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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR FISCAL YEAR ENDED DECEMBER 31, 2003
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number: 811-6268
SBM CERTIFICATE COMPANY
(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.)
5101 RIVER ROAD, SUITE 101, BETHESDA, MARYLAND 20816
(Address of principal executive offices) (Zip Code)
301-656-4200
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 of 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part II of this Form 10-K or any amendment to this
Form 10-K. |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes |_| No |X|
As of March 30, 2004, 250,000 shares of the registrant's common stock, $1 par
value, were outstanding. The registrant is a wholly-owned subsidiary and,
therefore, its common stock is not traded on a public market.
DOCUMENTS INCORPORATED BY REFERENCE
None.
TABLE OF CONTENTS
PART I
Item 1. Business ................................................................. 3
Item 2. Properties ............................................................... 8
Item 3. Legal Proceedings......................................................... 8
Item 4. Submission of Matters to a Vote of Security Holders ...................... 9
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters .... 9
Item 6. Selected Financial Data .................................................. 9
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations .................................................. 12
Item 7A. Quantitative and Qualitative Disclosures About Market Risk ............... 21
Item 8. Financial Statements and Supplementary Data .............................. 22
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure ................................................... 22
Item 9A. Controls and Procedures................................................... 23
PART III
Item 10. Directors and Executive Officers of the Registrant ....................... 23
Item 11. Executive Compensation ................................................... 25
Item 12. Security Ownership of Certain Beneficial Owners and Management ........... 25
Item 13. Certain Relationships and Related Transactions ........................... 26
Item 14. Principal accounting fees and services ................................... 27
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K .......... 29
2
PART I
ITEM 1. BUSINESS
(a) GENERAL DEVELOPMENT OF BUSINESS
SBM Certificate Company and Subsidiaries (the "Company") consists of SBM
Certificate Company ("SBM") and its 100% owned subsidiaries, Atlantic Capital
Funding Corporation ("ACFC") and SBM Securities I ("SBMS I"). SBM is a 100%
owned subsidiary of SBM Financial, LLC ("SBM Financial"), formerly known as
State Bond & Mortgage, LLC ("State Bond"). As of December 31, 2003, SBM
Financial is 100% owned by Geneva Capital Partners, LLC ("Geneva"). See Note 1
to the Notes to the Consolidating Financial Statements, which more fully
describes the organization of the Company and basis of consolidation. Unless
otherwise indicated by the context, the terms "Company," "we," "us," or "ours,"
refers to the consolidated entities of SBM, ACFC and SBMS I. Our executive
offices are located at 5101 River Road, Suite 101, Bethesda, Maryland 20816; our
telephone number is 301-656-4200.
On July 19, 2000, State Bond completed the purchase of all of the
outstanding common stock of SBM Certificate Company, a Minnesota corporation
("SBM MN"), from ARM Financial Group, Inc. ("ARM"), a Delaware corporation (the
"Purchase"). State Bond effected the Purchase 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").
1st Atlantic became a 100% owned subsidiary of Geneva on December 5, 2003. SBM
and 1st Atlantic are face-amount certificate companies registered as such under
the Investment Company Act of 1940 ("1940 Act").
As part of the Purchase transactions, SBM MN was merged into SBM. SBM was
formed for purposes of redomestication from Minnesota to Maryland and had
nominal assets when organized. SBM 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 (the "Exchange Act") and the 1940 Act.
On December 17, 2000, 1st Atlantic contributed its 100% ownership of ACFC
to SBM. ACFC is a mortgage broker and lender in conventional and HUD mortgage
programs as well as commercial lending.
Significant Events
In 2002, management discovered facts that came to its attention regarding
several transactions (the "Questioned Transactions") involving the Company. The
Questioned Transactions raised concerns that SBM's then 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 us to fail to comply with disclosure requirements
of the 1933 Act and the Exchange Act, caused us 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 to the
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Company by Mr. Lawbaugh in 2002. The balance of $868,917, together with legal
and accounting costs incurred because of these matters constitute the amount due
from shareholder on the December 31, 2002 Consolidating Balance Sheet of the
Company of $1,218,181.
As a result of the Questioned Transactions, on August 16, 2002, SBM'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. The investigation was performed by our
management under the supervision of two independent directors of the Board (the
"Special Committee") and our independent auditors. Our Form 8-K Current Report
describes the findings of the Special Committee created by the Board of
Directors to oversee the investigation of Mr. Lawbaugh's transactions,
summarizes the nature of the transactions and discusses various related matters.
In addition, SBM suspended the sale of its face-amount certificates on August
16, 2002. We restated our financial statements and amended our 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. SBM has not yet resumed sales. An
amendment to our 1933 Act registration statement for our face-amount
certificates is pending at the SEC.
On November 12, 2002, Mr. Lawbaugh resigned from the Board of Directors
and on November 14, 2002, entered into a Stock Escrow Agreement ("Escrow
Agreement"). The Escrow Agreement placed Mr. Lawbaugh's shares of 1st Atlantic
capital stock, representing majority ownership of 1st Atlantic, into escrow and
removed his voting rights associated with the shares. We filed a Form 8-K
Current Report dated November 12, 2002, with the SEC on November 27, 2002. That
Form 8-K Current Report describes the terms and conditions of the Escrow
Agreement. See Note 14 to the Notes to the Consolidating Financial Statements
for further description of the due from shareholder and the Questioned
Transactions.
The following summarizes the impact of the Questioned Transactions on the
Company for the respective periods indicated:
YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 2003 DECEMBER 31, 2002 DECEMBER 31, 2001 DECEMEBR 31, 2000 TOTAL
----------------- ----------------- ----------------- ----------------- -----
Qualified Assets $ (141,392) $ (56,700) $(1,396,907) $ (292,236) $(1,745,843)
Additional Paid in Capital $ -- $ -- $ (707,550) $ -- $ (707,550)
Shareholder's Equity $ (141,392) $ (265,762) $(1,146,957) $ (292,236) $(1,704,955)
Net Loss $ (141,392) $ (365,763) $ (439,407) $ (292,236) $(1,097,406)
On May 29, 2003, John Lawbaugh, 1st Atlantic's majority shareholder at the
time, 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 ("Bankruptcy Court").
On November 7, 2003, 1st Atlantic, Geneva and the Chapter 11 Bankruptcy
Trustee (the "Trustee"), as representative of the bankruptcy estate of John J.
Lawbaugh (the "Estate"), agreed to a settlement proposal for the sale of John J.
Lawbaugh's 7,500,000 shares of 1st Atlantic
4
common stock (the "Shares") to Geneva. An emergency motion was filed in
Bankruptcy Court on November 10, 2003 for the approval of the sale of the Shares
to Geneva under such proposal. On December 2, 2003, the Bankruptcy Court granted
the motion approving the settlement proposal for the sale of the Shares free and
clear of all liens and ordered the sale of the Shares to take place immediately.
On December 5, 2003, the sale of the Shares closed pursuant to the terms of the
Stock Purchase Agreement by and between the Trustee and Geneva dated December 2,
2003 (the "Sale Agreement") (the "Acquisition"). The Trustee sold the Shares to
Geneva for $2,532,981, which was distributed to 1st Atlantic and SBM in the
amounts of $1,175,955 and $1,357,026, respectively, to repay the amounts due
from Mr. Lawbaugh to 1st Atlantic and SBM (See Note 14 to the Notes to the
Consolidating Financial Statement). In addition, Geneva contributed $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, SBM Financial issued debt instruments secured by the
common stock of SBM 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.
Cash flows generated from the operations of the Company may be used to pay the
interest and principal of the debt as it becomes due. A total of $125,000 was
also paid by Geneva to the Trustee and certain other creditors of the Estate.
Immediately after closing, Geneva made additional contributions to the Company,
consisting of $1,000,000 cash and partnership interests in two separate real
estate investment funds totaling $820,000. These contributions were treated as
additional paid in capital.
Geneva obtained funds to acquire the Shares from the issuance of privately
placed investment notes to unaffiliated investors. The investment notes provide
for a fixed interest rate of 3.75%, payable quarterly, and mature in 2006, three
years from the date of the issuance. The funds obtained to acquire the Shares
and the additional capital contributed by Geneva after the sale of the Shares
are projected to be repaid at their maturity from excess cash flows generated
from the operations of the Company. Geneva is owned 100% by Eric M. Westbury,
Chairman and Chief Executive Officer of SBM.
See "Item 6. Selected Financial Data" to this Form 10-K for proforma
financial information related to the Acquisition.
(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
We have three business segments, issuing and servicing face-amount
certificates, mortgage lending and brokerage operations, and issuing privately
placed investment notes to accredited investors. The consolidating financial
statements of the Company presented in Item 15 present the financial information
of SBM and SBMS I as consolidated and ACFC is separately presented. SBMS I has
yet to issue any investment notes and, therefore has not generated any revenue.
