<PAGE> 1
Form 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended September 30, 1998
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the transition period from to
-------------- ---------------
Commission File Number 0-16023
UNIVERSITY BANCORP, INC.
(Exact name of registrant as specified in its charter)
Delaware 38-2929531
(State of incorporation) (IRS Employer Identification Number)
959 Maiden Lane,
Ann Arbor, Michigan 48105
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (734) 741-5858
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Common Stock, $0.010 par value Outstanding at November 10, 1998
1,963,436 shares
page 1 of 35 pages
Exhibit index on sequentially numbered page 33
<PAGE> 2
FORM 10-Q 2
---------
TABLE OF CONTENTS
-----------------
PART I - Financial Information
- ------------------------------
Item 1. Financial Statements PAGE
Consolidated Balance Sheets 3
Consolidated Statements of Operations 5
Consolidated Statements of Cash Flows 7
Notes to the Consolidated Financial
Statements 8
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9
Summary 10
Results of Operations 11
Liquidity and Capital Resources 25
PART II - Other Information
- ---------------------------
Item 1. Legal Proceedings 28
Item 2. Changes in Securities 28
Item 5. Other Information
Parent Company Condensed
Financial Information 31
Item 6. Exhibits & Reports on Form 8-K 34
Signature 34
- ---------
Exhibit Index 35
- --------------------------------------------------------------------------------
The information furnished in these interim statements reflects all
adjustments and accruals which are, in the opinion of management, necessary for
a fair statement of the results for such periods. The results of operations in
the interim statements are not necessarily indicative of the results that may be
expected for the full year.
<PAGE> 3
Part 1. - Financial Information
Item 1.- Financial Statements 3
UNIVERSITY BANCORP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
September 30, 1998 and December 31, 1997
(Unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
ASSETS 1998 1997
------------ ------------
<S> <C> <C>
Cash and due from banks $ 1,123,505 $ 2,062,307
Federal funds sold 3,545,757 314,652
------------ ------------
Total cash and cash equivalents 4,669,262 2,376,959
Securities available for sale at market 3,974,581 1,980,327
Loans held for sale 11,454,897 18,156,671
Loans 24,952,069 28,236,183
Allowance for Loan Loss (409,241) (520,953)
------------ ------------
Loans, net 24,542,828 27,715,230
Premises and equipment 1,469,987 1,955,919
Mortgage servicing rights 1,127,042 1,430,190
Investment in and advances to
Michigan BIDCO 806,543 742,669
Other real estate owned 697,611 433,003
Other assets 2,180,682 2,737,815
------------ ------------
Total other assets 6,281,865 7,299,596
------------ ------------
TOTAL ASSETS $ 50,923,433 $ 57,528,783
============ ============
</TABLE>
-Continued-
<PAGE> 4
UNIVERSITY BANCORP, INC. AND SUBSIDIARIES 4
Consolidated Balance Sheets
September 30, 1998 and December 31,1997
(Unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
LIABILITIES AND STOCKHOLDERS' EQUITY 1998 1997
------------ ------------
<S> <C> <C>
Liabilities
Deposits:
Demand - non interest bearing $ 1,645,272 $ 2,458,211
Demand - interest bearing 16,439,870 19,120,122
Savings 159,884 143,604
Time 21,005,557 23,545,234
------------ ------------
Total Deposits 39,250,583 45,267,171
FHLB advances 0 0
Mortgage escrow 157,766 86,686
Short term borrowings 0 2,744,188
Long term borrowings 1,546,435 1,749,070
Deferred noncompete income 40,819 67,072
Other liabilities 6,321,947 4,015,003
Minority Interest 201,257 201,149
Stockholders' equity:
Preferred Stock, $0.001 par value;
Authorized - 500,000 shares;
Issued - 0 shares in both 1997 and 1996 -- --
Common stock, $0.01 par value;
Authorized - 2,500,000 shares;
Issued - 2,000,859 shares in 1998
and 1,391,907 shares in 1997 20,009 13,919
Treasury Stock - 140,569 shares in 1998
and 103,465 in 1997 (339,869) (302,446)
Additional Paid-in-Capital 3,546,599 3,493,154
Retained earnings 191,260 181,549
Net unrealized gain/(loss) on securities
available for sale, net of tax
of $6,320 in 1997, and
($6,687) in 1998 (13,373) 12,268
------------ ------------
Total Stockholders' equity 3,404,626 3,398,444
------------ ------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 50,923,433 $ 57,528,783
============ ============
</TABLE>
<PAGE> 5
UNIVERSITY BANCORP, INC. AND SUBSIDIARIES 5
Consolidated Statements of Operations and Comprehensive Income
For the Periods Ended September 30, 1998, 1997
(Unaudited)
<TABLE>
<CAPTION>
For the Three Month For the Nine Month
Period Ended Period Ended
1998 1997 1998 1997
---------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
Interest income:
Interest and fees on loans $ 884,778 $1,046,143 2,848,881 $3,077,497
Interest on securities:
U.S. Government agencies 21,142 53,928 51,356 238,700
Other securities 17,172 9,306 50,829 50,668
Interest on bank deposits 561 29,279 1,142 45,041
Interest on federal funds 21,913 85,753 91,772 226,415
---------- ---------- ----------- ----------
Total interest income 945,566 1,224,409 3,043,980 3,638,321
---------- ---------- ----------- ----------
Interest expense:
Interest on deposits:
Demand deposits 184,419 262,024 565,396 742,784
Savings deposits 933 1,805 2,804 12,508
Time certificates of deposit 329,069 446,883 1,095,236 1,260,666
Bank and other short term borrowings 4,810 84,087 65,373 408,610
Long Term Notes Payable 19,973 0 62,917 0
---------- ---------- ----------- ----------
Total interest expense 539,204 794,799 1,791,726 2,424,568
---------- ---------- ----------- ----------
Net interest income 406,362 429,610 1,252,254 1,213,753
Provision for loan losses 58,433 22,500 95,933 261,500
---------- ---------- ----------- ----------
Net interest income after
provision for loan losses 347,929 407,110 1,156,321 952,253
---------- ---------- ----------- ----------
Other income:
Net security gains 13,481 0 86,038 7,715
Service charges and fees 11,771 7,466 32,771 13,315
Mortgage banking income 962,775 1,248,818 3,187,718 3,920,866
Profit(loss) from equity investment in
Michigan BIDCO 1,136 (97,182) 161,625 (53,660)
Other 116,153 14,190 275,311 114,965
---------- ---------- ----------- ----------
Total other income 1,105,316 1,173,292 3,743,463 4,003,201
---------- ---------- ----------- ----------
</TABLE>
-Continued-
<PAGE> 6
UNIVERSITY BANCORP, INC. AND SUBSIDIARIES 6
Consolidated Statements of Operations (continued)
For the Periods Ended September 30, 1998, 1997
(Unaudited)
<TABLE>
<CAPTION>
For the Three Month For the Nine Month
Period Ended Period Ended
1998 1997 1998 1997
-------------- ------------- -------------- -------------
<S> <C> <C> <C> <C>
Salaries and wages $ 893,858 $ 988,990 2,776,700 $ 3,063,025
Employee benefits 115,084 115,588 425,732 388,507
Occupancy, net 155,441 80,216 334,239 280,497
Taxes other than income 14,469 54,519 36,265 69,912
Data processing and equipment expense 58,242 60,961 198,507 256,270
Correspondent bank service charges 8,701 4,808 21,965 18,822
Advertising 18,683 20,074 67,185 83,364
Net expense of other real estate owned 8,192 3,206 39,262 (3,154)
Legal and audit expense 82,167 37,898 258,898 151,369
Other operating expenses 238,581 394,535 825,920 1,202,166
-------------- ------------- -------------- -------------
Total other expenses 1,593,418 1,760,795 4,984,673 5,510,778
-------------- ------------- -------------- -------------
Income (Loss) before income taxes (140,173) (180,393) (84,889) (555,324)
-------------- ------------- -------------- -------------
Income taxes (benefit) (24,803) 6,212 (100,692) (166,840)
-------------- ------------- -------------- -------------
Net Income (Loss) $ (115,370) $ (186,605) 15,803 $ (388,484)
============== ============= ============== =============
Comprehensive Income $ (117,281) $ (198,200) (9,838) $ (374,063)
============== ============= ============== =============
Earnings (loss) per common share
Basic $ (0.06) $ (0.09) 0.01 $ (0.20)
============== ============= ============== =============
Diluted $ NA $ NA 0.01 $ NA
============== ============= ============== =============
Weighted average shares outstanding
Basic 1,974,703 1,966,892 1,980,758 1,902,072
============== ============= ============== =============
Diluted NA NA 1,982,946 NA
============== ============= ============== =============
</TABLE>
<PAGE> 7
UNIVERSITY BANCORP, INC. AND SUBSIDIARY 7
Consolidated Statements of Cash Flows For the nine-month
periods ended September 30, 1998 and 1997
(Unaudited)
<TABLE>
<CAPTION>
1998 1997
------------- ------------
<S> <C> <C>
Cash flow from operating activities:
Net income (loss) $ 15,801 $ (388,484)
Adjustments to reconcile net loss to net cash from Operating Activities:
Depreciation and amortization 425,147 393,116
Provision for loan loss 95,933 261,500
Mortgage loans originated for sale (443,880,319) (345,531,138)
Proceeds from sale of loans and mortgage backed trading securities 452,563,183 365,308,482
Net loss/(gain) on loan sales and securitization (1,979,280) (2,469,554)
Market adjustment on loans held for sale (1,810) (6,198)
Net amortization/accretion on securities 5,452 9,564
Loss/(Gain) on sale of securities available for sale (86,308) (7,715)
Gain on Sale of Saline Office (99,903) --
Change in:
Investment in Michigan BIDCO, Inc. (63,874) 256,361
