date of sale of the investment.
SBM Certificate Company and Subsidiary
NOTES TO CONSOLIDATING FINANCIAL STATEMENTS - CONTINUED
December 31, 2001, 2000, and 1999
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Advertising Costs
The Company expenses the costs of advertising as incurred. Advertising expense for the years ended December 31, 2001 and 2000 was $93,422 and $0, respectively.
NOTE C - FIXED MATURITY INVESTMENTS
The amortized cost and estimated fair values of available-for-sale securities were as follows:
SBM Certificate Company and Subsidiary
NOTES TO CONSOLIDATING FINANCIAL STATEMENTS - CONTINUED
December 31, 2001, 2000, and 1999
NOTE C - FIXED MATURITY INVESTMENTS (Continued)
The amortized cost and estimated fair value of fixed maturity securities by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or repay obligations with or without call or prepayment penalties and because mortgage-backed securities provide for periodic payments throughout their life.
December 31, 2001 December 31, 2000 ------------------------- ------------------------- Estimated Estimated Cost fair value Cost fair value ----------- ----------- ----------- ----------- FIXED MATURITIES Due in one year or less $ -- $ -- $ -- $ -- Due after one year through five years 951,380 1,010,344 227,452 227,702 Due after five years through ten years 937,420 1,028,602 1,786,485 1,868,662 Due after ten years 2,161,121 2,179,148 2,155,466 2,184,509 Mortgage-backed securities 2,390,095 2,556,219 8,485,032 8,720,127 ----------- ----------- ----------- -----------
Total fixed maturities $ 6,440,016 $ 6,774,313 $12,654,435 $13,001,000 =========== =========== =========== ===========
Gains (losses) of $64,966, ($443,445), and ($470,507) were realized on sales of fixed maturities classified as available-for-sale for the years ended December 31, 2001, 2000, and 1999, respectively.
Gains of $3,731 and $14,863 were recognized on equity securities sold during 2001 and 2000, respectively. There were no gains or losses recognized on equity securities sold for the year ended December 31, 1999.
SBM Certificate Company and Subsidiary
NOTES TO CONSOLIDATING FINANCIAL STATEMENTS - CONTINUED
December 31, 2001, 2000, and 1999
NOTE D - COMPREHENSIVE INCOME
Comprehensive income is the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources, including net income and the change in unrealized gains or losses on the Company's available-for-sale securities.
The following table shows, for available-for-sale securities, a reconciliation of the net unrealized gain (loss) arising during the period and the change in net unrealized gains (losses) as reported on the accompanying consolidating statements of shareholder's equity. Amounts are reported net of related tax.
Year Ended December 31, ----------------------------------------- 2001 2000 1999 ----------- ----------- -----------
Net unrealized gain (loss) arising during period on available-for-sale securities $ 50,079 $ 221,294 $(1,162,300)
Reclassification adjustment for net realized (gains) losses included in net income (45,422) (8,503) 266,330 ----------- ----------- -----------
Change in net unrealized gains (losses) on available-for- sale securities $ 4,657 $ 212,791 $ (895,970) =========== =========== ===========
SBM Certificate Company and Subsidiary
NOTES TO CONSOLIDATING FINANCIAL STATEMENTS - CONTINUED
December 31, 2001, 2000, and 1999
NOTE E - FIXED ASSETS
Fixed assets are as follows as of December 31, 2001 and 2000:
2001 2000 ---------- ----------
Land and building $ 129,887 $ -- Furniture and fixtures 18,066 -- Computer equipment 77,311 68,072 ---------- ----------
Total cost 225,264 68,072 Less accumulated depreciation 20,658 -- ---------- ----------
$ 204,606 $ 68,072 ========== ==========
NOTE F - MORTGAGE NOTES HELD FOR SALE
At December 31, 2001 and 2000, the Company held residential and commercial mortgage notes receivable for sale of $6,964,413, net of capitalized origination fees of $47,191 and deferred direct loan costs of $9,834. The notes accrue interest at rates ranging from 9.25% to 14.5%, are secured by real property and have maturity dates through October 1, 2031. The Company's intention is to sell the notes to a buyer under certain favorable market conditions. As of December 31, 2001, there are no commitments from investors to purchase any of these mortgage notes.
SBM Certificate Company and Subsidiary
NOTES TO CONSOLIDATING FINANCIAL STATEMENTS - CONTINUED
December 31, 2001, 2000, and 1999
NOTE G - MORTGAGE NOTES HELD FOR INVESTMENT
The Company held two mortgage notes receivable as of December 31, 2001 and 2000 as long-term investments. These notes are serviced by the Company and are secured by real property. The notes accrue interest at rates of 12% and 8% with maturity dates through December 31, 2001.