SBMS I has incurred expenses, most of which are legal costs, for the year ended
December 31, 2003 of $225,117. These amounts remain unpaid as of December 31,
2003.
5
(c) NARRATIVE DESCRIPTION OF BUSINESS
General
SBM 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.
SBM issues various series of single-payment face-amount 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 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 above under "Significant
Events," SBM suspended the sale of its certificates on August 16, 2002. Any use
in this Form 10-K Annual Report of the term "offer," "sale" or "issues" and any
discussion in that context, is qualified by such suspension.
SBM periodically declares the interest rates payable for its certificates,
which are applicable for the entire guarantee period. The prevailing interest
rates available to investors for similar interest-bearing instruments are a
primary consideration in deciding upon the interest rates declared. However, SBM
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.
SBM'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 investment
decisions, general economic conditions, government monetary policy, the policies
of regulatory authorities that influence market interest rates, and SBM's
ability to respond to changes in such rates. Changes in market interest rates
may have a negative impact on earnings. See "Item 7. Management's Discussion and
Analysis of Results of Operations and Financial Condition".
Following the Purchase by State Bond on July 19, 2000, a methodology for
calculating the certificate liability was adopted and implemented, whereby the
certificate liability is carried at the certificate's surrender value. A
certificate's surrender value is the certificate's account value, principal plus
accrued interest, less the early withdrawal charge applicable to the
certificate.
6
Following the 2003 Acquisition, the certificate liability is carried at
the account value less an estimate for early surrender charges based on SBM's
history with regard to early surrenders. These methods are in accordance with
accounting principles generally accepted in the United States of America.
SBM maintains reserves for its certificate obligations in accordance with
Section 28 of the 1940 Act. Under provisions of the 1940 Act, SBM 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 is principally 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.
SBMS I is an entity newly formed for the purpose of issuing privately
placed investment notes to accredited investors. The investment notes represent
an obligation of SBMS I to pay the investor its principal investment plus
accrued interest at its maturity date. Proceeds from the issuance of the
investment notes will be invested in real estate, mortgage notes, fixed maturity
and equity securities.
Management of Investments
Subject to the oversight of the Board of Directors and its Investment
Committee, management is responsible for selecting and managing investments to
insure 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 portfolio with brokers and
dealers. In the future, the Company may engage one or more investment advisers
to assist the Company in the management of its investment portfolio.
Sale of Certificates and Competition
As disclosed in "Item 1. Business: Significant Events", SBM suspended
sales of its face-amount certificates on August 16, 2002 due to the discovery of
the Questioned Transactions. When SBM is selling, certificates are sold directly
by SBM and through broker-dealers who have entered into selling agreements with
SBM. Sales also may be made to members of affinity groups, such as service
organizations, non-profit associations and other types of member organizations.
Our 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. SBM's certificates are not guaranteed or insured by any
7
governmental agency or fund or independent third party but are supported by
reserves required by law. Our ability to offer competitive interest rates,
attractive terms, and efficient service is our primary basis for meeting
competition.
Relationship with SBM Financial (Formerly Known as State Bond)
SBM is an independent operating entity, but relies upon SBM Financial to
provide it with management, marketing and administrative services, as well as
personnel, for the conduct of its business. See "Item 13. Certain Relationships
and Related Transactions."
Regulation
Like many financial service companies that offer investment opportunities
to the public, we are subject to governmental regulation. In particular, the
1940 Act and rules issued by the SEC specify certain terms and conditions for
face-amount certificates, the method for calculating face-amount certificate
reserves, the minimum amounts and types of investments to be deposited with a
qualified custodian to support such certificate reserves and a variety of other
restrictions. See Note 2 and Note 20 of Notes to Consolidating Financial
Statements of the Company for more detail on our policies related to these
regulations.
(d) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT
SALES
We have no foreign operations.
ITEM 2. PROPERTIES
Our executive offices are located at 5101 River Road, Suite 101, Bethesda,
Maryland, 20816. The executive offices are the primary location for SBM
Financial and the Company's executive management, administrative services,
investment, accounting, corporate accounting, marketing activities and other
support personnel. These offices are leased by SBM Financial, which makes them
available to the Company under an Administrative Services Agreement. See "Item
13. Certain Relationships and Related Transactions." We also maintain
administrative offices at 125 Minnesota Street, New Ulm, Minnesota. This
property is owned by us and has a carrying value of $121,679.
ITEM 3. LEGAL PROCEEDINGS
We are not a party to, nor is any of our property the subject of, any
material pending legal proceedings, other than ordinary litigation routine to
its business.
8
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
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 SBM, all of
which is owned by SBM Financial.
Subject to its obligation to maintain investments in qualified assets as
required under Section 28(b) of the 1940 Act, SBM may pay dividends to its
parent as declared by its Board of Directors. There were no dividends declared
or paid for the years ended December 31, 2003 and 2002.
ITEM 6. SELECTED FINANCIAL DATA
The following table contains selected financial data of the Company for
the five years ended December 31, 2003. The financial data was derived from our
audited financial statements. The report of Reznick Fedder & Silverman,
independent auditors, with respect to the years ended December 31, 2003, 2002
and 2001, appear at page F-02 of this Annual Report. The data should be read in
conjunction with "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the financial statements, related
notes, and other financial information included in this Annual Report.
9
YEAR ENDED DECEMBER 31
--------------------------------------------------
2003 2002 2001 2000 1999
------ ------ ------ ------ ------
(in thousands, except per share data)
STATEMENT OF OPERATIONS DATA
Total investment income 2,766 2,439 1,615 1,618 2,292
Interest credited on certificate reserves (2,425) (1,349) (1,173) (1,523) (1,615)
Net investment spread 341 1,090 442 95 677
Total investment and other expenses (2,157) (2,951) (1,973) (528) (376)
Net investment income (loss) before taxes and gains (1,816) (1,861) (1,531) 188 409
Net realized investment gains (losses) 448 473 69 (429) (373)
Net investment income (loss) before taxes (1,368) (1,388) (1,462) (241) 36
Net other operating income (loss) (281) 118 (38) -- --
Net investment and other operating income (losses) (1,649) (1,270) (1,500) 188 409
Federal income tax (expense) benefit (15) -- 288 621 102
Net operating income (loss) (1,664) (1,270) (1,212) (241) 36
Non-operating expense (141) (406) (470) (342) --
Net income (loss) (1,805) (1,676) (1,682) (583) 36
Earnings (loss) per share* (7.22) (6.70) (6.73) (2.33) 0.14
BALANCE SHEET DATA (END OF PERIOD)
Total assets 51,172 35,115 23,881 21,967 34,285
Total liabilities 42,731 38,696 24,152 21,527 30,117
Shareholder's equity (deficit) 8,441 (3,581) (271) 440 4,168
- ----------
* Earnings (loss) per share based on 250,000 shares issued and outstanding.
