<PAGE> 1
UNITED STATES
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 the fiscal year ended December 31, 1999
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 or other jurisdiction of (I.R.S. Employer incorporation)
Identification No.
959 Maiden Lane, Ann Arbor, Michigan 48105
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (734) 741-5858
Securities registered pursuant to section 12(b) of the Act: NONE
Securities registered pursuant to section 12(g) of the Act:
Common Stock, par value $.010 per share
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 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 other information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates
of the Registrant based on the average bid and asked price for the Registrant's
Common Stock on March 17, 2000, as reported by NASDAQ, was approximately
$917,481.*
The number of shares outstanding of the Registrant's Common Stock as of
March 17, 2000: 2,012,801 shares.
* For purposes of this calculation shares of the Registrant held by directors
and officers of the Registrant and officers of its subsidiaries and other
affiliates have been excluded.
Documents Incorporated by Reference: Portions of the registrant's Proxy
Statement, to be filed by April 29, 2000 for the 2000 Annual Meeting of
Stockholders, are incorporated by reference into Part III of this Report.
page 1 of 97 pages
Exhibit index on sequentially numbered page 91
<PAGE> 2
PART I.
ITEM 1. - BUSINESS
OVERVIEW
University Bancorp
We own University Bank, a full service community bank serving Ann
Arbor, Michigan and the surrounding area, which also specializes in mortgage
loan servicing, and community development lending. Our bank operates from its
main office in Ann Arbor. In addition, our bank's mortgage subsidiary has a main
office, and a community development subsidiary also has a lending office. As of
December 31, 1999 we had total assets of $41.0 million, deposits of $32.1
million and shareholders' equity of $2.0 million.
Products and Services
We are a full service bank offering a wide range of commercial and
personal banking, investment and insurance services. Our services include
checking and savings accounts, certificates of deposit, money orders,
commercial, mortgage and consumer loans, credit cards, investment services and
insurance services.
Our specialized subsidiaries service mortgage loans for other financial
institutions and provide loans to growth companies which do not qualify for
traditional bank lending.
Market Area
Our market area for our community bank includes the cities of Ann Arbor
and Ypsilanti and the surrounding area in Washtenaw County, Michigan. This area
includes several growing communities and has a stable and diverse economic base.
Ann Arbor has a population of approximately 109,000, Ypsilanti has a population
of approximately 23,000 and Washtenaw County has a population of approximately
300,000. By far the largest employer in Ann Arbor is the University of Michigan,
and other major employers include the automotive supply, book publishing and
distribution and pharmaceutical industries, and state and local units of
government.
Our market area for our specialized subsidiaries varies. Our mortgage
loan servicing subsidiary provides services to financial institutions
nationwide. Our subsidiary which provide loans to growth companies which do not
qualify for traditional bank lending operates throughout Michigan.
Management
Our board of directors and management team represent a wide range of
business, community, banking and investment knowledge and experience. Many of
our management team have over 10 years of banking experience, and have
demonstrated a past track record of ability in attracting and retaining new
customer relationships while working for substantially larger organizations.
Most of our key management have significant equity or pay incentives tied to
performance of the business unit they manage on a daily basis.
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Strategy
Many bank customers are tired of dealing with the large nationwide
banks and are looking for something better. At University Bank we offer a
qualitatively different experience. We offer:
* Local Decision-Making
* Our Customers Receive Personal Service and Attention
* Competitive Pricing
* All Financial Services Products Available
* Low Fees
We believe that our personal service philosophy enhances our ability to
successfully compete in attracting individuals and small businesses. We actively
solicit retail customers and compete for deposits by offering customers personal
attention, professional service, fair interest rates and low fees. Our
experienced staff provides a superior level of personalized service, which
enables us to generate competitively priced loans and deposits, and to
cross-sell other quality financial services such as investments and insurance.
We utilize our own computers using software licensed from reliable
vendors to provide cost effective services to our customers. Where we do not
have the ability to provide cost effective services in-house, we have entered
into agreements with third-party service providers to provide products and
services using our brand name on the products. Examples of these products are
ATMs and credit cards. Sometimes, we sell products to our customers using the
brand name of a third-party service provider, when we cannot sell our own
product by law. Examples of these products are mutual funds, annuities, and
insurance products.
About Us
We incorporated in Delaware and own University Bank. University Bank
was organized as a Michigan Bank in 1908, and sold its operations in northern
Michigan in December 1994. In February 1996, we opened for business in Ann Arbor
where our bank now has its main office. In addition, our bank's mortgage
subsidiary has a main office, and a community development subsidiary also has a
lending office. University Bank's deposit accounts are insured by the Federal
Deposit Insurance Corporation to the extent permitted by law. Our main offices
are located at 959 Maiden Lane in the City of Ann Arbor, Michigan 48105, and our
telephone number is (734) 741-5858.
GENERAL BUSINESS DESCRIPTION
We are a Delaware corporation which operates as a bank holding company
for its wholly-owned subsidiary, University Bank. The Bank is a state chartered
community bank. The Bank was chartered by the state of Michigan in 1908 as began
business in 1890. The Bank changed its name from "The Newberry State Bank" to
its current name in July 1995 to more closely identify the name of the Bank with
its current place of business, Ann Arbor. Ann Arbor is a university town, the
home of the University of Michigan. The Bank's accounts are insured by the
Federal Deposit Insurance Corporation.
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University Bancorp, Inc. is essentially a holding company for the Bank.
We invest available cash resources in marketable equity and debt securities and
interest bearing deposits. At December 31, 1999 we had cash on deposit of
$15,834 and other investments at fair value of $73,630. We changed our name in
June 1996 from Newberry Bancorp, Inc., because we wanted to more closely
identify our name with the Bank.
University Bank is headquartered in the town of Ann Arbor, Michigan,
which is the largest city in Washtenaw County, just west of the Detroit
Metropolitan Statistical Area. On December 5, 1994 we sold the bank's offices,
assets and liabilities at its former main office in Newberry, Michigan and its
two branch offices in Sault Ste. Marie, Michigan. As a result, during 1995, we
relocated the Bank's main office to the former offices of its mortgage operation
in Sault Ste. Marie, Michigan. Sault Ste. Marie is the largest city in the
eastern Upper Peninsula of Michigan and the county seat of Chippewa County.
During 1995 we were primarily engaged in residential mortgage lending and
servicing operations, and the investment of deposits and other bank borrowings
in various investments, including investment securities issued by government
agencies and U.S. Treasury securities. On February 6, 1996, our Bank opened its
new Ann Arbor main office. During the fourth quarter of 1997, we closed the
Bank's Sault Ste. Marie office and centralized all of our banking operations in
Ann Arbor.
We conduct our banking business from the Bank's headquarters office in
Ann Arbor. Our primary market area is defined as the City of Ann Arbor and
surrounding areas in greater Washtenaw County.
Mortgage Banking. In October 1995, we established a new mortgage
banking subsidiary of the Bank, Varsity Funding, L.L.C. Varsity Funding
specialized in the purchase and origination of impaired credit, or subprime
quality, residential mortgages, for sale to non-U.S. government agency-backed
mortgage conduits. Varsity Funding's offices were located in Farmington Hills,
Michigan, which is located on the northwest side of the Detroit Metropolitan
Statistical Area. During early 1997, Varsity Funding also established a retail
residential mortgage operation through an office in Farmington Hills, Michigan.
The retail division was expanded to include an office in Columbus, Ohio in
January 1998. Varsity Funding discontinued its purchase of subprime mortgage
loans from correspondents in December 1998, as a result of upheavals in the
national secondary market for subprime quality residential mortgages. The
remaining retail operations were transferred to Varsity Mortgage at year-end
1998. The Columbus office was closed in early 1999, and in September 1999, the
retail division, then called MortgageQuest was sold to another retail mortgage
company. As a result of that sale, the Bank received a three year option to buy
that firm for a cash payment equal to that firm's shareholders equity as
calculated using Generally Accepted Accounting Principles and an additional
fixed payment in shares of our common stock.
In February 1996, we expanded the scope of Varsity Funding's operations
by establishing another subsidiary of the Bank, Varsity Mortgage, L.L.C. The
Varsity Mortgage mortgage banking operation purchases residential home loans
which generally qualify for sale to secondary market investors under the
underwriting criteria of the Federal Home Loan Mortgage
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Corporation and Federal National Mortgage Association from correspondents in
Michigan and in adjacent states. Loans purchased from correspondents or
originated internally by the Bank are then either pooled into mortgage-backed
securities and the securities are sold to investors or they are sold directly to
FHLMC or FNMA or other correspondents. While Varsity Mortgage earned us a total
of about $1,400,000 from February 1996 to March 1999, it was unprofitable in
1999. As a result we sold Varsity Mortgage in November 1999 to another bank in a
transaction that resulted in no additional gain or loss from the sale.
We generally sell on a continuous basis the servicing rights to the
loans originate for the secondary market, although our mortgage subservicing
subsidiary, Midwest Loan Services (see below) does retain servicing rights on
the loans it originates. In December 1998, the we sold the bulk of a small
portfolio of mortgage servicing rights owned by the Bank.
We also originate residential loans from the Bank's Ann Arbor office
and sell them to secondary mortgage correspondents including Varsity Mortgage.
Through the Bank's Sault Ste. Marie mortgage banking office, we previously
operated in similar fashion to Varsity Mortgage, by purchasing, from
correspondents in Michigan, or by originating, residential home loans which
generally qualify for sale to secondary market investors under the underwriting
criteria of the FHLMC and FNMA. In November 1996, we discontinued the Bank's
wholesale operation in Sault Ste. Marie and transferred all pooling and
packaging of residential loans to Varsity Mortgage. The Bank's Ann Arbor office
also originates residential mortgage loans which are retained for the Bank's
loan portfolio.
Mortgage Subservicing. In July 1995 we terminated the Bank's mortgage
servicing operation in Sault Ste. Marie by outsourcing our servicing operations
under a contract with Midwest Loan Services, Inc., of Houghton, Michigan. In
December 1995, we acquired 80% of the common stock of Midwest Loan Services and
Midwest Loan Services now operates as a 80% owned subsidiary of the Bank.
Midwest specializes in subservicing, for the account of credit unions, financial
institutions and mortgage brokers, of residential mortgage loans sold to FNMA,
FHLMC and other private residential mortgage conduits. We are seeking to sell
our shares in Midwest (see "Recent Events", on page 35).
Michigan BIDCO. In May 1993, we founded a BIDCO, which is a Business
and Industrial Development Company, called Michigan BIDCO, Inc. The BIDCO is
licensed by the Michigan Financial Institutions Bureau under the State of
Michigan BIDCO program. Michigan BIDCO invests in businesses in Michigan with
the objective of fostering job growth and economic development. We currently own
80.11% of the BIDCO. We hold 4.84% ourself, and the rest is held by the Bank.
Our ownership percentage of the BIDCO could drop to 26.59% if all of the BIDCO's
outstanding convertible bonds were converted to common stock. The BIDCO changed
its name to Michigan BIDCO, Inc. from Northern Michigan BIDCO, Inc. in late 1995
to reflect its strategic plan of seeking investment opportunities throughout the
entire state of Michigan. Originally, the BIDCO limited its investments to the
northern half of Michigan.
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Northern Michigan Foundation. In December 1995, the BIDCO donated
$225,000 to capitalize Northern Michigan Foundation, and in early 1996, donated
an additional $75,000 to the Foundation. The Foundation is an IRS-approved
501c(3) non-profit which is an intermediary lender to rural small businesses
under the U.S. Department of Agriculture's Intermediary Relending Program. The
Foundation was able to gain the right to borrow a total of up to $2,000,000 from
the U.S. RECDS at 1% interest with a 30 year term because the BIDCO donated the
$300,000. A portion of the BIDCO's overhead is reimbursed by the Foundation
under the terms of a management services contract. The BIDCO is paid a fee which
is currently $16,000 per month reflecting reimbursement for expenses incurred in
managing the Foundation. The BIDCO and the Foundation share administrative
staffs and offices, with the Foundation reimbursing the BIDCO for these
management services.
University Insurance & Investment Services. On December 31, 1996, we
established a new insurance and investment sales agency subsidiary of the Bank,
called, University Insurance & Investment Services, Inc., based in our Ann Arbor
main office. Our insurance agency is licensed by the State of Michigan to sell
insurance as agent for licensed insurance companies. The focus of the insurance
agency is life and healthcare insurance brokerage, and mutual fund and annuity
sales. On December 18, 1998, the agency acquired University Insurance Center,
Inc., a fully-licensed but inactive commercial insurance agency. University
Insurance Center, Inc. commenced business on February 25, 1999 and is a full
service property and casualty insurance agency offering insurance for homes,
autos, apartments and businesses.
EMPLOYEES
We employed 43 full-time persons at March 17, 2000:
Michigan BIDCO 3
Midwest Loan Services 14
University Bank, Ann Arbor 23
University Insurance & Investment 3
PROPERTIES
In May 1995, we purchased a building in Ann Arbor, Michigan for use as
the Bank's main office. Beginning October 1, 1995 we leased a portion of the
building to the University of Michigan. Currently 42% of the building is leased
for approx. $55,000, adjusted annually for inflation, plus a pro rata share of
the building's expenses. The lease is renewable each year.
In mid-1996, we leased a site which includes a registered historic
landmark building in Ann Arbor, at the corner where Washtenaw Avenue and Stadium
Boulevard merge. We also loaned a limited liability company, Tuomy, L.L.C.
(associated with non-affiliated third-parties), a sum sufficient to acquire the
site, and earned a 1/3 L.L.C. membership interest in the L.L.C. as additional
consideration for making the loan. We use the historic building as a multiple
ATM drive-through location, a BIDCO office and an off-site storage facility.
We lease an ATM location with an adjacent meeting room in Dexter,
Michigan under a three year lease.
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We lease the Bank's former loan office in Sault Ste. Marie to an
unrelated third-party. Management has listed the property with a local
commercial realtor for sale.
We lease an office in Farmington Hills, Michigan. About 80% of this
space is subleased to the new owner of Varsity Mortgage (see "Recent Events", on
page 35), and the Bank is attempting to sublease the balance.
Midwest Loan Services leases an office in Houghton, Michigan under a
year-to-year lease.
We believe that our office facilities are adequate to support the
anticipated level of future expansion of our business.
The following table sets forth certain information relating to real
estate owned and leased at December 31, 1999. We believe that the fair market
value of the real estate which we own exceeds its book value. Based upon a
recent appraisal and its assessment of current market conditions, we believe the
16-acre site where the former loan office is located has a fair market value
substantially more than its carrying cost of $266,079 as of December 31, 1999.
This property is carried as "other real estate owned" in our financial
statements as of December 31, 1999 since it is surplus to the Bank's
requirements.
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<TABLE>
<CAPTION>
Year Owned or
Office Location Opened Leased Cost
- --------------- -------- --------- ----
<S> <C> <C> <C>
Corporate Office,
Bank Main Office
959 Maiden Lane
Ann Arbor, MI 48105 1996 Owned $762,557
Former Loan Office
Easterday & I-75
Sault Ste. Marie, Michigan 1991 Owned $266,079
Tuomy ATM Drive-through
Washtenaw & Stadium
Ann Arbor, Michigan 1996 Leased (1) -
Dexter ATM & Meeting Room
Baker Road & Ann Arbor Road
Dexter, Michigan 1998 Leased -
Varsity Mortgage
33493 14 Mile Rd., Ste. 80
Farmington Hills, Michigan 1995 Leased (2) -
Midwest Loan Services
616 Sheldon Ave., Ste. 300
Houghton, Michigan 1991 Leased -
</TABLE>
(1) We own a 1/3 membership interest in the Limited Liability Company which owns
the site.
(2) About 80% of this space is subleased.
LINES OF BUSINESS
COMMUNITY BANKING, ANN ARBOR
We opened our Bank in Ann Arbor on February 6, 1996. Our retail savings
products and services include demand deposit and NOW interest-bearing checking
accounts, money market deposit accounts, regular savings accounts and term
deposit certificates ranging in maturity from three to three hundred months. We
also offer self-directed retirement accounts, free access to 24-Hour ATM
machines, telephone banking, VISA debit cards and Gold VISA accounts. In the
next 60 days we will offer a full internet banking package, including bill
payment and business cash management functions. We are also a member of
Mastercard, but currently are not offering a Mastercard product. We also offer
Canadian Dollar foreign exchange services. From time to time to raise liquidity,
we sell CDs through brokers.
Our community banking operation offers a range of traditional lending
products, including commercial small business loans, residential real estate
mortgage loans and home equity loans, commercial real estate mortgage loans,
consumer installment loans, and land development and construction loans.
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MORTGAGE BANKING
We became a seller/servicer of Federal Home Loan Mortgage Corporation
insured mortgages in late 1991 and began to originate FHLMC mortgages for sale
into the secondary market. In late 1994 we became a seller/servicer of Federal
National Mortgage Association insured mortgages and began to originate FNMA
mortgages for sale into the secondary market. We have been approved as a
seller/servicer of Government National Mortgage Association mortgages for many
years but only began using our license in 1999 to originate and sell these loans
without retaining the servicing rights.
With the exception of Midwest Loan Services, we are currently selling
the servicing right on all mortgages originated.
Please also refer to the discussion of the mortgage banking business in
ITEM 7. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, in the section entitled "Non-Interest Income and
Non-Interest Expense", under the heading Mortgage Banking for additional
information.
MORTGAGE SUBSERVICING
Mortgage servicing firms receive monthly payments from loan customers,
aggregate and account for these payments, and send the funds to mortgage-backed
securities holders, including pension funds and financial institutions. Mortgage
servicers also dun delinquent accounts and foreclose loans, if required.
Mortgage servicers receive a fixed monthly fee for performing this service. When
these services are performed for ourselves, it is called servicing. When these
services are performed for others, the activity is called subservicing. Our
80%-owned subsidiary, Midwest Loan Services, specializes in subservicing
residential mortgage loans sold to FNMA and FHLMC and other non-agency private
conduits for the account of credit unions, other financial institutions and
mortgage brokers. Midwest is regulated by FHLMC and FNMA.
Over the last three years, we sold the Bank's portfolio of mortgage
servicing rights to reduce our investment in this class of asset, while selling
all newly originated secondary market mortgage loans, servicing released. In the
third quarter of 1996, we sold 1/3 of the Bank's portfolio of accumulated
servicing rights for a gain of $256,840. In the third quarter of 1997, we sold
an additional 1/3 of the accumulated portfolio at cost. In December 1998 we sold
the final 1/3 of the portfolio for a loss of $121,224. In June 1999, a final
calculation of the early payoffs on the loans sold was calculated and a final
amount of $54,531 was charged against income.
During 1998, growth in loans serviced for third parties was offset by
payoffs due to record low interest rates, sales of servicing we owned and the
end of an agreement to subservice a portfolio of 900 loans that had been sold by
us last year under a one year subservicing agreement, so that the amount of
loans serviced by Midwest fell by approximately 19% during the year. Since we
have completed the Bank's plan of selling servicing rights,
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if Midwest Loan Services adds additional subservicing customers in the future,
there may be an increase in overall loans serviced. Previously, we were selling
servicing from the Bank's portfolio as Midwest gained additional customers. At
year-end 1998, 4,029 were serviced by Midwest Loan Services including 916 loans
that were serviced for the Bank or Midwest Loan Services' own account.
As of December 31, 1999, Midwest Loan Services serviced a total of
4,928 loans, an increase of 22% from the amount at December 31, 1998. Of the
total 661 loans were serviced for our own account. The loans subserviced
increased 37%, from 3,113 to 4,267. A total of 2,250 additional loans from three
financial institutions are currently under contract to be transferred, but there
is no assurance as to when or if they will actually be subserviced by Midwest.
INVESTMENT SECURITIES
We maintain surplus available funds in investments consisting of
short-term money market instruments, U.S. government bonds, U.S. federal agency
obligations, mortgage-backed securities backed by federal agency obligations and
obligations of local units of government. Our investments are managed by our
President, subject to the review and approval of the board of directors of each
firm. Our securities portfolio provides a source of liquidity to meet operating
needs. At December 31, 1999, our investments had a net unrealized loss of
approximately $584,897 versus a net unrealized loss of approximately $183,122 at
December 31, 1998 and $18,880 at December 31, 1997.
The following table discloses certain information regarding securities
we hold, the amortized cost of which exceeded more than 10% of stockholders'
equity as of December 31, 1999:
<TABLE>
<CAPTION>
Final Market Amortized
Issuer Coupon Yield Maturity Value Cost
- ------ ------ ----- -------- ----- ----------
<S> <C> <C> <C> <C> <C>
FHLBI equity (1) VAR 8.00% None 848,400 848,400
FNMA CMO93-205H (2) PO 4.15% 9/25/23 1,368,029 1,735,960
US Treasury Strip PO 5.33% 2/15/27 342,000 480,036
FHLMC Note (3) 6.60% 6.89% 4/20/09 461,000 490,195
Toll Road Invest (4) 0% 6.91% 2/15/10 453,120 503,240
</TABLE>
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(1) The rate varies quarterly. The Bank is required to maintain the investment
in Federal Home Loan Bank of Indianapolis common stock in an amount related
to the Bank's single family mortgage related assets and FHLBI advances.
Shares can be redeemed or sold at par value to the FHLBI as required from
time to time.
(2) This Principal Only strip has an expected average life of ten years.
(3) The note can be called at par on 4/20/2000.
(4) The bond is guaranteed by MBIA, which is rated AAA.
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MICHIGAN BIDCO
Michigan BIDCO, Inc., which was founded in May 1993, is licensed by the
Michigan Financial Institutions Bureau under the State of Michigan BIDCO Act. We
own 80.11% of the BIDCO. The BIDCO has $1,123,000 in convertible bonds
outstanding. We bought our 298 shares of the BIDCO for a total of $307,000 in
1993. In March 1999, the BIDCO repurchased 281 shares of its common stock and
some of its outstanding convertible bonds at a premium to book value of
$283,303, reducing shareholders' equity by that amount. The BIDCO had
shareholders' equity of $1,519,547 at December 31, 1999.
At the time of establishment, the BIDCO received $3,000,000 in
financing from the Michigan Strategic Fund. This investment was made in the form
of a ten year loan which carries concessionary terms allowing it to be converted
to a grant over time under certain circumstances. The BIDCO earns grants applied
against the $3,000,000 Michigan Strategic Fund financing if there is growth in
the sales and jobs of the businesses the BIDCO invests in. At the time of
establishment, Michigan BIDCO sold in installments $3,000,000 in 9% Senior
Convertible Bonds to match the State of Michigan's commitment. A total of
$1,850,000 of these bonds were repurchased by the BIDCO in April 1999, and we
converted $27,000 of our bonds into common stock at March 31, 1999 (see "Recent
Events", on page 35).
The financial statements of the BIDCO are presented using the
investment company method, and, accordingly, the BIDCO's Investments in stocks,
stock warrants, limited liability companies and loans are reported at fair
value. BIDCO typically invests in companies for which current market quotations
are not readily available; therefore we estimate the fair value of BIDCO
Investments on a quarterly basis and the board of directors approves the fair
value estimates. In deriving its estimates, we review the financial condition
and operating performance of the investee companies, as well as performance of
the company with its contractual arrangements with BIDCO. We then estimate the
fair value of BIDCO Investments by the use of operating cash flow multiples
applicable to a company's industry, discounted cash flow analyses, and other
valuation techniques. We believe the procedures used and assumptions made are
reasonable in the circumstances; however, the fair value estimates may differ
significantly from the values that would have been used had current market
quotations been available.
Our profit from our investment in the BIDCO was ($55,499), $128,219 and
$546,155 of income (loss) for the years ended December 31, 1997, 1998, and 1999
respectively. Our profit from our investment in the BIDCO during 1999 included a
charge of $13,427 from the BIDCO's acquisition of shares and convertible bonds
from its minority shareholders, and our paid in capital increased by an
additional amount of $196,989 as a result of the buy-out of those minority
shareholders of Michigan BIDCO on March 31, 1999 at a discount to current book
value.
Michigan BIDCO invests in businesses in Michigan with the objective of
fostering job growth and economic development. The BIDCO has, by general policy
of its board of directors, a loan to one borrower limit of $500,000. In order to
be able to make investments larger than this lending limit, Michigan BIDCO will
leverage its investment with loan guarantees from government agencies, the
guaranteed portion of which is sold in the form of
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<PAGE> 12
a participation, or if a government agency loan guarantee is unavailable, a
participation may be sold to one or more investors, including BIDCO management,
bondholders and directors. As of December 31, 1999, the BIDCO had made
twenty-eight investments, amounting to a total of $13,463,600 at original cost.
At December 31, 1999, Michigan BIDCO had total assets of $3,228,442.
Initially Michigan BIDCO made its investments in the form of both loans
and direct equity investments. Since 1996 the BIDCO has made no new direct
equity investments, but has focused on loans with warrants or participation
rights in the companies in which it invests. As a matter of policy, our Bank
restricts itself from investing or lending to a business that the BIDCO
finances, and related parties which co-invest with the BIDCO must do so on a
basis equal to or less favorable than the BIDCO. As of December 31, 1999,
investments, at original investment cost, have been made in the following types
of businesses:
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<TABLE>
<CAPTION>
Michigan BIDCO, investments:
Total Equity
Industry Investment Participation?
<S> <C> <C>
ABC-TV affiliate $ 1,472,000 repurchased
Adult foster care 40,000 no
Bridal shop 64,000 no
Cable TV 545,000 repurchased
Children's clothing manufacturer 200,000 repurchased
Commercial laundry 180,000 no
Environmental engineering 100,000 repurchased
Fishing supplies 50,000 no
Home health care 20,000 no
Hunting supplies 100,000 no
Industrial supply 85,000 no
Limited service hotels 738,600 yes
Manufacturing 200,000 no
Manufacturing 200,000 no
Manufacturing 200,000 no
Metal manufacturing 80,000 no
Paper converting 2,762,000 yes
Plastic injection molding 2,000,000 repurchased
Plastic mold manufacturing 25,000 no
Railcar parts manufacturing 125,000 no
Railroad boxcar leasing 1,500,000 no
Railroad 50,000 no
Recreational services 160,000 no
Recycled paper pulp mill 780,000 yes
Residential mortgage subservicing 450,000 repurchased
Secured credit card issuer 540,000 no
Tissue paper mill 700,000 repurchased
Truck maintenance 70,000 no
-----------
Total $13,463,600
===========
</TABLE>
Please refer to the discussion of the BIDCO's investments and
operations in Item 7. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS, in the section entitled "Non-Interest
Income and Non-Interest Expense", under the heading Michigan BIDCO for
additional information.