Purchased Mortgage Servicing Rights -- 640,063
Other real estate (264,608) (331,491)
Increase in other assets 897,102 (640,959)
Increase/(Decrease) in other liabilities 2,280,691 4,891,966
------------- -------------
Net cash from (used in) operating activities $ 9,907,207 $ 22,385,513
------------- -------------
Cash flow from investing activities:
Purchase of securities available for sale (2,131,988) (1,890,921)
Proceeds from sales of securities available for sale 110,856 5,879,886
Proceeds from maturities and paydowns of securities available for sale 82,093 45,880
Loans granted net of repayments 3,076,469 (7,284,307)
Sale of Saline Office 189,480 --
Premises and equipment expenditures (65,505) (266,767)
------------- -------------
Net cash from (used in) investing activities 1,261,405 (3,516,229)
------------- -------------
Cash flow used in financing activities:
Net increase (decrease) in deposits (6,016,588) 2,234,022
Net increase(decrease) in mortgage escrow accounts 71,080 (877,808)
Net increase (decrease) in other short term borrowings (2,744,188) (17,152,169)
Principal payment on notes payable (202,635) (37,500)
Increases in Treasury Stock (37,423) 0
Issuance of common stock 53,445 554,541
------------- -------------
Net cash from financing activities (8,876,309) (15,278,914)
------------- -------------
Net change in cash and cash equivalents 2,292,303 3,590,370
Cash and cash equivalents:
Beginning of period 2,376,959 12,550,812
------------- -------------
End of period $ 4,669,262 $ 16,141,182
============= =============
Supplemental disclosure of cash flow information:
Cash paid for interest expense $ 1,682,258 $ 2,362,125
</TABLE>
<PAGE> 8
UNIVERSITY BANCORP, INC. AND SUBSIDIARIES 8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(1) General
See note 1 of Notes to Financial Statements in the Company's 1997
Annual Report on Form 10-K, which should be read in conjunction with this
Report, for a summary of the Company's significant accounting policies.
The unaudited financial statements included herein were prepared from
the books of the Company in accordance with generally accepted accounting
principles and reflect all adjustments which are, in the opinion of management,
necessary to provide a fair statement of the results of operations and financial
position for the interim periods. Such financial statements generally conform to
the presentation reflected in the Company's 1997 Annual Report on Form 10-K. The
current interim periods reported herein are included in the fiscal year subject
to independent audit at the end of the year.
Under a new accounting standard, comprehensive income is now reported
for all periods. Comprehensive income includes net income and other
comprehensive income. Other comprehensive income includes the change in net
unrealized gains and losses on securities available for sale, net of tax.
(2) Available-for-sale Securities
The Bank's available-for-sale securities portfolio at September 30,
1998 had a net unrealized gain of approximately $5,000 as compared with a net
unrealized loss of approximately $17,000 and $19,000 at June 30, 1998 and
December 31, 1997.
Securities available for sale
<TABLE>
<CAPTION>
September 30, 1998
-----------------------------------------------------
Gross Estimated
Amortized Unrealized Fair
(in thousands) Cost Gains Losses Value
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. treasury $ 453 $ 7 $ -- $ 460
U.S. agency mortgage-backed 2,186 13 -- 2,199
Other agency mortgage-backed 456 -- (15) 441
Other mortgage-backed -- -- -- --
U.S. agency equity 848 -- -- 848
Other equity -- -- -- --
- --------------------------------------------------------------------------------
Total investment securities
available for sale $3,943 $20 $(15) $3,948
====== === ==== ======
</TABLE>
<PAGE> 9
Securities available-for-sale (continued) 9
<TABLE>
<CAPTION>
June 30, 1998
-----------------------------------------------------
Gross Estimated
Amortized Unrealized Fair
(in thousands) Cost Gains Losses Value
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. agency mortgage-backed $ 508 $5 $ -- $ 513
Other agency mortgage-backed 512 - (22) 490
Other mortgage-backed -- - -- --
U.S. agency equity 848 - -- 848
Other equity -- - -- --
- --------------------------------------------------------------------------------
Total investment securities
available for sale $1,868 $5 $(22) $1,851
====== == ==== ======
<CAPTION>
December 31, 1997
-----------------------------------------------------
Gross Estimated
Amortized Unrealized Fair
(in thousands) Cost Gains Losses Value
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. agency mortgage-backed $ 509 $ 9 $ -- $ 518
Other agency mortgage-backed 561 -- (28) 533
U.S. agency equity 848 -- -- 848
Other equity 44 37 -- 81
- --------------------------------------------------------------------------------
Total securities
available for sale $1,962 $46 $(28) $1,980
====== === ==== ======
</TABLE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
This Report contains certain forward-looking statements which reflect the
Company's expectation or belief concerning future events that involves risks and
uncertainties. Among others, certain forward looking statements relate to the
continued growth of various aspects of the Company's community banking, mortgage
banking and investment activities, the nature and adequacy of allowances for
loan losses, and matters relating to the Company's efforts to assess the impact
of and to address potential problems associated with Year 2000 dating in
computers, software programs, and embedded computer codes. The Company can give
no assurance that the expectations reflected in forward looking statements will
prove correct. Various factors could cause results to differ materially from the
Company's expectations. Among these factors are those referred to in the
introduction to the Company's Management Discussion and Analysis of Financial
Condition and Results of Operations which appears at Item 7. of the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 1997, which
should be read in conjunction with this Report, and those referred to elsewhere
in this Report. All forward looking statements in this document are qualified in
their entirety by the above cautionary statement.
<PAGE> 10
10
The above cautionary statement is for the purpose of qualifying for the
"safe harbor" provisions of Section 21E of the Securities Exchange Act of 1934.
SUMMARY
For the nine months ended September 30, 1998, net income of $15,803 was
realized versus a net loss of $388,484 in the same period in 1997. Net interest
income increased to $1,252,254 in the 1998 period from $1,213,753 in the 1997
period, and other income was $3,729,257 in the 1998 period versus $4,003,201 in
the 1997 period. Operating expenses decreased to $4,984,673 in the 1998 period
from $5,510,778 in the 1997 period. Basic and diluted net income per share in
the nine months ended September 30, 1998 was $0.01, compared to basic net loss
per share of $0.20 for the nine months ended September 30, 1997.
The net income in the 1998 period was primarily the result of increased
income at Varsity Mortgage and Michigan BIDCO. Results at University Bank were
assisted by cost control at the Bank, which was only partially offset by
increased expenses from amortization of mortgage servicing rights and a decrease
in earning assets.
For the three months ended September 30, 1998, a net loss of $115,370
was realized versus a net loss of $186,605 in the same period of 1997. Net
interest income decreased to $406,362 in the 1998 period from $429,610 in the
1997 period, and other income was $1,105,316 in the 1998 period versus
$1,173,292 in the 1997 period. Other operating expense decreased to $1,593,418
in the 1998 period from $1,760,795 in the 1997 period. The decreased net loss in
the 1998 period was primarily the result of improved results at Michigan BIDCO,
which were only partially offset by slightly decreased results at Varsity
Mortgage, Varsity Funding and Midwest Loan Services. Results at University Bank
were assisted by cost control at the Bank, which was only partially offset by
increased expenses from amortization of mortgage servicing rights and a decrease
in earning assets.
Profitability at the Bank in the first nine months of 1998 was
restrained by higher amortization of mortgage servicing rights ($304,000 in the
1998 period) due to lower long term mortgage interest rates. Conversely, results
of the Bank in the first nine months of 1997 were assisted by the realization of
a $395,356 gain on the sale of some residential mortgage loans purchased in 1995
from the RTC. 1997 results were also negatively impacted by a $261,500 provision
for allowance for loan losses and a special charge at Michigan BIDCO.
During the first nine months of the year, Michigan BIDCO was able to
realize capital gains on the disposition of several of its portfolio
investments, and had a 28% annualized return on equity, which is unlikely to be
repeated in the final quarter of 1998.
The results of Midwest Loan Services during the 1998 period were
negatively impacted by higher amortization of its own portfolio of mortgage
servicing rights ($102,590 in the 1998 period) due to lower long term mortgage
interest rates. The negative impact of servicing rights amortization was
partially offset by revenue from new refinancing and loan origination programs.