- --------------------------------------------------------------------------------
Proforma Financial Information Related to the Change of Control
The Acquisition disclosed in "Item 1. Business: Significant Events" to this Form
10-K was accounted for using the purchase method of accounting in accordance
with Statement of Financial Accounting Standards ("SFAS") 141, "Accounting for
Business Combinations." Certain items within the financial statements had a
material change due to the Acquisition. The following proforma consolidated
balance sheet reflects the impact of the Acquisition on the financial statements
of the Company:
10
SBM Certificate Company and Subsidiaries
PROFORMA CONDENSED CONSOLIDATED BALANCE SHEET
Pre-Acquisition Acquisition Post-Acquisition
December 5, 2003 Entries December 5, 2003
---------------- ------------ ----------------
Qualified assets
Cash and investments
Available-for-sale securities $ 6,665,571 42,427 1 $ 6,707,998
Mortgage notes held for sale 7,587,230 44,959 1 7,632,189
Mortgage notes held for investment 7,700,738 94,467 1 7,795,205
Warehouse line of credit receivable -- -- --
Investment in real estate partnerships 7,903,001 -- 7,903,001
Real estate tax lien certificates 602,609 -- 602,609
Real estate owned 2,760,509 (475,000) 1 2,285,509
Residual mortgage certificate 2,660,409 24,796 1 2,685,205
Certificate loans 68,575 -- 68,575
Cash and cash equivalents 600,654 1,357,026 2 1,957,680
------------ ------------ ------------
Total cash and investments 36,549,296 1,088,675 37,637,971
------------ ------------ ------------
Dividends and interest receivable 318,297 -- 318,297
------------ ------------ ------------
Total qualified assets 36,867,593 1,088,675 37,956,268
Other assets
Related party receivable 254,385 (4,989) 1 249,396
Fixed assets, net 198,684 -- 198,684
Investment in subsidiary -- -- --
Goodwill and intangible assets 591,463 (591,463) 1
3,636,030 1
7,045,080 3 10,681,110
Deferred acquisition costs, net 442,308 (442,308) 1 --
Due from shareholder 1,359,573 (2,547) 1
(1,357,026) 2 --
Allowance - due from shareholder (1,359,573) 1,359,573 1 --
Other assets 164,360 -- 164,360
------------ ------------ ------------
Total assets $ 38,518,793 10,731,025 $ 49,249,818
============ ============ ============
Liabilities
Statutory certificate liability $ 33,788,203 2,008,015 1 $ 35,796,218
Additional certificate liability -- --
Warehouse line of credit 2,068,000 2,068,000
Deferred revenue 1,295,890 (1,295,890) 1 --
Subscription and note payable 3,902,802 3,902,802
Accounts payable and other liabilities 419,634 419,634
Related party payable 18,084 18,084
------------ ------------ ------------
Total liabilities 41,492,613 712,125 42,204,738
------------ ------------ ------------
Shareholder's equity
Common stock, $1 par value; 10,000,000 shares
authorized; 250,000 shares issued and outstanding 250,000 (250,000) 1
250,000 3 250,000
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
6,795,080 3 6,795,080
Accumulated comprehensive loss, net of taxes (246,339) 246,339 1 --
Accumulated deficit (6,839,299) 6,839,299 1 --
------------ ------------ ------------
Total shareholder's equity (2,973,820) 10,018,900 7,045,080
------------ ------------ ------------
Total liabilities and shareholder's equity $ 38,518,793 10,731,025 $ 49,249,818
============ ============ ============
1 - Adjust assets and liabilities to fair value in accordance with SFAS 141
2 - Record receipt of cash for repayment of due from shareholder
3 - To push down unallocated purchase price to reporting unit of value, SBM, in
accordance with SFAS 141
11
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
General
SBM's predecessor, SBN MN, was incorporated in June 1990 to assume the
face-amount certificate business of SBM Company, which began in 1914. ARM
purchased most of the assets of SBM Company 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 Purchase on July 19, 2000, SBM assumed the
obligations of SBM MN's outstanding face-amount certificates. On December 5,
2003 a change of control of ownership of 1st Atlantic occurred as disclosed in
"Item 1. Business: Significant Events." As of the Acquisition date, SBM
Financial, the parent company of SBM, was a 100% owned subsidiary of 1st
Atlantic. Effective December 31, 2003, Geneva became the sole member of SBM
Financial through a dividend by 1st Atlantic to Geneva of the 100% ownership
interest of SBM Financial. 1st Atlantic was previously the sole member of SBM
Financial and its subsidiaries.
SBM issues and services fixed rate face-amount certificates and provides
related services to holders of the certificates. ACFC performs mortgage lender
and mortgage broker activities and SBMS I is an entity newly formed for the
purpose of issuing privately placed investment notes to accredited investors.
SBMS I has yet to issue any investment notes or generate any revenue.
The Questioned Transactions involving John J. Lawbaugh, referred to in
"Item 1. Business: Significant Events," that are more fully described in Note 14
and Note 15 of the Notes to Consolidating Financial Statements in "Item 8.
Financial Statements and Supplementary Data," have had a materially adverse
impact upon the Company's financial condition, operations and ability to carry
on the sale of its face-amount certificates, which were suspended on August 16,
2002.
Financial Condition, Changes in Financial Condition and Results Of Operations
2003 compared with 2002
During 2003, total assets increased $16.1 million from $35.1 million in
2002 to $51.2 million in 2003, while certificate liability increased $2.8
million from $33.2 million in 2002 to $36.0 million in 2003. As of December 31,
2003, subscription and notes payable totaling $4.9 million were outstanding. The
increase in total assets during 2003 was mainly from cash and other assets
received by us from the Acquisition and the goodwill that resulted from the
Acquisition. Cash of $1,357,026 as repayment of the due from shareholder was
received in connection with the Acquisition. In addition, cash of $1,000,000 and
non-cash assets of $820,000 were received as additional paid in capital, which
occurred after the Acquisition as described in Note 1 to the Notes to the
Consolidating Financial Statements.
12
Goodwill with a carrying value of $9,032,609 as of December 31, 2003
resulted from the Acquisition. Goodwill was due to the fair value of the
purchase price being greater than the net assets acquired. The purchase price
was comprised of the following components, which are detailed by the
consideration's cost and fair value:
Description Cost Fair Value
- ----------- ---------- ----------
Cash for purchase of shares $2,532,981 $2,532,981
Required 1940 Act reserve contribution (cash) 3,200,000 3,200,000
Debt issued by SBM Financial 1,616,772 781,414
Legal costs to creditors of Estate 125,000 125,000
---------- ----------
Total consideration $7,474,753 $6,639,395
---------- ----------
The fair value of the purchase price of $7,474,753 is less than the cost
of the purchase price of $6,639,395 due to the notes issued by SBM Financial
totaling $1,616,772 having a fair value of $781,414. The fair value of the notes
is less than the cost due to the risk associated with the notes and the low
stated interest rate on the debt (1.5%). Since the notes are secured by the
common stock of SBM and will possibly be repaid from excess cash flow from the
operations of SBM, there is significant risk to the holder of these notes. This
risk, coupled with an interest rate that does not compensate for such risk,
would cause the fair value of the notes to be at a discount from their face
value. Net liabilities assumed through the Acquisition, including 1st Atlantic
and its subsidiaries, was $4,041,715, resulting in a purchase price in excess of
net liabilities assumed of $10,681,110. Of this amount, $1,648,501 was assigned
to intangible assets and $9,032,609 was assigned to goodwill.
The increase in certificate liability of $2,753,596 is primarily due to
the change in the estimate for early surrender of the liability following the
Acquisition. This change in the estimate resulted in an increase of certificate
liability at the Acquisition date of $2,008,015. The new estimate of certificate
liability is the account value less an estimate for early surrender charges
based on our history with regards to early surrender charges, which we estimate
to be approximately 4% of outstanding certificates will have early withdrawal
charges applied. We previously estimated that 100% of outstanding certificates
would have early withdrawal charges. The change in estimate is a result of our
operating history.
During 2003, qualified assets increased $1.3 million. The increase was a
result of the $2,357,026 of cash and $820,000 of non-cash assets received at the
time of Acquisition and thereafter. This increase in qualified assets was
decreased by operating losses of $1,805,032 for the year ended December 31,
2003. Certificate reserve deposits required by the 1940 Act increased $1,501,779
in 2003 due to interest credited on the certificate reserve liability.
Our earnings are derived primarily from net investment income and net
other operating income. Net investment income is income earned from invested
assets less investment and other expenses and interest credited on
thecertificate reserve liability. Net other operating income is income earned
from the origination of loans in the mortgage lender/broker business less
operating expenses. Changes in net investment income are largely due to changes
in the rate of
13
return on investments. Changes in net other operating income is attributable to
changes in the volume and pricing of loans originated.
We had a net loss of $1,805,032 and $1,676,316 for the years ended
December 31, 2003 and 2002, respectively. The net loss for the years ended
December 31, 2003 and 2002, stemmed mainly from the net investment loss before
income tax of $1,367,253 and $1,388,507, respectively. The net other operating
loss before income taxes of $281,197 and reserve for losses - shareholder
receivable of $141,392 for the year ended December 31, 2003 also attributed to
the net loss for 2003. The reserve for losses - shareholder receivable of
$405,963 for the year ended December 31, 2002 added further to the net loss for
2002. See "Item 1. Business: Significant Events" to this Form 10-K and Note 14
and Note 15 of the Notes to the Consolidating Financial Statements for further
description of the reserve for losses - shareholder receivable. The net
investment loss before income taxes for 2003 and 2002 was due to the combination
of investment and other expenses and interest credited on certificate liability
exceeding the income generated from the investment portfolio. During 2003 and
2002, we held several non-revenue producing assets, which had a negative impact
on the income generated from the investment portfolio. However, the primary
reason for the net losses was the income generated from the investment portfolio
was not sufficient to cover the certificate interest costs and the fixed
operational costs related to the administrative services fee and legal and
accounting fees. When sales resume and the investment portfolio increases, the
fixed operational costs will have less of a negative impact on SBM as there is a
larger portfolio of assets generating income to cover the fixed costs. We do not
expect a significant increase in fixed costs as the investment portfolio
increases.
Investment income (excluding realized investment gains and losses) in 2003
was $2,765,689 compared to investment income of $2,438,503 for 2002. Total
investment income plus realized gains for 2003 and 2002 was $3,213,775 and
$2,911,224, respectively. Investment income plus realized investment gains
represents annualized investment yields of 10.17% and 10.69% on average cash and
investments of $31.6 million and $27.2 million for 2003 and 2002, respectively.
The increase in investment income is attributable to an increase in cash and
investments being held by the Company. The increase in average qualified assets
in 2003 was the result of the increased assets from the sale of face-amount
certificates in 2002, which were maintained throughout 2003.