COMPETITION
COMMUNITY BANKING, ANN ARBOR
Our attraction and retention of deposits depend on the Bank's ability
to provide investment opportunities that satisfy the requirements of investors
with respect to rate of return, liquidity, risk and other factors. We compete
for these deposits by offering personal service and attention, fair and
competitive rates, low fees, and a variety of savings programs including
tax-deferred retirement programs.
We compete for loan originations primarily through the quality of
services we provide to the Bank's loan customers, competitive interest rates
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and reasonable loan fees, rapid and local decision-making and the range of
services we offer. Our competition in originating loans comes principally from
other commercial banks, credit unions, insurance companies, mortgage banking
companies and savings and loans.
The following table shows market share of deposits for Washtenaw County
by financial institution for June 1999, June 1998 and June 1997, from the FDIC's
1999 annual branch deposit survey and NCUA FOIA data:
WASHTENAW COUNTY FINANCIAL INSTITUTION DEPOSITS:
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Great Lakes Bancorp 17.8% 16.2% 18.9%
National City Bank 12.8% 14.4% 15.6%
Bank One 11.1% 9.5% 10.2%
Comerica Bank 10.7% 9.8% 10.1%
Key Bank 7.3% 7.1% 7.4%
Ann Arbor Commerce Bank 4.5% 3.6% 3.0%
Standard Federal FSB 4.2% 4.1% 4.8%
Flagstar Bank FSB 4.0% 1.9% 1.4%
University of Michigan CU 3.5% 2.9% 3.0%
Chelsea State Bank 3.3% 3.1% 3.3%
Citizens Bank 3.2% 3.3% 3.6%
Huron River Area CU 3.0% 2.5% 2.7%
Bank of Ann Arbor 2.8% 2.2% 1.2%
Michigan Natl Bank 2.5% 2.3% 2.5%
Republic Bank 2.3% 11.1% 5.9%
Midwest Financial CU 2.0% 1.7% 1.9%
Automotive FCU 1.4% 1.2% 1.3%
University Bank 0.9% 1.0% 1.1%
United Bank & Trust 0.9% 0.0% 0.0%
Charter One FSB 0.7% 0.6% 0.7%
5 Credit Unions, 2 Banks 1.2% 1.4% 1.3%
Total Deposits (billions) $3.865 $4.060 $ 3.604
</TABLE>
Total deposits in the county decreased 4.8% from June 1998 to June 1999
as a result of the transfer of Republic Bank's headquarters deposits from Ann
Arbor to Lansing. Total deposits in the county increased 7.2% from June 1997 to
June 1999 and 10.3% from June 1996 to June 1999. Total deposits in the county
increased 12.7% from June 1997 to June 1998, however, this increase also was
distorted by the relocation of Republic Bank's headquarter deposits from Okemos
to Ann Arbor. In attracting deposits, our primary competitors for deposits are
mutual funds, other commercial banks, credit unions, savings and loans and
insurance companies.
Our main office is adjacent to the University of Michigan Hospital
Complex. The Complex employs a total of 7,800 persons. In mid-February 1999, the
nearest competitor to the Bank's main office, a National City Bank branch, was
permanently closed. The other major competitor in the local deposit market is
Midwest Financial Credit Union, formerly known as Hospital & Health Services
Credit Union. Our main office was formerly the headquarters of this credit
union, which moved its office to a new office building three miles from the
Medical Center Complex.
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The Ann Arbor banking market is dominated by banks which are owned by
out-of-area holding companies. In the city of Ann Arbor, the University of
Michigan Credit Union is the largest locally-owned financial institution. The
only locally-owned community financial institutions, excluding University Bank,
are Huron River Area Credit Union, Midwest Financial Credit Union, Bank of Ann
Arbor, Automotive Federal Credit Union and several smaller credit unions.
MORTGAGE BANKING
Origination. We originate internally or via other financial
institutions residential home loans which generally qualify for sale to
secondary market investors under the underwriting criteria of the Federal Home
Loan Mortgage Corporation, the Federal National Mortgage Association and the
Government National Mortgage Association. Loans purchased or originated
internally are either sold directly to FHLMC, FNMA or GNMA, or are pooled into
mortgage-backed securities and the securities are sold to investors in the
secondary market. We also keep some residential mortgages for our loan portfolio
as an investment.
Our retail mortgage origination operations encounter competition for
the origination of residential real estate loans primarily from savings
institutions, commercial banks, insurance companies and other mortgage banking
firms. Many of these firms have a well established customer and/or borrower
client base. Some competitors, primarily savings institutions, insurance
companies and commercial banks, have the ability to create unique loan products
from time to time because they are able to close the loans for their own
portfolio rather than sell into the secondary market. Our ability to hold
mortgage loans for our portfolio helps us to compete more effectively. Most
loans sold into the secondary market, however, go to the same sources, those
being Federal National Mortgage Association, Federal Home Loan Mortgage
Corporation and Government National Mortgage Association guaranteed securities.
Most lenders have access to these secondary market sources; therefore,
competition often becomes more a matter of service and pricing than that of
product. As a mortgage loan originator and a purchaser of mortgage loans through
correspondents, we must be able to compete with respect to the types of loan
products offered by competitors to borrowers and correspondents, including the
price of the loan in terms of origination fees or fee premium or discount, loan
processing costs, interest rates, and the service provided by our staff. An
important element in our ability to compete is master purchase agreements
negotiated periodically with FNMA and FHLMC with low and competitive loan
guarantee fees, a wide variety of mortgage programs, and a variety of flexible
underwriting criteria. Our ability to secure these master purchase agreements is
dependent upon the performance from a quality perspective of loans previously
sold to the agencies.
During lower interest rate environments, competition for loans is less
intense due to the large number of loans available for origination. As interest
rates rise and the number of loans available for origination diminishes,
competition becomes quite intense and companies with larger investor bases,
flexibility with respect to type of product offered and
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<PAGE> 16
greater experience in dealing in these types of markets tend to be the most
successful.
We also originate residential loans to be held in portfolio, and
management believes that this product together with the product offerings which
FHLMC, FNMA and GNMA have are sufficient for our competitive needs. Although we
are currently licensed as a HUD Title 1 and Multifamily seller/servicer, we have
no plans at this time to expand our utilization of HUD or GNMA programs. We also
are correspondents for several impaired credit conduits and sell this type of
residential mortgage on a non-recourse, servicing released basis.
Mortgage Subservicing and Servicing. Servicing competition is somewhat
less intense than the loan origination aspect of mortgage banking. Due to net
worth and management requirements, many mortgage origination companies do not
have the capacity to service loans. Falling interest rates present competitive
challenges for the mortgage servicing operation in that mortgagors are more
likely to refinance existing mortgages. The quality of service and the ability
of the origination operation to compete on price and service is important in
retaining these customers by refinancing them internally, rather than losing the
refinancing transaction to a competitor. Increased refinancing activity as a
result of falling interest rates should decrease profitability of mortgage
servicing by increasing amortization charges on purchased mortgage servicing
rights.
In the subservicing business, Midwest Loan Services competes primarily
with about 30 firms nationwide, including specialized subservicing units of
mortgage banking companies, and specialized firms owned by banks and savings and
loans. Most of these companies have substantially larger financial resources
than Midwest Loan Services, and some of them are located in rural areas with low
prevailing wages.
Midwest Loan Services is located in Houghton, Michigan in the western
Upper Peninsula of Michigan. Personnel and occupancy costs are the largest costs
in a mortgage servicing operation, and the prevailing wages and occupancy costs
in the Upper Peninsula of Michigan are generally lower than the national
average. As a result, we believe that Midwest Loan Services' mortgage servicing
operation has a competitive advantage. We are in negotiations to sell our shares
in Midwest. See "Recent Events", on page 35.
MICHIGAN BIDCO AND NORTHERN MICHIGAN FOUNDATION
Michigan BIDCO seeks to invest in businesses located in Michigan. The
BIDCO's objective is to seek profit while fostering job growth and economic
development in its market area. BIDCO competes with other specialized lenders
and wealthy investors who make risk-oriented investments in businesses located
in Michigan. The BIDCO assumes more credit risk in a typical investment than
commercial banks generally are willing to assume when they make loans. The BIDCO
does not make an investment in a company unless it can be shown that the funds
are not available from a traditional bank lender; therefore, the BIDCO does not
compete with banks. There is only one other BIDCO in Northern Michigan and there
are six active BIDCOs in Lower Michigan and of which invest throughout Michigan.
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The BIDCO's staff manages under a management contract a 501(c)3
IRS-qualified non-profit relending company, Northern Michigan Foundation, which
has received the right to borrow $2,000,000 at 1% interest for 30-years from the
U.S. Department of Agriculture (USDA) Intermediate Relending Program. The
Foundation is one of three non-profit, privately-run, USDA Intermediate
Relending Programs located in Northern Michigan. Each of these community
development loan funds covers six counties as its primary market area.
Generally, the Foundation competes with other specialized non-bank lenders and
wealthy investors who make risk-oriented investments in businesses located in
northern Michigan.
Since year-end 1996, the BIDCO has pursued a strategy of liquidating
its existing investment portfolio to raise cash for two purposes: the buyout of
some of the original minority investors in the BIDCO, and options in expanding
its funds under management through other government agency economic development
programs:
- formation of a Small Business Investment Company
- expansion of the Foundation's funds under management
The BIDCO completed its planned buyout of the minority investors in March and
April 1999. The BIDCO continues to evaluate the feasibility of expanding its
funds under management via the two government sponsored lending programs.
REGULATION
We are extensively regulated under federal law and state laws. Federal
and state laws and regulations generally applicable to financial institutions
and their holding companies regulate, among other things:
- the scope of business;
- investments;
- reserves against deposits;
- capital levels relative to operations;
- lending activities and practices;
- the nature and amount of collateral for loans;
- the establishment of branches;
- mergers, acquisitions and consolidations;
- dividends;
- internal controls
These laws and regulations are primarily intended to protect depositors and the
deposit insurance fund of the Federal Deposit Insurance Corporation, not us or
our shareholders. The following is a summary of certain statutes and regulations
affecting us. The following information is qualified in its entirety by
reference to the particular statutory and regulatory provisions.
Any change in applicable laws, regulations or regulatory policies of
various governmental regulatory authorities may have a material effect on our
business, operations and prospects. Those authorities include, but are not
limited to, the Board of Governors of the Federal Reserve System, the FDIC, the
Commissioner of the Michigan Financial Institutions Bureau, the
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<PAGE> 18
Internal Revenue Service, and state taxing authorities. We are unable to predict
the nature or extent of the effects that fiscal or monetary policies, economic
controls or new federal or state legislation may have on our future business and
earnings.
UNIVERSITY BANCORP, INC.
General. We are a bank holding company registered under the Federal
Bank Holding Company Act of 1956. The Federal Reserve Bank of Chicago is our
primary regulator. We are also subject to regulation, supervision and
examination by the Federal Reserve. We are required to file semi-annual reports
with the Federal Reserve and other information as required under the rules of
the Board of Governors of the Federal Reserve System. Additionally, the Federal
Reserve Board possesses enforcement powers over bank holding companies and their
non-bank subsidiaries to prevent or remedy actions that represent unsafe or
unsound practices or violations of applicable statutes and regulations. Among
these powers is the ability to proscribe the payment of dividends by banks and
bank holding companies.
Acquisitions. We are generally prohibited from engaging in a nonbanking
activity because we are a bank holding company. We cannot acquire more than 5%
of the shares of a company engaged in nonbanking activities. We can only acquire
direct or indirect control of more than 5% of the voting shares of a company
engaged in a banking related activity with the prior approval by the Federal
Reserve Board to acquire these shares or by regulatory exemption. The Federal
Reserve Board has identified specific banking related activities in which a bank
holding company may engage with notice to the Federal Reserve. The Federal
Reserve considers managerial, capital, and other financial factors, including
the impact on local competition of any proposal and past performance under the
Community Reinvestment Act in acting on acquisition or merger application.
Effective September 29, 1995, bank holding companies may acquire banks
located in any state in the United States without regard to geographic
restrictions or reciprocity requirements imposed by state law, but subject to
certain conditions, including limitations on the aggregate amount of deposits
that may be held by the acquiring company and all of its insured depository
institution affiliates.
Commitments. In connection with obtaining the consent of the Federal
Reserve to a 1989 merger transaction when we gained our listing on the NASDAQ
Small-Cap Market, we made certain commitments to the Federal Reserve. We agreed
that our Employee Stock Ownership Plan would not purchase more than 10% of the
common stock or 5% of any other class of our voting shares, without the prior
approval of the Federal Reserve. We also agreed not to incur additional debt or
to have the Bank pay dividends to us without the prior approval of the Federal
Reserve.
Capital Requirements. The Federal Reserve Board imposes certain capital
requirements on us under the Federal Bank Holding Company Act, including a
minimum leverage ratio and a minimum ratio of "qualifying" capital to
risk-weighted assets. These requirements are described below under "Capital
Regulations". The Federal Reserve uses capital adequacy
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<PAGE> 19
guidelines in its examination and regulation of bank holding companies. If
capital falls below minimum guidelines, a bank holding company may, among other
things, be denied approval to acquire or establish additional banks or non-bank
businesses. The "prompt corrective action" provisions of federal law and
regulation authorizes the Federal Reserve to restrict the payment of dividends
to us from an insured bank which fails to meet specified capital levels.
Source of Strength. In accordance with Federal Reserve Board policy, we
are expected to act as a source of financial strength to the Bank and to commit
resources to support the Bank in circumstances in which we might not otherwise
do so. Under the Federal Bank Holding Company Act, the Federal Reserve may
require a bank holding company to terminate any activity or relinquish control
of a bank subsidiary if the agency determines that divestiture may aid the
depository institution's financial condition. In addition, if the Commissioner
deems our Bank's capital to be impaired, the Commissioner may require the Bank
to restore its capital by a special assessment upon us as University Bank's sole
shareholder. If we were to fail to pay any assessment, the directors of the Bank
would be required, under Michigan law, to sell the shares of the Bank's stock
owned by us to the highest bidder at either a public or private auction and use
the proceeds of the sale to restore the Bank's capital.
Recent Regulatory Developments. Effective March 11, 2000, bank holding
companies may apply to become Financial Holding Companies. Financial Holding
Companies may engage in a wider range of nonbanking activities than Bank Holding
Companies, including greater authority to engage in securities and insurance
activities. The expanded powers are available to a bank holding company only if
the bank holding company and its bank subsidiaries remain well-capitalized and
well-managed. The new law also imposes various restrictions on transactions
between the depository institution subsidiaries of bank holding companies and
their non-bank affiliates. These restrictions are intended to protect the
depository institutions from the risks of the new nonbanking activities
permitted to affiliates.
UNIVERSITY BANK
Primary Regulators. University Bank is a Michigan banking corporation
and its deposit accounts are insured by the Bank Insurance Fund (the "BIF") of
the FDIC. As a Michigan-chartered commercial bank, University Bank is subject to
the examination, supervision, reporting and enforcement requirements of the
Commissioner, as the chartering authority for Michigan banks, and the FDIC, as
administrator of the BIF. These agencies and the federal and state laws
applicable to the Bank and its operations, extensively regulate various aspects
of the banking business including, among other things, permissible types and
amounts of loans, investments and other activities, capital adequacy, branching,
interest rates on loans and on deposits, the maintenance of non-interest bearing
reserves on deposit accounts, and the safety and soundness of banking practices.
As an insured bank, University Bank is also required to file quarterly reports
and other information as required with the FDIC.
All subsidiaries of University Bank including Midwest Loan Services and
University Insurance & Investment Services are all also subject to all
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<PAGE> 20
regulations applicable to University Bank itself, including regular on-site
examination by both the FIB and the FDIC.
Other Regulators. As a FHLMC, FNMA, and HUD Title 1 and Title 2 and HUD
multifamily seller/servicer, University Bank's mortgage banking operation, and
its mortgage operation subsidiaries, including Midwest Loan Services and Varsity
Mortgage are subject to regulation and regular on-site examination by FHLMC,
FNMA and HUD. In addition, University Insurance & Investment Services are also
subject to examination by the State of Michigan's Financial Institutions Bureau,
Insurance Division, the National Association of Securities Dealers, and the
Securities & Exchange Commission.
Other Regulations. University Bank and its subsidiaries are also subject to
various regulations including:
* the Community Reinvestment Act;
* federal Truth-in-Lending Act;
* the Home Mortgage Disclosure Act of 1975;
* the Equal Credit Opportunity Act;
* the Fair Credit Reporting Act of 1978;
* the Fair Debt Collection Act;
* the federal Right to Privacy Act;
* the Real Estate Settlement Procedures Act;
* the Bank Secrecy Act;
* the Electronic Funds Transfer Act;
* all Federal Reserve regulations;
* state usury laws; and
* certain federal laws concerning interest rates.
Also, University Bank may not engage in any activity not authorized by the
Michigan Banking Code unless it is authorized by the Commissioner of the FIB as
being closely related to banking.
Deposit Insurance. As an FDIC-insured institution, the Bank is required to
pay deposit insurance premium assessments to the FDIC. The FDIC has adopted a
risk-based assessment system under which all insured depository institutions are
placed into one of nine categories and assessed insurance premiums, based upon
their respective levels of capital and results of supervisory evaluation.
Banks classified as well-capitalized, as defined by the FDIC, and
considered healthy pay the lowest premium while institutions that are less than
adequately capitalized, as defined by the FDIC, and considered of substantial
supervisory concern pay the highest premium. Risk classification of all insured
institutions is made by the FDIC for each semi-annual assessment period.
The Federal Deposit Insurance Act ("FDIA") requires the FDIC to establish
assessment rates at levels which will maintain the Deposit Insurance Fund at a
mandated reserve ratio of not less than 1.25% of estimated insured deposits.
Accordingly, the FDIC established the schedule of BIF insurance assessments for
the first semi-annual assessment period of 1999, ranging from 0% of deposits for
institutions in the lowest risk category to .27% of deposits for institutions in
the highest risk category.
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<PAGE> 21
The FDIC may terminate the deposit insurance of any insured depository
institution if the FDIC determines, after a hearing, that the institution or its
directors have engaged or are engaging in unsafe or unsound practices, or have
violated any applicable law, regulation, order, or any condition imposed in
writing by, or written agreement with, the FDIC, or if the institution is in an
unsafe or unsound condition to continue operations. The FDIC may also suspend
deposit insurance temporarily during the hearing process for a permanent
termination of insurance if the institution has no tangible capital.
Commissioner Assessments. Michigan banks are required to pay supervisory
fees to the Commissioner to fund the operations of the Commissioner. The amount
of supervisory fees paid by a bank is based upon the bank's total assets, as
reported to the Commissioner.
FICO Assessments. Pursuant to federal legislation enacted September 30,
1996, University Bank, as a member of the BIF, is subject to assessments to
cover the payments on outstanding obligations of the Financing Corporation
(FICO). FICO was created in 1987 to finance the recapitalization of the Federal
Savings and Loan Insurance Corporation, the predecessor to the FDIC's Savings
Association Insurance Fund (SAIF) which insures the deposits of thrift
institutions. Between January 1, 2000 and the maturity of the outstanding FICO
obligations in 2019, BIF members and SAIF members will share the cost of the
interest on the FICO bonds on a pro rata basis. It is estimated that FICO
assessments during this period will be less than 0.025% of deposits.
Capital Regulations. The FDIC has established the following minimum capital
standards for state-chartered, FDIC-insured non-member banks, like University
Bank:
* a leverage requirement consisting of a minimum ratio of Tier 1
capital to total assets of 3% for the most highly-rated banks with
minimum requirements of 4% to 5% for all others;
* and a risk-based capital requirement consisting of a minimum ratio
of total capital to total risk-weighted assets of 8%, at least
one-half of which must be Tier 1 capital.
Tier 1 capital consists principally of shareholders' equity. These capital
requirements are minimum requirements. Higher capital levels will be required if
warranted by the particular circumstances or risk profiles of individual
institutions. For example, FDIC regulations provide that higher capital may be
required to take adequate account of, among other things, interest rate risk and
the risks posed by concentrations of credit, nontraditional activities or
securities trading activities.
Federal law provides the federal banking regulators with broad power to
take prompt corrective action to resolve the problems of undercapitalized
institutions. Depending upon the capital category to which an institution is
assigned, the regulators' corrective powers include: requiring the submission of
a capital restoration plan; placing limits on asset growth and restrictions on
activities; requiring the institution to issue additional capital stock,
including additional voting stock, or to be acquired; restricting transactions
with affiliates; restricting the interest rate the
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institution may pay on deposits; ordering a new election of directors of the
institution; requiring that senior executive officers or directors be dismissed;
prohibiting the institution from accepting deposits from correspondent banks;
requiring the institution to divest certain subsidiaries; prohibiting the
payment of principal or interest on subordinated debt; and ultimately,
appointing a receiver for the institution.
In general, a depository institution may be reclassified to a lower
category than is indicated by its capital levels if the appropriate federal
depository institution regulatory agency determines the institution to be
otherwise in an unsafe or unsound condition or to be engaged in an unsafe or
unsound practice. This could include a failure by the institution, following
receipt of a less-than-satisfactory rating on its most recent examination
report, to correct the deficiency.
The extent of the regulators' powers depends on whether the institution in
question is "well capitalized," "adequately capitalized," "undercapitalized,"
"significantly undercapitalized," or "critically undercapitalized." An
institution is critically undercapitalized if it has a tangible equity to total
assets ratio that is equal to or less than 2%. An institution is well
capitalized if it has a total risk-based capital ratio of 10% or greater, core
risk-based capital of 6% or greater, and a leverage ratio of 5% or greater, and
the institution is not subject to an order, written agreement, capital
directive, or prompt corrective action directive to meet and maintain a specific
capital level for any capital measure. An institution is adequately capitalized
if it has a total risk-based capital ratio of not less than 8%, a core
risk-based capital of not less than 4%, and a leverage ratio of not less than
4%. Under these regulations, as of December 31, 1998 and December 31, 1999
University Bank was well capitalized.
These capital guidelines can affect us in several ways. Our capital levels
are currently adequate. However, rapid growth, poor loan portfolio performance,
or poor earnings performance, or a combination of these factors, could change
our capital position in a relatively short period of time, making an additional
capital infusion necessary. In general, if the FDIC's assessment of a Bank's
financial and managerial strength changes negatively, the Bank's cost of FDIC
insurance will rise in subsequent semi-annual periods. A financial institution
may also be ordered to restrict its growth, dispose of certain assets, rescind
agreements or contracts, or take other actions as determined by the ordering
agency to be appropriate.
Dividends. Under Michigan law, the Bank is restricted as to the maximum
amount of dividends it may pay on its common stock. The Bank may not pay
dividends except out of net profits after deducting its losses and bad debts.
The Bank may not declare or pay a dividend unless the bank will have a surplus
amounting to at least 20% of its capital after the payment of the dividend. If
the Bank has a surplus less than the amount of its capital, it may not declare
or pay any dividend until an amount equal to at least 10% of net profits for the
preceding one-half year (in the case of quarterly or semi-annual dividends) or
full-year (in the case of annual dividends) has been transferred to surplus. The
Bank may not declare or pay any dividend until the cumulative dividends on
preferred stock, should any
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preferred stock be issued and outstanding, have been paid in full. The Bank's
articles of incorporation do not authorize the issuance of preferred stock and
there are no current plans to seek this authorization.
Federal law generally prohibits the Bank from making any capital
distribution, including payment of a dividend, or paying any management fee to
us if the Bank would thereafter be undercapitalized. The FDIC may prevent the
Bank from paying dividends if the Bank is in default of payment of any
assessment due to the FDIC. In addition, the FDIC may prohibit the payment of
dividends by the Bank, if a payment is determined, by reason of the financial
condition of the Bank, to be an unsafe and unsound banking practice.
Insider Transactions. The Bank is subject to certain restrictions imposed
by the Federal Reserve Act including:
* any extensions of credit to us;
* investments in our stock or other securities;
* the acceptance of our stock as collateral for loans.
Certain limitations and reporting requirements are also placed on extensions of
credit by the Bank to its directors and officers, to our directors and officers,
to our principal shareholders, and to "related interests" of the directors,
officers and principal shareholders. In addition, federal law and regulations
may affect the terms upon which any person becoming one of our directors or
officers or one of our principal shareholders may obtain credit from banks with
which the Bank maintains a correspondent relationship.
Safety and Soundness Standards. The federal banking agencies have adopted
guidelines to promote the safety and soundness of federally insured depository
institutions. These guidelines establish standards for:
* internal controls;
* information systems;
* internal audit systems;
* loan documentation;
* credit underwriting;
* interest rate exposure;
* asset growth;
* compensation;
* fees and benefits;
* asset quality; and
* earnings.
In general, the guidelines prescribe the goals to be achieved in each area, and
each institution is responsible for establishing its own procedures to achieve
those goals. If an institution fails to comply with any of the standards set
forth in the guidelines, the institution's primary federal regulator may require
the institution to submit a plan for achieving and maintaining compliance. The
preamble to the guidelines states that the agencies expect to require a
compliance plan from an institution whose failure to meet one or more of the
standards is of the severity that it could threaten the safe and sound operation
of the institution. Failure to submit an acceptable compliance plan, or failure
to adhere to a compliance plan that has been accepted by the appropriate
regulator, would constitute grounds for further enforcement action.
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<PAGE> 24
State Bank Activities. Under federal law and FDIC regulations, FDIC-insured
state banks are prohibited, subject to certain exceptions, from making or
retaining equity investments of a type, or in an amount, that are not
permissible for a national bank. Federal law, as implemented by FDIC
regulations, also prohibits FDIC-insured state banks and their subsidiaries,
subject to certain exceptions, from engaging as principal in any activity that
is not permitted for a national bank or its subsidiary, respectively, unless the
bank meets, and continues to meet, its minimum regulatory capital requirements
and the FDIC determines the activity would not pose a significant risk to the
deposit insurance fund of which the bank is a member. Impermissible investments
and activities must be divested or discontinued within certain time frames set
by the FDIC in accordance with federal law.