<PAGE> 11
11
The following table summarizes the pre-tax income of each profit center
of the Company for the nine months ended September 30th (in thousands):
<TABLE>
<CAPTION>
PRE-TAX INCOME (LOSS) SUMMARY 1998 1997
<S> <C> <C>
Banking
Community & mortgage banking $(646) (681)
Midwest Loan Services 0 49
Varsity Mortgage & Varsity Funding 423 295
Equity in the earnings of Michigan BIDCO 162 (54)
Corporate Office (24) (164)
---- ----
Total $ (85) $(555)
</TABLE>
RESULTS OF OPERATIONS
Net Interest Income
Net interest income decreased to $406,362 for the three months ended
September 30, 1997 from $429,610 for the three months ended September 30, 1998.
Net interest income fell from the year ago period because of a decrease in
average earning assets and the yield on earning assets (partially as a result of
the restructuring of the Bank's agreement with Varsity Mortgage's management in
1997) which more than offset a more rapid decline in the average balance of
interest bearing liabilities and a less rapid decline in the percentage cost of
interest bearing liabilities. The yield on interest earning assets decreased to
8.54% in the 1998 period from 9.17% in the 1997 period. The average balance of
non-interest bearing liabilities increased and the cost of interest bearing
liabilities decreased from 5.80% in the 1997 period to 5.53% in the 1998 period,
causing net interest income as a percentage of total earning assets to increase
to 3.67% from 3.22% in the 1997 period.
For the nine month period ended September 30, 1998, net interest income
increased from $1,213,753 to $1,252,254 in the 1998 period. The yield on
interest earning assets decreased from 9.40% in the 1997 period to 8.67% in the
1996 period. The cost of interest bearing liabilities decreased from 6.05% in
the 1997 period to 5.58% in 1996 period. As a result, net interest income
increased as a percent of total average earning assets from 3.14% from 3.57%.
Interest income
Interest income decreased to $945,566 in the quarter ended September
30, 1998 from $1,224,409 in the quarter ended September 30, 1997. The average
volume of interest earning assets decreased from $52,950,048 in the 1997 period
to $44,271,772 in the 1998 period, a decrease of 16.4%. The decreased volume of
earning assets was due to a 66.8% decline in investment securities, and a 4.7%
decrease in loans. Interest income decreased as a result of a decrease in
earning assets and the yield on earning assets. The overall yield on earning
assets decreased from 9.17% to 8.54%, as more earning assets were invested in
<PAGE> 12
12
loans, and the yield on real estate mortgages held for sale decreased due to a
restructuring of the agreement with Varsity Mortgage's management in mid-1997.
Interest income decreased in the nine months ended September 30, 1998
from $3,638,321 from $3,043,980 in the nine months ended September 30, 1997. The
average volume of interest earning assets decreased to $46,933,778 in the 1997
period from $51,738,245 in the 1998 period, a decrease of 9.3%. The decrease in
interest income was attributable to the decrease in the volume of earning assets
and a decrease in the average yield on earning assets. The overall yield on
earning assets decreased to 8.67% from 9.40%, as more earning assets were
invested in loans, and lower yielding investment securities were sold to fund
loan growth. The increase in loans was the result of the activity generated from
the Bank's Ann Arbor office and the activity generated by Varsity Mortgage and
Varsity Funding.
The average volume of investment securities in the three months ended
September 30, 1998 decreased 66.8% over the same periods in 1997, as the Bank's
portfolio, which consists of adjustable rate agency backed mortgage securities
and invested fed funds, was liquidated and the funds used to repay higher cost
wholesale borrowings. In the nine month period, the average volume of securities
and investments decreased 67.6% over the same period in 1997, as the Bank sold
investment securities to repay higher cost wholesale borrowings. The yield on
the securities portfolio increased from 7.08% in the three month period ended
September 30, 1997 to 7.32% in the 1998 period. The yield on the securities
portfolio increased from 6.73% in the nine month period ended September 30, 1997
to 7.23% in the 1998 period. The increase in yields in both periods was the
result of a decrease in the amount of invested fed funds relative to the higher
yielding portfolio of mortgage-backed securities.
Interest Expense
Interest expense decreased from $794,799 in the three months ended
September 30, 1997 to $539,204 in the 1998 period. The decrease was due to a
decrease in interest bearing liabilities as a result of management's strategy of
decreasing reliance on high cost time deposits and wholesale funds. The average
cost of funds decreased from 5.80% in the 1997 period to 5.53% in the 1998
period. The average volume of interest bearing liabilities decreased 28.3% in
the 1998 period versus the 1997 period.
In the nine month periods ending September 30, 1998 and 1997, interest
expense decreased to $1,791,726 in 1998 from $2,424,568 in the 1997 period. The
decrease was due to the same factors as in the three months periods discussed
above. The cost of funds decreased from 6.05% in the 1997 period to 5.58% in the
1996 period. The average volume of interest bearing liabilities decreased 19.9%
in the 1998 period versus the 1997 period.
<PAGE> 13
13
<TABLE>
<CAPTION>
Three Months Ended September 30,
--------------------------------------------------------------------------------
1998 1997
---------------------------------------- --------------------------------------
Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Interest Earning Assets:
Short Term Investments:
Interest Bearing Deposit $ 89,018 $ 561 2.52% $ 337,038 $ 3,901 4.59%
Federal Funds Sold 1,559,390 21,913 5.62% 7,522,433 111,131 5.86%
Securities:
Non-taxable (1) - - - - - -
Taxable 1,672,241 38,314 9.16% 2,135,474 63,234 11.75%
----------- -------- ----- ----------- ---------- -----
Total Securities & S. T. Investments 3,320,649 60,788 7.32% 9,994,945 178,266 7.08%
----------- -------- ----- ----------- ---------- -----
Loans:
Commercial 9,773,604 239,256 9.79% 13,114,410 315,697 9.55%
Real Estate Mortgage 26,752,149 530,790 7.94% 24,592,072 596,096 9.62%
Installment/Consumer 4,425,370 114,732 10.37% 5,248,621 134,350 10.16%
Total Loans 40,951,123 884,778 8.64% 42,955,103 1,046,143 9.66%
----------- -------- ----- ----------- ---------- -----
Total Interest Bearing Assets 44,271,772 945,566 8.54% 52,950,048 1,224,409 9.17%
----------- -------- ----- ----------- ---------- -----
Less allowance for possible
loan losses & deferred fees (361,814) (520,930)
----------- -----------
43,909,958 52,429,118
Mortgage servicing rights 1,168,581 1,478,107
Non earning assets 7,033,242 7,607,112
----------- -----------
Total Assets $52,111,781 $61,514,337
=========== ===========
LIABILITIES
Interest Bearing Liabilities:
Deposit Accounts:
Now/S-Now $ 2,825,162 $ 26,433 3.74% $ 3,621,020 $ 45,240 4.96%
Savings 147,651 918 2.49% 106,121 676 2.53%
Canadian Dollar Savings 2,539 15 2.36% 188,333 1,129 2.38%
Time 21,934,872 329,069 6.00% 29,085,411 446,883 6.10%
Borrowed Funds 326,975 4,810 5.88% 3,136,381 58,691 7.42%
Money Market Accounts 12,918,552 157,986 4.89% 17,332,757 216,783 4.96%
Holding Company Debt 872,470 19,973 9.16% 929,212 25,397 10.84%
----------- -------- ----- ----------- ---------- -----
Total interest bearing
liabilities $39,028,221 539,204 5.53% $54,399,235 794,799 5.80%
=========== -------- ----- =========== ---------- -----
Net interest income $406,362 $ 429,610
======== ==========
Weighted average rate spread 3.02% 3.38%
===== =====
Net yield on average earning
assets 3.67% 3.22%
</TABLE>
(1) Actual yields; not adjusted for tax-equivalent yields
(2) For purposes of computing average yields on the loan portfolio as presented
in the above analysis, loans on non-accrual status are included in the
average loan balances.