Net investment spread, which is the difference between investment income
and interest credited on certificate liability, was $341,228 for 2003 compared
to $1,089,179 in 2002. On an annualized yield basis, these amounts reflect net
investment spread for 2003 and 2002 of 0.99% and 3.82%, respectively.
Interest credited on certificate liability for 2003 and 2002 was
$2,424,461 and $1,349,324, respectively. These amounts represent annualized
average rates of interest credited of 7.01% and 4.73% on average certificate
liability of $34.6 million and $28.5 million for 2003 and 2002, respectively. We
monitor 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 periodically
by SBM. In addition, during
14
2002 there were surrender charges recognized on 100% sales of new face-amount
certificates that reduced interest credited on certificate liability for 2002.
Investment and other expenses were $2,156,567 and $2,950,407 for 2003 and
2002, respectively. The decrease in investment and other expenses was mainly the
result of a decrease in advertising expense and a decrease in the administrative
services fee to SBM's parent, SBM Financial. Legal and accounting fees increased
from 2002 to 2003 as did other expenses. There were no advertising expenses in
2003 as compared to $361,739 for 2002. The decrease in advertising expense in
2003 was due to the halting of advertising as certificate sales were suspended.
The administrative services fee for the year ended December 31, 2003 and 2002
was $1,029,800 and $1,794,700, respectively. The decrease in the administrative
services fee of $715,861 was due to SBM Financial lowering its operational
costs, which are funded through the administrative services fee. Legal and
accounting fees for 2003 and 2002 were $553,747 and $371,090, respectively. The
increase in legal and accounting fees was due to legal and accounting costs
related to the Questioned Transactions being charged to due from shareholder
during 2002. In 2003 legal and accounting costs were charged to due from
shareholder until Mr. Lawbaugh filed for bankruptcy on May 29, 2003. After the
bankruptcy filing, any legal and accounting costs could not be charged to Mr.
Lawbaugh under Bankruptcy Law. Other expenses for 2003 and 2002 were $378,450
and $231,880, respectively. The increase in other expenses was attributable to
higher insurance costs and trail commissions paid to brokers. An increase in
directors' fees as a result of more Board meetings related to the Questioned
Transactions and the Acquisition by Geneva added further to the increase in
other expenses.
Net other operating income (loss) before income tax for the years ended
December 31, 2003 and 2002, was ($281,197) and $118,154, respectively. This
consists of the mortgage lender/broker operations of ACFC. For the years ended
December 31, 2003 and 2002, other operating income was $2,738,902 and
$2,261,801, 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 2003 as compared to 2002 was due to an increase in the volume of
loans originated. The first seven months of 2003 resulted in a higher volume of
loan originations from the same period in 2002. This increased loan origination
volume in 2003 was due to a low interest rate environment resulting in a high
volume of mortgage refinances. ACFC experienced a sharp decline in loan
origination volume in the last five months of 2003 as compared to the first
seven months of 2003. This was the result of an increase in market interest
rates, as well as, the sales division of the mortgage operations was
restructured and resulted in a significant reduction of staff. Both of these
events had a material negative impact on the financial results of ACFC in the
last five months of 2003, causing the net loss for 2003. By early 2004, ACFC had
replaced a significant portion of the loan sales staff that was lost in 2003 and
intends to continue increasing the sales staff throughout 2004 to increase
revenues. For the years ended December 31, 2003 and 2002, other operating
expenses were $3,020,099 and $2,143,647, 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 2003 as compared to 2002, was mainly due to higher commissions paid
on the increased revenues generated and higher interest expense from an increase
in the use of the warehouse line of credit.
15
Realized investment gains were $448,086 and $472,721 for 2003 and 2002,
respectively. The realized investment gains for 2003 were the result of a gain
of $828,503 recognized from the sale of property (see Note 12 to the Notes to
the Consolidating Financial Statements), loss on the sale of a loan of $20,474
and losses of $359,943 from the sale of available for sale securities. The
realized investment gains of $472,721 for 2002 was due to the sale of certain
available-for-sale securities, which had significant increases in their market
value from their amortized cost. Realized investment gains and losses are
primarily interest-rate related and attributable to our asset/liability
management strategies. We invest 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.
In the event that SBM experiences higher than historical levels of
certificate surrenders, SBM might need to liquidate investments other than in
accordance with its normal asset/liability management strategy and, as a result,
SBM could experience substantial realized investment losses.
For the year ended December 31, 2003 and 2002, reserve for losses -
shareholder receivable was $141,392 and $405,963, respectively. See "Item 1.
Business: Significant Events" and Note 14 of the Notes to Consolidating
Financial Statements for further descriptions of this item.
2002 compared with 2001
During 2002, total assets increased $11.2 million from $23.9 million in
2001 to $35.1 million in 2002, while certificate liability increased $9.4
million from $23.8 million in 2001 to $33.2 million in 2002. The increase in
total assets and certificate liability is primarily due to certificate sales
exceeding certificate maturities, redemptions and early surrenders.
Our earnings are derived primarily from net investment income and net
other operating income. Net investment income is income earned from invested
assets less investment and other expenses and interest credited on certificate
reserve liability. Net other operating income is income earned from the
origination of loans in the mortgage lender/broker business less operating
expenses. Changes in net investment income are largely due to changes in the
rate of return on investments. Changes in net other operating income is
attributable to changes in the volume and pricing of loans originated.
We had a net loss of $1,676,316 and $1,681,812 for the years ended
December 31, 2002 and 2001, respectively. The net loss for the years ended
December 31, 2002 and 2001, stemmed mainly from the net investment loss before
income tax of $1,388,507 and $1,462,053, respectively, and the reserve for
losses - shareholder receivable of $405,963 and $469,982, respectively. See
"Item 1. Business: Recent Significant Events" to this Form 10-K and Note 14 and
Note 15 of the Notes to the Consolidating Financial Statements for further
description of the reserve for losses - shareholder receivable. The net
investment loss before income tax for 2002 and 2001 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.
16
During 2002 and 2001, we held several non-revenue producing assets, which had a
negative impact on the income generated from the investment portfolio. In
addition, high operational costs related to the administrative services fee,
legal fees and advertising resulted in an operating loss. The reserve for losses
- - shareholder receivable contributed further to the net loss for the years ended
December 31, 2002 and 2001.
Investment income (excluding realized investment gains and losses) in 2002
was $2,438,503 compared to investment income of $1,615,128 for 2001. Total
investment income plus realized gains for 2002 and 2001 was $2,911,224 and
$1,683,825, respectively. Investment income plus realized investment gains
represents annualized investment yields of 10.69% and 7.90% on average cash and
investments of $27.2 million and $21.3 million for 2002 and 2001, respectively.
The increase in investment income is attributable to an increase in cash and
investments being held by us and an increase in the yield of the investment
portfolio. The increase in investment portfolio yield was primarily due to
realized gains totaling $472,721 resulting from the sale of available-for-sale
securities.
Net investment spread, which is the difference between investment income
and interest credited on certificate liability, was $1,089,179 for 2002 compared
to $442,576 in 2001. On an annualized yield basis, these amounts reflect net
investment spread for 2002 and 2001 of 3.82% and 1.98%, respectively.
Interest credited on certificate liability for 2002 and 2001 was
$1,349,324 and $1,172,552, respectively. These amounts represent annualized
average rates of interest credited of 4.73% and 5.24% on average certificate
liability of $28.5 million and $22.4 million for 2002 and 2001, 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 SBM
periodically. In addition, there are surrender charges on new face-amount
certificates resulting in the overall decrease in the average crediting rate.
Investment and other expenses were $2,950,407 and $1,973,326 for 2002 and
2001, respectively. The increase in investment and other expenses was the result
of an increase in the administrative services fee to SBM's parent, SBM
Financial, and an increase in other operating expenses. The increase in the
administrative services fee was due to the payment of the fee to SBM Financial
in 2002 being classified solely as an administrative services fee, whereas, in
2001, the payment to SBM Financial was in the form of both an administrative
services fee totaling $1,078,839 and dividends of $579,934. Total dividends paid
plus the administrative services fee in 2002 and 2001 was $1,794,700 and
$1,658,773, respectively. Investment and other expenses were further increased
by higher advertising costs for the year ended December 31, 2002, as compared to
the year ended December 31, 2001. Advertising expense for the year ended
December 31, 2002 was $361,739 as compared to $93,422 for the year ended
December 31, 2001. The increase in advertising expense in 2002 was due to SBM's
advertising campaign associated with its retail sales division.