Consumer Protection Laws. The Bank's business includes making a variety of
types of loans to individuals. In making these loans, the Bank is subject to
State usury and regulatory laws and to various federal statutes, including:
* the Equal Credit Opportunity Act;
* the Fair Credit Reporting Act;
* the Truth in Lending Act;
* the Real Estate Settlement Procedures Act; and
* the Home Mortgage Disclosure Act,
and the regulations flowing from these laws which prohibit discrimination,
specify disclosures to be made to borrowers regarding credit and settlement
costs, and regulate the mortgage loan servicing activities of the Bank,
including the maintenance and operation of escrow accounts and the transfer of
mortgage loan servicing. In receiving deposits, the Bank is subject to extensive
regulation under State and federal law and regulations, including:
* the Truth in Savings Act;
* the Expedited Funds Availability Act;
* the Bank Secrecy Act;
* the Electronic Funds Transfer Act; and
* the Federal Deposit Insurance Act.
Violation of these laws could result in the imposition of significant damages
and fines upon the Bank and its directors and officers.
Real Estate Lending Regulations. The federal regulators have adopted
uniform standards for appraisals of loans secured by real estate or made to
finance improvements to real estate. Banks are required to establish and
maintain written internal real estate lending policies consistent with safe and
sound banking practises and appropriate to the size of the institution and the
nature and scope of its operations. The regulations establish loan to value
ratio limitations on real estate loans, which generally are equal to or less
than the loan to value limitations established under University Bank's lending
policies.
Branching Authority. Michigan banks, including the Bank, have the authority
under Michigan law to establish branches anywhere in the State of Michigan,
subject to receipt of all required regulatory approvals, including the approval
of the Commissioner and the FDIC.
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
allows banks to establish interstate branch networks through acquisitions of
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<PAGE> 25
other banks, subject to certain conditions, including certain limitations on the
aggregate amount of deposits that may be held by the surviving bank and all of
its insured depository institution affiliates. The establishment of de novo
interstate branches or the acquisition of individual branches of a bank in
another state, rather than the acquisition of an out-of-state bank in its
entirety, is allowed only if specifically authorized by state law.
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
allowed individual states to "opt-out" of interstate branching authority by
enacting appropriate legislation prior to June 1, 1997. Michigan did not opt
out, and now permits both U.S. and non-U.S. banks to establish branch offices in
Michigan. The Michigan Banking Code permits, in appropriate circumstances and
with the approval of the Commissioner:
* the acquisition of all or substantially all of the assets of a
Michigan-chartered bank by an FDIC-insured bank, savings bank, or
savings and loan association located in another state;
* the acquisition by a Michigan-chartered bank of all or substantially
all of the assets of an FDIC-insured bank, savings bank or savings and
loan association located in another state;
* the consolidation of one or more Michigan-chartered banks and
FDIC-insured banks, savings banks or savings and loan associations
located in other states having laws permitting this consolidation,
with the resulting organization chartered by Michigan;
* the establishment by a foreign bank, which has not
previously designated any other state as its home state under the
International Banking Act of 1978, of branches located in Michigan
* the establishment or acquisition of branches in Michigan by
FDIC-insured banks located in other states, the District of Columbia
or U.S. territories or protectorates having laws permitting
Michigan-chartered banks to establish branches in these jurisdictions.
Further, the Michigan Banking Code permits, upon written notice to the
Commissioner:
* the acquisition by a Michigan-chartered bank of one or more branches,
not comprising all or substantially all of the assets, of an
FDIC-insured bank, savings bank or savings and loan association
located in another state, the District of Columbia, or a U.S.
territory or protectorate;
* the establishment by Michigan-chartered banks of branches located in
other states, the District of Columbia, or U.S. territories or
protectorates; and
* the consolidation of one or more Michigan-chartered banks and
FDIC-insured banks, savings banks or savings and loan associations
located in other states, with the resulting organization chartered by
one of the other states.
MICHIGAN BIDCO
Michigan BIDCO is regulated and supervised by the Michigan Department of
Commerce, Financial Institutions Bureau, Bank & Trust Division. The BIDCO is
examined annually by the Bank & Trust Division, and is required to make annual
filings of financial statements and to maintain a license from the Bureau.
Licensing under the terms of the Michigan BIDCO Act conveys
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<PAGE> 26
certain exemptions upon the BIDCO under Michigan law, which are beneficial to
the operations and investment flexibility of the BIDCO. Most importantly, the
BIDCO is partially exempt from the state's usury law. As a result, the BIDCO can
lend money to a firm and take equity participation in the firm it lends to, with
the result that the BIDCO's overall combined yield on the investment and loan
can exceed the state's usury limit. The amount of the BIDCO's return from the
equity participation or contingent payments is excluded from the calculation to
determine compliance with the state's usury limits.
CERTAIN FINANCIAL INFORMATION
for the years ended December 31, 1999, 1998 and 1997 (in $000s)(1)(2):
<TABLE>
<CAPTION>
Revenues: 1999 1998 1997
<S> <C> <C> <C>
Banking
Mortgage banking 139 809 882
Retail banking 2,899 2,365 3,467
Midwest Loan Services 901 958 713
Varsity (2) 2,292 5,674 4,802
Merchant Banking (3) 1,091
Corporate Office 6 179 61
------- ------- -------
Total 7,328 9,985 9,925
Michigan BIDCO (1) 1,333 991 624
Expenses:
Banking
Mortgage banking 457 974 759
Retail banking 3,478 3,148 4,954
Midwest Loan Services 901 943 808
Varsity (2) 2,484 5,073 4,539
Merchant Banking (3) 545
Corporate Office 346 243 276
------- ------- -------
Total 8,211 10,381 11,336
Michigan BIDCO (1) 619 634 864
Pre-tax income:
Banking
Mortgage banking (318) (165) 123
Retail banking (579) (783) (1,487)
Midwest Loan Services -- 15 (95)
Varsity (2) (192) 601 263
Merchant Banking (3) 546
Corporate Office (340) (64) (215)
------- ------- -------
Total (883) (396) (1,411)
Michigan BIDCO (1)(3) 714 357 (55)
Assets, at Dec. 31, 1999, 1998 and 1997:
Banking
Retail banking &
Mortgage banking 35,496 40,704 39,084
Midwest Loan Services 1,596 1,387 1,340
Varsity -- 12,242 15,902
Merchant Banking (3) 3,262
Corporate Office 116 203 1,203
------- ------- -------
Total 40,470 54,536 57,529
Michigan BIDCO (3) -- 5,327 5,684
</TABLE>
[table and footnotes continued on following page]
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<PAGE> 27
Liabilities and Stockholders' Equity,
at Dec. 31, 1999, 1998 and 1997 (in thousands):
<TABLE>
<CAPTION>
Banking 1999 1998 1997
<S> <C> <C> <C>
Retail banking
& Mortgage banking 37,136 41,375 39,929
Midwest Loan Services 579 363 334
Varsity -- 11,942 15,502
Merchant Banking (3) 1,743
Corporate Office 1,012 855 1,764
------ ------ ------
Total 40,470 54,536 57,529
Michigan BIDCO (3) -- 5,327 5,684
Intersegment Information, at Dec. 31, 1998, 1997 and 1996:
Assets:
Retail banking
& Mortgage banking (1,640) (672) (845)
Midwest Loan Services 1,017 1,024 1,006
Varsity -- 300 400
Merchant Banking (3) 1,519
Corporate Office (896) (652) (561)
Michigan BIDCO (3) -- -- --
</TABLE>
Notes to Certain Financial Information Table
for the years ended December 31, 1999, 1998 and 1997 (in thousands)
(1) Reflects only the Bank's share of Michigan BIDCO's net income in the first
quarter of 1999, 1998 and 1997 under the equity method which was 44.1%
(see footnote 3, below)
(2) Includes all Varsity LLCs. Varsity Mortgage commenced operations in March
1996 and was sold in November 1999. Varsity Funding was sold in August
1999.
(3) Effective April 1, 1999, we increased our overall ownership of Michigan
BIDCO to 80.1%, as the results of Michigan BIDCO are included in our
consolidated results from that day forward.
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<PAGE> 28
ITEM 3. - LEGAL PROCEEDINGS
We are not currently involved in any material pending legal disputes.
ITEM 4. - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II.
ITEM 5. - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
COMMON STOCK AND DIVIDEND INFORMATION
Our common stock trades on the NASDAQ Small-Cap Market under the symbol
UNIB. The high and low sales prices of our common stock as quoted by NASDAQ, for
the each quarter since January 1, 1998 are listed below:
<TABLE>
<CAPTION>
High Low
<S> <C> <C>
1999
First Quarter $3 3/8 $2 1/8
Second Quarter 4 3/16 2
Third Quarter 3 1/2 2 9/16
Fourth Quarter 2 3/4 1 1/4
1998
First Quarter $5 31/64 $2 2/3
Second Quarter 5 1/8 2 3/8
Third Quarter 4 19/32 3 1/16
Fourth Quarter 3 7/16 1 31/32
</TABLE>
These quotations represent inter-dealer prices, without retail markup,
markdown or commission, and may not represent actual transactions. As of the
March 15, 2000 we had approximately 375 stockholders including approximately 240
beneficial owners of shares held by brokerage firms or other institutions.
We effected a three for two stock split of our common stock (effected as a
stock dividend) in February 1998. All per share and number of share amounts in
this report are adjusted to reflect the stock split. No cash dividends have been
paid on our common stock. We do not currently anticipate declaring or paying
dividends.
CERTAIN SALES OF EQUITY SECURITIES
Not applicable.
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<PAGE> 29
ITEM 6. - SELECTED FINANCIAL DATA
UNIVERSITY BANCORP, INC. AND SUBSIDIARIES
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
(Dollars in Thousands Except Per Share Data)
<TABLE>
<CAPTION>
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
SUMMARY OF OPERATIONS (1)
Interest income $ 3,403 $ 4,011 $ 4,736 $ 3,724 $ 2,379
Interest expense 1,966 2,359 3,208 2,733 1,845
Net interest income 1,437 1,652 1,528 991 534
Provision for loan losses 93 118 260 191 17
Net interest income after
provision for loan losses 1,344 1,534 1,268 800 517
Net gain (loss) on investments (15) 98 8 399 56
Profit from investment
in Michigan BIDCO (2) 315 128 (55) 50 95
Other non-interest income 3,754 5,748 5,236 2,770 631
Non-interest expense 6,281 7,904 7,868 4,915 1,699
Income (loss) before income tax (883) (396) (1,411) (896) (402)
Income tax expense (benefit) 32 (198) (293) (359) (107)
Net income (loss) (915) (198) (1,118) (537) (295)
SELECTED YEAR END BALANCES
Total assets 40,883 54,536 57,529 78,366 38,275
Loans receivable, net 30,580 23,193 27,715 20,669 8,954
Loans held for sale 305 11,863 18,157 30,534 7,983
Cash, cash equivalents
and securities 1,551 13,040 4,357 19,898 15,028
Deposits 32,051 43,220 45,267 49,941 20,745
Note payable 694 826 923 963 1,000
FHLB advances 3,114 -- -- -- 10,000
Minority interest 506 205 201 201 201
Stockholders' equity 1,950 3,083 3,398 3,913 4,651
SHARES OUTSTANDING AND PER
SHARE DATA (3)
Common shares, year-end 2,013 1,989 1,984 1,943 1,914
Weighted average shares, year 2,103 1,991 1,922 1,866 1,802
Cash dividends -- -- -- -- --
Net income (loss) ($0.44) ($0.10) ($0.58) ($0.29) ($0.17)
Book value $0.97 $1.55 $1.81 $2.01 $2.43
SELECTED RATIOS
Net avg. interest rate spread 2.98% 2.96% 3.43% 2.09% 1.09%
Net yield on average
earning assets 3.42% 3.48% 3.07% 2.17% 1.69%
Return on average assets (1.92%) (0.35%) (1.76%) (1.08%) (0.84%)
Return on average equity (36.38%) (6.22%) (29.23%) (13.85%) (6.94%)
Avg. equity to asset ratio 5.28% 5.79% 5.76% 7.77% 12.14%
</TABLE>
[See the Notes on the following page]
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<PAGE> 30
(1) Includes results of Varsity Mortgage and Varsity Funding, which were sold
during 1999.
(2) Reflects only equity income accrued by the Bank from its investment in
BIDCO.
(3) Share and per share data have been retroactively restated to reflect a 3
for 2 stock split in February 1998.
ITEM 7. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The purpose of the following discussion and analysis is to assist the
reader in understanding and evaluating the changes in financial position and
results of operations over the past several years. You should refer to the
consolidated financial statements, the related notes thereto, and statistical
information presented elsewhere in this report when reading this section of the
report.
STRATEGY
Since its inception, we have pursued a strategy of growth through internal
expansion built on providing a full range of quality banking services in
selected community market areas, together with the creation of niche-oriented
specialty financial services units which aim to provide us with a higher return
on equity together with economies of scale to enhance the competitiveness of our
banking services in our targeted community markets.
Our current plan is to continue to grow the Bank's traditional community
banking, insurance & investment operations in the Ann Arbor area, to expand our
money management activities (including Michigan BIDCO and University Insurance &
Investment Services), and to sell our remaining mortgage banking subsidiary,
Midwest Loan Services and redeploy that capital into the community bank. We are
currently in negotiations to sell Midwest.
This report contains certain forward looking statements which reflect
our expectation or belief containing future events that involve risks and
uncertainties. These statements may be identified by the use of words including
"believes," "expects," "may," "will," "should," "seeks," "pro forma," or
"anticipates," and similar expressions. Among others, certain forward looking
statements relate to the continued growth of various aspects of our community
banking, mortgage banking and money management operations and the nature and
adequacy of allowances for loan losses. We can give no assurance that the
expectations reflected in the forward looking statements will prove to be
correct. Various factors could cause results to differ materially from our
expectations.
Without intending to be exhaustive, these factors include:
RISK FACTORS
Our business involves a high degree of risk. You should carefully consider
the risks and uncertainties described below and the other information in this
report before deciding whether to invest in shares of
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<PAGE> 31
our common stock. If any of the following risks actually occur, our business,
financial condition and results of operations could be materially adversely
affected. This could cause the trading price of our common stock to decline, and
you may lose all or part of your investment.
THE BANK HAS A LIMITED OPERATING HISTORY AND WE HAVE INCURRED SIGNIFICANT
START-UP LOSSES
Our Bank's operations were relocated to Ann Arbor in 1996, are not yet
profitable and have incurred substantial operating losses during the start-up
phase. We are subject to the risks inherent in starting a new business. Our
profitability will depend primarily upon our operations and we might never
become profitable. We believe that as the size of portfolio loans and retail
deposits at the Bank increases, that the Bank should become profitable, but
there is no assurance that expenses won't rise at a faster rate than expected as
the Bank grows. There is no assurance that the Ann Arbor operation will grow to
a size that will enable it to become profitable. We had a net loss from
continuing operations of $999,883 during 1998, and $691,201 during 1999. As of
December 31, 1999, we had a retained deficit of $931,980.
OUR FAILURE TO MANAGE FUTURE GROWTH COULD HAVE ADVERSE EFFECTS
Our strategy includes increasing the Bank's portfolio loans and retail
deposits, adding internet banking services, developing our financial services
products including insurance and investment products, and expanding our
specialized subsidiaries including mortgage servicing, and community development
lending. Our ability to achieve and manage our growth and expansion, as well as
our ability to manage our operations and internal controls, and our ability to
continue to attract and retain capable management and operations personnel will
determine the success of our growth strategy.
WE MAY NEED ADDITIONAL CAPITAL
We may need additional capital in the future to support the Bank's growth
or operating losses. Additional capital beyond:
* our present capital
* the capital which may be provided by future rights offerings
* the capital which may be provided by future private placements
* any amounts likely to be generated by our operations over the next
several years
may be necessary if we continue to lose money, or if we want to expand our
operations. Funds necessary to finance this expansion might not be available.
Regulatory capital requirements and borrowing restrictions that apply to us may
also have the effect of constraining future growth. If we sell additional equity
securities to finance future expansion, this sale could result in significant
dilution to the interests of persons who own our common stock.
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<PAGE> 32
GOVERNMENT REGULATION, FISCAL AND MONETARY POLICY AFFECT US AND THE BANKING
INDUSTRY
We are subject to extensive state and federal governmental supervision and
regulation which can negatively impact our financial results and our industry.
Existing state and federal banking laws subject University Bank to substantial
limitations with respect to loans, purchase of securities, payment of dividends
and many other aspects of our banking business. These limitations include a
requirement that we maintain a ratio of Tier 1 leverage capital to total assets
of at least 7% and maintain an adequate loan loss reserve. We currently maintain
a ratio of Tier 1 leverage capital to total assets in excess of the 7%
requirement. Future legislation or government policy might adversely affect the
banking industry or our operations. Federal economic, monetary and tax policy
may affect our ability to attract deposits, make loans and achieve satisfactory
interest spreads.
WE DO NOT CURRENTLY PAY ANY DIVIDENDS
Investors in our common stock must rely upon capital gains for a return on
their investment for at least the next two years because we have never paid a
dividend, and do not anticipate paying dividends for at least the next two
years. Our future earnings may not be sufficient to permit the legal payment of
dividends to our shareholders at any time in the future. Even if we may legally
declare dividends, the amount and timing of any dividends will be at the
discretion of our board of directors. Our payment of any cash dividends in the
future will depend to a large extent on the receipt of dividends from the Bank.
The ability of the Bank to pay cash dividends to us and by us to our
stockholders are both subject to certain statutory and regulatory restrictions.
WE ARE SIGNIFICANTLY SMALLER THAN THE MAJORITY OF OUR NATIONAL COMPETITORS
We face strong competition for deposits, loans and other financial services
from numerous Michigan and out-of-state banks, thrifts, credit unions and other
financial institutions as well as other entities which provide financial
services. Some of the financial institutions and financial services
organizations with which we compete are not subject to the same degree of
regulation as we are. Many of these financial institutions aggressively compete
for business in our market area. Most of our competitors have been in business
for many years, have established customer bases, are larger, have substantially
higher lending limits than we do and offer certain services, including numerous
branches and international banking services. The dominant competitors in our
market area are Great Lakes Bank, National City Bank, Comerica Bank, Bank One,
Key Bank and Republic Bank. In addition, federal and Michigan legislation
regarding interstate branching and banking may act to increase competition in
the future from large out-of-state banks.
WE MUST KEEP UP WITH TECHNOLOGICAL CHANGE
The banking industry is undergoing rapid technological changes with
frequent introductions of new technology-driven products and services. In
addition to better serving customers, the effective use of technology
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<PAGE> 33
increases efficiency and enables financial institutions to reduce costs. It is
not possible to predict the manner in which existing technology, and changes in
existing technology, will affect us. Changes in technology are likely to require
additional capital investments to remain competitive. Although we have invested
in new technology in the past, there can be no assurance that we will have
sufficient financial resources or access to the proprietary technology which
might be necessary to remain competitive in the future. Many of our competitors
have substantially greater resources to invest in technological improvements. We
might not be able to effectively implement new technology-driven products and
services or be successful in marketing these products and services to our
customers.
WE MUST RETAIN KEY EXECUTIVES AND PERSONNEL
We are and will continue to be dependent upon the services of our
management team, including our Chief Executive Officer, Stephen Lange Ranzini,
and our other senior managers. While we do maintain key man life insurance on
Stephen Lange Ranzini, losing one or more key members of the management team
could adversely affect our operations if we are unable to attract new senior
managers due to our history of unprofitability.
BANKS ARE BY THEIR NATURE HIGHLY LEVERAGED AND POOR LENDING DECISIONS CAN HAVE A
LARGE AND NEGATIVE IMPACT ON PROFITABILITY
We are in the business of making loans, and there is an inherent risk that
loans might not be repaid. If our customers fail to repay their loans, this
could materially adversely affect our earnings and overall financial condition,
as well as the price of our common stock. We also focus on loans to individuals
and loans to small-to-medium sized businesses that may be riskier than loans to
larger companies. We attempt to manage our credit exposure by monitoring the
concentration of loans within specific industries and through prudent loan
application and approval procedures. However, we can not guarantee that our
monitoring and procedures will reduce our lending risks sufficiently to avoid
material losses. Typically banks have five to ten times as many loans as equity
capital. Therefore, poor lending can quickly deplete a bank's capital base.
Our legal lending limit is currently approximately $850,000. The board of
directors has established an "in-house" limit of $500,000. Accordingly, the size
of the loans which the Bank can offer to potential customers is less than the
size of loans that many of our competitors are able to offer. These limits
affect to some degree our ability to seek relationships with the area's larger
businesses. We can accommodate loan volumes in excess of our lending limit
through the sale of participations in these loans to other banks. However, we
might not be successful in attracting or maintaining customers seeking larger
loans. In addition, we might not be able to sell participations in these loans
on terms favorable to us.
INTEREST RATES AND ECONOMIC CONDITIONS CAN CHANGE DRAMATICALLY AND THESE CHANGES
CAN HAVE A NEGATIVE IMPACT ON US
The results of operations for financial institutions, including our Bank,
may be materially and adversely affected by changes in prevailing economic
conditions, including declines in real estate market values, rapid changes in
interest rates and the monetary and fiscal policies of the
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<PAGE> 34
federal government. Our profitability is in part a function of the spread
between the interest rates earned on investments and loans and the interest
rates paid on deposits and other interest-bearing liabilities. In the early
1990s, many banking organizations experienced historically high interest rate
spreads. More recently, interest rate spreads have generally narrowed due to
changing market conditions and competitive pricing pressure, and there can be no
assurance that these factors will not continue to exert this pressure or that
these high interest rate spreads will return. Substantially all our loans are to
businesses and individuals in southeastern Michigan and any decline in the
economy of this area could adversely affect us.
Like most banking institutions, our net interest spread and margin will be
affected by general economic conditions and other factors that influence market
interest rates and our ability to respond to changes in these rates. At any
given time, our assets and liabilities will be affected differently by a given
change in interest rates. As a result, an increase or decrease in rates, the
length of loan terms or the mix of adjustable and fixed rate loans in our
portfolio could have a positive or negative effect on our net income or loss,
capital and liquidity. The positive trends or developments discussed in this
report might not continue. Negative trends or developments might have a material
adverse effect on us.
MANAGEMENT CONTROLS US THROUGH ITS OWNERSHIP OF MORE THAN A MAJORITY OF THE
COMMON STOCK OUTSTANDING
The total number of shares of common stock held by the Ranzini Group (Mr.
Joseph L. Ranzini, Mr. Stephen Lange Ranzini, Mrs. Mildred Ranzini, the two
Ranzini Family Trusts) and the ESOP shares beneficially owned by Stephen Lange
Ranzini, is 1,313,362, or 66% of the issued and outstanding shares at March 15,
2000. These individuals are able to exert a significant measure of control over
our affairs and policies. This control could be used, for example, to help
prevent an acquisition of University Bancorp, precluding shareholders from
possibly realizing any premium which may be offered for the common stock by a
potential acquiror.
THE GOVERNMENT REGULATES CONTROL OF US AND CONTROL CANNOT CHANGE WITHOUT
GOVERNMENT APPROVAL
Individuals, alone or together with others, who seek to acquire more than
10% of our common stock must comply with the Change in Bank Control Act. Anyone
who seeks to acquire 5% or more of our common stock must comply with the Bank
Holding Company Act. Accordingly, prospective investors need to be aware of
these requirements and to comply with these requirements, if applicable, in
connection with any purchase of shares of the common stock.
WE HAVE PROVIDED COMPLETE INDEMNIFICATION TO ALL OF OUR DIRECTORS AND OFFICERS
FOR OFFICIAL ACTS
Our Articles of Incorporation provide for the indemnification of our
officers and directors and insulate our officers and directors from liability
for certain breaches of the duty of care. It is possible that the
indemnification obligations imposed under these provisions could reduce our
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<PAGE> 35
earnings and adversely affect our ability to pay dividends. The Articles of
Incorporation of University Bank contain similar provisions.
THERE IS ONLY A LIMITED TRADING MARKET FOR OUR COMMON STOCK
Although the common stock is listed for trading on the NASDAQ Small-Cap
Market, the trading market in our common stock on the exchange historically has
been less active than the average trading market for companies listed on the
exchange. Our share price has been volatile. The price of our common stock in
the past year has ranged from $4.5325 to $1.375. A public trading market having
the positive characteristics of depth, liquidity and orderliness depends upon
the presence in the marketplace of willing buyers and sellers of common stock at
any given time, which presence is dependent upon the individual decisions of
investors and general economic and market conditions over which we have no
control.
Even with market makers, factors like as the limited number of shares
outstanding, the lack of earnings history and the absence of a reasonable
expectation of dividends within the near future mean that there might not be an
active and liquid market for the common stock. Even if an active market
develops, there can be no assurance that a market will continue, or that
shareholders will be able to sell their shares in the open market. Purchasers of
common stock should carefully consider the potentially illiquid and long-term
nature of their investment in the shares.
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.
BACKGROUND
The discussion below must be considered in light of the fundamental
changes resulting from 1) the opening in February 1996 of a new main office of
the Bank in Ann Arbor, and 2) the sale in November 1999 of Varsity Mortgage and
the sale in August 1999 of Varsity Funding. As a result of the sale of both
Varsity Mortgage and Varsity Funding, in the Company's financial statements,
certain adjustments have been made to reflects these subsidiaries as
discontinued operations. The discussion of the Company's operating results for
the past three years, unless otherwise stated, reflects the combined total of
both continuing and discontinued operations of the Company.
RECENT EVENTS
In 1996, a private investor group of ten individuals who were
investors in the BIDCO including Joseph and Stephen Ranzini purchased a $28,000
investment in the limited service hotel project to reduce the BIDCO's net
exposure to $500,000. The hotel was sold in early 2000, realizing a capital gain
for the BIDCO in an amount equal to the carrying value at December 31, 1999.
In December 1995, we acquired 80% of the common stock of the
residential mortgage servicing business, Midwest Loan Services. From this
acquisition, the BIDCO received 34,500 shares of our common stock, in
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<PAGE> 36
exchange for its ownership of 10% of the common stock of Midwest Loan Services
and options to buy an additional 30% of the common stock of that company. The
consideration the BIDCO received for its stake was on substantially similar
terms to the terms the other selling shareholders of Midwest Loan Services
received from us. Joseph and Stephen Ranzini's proceeds of the hotel sale
discussed above and some additional personal funds were used to purchase these
shares of our common stock from the BIDCO in early 2000 at $3 per share.