NOTE H - REAL ESTATE TAX LIEN CERTIFICATES
The Company held investments in real estate tax lien certificates at December 31, 2001 in the amount of $2,917,063. Interest is earned based on a fixed rate of 20% on the outstanding taxes owed. Interest income on these investments for the year ended December 31, 2001 was $159,354 and accrued interest at December 31, 2001 was $142,967. The Company recovers the cost of its investment plus accrued interest from pass through payments on the tax bills from the municipality, which receives payments directly from the tax payers. The Company may also recover the cost of its investment plus accrued interest by exercising its rights to foreclose on the underlying properties within a two year period from the date of the investment purchase.
NOTE I - CERTIFICATE LIABILITY
The Company's certificate liability consists of the statutory certificate liability and the additional certificate liability. The statutory certificate liability is calculated based on section 28(a) of the 1940 Act. The Company maintains an additional certificate liability amount in excess of the statutory liability. This additional liability plus the statutory liability is equal to the certificates' surrender value.
The total certificate liability at December 31 is summarized as follows:
SBM Certificate Company and Subsidiary
NOTES TO CONSOLIDATING FINANCIAL STATEMENTS - CONTINUED
December 31, 2001, 2000, and 1999
NOTE J - FAIR VALUES OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair values of financial instruments is made in accordance with the requirements of SFAS No. 107, "Disclosures About Fair Value of Financial Instruments." The estimated fair value amounts have been determined using available market information and appropriate valuation methodologies. However, considerable judgment was required to develop these estimates. Accordingly, the estimates are not necessarily indicative of the amounts which could be realized in a current market exchange. The use of different market assumptions or estimation methodologies may have a material effect on the estimated fair value amounts.
The following methods and assumptions were used in estimating fair values:
Fixed Maturities and Equity Securities
Fair values for investments in securities are based on quoted market prices, where available. For fixed maturities and equity securities for which a quoted market price is not available, fair values are estimated using internally calculated estimates or quoted market prices of comparable instruments.
SBM Certificate Company and Subsidiary
NOTES TO CONSOLIDATING FINANCIAL STATEMENTS - CONTINUED
December 31, 2001, 2000, and 1999
NOTE J - FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)
Certificate Loans
The carrying value of certificate loans approximates their fair value.
Mortgate Notes Held for Sale
Fair value is estimated by evaluating, on a loan-by-loan basis, the note receivable's expected loan payments and the market value of the real estate securing the loan.
Mortgate Notes Held for Investment
Estimated fair value of mortgage notes held for investment approximates their carrying value.
Real Estate Tax Lien Certificates
Estimated fair value of tax lien certificates approximates their carrying value.
Cash and Cash Equivalents
The carrying amounts of cash and cash equivalents approximate their fair value given the short-term nature of these assets.
Certificate Liability
The fair value and carrying value of the certificate liability is based on the surrender value of the applicable certificate prospectus.
SBM Certificate Company and Subsidiary
NOTES TO CONSOLIDATING FINANCIAL STATEMENTS - CONTINUED
December 31, 2001, 2000, and 1999
NOTE K - INCOME TAXES
Deferred income taxes reflect the net tax effects of (i) temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, and (ii) operating and capital losses. Significant components of the deferred tax liabilities and assets as of December 31, 2001 and 2000 were:
2001 2000 ----------- ----------- Deferred tax liabilities Net unrealized gains on available-for-sale securities $ 116,849 $ 133,774 Certificate liability 640,269 630,724 ----------- -----------
Total deferred tax liabilities 757,118 764,498 ----------- -----------
Deferred tax assets Investments 185,644 311,829 Mortgage notes -- 38,136 Capital loss carryover 381,925 206,455 Net operating loss carryforward 967,671 109,324 ----------- -----------
Total deferred tax assets 1,535,240 665,744
Valuation allowance for deferred tax assets (778,122) (206,455) ----------- -----------
Net deferred tax assets 757,118 459,289 ----------- -----------
Deferred tax liabilities shown on the accompanying balance sheets $ -- $ 305,209 =========== ===========
In 2001 and 2000, the Company has provided a valuation allowance for deferred tax assets for net operating loss carryforwards and capital loss carryforwards in which realization of these future benefits cannot be reasonably assured as a result of recurring operating losses and the uncertainty of the Company's ability to realize the capital loss carryforwards. If the Company has capital gains, these capital loss carryforwards would be available to offset such gain, subject to certain limitations. If the Company achieves profitability, these deferred tax assets would be available to offset future income tax liabilities and expense, subject to certain limitations.