Net other operating income (loss) before income tax for the years ended
December 31, 2002 and 2001, was $118,154 and ($38,041), respectively. This
consists of the mortgage
17
lender/broker operations of ACFC. For the years ended December 31, 2002 and
2001, other operating income was $2,261,801 and $897,267, 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 year ended December 31,
2002 as compared to the year ended December 31, 2001 was due to an increase in
the volume of loans originated. For the years ended December 31, 2002 and 2001,
other operating expenses were $2,143,647 and $935,808, 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 year ended December 31, 2002 as compared to
the year ended December 31, 2001, was mainly due to higher commissions paid on
the increased revenues generated.
Realized investment gains were $472,721 and $68,697 for 2002 and 2001,
respectively. The increase in realized investment gains was due to the sale of
certain available-for-sale securities, which had significant increases in their
market value over their amortized cost. Realized investment gains and losses are
primarily interest-rate related and attributable to our asset/liability
management strategies. We invest 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.
In the event that SBM experiences higher than historical levels of
certificate surrenders, SBM might need to liquidate investments other than in
accordance with its normal asset/liability management strategy and, as a result,
SBM could experience substantial realized investment losses.
For the year ended December 31, 2002 and 2001, reserve for losses -
shareholder receivable was $405,963 and $469,982, respectively. See "Item 1.
Business: Significant Events" and Note 14 of the Notes to Consolidating
Financial Statements for further descriptions of this item.
Asset Portfolio Review
We invest our 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 as amended in 2003, and other such assets as the SEC may permit under
the 1940 Act. Our 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 our cash requirements. We have various
investment types as of December 31, 2003, which include fixed maturity
securities, equity securities, mortgage notes, real estate, real estate
partnerships, a residual mortgage certificate and real estate tax lien
certificates. We monitor our short-term liquidity needs to ensure that cash flow
from investments allows for the payment of all of our 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
18
investment strategy also is designed to provide protection of the investment
portfolio from adverse changes in interest rates.
Our investments in available-for-sale securities totaled $6,900,227 at
December 31, 2003, 20.51% 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, corporate debt and closed-end mutual funds.
As of December 31, 2003, the Company held one fixed maturity security that had
defaulted on interest payments. The market value of available-for-sale
securities fluctuates with changing economic conditions. Fixed maturity
securities are influenced greatly by market interest rates. Corporate debt
market value is effected by market interest rates and 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. Our 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. We take into account
the current and expected future market environment in evaluating investment risk
and investment yields.
Based on the provisions of SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities," we classify our fixed maturity and
equity 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 2003, the fair value of
available-for-sale securities increased by $2,252,250. Due to the Acquisition,
the market value of the available for sale securities at the Acquisition date,
December 5, 2003, is now the cost basis of the securities. Any changes in market
value subsequent to the Acquisition date are adjusted to the carrying value of
the security with a corresponding charge to unrealized gains (losses).
Unrealized gain (loss), net of tax at December 31, 2003 and 2002 was $194,902
and ($2,055,348), respectively. 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 our available-for-sale securities without
reflecting offsetting changes in the value of our liabilities or other assets
creates volatility in reported shareholder's equity but does not reflect the
underlying economics of the Company's business.
Our investments in residential and commercial real estate mortgage notes
receivable totaled $15,991,009 at December 31, 2003, 47.54% of the investment
portfolio (40.73% at December 31, 2002). These real estate mortgage notes accrue
interest at rates ranging from 4.125% to 14.5% per annum and are secured by the
underlying real property. Our intention is to sell the mortgage notes held for
sale to a buyer under certain favorable market conditions. See Note 6 to the
Notes to Consolidating Financial Statements.
We hold investments in certain real estate partnerships with a carrying
value of $9,736,335 as of December 31, 2003. These partnerships directly acquire
or develop residential and commercial real estate and as of December 31, 2003 we
are obligated for future funding commitments to the partnerships of $4,902,802.
As of December 31, 2003, we have invested
19
$4,820,000 of our portfolio funds into the partnerships, 14.33% of the
investment portfolio. See Note 13 to the Notes to the Consolidating Financial
Statements.
Our investment in real estate tax lien certificates are comprised of
delinquent real estate tax bills purchased from municipalities at a premium.
They accrue interest at the rate of 20% per annum on the outstanding principal
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, 2003, the real estate tax lien certificates had a
balance of $460,252, 1.37% of the investment portfolio (5.05% at December 31,
2002). See Note 9 to the Notes to Consolidating Financial Statements.
We hold an investment in a residual mortgage certificate with a principal
balance of $2,685,180 as of December 31, 2003, 7.98% of the investment portfolio
(12.50% at December 31, 2002). The investment was purchased in 2002 and
represents an ownership interest in a trust (the "Trust") that owns a
securitized pool of mortgage loans. The residual interest we own is a
subordinate interest in the Trust. The individual mortgage notes held in the
Trust generate income to the Trust, which then pays certain operating costs of
the Trust and pays the owners with a guaranteed interest in the Trust. Any
excess income generated after these payments is then paid to us. We will only
receive payments if there is cash generated by the Trust in excess of operating
costs and payments to guaranteed interest holders. The weighted average coupon
rate of the underlying pool of mortgages is approximately 10.50% and the
weighted average pass-through rate paid to guaranteed interest holders is 4.70%,
the difference being the excess income generated by the Trust to pay operating
expenses, cover reserve losses and then make payments to us. See Note 10 to the
Notes to Consolidating Financial Statements.
We also own two parcels of real estate totaling $2,285,509 as of December
31, 2003, 6.80% of the investment portfolio (8.19% at December 31, 2002). These
properties were acquired through foreclosure of delinquent mortgage notes held
by us and are currently held for sale. See Note 11 to the Notes to Consolidating
Financial Statements. One of the properties was determined to have a decrease in
fair value of $475,000 as of the Acquisition date and the carrying value was
therefore adjusted. The fair value was based on a contract with a third party to
purchase the property.
Liquidity and Financial Resources
As of December 31, 2003, we had $542,410 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 SBM relates to its payment of
certificate maturities and surrenders and payment of its legal costs and
administrative services fee. The principal sources of cash to meet such
liquidity requirements are investment income and proceeds from maturities and
redemptions of investments. SBM has $12.4 million of certificate obligations
coming due in 2004. In 2003, SBM experienced an 84% renewal rate; therefore,
management expects principal and interest payments to certificate holders to be
approximately $1.9 million in
20
2004. In connection with the Acquisition, SBM Financial issued debt instruments
totaling $1,616,772 with interest payable semi-annually at a rate of 1.5% per
annum. Cash flows generated from the Company may be used to service the debt
payments in 2004 and in subsequent years. Principal and interest payments to be
made for such debt in 2004 total $185,322. See Note 1 to the Notes to the
Consolidating Financial Statements.
At December 31, 2003, cash and cash equivalents totaled $1.4 million, a
decrease of $0.8 million from December 31, 2002. We aim to manage our cash and
cash equivalents position so as to satisfy short-term liquidity needs. In
connection with this management of cash and cash equivalents, we may invest idle
cash in short duration fixed maturities to capture additional yield when
short-term liquidity requirements permit.
Cash flows of $5.8 million, ($6.1) million and ($1.2) million were
generated from (used in) operating activities in 2003, 2002, and 2001,
respectively. These cash flows resulted principally from investment income, less
management fees, changes in mortgage notes held for sale, and commissions paid.
Proceeds from investing activities generated $16.0 million, $8.9 million, and
$9.7 million in cash flows during 2003, 2002, and 2001, respectively, which were
offset by purchases of investments of $20.6 million, $16.6 million, and $7.9
million, respectively.
ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our investments are represented by a mixture of available-for-sale
securities (comprised of government and corporate bonds, mortgage-backed
securities, closed-end mutual funds and equity securities), mortgage notes, real
estate, real estate partnerships and real estate tax lien certificates. Managing
interest rates between those earned on our investments and those paid under the
face-amount certificates is fundamental to our 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, we have a portion of our portfolio invested in real estate and
real estate loans, which includes $16.0 million of mortgage notes held for sale
and $2.3 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, we mitigate 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.
As of December 31, 2003 we also have investments in real estate
partnerships with a carrying value of $9,736,335 and future funding commitments
of $4,902,802, which are reflected as subscription and notes payable in the
financial statements. These partnerships were formed for the purpose of
acquiring and developing residential and commercial real estate. Acquiring or
developing commercial and residential real estate has risk related to the
construction and the
21
leasing and rental market for the respective properties, since leasing and
rental revenue is the source of cash flows for the properties. A strong leasing
and rental market could have a positive impact on projected performance, while a
weaker leasing and rental market could have a negative impact on future
projected cash flows from the investment. The partnership guidelines have
certain requirements on the type and quality of the real estate to be acquired
or developed. By investing in markets with low leasing vacancy rates, high
quality real estate and partnering with other groups with extensive building
management experience, we are able to moderate the risk for such investments in
relation to the expected return.