In early 2000 University Bancorp purchased in a private placement
$37,500 of shares and warrants of a NASDAQ listed internet consulting firm. The
market value of the shares as of March 17, 2000 was $230,625, an unrealized gain
of $193,125.
The Bank is soliciting offers to sell its shares of Midwest Loan
Services. Management of Midwest has also expressed an interest in purchasing the
Bank's shares of Midwest. There is no assurance that an offer on terms
acceptable to the Bank will be received.
The BIDCO has called for conversion, its remaining convertible bonds,
effective March 31, 2000. If all bonds all converted into common stock of the
BIDCO, our ownership of the BIDCO will drop from 80.11% to 27.08%, and the
BIDCO's results will no longer be consolidated into our results. Also,
management is exploring a restructuring of the Bank's investment in the BIDCO.
The board of directors of Michigan BIDCO have approved an offer to purchase the
Bank's shares in the BIDCO for:
* a cash payment of approx. $1,141,417 (the Bank's pro rata interest in
the BIDCO's book value at 3/31/00)
* payment of 27.08% of any amount received by BIDCO from Village Cable
TV above $363,150
* a cash payment for taxes due (when calculated)
* participation of 27.08% of any amount received from the Pay-it!TM
patent in cash or shares.
* the management contract for the SBIC, if and when formed will pass to
the Bank's investment subsidiary.
* when, and if SBIC is formed, the management contract for Foundation
will pass to the Bank's investment subsidiary.
* if and when the SBIC is formed, the Bancorp will issue $461,875 worth
of shares of Company common stock to the BIDCO shareholders as
compensation for the SBIC contract.
The BIDCO together with the National Center for Manufacturing Sciences
havesubmitted a patent application for a method of transfering money in a secure
fashion over the internet using an email file attachment. They have executed a
licensing agreement covering a core technology used in the money transfer
technology from ASPSecure.com, and are negotiating an agreement to form a
company called pay-it.net to commercialize the technology under the name
Pay-it!TM
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<PAGE> 37
THE YEAR ENDED DECEMBER 31, 1999 COMPARED TO THE YEARS ENDED DECEMBER 31, 1998
AND 1997
SUMMARY OF RESULTS OF OPERATIONS
Our net loss from continuing operations was $723,725 in 1999, $801,291
in 1998 and $1,381,055 in 1997. Earnings (loss) per share from continuing
operations for 1999, 1998 and 1997 were $(0.34), $(0.40) and $(0.72),
respectively. Including both continuing operations and discontinued operations,
our net loss was $915,480 in 1999, $198,049 in 1998 and $1,117,924 in 1997.
Including both continuing operations and discontinued operations, the
increased loss in 1999 versus 1998 was principally due to losses at the Bank's
mortgage subsidiary, Varsity Mortgage, which was sold in November 1999 and the
loss of a legal suit, which were only partially offset by improved results at
the Ann Arbor main office as a result of a 28% increase in portfolio loans and
Michigan BIDCO. The Bank's mortgage banking subsidiaries, Varsity Mortgage and
Varsity Funding had total losses of $191,755 in 1999 versus profits of $603,242
in 1998, and the $794,997 swing accounted for more than 100% of the Bank's
overall shortfall in pre-tax income versus management's budget. The lawsuit
caused a loss of $152,000 plus legal expenses of about $40,000.
The decreased loss in 1998 versus 1997 was principally due to decreased
losses at the Bank's new Ann Arbor main office. During the year non-interest
expenses at the retail bank division were decreased by $890,139, and certain
aspects of underlying operating results including key indicators such as net
interest income improved so that the Bank achieved a break-even result during
the year from ongoing operations. Unusual or non-recurring expenses exceeded
unusual or non-recurring profits and decreased the Bank's income by $342,000.
The Bank's mortgage banking and other specialized financial subsidiaries had
total increased profits of $581,381 in 1998, a 33% return on average investment
and offset a portion of the losses from the retail banking operations.
NET INTEREST INCOME
Net interest income represents the dollar amount by which interest
income generated by interest-earning assets exceeds the cost of funds.
Interest-earning assets consist primarily of loans, short term investments and
investment securities, and the principal cost of funds is the interest paid on
deposit accounts and other borrowings. Net interest income is affected by (i)
the difference between the average rate of interest earned on the Bank's
interest-earning assets and the average rate paid on its interest-bearing
liabilities ("interest rate spread") and (ii) the relative amounts of its
average interest-earning assets and interest-bearing liabilities. In order to
maintain and increase earnings during periods of fluctuating interest rates, it
is imperative that interest-earning assets and interest-bearing liabilities be
managed effectively. Trends in net interest income provide a measure of the
effectiveness by which a financial institution manages its interest rate
sensitivity.
-37-
<PAGE> 38
In each period, net interest income on a consolidated basis was reduced
by interest expense associated with University Bancorp's bank loan indebtedness.
The interest expense was $0.08 million in 1999, $0.09 million in 1998 and $0.11
million in 1997.
In the following table, non-accrual loans are included in the average
balances. The table presents, for the periods and dates indicated, the average
balances (all averages are calculated using monthly averages) of, the interest
earned or paid on, and the weighted average yield earned or rate paid on, our
interest-bearing assets and liabilities:
-38-
<PAGE> 39
<TABLE>
<CAPTION>
Net Interest Income
At ---------------------------------- -----------------------------
31-Dec-99 1999 1998
------------- ---------------------------------- -----------------------------
Average Average Interest Average Average Interest Average
Yield Balance Inc(Exp) Yield Balance Inc(Exp) Yield
Yield Balance Inc(Exp) Yield Balance Inc(Exp) Yield
<S> <C> <C> <C> <C> <C> <C> <C>
Interest Earning Assets:
Loans:
Commercial 9.36% 10,991,176 1,100,049 10.01% 9,680,308 1,010,205 10.44%
Real Estate Construction 9.69% 1,251,077 120,269 9.61% 644,430 65,269 10.13%
Real Estate Mortgage 8.29% 21,008,212 1,525,846 7.26% 28,476,557 2,192,636 7.70%
Installment/Consumer 9.56% 4,115,908 404,801 9.84% 4,590,026 464,041 10.11%
--------- ---------- --------- ------ ---------- --------- -----
Total Loans 8.91% 37,366,373 3,150,965 8.43% 43,391,321 3,732,151 8.60%
Investment Securities(1) 6.07% 3,482,913 197,367 5.67% 1,796,853 154,648 8.61%
Federal Funds & Bank Deposits 5.26% 1,177,852 55,015 4.67% 2,255,064 123,810 5.49%
--------- ---------- --------- ------ ---------- --------- -----
Total Interest Bearing Assets 8.61% 42,027,138 3,403,347 8.10% 47,443,238 4,010,609 8.45%
Interest Bearing Liabilities:
Deposit Accounts:
Now/Super-Now 3.14% 3,169,317 100,543 3.17% 2,956,611 118,622 4.01%
Savings 2.00% 225,017 4,799 2.13% 158,350 3,900 2.46%
Time 6.13% 18,992,483 1,071,991 5.64% 24,238,176 1,444,236 5.96%
Borrowed Funds 5.72% 1,751,173 111,245 6.35% 1,481,112 85,604 5.78%
Money Market Accts 4.39% 11,747,329 487,866 4.15% 13,218,519 617,431 4.67%
--------- ---------- --------- ------ ---------- --------- -----
Total 4.83% 35,885,319 1,776,444 4.95% 42,052,768 2,269,793 5.40%
BIDCO Debt 9.00% 1,793,542 111,725 6.23%
Holding Company Debt 9.75% 757,285 78,392 10.35% 884,764 88,893 10.05%
--------- ---------- --------- ------ ---------- --------- -----
Total Interest Bearing
Liabilities 5.40% 38,436,146 1,966,561 5.12% 42,937,532 2,358,686 5.49%
--------- ---------- --------- ------ ---------- --------- -----
Net Earning Assets, net interest
income, and interest rate spread 3.21% 3,590,992 1,436,786 2.98% 4,505,706 1,651,923 2.96%
Net yield on interest-earning assets 3.38% 3.42% 3.48%
</TABLE>
<TABLE>
<CAPTION>
-----------------------------------------------
1997
-----------------------------------------------
Average Interest Average
Balance Inc(Exp) Yield
<S> <C> <C> <C>
Interest Earning Assets:
Loans:
Commercial 12,051,647 1,092,970 9.07%
Real Estate Construction 828,157 65,665 7.93%
Real Estate Mortgage 24,323,766 2,444,817 10.05%
Installment/Consumer 4,786,743 471,542 9.85%
------------ ------------ ------
Total Loans 41,990,313 4,074,994 9.70%
Investment Securities(1) 2,272,225 305,966 13.47%
Federal Funds & Bank Deposits 5,498,798 355,151 6.46%
------------ ------------ ------
Total Interest Bearing Assets 49,761,336 4,736,111 9.52%
Interest Bearing Liabilities:
Deposit Accounts:
Now/Super-Now 3,360,913 156,902 4.67%
Savings 572,551 13,745 2.47%
Time 27,885,534 1,672,477 6.00%
Borrowed Funds 3,256,164 424,419 13.03%
Money Market Accts 16,686,401 832,345 4.99%
------------ ------------ ------
Total 51,761,563 3,099,888 5.99%
BIDCO Debt
Holding Company Debt 937,363 108,195 11.54%
------------ ------------ ------
Total Interest Bearing
Liabilities 52,698,926 3,208,083 6.09%
------------ ------------ ------
Net Earning Assets, net interest
income, and interest rate spread (2,937,590) 1,528,028 3.43%
Net yield on interest-earning assets 3.07%
</TABLE>
(1) Actual yields; not adjusted to take into account tax-equivalent yields
resulting from tax-free municipal income and includes bank deposits.
-39-
<PAGE> 40
The table above does not specify the average level of non-interest
bearing demand deposits, which were $2,306,983, $2,626,160 and $3,510,337 for
the years ended December 31, 1999, 1998 and 1997, respectively, as computed
using month-end balances for these years.
Including both continuing operations and discontinued operations, net
interest income of the Bank decreased from $1.65 million in 1998 to $1.44
million in 1998, mainly as a result of a decrease in interest-earning assets,
which was only partially offset by a decline in the yield on interest-earning
liabilities. During the year ended December 31, 1999, the Bank's average
interest-earning asset base fell by $5.42 million or 11.4% over 1998, while
average interest-bearing liabilities decreased by $3.62 million or 8.6%. Net
interest earning asset decreased by $0.91 million as a result of the
consolidation of the BIDCO into our results because BIDCO owns various
non-interest-earning assets. Due to the decreased level of activity at the
Bank's Varsity subsidiaries, the average balance of real estate mortgages held
for sale decreased by $10.7 million. Due to the decrease of wholesale deposits
in the mix of interest-earning liabilities, the average cost of deposits
decreased from 5.40% in 1998 to 4.95% in 1999. As a result of the decrease in
yield on interest-earning liabilities in an amount greater than the decline in
the yield on interest-earning assets, which more than offset the decline in
interest-earning assets relative to interest-earning liabilities, the net
interest margin increased to 2.98% in 1999 from 2.96% in 1998. Short term
interest rates in both 1998 and 1999 were mostly stable until mid-year 1999, and
since then short term interest rates have risen sharply. Long term interest
rates hit 30-year lows in October 1998 and trended sharply higher throughout
1999.
Net interest income of the Bank increased to $1.65 million in 1998 from
$1.53 million in 1997, mainly as a result of a larger decrease in
interest-earning liabilities than the decrease in interest-earning assets, which
was only partially offset by a decline in the yield on interest-earning assets,
which fell faster than the decline in the cost of interest-earning liabilities.
During the year ended December 31, 1998, the Bank's average interest-earning
asset base fell by $2.32 million or 4.7% over 1997, while average
interest-bearing liabilities decreased by $9.71 million or 18.8%. Due to a
restructuring of the interest rate earned on loans held for sale charged to the
Bank's Varsity subsidiaries, the average yield on interest-earning assets
decreased to 8.45% from 9.52% in 1997. Due to the decrease of wholesale deposits
in the mix of interest-earning liabilities, the average cost of deposits
decreased from 5.99% in 1997 to 5.40% in 1998. As a result of the decrease in
yield on interest-earning assets in an amount greater than the decline in the
cost of interest-earning liabilities, which more than offset an expansion in
interest-earning assets relative to interest-earning liabilities, the net
interest margin decreased to 2.96% in 1998 from 3.43% in 1997. Interest rates
were mostly stable until September 1998, and short term interest rates declined
for the balance of the year.
At December 31, 1999, the net yield on the Bank's interest-earning
assets was 3.38% down from the average net spread for the 1999 year of 3.42%,
principally as a result of higher rates on wholesale time deposits. Fee income
from our mortgage banking originations, income from our portfolio
-40-
<PAGE> 41
of mortgage servicing rights and the income or loss from the Bank's investment
in its subsidiaries are not included in these calculations.
The following table presents information regarding fluctuations in our
interest income and interest expense for the periods indicated. For each
category of interest-earning asset and interest-bearing liability, information
is provided on changes attributable to (1) changes in volume (changes in volume
multiplied by old rate); and (2) changes in rate (changes in rate multiplied by
old volume); with the rate/volume variance allocated to changes in rate:
-41-
<PAGE> 42
<TABLE>
<CAPTION>
Rate / Volume Analysis
------------------------------------- -------------------------------------------------
1999 1998
------------------------------------- -------------------------------------------------
Volume Rate Total Volume Rate Total
<S> <C> <C> <C> <C> <C> <C>
Interest Income
Loans:
Commercial 136,798 (46,954) 89,844 (215,058) 132,293 (82,765)
Real Estate Construction 61,443 (6,443) 55,000 (14,568) 14,172 (396)
Real Estate Mortgage (575,047) (91,743) (666,790) 417,403 (669,584) (252,181)
Installment/Consumer (47,932) (11,307) (59,240) (19,379) 11,877 (7,502)
-------- -------- -------- ------------ ------------ -------------
Total Loans (424,739) (156,447) (581,186) 168,398 (511,242) (342,844)
Investment Securities 108,773 (66,054) 42,719 (64,011) (87,307) (151,318)
Federal Funds (59,142) (9,653) (68,795) (209,503) (21,838) (231,341)
-------- -------- -------- ------------ ------------ -------------
Total Interest Income (375,108) (232,154) (607,262) (105,116) (620,387) (725,503)
Interest Bearing Liabilities:
Deposit Accounts:
Now/Super-Now 8,534 (26,613) (18,079) (18,875) (19,406) (38,281)
Savings 1,642 (743) 899 (9,851) 6 (9,845)
Time (312,566) (59,679) (372,245) (218,756) (9,485) (228,241)
Borrowed Funds 15,609 10,032 25,641 (167,648) (171,167) (338,815)
Money Markets (68,719) (60,846) (129,565) (172,984) (41,930) (214,914)
-------- -------- -------- ------------ ------------ -------------
Total Deposit Interest Expense (355,500) (137,849) (493,349) (588,114) (241,982) (830,096)
BIDCO Debt 111,725 0 111,725
Holding Company Debt (12,808) 2,307 (10,501) (6,071) (13,231) (19,302)
-------- -------- -------- ------------ ------------ -------------
Total Interest Expense (256,582) (135,543) (392,125) (594,185) (255,213) (849,398)
-------- -------- -------- ------------ ------------ -------------
Net Interest Income (118,526) (96,612) (215,137) 489,069 (365,174) 123,895
======== ======== ======== ============= ============= =============
</TABLE>
<TABLE>
<CAPTION>
----------------------------------------------
1997
----------------------------------------------
Volume Rate Total
<S> <C> <C> <C>
Interest Income
Loans:
Commercial 648,516 (153,899) 494,617
Real Estate Construction 61,778 (9,247) 52,531
Real Estate Mortgage 171,746 342,115 513,861
Installment/Consumer 225,152 (32,174) 192,978
------------ ------------ ------------
Total Loans 1,107,192 146,795 1,253,987
Investment Securities (480,798) 162,910 (317,888)
Federal Funds 33,805 42,681 76,486
------------ ------------ ------------
Total Interest Income 660,199 352,386 1,012,585
Interest Bearing Liabilities:
Deposit Accounts:
Now/Super-Now 123,396 (12,072) 111,324
Savings (26,225) (11,888) (38,113)
Time 173,925 (39,356) 134,569
Borrowed Funds (322,098) 212,017 (110,081)
Money Markets 415,466 (60,123) 355,343
------------ ------------ ------------
Total Deposit Interest Expense 364,464 88,578 453,042
BIDCO Debt
Holding Company Debt (3,526) 25,854 22,328
------------ ------------ ------------
Total Interest Expense 360,938 114,432 475,370
------------ ------------ ------------
Net Interest Income 299,261 237,954 537,215
============= ============ ============
</TABLE>
-42-
<PAGE> 43
LOAN PORTFOLIO
Information regarding the Bank's loan portfolio as of December 31, 1999
and 1998 is set forth under Note 5 to University Bancorp's consolidated
financial statements included with this report.
PROVISION FOR LOAN LOSSES
The Bank charges to operations a provision for possible loan losses
which is intended to create an allowance for future loan losses inherent in the
Bank's portfolio. Each year's provision reflects management's analysis of the
amount necessary to maintain the allowance for possible loan losses at a level
adequate to absorb anticipated losses. In its evaluation, management considers
factors like historical loan loss experience, specifically identified problem
loans, composition and growth of the loan portfolio, current and projected
economic conditions, and other pertinent factors. A loan is charged-off by
management as a loss when deemed uncollectible, although collection efforts
continue and future recoveries may occur.
Non-performing loans are defined as loans which have been placed on
non-accrual status and loans over 90 days past due as to principal or interest
and still in an accrual status. Where serious doubt exists as to the
collectibility of a loan, the accrual of interest is discontinued. See Notes 5
and 6 of the Consolidated Financial Statements for additional information
regarding impaired and past due loans.
Non-performing loans amounted to $540,739 and $467,402 at December 31,
1999 and 1998, respectively. The increase in non-performing loans during 1999 is
the result of the inclusion of the BIDCO's loans in the consolidated totals.
Excluding one BIDCO loan on non-accrual at December 31, 1999, the non-performing
loans at December 31, 1999 had declined to $144,739 versus $467,402 the prior
year.
Including both continuing operations and discontinued operations, the
provision for loan losses in 1999 was $92,648, a decrease of $25,785 from the
1998 level, which in turn was a decrease of $141,567 from the 1997 level of
$260,000. Loans charged off net of recoveries were $19,064, $180,385 and $36,830
in 1999, 1998 and 1997, respectively. The allowance for possible loan losses
totaled $532,585, $459,001 and $520,953 at the end of 1999, 1998 and 1997,
respectively.
A summary of loan loss expense for the Bank for the years indicated is
presented below:
-43-
<PAGE> 44
Analysis of the Allowance for Loan Losses
($ in thousands)
<TABLE>
<CAPTION>
Years Ending December 31,
-------------------------
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Balance at beginning of period $459 $521 $298
Chargeoffs:
Domestic:
Commercial, financial and agricultural 0 25 55
Real estate-construction 0 0 0
Real estate-mortgage 60 165 0
Installment loans to individuals 7 66 28
Lease financing 0 0 0
Foreign 0 0 0
---- ---- ----
66 256 83
---- ---- ----
Recoveries:
Domestic:
Commercial, financial and agricultural 28 10 3
Real estate-construction 0 0 0
Real estate-mortgage 0 42 24
Installment loans to individuals 19 24 19
Lease financing 0 0 0
Foreign 0 0 0
---- ---- ----
47 76 46
---- ---- ----
Net charge-offs 19 180 37
---- ---- ----
Provision for loan losses 93 118 260
---- ---- ----
Balance at end of period $533 $459 $521
==== ==== ====
Ratio of net charge-offs during period
to average loans outstanding during period 0.05% 0.42% 0.09%
==== ==== ====
</TABLE>
-44-
<PAGE> 45
Analysis of the Allowance for Loan Losses
-----------------------------------------
($ in thousands)
<TABLE>
<CAPTION>
December 31,
Percent of loans
Balance at End of Period in each category
Applicable to: Amount to total loans
-------------- --------------- --------------
1999 1998 1999 1998
<S> <C> <C> <C> <C>
Domestic
Commercial, financial,
agricultural $268 $ 158 50.3% 34.4%
Real estate-construction 10 8 1.9% 1.8%
Real estate-mortgage 110 185 20.6% 40.3%
Installment loans to
individuals 47 68 8.8% 14.8%
Unallocated 98 40 18.4% 8.7%
----- ----- ------ ------
533 459 100.0% 100.0%
===== ===== ====== ======
</TABLE>
<TABLE>
<CAPTION>
December 31, December 31,
1999 1998
----------- -------------
<S> <C> <C>
Total loans (1) 31,112 23,652
Allowance for loan losses 533 459
Allowance/Loans, % (1) 1.71% 1.94%
</TABLE>
(1) Excludes loans held for sale.
The monthly provision for loan loss remained at $7,500 during 1999.
Management at Midwest added a special provision of $2,648 during the year for a
specific loan loss.
The Bank's overall loan portfolio is geographically concentrated in Ann
Arbor and the future performance of these loans is dependent upon the
performance of relatively limited geographical areas.
Management believes that the current reserve level is adequate to
absorb losses inherent in the loan portfolio, although the ultimate adequacy of
the allowance for loan losses is dependent upon future economic factors beyond
our control. A downturn in the general nationwide economy will tend to
aggravate, for example, the problems of local loan customers currently facing
some difficulties. A general nationwide business expansion could conversely tend
to diminish the severity of any these difficulties.
NON-INTEREST INCOME AND NON-INTEREST EXPENSE
Included in results for 1999 is a loss of $152,000 due to an adverse
legal judgement and associated legal expenses of about $40,000. In November
1999, the Bank sold its Varsity Mortgage subsidiary. Varsity Mortgage had a loss
of $214,172 for the 1999 year versus a profit in 1998 of $699,077, and had
$2,137,522 of total non-interest expenses during 1999.
-45-
<PAGE> 46
Non-interest income. Including both continuing operations and
discontinued operations, non-interest income in 1999 dropped from $6,504,365 to
$4,054,127 in 1999, a decrease of $2,450,238, or 37.7%. The decrease in 1999 was
mainly the result of mortgage banking income, which decreased 50.6%, or
$2,947,597. This decline was only partially offset by merchant banking (BIDCO)
income, which was included because the BIDCO's results were consolidated for the
first time. Other non-interest income in 1998 also included gains from the sale
of excess property.
Non-interest income in 1998 rose to $6,504,365 from $5,511,634 in 1997,
an increase of $992,731, or 18.0%. The increase in 1998 was mainly the result of
mortgage banking income, which increased 10.9%, or $572,743, but all categories
increased, including increased gains from securities sales, gains from the sale
of excess property, increased service charges and fees, and net income from
Michigan BIDCO.
Mortgage Banking. Mortgage banking, servicing and origination fees
decreased to $2,874,491 in 1999 from $5,822,088 in 1998. The decrease in
mortgage banking fee income was the result of a 57% decrease in loan purchase
and origination volumes during 1999 as a result of decreased volumes at the
Bank's mortgage banking subsidiary, Varsity Mortgage.
The servicing rights portfolio totaled $64,366,643 of FHLMC and FNMA
mortgages at December 31, 1999, versus $95,588,808 at December 31, 1998. All
servicing in 1999 was done by Midwest Loan Services. The amount decreased as a
result of a portfolio sale of servicing rights by the Bank in December 1998
(which settled in March 1999), and payoff and refinancing of existing rights
throughout the year. The following table summarizes the portfolio by type and
mortgage note rate:
Interest Rate Stratification of the Bank's Servicing
----------------------------------------------------
<TABLE>
<CAPTION>
($ thousands) FIXED RATE - BY MATURITY (in years)
-----------------------------------
MORTGAGE RATE (%) ARMs UNDER 10 10-25 OVER 25
<S> <C> <C> <C> <C>
9.00 and up 397 - 97 613
8.50 - 8.99 823 - 167 1,523
8.00 - 8.49 3,070 - 288 4,743
7.50 - 7.99 2,057 - 2,591 20,649
7.00 - 7.49 975 - 6,188 11,381
6.50 - 6.99 - 25 4,903 2,840
6.00 - 6.49 - - 772 88
under 6.00 - - - 177
------ ----- ------ ------
7,322 25 15,006 42,014
Current market
interest rates 7.50% 7.50% 8.13% 8.38%
Average annual
servicing fee 0.38% 0.25% 0.25% 0.27%
</TABLE>
Mortgage interest rates hit 30-year lows in October 1998 and rose
steadily from that point throughout 1999. Midwest Loan Services actively
-46-
<PAGE> 47
refinanced its existing portfolio during 1999, causing increased amortization
and increased fee income.
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 slightly exceeds 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.
Servicing Rights Held by University Bank
----------------------------------------
<TABLE>
<CAPTION>
(amounts in $ thousands) December 31, December 31,
1999 1998
---------------------------------------
<S> <C> <C>
Total servicing 64,367 95,589
Book value of servicing 704 948
Estimated market value of servicing:
Management estimate (1) 755 950
Discounted cash flow (2) 869 1,066
Estimated excess of market
over book value (3) 165-51 118- 2
</TABLE>
(1) Assumes a price based upon market transactions at December 31, 1999 of
5.3x (5.3 times the servicing fee) for 30-year servicing, 4.4x for 15-year
servicing, 3.6x for Balloon servicing and 3.0x for ARM servicing. The
market value of servicing at December 31, 1998 was based on a price of
4.3x for 30-year servicing, 3.6x for 15-year servicing, 2.6x for Balloon
servicing and 1.8x for ARM servicing. Excess servicing is discounted from
these amounts at a multiple of one times the servicing fee.
(2) Uses net present value analysis of future cash flows, discounted back at
rates ranging from 10 to 12% in 1999 and 1998.
(3) Range based upon the two methods used in (1) and (2), above. During 1999
purchases and sales of mortgage servicing rights by third-parties
evidenced an increasing trend in price as long term interest rates
increased throughout the year.