<PAGE> 14
14
<TABLE>
<CAPTION>
Nine Months Ended September 30,
--------------------------------------------------------------------------------
1998 1997
---------------------------------------- --------------------------------------
Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Interest Earning Assets:
Short Term Investments:
Interest Bearing Deposit$ $ 48,929 $ 1,142 3.12% $ 560,468 $ 19,663 4.69%
Federal Funds Sold 2,149,153 91,772 5.71% 5,822,066 251,793 5.78%
Securities:
Non-taxable (1) - - - - - -
Taxable 1,409,098 102,185 9.70% 4,758,870 289,368 8.13%
----------- ---------- ----- ----------- ---------- -----
Total Securities & S. T. Investments 3,607,180 195,099 7.23% 11,141,404 560,824 6.73%
----------- ---------- ----- ----------- ---------- -----
Loans:
Commercial 10,921,888 855,087 10.47% 12,291,646 846,617 9.21%
Real Estate Mortgage 27,786,074 1,640,755 7.89% 23,749,437 1,888,059 10.63%
Installment/Consumer 4,618,636 353,039 10.22% 4,555,758 342,821 10.06%
----------- ---------- ----- ----------- ---------- -----
Total Loans 43,326,598 2,848,881 8.79% 40,596,841 3,077,497 10.14%
----------- ---------- ----- ----------- ---------- -----
Total Interest Bearing Assets 46,933,778 3,043,980 8.67% 51,738,245 3,638,321 9.40%
----------- ---------- ----- ----------- ---------- -----
Less allowance for possible
loan losses & deferred fees (460,181) (357,134)
----------- -----------
46,473,597 51,381,111
Mortgage servicing rights 1,168,581 1,492,628
Non earning assets 5,336,202 7,658,904
----------- -----------
Total Assets $52,978,380 $60,532,643
=========== ===========
LIABILITIES
Interest Bearing Liabilities:
Deposit Accounts:
Now/S-Now $ 2,994,869 $ 88,691 3.96% $ 3,090,499 $ 113,883 4.93%
Savings 129,032 2,408 2.50% 109,603 2,060 2.51%
Canadian Dollar Savings 23,864 396 2.22% 583,053 10,448 2.40%
Time 24,337,424 1,095,236 6.02% 27,069,558 1,260,666 6.23%
Borrowed Funds 1,453,015 65,373 6.02% 5,303,480 338,479 8.53%
Money Market Accounts 13,091,531 476,705 4.87% 16,482,414 628,900 5.10%
Holding Company Debt 900,083 62,917 9.35% 941,621 70,132 9.96
----------- ---------- ----- ----------- ---------- -----
Total interest bearing
liabilities $42,929,818 1,791,726 5.58% $53,580,228 2,424,568 6.05%
=========== ========== ===== =========== ========== =====
Net interest income $1,252,254 $1,213,753
========== ==========
Weighted average rate spread 3.09% 3.35%
===== =====
Net yield on average earning
assets 3.57% 3.14%
</TABLE>
(1) Actual yields; not adjusted for tax-equivalent yields (2) For purposes of
computing average yields on the loan portfolio as presented
in the above analysis, loans on non-accrual status are included in the
average loan balances.
<PAGE> 15
15
MONTHLY AVERAGE BALANCE SHEET AND
INTEREST MARGIN ANALYSIS
The preceeding tables summarize monthly average balances, revenues from
earning assets, expenses of interest bearing liabilities, their associated yield
or cost and the net return on earning assets for the three and nine months ended
September 30, 1998 and 1997.
Allowance for Loan Losses
The monthly allowance for loan loss remained at a rate of $7,500 in the
third quarter of 1998, although management added a special provision of $35,933
to create a new allowance for loan losses at Varsity Funding and Midwest Loan
Services for portfolio loans at these subsidiaries.
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
----------------------------------------------
Allowance for loan losses $ 58,433 $ 22,500 $ 95,933 $261,500
Loan charge-offs (28,115) (10,000) (253,142) (56,772)
Recoveries 10,354 7,755 24,247 30,799
-------- -------- --------- --------
Net increase (decrease)
in allowance $ 40,804 $ 20,255 $(132,962) $235,527
======== ======== ========= ========
At At At
Sept. 30, June 30, December 31,
1998 1998 1997
-----------------------------------------------
Total loans (1) $24,952,069 $25,371,449 $28,236,184
Reserve for loan losses 409,241 347,187 520,953
Reserve/Loans, % (1) 1.64% 1.37% 1.84%
(1) Excludes loans held for sale.
Economic conditions in the Bank's primary market area in Ann Arbor were
strong in the period. The Sault Ste. Marie and Newberry areas appear not to be
growing. Less than 5.5% of the Bank's loans now relate to credits located in the
Upper Peninsula of Michigan.
Management believes that the current reserve level and the ongoing
reserve for loan losses is adequate to absorb losses inherent in the loan
portfolio, although the ultimate adequacy of the reserve is dependent upon
future economic factors beyond the Company's control. A downturn in the general
nationwide economy will tend to aggravate, for example, the problems of local
loan customers currently facing some difficulties, and could decrease
residential home prices. A general nationwide business expansion could
conversely tend to diminish the severity of any such difficulties. Since most of
the Bank's non-performing assets relate to homes, the future value of homes in
the Bank's primary market area, and to a lesser extent in other areas
<PAGE> 16
16
nationwide where the non-performing assets are located, will also be a major
factor in determining the ultimate adequacy of the reserve.
The following schedule summarizes the Company's nonperforming loans for
the periods indicated:
<TABLE>
<CAPTION>
At At At
Sept. 30, June 30, December 31,
1998 1998 1997
-------------------------------------------
<S> <C> <C> <C>
Past due 90 days and over and still
accruing:
Real estate 135,904 118,350 233,697
Installment 2,153 29,260 5,556
Commercial 64,810 52,071 295,643
------- ------- -------
Subtotal 202,867 199,681 534,896
Nonaccrual loans:
Real estate 323,701 343,808 532,821
Installment -- -- 44,409
Commercial -- -- 9,479
------- ------- -------
Subtotal 323,701 343,808 586,709
Other real estate
owned (see below) 697,611 714,361 433,003
------- ------- -------
Total 1,224,179 1,257,850 1,554,608
As % of loans (1) 4.91% 4.96% 5.51%
Ratio of reserve for loan
losses to all loans
90 days and over 77.7% 60.3% 46.5%
</TABLE>
(1) Excluding loans held for sale.
Other real estate owned at September 30, June 30, 1998 and December 31,
1997 includes a commercial development site in Sault Ste. Marie, Michigan. Based
upon a recent appraisal of the site, management believes the 16-acre site where
a former loan office is located has a fair market value substantially more than
its carrying cost of $266,079. This property is carried as other real estate
owned in the Company's financial statements since it is surplus to the Bank's
requirements. While it is management's goal to sell this site, there is no
assurance that a sale will be consummated.
With the exception of a part interest in a commercial building carried
at less than $3,000, all of the other real estate owned, other than the property
mentioned above, consists of residential single family properties. The
non-performing residential single family properties and loans mainly relate to
single family residential loans originated for the secondary market which have
become delinquent and are either under modification agreements to bring the
loans current or in the process of foreclosure. Based upon management's review
of
<PAGE> 17
17
appraisal information and current broker price opinions, management believes
that the Bank is well secured with respect to these loans and the other real
estate owned. Other real estate owned is carried at the lower of cost or fair
value less estimated costs to sell. During the quarter ended June 30, 1998, the
Bank accepted offers to sell nearly all of its remaining other real estate owned
in the Upper Peninsula (other than the commercial development site discussed
above) as part of an overall effort to wind-down the Bank's activities there,
resulting in charge-offs of approximately $20,000. If the Bank is successful in
winding up its loan servicing activities in the Upper Peninsula, the Bank may be
able to reduce all or a portion of the operating expenses of its Newberry loan
servicing office, which have been approximately $70,000 per year. Subsequent to
quarter-end, the Bank sold the Newberry loan servicing office building,
resulting in a gain of approximately $10,000.
Non-Interest Income
Total non-interest income decreased to $1,105,316 for the three months
ended September 30, 1998 from $1,173,292 for the three months ended September
30, 1997. The decrease was principally a result of a decrease in mortgage
banking income, which was partially offset by an increase in profit from
Michigan BIDCO and a gain on sale of surplus real estate. Mortgage banking
income in the 1997 period was increased by the realization of a $395,356 gain on
the sale of some residential mortgage loans purchased in 1995 from the RTC.
Total non-interest income decreased to $3,743,463 for the nine months
ended September 30, 1998 from $4,003,201 for the nine months ended September 30,
1998. The decrease was principally a result of the same factors which decreased
non-interest income in the three month periods as discussed above.
Securities. Taking into account realized and unrealized gains and
losses on the securities portfolio, during the first nine months of 1998, the
yield on the Company's investment securities portfolio was 13.38%. During the
three and nine months ended September 30, 1998, there were no securities sales
from the Bank's available-for-sale securities portfolio. During the three months
ended September 30, 1998, the Company realized a $13,481 gain on a sale of a
portion of its investment in Michigan BIDCO convertible bonds. In the nine
months ended September 30, 1998, gains of $86,038 were realized by the Company.
Gross proceeds from these sales were $216,132.
Mortgage Banking. Mortgage banking income decreased to $962,775 in the
three months ended September 30, 1998 from $1,248,818 in the three months ended
September 30, 1997. Mortgage banking income in the 1997 period was increased by
the realization of a $395,356 gain on the sale of some residential mortgage
loans purchased in 1995 from the RTC. Excluding this gain, increased income from
mortgage banking activity from higher origination volume was partially offset by
increased amortization of the Company's mortgage servicing rights portfolio as a
result of increased refinancing activity due to lower long term
<PAGE> 18
18
interest rates.