We also invest in real estate tax lien certificates, which have a balance
of $460,252 at December 31, 2003. The greatest risk associated with this
investment is the time and costs of the foreclosure process when amounts remain
unpaid beyond the Company's aging policy. The risk is mitigated by our first
priority lien on the property on which the tax is owed, and our general policy
of securing these investments, in most circumstances, only with properties in
which the amount paid by us to acquire the certificates is less than 10% of the
market value of the property that secures the investment.
Our ownership of the residual mortgage certificate was $2.7 million at
December 31, 2003 and represents a subordinate ownership interest in the Trust.
We assume the risk of default on the mortgages held within the Trust. Defaults
of principal and interest by borrowers will adversely affect our return on this
investment. A reserve for defaults was calculated into the original purchase
price to account for 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%.
We regularly analyze 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 our earnings if rates
moved higher or lower than the expected targets set in our investment
guidelines. We will continue to formulate strategies directed at protecting
earnings for the potential negative effects of changes in interest rates.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's financial statements begin on page F-02. Reference is made
to the Index to Financial Statements on page F-01 of this Annual Report. The
Company's supplementary financial information as required per regulation S-X
begins on page S-01.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
22
ITEM 9A. 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 Annual Report
on Form 10-K. 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 Annual Report on Form 10-K that has
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.
PART III
ITEM 10. EXECUTIVE OFFICERS AND DIRECTORS
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 (*). Officers are appointed annually at
the annual meeting of the Company's Board of Directors.
Each of the directors named below became a director of the Company in May 2000,
upon the organization of the Company, except that Eric M. Westbury became a
director and Chairman of the Board on January 28, 2004.
23
Positions with
Name and Age the Company Principal Occupations During the Past Five Years
- ------------------------------- -------------------------- --------------------------------------------------------
Eric M. Westbury (40)*......... Chairman of the Board and Chairman of the Board of Directors of the Company (since
President, Chief Executive January 28, 2004); President and Chief Executive
Officer Officer, of the Company, (since August 2002,; President
(since August 2000) and Executive Vice President (from
November 1999 to August 2000) of 1st Atlantic; prior to
that, President and Chief Operating Officer of The
Washington Development Group (private real estate
development and management company), from September 1997
through November 1999. Prior to that, Vice-President,
Market Executive (commercial and retail banking) First
Union National Bank, Washington, DC.
Iraline G. Barnes (56)......... Director Director - Public Affairs Management, Duane Morris and
Associates; Special Counsel, Roseman & Colin (since
1999); Prior to that, Senior Judge, District of Columbia
Superior Court; Prior to that, Vice President of
Corporate Relations, Potomac Electric Power Co.
Kumar Barve (45)............... Director Majority Leader (since January 2003) and Delegate to the
Maryland House of Delegates (since January 1991);
Accountant/Chief Financial Officer, Environmental
Management Services, Inc. (Hazardous Waste Disposal and
Environmental Consulting)
Nancy Hopkinson (62)........... Director Retired (since 1996); prior to that, Teacher and School
Administrator, Montgomery County Public Schools
(Maryland)
Brian Murphy (60)*............. Director Partner, Griffin Farmer & Murphy LLP (law firm) and
predecessor law firms.
Marialice B. Williams(58) ..... Director Special Counsel to the Office of Public Charter School
Financing and Support; President, Risk Mitigation
Strategists, LLC; serving as consultant to develop
financial structuring for affordable supportive housing
transactions for the DC Department of Mental Health.
Trey Stafford (30) ............ Chief Financial and Chief Financial Officer (since July 2001) of the
Accounting Officer Company; Vice President of Finance and Accounting, SBM
Financial (since July 2001); Secretary of Board of
Directors, ACFC (since December 2001); Audit
Manager/Senior, Reznick Fedder & Silverman, CPA's
(September 1997-July 2001); Staff Accountant, Charles E.
Smith Residential Realty, (September 1996-1997).
Dia H. Snowden (42) ........... Secretary Vice President of SBM Financial (since January 2004);
Secretary (since March 2002) of the Company; Client
Services Manager of the Company, (since July 2000);
prior to that, Corporate Administrator, The Washington
Development Group, Inc. (1996-1999) (private real estate
development and management company).
24
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 annual
meeting of shareholders. Each Director of the Company receives a $1,250 fee for
each regular or special Board meeting he or she attends. A Director who is also
an officer of the Company, however, receives no additional compensation for
service as a Director of the Company. Directors also are reimbursed for their
expenses incurred in attending any meeting of the Board. The Board generally
meets quarterly.
Audit Committee
The members of the Audit Committee consult with the Company's independent
auditors and meet as a committee at least four times annually to discuss the
scope and results of the annual audit of the Company and such other matters as
required by law or as the Committee members deem appropriate or desirable.
Iraline G. Barnes, Kumar Barve and Marialice B.Williams are members of the Audit
Committee. Members of the Audit Committee receive a fee of $750 for each meeting
and also receive a fee for time incurred related to Audit Committee duties
outside of scheduled meetings. Such a fee is based on a predetermined hourly
rate.
Investment Committee
The Board of Directors has recently formed an Investment Committee whose
members currently also are members of the Audit Committee. The Investment
Committee is responsible for ongoing oversight of the Company's investment
portfolio and its investment activities and practices, consistent with the
requirements of the Insurance Code of the District of Columbia as applicable to
face-amount certificate companies. The Investment Committee will meet with the
Company's management periodically to review the Company's investment portfolio,
activities and practices, and will receive reports from management on at least a
quarterly basis. At this time members of the Investment Committee receive no
compensation for their services in addition to their compensation as members of
the Audit Committee.
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. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The Company is a wholly-owned subsidiary of SBM Financial. On December 5,
2003 Geneva acquired the majority of outstanding shares of common stock of 1st
Atlantic, which, at that date, was the sole member of SBM Financial. Effective
December 31, 2003, Geneva
25
became the sole member of SBM Financial through a dividend by 1st Atlantic to
Geneva of the 100% ownership interest of SBM Financial. Eric M. Westbury is the
sole member of Geneva.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On December 5, 2003, the Acquisition by Geneva closed as described more
fully in Note 1 to the Notes to the Consolidating Financial Statements. Geneva's
sole member is SBM's President and Chief Executive Officer, Eric M. Westbury.
SBM Financial provides the Company with administrative services pursuant
to an Administrative Services Agreement. This agreement stipulates that SBM
Financial shall provide certain administrative and support services for the
Company. Services include use of SBM Financial's property and equipment,
facilities and personnel needed for SBM-MD's daily operations. For providing
such services, SBM Financial 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 $2,500,000. The charge is determined monthly by SBM Financial and
the Company's management based on the costs incurred by SBM Financial for such
administrative and support services. During 2003, 2002 and 2001, a fee was
charged totaling $1,029,800, $1,794,700 and $1,078,839, respectively, and
payments for such fees were $1,029,800, $1,794,700 and $1,119,128, respectively.
From time-to-time the Company makes dividend payments to SBM Financial,
which, in turn, may make dividend payments to Geneva, SBM Financial's parent
since December 5, 2003. There have been no dividends paid since the Acquisition
by Geneva. During 2001, the Company paid $579,934 of cash dividends to SBM
Financial.
On December 12, 2003, Geneva contributed as additional paid in capital a
$500,000 interest in a real estate partnership and $1,000,000 cash to the
Company. In addition, on December 31, 2003, Geneva contributed as additional
paid in capital a $320,000 limited partner interest in a real estate
partnership.
On December 19, 2002, the Company made a mortgage loan in the amount of
$88,638, with interest at the rate of 12.5% per annum, to James M. Barnes,
husband of Iraline G. Barnes, a director of the Company. The loan, by its terms,
matured on May 1, 2003, and remains outstanding. However, the Company has been
advised by Mr. Barnes that he is in the process of seeking a refinancing of the
mortgage note held by the Company.
On September 30, 2001, SBM Financial contributed as additional paid in
capital a mortgage note to the Company which totaled $1,136,047 at that date. On
June 30, 2002 SBM Financial contributed an additional mortgage note which
totaled $639,227.
On September 30, 2001, SBM Financial through its then sole member, 1st
Atlantic, contributed as additional paid in capital to the Company a beneficial
interest in a property consisting of land and building held for sale which
totaled $410,087 at the date of the contribution. The basis in the property at
the contribution date is the original cost basis of the shareholders of 1st
Atlantic at the date of the original contribution to 1st Atlantic (September 30,
26
1998), increased for the expenditures made by 1st Atlantic and subsequently by
the Company in connection with the investment in the property held for sale. As
of December 31, 2001, the carrying amount of the property was $419,923. On
December 31, 2002, this property was sold (See Note 12 to the Notes to
Consolidating Financial Statements).
The Company made a mortgage loan to a partnership in which an affiliate
owned a 51% interest. As of December 31, 2001, the outstanding principal balance
of the mortgage note was $378,950 and accrued interest totaled $59,104. In April
2002, the outstanding principal balance of the mortgage note and accrued
interest was paid in full satisfaction on the receivable in the amount of
$533,120.