Additional information regarding the Bank's mortgage banking activities
for the past three years is set forth in Note 4 to our consolidated financial
statements.
Michigan BIDCO. Michigan BIDCO, invests in businesses in Michigan with
the objective of capital gains while fostering job growth and economic
development. As of December 31, 1999, the BIDCO had made twenty-eight
investments, amounting to a total of $13,463,600 at original cost, before
repayments or participations sold. At December 31, 1999, Michigan BIDCO had
total assets of $3,228,441 versus $5,327,697 at December 31, 1998. As discussed
above under "ITEM 1.- Business, Lines of Business, Michigan BIDCO", the
financial statements of the BIDCO are presented using the investment company
method, and, accordingly, investments in stocks, stock warrants, limited
liability companies and loans ("BIDCO Investments") are reported at fair value.
-47-
<PAGE> 48
The BIDCO's financial results for 1999 reflect net income in the amount
of $459,432 versus net income of $259,238 in 1998. Operating expenses declined
$23,634 or 9.0% as expenses were well controlled. Net interest income recovered
to $71,809, an increase of $58,499 from the prior year. Realized gains on the
sale of a major investment in the amount of $500,000 had no impact on income as
the valuations had been taken into account in the year-end 1998 valuation. The
Bank benefitted by absorbing the $231,031 in tax benefit as the BIDCO's taxable
income was sheltered by the Bank's tax loss carryforward.
The BIDCO's financial results for 1998 reflect net income in the amount
of $259,238 versus a net loss of 163,539 in 1997. Operating expenses declined
$167,637 or 38.9%, as expenses were well controlled and the expense
reimbursement from Northern Michigan Foundation increased $80,000 to $190,000.
Net interest income recovered to $13,310, an increase of $233,698 from the prior
year. Realized gains on the sale of two major investments in the amount of
$720,000 had no impact on income as the valuations had been taken into account
in the year-end 1997 valuation. Additional market value provisions were recorded
on the mixed office recycled paper pulp mill investment, because continued
record low paper prices decreased the revenue that had been anticipated from a
royalty on sales.
At December 31, 1999, the BIDCO had no outstanding conditional
commitments to lend.
Securities. Proceeds from sales of marketable equity securities
included in proceeds from sales of investment securities were $71,327, $142,088
and $166,498 for the years ended December 31, 1999, 1998 and 1997, respectively.
Gross gains of approximately $1,879, $97,993 and $41,155 were realized on 1999,
1998 and 1997 sales, respectively. Gross losses of $17,981 were realized on 1999
sales and no gross losses were realized on 1998 and 1997 sales. See "Recent
Events", above.
Proceeds from sales of available for sale securities were $502,730, $0
and $5,740,991 for the years ended December 31, 1999, 1998 and 1997,
respectively, excluding sales associated with the Bank's mortgage banking
operation. There was a gross gain of $625 on 1999 sales, and no gain or loss on
1998 sales. Gross gains of approximately $29,726 and gross losses of
approximately $63,166 were realized on 1997 sales.
At December 31, 1999, gross unrealized losses in the Bank's
available-for-sale securities were $585,051 and gross unrealized gains were $0.
At December 31, 1998 gross unrealized losses in the Bank's available-for-sale
securities were $156,993 and gross unrealized gains were $3,776. At December 31,
1997 gross unrealized losses in our available-for-sale securities were $27,961
and gross unrealized gains were $46,549. Sales of loans pooled into mortgage
backed securities in connection with the Bank's mortgage banking activities were
$24,603,694 in 1999, $48,236,448 in 1998 and 171,639,196 in 1997.
Non-interest expense. Including both continuing operations and
discontinued operations, our non-interest expense decreased by $2,153,422 or
25.5% in 1998. During the year non-interest expenses at the retail bank division
were decreased by $244,297, or 9.5%, as a result of continued
-48-
<PAGE> 49
efforts at cost control. During 1999, the Bank sold both Varsity Mortgage and
Varsity Funding Services, which also caused a decrease in non-interest expenses.
Legal expenses remained high as a result of a adverse judgement in a lawsuit
which resulted in about $192,000 in total costs. Data processing expenses were
$92,444 higher primarily because of a variety of Year 2000 expenses which were
incurred and expensed and various internet initiatives, including internet
banking and development projects at Midwest Loan Services. University Bancorp
total expense increased $102,941 because of an adverse legal judgement against
the company, which caused legal and audit expense to increase $160,502 which was
only partially offset by declines in other categories including interest,
salaries and benefits, occupancy and other expense.
Our non-interest expense increased by $244,092 or 3.0% in 1998. During
the year non-interest expenses at the retail bank division were decreased by
$890,139 as a result of a variety of cost cutbacks in an effort to streamline
the operation. During the year, the Newberry and Saline operation centers were
sold and all operations centralized in the Ann Arbor main office. Excess
personnel costs were reduced, and a variety of other efficiencies realized. This
decrease was offset by ongoing growth at the Bank's mortgage subsidiaries,
Varsity and Midwest Loan Services. In addition, legal and audit expenses
remained high as a result of various projects including approximately $75,000
spent on the unsuccessful litigation against the RTC, and a variety of Year 2000
expenses were incurred and expensed. University Bancorp total expense decreased
$13,963 primarily as a result of decreases in public listing expense and audit
and legal expense as certain projects finished in 1997. Partially offsetting
this decrease at University Bancorp was an increase in ESOP benefits expense and
salary and expenses reimbursed to a consultant in connection with a special
project.
Internet Banking. Management has begun a project to offer transactional
internet banking for all bank products. The internet banking product is expected
to be available in production mode during the second quarter of 2000. The
project, which has a capital budget of approximately $100,000, will add ongoing
depreciation and operating expenses which are expected to be more than offset by
the transfer to the Bank of approximately $6,400,000 in mortgage servicing
escrow accounts controlled by Midwest Loan Services. These escrow deposit
accounts are currently held at another bank due to the inability of the Bank
currently to offer PC banking to Midwest to facilitate Midwest's daily
operational needs.
LIQUIDITY AND CAPITAL RESOURCES
Our total assets at December 31, 1999 amounted to $40.82 million
compared to $54.54 million at December 31, 1998. Loans receivable, net of
reserves, increased by $7.39 million to $30.58 million from $23.19 million. Cash
and cash equivalents including Federal Funds sold on an overnight basis at the
end of 1999 decreased by $7.69 million from the prior year, while securities
decreased by $0.32 million. Loans held for sale in the Bank's mortgage banking
division decreased by $11.55 million to $0.31 million from $11.86 million.
During 1999, management of the Bank continued to pursue a policy of decreasing
reliance on certain high cost deposits and borrowings
-49-
<PAGE> 50
and increasing the rate at which loans held for sale were sold to improve
profitability. This policy has resulted in a reduction in total assets, loans
held for sale and deposits. In late 1999, we sold Varsity Mortgage, which caused
a further drop in loans held for sale. At year-end 1999, the Bank had an unused
line of credit from the Federal Home Loan Bank of Indianapolis of $4,386,140,
and an unused line of credit from the Federal Reserve Bank of Chicago of
$5,252,000.
University Bank, as an FDIC-insured bank, is subject to certain
regulations which require the maintenance of minimum liquidity levels of cash
and eligible investments. The Bank has historically exceeded this minimum as a
result of its investments in Federal Funds sold, U.S. Government and U.S. Agency
securities and cash. In addition University Bancorp had $15,834 in cash and
equity securities at the end of 1999 to meet cash needs, primarily operating
expenses and interest and principal reductions on the University Bancorp's bank
loan. The balance of the loan was $694,000 and $826,000 at year end 1999 and
1998. The note was refinanced in late 1997, into a seven-year fully amortizing
loan. In an effort to maintain the Bank's Tier 1 capital to assets ratio above
7% and to increase capital through retained earnings, management does not expect
that the Bank will pay dividends to us during 1999. Management intends that the
cash and securities on hand, together with cash from the sale of common stock
and the exercise of stock options to be sufficient to cover the required
principal reductions during 1999 on University Bancorp's loan.
At December 31, 1999, University Bancorp had outstanding $304,000 of
equity conversion notes, which bear interest at prime rate although all payment
of interest in deferred until conversion into common stock or redemption and are
redeemable only through the proceeds of a future sale of common stock and. Our
President, Chairman and members of their family hold the equity conversion notes
and have committed to provide at least $70,000 in additional financing during
early 2000 through the purchase of additional equity conversion notes. See
"Recent Events", above.
Our total stockholders' equity at December 31, 1999 was approximately
$1.95 million (or 4.8% of total assets) compared to $3.08 million (or 5.7% of
total assets) the year earlier. The Bank's regulatory capital at year end was
$3.99 million or 9.43% of the Bank's total regulatory assets and the
risk-adjusted capital ratio of 13.5% exceeded the minimum regulatory risk-based
capital requirement of 8% of the risk-adjusted assets for the Bank. The
following table provides additional information about the risk-adjusted assets
of the Bank and University Bancorp's actual capital percentages:
-50-
<PAGE> 51
UNIVERSITY BANK
Risk-Based Capital Calculation
December 31, 1999
<TABLE>
<CAPTION>
Balance Risk Weighted
0% RISK CATEGORY Sheet (000) Assets (000)
----------------------------------
<S> <C> <C>
U.S. Treasury Securities 480 --
Mort-Backed Sec Guaran by GNMA 1 --
Currency & Coin 436 --
Federal Reserve Balance 26 --
------- -------
TOTAL 943 --
20% RISK CATEGORY
Interest-bearing Balances 23 5
Fed Funds Sold 9 2
U.S. Gov't sponsored Agency Sec 2,228 446
Cash Items 219 44
FHLB Stock 848 170
Balances due from depository Inst 890 178
------- -------
TOTAL 4,217 843
50% RISK CATEGORY
Municipal Revenue Obligation 494 247
Qualifying 1st liens on 1-4 family 12,175 6,088
------- -------
TOTAL 12,669 6,335
100% RISK CATEGORY
All other Assets 25,026 25,026
On Balance Sheet Items excluded from calculation:
Portion of Mortgage Servicing Rights 70 (123)
Unrealized Loss on Securities available for sale (585)
======= =======
TOTAL ASSETS 42,340 32,081
======= =======
TIER 1 CAPITAL
Common Stock 200
Surplus 4,433
Undivided Profits & Capital Reserves (1,151)
Minority Interest 579
Other identifiable Intangible Assets (70)
TOTAL TIER 1 CAPITAL 3,991
TIER 2 CAPITAL
Allowance for loans & Lease losses 532
Excess LLR (limited to 1.25% gross risk-weighted assets (123)
TOTAL TIER 2 CAPITAL 409
TOTAL TIER 1 & TIER 2 CAPITAL 4,400
TIER 1/TOTAL ASSETS 9.43%
TIER 1 & 2/TOTAL ASSETS 10.39%
TIER 1/TOTAL RISK-WEIGHTED ASSETS 12.44%
TIER 1 & 2/TOTAL RISK-WEIGHTED ASSETS 13.72%
</TABLE>
-51-
<PAGE> 52
IMPACT OF INFLATION
The primary impact of inflation on our operations is reflected in
increased operating costs. Since our assets and liabilities are primarily
monetary in nature, changes in interest rates have a more significant impact on
our performance than the general effects of inflation. However, to the extent
that inflation affects interest rates, it also affects our net income.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
All financial institutions are significantly affected by fluctuations in
interest rates commonly referred to as "interest rate risk." The principal
exposure of a financial institution's earnings to interest rate risk is the
difference in time between interest rate adjustments or maturities on
interest-earning assets compared to the time between interest rate adjustments
or maturities on interest-bearing liabilities. This difference is commonly
referred to as a financial institution's "gap position." In periods when
interest rates are increasing, a negative gap position will result in generally
lower earnings as long-term assets are repricing upward slower than short-term
liabilities. However during a declining rate environment, the opposite effect on
earnings is true, with earnings rising due to long-term assets repricing
downward slower than short-term liabilities.
Rising long term and short term interest rates tend to increase the
value of Midwest Loan Services' investment in mortgage servicing rights and
improve Midwest Loan Services' current return on these rights by lowering
required amortization rates on the rights. Rising interest rates tends to
decrease new mortgage origination activity, negatively impacting current income
from the Bank's retail mortgage banking operations and Varsity Mortgage's
operations. Rising interest rates also slow Midwest Loan Services' rate of
growth, but increases the duration of its existing subservicing contracts.
The Bank performs a software risk model to determine its overall exposure
to changes in interest rates. At December 31, 1999, the model predicts that the
Bank's average 12 month GAP as a % of Earning Assets was -4.01%. The model
predicts that in a 400 bp shift environment up that the Bank only has $41,000 of
annual net interest margin at risk, and $56,000 at risk in a down 400bp
environment.
However, the software model does not account entirely for the convexity of
the Bank's long term zero coupon Treasury securities, the optionality of the
Bank's Principal Only securities or our servicing rights which act as Interest
Only securities. The Bank's securities portfolio is designed to offset a portion
of the market value risk associated with the servicing rights. During 1999, the
change in market value of the servicing rights on the cash flow net present
value basis as calculated by management was an increase of $47,000, or an
increase of $261,259 net of booked amortization. The change in market value of
the servicing rights versus book based on management's estimate of market value
was an increase of $49,000, or an increase of $263,259 net of booked
amortization. During 1999, the bonds used for hedging decreased in value by
$280,896 to $1,710,029.
-52-
<PAGE> 53
The Bank also performs a static gap analysis which has limited value as a
simulation because of competitive and other influences that are both within and
beyond the control of the Bank. The table on page 54 details the Bank's interest
sensitivity gap between interest-earning assets and interest-bearing liabilities
at December 31, 1999. The table is based upon various assumptions of management
which may not necessarily reflect future experience. As a result, certain assets
and liabilities indicated in the table as maturing or re-pricing within a stated
period may, in fact, mature or re-price in other periods or at different
volumes. The one-year static gap position at December 31, 1999 was estimated to
be ($10,230,000) or -24.10%:
-53-
<PAGE> 54
UNIVERSITY BANK
Asset/Liability Position Analysis
($ in 000's)
Maturing or Repricing in
<TABLE>
<CAPTION>
3 Mos 91 Days to 1 - 3 3 - 5 Over 5 All
ASSETS or Less 1 Year Years Years Years Others Total
------ ------- ------ ----- ----- ----- ------ -----
<S> <C> <C> <C> <C> <C> <C> <C>
Short term investments 9 - - - - - 9
Loans, net 7,942 8,713 5,309 2,787 5,593 - 30,344
Non-Accrual Loans - - - - - 541 541
Securities - - 1 - 3,474 - 3,475
Other Assets - - 683 - 1,502 4,244 6,429
Cash & Due From Banks - 23 - - - 1,519 1,542
---------------------------------------------------------------------------
TOTAL ASSETS 7,951 8,736 5,993 2,787 10,569 6,304 42,340
---------------------------------------------------------------------------
LIABILITIES
CD's over $100,000 867 610 733 - 102 - 2,312
CD's under $100,000 7,309 4,087 1,384 7 691 - 13,478
MMDA 5,394 5,394 - - - - 10,788
NOW - - 3,067 - - - 3,067
Demand & Escrow - - - - - 2,130 2,130
Savings - - 295 - - - 295
Other Borrowings 3,114 - - - - - 3,114
Other Liabilities 142 - 1,339 289 - 3,436 5,206
Equity - - - - - 1,950 1,950
---------------------------------------------------------------------------
TOTAL LIABILITIES 16,826 10,091 6,818 296 793 7,516 42,340
---------------------------------------------------------------------------
GAP (8,875) (1,355) (825) 2,491 9,776 (1,212)
===========================================================================
CUMULATIVE
GAP (8,875) (10,230) (11,055) (8,564) 1,212 -
GAP
PERCENTAGE -20.96% -24.16% -26.11% -20.23% 2.86% 0.00%
</TABLE>
-54-
<PAGE> 55
The following repricing information is provided for the Bank's
investment portfolio, using book values, as of December 31, 1999:
Investment Portfolio Maturities (in $000s) and Yield by Type:
-------------------------------------------------------------
<TABLE>
<CAPTION>
Maturity or Repricing Interval
---------------------------------------------------------
Under 1 Year to 5 Years to More Than
One Year 5 Years 10 Years 10 Years
<S> <C> <C> <C> <C>
Treasuries and
Gov't Agencies
- Amount $ -0- $ 1 $ 490 $2,216
- Yield --% 7.38% 6.89% 4.41%
All Other Securities
- Amount $ -0- $ -0- $ -0- $ 503
- Yield --% --% --% 6.91%
</TABLE>
Additional information regarding the Bank's investments as of December
31, 1999 and 1998 is set forth under note 3 to our consolidated financial
statements included with this report.
The following information illustrates the maturities and sensitivities
of the Bank's loan portfolio to changes in interest rates as of December 31,
1999:
Loan Portfolio Maturities by Type (in $000s):
---------------------------------------------
<TABLE>
<CAPTION>
Maturity
----------------------------------------------------------
Under 1 Year to After 5
One Year 5 Years Years
<S> <C> <C> <C>
Commercial & Financial $3,750 $4,562 $4,003
Agricultural $ -0- $ -0- $ -0-
Real Estate:
Construction $1,007 $ -0- $ -0-
Mortgage (1) $2,754 $7,609 $1,404
Consumer $ 706 $2,339 $2,978
------ ------ ------
Total $8,217 $14,510 $9,573
</TABLE>
<TABLE>
<CAPTION>
Maturity Maturity
Under One Year Total
One Year or More Loans
<S> <C> <C> <C>
Total Variable Rate Loans $ 1,486 $12,848 $14,334
Total Fixed Rate Loans $ 2,852 $13,926 $16,778
Total Loans (1) $ 4,338 $26,774 $31,112
======= ======= =======
</TABLE>
(1) Excludes residential loans held for sale of $305, and the allowance for loan
losses.
-55-
<PAGE> 56
Year 2000 Readiness. The following statements are Year 2000 Readiness
Disclosures for purposes of the Federal Year 2000 Information and Readiness
Disclosure Act, and you are entitled to protection in accordance with that act.
The Year 2000 issue concerns the potential impact of computer software code that
only utilizes two digits to represent the calendar year (e.g. "99" for "1999").
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 future dates have a lower two digit year number than dates in this
century.
We renovated and tested as Year 2000 compliant all systems and have
experienced no Year 2000 problems. No additional Year 2000 costs or impacts are
anticipated.
INCOME TAXES
Income tax expense (benefit) in 1999 was $32,524, versus $(198,592) in
1998 and $(292,818) in 1997. The effective tax (benefit) rate was (3.7%) in
1999, (50.1)% in 1998 and (33.9)% in 1997. A tax benefit was realized in 1999,
1998 and 1997 for net operating loss carryforwards as a result of the net losses
from operations.
In February 1996, the Bank, through a subsidiary, purchased a
$1,000,000 interest in a partnership investment in Michigan Capital Fund for
Housing Limited Partnership I, a Michigan limited partnership, which invested in
federal low income housing tax credits. The initial investment consisted of a
$50,000 equity purchase and the execution by the subsidiary of a $950,000
promissory note held by this Partnership. Additional capital contributions are
made over time to reduce the balance of the note. The purchase of the tax
credits increased our deferred federal income tax assets in 1999, 1998 and 1997
and is expected to decrease the amount of federal income taxes we would
otherwise pay annually through 2005.
At December 31, 1999, we had available federal income tax loss
carryforwards that could be utilized to shelter approximately $2,200,000 in
taxable income, and carried a deferred tax asset on our books of $0, net of
deferred tax asset reserves of $750,218. If we are able to generate sufficient
taxable income in future years, the reserve against our deferred tax asset could
be reversed, resulting in an increase in future net income. However, if we do
not generate income in the future to utilize the existing deferred tax assets,
the amount of the reserve could be increased, resulting in a decrease in future
net income.
LEGAL PROCEEDINGS
From December 1995, we were engaged in a dispute over a $30,000 amount
owed to us, and refused to pay $45,000 which we owed to the same party until the
$30,000 was paid to us. During the third quarter of 1999, University Bancorp a
mediator ruled against us in this dispute awarding the plaintiff a sum of
$167,000, including interest, legal fees, and the sum of $80,000, which related
to another matter which was not originally in dispute and subject to a separate
agreement, which the mediator voided. As a result, $152,000 was charged as an
expense during the third quarter of 1999.
<PAGE> 57
Auditor's Opinion
(TO COME)
<PAGE> 58
UNIVERSITY BANCORP, INC.
----------------------
CONSOLIDATED FINANCIAL STATEMENTS
----------------------
DECEMBER 31, 1999, 1998, 1997
<PAGE> 59
Part 1. - Financial Information
Item 1.- Financial Statements
UNIVERSITY BANCORP, INC.
Consolidated Balance Sheets
December 31,1999 and 1998
<TABLE>
<CAPTION>
ASSETS 1999 1998
------------ ------------
<S> <C> <C>
Cash and due from banks $ 1,542,567 $ 703,015
Short term investments 8,753 8,543,000
------------ ------------
Total cash and cash equivalents 1,551,320 9,246,015
Securities available for sale at market 2,626,415 2,945,832
Federal Home Loan Bank Stock 848,400 848,400
Loans held for sale 305,049 11,862,665
Loans 31,112,496 23,652,103
Allowance for Loan Loss (532,585) (459,001)
------------ ------------
Loans, net 30,579,911 23,193,102
Premises and equipment 1,405,210 1,439,440
Mortgage servicing rights 704,164 948,208
Investment in and advances to
Michigan BIDCO -- 725,733
Other real estate owned 683,784 707,730
Net tax assets -- 377,088
Accounts receivable 159,584 1,198,661
Accrued interest receivable 234,252 115,703
Equity investments of Michigan BIDCO 892,965 --
Investment in Michigan Capital Fund LP I 656,904 756,904
Other assets 174,580 170,077
------------ ------------
TOTAL ASSETS $ 40,822,538 $ 54,535,558
============ ============
</TABLE>
-Continued-
-58-
<PAGE> 60
UNIVERSITY BANCORP, INC.
Consolidated Balance Sheets (continued)
December 31,1999 and 1998
<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY 1999 1998
------------- ------------
<S> <C> <C>
Liabilities
Deposits:
Demand - non interest bearing $ 2,126,157 $ 1,801,347
Demand - interest bearing 13,840,469 16,373,832
Savings 294,487 177,093
Time 15,789,866 24,867,369
------------ ------------
Total Deposits 32,050,979 43,219,641
Mortgage escrow 3,058 140,673
Short term borrowings 3,113,860 277,000
Long term borrowings 2,627,116 1,196,097
Deferred noncompete income -- 32,068
Drafts payable -- 5,065,281
Accounts payable 230,802 744,928
Accrued interest payable 240,106 415,060
Other Liabilities 100,442 157,081
------------ ------------
Total Liabilities 38,366,363 51,247,829
Minority Interest 505,795 204,949
Stockholders' equity:
Preferred Stock, $0.001 par value;
Authorized - 500,000 shares;
Issued - 0 shares in 1999 and 1998 -- --
Common stock, $0.01 par value;
Authorized - 2,500,000 shares;
Issued - 2,127,985 shares in 1999 and
2,104,323 shares in 1998 21,280 21,043
Treasury Stock - 115,184 shares in 1999
and 1998 (340,530) (340,530)
Additional Paid-in-Capital 3,786,508 3,539,474
Retained deficit (931,980) (16,500)
Accumulated other comprehensive loss (584,898) (120,707)
------------ ------------
Total Stockholders' equity 1,950,380 3,082,780
------------ ------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 40,822,538 $ 54,535,558
============ ============
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
-59-
<PAGE> 61
UNIVERSITY BANCORP, INC.
Consolidated Statements of Operations
For the Years Ended December 31, 1999, 1998 and 1997
<TABLE>
<CAPTION>
1999 1998 1997
------------ ----------- -----------
<S> <C> <C> <C>
Interest income:
Interest and fees on loans $ 2,623,863 $ 3,186,539 $ 3,584,371
Interest on securities:
U.S. Treasury Securities 13,212 18,144 --
U.S. Government agencies 116,283 67,338 238,190
Other securities 67,872 67,936 67,776
Interest on bank deposits 1,452 1,214 50,458
Interest on short term investments 53,529 123,810 304,693
----------- ----------- -----------
Total interest income 2,876,211 3,464,981 4,245,488
----------- ----------- -----------
Interest expense:
Interest on deposits:
Demand deposits 588,409 736,053 989,247
Savings deposits 4,799 3,900 13,745
Time certificates of deposit 1,071,991 1,444,236 1,672,477
Bank and other short term borrowings (207,138) 6,274 195,380
Long Term Notes Payable 190,117 88,893 108,195
----------- ----------- -----------
Total interest expense 1,648,178 2,279,356 2,979,044
----------- ----------- -----------
Net interest income 1,228,033 1,185,625 1,266,444
Provision for loan losses 92,648 110,055 260,000
----------- ----------- -----------
Net interest income after
provision for loan losses 1,135,385 1,075,570 1,006,444
----------- ----------- -----------
Other income:
Net security gains (losses) (15,477) 97,993 7,715
Service charges and fees 62,716 43,082 17,910
Loan origination and other fees 528,525 349,157 214,584
Gain on sale of mortgage loans 66,113 97,692 620,508
Loan servicing and subservicing fees 557,285 1,046,246 734,605
Profit(loss) from equity investment in
Michigan BIDCO 19,955 128,219 (55,499)
Merchant banking 897,036 -- --
Insurance & investment services 90,185 74,040 39,993
Other 82,788 293,065 239,905
----------- ----------- -----------
Total other income 2,289,126 2,129,494 1,819,721
----------- ----------- -----------
</TABLE>
-Continued-
-60-
<PAGE> 62
UNIVERSITY BANCORP, INC.