Mortgage banking income decreased to $3,187,718 in the nine months
ended September 30, 1998 from $3,920,866 in the nine months ended September 30,
1997. The decrease in mortgage banking income during the 1998 period versus the
1997 period was principally a result of increased amortization of the Company's
mortgage servicing rights portfolio as a result of increased refinancing
activity due to lower long term interest rates more than offsetting increased
income from mortgage banking activity from higher origination volume. In
addition, mortgage banking income in the 1998 period was not assisted by the
$395,356 realized gain in the 1997 period mentioned above.
At September 30, 1998, the Bank and its subsidiaries owned the right to
service $101,275,062 of FHLMC, FNMA and private conduit mortgages for others, of
which approximately 60% was owned by Midwest Loan Services, and the remainder by
the Bank. The following table summarizes the portfolio by type and mortgage note
rate:
Interest Rate Stratification of the Company's Servicing
-------------------------------------------------------
<TABLE>
<CAPTION>
($ in 000s) FIXED RATE - BY MATURITY
------------------------------
Mortgage Rate (%) ARMs UNDER 10 10-25 OVER 25
<S> <C> <C> <C> <C>
9.00 and up 267 - 107 1,664
8.50 - 8.99 3,515 - 475 3,557
8.00 - 8.49 6,149 - 868 11,553
7.50 - 7.99 728 63 3,118 33,548
7.00 - 7.49 247 - 7,671 15,858
6.50 - 6.99 - 173 4,526 5,654
6.00 - 6.49 - - 869 657
under 6.00 - - - 8
------ --- ------ ------
10,906 237 17,634 72,499
Current market
interest rates 6.50% 6.75% 7.00% 7.25%
Average annual
servicing fee 0.39% 0.56% 0.26% 0.26%
</TABLE>
Until October 1998, interest rates were stable for over thirty months,
a record in the post-war period. Since then short term rates have followed long
term interest rates lower. Long term interest rates fell to levels in the third
quarter of 1998 which prompted record levels of refinancing activity. As a
result, the portfolio is experiencing increased refinancings and payoffs, which
hurts income. In the three and nine months ended September 30, 1998, $81,000 and
$304,000, respectively, was charged to income to amortize the Company's
servicing rights. Based on recent comparable sales and indications of market
value from industry brokers, management believes that the current market value
of the Bank's portfolio of mortgage servicing rights approximates cost. Market
interest rate conditions can quickly affect the value of mortgage servicing
rights in a positive or negative fashion, as long term interest rates rise and
fall. In addition,
<PAGE> 19
19
volatility of long term interest rates can negatively affect the value of
mortgage servicing rights. Recent record levels of long term interest rate
volatility and record low long term interest rates have depressed the value of
mortgage servicing rights.
In mid-September 1998, management decided to enter into a market value
hedge to decrease the likelihood of future loss of economic value in the event
that long term interest rates decreased further. An investment was made in a
long term Treasury strip ($2,000,000 face amount of a zero coupon bond, the U.S.
Treasury PO (Principal Only Strip) of 2/15/2027) and a mortgage-backed Principal
Only (PO) security, $2,350,000 face amount of FNMA 93-205H, a 7% coupon 30-year
PO. While there is no assurance that the hedging securities will be closely
correlated in value to the Bank's portfolio of mortgage servicing rights, there
should theoretically be a correlation in the fact that the mortgages underlying
the FNMA 30-year PO MBS have interest rates between 7.25% and 8.25%, which is
correlated to the bulk of the Bank's portfolio of 30-year mortgage servicing
rights.
At September 30, 1998, the Bank had outstanding purchase commitments to
buy single family secondary market qualifying mortgage loans of $46,007,950 and
outstanding forward commitments to deliver secondary mortgage qualifying loans
of $34,462,200, substantially all of which commitments were for delivery within
three months or less.
Servicing Rights Held by the Company
<TABLE>
<CAPTION>
(amounts in $000s) Sept. 30, June 30, December 31,
1998 1998 1997
----------------------------------------
<S> <C> <C> <C>
Total servicing 101,275 106,652 124,719
Book value of servicing 1,127 1,207 1,430
Estimated market value of
servicing:
Management estimate (1) 1,149 1,237 1,440
Discounted cash flow (2) 1,154 1,346 1,583
Estimated excess of market
over book value (3) 22- 27 139- 31 153- 10
</TABLE>
(1) Assumes a price based upon market transactions at September 30, June 30,
1998 and December 31, 1997 of 4.6x (4.6 times the servicing fee) for 30-year
servicing, 3.5x for 15-year servicing, 1.9x for Balloon servicing and 2.0x
for ARM servicing. Excess servicing is discounted from these amounts at a
multiple of one times the servicing fee, and higher coupon interest rate
servicing is discounted by between 15% and 50%.
(2) Uses net present value analysis of future cash flows, discounted back at
rates ranging from 10 to 12%.
(3) Range based upon the two methods used in (1) and (2), above.
During the three month period ended September 30, 1998 purchases and
sales of mortgage servicing rights by third-parties evidenced a sharp decrease
in price because of a decrease in long term interest rates.
<PAGE> 20
20
RTC Loan Pool. In mid-March 1995, the Bank purchased four Participation
Certificates in sub-performing home equity loans with approximately $6,600,000
in unpaid principal balance and $1,000,000 of unpaid accrued interest from a
private investor group (which had purchased them from the Resolution Trust
Corporation (RTC)) for approximately $1,903,000 (the "RTC Loan Pool"). In
September 1996 an additional $700,000 in home equity loans purchased from a home
equity loan originator were added to the RTC Loan Pool as a fifth Participation
Certificate at a cost of $115,000.
Substantially all of the remaining loans underlying the first four
Participation Certificates were sold as of March 28, 1997 for $1,725,000. As a
result the Bank's investment in the RTC Loan Pool was reduced to zero, and the
balance of the proceeds from the sale, per the terms of the RTC Loan Pool
acquisition agreement, was split 50/50 with the servicer of the RTC Loan Pool.
In addition, in March 1998, the Bank sold all the remaining loans underlying the
five Participation Certificates for $200,000, generating a gain for the Bank of
$100,000.
In mid-1996, the servicer submitted a request to the RTC for a $650,000
refund of loans that had previously been paid off, but were included in the RTC
Loan Pool, pursuant to the original purchase agreement. In April 1997, the
servicer was notified that the RTC had accepted the refund request in the amount
of $300,000 with a request for additional information regarding the remaining
$350,000. After the additional information was submitted, the RTC rejected the
claim entirely. As a result, the Bank filed a lawsuit in late October 1997
against the RTC in the U.S. District Court for the District of Columbia seeking
recovery of the requested $650,000 refund. In March 1998, the Bank filed an
amended and reduced refund request in the amount of $505,000, plus interest from
mid-March 1995 at the applicable statutory rate of 12%. In October 1998, the
U.S. District Court judge presiding in the case ruled in the RTC's favor in the
dispute despite the merits of the Company's position. Due to the cost and
likelihood that an appeal of the judge's opinion would not be successfully
overruled, management decided to drop further pursuit of the funds.
Michigan BIDCO. Michigan BIDCO (the "BIDCO") invests in businesses in
Michigan with the objective of fostering job growth and economic development.
The Bank owns 280 shares of common stock in the BIDCO, currently representing a
44.1% equity interest. The Company's consolidated fully diluted ownership in the
BIDCO is 13.4%, after considering the impact of convertible bonds.
As of September 30, 1998, the BIDCO had made investments in
twenty-seven unrelated entities, amounting to a total of $13,413,600 at original
cost (before repayments or participations sold). At September 30, 1998, the
BIDCO had total unaudited assets of $5,451,244.
For the three and nine months ended September 30, 1998 and 1997, the
Bank's 44.1% equity share in the BIDCO's reported net income (loss) was $1,136
and $161,625 and ($97,182) and ($53,660), respectively. The BIDCO's income in
the 1998 periods was increased by the realization of capital gains on several
BIDCO investments, including the sale of an interest in an ABC-TV affiliate, a
cable TV firm and a Railroad boxcar lease.
<PAGE> 21
21
As a result of the realization of capital gains, at September 30, 1998,
the BIDCO had $1,992,094 in cash and cash equivalents on hand. Management of the
BIDCO hopes to raise additional cash through the realization of its equity
investments in additional firms and through the sale of all or a part of its
loan portfolio with the intent of using the cash to capitalize a new Small
Business Investment Company (SBIC). To form a SBIC, a total of at least
$5,000,000 must be invested as equity capital into the SBIC. There is no
assurance that sufficient capital will be raised to form an SBIC, or that the
various governmental permissions will be received which are a required
prerequisite to the BIDCO investing in a new SBIC. In the meantime, the BIDCO's
net income could suffer in future periods while the bulk of its assets are held
in relatively low-yielding cash equivalents.
Michigan BIDCO makes its investments in the form of loans or direct
equity investments, or a combination thereof. The BIDCO's limit on its
investment in one borrower is currently $500,000, and the BIDCO arranges
participations for investments in excess of this amount. By management policy,
the Bank is restricted from investing or lending to a business that the BIDCO
finances. The BIDCO typically receives warrants or participation rights in the
companies in which it invests. To date, investments (at original investment
cost) have been made in the following types of businesses:
<PAGE> 22
22
Michigan BIDCO, investments:
Total Equity
Industry Investment Participation?
