University Bank Expanding Islamic Finance

September 16, 2005
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GRAND RAPIDS — Only a handful of financial institutions in the country offer what is referred to as an Islamic mortgage, and one of the earliest pioneers of the movement is located right here in Michigan.

Two years ago, University Bank in Ann Arbor became the first in the state to offer Muslims no-interest financing options. It closed its first Islamic mortgage in July 2003 and currently has more than $12 million in Islamic mortgages on the books.

Islamic mortgages are designed to help America’s devout Muslims realize the American dream of homeownership, while at the same time observing traditional Islamic restrictions against paying interest on mortgages and other types of debt. The Quran forbids adherents of the religion of Islam from paying or receiving interest.

Freddie Mac, Standard Federal Bank and Detroit-based United Mortgage of America actually developed the initiative and introduced it in August 2001. Freddie Mac launched Islamic home financing through American Finance House-LARIBA in 15 states, including Michigan.

Standard Federal, now LaSalle Bank, had a program in place for a short while, said Robert Darmanin, LaSalle’s vice president and director of corporate relations.

“Right now we don’t have a program that’s active,” he said. “We tried it, and it’s very complex. It was so complex that we kind of stepped back from it, and we’re taking a look at what else is out there. We’re still interested in Islamic mortgages, but we had to pull back on that program.”

University Bank currently offers a lease-to-own (ijara) method of Islamic finance and hopes to offer an installment credit sale (murabaha) method in the future.

In a lease-to-own arrangement, the bank forms an individual trust entity and buys the home on behalf of the lessee, and the trust holds the title to the home. The programs are open to any potential home-buyer of any religion. But they are not a better deal, they just conform to the Islamic standards.

“On the closing cost side it is slightly more expensive as far as what your monthly payment would come out to be,” said Mushir Khwaja, one of four Islamic bankers on University’s staff. “On these transactions there are additional closing costs that arise from setting up an individual trust to purchase the home.

“It depends on what our lease rates are at the time compared to conventional interest rates. We’ve seen it be quite competitive. It doesn’t necessarily cost more on your monthly payment, per se.”

Khwaja said the bank has a trust participation certificate for its investors and that’s what allows the bank to securitize the transaction on the secondary market and get secondary market investors for it.

Under an installment credit sale arrangement, the bank purchases the home and then sells it to the buyer at a markup. The bank initially holds title to the property, and the title reverts to the buyer once he purchases the home.

The same type of arrangements can be used by Muslims to buy commercial real estate property, for commercial construction and to purchase business equipment, Khwaja noted.

“We are looking to offer it on the commercial side but we’re not able to do that as of right now,” he said. “But we’re definitely looking to provide that service in the future.”

Another method of Islamic finance is co-ownership (musharaka), which University Bank does not offer. In a co-ownership arrangement, the bank forms an LLC and buys the home in partnership with the buyer, and the LLC and the buyer jointly own the title to the home.

It took a lot of work to set up the Islamic finance program, Khwaja acknowledged, and it required the creation of some very unique documents.

Since ijara, murabaha and musharaka are faith-based products, Islamic scholars as well as legal counsel are needed to develop carefully tailored financing documents and program specifications to ensure they satisfy Islamic principals, as well as state and local law.

Such products are backed by a fatwa, which is a written and signed legal statement in Islam that’s issued by a religious law specialist to document legitimacy.

“So a bank in Grand Rapids that chose to offer Islamic mortgages would have to have a religious group of scholars who said that their process and the documents they were using were religiously acceptable,” explained Robert Sickler, a University Bank spokesman.

Khwaja said University has all of its unique documents pretty much automated, so processing an Islamic mortgage doesn’t take much more time and effort than it might on any other conventional mortgage.

To the bank’s knowledge, it’s the only financial institution in the country that offers an FDIC-insured, Islamic acceptable, Sharia compliant deposit product that is interest free, as well.

The deposit product allows clients to invest their deposits into University’s home acquisition portfolio, either in a money market account or a certificate of deposit. Khwaja said those deposits support the Islamic home financing products.

“All the money that is placed into a money market or CD account is actually used to back fund our home financing portfolio, which is a little bit over $12 million. We keep all of that on our own books, and any money we receive in those specific accounts, we will slowly invest it in the homes that have been purchased through our Islamic banking division.”

University Bank is able to offer its Islamic finance products throughout Michigan and Virginia.

“When we do, hopefully, expand to include the installment credit sale method of financing, we will definitely be looking to expand to other states where we are able to offer both products. We’ll be looking to expand first in the Midwest, then move on from there.”

Since the program’s inception, some 55 homes have been purchased through the Islamic banking division, most of them in southeast Michigan. Khwaja estimates that only about five of the homes purchased through the program are in Ann Arbor.

University Bank has four competitors in the Islamic mortgage market: Guidance Financial of Virginia, Devon Bank of Illinois, LaRiba of California and HSBC of New York.

Demographers estimate that more than 8 million Muslims livein the United States. According to the American Islamic Chamber of Commerce, Michigan’s Muslim population is the second highest in the nation. An estimated 490,000 Arab Americans reside in Michigan, and about half of Arab Americans are Muslim.

Islamic Chamber statistics show that the highest concentrations of Arab Americans in Michigan are in Wayne County (39 percent), Oakland County (26 percent) and Macomb County (17 percent). Kent County is home to 2.5 percent of Michigan’s Arab-American residents.

“What we have found is that if you have a hospital, you have a Muslim population,” said University Bank’s Sickler.

In an effort to remove any roadblocks in the way of Islamic mortgages, Michigan’s Office of Financial and Insurance Services issued a bulletin in July stating that an individual purchasing a home with an Islamic mortgage is technically classified as a “homeowner,” thus is eligible to purchase the traditional homeowner’s insurance policy required to close a mortgage.  

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