Due from shareholder totaling $1,218,181 as of December 31, 2002,
represents amounts paid to John J. Lawbaugh, the majority shareholder of 1st
Atlantic, directly or through companies affiliated with the shareholder and
other costs incurred by the Company related to those transactions. An allowance
has been recorded in the full amount due from shareholder (See Notes 14 and 15
to the Notes to Consolidating Financial Statements).
Related party receivable and related party payable represents certain
advances made by the Company to affiliates and advances the Company has received
from affiliates. Most advances relate to operational transactions. As of
December 31, 2003 and 2002, related party receivables total $219,371 and
$129,351 respectively. As of December 31, 2003 and 2002, related party payables
total $49,130 and $117,925, respectively.
A warehouse line of credit has been established between SBM and ACFC (See
Note 8 to the Notes to Consolidating Financial Statements).
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The Following table shows fees that we paid (or accrued) for professional
services by our independent auditors for fiscal years 2003 and 2002:
Fiscal Fiscal
Fee Category 2003 2002
- ----------------------------- --------- ---------
Audit Fees $ 149,286 $ 33,942
Audit-Related Fees 2,825 16,947
Tax Fees 17,700 17,440
All Other Fees 7,437 --
--------- ---------
Total All Fees $ 177,248 $ 68,329
========= =========
27
Audit Fees
Consists of fees billed for professional services rendered for the audit
of our financial statements and review of the interim financial statements
included in quarterly reports.
Audit-Related Fees
Consists of fees billed for assurance and related services that are
reasonably related to the performance of the audit or review of our financial
statements that are not reported under "Audit Fees," and services that are
normally provided by our independent auditors in connection with statutory and
regulatory filings or engagements. These services include accounting
consultations in connection with acquisitions and consultations concerning
financial accounting and reporting standards.
Tax Fees
Consists of fees billed for professional services for tax compliance, tax
advice and tax planning. These services include tax planning, assistance with
the preparation of various tax returns, services rendered in connection with
acquisitions and advice on other tax-related matters.
All Other Fees
Consists of other fees not reported in the above categories. In fiscal
2002 and 2003, these services were in connection with the Questioned
Transactions.
Policy on Audit Committee Pre-Approval of Services Performed by the Independent
Auditors.
The Audit Committee's policy is to pre-approve at the beginning of each
fiscal year all audit and permissible non-audit services to be provided by the
independent auditors during that fiscal year. The Audit Committee pre-approves
these services by authorizing specific projects within the categories of
services outlined above, subject to a budget for each category. In addition, the
Audit Committee may also pre-approve particular services on a case-by-case
basis. The independent auditor and management must report to the Audit Committee
actual fees versus the budget periodically throughout the fiscal year.
28
ITEM 15. 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 F-01 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, 2003
Schedule II Investments in and Advances to Affiliates and Income Thereon -
December 31, 2003
Schedule III Mortgage loans on real estate and interest earned on Mortgages -
December 31, 2003
Schedule IV Real Estate Owned and Rental Income - December 31, 2003
Schedule V Qualified Assets on Deposit - December 31, 2003
Schedule VI Certificate Reserves-Year Ended December 31, 2003
Schedule VII Valuation and Qualifying Accounts-December 31, 2003
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.
29
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
(4)(b) Form of Account Statement
(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) Subsidiaries
(24) Powers of Attorney, incorporated by reference to Exhibit (24) of
Form 10-K for the year ended December 31, 2001 of SBM Certificate
Company (File No. 811-06268).
(31.1) Certification of Chief Executive Officer
(31.2) Certification of Chief Financial Officer
30
(32.1) Written Statement of the Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350
(99.1) Escrow Agreement dated November 14, 2002, among 1st Atlantic
Guaranty Corporation, John J. Lawbaugh and Baker Botts, as escrow
agent, incorporated by reference to Exhibit 99.1 to the Company's
Form 8-K dated November 12, 2002 (File No. 811-6268).
(99.2) Order Approving Settlement Agreement Between Chapter 11 Trustee, 1st
Atlantic Guaranty Corporation, Geneva Capital Partners, LLC, APT
Creditors, SBM Financial, LLC, SBM Certificate Company, Atlantic
Capital Funding Corporation and Escrow Agent dated December 2, 2003,
incorporated by reference to Exhibit 99.1 to Company's Form 8-K
dated December 2, 2003 (File No. 811-6268).
(99.3) Term Sheet Between Trustee, 1st Atlantic, Geneva, APT Creditors, SBM
Financial, SBM Certificate Company, ACFC, and Escrow Agent dated
November 7, 2003, incorporated by reference to Exhibit 99.2 to
Company's Form 8-K dated December 2, 2003 (File No. 811-6268).
(99.4) Stock Purchase Agreement By and Between Mark D. Taylor, Bankruptcy
Trustee, in his Capacity as Representative of John J. Lawbaugh
Bankruptcy Estate and Geneva Capital Partners, LLC dated as of
December 2, 2003, incorporated by reference to Exhibit 99.3 to
Company's Form 8-K dated December 2, 2003 (File No. 811-6268).
(99.5) Settlement and Release Agreement By and Between the Trustee, APT
Creditors and Geneva dated December 2, 2003, incorporated by
reference to Exhibit 99.4 to Company's Form 8-K dated December 2,
2003 (File No. 811-6268).
(99.6) Secured Promissory Notes By and Between SBM Financial, LLC, formerly
State Bond & Mortgage, LLC, and APT Creditors, incorporated by
reference to Exhibit 99.5 to Company's Form 8-K dated December 2,
2003 (File No. 811-6268).
(99.7) Security Agreement By and Between SBM Financial, LLC (formerly State
Bond & Mortgage, LLC), Escrow Agent and Noteholders pursuant to the
Settlement Agreement, incorporated by reference to Exhibit 99.6 to
Company's Form 8-K dated December 2, 2003 (File No. 811-6268).
(99.8) Consent to Entry of Final Judgment and Permanent Injunction Between
the Securities and Exchange Commission and 1st Atlantic Guaranty
Corporation dated December 2, 2003, incorporated by reference to
Exhibit 99.7 to Company's Form 8-K dated December 2, 2003 (File No.
811-6268).
31
(99.9) Final Judgment as to Defendant 1st Atlantic Guaranty Corporation
Entered by the United States District Court for the District of
Maryland dated December 8, 2003, incorporated by reference to
Exhibit 99.8 to Company's Form 8-K dated December 2, 2003 (File No.
811-6268).
(99.10) Letter of Preferrable Accounting Treatment from Reznick Fedder &
Silverman dated January 23, 2004.
(b) REPORTS ON FORM 8-K
SBM filed the following Current Reports on Form 8-K during the quarter
ended December 31, 2003:
Current Report on Form 8-K dated December 2, 2003 providing
information under Item 1 and Item 5.
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 30th day of March, 2004.
SBM Certificate Company
By: /s/ Eric M. Westbury
-----------------------
Eric M. Westbury
Chief Executive Officer
32
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:
SIGNATURE CAPACITY DATE
- ------------------- ------------------------------------- ---------------
/s/ Eric M. Westbury President & Chief Executive Officer March 30, 2004
- -------------------------
Eric M. Westbury
/s/ Trey Stafford Chief Financial and Accounting March 30, 2004
- ------------------------- Officer
Trey Stafford
/s/ Iraline G. Barnes Director March 30, 2004
- -------------------------
Iraline G. Barnes
/s/ Kumar Barve Director March 30, 2004
- -------------------------
Kumar Barve
/s/ Nancy Hopkinson Director March 30, 2004
- -------------------------
Nancy Hopkinson
/s/ Brain Murphy Director March 30, 2004
- -------------------------
Brian Murphy
/s/ Marialice B. Williams Director March 30, 2004
- -------------------------
Marialice B. Williams
33
SBM Certificate Company and Subsidiary
TABLE OF CONTENTS
PAGE
INDEPENDENT AUDITORS' REPORT F-02
FINANCIAL STATEMENTS
CONSOLIDATING BALANCE SHEETS F-03
CONSOLIDATING STATEMENTS OF OPERATIONS F-05
CONSOLIDATING STATEMENTS OF SHAREHOLDER'S EQUITY F-08
CONSOLIDATING STATEMENTS OF CASH FLOWS F-09
NOTES TO CONSOLIDATING FINANCIAL STATEMENTS F-12
SUPPLEMENTAL SCHEDULES
SCHEDULE I - INVESTMENTS IN SECURITIES OF UNAFFILIATED
ISSUERS S-01
SCHEDULE II - INVESTMENTS IN ADVANCES TO AFFILIATES
AND INCOME THEREON S-03
SCHEDULE III - MORTGAGE LOANS ON REAL ESTATE AND
INTEREST EARNED ON MORTGAGES S-04
SCHEDULE IV - REAL ESTATE OWNED AND RENTAL INCOME S-05
SCHEDULE V - QUALIFIED ASSETS ON DEPOSIT S-06
SCHEDULE VI - CERTIFICATE RESERVES S-07
SCHEDULE VII - VALUATION AND QUALIFYING ACCOUNTS S-13
Schedules required by Article 6 of Regulation S-X 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.