Consolidated Statements of Operations (continued)
For the Years Ended December 31, 1999, 1998 and 1997
<TABLE>
<CAPTION>
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Other expenses:
Salaries and wages $ 1,437,919 $ 1,258,476 $ 1,840,450
Employee benefits 322,751 297,748 303,369
Occupancy, net 249,855 354,082 359,633
Taxes other than income 2,942 25,800 31,126
Data processing and equipment expense 306,531 163,728 164,000
Correspondent bank service charges 12,685 24,077 42,617
Advertising 145,824 93,845 103,139
Supplies and postage 133,171 222,035 221,100
Net expense of other real estate owned 30,608 44,281 (782)
Legal and audit expense 423,633 364,969 274,093
Servicing rights amortization 214,259 530,466 322,530
Mortgage banking expense 156,467 93,403 144,705
Travel and entertainment 112,398 65,292 30,898
Insurance 48,793 37,493 26,887
Consultant fees 119,456 110,191 113,879
Other operating expenses 398,420 519,061 522,394
----------- ----------- -----------
Total other expenses 4,115,712 4,204,947 4,500,038
----------- ----------- -----------
Loss from continuing operations
before income taxes (691,201) (999,883) (1,673,873)
----------- ----------- -----------
Income taxes (benefit) 32,524 (198,592) (292,818)
----------- ----------- -----------
Net Loss from continuing operations (723,725) (801,291) (1,381,055)
Basic and diluted loss from continuing
operations per common share $ (0.34) $ (0.40) $ (0.72)
=========== =========== ===========
Discontinued operations (Note 2)
Income (loss) from Varsity Mortgage
& Varsity Funding (191,755) 603,242 263,131
Net loss $ (915,480) $ (198,049) $(1,117,924)
=========== =========== ===========
Basic and diluted loss per common share $ (0.44) $ (0.10) $ (0.58)
=========== =========== ===========
Weighted average shares outstanding 2,103,225 1,990,509 1,921,721
=========== =========== ===========
</TABLE>
-Continued-
-61-
<PAGE> 63
UNIVERSITY BANCORP, INC.
Statement of Comprehensive Income
For the Years Ended December 31, 1999, 1998 and 1997
<TABLE>
<CAPTION>
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
Net Loss ($ 915,480) ($ 198,049) ($1,117,924)
Other comprehensive income:
Unrealized gains/(losses) arising
during period (464,191) (201,477) 26,411
Less: reclassification adjustment
for accumulated losses/(gains)
included in net income 15,477 (97,993) (7,715)
----------- ----------- -----------
Other comprehenisve income/(loss),
before tax effect (448,714) (299,470) 18,696
Income tax effect on unrealized
losses/(gains) arising during period -- 68,502 (8,979)
Income tax effect on reclassification
adjustments -- 33,318 2,623
----------- ----------- -----------
Other comprehensive income/(loss),
net of tax (448,714) (197,650) 12,340
----------- ----------- -----------
Comprehensive loss (1,364,194) (395,699) (1,105,584)
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
-62-
<PAGE> 64
UNIVERSITY BANCORP, INC.
Consolidated Statements of Stockholders' Equity
For the years ended December 31, 1999, 1998, and 1997
<TABLE>
<CAPTION>
Common Stock $.01 Treasury Stock
Par Value
----------------------------------------------------
Number of Par Number of
Shares Value Shares Cost
----------------------------------------------------
<S> <C> <C> <C> <C>
Balance January 1, 1997 1,295,366 $ 12,954 (68,765) $ (300,883)
Issuance of shares weighted average at $6.43 per share 86,541 865 -- --
Exercised option shares at $3.13 per share 10,000 100 -- --
Purchase of shares at $7.37 per share -- -- (212) (1,563)
Net change in unrealized gain on securities available for sale, net of tax -- -- -- --
Net Loss -- -- -- --
----------- ----------- ----------- -----------
Balance December 31, 1997 1,391,907 13,919 (68,977) (302,446)
3 for 2 stock split 695,972 6,960 (34,489) --
Issuance of shares weighted average at $3.25 per share 16,444 164 -- --
Purchase of shares at $3.25 per share -- -- (11,718) (38,084)
Net change in unrealized loss on securities available for sale, net of tax -- -- -- --
Net Loss -- -- -- --
----------- ----------- ----------- -----------
Balance December 31, 1998 2,104,323 21,043 (115,184) (340,530)
Issuance of shares weighted average at $2.125 per share 23,662 237 -- --
Capital increase due to retirement of BIDCO shares -- -- -- --
Capital increase due to conversion of BIDCO bonds to BIDCO stock -- -- -- --
Net change in unrealized loss on securities available for sale -- -- -- --
Net Loss -- -- -- --
----------- ----------- ----------- -----------
Balance December 31, 1999 2,127,985 $ 21,280 (115,184) $ (340,530)
=========== =========== =========== ===========
</TABLE>
<TABLE>
<CAPTION>
Accumulated
Additional Other Total
Paid In Retained Comprehensive Stockholders
Capital Earnings Income Equity
------------------------------------------------------
<S> <C> <C> <C> <C>
Balance January 1, 1997 $ 2,906,389 $ 1,299,473 $ (5,164) $ 3,912,769
Issuance of shares weighted average at $6.43 per share 555,615 -- -- 556,480
Exercised option shares at $3.13 per share 31,150 -- -- 31,250
Purchase of shares at $7.37 per share -- -- -- (1,563)
Net change in unrealized gain on securities available for sale, net of tax -- -- 17,432 17,432
Net Loss -- (1,117,924) -- (1,117,924)
----------- ----------- ----------- -----------
Balance December 31, 1997 3,493,154 181,549 12,268 3,398,444
3 for 2 stock split (6,960) -- -- --
Issuance of shares weighted average at $3.25 per share 53,280 -- -- 53,444
Purchase of shares at $3.25 per share -- -- -- (38,084)
Net change in unrealized loss on securities available for sale, net of tax -- -- (132,975) (132,975)
Net Loss -- (198,049) -- (198,049)
----------- ----------- ----------- -----------
Balance December 31, 1998 3,539,474 (16,500) (120,707) 3,082,780
Issuance of shares weighted average at $2.125 per share 50,045 -- -- 50,282
Capital increase due to retirement of BIDCO shares 170,872 -- -- 170,872
Capital increase due to conversion of BIDCO bonds to BIDCO stock 26,117 -- -- 26,117
Net change in unrealized loss on securities available for sale -- -- (464,191) (464,191)
Net Loss -- (915,480) -- (915,480)
----------- ----------- ----------- -----------
Balance December 31, 1999 $ 3,786,508 $ (931,980) $ (584,898) $ 1,950,380
=========== =========== =========== ===========
</TABLE>
The accompanying footnotes are an integral part of the consolidated financial
statements.
-63-
<PAGE> 65
UNIVERSITY BANCORP, INC.
Consolidated Statements of Cash Flows
For the years ended December 31, 1999, 1998 and 1997
<TABLE>
<CAPTION>
1999 1998 1997
-------------- ------------- -------------
<S> <C> <C> <C>
Cash flow from operating activities:
Net loss $ (915,480) (198,049) $ (1,117,924)
Adjustments to reconcile net loss to net cash from Operating Activities:
Depreciation and amortization 471,906 321,275 663,076
Compensation Expense 50,282 53,455 36,322
Provision for loan loss 92,648 118,433 260,000
Mortgage loans originated for sale and securitization (236,141,300) (525,438,872) (396,723,436)
Proceeds from sale of loans 248,693,916 534,353,849 413,672,875
Net loss/(gain) on loan sales and securitization (995,000) (2,620,971) (2,564,188)
Gain on sale of home equity loans 0 0 (429,260)
Gain on disposal of fixed assets 0 (114,199) 0
Net amortization/accretion on securities 84,409 (23,718) 14,856
Loss/(Gain) on sale of securities available for sale 15,477 (97,993) (7,715)
Change in:
Investment in Michigan BIDCO, Inc. 725,733 16,936 73,121
Other real estate 23,946 (274,727) (166,924)
Increase/(Decrease) in other assets 500,148 187,886 (2,736,723)
Increase/(Decrease) in other liabilities (5,510,154) 2,282,686 (1,204,317)
------------- ------------- -------------
Net cash from (used in) operating activities 7,096,531 8,565,991 9,769,763
------------- ------------- -------------
Cash flow from investing activities:
Purchase of securities available for sale (980,412) (2,175,534) (1,890,921)
Proceeds from sales of securities available for sale 605,313 142,088 5,879,886
Proceeds from maturities and paydowns of securites available for sale 156,556 139,775 1,396,835
Capitalized mortgage servicing rights (129,992) (48,484) (275,680)
Proceeds from sale of servicing rights 159,777 530,466 835,396
Loans granted net of repayments (7,479,457) 4,403,695 (6,877,463)
Proceeds from disposal of assets 0 390,012 0
Premises and equipment expenditures (255,485) (80,609) (439,280)
------------- ------------- -------------
Net cash from (used in) investing activities (7,923,700) 3,301,409 (1,371,227)
------------- ------------- -------------
Cash flow used in financing activities:
Net increase (decrease) in deposits (11,168,662) (2,047,530) (4,673,360)
Payments of FHLB advances 0 0 (6,000,000)
Net increase(decrease) in mortgage escrow accounts (137,615) 53,987 (866)
Net increase (decrease) in other short term borrowings 2,836,860 (2,467,188) (9,234,578)
Principal payment/borrowings on notes payable 1,431,019 (552,973) 786,570
Issuance of common stock 0 53,444 551,408
Conversion of BIDCO bonds and buyout of minority interests 170,872 0 0
Purchase of treasury stock 0 (38,084) (1,563)
------------- ------------- -------------
Net cash from financing activities (6,867,526) (4,998,344) (18,572,389)
------------- ------------- -------------
Net change in cash and cash equivalents (7,694,695) 6,869,056 (10,173,853)
Cash and cash equivalents:
Beginning of period 9,246,015 2,376,959 12,550,812
------------- ------------- -------------
End of period $ 1,551,320 9,246,015 $ 2,376,959
============= ============= =============
Supplemental disclosure of cash flow information:
Cash paid for interest $ 2,141,515 2,151,058 $ 3,356,692
Supplemental disclosure of noncash investing activities:
Par value of mortgage loans securitized $ 24,603,694 48,236,448 $ 171,639,196
BIDCO conversion of bonds to common stock $ 26,117
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
-64-
<PAGE> 66
UNIVERSITY BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
1. Summary of significant accounting policies
Principles of Consolidation and Nature of Operations
The consolidated financial statements of University Bancorp, Inc. (the
Company) include the operations of its wholly-owned subsidiary,
University Bank (the Bank), the Bank's wholly-owned subsidiaries,
Varsity Funding Services, L.L.C. (Varsity Funding), Varsity Mortgage,
L.L.C. (Varsity Mortgage), University Insurance & Investment Services,
Inc. (Agency) and Arbor Street, L.L.C. (Arbor), 80.1% owned subsidiary,
Michigan BIDCO, Inc. (BIDCO) and 80% owned subsidiary, Midwest Loan
Services, Inc. (Midwest). The accounts are maintained on an accrual
basis in accordance with generally accepted accounting principles and
predominant practices within the banking industry. All significant
intercompany balances and transactions have been eliminated in
preparing the consolidated financial statements.
The Company is a bank holding company. The subsidiary bank, which is
located in Michigan, is a full service community bank, which offers all
customary banking services, including the acceptance of checking,
savings and time deposits. The Bank also makes commercial, real estate,
personal, home improvement, automotive and other installment, credit
card and consumer loans, and provides fee based services such as
annuity and mutual fund sales, stock brokerage and money management,
life insurance, property casualty insurance and foreign currency
exchange. The Bank considers its customer base to be primarily located
in the Ann Arbor, Michigan area. The Bank established its main office
in Ann Arbor in February 1996, by relocating from the eastern Upper
Peninsula of Michigan. The Ann Arbor office is the focus of the Bank's
future business development plan. The consolidated assets of the
Company of $40,822,538 as of December 31, 1999, primarily represent
commercial and retail banking activity as well as its mortgage banking
operation. Mortgage loans that have been sold into the secondary market
and are being serviced by the Bank and Midwest for others of
$64,000,000 as of December 31, 1999, are not included in the Company's
consolidated balance sheet. The Bank uses brokers to arrange time
deposits, and during 1999, a significant portion of the Bank's time
deposits were brokered deposits (See Note 8).
The Bank's operating subsidiary, Midwest, is engaged in the residential
home "mortgage banking" business. Midwest Loan Services began
operations in 1992 and was acquired by University Bank in December,
1995. Midwest is based in Houghton, Michigan, and is a specialist in
servicing residential mortgage loans for itself and other financial
institutions, including the Bank (See Notes, 5 & 11.) During 1999
University Bank sold its investment in two other mortgage banking
subsidiaries, Varsity Mortgage, LLC and Varsity Funding Services, LLC,
which were based in Farmington Hills, Michigan, and specialized in the
wholesale mortgage banking business, which involves the purchase, from
correspondents, and the sale to the secondary market, of conforming and
nonconforming residential loans, respectively (See Note 2).
The Agency is engaged in the sale of insurance products including life,
health, property and casualty, and investment products including
annuities, mutual funds, stock brokerage and money management. The
Agency is located in the Bank's Ann Arbor main office.
The Bank's 100%-owned subsidiary, Arbor Street LLC, has purchased a
$1,000,000 limited partnership investment representing $1,226,874 in
low-income housing tax credits through Michigan Capital Fund for
Housing Limited Partnership I with the assistance of $950,000 in
initial financing in the form of a loan from the General Partner,
Michigan Capital Fund for Housing.
The Company's loan portfolio is concentrated in Ann Arbor and Washtenaw
County, Michigan. While the loan portfolio is diversified, the
customers' ability to honor their debts is partially dependent on the
local economy. The Ann Arbor area is primarily dependent on the
education, healthcare, services, and manufacturing (automotive and
other) industries. Most real estate loans are secured by residential or
commercial real estate and business assets secure most business loans.
Generally, installment loans are secured by various items of personal
property. A large portion of time deposits consists of certificates of
deposit obtained through brokers and is subject to withdrawal (with
penalties for early withdrawal) in the future.
-65-
<PAGE> 67
UNIVERSITY BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
1. Summary of significant accounting policies (continued)
Michigan BIDCO, Inc.
The financial statements of Michigan BIDCO, Inc. are stated using the
prescribed accounting practices of investment companies. Until March
31, 1999, the Company's investment in Michigan BIDCO, Inc. (the BIDCO)
was accounted for under the equity method of accounting. Subsequent to
that date, the Company increased its ownership of the BIDCO and it
became a consolidated subsidiary of the Company. The Company owns 80.1%
of the BIDCO at December 31, 1999 (of which 75.3% was held by the Bank
and the balance by the Company), which began operations in May, 1993.
If there were a conversion of all outstanding convertible bonds, the
Bank and the Company would together own 26.59% and 12.17% at December
31, 1999 and 1998, respectively. In addition, upon conversion, certain
Company officers and directors and their immediate family (two of whom
serve as President and Chairman of the Company) would have an ownership
interest in the BIDCO of 55.4%. The conversion may take place, at the
election of the BIDCO, subsequent to any time that the BIDCO's equity
pursuant to an audit performed using generally accepted auditing
standards exceeds $1,500,000. Investments made by the BIDCO are
evaluated by management and carried at estimated fair value. Total
equity of the BIDCO was $1,519,547 at December 31, 1999. Management of
the BIDCO intends to call the bonds for conversion in early 2000.
Use of Estimates in Preparing Financial Statements: The preparation of
financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions based
upon available information. These estimates and assumptions affect the
reported amounts and disclosures. Actual results could differ from
those estimates.
The significant estimates incorporated into these consolidated
financial statements which are more susceptible to change in the near
term include the value of mortgage servicing rights, the allowance for
loan losses, the identification and valuation of impaired loans, the
equity interest in the fair value and the change in the fair value of
investments made by the BIDCO, the fair value of financial instruments,
and the valuation of deferred tax assets.
Cash flow reporting
For purposes of the Consolidated Statements of Cash Flows, cash and
cash equivalents is defined to include the cash on hand, non-interest
bearing deposits in other institutions, federal funds sold and other
investments with a maturity of three months or less when purchased. Net
cash flows are reported for customer loan and deposit transactions and
interest bearing deposits with other banks.
Securities
Securities are classified as held to maturity and carried at amortized
cost when management has the positive intent and ability to hold them
to maturity. Securities are classified as available for sale when they
might be sold before maturity. Securities available for sale are
carried at fair value, with unrealized holding gains and losses
reported in other comprehensive income. Realized gains are based on
specific identification of amortized cost. Securities are written down
to fair value when a decline in fair value is not temporary. Interest
income includes amortization of purchase premium or discount. Trading
securities are carried at fair value, with changes in unrealized
holding gains and losses included in income. Other securities such as
Federal Home Loan Bank stock are carried at cost.
Loans
Loans are reported at the principal balance outstanding, net of
unearned interest, deferred loan fees and costs, and an allowance for
loan losses. Interest income is reported on the interest method and
includes amortization of net deferred loan fees and costs over the loan
term. Interest income is not reported when full loan repayment is in
doubt, typically when payments are past due over 90 days. Payments
received on such loans are reported as principal reductions, unless all
interest and principal payments in arrears are paid in full.
-66-
<PAGE> 68
UNIVERSITY BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
1. Summary of significant accounting policies (continued)
Mortgage banking activities
Mortgage banking activities includes wholesale, retail and servicing
operations. Wholesale activities include the purchase of loans from
correspondents. The agreements with the correspondents and the degree
of underwriting the Bank performs on the loans determine whether the
loans are purchased with or without recourse. Mortgage loans held for
sale as part of the Bank's mortgage banking activities are valued at
the lower of cost or market as determined by bid prices for loans in
the secondary market. Certain loans are securitized into mortgage
backed trading securities. Upon securitization, the loans are
transferred at market value to trading securities, and a gain or loss
on securitization of loans is recorded. The Company sold its mortgage
wholesale subsidiaries Varsity Mortgage and Varsity Funding during 1999
and discontinued its wholesale activities.
Allowance for loan losses
The allowance for loan losses is a valuation allowance for probable
credit losses, increased by the provision for loan losses and decreased
by charge-offs, less recoveries. Management estimates the allowance
balance required based on past loan loss experience, known and inherent
risks in the portfolio, information about specific borrower situations
and estimated collateral values, economic conditions, and other
factors. Allocations of the allowance may be made for specific loans,
but the entire allowance is available for any loan that, in
management's judgment, should be charged-off.
Loan impairment is reported when full payment under the loan terms is
not expected. Impairment is evaluated in total for smaller-balance
loans of similar nature such as residential mortgage, consumer, and
credit card loans, and on an individual loan basis for other loans. If
a loan is impaired, a portion of the allowance is allocated so that the
loan is reported, net, at the present value of estimated future cash
flows using the loan's existing rate or at the fair value of collateral
if repayment is expected solely from the collateral. Loans are
evaluated for impairment when payments are delayed, typically 90 days
or more, or when it is probable that all principal and interest amounts
will not be collected according to the original terms of the loan.
Premises and equipment
Bank premises and equipment are stated at cost less accumulated
depreciation. Depreciation is computed primarily on the straight-line
method for bank premises and the accelerated methods for equipment and
land improvements over their estimated useful lives. These assets are
reviewed for impairment when events indicate the carrying amount may
not be recoverable.
Other real estate owned
Real estate properties acquired in collection of a loan are recorded at
fair value at the acquisition. Any reduction to fair value from the
carrying value of the related loan is accounted for as a loan loss.
After acquisition, a valuation allowance reduces the reported amount to
the lower of the initial amount or fair value less costs to sell.
Expenses, gains and losses on disposition, and changes in the valuation
allowance are reported in other expenses.
Servicing rights
Servicing rights represent both purchased rights and the allocated
value of servicing rights retained on loans originated and sold.
Servicing rights are expensed in proportion to, and over the period of,
estimated net servicing revenues. Impairment is evaluated based on the
fair value of the rights, using grouping of the underlying loans as to
type, term and interest rates. Any impairment of a grouping is reported
as a valuation allowance.
Income taxes
Income tax expense/benefit is the sum of the current year estimated tax
obligation or refund per the income tax return, and the change in the
estimated future tax effects of temporary differences and
carryforwards. Deferred tax assets or liabilities are computed by
applying enacted income tax rates to the expected reversals of
temporary differences between financial reporting and income tax
reporting, and by considering carryforwards for operating losses and
tax credits. A valuation allowance adjusts deferred tax assets to the
net amount that is more likely than not to be realized.
-67-
<PAGE> 69
UNIVERSITY BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
1. Summary of significant accounting policies (continued)
Retirement plan
The Bank has a 401-K Plan that allows an employee to contribute up to
15% of salary pre-tax, to the allowable limit prescribed by the
Internal Revenue Service. Management has discretion to make matching
contributions to the Plan. However, the Bank made no matching
contributions for the years ended December 31, 1999, 1998 and 1997.
Employees Stock Ownership Plan (ESOP)
The Company has a noncontributory ESOP covering all full-time employees
who have met certain service requirements. The employees' share in the
Company's contribution is based on their current compensation as a
percentage of the total employee compensation. As shares are
contributed to the plan they are allocated to employees and
compensation expense is recorded at the shares' fair value.
Stock options
No expense for stock options is recorded, as the grant price equals the
market price of the stock at grant date. Pro-forma disclosures show the
effect on income and earnings per share had the options' fair value
been recorded using an option pricing model.
Dividend restriction
Banking regulations require the maintenance of certain capital levels
and may limit the amount of dividends that may be paid by the bank to
the holding company or by the holding company to shareholders. In
addition, the Bank cannot pay a dividend until it has net retained
earnings. The retained deficit of the Bank at December 31, 1999 and
1998 was $1,162,012 and $624,615 respectively.
Earnings per share
Basic earnings per share is based on weighted-average common shares
outstanding. Diluted earnings per share further assumes issue of any
dilutive potential common shares. Earnings per share and share amounts
are restated for all subsequent stock dividends and splits.
Fair Values of Financial Instruments
Fair values of financial instruments are estimated using relevant
market information and other assumptions, as more fully disclosed in a
separate note. Fair value estimates involve uncertainties and matters
of significant judgment regarding interest rates, credit risk,
prepayments, and other factors, especially in the absence of broad
markets for particular items. Changes in assumptions or in market
conditions could significantly affect the estimates.
Comprehensive Income (Loss):
Comprehensive income (loss) includes both net income and the change in
unrealized gains and losses on securities available for sale.
Reclassifications
Certain items in the 1998 and 1997 financial statements and notes have
been reclassified to conform to the 1999 presentation.
Segment Reporting
The Company's segments are determined by the products and services
offered, primarily distinguished between banking and mortgage banking
operations. Loans, investments, and deposits provide the revenues in
the banking operation, and servicing fees, underwriting fees and loan
sales provide the revenues in mortgage banking. All operations are
domestic.
-68-
<PAGE> 70
UNIVERSITY BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
2. Discontinued Operations
In November 1999 the Company sold Varsity Mortgage in a transaction
that resulted in no gain or loss to the Company. In August 1999 the
Company sold Varsity Funding's operating subsidiary, MortgageQuest in a
transaction that resulted in no gain or loss to the Company.
Accordingly, the income statement reflects these disposals as
discontinued operations at December 31, 1999 with prior periods shown
comparatively. The following schedule discloses the reclassification
from the income statement:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Interest and fees on loans $527,136 $545,628 $490,623
Interest expense 318,383 79,330 229,039
Provision for loan losses 0 8,378 0
Mortgage banking income 1,722,568 4,328,993 3,679,648
Other income 42,433 45,878 12,265
Salaries and benefits 1,153,677 2,960,876 2,608,419
Occupancy 158,758 204,776 140,205
Data Processing 69,913 120,272 105,820
Supplies and postage 65,709 51,299 40,975
Mortgage banking expense 558,833 657,154 533,485
Travel and entertainment 22,537 68,269 100,398
Consultant fees 10,450 74,531 67,210
Other operating expenses 125,632 92,372 93,854
Pretax profit (loss) from discontinued
operations (191,755) 603,242 263,131
</TABLE>
3. Sale of branches and associated loans
On December 5, 1994 the Bank sold three branches, certain deposits and
associated loans to another bank. A portion of the sales price,
$175,000, was allocated to deferred income attributable to the
non-compete agreement. This deferred income was amortized into income
over the five-year term of the agreement. The agreement was fully
amortized as of December 31, 1999.
4. Securities available for sale
The following is a summary of the amortized cost and fair value of
securities available for sale at December 31, 1999 and 1998:
<TABLE>
<CAPTION>
December 31, 1999
-----------------
Amortized Gross Unrealized Fair
Cost Gains Losses Value
-------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. agency mortgage-backed $1,738,000 - $(368,000) $1,370,000
U.S. agency note 490,000 - (29,000) 461,000
U.S. Treasury 480,000 - (138,000) 342,000
Municipal obligations 503,000 - (50,000) 453,000
-------------------------------------------------------------------------------------------
Total securities
available for sale $3,211,000 $0 $(585,000) $2,626,000
========== == ========= ==========
</TABLE>
-69-
<PAGE> 71
UNIVERSITY BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
4. Securities available for sale (continued)
<TABLE>
<CAPTION>
December 31, 1998
-----------------
Amortized Gross Unrealized Fair
Cost Gains Losses Value
----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. agency mortgage-backed $2,191,000 $4,000 $(136,000) $2,059,000
Other mortgage-backed 421,000 4,000 - 425,000
U.S. Treasury 467,000 - (25,000) 442,000
Other equity 50,000 - (30,000) 20,000
----------------------------------------------------------------------------------------------------
Total securities
available for sale $3,129,000 $8,000 $(191,000) $2,946,000
========== ====== ========== ==========
</TABLE>
Investment securities with an amortized cost of approximately
$2,708,000 at December 31, 1999 and $3,128,000 at December 31, 1998
were pledged to secure certain borrowings.