#1 ABC-TV affiliate $1,472,000 repurchased
#2 Adult foster care 40,000 no
#3 Bridal shop 64,000 no
#4 Cable TV 545,000 repurchased
#5 Children's clothing manufacturer 200,000 repurchased
#6 Commercial laundry 180,000 no
#7 Environmental engineering 100,000 repurchased
#8 Fishing supplies 50,000 no
#9 Home health care 20,000 no
#10 Hunting supplies 100,000 no
#11 Industrial supply 85,000 no
#12 Limited service hotels 738,600 yes
#13 Manufacturing 200,000 no
#14 Manufacturing 200,000 no
#15 Manufacturing 200,000 no
#16 Metal manufacturing 80,000 no
#17 Paper converting 2,762,000 yes
#18 Plastic injection molding 2,000,000 repurchased
#19 Plastic mold manufacturing 25,000 no
#20 Railcar parts manufacturing 125,000 no
#21 Railroad boxcar leasing 1,500,000 no
#22 Recreational services 160,000 no
#23 Recycled paper pulp mill 780,000 yes
#24 Residential mortgage subservicing 450,000 repurchased
#25 Secured credit card issuer 540,000 no
#26 Tissue paper mill 700,000 yes
#27 Truck maintenance 70,000 no
-----------
Total $13,413,600
===========
The loans associated with investments #1, 2, 5, 6, 7, 9, 13, 18, 19, 21
and 24 have been repaid in full. Loan participations have been sold in loans
associated with investments #1, 3, 4, 6, 10, 11, 17, 18, 21, 23 and 27. At
September 30, 1998, the BIDCO had no outstanding conditional commitments to
lend.
Northern Michigan Foundation. In 1995 and 1996, the BIDCO donated
$300,000 to capitalize Northern Michigan Foundation (the "Foundation"). The
BIDCO and the Foundation share administrative staffs and offices, with the
Foundation reimbursing the BIDCO for these services. The monthly management fee
paid by the Foundation to the BIDCO is currently approximately $16,000. As a
result of its capitalization by the BIDCO, the Foundation was able to borrow a
total of $2,000,000 from the U.S. Department of Agriculture's Rural Development
Service ("USDA RDS") at 1% interest with a 30 year term. As of September 30,
1998, the Foundation had a portfolio of $958,296 of loans to thirteen borrowers,
with $338,750 undrawn and available for lending from the USDA RDS loan, and cash
available of $1,022,167 for relending from paid off loans and the Foundation's
initial equity capital.
<PAGE> 23
23
Non-Interest Expense
Non-interest expense decreased to $1,593,418 in the three months ended
September 30, 1998 from $1,760,795 for the three months ended September 30,
1997. The decrease was primarily the result of cost containment measures at the
Bank, which were only partially offset by profit sharing reflected as salary and
wage expense at Varsity Mortgage, and the expansion of business at Varsity
Mortgage, Varsity Funding and Midwest Loan Services.
Non-interest expense decreased to $4,984,673 in the nine months ended
September 30, 1998 from $5,510,778 for the nine months ended September 30, 1997.
The decrease was principally a result of the same factors as in the three month
periods discussed above.
Non-interest operating expense for only the parent company increased to
$37,020, for the three month 1998 period from $19,963 for the 1997 period.
Salary expense was higher in the 1998 period as a result of exploratory work on
the formation of a real estate investment trust. Non-interest operating expense
for only the parent company increased to $151,541 for the nine month 1998 period
to $126,898 for the 1997 period. Legal, audit, public listing and interest
expenses were lower in the 1998 period as a result of cost containment measures,
but were more than offset the increase in project related salary discussed
above.
Year 2000 Issue
The Year 2000 issue concerns the potential impact of computer software
code that only utilizes two digits to represent the calendar year (e.g. "98" for
"1998"). Software of this type, if not corrected, could produce inaccurate or
unpredictable results at any time, and especially after January 1, 2000, when
current and futures dates have a lower two digit year number than dates in this
century. The Company, similar to most financial services providers, is
significantly subject to the potential impact of the Year 2000 issue due, among
other matters, to the nature of financial information. Potential impacts to the
Company may arise from software, computer hardware, and other equipment both
within the Company's direct control and outside of the Company's ownership, yet
with which the Company electronically or operationally interfaces. Financial
institution regulators have intensively focused on Year 2000 exposures in the
institutions they regulate, issuing guidance concerning the responsibilities of
senior management and directors. Year 2000 testing and certification is being
addressed as a key safety and soundness issue in conjunction with regulatory
exams. The failure to implement an adequate Year 2000 program can be identified
as an unsafe and unsound banking practice.
In order to address the Year 2000 issue, the Bank has formed a Year
2000 coordination committee with key members of management from the Bank and
each operating subsidiary and appointed its Compliance Officer as Year 2000
Coordinator. The Bank and Midwest rely on mainframe computers, which are IBM A/S
400s. Although both A/S 400s are certified as Year 2000 compliant, management
decided to pursue an
<PAGE> 24
24
upgrade of the Bank's IBM A/S 400 mainframe memory in connection with the
upgrade to a Year 2000 compliant version of the Bank's main banking software
application from Peerless Group. Peerless Group has shipped to the Bank a Year
2000 compliant software update and has indicated that it will ship a testing
module as soon as the new A/S 400 is installed, which is anticipated shortly.
The Bank intends to perform the update procedure and testing in the fourth
quarter of 1998. The Bank's total budget for Year 2000 readiness is
approximately $93,000 (an increase of $40,000 from the previous estimate as a
result of the purchase of the upgraded A/S 400 discussed above), of which
approximately 50% was spent as of September 30, 1998, and with the bulk of the
remainder (upon delivery of the A/S 400) projected to be spent by year-end 1998.
The bulk of the Year 2000 budget is allocated to capital expenditures for
software updates and hardware upgrades.
Actual and budgeted Year 2000 readiness costs do not include the
implicit costs associated with the reallocation of internal staff hours to Year
2000 readiness related efforts. Budgeted costs also do not include normal
ongoing costs for computer hardware and software that would be replaced even
without the presence of the Year 2000 issue in conjunction with the Company's
ongoing programs for updating its infrastructure. The Year 2000 budget estimates
may change as the Company progresses in its Year 2000 program and obtains
additional information and conducts further testing regarding the Year 2000
readiness of third parties.
The Bank is currently scheduling testing with outside vendors and
expects to complete testing in early 1999. Renovation and testing is now
complete with respect to an upgraded Novell LAN system recently installed at the
Bank, and renovation and testing is nearly complete on all Bank PCs and PC-based
software. Additional network-based PC software will be installed and tested once
the upgraded A/S 400 has been installed.
Evaluation, renovation and testing of all PCs, software and the Novell
LAN system are complete at Varsity Mortgage and Varsity Funding, and their
systems are now believed to be Year 2000 compliant.
At Midwest Loan Services, its IBM A/S 400 mainframe computer is
certified to be Year 2000 compliant, and installation of upgraded LSMAS
servicing software is scheduled for later this year, with testing anticipated to
be completed shortly thereafter. All PC systems and PC software have been
evaluated and tested and the bulk are now believed to be Year 2000 compliant.
Some non-compliant PC systems will be replaced around year-end 1998. Testing of
the PCs that are scheduled to be replaced will occur shortly thereafter.
The Company has communicated and will continue to communicate with
various significant suppliers and major borrowers and customers to determine the
extent to which the Company is vulnerable to those third parties' failure to
remediate their own Year 2000 issues. The Company is requesting that such third
party vendors indicate whether their products and services are Year 2000
compliant and whether they have a program to test for that compliance. However,
the activities of third
<PAGE> 25
25
parties in responding to the Year 2000 issue is beyond the control of the
Company.
Despite the Company's activities to address the Year 2000 issue, there
is no assurance that certain mission critical vendors such as the Federal
Reserve Bank, the Bank's ATM processor, and local power and phone utilities will
be Year 2000 compliant by year-end 1999, and if they are not this could have a
material adverse effect on the Company's operations, and the Company's borrowers
and customers. There can also be no assurance that partial or total systems
interruptions or the costs necessary to implement contingency plans, or Year
2000 systems failures affecting borrowers, customers or third party vendors
would not have a material adverse effect on the Company's operations and
business prospects. The Company cannot estimate the additional cost, if any, of
implementing any such contingency plan.
The Bank has evaluated the Year 2000 readiness of its major borrowers
and determined that it has a below average risk (relative to its peer group)
from Year 2000 related potential loan losses, due to its primary focus on real
estate secured lending. All business loans and loan renewals by the Bank are
being evaluated in the context of the Year 2000 readiness of each business.
However, it is impossible for the Company to know with any certainty that the
Bank or its subsidiaries will not sustain Year 2000 related credit losses, and
whether or not such credit losses would be material.