F-01
INDEPENDENT AUDITORS' REPORT
To the Board of Directors
SBM Certificate Company
We have audited the accompanying consolidating balance sheets of SBM
Certificate Company and Subsidiaries as of December 31, 2003 and 2002, and the
related consolidating statements of operations, shareholder's equity, and cash
flows for the years ended December 31, 2003, 2002 and 2001. 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 audits.
We conducted our audit 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 Subsidiaries at December 31, 2003 and 2002, and the
results of their operations and cash flows for the years ended December 31,
2003, 2002 and 2001, 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
January 23, 2004
F-02
SBM Certificate Company and Subsidiaries
CONSOLIDATING BALANCE SHEET
December 31, 2003
SBM Certificate
Company and Atlantic Capital Eliminating
SBMS I Funding Corp. Entries Totals
--------------- ---------------- ------------- -------------
Qualified assets
Cash and investments
Available-for-sale securities
(amortized cost: $6,705,325) $ 6,900,227 $ -- $ -- $ 6,900,227
Mortgage notes held for sale 5,653,398 2,542,405 -- 8,195,803
Mortgage notes held for investment 7,795,206 -- -- 7,795,206
Warehouse line of credit receivable 934,750 (934,750) --
Investments in real estate partnerships 9,736,335 -- -- 9,736,335
Real estate tax lien certificates 460,252 -- -- 460,252
Real estate owned 1,784,545 500,964 -- 2,285,509
Residual mortgage certificate 2,685,180 -- -- 2,685,180
Certificate loans 69,738 -- -- 69,738
Cash and cash equivalents 1,332,442 59,673 -- 1,392,115
------------- ------------- ------------- -------------
Total cash and investments 37,352,073 3,103,042 (934,750) 39,520,365
------------- ------------- ------------- -------------
Dividends and interest receivable 352,783 29,485 -- 382,268
------------- ------------- ------------- -------------
Total qualified assets 37,704,856 3,132,527 (934,750) 39,902,633
Other assets
Related party receivable 236,549 5,074 (22,252) 219,371
Fixed assets, net of accumulated depreciation
of $330 & $748 187,310 43,017 -- 230,327
Investment in subsidiary 990,203 -- (990,203) --
Goodwill 9,032,609 -- -- 9,032,609
Intangible asset - registration statement 755,202 -- 755,202
Intangible asset - client list 893,299 -- 893,299
Deferred acquisition costs, net 802 -- -- 802
Other assets 124,318 13,083 -- 137,401
------------- ------------- ------------- -------------
Total assets $ 49,925,148 $ 3,193,701 $ (1,947,205) $ 51,171,644
============= ============= ============= =============
Liabilities
Statutory certificate liability $ 32,912,452 $ -- $ -- $ 32,912,452
Additional certificate liability 3,029,970 -- -- 3,029,970
Warehouse line of credit -- 2,156,750 (934,750) 1,222,000
Subscription and note payable 4,902,802 -- -- 4,902,802
Accounts payable and other liabilities 607,018 7,290 -- 614,308
Related party payable 31,924 39,458 (22,252) 49,130
------------- ------------- ------------- -------------
Total liabilities 41,484,166 2,203,498 (957,002) 42,730,662
------------- ------------- ------------- -------------
Shareholder's equity
Common stock, $1 par value; 10,000,000 shares
authorized; 250,000 shares issued and outstanding 250,000 -- -- 250,000
Common stock, $2 par value; 10,000 shares
authorized; 10,000 shares issued and outstanding -- 20,000 (20,000) --
Additional paid-in capital 8,615,080 1,082,548 (1,082,548) 8,615,080
Accumulated comprehensive income, net of taxes 194,902 -- -- 194,902
Accumulated deficit (619,000) (112,345) 112,345 (619,000)
------------- ------------- ------------- -------------
Total shareholder's equity 8,440,982 990,203 (990,203) 8,440,982
------------- ------------- ------------- -------------
Total liabilities and shareholder's equity $ 49,925,148 $ 3,193,701 $ (1,947,205) $ 51,171,644
============= ============= ============= =============
See accompanying summary of accounting policies and notes to
consolidating financial statements
F-03
SBM Certificate Company and Subsidiary
CONSOLIDATING BALANCE SHEET
December 31, 2002
SBM Certificate Atlantic Capital Eliminating
Company Funding Corp. Entries Totals
--------------- ---------------- ------------- -------------
Qualified assets
Cash and investments
Available-for-sale securities
(amortized cost: $11,245,510) $ 9,190,162 $ -- $ -- $ 9,190,162
Mortgage notes held for sale 7,124,110 6,039,718 -- 13,163,828
Warehouse line of credit receivable 3,008,900 -- (3,008,900) --
Real estate tax lien certificates 1,632,437 -- -- 1,632,437
Residual mortgage certificate 4,038,607 -- -- 4,038,607
Real estate owned 2,188,092 459,003 -- 2,647,095
Escrows 100,000 -- -- 100,000
Certificate loans 77,462 -- -- 77,462
Cash and cash equivalents 1,888,269 342,617 -- 2,230,886
------------- ------------- ------------- -------------
Total cash and investments 29,248,039 6,841,338 (3,008,900) 33,080,477
------------- ------------- ------------- -------------
Dividends and interest receivables 360,801 33,948 -- 394,749
------------- ------------- ------------- -------------
Total qualified assets 29,608,840 6,875,286 (3,008,900) 33,475,226
Other assets
Related party receivable 105,000 51,491 (27,140) 129,351
Fixed assets, net of accumulated depreciation
of $38,180 and $7,954 169,834 45,583 -- 215,417
Investment in subsidiary 1,188,857 -- (1,188,857) --
Goodwill 591,463 -- -- 591,463
Deferred acquisition costs, net 581,534 -- -- 581,534
Due from shareholder 1,218,181 -- -- 1,218,181
Allowance - due from shareholder (1,218,181) -- -- (1,218,181)
Other assets 108,923 13,146 -- 122,069
------------- ------------- ------------- -------------
Total assets $ 32,354,451 $ 6,985,506 $ (4,224,897) $ 35,115,060
============= ============= ============= =============
Liabilities
Statutory certificate liability $ 31,418,457 $ -- $ -- $ 31,418,457
Additional certificate liability 1,770,369 -- -- 1,770,369
Warehouse line of credit -- 5,551,500 (3,008,900) 2,542,600
Deferred revenue 1,640,425 -- -- 1,640,425
Real estate liabilities 870,317 -- -- 870,317
Accounts payable and other liabilities 208,457 127,425 -- 335,882
Related party payable 27,341 117,724 (27,140) 117,925
------------- ------------- ------------- -------------
Total liabilities 35,935,366 5,796,649 (3,036,040) 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
Common stock, $2 par value; 10,000 shares
authorized; 10,000 shares issued and outstanding -- 20,000 (20,000) --
Additional paid-in capital 3,861,818 1,621,481 (1,621,481) 3,861,818
Accumulated comprehensive income (loss), net of taxes (2,055,348) -- -- (2,055,348)
Accumulated deficit (5,637,385) (452,624) 452,624 (5,637,385)
------------- ------------- ------------- -------------
Total shareholder's equity (deficit) (3,580,915) 1,188,857 (1,188,857) (3,580,915)
------------- ------------- ------------- -------------
Total liabilities and shareholder's equity (deficit) $ 32,354,451 $ 6,985,506 $ (4,224,897) $ 35,115,060
============= ============= ============= =============
See accompanying summary of accounting policies and notes to
consolidating financial statements
F-04
SBM Certificate Company and Subsidiaries
CONSOLIDATING STATEMENT OF OPERATIONS
Year ended December 31, 2003
SBM Certificate
Company and Atlantic Capital Eliminating
SBMS I Funding Corp. Entries Totals
--------------- ---------------- ------------ ------------
Investment income
Interest and dividend income $ 478,171 $ 2,446 $ -- $ 480,617
Other investment income 61,762 -- -- 61,762
Loss from investment in subsidiary (183,208) -- 183,208 --
Loan fee income 90,173 -- -- 90,173
Mortgage interest income 2,008,818 293,156 (168,837) 2,133,137
------------ ------------ ------------ ------------
Total investment income 2,455,716 295,602 14,371 2,765,689
------------ ------------ ------------ ------------
Investment and other expenses
Administrative services fee 1,029,800 -- -- 1,029,800
Legal and accounting fees 553,747 -- -- 553,747
Deferred a