University Bancorp, Inc.

What they do

University Bank is a state-chartered community bank serving Ann Arbor and Washtenaw County, offering deposit products and lending ranging from small business and residential mortgage loans to Sharia'a-compliant home financings. Subsidiary Midwest Loan Services originates, services and sub-services residential mortgage loans for credit unions, financial institutions and brokers. Other units include University Insurance & Investment Services, a Michigan-licensed insurance and investment agency, and University Islamic Financial Corporation, formed in December 2005 to pursue Islamic banking.

Revenue drivers

• Community Banking (net interest income) — Traditional spread income from deposits and lending products; net interest and financing income for the nine months ended September 30, 2008 was $3,216,789, up 25.11% year over year. The third-quarter net spread rose to 5.15% from 4.64% a year earlier.
• Midwest Loan Services (mortgage sub-servicing) — Specializes in origination, servicing and sub-servicing of mortgage loans for credit unions, financial institutions and mortgage brokers; sub-serviced 42,781 mortgages at September 30, 2008, up 30.55% from 32,770 a year earlier. It reported pre-tax net income of $181,000 in Q3 2008 versus $214,000 in Q3 2007.
• University Islamic Financial Corporation (Islamic finance) — Formed December 30, 2005; University Bank purchased 80% for an $8,000,000 cost basis plus $5,588,000 of Series A preferred. It solicits Sharia'a-compliant FDIC-insured deposits and originates Sharia'a home financings as agent for the Bank. A February 2006 master commitment with Freddie Mac created a secondary market for these Michigan transactions.
• University Insurance & Investment Services — State of Michigan-licensed insurance agency, based in Ann Arbor, selling life, health, annuities, mutual funds and, since 1999, property and casualty insurance for homes, autos, apartments and businesses. Its broker-dealer investment services operate through clearing arrangements with Equitas America LLC and Pershing, a division of Bank of New York.

Recent performance

For the third quarter of 2008, net income was $121,238 versus a net loss of $49,738 in the same period of 2007. Community Banking posted a pre-tax loss of $57,000, an improvement from a $226,000 pre-tax loss a year earlier, while Midwest Loan Services earned $181,000 pre-tax compared with $214,000. Nine-month 2008 net income was $469,500 versus $1,015,294 in the same 2007 period, which had benefited from $1,175,284 of termination fee income at Midwest. Net interest and financing income rose 42.86% to $1,262,235 in Q3 2008, and 25.11% to $3,216,789 for the nine months, driven by higher earning-asset balances.

Strategy

Management states that Community Banking results reflect ongoing investment in the expansion of University Islamic Financial and University Lending Group, including legal and personnel costs to expand the product offering into additional states. Growth in earning assets and loans, supported by Sharia'a-compliant deposits and financings, is the stated driver of net interest and financing income. The company also relies on brokered certificates of deposit for liquidity, with approximately $5.9 million of brokered CDs outstanding at December 31, 2005. The February 2006 Freddie Mac master commitment was intended to create a secondary market for Sharia'a-compliant home financings with the intent to expand the program over time.

Risks

• Islamic finance expansion costs — Community Banking's pre-tax losses reflect ongoing legal and personnel investment to expand University Islamic Financial and University Lending Group into additional states, with no assurance the expansion will become profitable.
• Mortgage servicing rights valuation — Servicing rights are evaluated quarterly for impairment using prepayment-speed and retention assumptions, and Q3 2008 results were reduced by a decrease in the fair value of mortgage servicing rights.
• Concentration in mortgage sub-servicing — Midwest Loan Services' portfolio consists largely of residential mortgage loans sold to Fannie Mae, Freddie Mac and conduits including a Lehman Brothers jumbo and subprime conduit, exposing results to mortgage market and counterparty conditions.
• Listing failure — The company received a delisting notice or listing-rule failure event dated January 2, 2009, per its 8-K filings, which could affect the liquidity and marketability of its common stock.

Outlook

Management links future profitability to broader demand for its products, net interest margin trends and the cost of expansion into additional states for University Islamic Financial and University Lending Group. The company's filings caution that actual results depend on interest rates, general economic conditions, loan and investment portfolio quality, deposit flows and competition. No specific earnings or growth target is provided in the excerpts.