The Bank and its subsidiaries have established back-up contingency
plans to continue operations in the event of a Year 2000 systems failure, based
on the assumption that all mission critical computer systems can be certified
and tested as being Year 2000 compliant in the next several months. Alternative
software and hardware vendors will be utilized in the event that this cannot be
accomplished. In addition, a final contingency plan has been established to
conduct manual operations using paper forms until such time as a systems failure
can be corrected. Management believes that as a temporary measure, it is
feasible with the volume of current activity to continue operations in this
manner, but there is no assurance that it is possible or what that the cost
would not be material.
LIQUIDITY AND CAPITAL RESOURCES
Capital Resources. The table on the following page sets forth the
Bank's risk based assets, and the capital ratios and risk based capital ratios
of the Bank. At September 30, 1998, the Bank was well capitalized (the required
ratio for "well capitalized" was 5% of total assets (Leverage), 6% (Tier 1) of
risk-based assets, and 10% (Tier 1 and 2) of risk-based assets).
<PAGE> 26
26
University Bank
Risk Adjusted Assets & Risk Adjusted Capital Ratio
September 30, 1998
<TABLE>
<CAPTION>
Balance Risk Weighted
Sheet (000) Assets (000)
<S> <C> <C>
0% RISK CATEGORY
Mort-Backed Sec Guaran by GNMA 2 -
Currency & Coin 202 -
US Treasury Strip 453 -
Federal Reserve Balance 26 -
-----------------------------
TOTAL 683 -
20% RISK CATEGORY
Interest-bearing Balances 82 16
Fed Funds Sold 3,546 709
U.S. Gov't sponsored Agency Sec 2,640 528
Other Mortgage-Back Securities - -
Cash Items 551 110
FHLB Stock 848 170
Balances due from depository Inst 263 53
-----------------------------
TOTAL 7,930 1,586
50% RISK CATEGORY
Qualifying 1st liens on 1-4 family 21,504 10,752
-----------------------------
TOTAL 21,504 10,752
100% RISK CATEGORY
ALL OTHER ASSETS 20,951 20,951
ON BALANCE SHEET ITEMS EXCLUDED FROM CALCULATION 113
TOTAL ASSETS 51,181 33,289
=============================
<CAPTION>
TIER 1 CAPITAL Balance
Common Stock 200
Surplus 4,262
Undivided Profits & Capital Reserves (451)
Minority Interest 201
Other identifiable Intangible Assets -
TOTAL TIER 1 CAPITAL 4,212
TIER 2 CAPITAL
Allowance for loans & Lease losses 388
Excess LLR (limited to
1.25% gross risk-weighted assets -
TOTAL TIER 2 CAPITAL 388
TOTAL TIER 1 & TIER 2 CAPITAL 4,600
TIER 1/TOTAL ASSETS 8.23%
TIER 1 & 2/TOTAL ASSETS 8.99%
TIER 1/TOTAL RISK-WEIGHTED ASSETS 12.65%
TIER 1 & 2/TOTAL RISK-WEIGHTED ASSETS 13.82%
</TABLE>
<PAGE> 27
27
Bank Liquidity. The Bank's primary sources of liquidity are customer
deposits, scheduled amortization and prepayments of loan principal, cash flow
from operations, maturities of various investments, the sale of loans held for
sale, and borrowings from correspondent lenders secured by securities and/or
residential mortgage loans. In addition, the Bank invests in overnight Federal
Funds. At September 30, 1998, the Bank had cash and due from banks and fed funds
on hand of $4,669,262. The Bank has an unused $5,000,000 line of credit secured
by investment securities and portfolio residential mortgage loans and a line of
credit from a correspondent secured by mortgage loans for sale to the secondary
market. In order to bolster liquidity, the Bank has also sold brokered CDs from
time to time.
Parent Company Liquidity. At year-end 1997, University Bancorp, Inc.
held cash and marketable equity securities of $123,180. This decreased by
$69,730 to $53,450 at September 30, 1998. The decrease in cash and marketable
equity securities was due to the amortization of the Company's indebtedness,
which was only partially offset by the realization of capital gains on the
securities available for sale.
During the nine months ended September 30, 1998 no dividends were paid
from the Bank, as a result of low profitability at the Bank. Dividends from the
Company's bank subsidiary together with earnings from the cash and marketable
equity securities held by the parent company are the principal sources of cash
used to fund the parent company's indebtedness owing to North Country Bank &
Trust ("NCB&T"), which amounted to $856,688 at September 30, 1998 and $922,688
at December 31, 1997. The NCB&T note calls for fully amortizing principal
payments of $33,000 per quarter through maturity in 2004. Management believes
that the cash and securities on hand and the Company's remaining investment in
Michigan BIDCO convertible bonds are currently sufficient to cover expected
required principal reductions during 1998 and early 1999 on the holding
company's loan.
Impact of Inflation
The primary impact of inflation on the Company's operations is
reflected in increased operating costs. Since the assets and liabilities of the
Company are primarily monetary in nature, changes in interest rates have a more
significant impact on the Company's performance than the general effects of
inflation. However, to the extent that inflation affects interest rates, it also
affects the net income of the Company.
<PAGE> 28
28
Falling long term and short term interest rates tend to decrease the
value of the Bank's and Midwest Loan Services' investment in mortgage servicing
rights and decrease the Bank's and Midwest Loan Services' current return on such
rights by increasing required amortization rates on the rights. Falling long and
short term interest rates also decrease origination activity at Varsity Funding
as residential lenders focus on refinancing activity rather than borrowers who
need alternative sources of funding outside of traditional secondary market
loans. However, falling interest rates tend to increase new mortgage origination
activity, positively impacting current income from the Bank's retail mortgage
banking operations and Varsity Mortgage's operations. Falling interest rates
also increase Midwest Loan Services' rate of growth, but decrease the duration
of its existing subservicing contracts. Lastly, falling long term interest rates
would tend to increase the value of certain securities owned by the Bank
intended as market value hedges for the Company's portfolio of mortgage
servicing rights. The table on the following page details the Bank's
asset/liability sensitivity as of September 30, 1998.
PART II OTHER INFORMATION
Item 1. Legal Proceedings
There are no material pending legal proceedings to which the Company or
any of its subsidiaries is party or to which any of their properties are
subject.
Item 2. Changes in Securities
During June 1998 an aggregate of 16,445 shares of common stock, par
value $0.01 per share of the Company were issued to the Company's
non-contributory Employee Stock Ownership Plan. The Company charged to
non-interest expense, salaries and benefits, the fair market value of the shares
contributed, $53,445.
Item 5. Other Information
Annual Meeting Shareholder Proposals
Under SEC Rule 14a-4(c)(1), if a proposal is to be submitted for a vote
at the Company's next annual meeting of stockholders and the proposal is not
submitted for inclusion in the Company's proxy statement and proxy card in
compliance with the processes of SEC Rule 14a-8, then, if the Company does not
have notice of the proposal at least 45 days before the date on which the
Company first mailed its proxy materials for the prior year's annual meeting (or
any earlier or later date specified in any overriding advance notice provision
in the Company's certificate of incorporation or by-laws), proxies solicited by
the Company may confer discretionary authority to vote on the proposal.
Therefore, the date after which a notice of a proposal submitted outside the
processes of Rule 14a-8 will be considered untimely with respect to the
Company's 1999 annual meeting of
<PAGE> 29
29
stockholders is March 1, 1999.
Parent Company Condensed Financial Information
Certain condensed financial information with respect to
University Bancorp, Inc. follows:
<PAGE> 30
UNIVERSITY BANK 30
Asset/Liability Position Analysis 09/30/98
($ in 000's)
Maturing or Repricing in
<TABLE>
<CAPTION>
3 Mos 91 Days to 1 - 5 Over 5 ALL
ASSETS or Less 1 Year Years Years OTHERS TOTAL
------ ------- ------ ----- ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Fed Funds 3,546 0 0 0 0 3,546
Loans (1) 2,447 3,634 7,011 2,471 0 15,563
Canadian Investments 0 0 0 0 0 0
Securities Available for Sale 959 0 2 2,974 0 3,935
Securities held for Sale 0 0 0 0 0 0
Loans held for Sale 11,455 0 0 0 0 11,455
Matured Loans 527 0 0 0 0 527
Variable Rate Loans 8,149 0 0 0 0 8,149
Other Assets 1,089 0 0 3,336 0 4,425
Fixed Assets 37 110 275 1,054 0 1,476
Cash and Due from Banks 0 0 0 1,074 0 1,074
Overdrafts 2 0 0 0 0 2
Non-Accrual Loans 0 0 0 323 0 323
Discount FHA Title 1 0 0 0 0 0 0
Valuation Adjustment 0 0 0 0 0 0
------ ----- ----- ------ ---- ------
TOTAL ASSETS 28,211 3,744 7,288 11,232 0 50,475
LIABILITIES
CD's over $100,000 1,140 8,405 986 0 0 10,531
CD's under $100,000 2,457 4,921 3,040 57 0 10,475
MMDA 13,413 0 0 0 0 13,413
NOW 3,032 0 0 0 0 3,032
Demand 127 0 0 1,698 0 1,825
Savings 0 160 0 0 0 160
Canadian Savings 0 0 0 0 0 0
Other Liabilities 0 826 825 363 0 2,014
Drafts Payable 5,010 0 0 0 0 5,010
Borrowings 0 0 0 0 0 0
Equity 0 0 0 4,015 0 4,015
------ ------ ----- ----- ---- ------
TOTAL LIABILITIES 25,179 14,312 4,851 6,133 0 50,475
GAP 3,032 (10,568) 2,437 5,099 0 0
CUMULATIVE
GAP 3,032 (7,536) (5,099) 0 0
GAP
PERCENTAGE 6.01% -14.93% -10.10% 0.00% 0.00%
</TABLE>
Notes:
(1) Net of bad debt reserves.