<TABLE>
<CAPTION>
Sales of available for sale securities: 1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Proceeds $ 605,313 $ 142,088 $ 5,907,489
Realized Gains 2,504 97,993 70,881
Realized Losses 17,981 0 63,166
</TABLE>
The scheduled maturity date of the securities available for sale at
December 31, 1999 is:
<TABLE>
<CAPTION>
Amortized Fair
Cost Value
<S> <C> <C>
2000 $ 0 $ 0
2001-2004 1,000 1,000
2005-2009 490,000 461,000
After 2009 2,720,000 2,164,000
--------- ---------
$ 3,211,600 $ 2,626,000
=========== ===========
</TABLE>
5. Secondary market mortgage operations
The Bank, and its subsidiaries (including Midwest Loan Services,
Varsity Mortgage and Varsity Funding) originate, purchase, sell and
service single-family mortgage loans. During 1999, the Company sold
Varsity Mortgage and Varsity Funding, which comprised a large portion
of mortgage banking activity (See Note 2). The following summarizes the
secondary market activities of the Bank, Midwest, Varsity Funding and
Varsity Mortgage, for the years ended:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Origination and other fees $1,322,206 $2,154,871 $1,521,292
Gain on sale and securitization of mortgages 995,000 2,620,971 2,993,448
Loan servicing and subservicing fees 557,285 1,046,246 734,605
---------- ---------- ----------
Mortgage banking income 2,874,491 5,822,088 5,249,345
Interest income allocation 570,403 2,020,265 1,699,400
Interest expense allocation 366,817 (1,269,149) (1,332,100)
Operating expense allocation (3,800,753) (6,120,041) (5,326,328)
---------- ---------- ----------
Pretax profit (loss) from secondary market
mortgage operations $ (722,676) $ 453,162 $ 290,317
========== ========== ==========
</TABLE>
-70-
<PAGE> 72
UNIVERSITY BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
5. Secondary market mortgage operations (continued)
Certain assumptions were used to calculate the profit and loss from
secondary market activities. Interest income was calculated using the
average annual balance of loans held for sale at the Bank's average
yield on mortgage loans. Interest expense was calculated using the
average annual balance of loans held for sale, net of escrow balances,
at the Bank's average cost of funds rate. Operating expenses included
certain direct costs, but a significant portion is based upon
management's estimates using the best available information.
An analysis of the activities within loans held for sale:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Loans held for sale, January 1 $ 11,862,665 $ 18,156,671 $ 30,534,574
Origination or acquisition of loans held for sale 236,141,300 525,438,872 401,294,972
Sale of loans originated for sale (223,095,022) (483,496,430) (242,033,679)
Securitization of loans (24,603,694) (48,236,448) (171,639,196)
------------- ------------- -------------
Loans held for sale, December 31 $ 305,049 $ 11,862,665 $ 18,156,671
============= ============= =============
</TABLE>
The aggregate market value of the loans held for sale exceeded their
cost at December 31, 1999, 1998, and 1997, therefore a reserve for loss
is not required.
Mortgage loans serviced for other institutions are not included in the
accompanying consolidated balance sheets. Such mortgage loans have been
sold predominately without recourse or with limited recourse. At
December 31, the unpaid principal balance of these loans was
$64,366,000 in 1999, $95,588,000 in 1998 and $125,000,000 in 1997.
Midwest also provides sub-servicing of loans for other financial
institutions. At December 31, the unpaid principal balance of
sub-serviced loans was $352,238,000 in 1999, $116,179,291 in 1998 and
$321,896,000 in 1997.
Custodial balances maintained in connection with the foregoing loan
servicing were $6,457,126, $1,670,138, and $425,756 at December 31,
1999, 1998 and 1997, respectively.
Following is an analysis of the change in the asset balance of mortgage
servicing rights:
<TABLE>
<S> <C>
Balance, January 1, 1997 $ 2,312,436
Additions - Purchased 113,905
Additions - Originated 161,775
Bulk sale of servicing (835,396)
Amortization (322,530)
-----------
Balance, December 31, 1997 $ 1,430,190
Additions - Originated 48,484
Bulk sale of servicing 0
Amortization (530,466)
-----------
Balance, December 31, 1998 $ 948,208
Additions - Originated 129,905
Bulk sale of servicing (159,690)
Amortization (214,259)
-----------
Balance, December 31, 1999 $ 704,164
===========
</TABLE>
There was no valuation allowance necessary at December 31, 1999, 1998 or
1997.
-71-
<PAGE> 73
UNIVERSITY BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
6. Loans
Major classifications of loans are as follows as of December 31:
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Commercial $ 12,316,481 $ 7,931,824
Real estate - mortgage 11,766,587 8,658,285
Real estate - construction 1,006,710 1,572,522
Installment 6,022,718 5,489,472
------------ ------------
31,112,496 23,652,103
Allowance for loan losses (532,585) (459,001)
Net Loans $ 30,579,911 $ 23,193,102
============ ============
</TABLE>
Changes in the allowance for loan losses were as follows:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Balance, beginning of year $ 459,001 $ 520, 953 $ 297,783
Provision charged to operating expense 92,648 118,433 260,000
Recoveries 47,206 76,283 46,435
Charge-offs (66,270) (256,668) (83,265)
--------- ---------- ---------
Balance, end of year $ 532,585 $ 459,001 $ 520,953
========= ========== =========
</TABLE>
Past due and non-accrual loans at December 31 are as follows:
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Past due loans:
90 days and more and still accruing:
Real estate $ 93,883 $4,430
Installment loans 0 0
Commercial loans 123,688 0
-------- ------
$217,571 $4,430
======== ======
Non accrual loans:
Real estate $144,739 $ 467,402
Installment loans 0 0
Commercial loans 396,000 0
-------- --------
$540,739 $467,402
======== ========
</TABLE>
Information regarding impaired loans for the years ended December 31, is
as follows:
<TABLE>
<CAPTION>
Impaired loans: 1999 1998 1997
-------------- ---- ---- ----
<S> <C> <C> <C>
Loans with no allowance allocated $ 489,510 $0 $ 34,255
Loans with allowance allocated $51,229 $0 $314,201
Amount of allowance for loan losses allocated $7,684 $0 $10,085
Impaired loans:
Average balance during the year $489,551 $92,687 $227,345
Interest Income recognized thereon $ 2,548 7,079 1,097
Cash-basis interest income recognized $ 0 7,079 1,097
</TABLE>
Included in non-accrual and impaired loans at December 31, 1999 was one
$396,000 held by Michigan BIDCO. Michigan BIDCO uses the investment
company method of accounting where loans and investments are carried at
market value on the balance sheet. The original balance of this loan
was $791,076.
-72-
<PAGE> 74
UNIVERSITY BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
7. Premises and equipment
Classifications at December 31are summarized as follows:
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Land 132,931 $ 133,290
Buildings and improvements 1,011,300 991,001
Furniture, fixtures, and equipment 1,501,221 1,272,126
----------- -----------
2,645,452 2,396,423
Less: accumulated depreciation (1,240,242) (956,983)
----------- -----------
Net premises and equipment $ 1,405,210 $ 1,439,440
=========== ===========
</TABLE>
Depreciation expense amounted to $289,715, $269,698, and $242,376, for
the years ended December 31, 1999, 1998 and 1997, respectively.
The Bank leases its ATM Drive-thru location in Ann Arbor for $24,000
per year, and an office in Farmington Hills, previously occupied by
Varsity Mortgage for $24,000 per year. Midwest leases its office space
for a nominal amount from the city of Houghton, Michigan. Total rental
expense for the operating leases was $131,654 in 1999, $156,633 in
1998, and $131,774 in 1997. As of December 31, 1999, the Company had no
minimum rental commitments under non-cancelable operating leases. The
Bank had annual minimum rent as of December 31, 1999 of $48,000, with a
total minimum amount of future rent payable over the next 6 years of
$203,000.
The Bank remains contingently liable in the event that the purchaser of
one of its branch locations in Sault Ste. Marie does not meet its
future obligations to the lessor. As of December 31, 1999, management
believes that the purchaser was in compliance with these lease terms.
The annual base rent for such branch is currently $32,000, and the
future minimum rent due is $122,000.
The Bank remains contingently liable in the event that the purchaser of
the Varsity Mortgage location in Farmington Hills does not meet its
future obligations to the lessor. As of December 31, 1999, management
believes that the purchaser was in compliance with these lease terms.
The annual base rent for such office is currently $69,000, and the
future minimum rent due is $171,000.
8. Time deposits
Time deposit liabilities issued in denominations of $100,000 or more at
December 31, 1999 and 1998, were $9,381,072 and $15,445,336
respectively.
At December 31, 1999, stated maturities of time deposits were:
<TABLE>
<S> <C>
2000 $12,872,478
2001 1,694,517
2002 422,625
2003 5,482
2004 2,076
Thereafter 792,688
-----------
$15,789,866
===========
</TABLE>
At December 31, 1999 and 1998, the Bank had issued through brokers
$6,843,000 and $10,687,000 of time deposits with maturities ranging from
one to 60 month which are included in the table above.
Related party deposits totaled $618,403 and $278,003 at December 31,
1999 and 1998.
-73-
<PAGE> 75
UNIVERSITY BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
9. Stock options
Director Stock Options
In 1993, the Board of Directors approved the grant of options to
purchase 15,000 shares of common stock to each of the four
non-executive directors, in lieu of compensation. The exercise price of
options granted was set at $2.08 per share, which was the then current
bid price per share as reported by NASDAQ. The options are immediately
exercisable and expire July 19, 2003. No options were exercised in 1999
or 1998. Options covering 15,000 shares were exercised during 1997.
Options granted on 45,000 shares remain outstanding under this plan at
December 31, 1999.
1995 Stock Plan
In 1995, the Company adopted a stock option and stock award plan (the
1995 Stock Plan), which provides for the grant of incentive stock
options, as defined in Section 422(b) of the Internal Revenue Code of
1986, as amended, as well as the grant of non-qualified stock options
and other stock awards. The plan provides for the grant to officers,
directors and key employees of the Company, and independent contractors
providing services to the Company, of options to purchase and other
awards of common stock. The exercise price of options granted under the
plan shall be as determined by the Board of Directors, or a
compensation committee thereof. Options shall expire on the date
specified by the Board of Directors or such committee, but not more
than 10 years from the date of grant (or five years from the date of
grant for incentive stock options if the grantee owned 10% of the
Company's voting stock at the date of grant). Unless amended, the 1995
Stock Plan will terminate on November 15, 2005.
The following table summarizes the activity relating to options to
purchase the Company's common stock:
<TABLE>
<CAPTION>
Number of Weighted Average
Options Exercise Price
Per Share
<S> <C> <C>
Outstanding at January 1, 1997 450,750 $2.95
Granted - 1997 ($0.21 Fair Value) 140,700 3.67
Exercised - 1997 (37,753) 3.03
Forfeited - 1997 (93,750) 3.67
--------
Outstanding at December 31, 1997 459,947 3.05
--------
Granted - 1998 ($0.47 Fair Value) 67,500 3.00
Exercised - 1998 0 0
Forfeited - 1998 (346,697) 3.16
--------
Outstanding at December 31, 1998 180,750 2.83
-------- ----
Granted - 1999 ($0.92 Fair Value) 30,315 2.40
Exercised - 1999 0 0
Forfeited - 1999 (60,000) 3.00
Outstanding at December 31, 1999 151,065 $2.67
-------- -----
</TABLE>
Options outstanding have been restated for a 3 for 2 stock split in
1998. Options allowable for grant under the plan are not adjusted
without shareholder approval. Due to forfeitures in 1998 prior to the
split, the number of shares allowable for grant did not require
adjustment, and the number of options has remained within allowable
amounts.
-74-
<PAGE> 76
================================================================================
UNIVERSITY BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999, 1998 and 1997
9. Stock options (continued)
At December 31, 1999
<TABLE>
<CAPTION>
<S> <C>
Number of options immediately exercisable 114,065
Weighted average exercise price of immediately exercisable options $ 2.67
Range of exercise price of options outstanding $2.00 - $3.33
Weighted-average remaining life of options outstanding 3.0 years
</TABLE>
SFAS No. 123 requires pro forma disclosures for companies that do not
adopt its fair value accounting method for stock-based employee
compensation. Accordingly, the following pro forma information presents
net income and earnings per share had the Standard's fair value method
been used to measure compensation cost for stock options granted in
1996. Compensation cost recognized for stock options under APB No. 25
was $0 for 1999 and 1998, because options were granted at exercise
prices equal to the underlying stock prices at date of grant. At
year-end 1999, the Company had 169,370 shares authorized for future
grants.
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Estimated fair value stock options granted:
Assumptions used:
Risk-free interest rate 5.75% 4.55%
Expected option life 3.0 years 3.5 years
Expected stock price volatility 27.7% 36.2%
Expected dividends $ 0 $ 0
Pro-forma net loss and loss earnings per share,
assuming FAS 123 fair value method was used
for stock options:
Net Loss $(923,670) $(210,799)
Loss per share $(0.44) $(0.11)
</TABLE>
10. Employee stock ownership plan
The employees' allocation of ESOP assets is based on their current
compensation, after 1 year of service and upon reaching the age of
twenty-one. The annual contribution to the ESOP is at the discretion of
the Company. The assets of the ESOP are held in trust and were valued
at approximately $274,000 and $144,000 as of December 31, 1999 and
1998, respectively. The assets of the plan are comprised entirely of
91,462 and 67,800 shares of the Company's stock at December 31, 1999
and 1998, respectively, all of which were fully allocated at December
31, 1999. Upon retirement from the plan, participants have distributed
to them their allocated shares of the Company's stock.
The Company made additional contributions to the plan for the years
ended December 31, 1999, 1998, and 1997 of 23,662, 16,445, and 9,906
shares of common stock with an approximate fair market value at the
time of the contribution of $50,282, $53,445, and $36,322 respectively.
11. Minority Interest
The Bank owns an 80% interest in the common stock of Midwest Loan
Services, with the remaining 20% owned by the President of Midwest. At
December 31, 1999 and 1998, total common shareholders' equity of
Midwest was $1,016,949 and $1,024,746 resulting in a $203,390 and
$204,949 minority interest reflected on the Company's consolidated
balance sheet, respectively. The results of Midwest's operations for
1999 and 1998 are included in the Company's consolidated statement of
operations.
-75-
<PAGE> 77
UNIVERSITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999, 1998, AND 1997
11. Minority Interest (continued)
In April 1999, the Company and the Bank made additional investments in
the common stock of Michigan BIDCO bringing their combined ownership to
80.1%. At December 31, 1999, total common shareholders' equity of the
BIDCO was $1,519,546 resulting in a $302,405 minority interest reflected
on the Company's consolidated balance sheet, respectively. The results
of the BIDCO's operations for 1999 from April 1, 1999 forward are
included in the Company's consolidated statement of income, and the
results of BIDCO's operations are included on the equity method of
accounting prior to that date.
12. Commitments and contingencies
The Bank is party to financial instruments with off-balance sheet risk
in the normal course of business to meet the financing needs of its
customers. These financial instruments include commitments to buy, sell
and fund loans, letters of credit and unused lines of credit. The Bank's
exposure to credit loss in the event of non-performance is equal to or
less than the contractual amount of these instruments. The Bank follows
the same credit policy to make such commitments as that followed by
loans recorded in the consolidated financial statements. (1998 amounts
include commitments made by Varsity Mortgage Services).
The following is a summary of commitments as of December 31, 1999 and
1998:
<TABLE>
<CAPTION>
1999 1998
---------- -----------
<S> <C> <C>
Commitments to buy loans $ 0 $31,111,200
Commitments to sell loans 0 22,861,600
Unused lines of credit 3,757,000 7,010,000
</TABLE>
13. Related party transactions
The Company's Chairman and President also serve as officers and
directors of BIDCO. As such, the Chairman and President are actively
involved in BIDCO operations, including investment activity and
estimation of the fair value of investments. In addition, in the
ordinary course of business the BIDCO has invested in several limited
liability companies (LLCs), and the Chairman and President have also
personally invested in certain of the same LLCs.
In connection with the Arbor Street investment of $1,000,000 in federal
low-income housing tax credits through a partnership, the Bank was not
permitted by regulation to guarantee a $950,000 loan from the Michigan
Housing Development Authority to Arbor Street. The Chairman of the
Company instead personally guaranteed such loan, and common stock of the
Company held by a trust for the benefit of the President of the Company
was pledged as additional security for the loan.
14. Income taxes
The provision for federal income taxes is composed of the following
amounts:
<TABLE>
<CAPTION>
1999 1998 1997
------- --------- ---------
<S> <C> <C> <C>
Current expense (benefit) $ 0 $ 71,691 $(257,738)
Deferred expense (benefit) 32,524 (270,283) (35,080)
------- -------- ---------
Total year $32,524 $(198,592) $(292,818)
======= ========= =========
</TABLE>
-76-
<PAGE> 78
UNIVERSITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999, 1998, AND 1997
14. Income taxes (continued)
The net deferred tax asset at December 31, 1999 and 1998 is comprised of
the following:
<TABLE>
<CAPTION>
1999 1998
-------- ----------
<S> <C> <C>
Loans available for sale $ 0 $ 358
Accrual to cash (82,133) 0
Allowance for loan losses 126,843 92,042
Temporary differences from LLCs (328,577) 32,582
Non-accrual loan interest income 1,797 12,164
Net operating loss carry-forward 463,707 222,092
Tax credit carry-forward 515,114 400,511
Donation carry-forward 74,469 0
Installment sale (70,544) 0
Unrealized loss on investment available for sale 0 62,216
Other 38,896 0
--------- ---------
Deferred tax assets 873,866 821,965
=========
Unrealized gain on investments available for sale 0 0
Servicing rights (105,918) (65,971)
Other (17,730) (18,906)
-------- ---------
Deferred tax liabilities (123,648) (84,877)
-------- ---------
Net deferred tax asset $750,218 $ 737,088
Valuation allowance for deferred tax assets (750,218) (360,000)
-------- ---------
Net deferred tax asset $ 0 $ 377,088
-------- ---------
</TABLE>
The Company has net operating loss carry-forwards of approximately
$1,360,000 which expire beginning in 2012; and general business credit
carry-forwards of approximately $425,000 which expire beginning in 2011.
In addition, the Company has an alternative minimum tax (AMT) credit
carry-forward of approximately $90,000. Under current tax regulations,
the AMT credit can be carried forward indefinitely. Management has
established an allowance for deferred tax assets that are not considered
realizable at both December 31, 1999 and 1998.
The difference between the financial statement tax expense and amounts
computed by applying the statutory federal tax rate of 34% to pretax
income is reconciled as follows:
<TABLE>
<CAPTION>
1999 1998 1997
--------- ---------- ---------
<S> <C> <C> <C>
Statutory rate applied to income before taxes $(300,654) $ (134,858) $(479,652)
Add (Deduct):
Undistributed earnings of unconsolidated subsidiary (12,525) (38,837) 24,495
Tax Credits (122,000) (122,314) (118,742)
Change in valuation allowance 390,218 35,000 185,000
Other 77,485 62,416 96,081
--------- ---------- ---------
Current year provision (benefit) for income tax $ 32,524 $ (198,592) $(292,818)
========= ========== =========
</TABLE>
15. Short Term Borrowings
The Bank has a line of credit available from the Federal Home Loan Bank
(the FHLB) in the amount of $7,500,000. $3,113,860 was outstanding from
the FHLB at December 31, 1999. Borrowings are secured by the pledge of
specific mortgage loans held for investment with unpaid principal
balances of $4,594,879 and available-for-sale securities with a balance
of $2,708,000.
The Bank has a line of credit available from the Federal Reserve Bank of
Chicago (the FRB) in the amount of $5,252,000. There was no outstanding
on this line from the FRB at December 31, 1999. Borrowings are secured by
the pledge of specific commercial loans held for investment with unpaid
principal balances of $8,511,749.
-77-
<PAGE> 79
UNIVERSITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999, 1998 AND 1997
16. Long Term Borrowings
The Company has a note payable to North Country Bank & Trust (NCB&T)
secured by the stock of the Bank with a balance of $694,000 at December
31, 1999. The note has a maturity date of February 15, 2005. Interest is
payable quarterly at the prime rate of NCB&T plus 1.00 percent.
Principal payments required for the note are as follows:
<TABLE>
<CAPTION>
<S> <C>
2000 $132,000
2001 $132,000
2002 $132,000
2003 $132,000
2004 $132,000
Thereafter $ 34,000
--------
Total $694,000
========
</TABLE>
Dividends by the Bank to the holding company in excess of the prior
year's annual net income are not permitted without prior permission from
NCB&T under the terms of the Company's credit facility.
Arbor Street, LLC has an obligation of $506,116 at December 31, 1999
payable to the Michigan Housing Development Authority in connection with
its investment in a low-income housing limited partnership.
Payments are due on demand, but are expected to be funded as follows:
<TABLE>
<CAPTION>
<S> <C>
2000 $142,000
2001 $140,000
2002 $137,000
2003 $ 87,116
--------
Total $506,116
========
</TABLE>
Michigan BIDCO, Inc. issued $3,000,000 of 9% Convertible Senior Secured
bonds due January 15, 2002. During 1999, $1,877,000 of the convertible
bonds were retired, and there are now $1,123,000 of convertible bonds
outstanding. The BIDCO may convert the bonds to common stock and has
called for conversion or redemption effective March 31, 2000 the
remaining outstanding bonds.
During 1999 the Company issued $304,000 of Equity Conversion Notes.
Pursuant to a commitment to the Federal Reserve Bank of Chicago, the
notes will only be redeemed from the proceeds of the sale of additional
common stock, or will be converted into common stock. The notes bear
interest at the prime rate however all interest is deferred until
maturity and are due upon demand provided that a sale of common stock
has occurred. All of the equity conversion notes are held by related
parties at December 31, 1999.
17. Earnings per share
Due to the net losses in 1999, 1998, and 1997 the stock options
outstanding were considered anti-dilutive and are not included in
earnings per share calculations. As a result, both basic and diluted
earnings per share are equal to net loss divided by weighted average
common shares outstanding.
In February of 1998, the Company declared a 3 for 2 share stock split in
the form of a dividend. Calculated fractional shares were paid in whole
share amounts. All weighted average share numbers have been adjusted for
this stock split.
-78-
<PAGE> 80
UNIVERSITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999, 1998 AND 1997
18. Regulatory matters
The Bank is subject to regulatory capital requirements administered by
federal banking agencies. Capital adequacy guidelines and prompt
corrective action regulations involve quantitative measures of assets,
liabilities, and certain off-balance-sheet items calculated under
regulatory accounting practices. Capital amounts and classifications are
also subject to qualitative judgments by regulators about components,
risk weightings, and other factors, and the regulators can lower
classifications in certain cases. Failure to meet various capital
requirements can initiate regulatory action that could have a direct
material effect on the financial statements. The prompt corrective
action regulations provide five classifications, including well
capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized, and critically undercapitalized, although these terms
are not used to represent overall financial condition. If adequately
capitalized, regulatory approval is required to accept brokered
deposits. If undercapitalized, capital distributions are limited, as is
asset growth and expansion, and plans for capital restoration are
required. The minimum requirements are:
<TABLE>
<CAPTION>
Total capital to Tier 1 capital to Tier 1 capital to
risk-weighted assets risk-weighted assets to average assets
-------------------- -------------------- -----------------
<S> <C> <C> <C>
Well capitalized 10% 6% 5%
Adequately capitalized 8% 4% 4%
Undercapitalized 6% 3% 3%
</TABLE>
The Bank presently has an agreement with its regulators that no
dividends will be declared without prior regulatory approval, and the
tier 1 to average assets be at 7% or more.
At year-end, actual capital levels of the bank (in millions) and minimum
required levels to be well capitalized were:
<TABLE>
<CAPTION>
Total Capital to Tier 1 Capital to Tier 1 Capital to
Risk-Weighted Assets Risk-Weighted Assets Average Assets
-------------------- -------------------- --------------
Regulatory Actual Actual Regulatory Actual Actual Regulatory Actual Actual
Minimum Ratio Amount Minimum Ratio Amount Minimum Ratio Amount
------- ----- ------ ---------- ------ ------ ------- ----- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1999 10% 13.7% $4.4 6% 12.4% $4.0 5% 9.4 $4.0
1998 10% 13.1% $4.4 6% 11.8% $3.9 5% 7.2% $3.9
</TABLE>
At year-end 1999, the Bank was categorized as `well capitalized'.
19. Management's Plan Regarding Continuing Operations
At December 31, 1999, University Bancorp had a retained deficit of
$931,980 and recurring losses from operations for the past 3 years.
Future operations of University Bancorp are intended to continue.
Management has reviewed operating results, prepared projections of
possible future results, performed other analyses of its operations to
reduce operating costs and divested unprofitable subsidiaries.
Management of the Company has developed a plan to improve earnings by
divesting its unprofitable mortgage banking subsidiaries, growing the
loan portfolio of the core banking operation in Ann Arbor to gain
critical mass, and increasing money under management in the merchant
banking division by forming a Small Business Investment Company. The
Company's continued existence is dependent upon its ability to achieve
profitable operations and maintain adequate capital levels.
20. Fair Value of Financial Instruments
The following methods and assumptions were used to estimate fair values
for financial instruments. The carrying amount is considered to estimate
fair value for cash and short-term instruments, demand deposits,
short-term borrowings, accrued interest, and variable rate loans or
deposits that reprice frequently and fully. Securities fair values are
based on quoted market prices or, if no quotes are available, on the
rate and term of the security and on information about the issuer. For
fixed rate loans or deposits and for variable rate loan or deposits with
infrequent repricing or repricing limits, the fair value is estimated by
the discounted cash flow analysis using current market rates for the
estimated life and credit risk. Fair values for impaired loans are
estimated using discounted cash flow analyses
-79-
<PAGE> 81
UNIVERSITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999, 1998, 1997
20. Fair Value of Financial Instruments (continued)
or underlying collateral values, where applicable. Fair value of loans
held for sale is based on market estimates. Fair value of mortgage
servicing rights is estimated using discounted cash flows based on
current market interest rates net of estimated costs of servicing loans.