SBM Certificate Company and Subsidiary
NOTES TO CONSOLIDATING FINANCIAL STATEMENTS - CONTINUED
December 31, 2001, 2000, and 1999
NOTE K - INCOME TAXES (Continued)
At December 31, 2001 and 2000, the Company had net operating loss carryforwards of approximately $2,506,919 and $283,223, respectively, for income tax purposes which expire in various years through 2021. The Company had capital loss carryforwards at December 31, 2001 and 2000 of approximately $988,930 and $283,223, respectively, which expire in various years through 2006.
The components of the provision for federal income tax expense consist of the following:
Year Ended December 31, ------------------------------------ 2001 2000 1999 --------- --------- --------- Current $ -- $ -- $(211,503) Deferred (288,264) (621,055) 11,513 --------- --------- ---------
Total federal income tax benefit $(288,264) $(621,055) $(199,990) ========= ========= =========
Federal income tax expense differs from that computed by using the income tax rate of 35%, as shown below.
Year Ended December 31, ----------------------------------- 2001 2000 1999 --------- --------- ---------
Income tax benefit at statutory rate $(441,577) $(309,977) $ (57,346) State tax benefit, net of federal tax benefit (86,968) (24,277) -- Increase in valuation allowance related to capital loss and NOL carryovers 571,667 206,455 66,700 Decrease in contingent tax liability -- -- (200,000) Dividend received deduction -- -- (7,211) Certificate liability adjustment (287,735) (615,904) -- Mortgage notes marked to market -- 38,136 -- Tax-exempt interest (12,000) (12,000) (2,612) Other (31,651) 96,512 479 --------- --------- ---------
Total federal income tax benefit $(288,264) $(621,055) $(199,990) ========= ========= =========
SBM Certificate Company and Subsidiary
NOTES TO CONSOLIDATING FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
NOTE L - RELATED PARTY TRANSACTIONS
State Bond provides the Company with administrative services pursuant to an Administrative Services Agreement. This agreement stipulates that State Bond shall provide certain administrative and special services for the Company. Services include the use of State Bond's property and equipment, facilities and personnel needed for SBM-MD's daily operations. For providing such services, State Bond earns an annual fee from the Company calculated at either 1% of the Company's average certificate liability balances, or an amount not to exceed $2.5 million. The charge is determined monthly by State Bond and Company management. During 2001 and 2000, a fee was charged totaling $1,078,839 and $112,223, respectively. Management fees paid in 2001 and 2000 were $1,119,128 and $71,934, respectively, and $40,289 remained payable at December 31, 2000.
On September 30, 2001, State Bond contributed as additional paid-in capital two mortgage notes to the Company which totaled $2,253,684 at that date. One of such notes in the amount of $1,127,473, is secured by real estate that is owned by the borrower, a partnership in which 1st Atlantic has an 85% partnership interest.
A director of the Company provided legal services relating to the Acquisition and throughout 2001. Total costs for services provided during 2001 and 2000 were $8,150 and $61,960, respectively, and $18,000 remained payable as of December 31, 2000.
The Controlling shareholder of 1st Atlantic, State Bond's parent, is also Chairman of the Board of Directors of SBM-MD.
NOTE M - SHAREHOLDER'S EQUITY AND 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 ($21.5 million and $20.2 million at December 31, 2001 and 2000, respectively). The Company had qualified assets (at amortized cost) of $23.6 million and $20.4 million at those respective dates.
For purposes of determining compliance with the foregoing provisions, qualified assets are valued in accordance with District of Columbia Insurance Laws (the "D.C. Laws") as required by the 1940 Act. Qualified assets for which no provision for valuation is made in the D.C. Laws are valued in accordance with rules, regulations, or orders prescribed by the SEC. These values are the same as the financial statement carrying values, except that for financial statement purposes, fixed maturities and equity securities classified as available-for-sale are carried at fair value. For qualified asset purposes, fixed maturities classified as available-for-sale are valued at amortized cost and equity securities are valued at cost.
SBM Certificate Company and Subsidiary
NOTES TO CONSOLIDATING FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
NOTE M - SHAREHOLDER'S EQUITY AND REGULATORY MATTERS (Continued)
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 December 31, 2001 and 2000, as shown in the following table. Certificate loans, secured by applicable certificate liabilities, are deducted from certificate reserves in computing deposit requirements.