<PAGE> 31
UNIVERSITY BANCORP, INC. (The Parent) 31
Condensed Balance Sheets
September 30, 1998 and December 31,1997
(Unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
---------------- ----------------
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 27,342 $ 41,676
Securities available for sale 25,845 81,504
Michigan BIDCO senior debentures 114,223 200,916
Investment in subsidiary Bank 4,014,892 3,958,927
Other Assets 102,223 879,328
--------- -----------
Total Assets $4,284,525 $5,162,351
========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Note payable $ 856,688 $ 922,688
Accounts payable and other liabilities 23,211 841,219
---------- -----------
Total Liabilities 879,899 1,763,907
Stockholders Equity 3,404,626 3,398,444
---------- -----------
Total Liabilities and Stockholders Equity $4,284,525 $5,162,351
========== ===========
</TABLE>
<PAGE> 32
UNIVERSITY BANCORP, INC. AND SUBSIDIARIES 32
Condensed Statements of Operations and Comprehensive Income
For the Periods Ended September 30, 1998, 1997
(Unaudited)
<TABLE>
<CAPTION>
For Three Month For Three Month For Nine Month For Nine Month
Period Ended Period Ended Period Ended Period Ended
1998 1997 1998 1997
---------------- ---------------- ---------------- ---------------
<S> <C> <C> <C> <C>
Income:
Dividends from subsidiary - $ - - $ -
Securities Gain 13,481 - 86,038 41,155
Other $ 61,874 4,671 $ 79,619 15,973
---------------- ---------------- ---------------- ---------------
Total Income 75,355 4,671 165,657 57,128
Expense:
Interest 19,973 23,397 62,917 70,132
Public Listing Expense 3,505 10,215 21,181 53,120
Salary & Benefits 24,442 1,045 78,107 37,367
Legal/Accounting 8,016 6,594 14,689 38,848
Other 1,059 2,110 12,921 22,206
---------------- ---------------- ---------------- ---------------
Total Expense 56,995 43,361 189,815 221,673
Income (loss) before federal income taxes
(benefit) and equity in undistributed
net income (loss) of subsidiaries 18,360 (38,690) (24,158) (164,545)
Federal income taxes (benefit) 0 (26,885) 0 (48,567)
---------------- ---------------- ---------------- ---------------
Income (loss) before equity in
undistributed net income of subsidiaries 18,360 (11,805) (24,158) (115,978)
Equity in undistributed net income (loss)
of subsidiaries. (133,731) (174,800) 39,960 (272,506)
---------------- ---------------- ---------------- ---------------
Net Income $ (115,371) $ (186,605) $ 15,802 $ (388,484)
================ ================ ================ ===============
Comprehensive Income $ (117,282) $ (198,200) $ (9,839) $ (374,063)
================ ================ ================ ===============
Net Income per Common Share
Basic $ (0.06) $ (0.09) $ 0.01 $ (0.20)
================ ================ ================ ===============
Diluted $ NA $ NA $ 0.01 $ NA
================ ================ ================ ===============
</TABLE>
<PAGE> 33
UNIVERSITY BANCORP, INC. (The Parent) 33
Condensed Statement of Cash Flows
For the Three Month Periods Ended September 30, 1998 and 1997
<TABLE>
<CAPTION>
1998 1997
--------------- ---------------
<S> <C> <C>
Reconciliation of net income (loss) to net cash used in
operating activities:
Net Income (Loss) $ 15,801 $ (388,485)
Loss(gain) on sale of investments (86,038) 0
Decrease/(increase) in receivable from affiliate 21,300 675,465
Decrease/(increase) in Other Assets 0 (692,924)
Increase(Decrease) in interest payable (47,361) 5,175
Increase(Decrease) in other liabilities (19,179) (121,454)
Decrease(Increase) investment in subsidiaries (39,960) (81,924)
--------------- ---------------
Net cash provided by (used in) operating activities (155,437) (604,147)
--------------- ---------------
Cash flow from investing activities:
Subsidiary dividends received 0 0
Contributions of capital to subsidiary 0 0
Advances to Michigan BIDCO 0 0
Purchase of available for sale securities (25,845) 0
Proceeds from sale of available for sale securities 216,927 54,372
--------------- ---------------
Net cash provided by (used in) investing activities 191,082 54,372
--------------- ---------------
Cash flow from financing activities:
Principal payment on notes payable (66,000) (37,500)
Proceeds from sale of common stock 53,445 554,543
Purchase of treasury stock (37,424) 0
--------------- ---------------
Net cash provided by (used in) financing activities (49,979) 517,043
--------------- ---------------
Net changes in cash and cash equivalents (14,334) (32,732)
Cash and cash equivalents:
Beginning of year 41,676 41,113
--------------- ---------------
End of period $ 27,342 $ 8,381
=============== ===============
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest $ 54,318 $ 18,726
</TABLE>
<PAGE> 34
34
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
11. Computation of Per Share Earnings.
27. Financial Data Schedule.
(b) Reports on Form 8-K.
No reports on Form 8-K have been filed during the quarter for
which this report is filed.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
UNIVERSITY BANCORP, INC.
Date: November 13, 1998 /s/ Donald F. Rositano
-------------------------
Donald F. Rositano
Chief Financial Officer
(On behalf of the registrant
and as
Principal Financial Officer)
<PAGE> 35
35
Exhibit Index
------------- Sequentially
Numbered
Page
------------
11. Computation of per share earnings 36
27. Financial Data Schedule 37
<PAGE> 1
36
Exhibit 11. Reconciliation of Basic and Diluted Earnings Per Share
<TABLE>
<CAPTION>
FOR THREE MONTHS ENDED SEPT 30, FOR NINE MONTHS ENDED SEPT 30,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
EARNINGS PER SHARE
Net Income available to common shareholders (115,371) (186,605) 15,802 (388,484)
============== ============== ============== ============
Weighted average common shares outstanding 1,974,703 1,966,892 1,980,758 1,902,072
============== ============== ============== ============
EARNINGS PER SHARE $ (0.06) $ (0.09) $ 0.01 $ (0.20)
============== ============== ============== ============
EARNINGS PER SHARE ASSUMING DILUTION
Net Income available to common shareholders NA NA 15,802 NA
============== ============== ============== ============
Weighted average common shares outstanding NA NA 1,980,758 NA
============== ============== ============
Add: dilutive effects of assumed exercises:
Incentive Stock Options NA NA 2,188 NA
============== ============== ============== ============
Weighted average common and dilutive potential common
shares outstanding NA NA 1,982,946 NA
============== ============== ============== ============
EARNINGS PER SHARE ASSUMING DILUTION NA NA $ 0.01 NA
============== ============== ============== ============
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 1,041,630
<INT-BEARING-DEPOSITS> 81,875
<FED-FUNDS-SOLD> 3,545,757
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 3,974,581
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 36,406,966
<ALLOWANCE> (409,241)
<TOTAL-ASSETS> 50,923,433
<DEPOSITS> 39,250,583
<SHORT-TERM> 0
<LIABILITIES-OTHER> 6,548,944
<LONG-TERM> 1,546,435
13,919
0
<COMMON> 0
<OTHER-SE> 3,390,708
<TOTAL-LIABILITIES-AND-EQUITY> 50,923,433
<INTEREST-LOAN> 2,848,881
<INTEREST-INVEST> 102,184
<INTEREST-OTHER> 92,915
<INTEREST-TOTAL> 2,951,065
<INTEREST-DEPOSIT> 1,663,437
<INTEREST-EXPENSE> 1,791,727
<INTEREST-INCOME-NET> 1,159,338
<LOAN-LOSSES> 95,933
<SECURITIES-GAINS> 86,038
<EXPENSE-OTHER> 4,984,673
<INCOME-PRETAX> (84,890)
<INCOME-PRE-EXTRAORDINARY> (84,890)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 15,802
<EPS-PRIMARY> 0.01
<EPS-DILUTED> 0.01
<YIELD-ACTUAL> 3.57
<LOANS-NON> 0
<LOANS-PAST> 526,568
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 458,024
<ALLOWANCE-OPEN> 520,953
<CHARGE-OFFS> 231,892
<RECOVERIES> 24,247
<ALLOWANCE-CLOSE> 409,241
<ALLOWANCE-DOMESTIC> 409,241
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 10,133
</TABLE>