The fair value of debt is based on currently available rates for similar
financing. The fair value of off-balance sheet items is based on the
fees or cost that would normally be charged to enter into or terminate
such agreements. Fair value of unrecognized financial instruments
include commitments to extend credit and the fair value of letters of
credit are considered immaterial
The carrying amounts and fair values of the Company's financial
instruments were as follows:
<TABLE>
<CAPTION>
December 31, 1999
------------------------------
Carrying Fair
Amount Value
----------- ------------
<S> <C> <C>
Financial Assets
Cash and short term investments $ 1,551,000 $ 1,551,000
Securities Available for sale 2,626,000 2,626,000
Federal Home Loan Bank stock 848,000 848,000
Loans held for sale 305,000 305,000
Loans, net 30,580,000 31,035,000
Mortgage servicing rights 704,000 755,000
Accrued interest receivable 234,000 234,000
Mortgage subservicing rights 0 672,000
Financial Liabilities
Deposits 32,051,000 32,005,000
Mortgage escrow 3,000 3,000
Short term borrowings 3,114,000 3,114,000
Long term borrowings 2,768,000 2,768,000
Accrued interest payable 240,000 240,000
<CAPTION>
December 31, 1998
------------------------------
Carrying Fair
Amount Value
----------- ------------
<S> <C> <C>
Financial Assets
Cash and short term investments $ 9,246,000 $ 9,246,000
Securities Available for sale 2,946,000 2,946,000
Federal Home Loan Bank stock 848,000 848,000
Loans held for sale 11,863,000 12,007,000
Loans, net 23,193,000 23,452,000
Mortgage servicing rights 948,000 950,000
Accrued interest receivable 116,000 116,000
Financial Liabilities
Deposits 43,220,000 43,364,000
Mortgage escrow 141,000 141,000
Short term borrowings 277,000 277,000
Long term borrowings 1,196,000 1,196,000
Drafts Payable 5,065,000 5,065,000
Accrued interest payable 415,000 415,000
</TABLE>
-80-
<PAGE> 82
UNIVERSITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999, 1998, AND 1997
21. Segment Reporting
The Company's operations include three primary segments: banking,
merchant banking and mortgage banking. Through its banking subsidiary's
branch in Ann Arbor, the Company provides traditional community banking
services such as accepting deposits, making loans, and providing cash
management services to individuals and local businesses. Merchant
banking is conducted through Michigan BIDCO, which makes loans to
growing businesses. As additional consideration for the loans it makes,
BIDCO typically receives equity or options in each business. Mortgage
banking activities includes wholesale mortgage lending, retail mortgage
and servicing of residential mortgage loans for others. The wholesale
operations which were conducted through Varsity Mortgage and Varsity
Funding were sold in 1999 and the Company discontinued its wholesale
activities.
The Company's three reportable segments are strategic business units
that are separately managed as they offer different products and
services and have different marketing strategies. In addition, each of
the merchant banking segment and mortgage banking segment service a
different customer base than the banking segment.
The segment financial information provided below has been derived from
the internal profitability reporting system used by management to
monitor and manage the financial performance of the Company. The
accounting policies of the three segments are the same as those
described in the summary of significant accounting principles. The
Company evaluates segment performance based on profit or loss before
income taxes, not including nonrecurring gains and losses. Except for
the subsidiary corporations which operate independently such as Varsity
Mortage, Varsity Funding and Midwest Loan Services, certain indirect
expenses have been allocated based on actual volume measurements and
other criteria, as appropriate. The Company accounts for intersegment
revenue and transfers at current market prices.
Information about reportable segments for the year ended December 31,
1999 follows:
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------
Mortgage Merchant
Banking Banking Banking Totals
-----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest revenue $ 2,642,275 $ 570,403 $ 190,669 $ 3,403,347
Other non-interest income 282,600 2,874,491 897,036 4,054,127
Interest expense 1,488,019 366,817 111,725 1,966,561
Provision for loan losses 90,000 2,648 - 92,648
Salaries, wages & benefits 888,497 1,829,907 192,728 2,911,132
Occupancy 262,116 136,392 10,105 408,613
Data processing 285,817 82,877 7,750 376,444
Advertising 116,101 28,292 2,545 146,938
Legal and audit 191,663 215,885 16,086 423,633
Other operating expense 306,117 1,504,752 203,592 2,014,461
Income before tax expense (703,454) (722,676) 543,174 (882,956)
Income tax expense (benefit) (206,213) 7,706 231,031 32,524
Segment profit (497,241) (730,382) 312,143 (915,480)
Segment assets 35,997,640 1,596,457 3,228,441 40,822,538
Capital expenditures 195,409 39,626 7,681 242,716
Depreciation and amortization 200,975 80,990 7,750 289,715
-----------------------------------------------------------------------------------------------------
</TABLE>
-81-
<PAGE> 83
UNIVERSITY BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999, 1998 AND 1997
21. Segment Reporting (continued)
The For the year ended December 31, 1998:
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------
Mortgage
Banking Banking Other Totals
-----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest revenue $ 1,990,344 $ 2,020,265 $ 0 $ 4,010,609
Other revenue --- external 554,058 2,670,651 128,219 3,352,928
Customers
Interest expense 1,089,537 1,269,149 0 2,358,686
Other operating expense 5,590,558 1,992,197 0 7,582,755
Depreciation and amortization 225,618 95,657 0 321,275
Other significant non-cash items:
Provision for loan losses 82,500 35,933 0 118,433
Net gain on sale of loans 0 2,620,971 2,620,971
Impairment of mortgage
servicing rights
Income tax expense (198,592) 0 (198,592)
Segment profit (779,430) 453,162 128,219 (198,049)
Segment assets 23,844,259 30,033,543 657,756 54,535,558
Expenditures for additions to 51,437 29,172 0 80,609
Premises
-----------------------------------------------------------------------------------------------------
</TABLE>
Amounts presented in the "other" column reflect the Company's investment
in Michigan BIDCO. Segment profit is measured before allocation of
corporate overhead and income tax expense. Transactions between segments
are reported at cost (fair value). As discussed in Note 2, the Company
sold Varsity Mortgage and Varsity Funding during 1999. These
subsidiaries comprised a large portion of the mortgage banking activity.
Mortgage banking activities includes wholesale mortgage lending, retail
mortgage lending and servicing of residential mortgage loans for others.
-82-
<PAGE> 84
UNIVERSITY BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999 And 1998
21. University Bancorp (Parent Company Only) Condensed Financial Information
CONDENSED BALANCE SHEET
<TABLE>
<CAPTION>
December 31, December 31,
1999 1998
------------ ------------
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 15,834 $ 33,702
Securities available for sale 233 20,328
Michigan BIDCO senior convertible debentures -- 67,977
Investment in subsidiary Bank 2,885,704 3,736,157
Investment in Michigan BIDCO 73,397 --
Tax Assets -- 78,890
Other Assets 3,584 2,458
---------- ----------
Total Assets $2,978,752 $3,939,512
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Notes payable $ 998,000 $ 826,000
Accounts payable 5,293 13,325
Accrued interest payable 25,000 15,654
Tax Liabilities 79 --
---------- ----------
Total Liabilities 1,028,372 854,979
Stockholders Equity 1,950,380 3,084,533
---------- ----------
Total Liabilities and Stockholders Equity $2,978,752 $3,939,512
========== ==========
</TABLE>
CONDENSED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
1999 1998 1997
---------- --------- ---------
<S> <C> <C> <C>
Income:
Interest & dividends on investments $ 22,133 $ 21,190 $ 20,048
Net security gains (16,102) 97,993 41,155
Other income 355 59,743 88
--------- --------- ---------
Total Income 6,386 178,926 61,291
Expense:
Interest 78,392 88,894 108,195
Salaries & benefits 1,544 35,509 1,866
ESOP contributions 50,282 53,595 37,818
Public listing 24,126 23,806 59,123
Audit & legal 184,251 23,749 47,519
Other taxes 1,986 2,634 2,507
Occupancy & other miscellaneous 5,229 14,682 19,106
--------- --------- ---------
Total Expense 345,810 242,869 276,133
</TABLE>
-83-
<PAGE> 85
UNIVERSITY BANCORP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999 And 1998
21. University Bancorp (Parent Company Only) Condensed Financial Information
(continued)
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Income (loss) before federal income taxes
(benefit) and equity in undistributed
net income (loss) of subsidiaries (339,424) (63,943) (214,842)
Federal income taxes (benefit) 38,659 -- (70,472)
----------- ----------- -----------
Income (loss) before equity in
undistributed net income of subsidiaries (378,083) (63,943) (144,370)
Equity in undistributed net income (loss)
of subsidiaries (345,642) (737,348) (1,236,685)
----------- ----------- -----------
Net Loss from continuing operations (723,725) (801,291) (1,381,055)
Discontinued Operations:
Income (loss) from Varsity Mortgage and
Varsity Funding) (191,755) 603,242 262,131
----------- ----------- -----------
Net Loss $ (915,480) $ (198,049) $(1,118,924)
=========== =========== ===========
</TABLE>
-84-
<PAGE> 86
UNIVERSITY BANCORP, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements
December 31, 1999 And 1998
21. University Bancorp (Parent Company Only) Condensed Financial Information
(continued)
CONDENSED STATEMENT OF CASHFLOWS
<TABLE>
<CAPTION>
For Year Ended
1999 1998 1997
----------- ----------- ------------
<S> <C> <C> <C>
Reconciliation of net income (loss) to net cash used in
operating activities:
Net Income (Loss) $ (915,480) $ (198,049) $(1,117,924)
Contribution to ESOP 50,282 53,595 37,818
Loss(gain) on sale of investments 16,102 (97,993) (41,155)
Decrease/(Increase) in receivable from affiliate 0 790,572 675,465
Decrease/(Increase) in other assets 67,675 7,408 (660,594)
Increase(Decrease) in accounts payable (8,032) 195 5,175
Increase(Decrease) in other liabilities 9,346 (938,635) (90,022)
Decrease(Increase) investment in Michigan BIDCO (19,955) 0 0
Decrease(Increase) investment in subsidiaries 364,772 222,771 920,576
----------- ----------- -----------
Net cash provided by (used in) operating activities (435,290) (160,136) (270,661)
----------- ----------- -----------
Cash flow from investing activities:
Subsidiary dividends received 0 0 0
Contributions of capital to subsidiary 0 0 (350,000)
Advances to Michigan BIDCO 0 157,436 0
Purchase of available for sale securities 0 (50,000) (55,309)
Proceeds from sale of available for sale securities
and BIDCO debentures 74,550 179,497 166,498
----------- ----------- -----------
Net cash provided by (used in) investing activities 74,550 286,933 (238,811)
----------- ----------- -----------
Cash flow from financing activities:
Principal payment on notes payable (132,000) (96,687) (39,812)
Issuance of equity conversion bonds 304,000 0 0
Proceeds from sale of common stock 0 0 551,410
Purchase of treasury stock 0 (38,084) (1,563)
Capital increase from buy-out of minority interest in BIDCO 170,872 0 0
----------- ----------- -----------
Net cash provided by (used in) financing activities 342,872 (134,771) 510,035
----------- ----------- -----------
Net changes in cash and cash equivalents (17,868) (7,974) 563
Cash and cash equivalents:
Beginning of year 33,702 41,676 41,113
----------- ----------- -----------
End of period $ 15,834 $ 33,702 $ 41,676
=========== =========== ===========
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest $ 69,046 $ 88,699 $ 92,736
Income Tax 38,659 0 0
</TABLE>
-85-
<PAGE> 87
ITEM 8. - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements provided pursuant to this item are listed
under Item 14(a) below and appear beginning on page 57.
ITEM 9. - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES.
None.
PART III.
ITEM 10. - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is incorporated by reference
herein from the portions of the Company's Proxy Statement for its 2000 Annual
Meeting (the "Proxy Statement") to be under the captions:
Election of Directors
Executive Officers
Section 16(a) Beneficial Ownership Reporting Compliance
ITEM 11. - EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference
herein from the portions of the Company's Proxy Statement to be under the
captions:
Executive Compensation
Compensation Plans
ITEM 12. - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference
herein from the portion of the Company's Proxy Statement to be under the
caption:
Security Ownership of Certain Beneficial Owners and
Management
ITEM 13. - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference
herein from the portion of the Company's Proxy Statement to be under the
caption:
Certain Relationships and Related Transactions
-86-
<PAGE> 88
PART IV.
ITEM 14. - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORT ON FORM 8-K
(a) (1) Index of Financial Statements: The following financial
statements are filed as part of this Report:
Audited consolidated balance sheets as of December 31, 1999
and December 31, 1998, and consolidated statements of operations, stockholders'
equity and cash flows for the years ended December 31, 1999, 1998 and 1997, of
the Company.
(b) Reports on Form 8-K. None.
(c) Exhibits:
(3) Certificate of Incorporation and By-laws:
3.1 Composite Certificate of Incorporation of the Company, as
amended (incorporated by reference to Exhibit 3.1 to the Company's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1996 (the "June 30, 1996
10-Q")).
3.1.1 Certificate of Amendment, dated June 10, 1998, of the
Company's Certificate of Incorporation (incorporated by reference to Exhibit
3.1.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended June
30, 1998 (the "June 30, 1998 10-Q"))
3.2 Composite By-laws of the Company (incorporated by
reference to Exhibit 3.2 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1989 (the "1989 10-K")).
(10) Material Contracts.
10.1 Loan Agreement and Promissory Note dated December 31,
1997 issued to North Country Bank & Trust (incorporated by reference to Exhibit
10.1 to the Company's Annual Report on Form 10-K for the year ended December 31,
1997 (the "1997 10-K")).
10.2 University Bancorp, Inc. Employee Stock Ownership Plan
(the "ESOP"), as amended November 27, 1990 (incorporated by reference to Exhibit
10.2 to the Company's Annual Report on Form 10-K for the year ended December 31,
1990 10-K). *
10.2.1 Amendment to the ESOP, effective as of December 31,
1991 (incorporated by reference to Exhibit 10.2.A to the Company's Annual Report
on Form 10-K for the year ended December 31, 1991 10-K. *
10.3 University Bank 401(k) Profit Sharing Plan, adopted
August 1, 1996, effective as of January 1, 1996 (incorporated by reference to
Exhibit 10.3 to the Company's Annual Report on Form 10-K for the year ended
December 31, 1996 (the "1996 10-K")). *
-87-
<PAGE> 89
10.4 Letter regarding grant of options to outside directors,
dated as of July 20, 1993 (incorporated by reference to Exhibit 10.6 to the
Company's Annual Report on Form 10-K for the year ended December 31, 1993 (the
"1993 10-K")). *
10.5 1995 Stock Plan of the Company (incorporated by reference
to Exhibit A to the definitive Proxy Statement of the Company for 1996 Annual
Meeting of Stockholders (the "1996 Proxy")). *
10.5.1 Form of Stock Option Agreement related to the 1995
Stock Plan (incorporated by reference to Exhibit 10.7.1 to the Annual Report on
Form 10-K for the year ended December 31, 1995 (the "1995 10-K")). *
10.6 Letter, dated December 1, 1989, from Federal Reserve Bank
of Minneapolis (incorporated by reference to Exhibit 10.9 to the 1989 10-K).
10.7 Lease Agreement (the "Cascade Lease Agreement") between
RG Properties, Inc., as agent for Sault Associates, a Michigan Limited
Partnership, and University Bank, dated September 30, 1992 (incorporated by
reference to exhibit 10.9 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1992 (the "1992 10-K").
10.7.1 First Amendment to the Cascade Lease Agreement, dated
January 5, 1993 (incorporated by reference exhibit 10.9.1 to the 1992 10-K).
10.8 Federal Income Tax Allocation Agreement Between Newberry
State Bank and Newberry Holding Inc. dated March 21, 1992 (incorporated by
reference to Exhibit 10.11 to the 1991 10-K).
10.8.1 Federal Income Tax Allocation Agreement Between
Newberry Holding Inc. and University Bancorp, Inc. dated May 21, 1991
(incorporated by reference to Exhibit 10.11.1 to the 1991 10-K).
10.9 Purchase and Sale Agreement, dated November 1, 1995,
concerning Common Stock of Midwest Loan Services, Inc., among its shareholders
and University Bank and Newberry Bancorp, Inc (incorporated by reference to
Exhibit 10.16 of the 1995 10-K).
10.10 Equity Conversion Note Agreements, between various
related parties and University Bancorp, Inc. (incorporated by reference to
Exhibit 10.15 of the Company's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1999 (the "September 30, 1999 10-Q"))
-88-
<PAGE> 90
10.10.1 Equity Conversion Note Agreements, between various
related parties and University Bancorp, Inc.
* Each of the exhibits noted by an "*" is a management compensatory plan or
arrangement.
(21) Subsidiaries of Registrant: List of subsidiaries filed herewith.
(27) Financial Data Schedule (EDGAR version only)
-89-
<PAGE> 91
SIGNATURES
Pursuant to the requirements of Sections 13 or 15(d) 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.
By: /s/Stephen Lange Ranzini
----------------------------
Stephen Lange Ranzini,
President, Chief Executive
Officer and
Chief Accounting Officer
Date: March 30, 2000
---------------
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/Stephen Lange Ranzini Director, President, March 30, 2000
- ------------------------ Chief Executive Officer,
Stephen Lange Ranzini Chief Accounting Officer
/s/Joseph L. Ranzini Director, Secretary, March 30, 2000
- ------------------------ Chairman
Joseph L. Ranzini
/s/Keith Brenner Director March 30, 2000
- ------------------------
Keith E. Brenner
/s/Mildred Lange Ranzini Director March 30, 2000
- ------------------------
Mildred Lange Ranzini
/s/Michael Talley Director March 30, 2000
- ------------------------
Michael Talley
/s/Robert Goldthorpe Director March 30, 2000
- ------------------------
Robert Goldthorpe
/s/Dr. Joseph L. Ranzini Director March 30, 2000
- ------------------------
Dr. Joseph Lange Ranzini
/s/Paul Lange Ranzini Director March 30, 2000
- ------------------------
Paul Lange Ranzini
</TABLE>
-90-
<PAGE> 92
Index of Exhibits
<TABLE>
<CAPTION>
Sequentially
Exhibit No. and Description Numbered Page
--------------------------- -------------
<S> <C> <C>
(3) Certificate of Incorporation and By-laws:
3.1 Composite Certificate of Incorporation of the Company, as amended
(incorporated by reference to Exhibit 3.1 to the June 30, 1996 10-Q").
3.1.1 Certificate of Amendment, dated June 10, 1998, of the Company's
Certificate of Incorporation (incorporated by reference to Exhibit
3.1.1 to the June 30, 1998 10-Q").
3.2 Composite By-laws of the Company (incorporated by reference to Exhibit
3.2 to the 1989 10-K).
(10) Material Contracts.
10.1 Loan Agreement and Promissory Note dated December 31, 1997 issued to
North Country Bank & Trust (incorporated by reference to Exhibit 10.1
to the 1997 10-K"))
10.2 University Bancorp, Inc. Employee Stock Ownership Plan (the "ESOP"), as
amended November 27, 1990 (incorporated by reference to Exhibit 10.2 to
the 1990 10-K).
10.2.1 Amendment to the ESOP, effective as of December 31, 1991 (incorporated
by reference to Exhibit 10.2.A to the 1991 10-K).
10.3 University Bank 401(k) Profit Sharing Plan, adopted August 1, 1996,
effective as of January 1, 1996 (incorporated by reference to Exhibit
10.3 to the 1996 10-K).
10.4 Letter regarding grant of options to outside directors, dated as of
July 20, 1993 (incorporated by reference to Exhibit 10.6 to the
Company's Annual Report on Form 10-K for the year ended December 31,
1993 (the "1993 10-K")).
10.5 1995 Stock Plan of the Company (incorporated by reference to Exhibit A
to the definitive Proxy Statement of the Company for the 1996 Annual
Meeting of Stockholders (the "1996 Proxy).
10.5.1 Form of Stock Option Agreement related to the 1995 Stock Plan
(incorporated by reference to Exhibit 10.7.1 to the 1995 10-K).
</TABLE>
-91-
<PAGE> 93
<TABLE>
<S> <C> <C>
10.6 Letter, dated December 1, 1989, from Federal Reserve Bank of
Minneapolis (incorporated by reference to Exhibit 10.9 to the 1989
10-K).
10.7 Lease Agreement (the "Cascade Lease Agreement") between RG Properties,
Inc., as agent for Sault Associates, a Michigan Limited Partnership,
and University Bank, dated September 30, 1992 (incorporated by
reference to exhibit 10.9 to the
1992 10-K).
10.7.1 First Amendment to the Cascade Lease Agreement, dated January 5, 1993
(incorporated by reference exhibit 10.9.1 to the 1992 10-K).
10.8 Federal Income Tax Allocation Agreement Between
Newberry State Bank and Newberry Holding Inc. dated
March 21, 1992 (incorporated by reference to
Exhibit 10.11 to the 1991 10-K).
10.8.1 Federal Income Tax Allocation Agreement Between
Newberry Holding Inc. and University Bancorp, Inc.
dated May 21, 1991 (incorporated by reference to
Exhibit 10.11.1 to the 1991 10-K).
10.9 Purchase and Sale Agreement, dated November 1, 1995, concerning Common
Stock of Midwest Loan Services, Inc., among its shareholders and
University Bank and Newberry Bancorp, Inc (incorporated by reference to
Exhibit 10.16 of the
1995 10-K).
10.10 Equity Conversion Note Agreements, between various related parties and
University Bancorp, Inc. (incorporated by reference to Exhibit 10.15 of
the September 30, 1999 10-Q).
10.10.1 Equity Conversion Note Agreements, between various
related parties and University Bancorp, Inc. 93
(21) Subsidiaries of Registrant. 95
(27) Financial Data Schedule 96
</TABLE>
-92-
<PAGE> 1
EXHIBIT 10.10.1
959 Maiden Lane
Ann Arbor, MI 48105
November 30, 1999
NOTE
For value received, University Bancorp, Inc. (the ("Obligor") promises
to pay to Mildred Lange Ranzini Trust (the "Holder" or "Lender"), on your order,
at the address above, the principal sum of: SIX THOUSAND ONE AND NO/100 Dollars
($6,001.00).
1. Payment. Obligor will make no periodic payments under this note,
with a Final Payment in the amount of the principal plus all accrued interest at
maturity. The amount of the Final Payment shall be paid solely through the sale
of common stock of University Bancorp, Inc. by the Obligor (subject to
completion of a separate private placement agreement in accordance with the
rules of the Securities & Exchange Commission), in the event that an anticipated
rights offering of University Bancorp, Inc. common stock is not completed prior
to maturity.
2. Interest. Interest accrues on a Actual/365 basis. Post-maturity
interest will accrue at the same rate as prior to maturity on the balance of
this note not paid at maturity, including maturity, including maturity by
acceleration. Interest shall be accrued but not paid until maturity from
November 30, 1999 at the Wall Street Journal Prime Rate of 8.50% until maturity.
3. Purpose. The purpose of this loan is to fund working capital
requirements of the Obligor.
4. Security. This note is unsecured.
5. Prepayment. If Obligor pays off this Note early, it will not have to
pay a penalty.
6. Signatures. Obligor agrees to the terms set out on page 1 and page 2
of this agreement. Obligor has received a copy of this document on today's date.
Signature: University Bancorp, Inc.
By: /s/Stephen Lange Ranzini
---------------------------------
Its: President & CEO
Mildred Lange Ranzini
By: /s/Mildred Lange Ranzini
---------------------------------
-93-
<PAGE> 2
959 Maiden Lane
Ann Arbor, MI 48105
February 10, 2000
NOTE
For value received, University Bancorp, Inc. (the ("Obligor") promises
to pay to Mildred Lange Ranzini Trust (the "Holder" or "Lender"), on your
korder, at the address above, the principal sum of: SIXTY-ONE THOUSAND AND
NO/100 Dollars ($61,000.00).
1. Payment. Obligor will make no periodic payments under this note,
with a Final Payment in the amount of the principal plus all accrued interest at
maturity. The amount of the Final Payment shall be paid solely through the sale
of common stock of University Bancorp, Inc. by the Obligor (subject to
completion of a separate private placement agreement in accordance with the
rules of the Securities & Exchange Commission), in the event that an anticipated
rights offering of University Bancorp, Inc. common stock is not completed prior
to maturity.
2. Interest. Interest accrues on a Actual/365 basis. Post-maturity
interest will accrue at the same rate as prior to maturity on the balance of
this note not paid at maturity, including maturity, including maturity by
acceleration. Interest shall be accrued but not paid until maturity from
February 10, 2000 at the Wall Street Journal Prime Rate of 8.75% until maturity.
3. Purpose. The purpose of this loan is to fund working capital
requirements of the Obligor.
4. Security. This note is unsecured.
5. Prepayment. If Obligor pays off this Note early, it will not have to
pay a penalty.
6. Signatures. Obligor agrees to the terms set out on page 1 and page 2
of this agreement. Obligor has received a copy of this document on today's date.
Signature: University Bancorp, Inc.
By: /s/Stephen Lange Ranzini
---------------------------------
Its: President & CEO
Mildred Lange Ranzini Trust
By: /s/Stephen Lange Ranzini
---------------------------------
Its: Trustee
-94-
<PAGE> 1
EXHIBIT 21
Exhibit 21. Subsidiaries of Registrant.
University Bank, a Michigan state chartered bank.
Michigan BIDCO, Inc., a Michigan Corporation (4.84% owned by the
Corporation and 75.27% owned by the Bank)
Midwest Loan Services, Inc., a Michigan Corporation (80% owned by
Bank)
University Insurance & Investment Services, Inc., a Michigan
Corporation (100% owned by Bank)
-95-
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> DEC-31-1999
<CASH> 1,542,567
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 8,753
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 3,474,815
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 31,112,496
<ALLOWANCE> (532,585)
<TOTAL-ASSETS> 40,822,538
<DEPOSITS> 32,050,979
<SHORT-TERM> 3,113,860
<LIABILITIES-OTHER> 574,408
<LONG-TERM> 2,627,116
0
0
<COMMON> 21,280
<OTHER-SE> 1,929,100
<TOTAL-LIABILITIES-AND-EQUITY> 40,822,538
<INTEREST-LOAN> 2,623,863
<INTEREST-INVEST> 197,367
<INTEREST-OTHER> 54,981
<INTEREST-TOTAL> 2,876,211
<INTEREST-DEPOSIT> 1,473,681
<INTEREST-EXPENSE> 1,648,178
<INTEREST-INCOME-NET> 1,228,033
<LOAN-LOSSES> 92,648
<SECURITIES-GAINS> (15,477)
<EXPENSE-OTHER> 4,204,947
<INCOME-PRETAX> (915,480)
<INCOME-PRE-EXTRAORDINARY> (915,480)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (915,480)
<EPS-BASIC> (0.44)
<EPS-DILUTED> (0.44)
<YIELD-ACTUAL> 3.42
<LOANS-NON> 540,739
<LOANS-PAST> 217,571
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 540,739
<ALLOWANCE-OPEN> 459,001
<CHARGE-OFFS> 66,270
<RECOVERIES> 47,206
<ALLOWANCE-CLOSE> 532,585
<ALLOWANCE-DOMESTIC> 532,585
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 97,236
</TABLE>