December 31, ---------------------------- 2001 2000 ------------ ------------ Qualified assets on deposit: Central depository $ 23,301,100 $ 20,114,019 State governmental authorities 270,899 265,110 ------------ ------------
Total qualified assets on deposit $ 23,571,999 $ 20,379,129 ============ ============
Certificate reserve under Section 28(a) $ 21,311,350 $ 20,020,189 Less: Certificate loans (98,137) (110,069) Plus: Base capital requirement 250,000 250,000 ------------ ------------
Required deposits $ 21,463,213 $ 20,160,120 ============ ============
NOTE N - CONCENTRATIONS
During 2001, the Company had selling agreements in place with six broker-dealer firms to sell the face-amount certificates of the Company. Of the Company's $6,472,858 of new certificate sales, $4,226,506, or 65%, were sold by one broker-dealer, ARM Securities. To mitigate this concentration, in 2002, the Company has executed one new selling agreement and has begun extensive marketing to the other broker-dealers with which it has selling agreements. In addition, the Company has implemented a new internal retail sales division.
SBM Certificate Company and Subsidiary
SUPPLEMENTAL SCHEDULES
SCHEDULE I - INVESTMENTS IN SECURITIES OF UNAFFILIATED ISSUERS
December 31, 2001
S-01
SBM Certificate Company and Subsidiary
SUPPLEMENTAL SCHEDULES - CONTINUED
SCHEDULE I - INVESTMENTS IN SECURITIES OF UNAFFILIATED ISSUERS - CONTINUED
December 31, 2001
S-02
SBM Certificate Company and Subsidiary
SUPPLEMENTAL SCHEDULES - CONTINUED
SCHEDULE II - INVESTMENTS IN AND ADVANCES TO AFFILIATES AND INCOME THEREON
Year ended December 31, 2001
S-03
SBM Certificate Company and Subsidiary
SUPPLEMENTAL SCHEDULES - CONTINUED
SCHEDULE III - MORTGAGE LOANS ON REAL ESTATE AND INTEREST EARNED ON MORTGAGES
Year ended December 31, 2001
S-04
SBM Certificate Company and Subsidiary
SUPPLEMENTAL SCHEDULES - CONTINUED
SCHEDULE V - QUALIFIED ASSETS ON DEPOSIT
December 31, 2001
(a) Represents amortized cost of bonds and securities.
(b) Represents dividend and interest receivable on qualified assets.
S-05
SBM Certificate Company and Subsidiary
SUPPLEMENTAL SCHEDULES - CONTINUED
SCHEDULE VI - CERTIFICATE RESERVES PART I - SUMMARY OF CHANGES
Year ended December 31, 2001
S-06
SBM Certificate Company and Subsidiary
SUPPLEMENTAL SCHEDULES - CONTINUED
SCHEDULE VI - CERTIFICATE RESERVES - CONTINUED PART I - SUMMARY OF CHANGES - CONTINUED
Year ended December 31, 2001
S-07
SBM Certificate Company and Subsidiary
SUPPLEMENTAL SCHEDULES - CONTINUED
SCHEDULE VI - CERTIFICATE RESERVES - CONTINUED PART II - INFORMATION REGARDING INSTALLMENT CERTIFICATES CLASSIFIED BY AGE GROUPINGS
Year ended December 31, 2001
S-08
SBM Certificate Company and Subsidiary
SUPPLEMENTAL SCHEDULES - CONTINUED
SCHEDULE VI - CERTIFICATE RESERVES - CONTINUED PART II - INFORMATION REGARDING INSTALLMENT CERTIFICATES CLASSIFIED BY AGE GROUPINGS - CONTINUED
Year ended December 31, 2001
S-09
SBM Certificate Company and Subsidiary
SUPPLEMENTAL SCHEDULES - CONTINUED
SCHEDULE VI - CERTIFICATE RESERVES - CONTINUED PART II - INFORMATION REGARDING INSTALLMENT CERTIFICATES CLASSIFIED BY AGE GROUPINGS
Year ended December 31, 2001
(continued)
S-10
SCHEDULE VI - CERTIFICATE RESERVES - CONTINUED PART II - INFORMATION REGARDING INSTALLMENT CERTIFICATES CLASSIFIED BY AGE GROUPINGS - CONTINUED
Year ended December 31, 2001
S-11
SBM Certificate Company and Subsidiary
SUPPLEMENTAL SCHEDULES - CONTINUED
SCHEDULE VII - VALUATION AND QUALIFYING ACCOUNTS
(1) The valuation allowance was increased as a result of establishing a full valuation allowance on deferred tax assets for capital loss carryforwards and NOL carryforwards.
(2) The valuation allowance was increased as a result of establishing a full valuation allowance on deferred tax assets for unrealized losses on assets available-for-sale. The increase in valuation allowance resulted in a reduction of shareholders' equity.
(3) The capital loss carryover was utilized during 1998, and therefore the related valuation allowance was released.
S-12