INDIANA 35-1286807
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
500 WASHINGTON STREET COLUMBUS, INDIANA 47201
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(812) 376-1909
(CORPORATION'S TELEPHONE NUMBER, INCLUDING AREA CODE)
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TITLE OF CLASS: COMMON STOCK*
TITLE OF CLASS: 9.25% CUMULATIVE TRUST PREFERRED SECURITIES ISSUED BY IFC
CAPITAL TRUST I AND THE GUARANTEE WITH RESPECT THERETO.
TITLE OF CLASS: 10.50% CUMULATIVE TRUST PREFERRED SECURITIES ISSUED BY IFC
CAPITAL TRUST II AND THE GUARANTEE WITH RESPECT THERETO.
TITLE OF CLASS: 8.75% CUMULATIVE TRUST PREFERRED SECURITIES ISSUED BY IFC
CAPITAL TRUST III AND THE GUARANTEE WITH RESPECT THERETO.
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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 Corporation's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of the Corporation was $277,671,410 as of March 11, 2002. As of March 11, 2002, there were outstanding 27,534,021 common shares of the Corporation.
* Includes associated rights.
SELECTED PORTIONS OF THE FOLLOWING DOCUMENTS PART OF FORM 10-K INTO WHICH INCORPORATED
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DEFINITIVE PROXY STATEMENT FOR ANNUAL MEETING PART III
OF SHAREHOLDERS TO BE HELD APRIL 25, 2002
EXHIBIT INDEX ON PAGES 98 THROUGH 99
TOTAL PAGES IN THIS FILING: 104
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Part I
Item 1 -- Business.................................................... 2
Item 2 -- Properties.................................................. 15
Item 3 -- Legal Proceedings........................................... 17
Item 4 -- Submission of Matters to a Vote of Security Holders......... 19
Part II
Item 5 -- Market for Corporation's Common Equity and Related Security
Holder Matters.............................................. 20
Item 6 -- Selected Financial Data..................................... 21
Item 7 -- Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 23
Item 7(A) -- Quantitative and Qualitative Disclosures about Market
Risk........................................................ 64
Item 8 -- Financial Statements and Supplementary Data................. 65
Item 9 -- Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 96
Part III
Item 10 -- Directors and Executive Officers of the Corporation......... 97
Item 11 -- Executive Compensation...................................... 97
Item 12 -- Security Ownership of Certain Beneficial Owners and
Management.................................................. 97
Item 13 -- Certain Relationships and Related Transactions.............. 97
Part IV
Item 14 -- Exhibits and Reports on Form 8-K............................ 98
Signatures...................................................................... 101
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ITEM 1. BUSINESS
GENERAL
We are a diversified financial services company headquartered in Columbus, Indiana with $3.1 billion in assets at December 31, 2001. We focus primarily on the extension of credit to consumers and small businesses as well as providing the ongoing servicing of those customer accounts. We currently operate five major lines of business through our direct and indirect subsidiaries. Our major lines of business are: commercial banking, mortgage banking, home equity lending, equipment leasing and venture capital.
We are a regulated bank holding company and we conduct our consumer and commercial lending businesses through various operating subsidiaries. Our banking subsidiary, Irwin Union Bank and Trust, was organized in 1871 and we formed the holding company in 1972. Our direct and indirect major subsidiaries include Irwin Union Bank and Trust, a commercial bank, which together with Irwin Union Bank, F.S.B., a federal savings bank, conducts our commercial banking activities; Irwin Mortgage Corporation, a mortgage banking company; Irwin Home Equity Corporation, a consumer home equity lending company; Irwin Capital Holdings Corporation, an equipment leasing subsidiary; and Irwin Ventures LLC, a venture capital company.
At the parent level, we work actively to add value to our lines of business by interacting with the management teams, capitalizing on interrelationships, providing centralized services and coordinating overall organizational decisions. Under this organizational structure, our separate businesses hold and fund the majority of their assets through Irwin Union Bank and Trust. This provides additional liquidity and results in regulatory oversight of each of our lines of business.
MAJOR LINES OF BUSINESS
Mortgage Banking
We established our mortgage banking line of business when we acquired our subsidiary, Irwin Mortgage Corporation, formerly Inland Mortgage Corporation, in 1981. In this line of business, Irwin Mortgage, in conjunction with Irwin Union Bank and Trust, originates, purchases, sells, and services conventional and government agency-backed residential mortgage loans throughout the United States. Most of our mortgage originations either are insured by an agency of the federal government, such as the Federal Housing Authority, or FHA, or the Veterans Administration, or VA, or, in the case of conventional mortgages, meet requirements for resale to the Federal National Mortgage Association, or FNMA, or the Federal Home Loan Mortgage Corporation, or FHLMC. We originate mortgage loans through retail offices, direct marketing and our Internet website. We also purchase mortgage loans through mortgage brokers. Our relationships with realtors, homebuilders and brokers help us identify potential borrowers. We sell mortgage loans to institutional and private investors but may retain servicing rights to the loans we originate or purchase from correspondents. Irwin Mortgage collects and accounts for the monthly payments on each loan serviced and pays the real estate taxes and insurance necessary to protect the integrity of the mortgage lien, for which it receives a servicing fee.
At December 31, 2001, Irwin Mortgage operated 100 production and satellite offices in 27 states. We discuss this line of business further in the Mortgage Banking section of Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) of this report.
Home Equity Lending
We established this line of business when we formed Irwin Home Equity Corporation as our subsidiary in 1994, headquartered in San Ramon, California. Irwin Home Equity became a subsidiary of Irwin Union Bank and Trust in 2001. In conjunction with Irwin Union Bank and Trust, Irwin Home Equity originates, purchases, securitizes and services home equity loans and lines of credit nationwide. Our target customers are credit worthy, home owning consumers who are active, unsecured credit card debt users. We market our home equity products through direct mail, telemarketing, mortgage brokers and correspondent lenders nationwide and through the Internet.
We discuss this line of business further in the Home Equity Lending section of the MD&A of this report.
Commercial Banking
Our commercial banking line of business provides credit, cash management and personal banking products to small businesses and business owners. We offer a full line of consumer, mortgage and commercial loans, as well as personal and commercial checking accounts, savings and time deposit accounts, personal and business loans, credit card services, money transfer services, financial counseling, property, casualty, life and health insurance agency services, trust services, securities brokerage and safe deposit facilities.
We offer commercial banking services through our banking subsidiaries, Irwin Union Bank and Trust, an Indiana state-chartered commercial bank, and Irwin Union Bank, F.S.B., a federal savings bank.
- Irwin Union Bank and Trust Company -- headquartered in Columbus, Indiana and organized in 1871, is a full service Indiana state-chartered commercial bank with offices currently located throughout nine counties in central and southern Indiana, as well as in Kalamazoo, Grandville (near Grand Rapids), Traverse City and Lansing, Michigan, and Carson City, Nevada; and
- Irwin Union Bank, F.S.B. -- headquartered in Louisville, Kentucky, is a full-service federal savings bank that began operations in December 2000. Currently we have offices located in Brentwood, Missouri (near St. Louis), Louisville, Kentucky, Salt Lake City, Utah, Las Vegas, Nevada and Phoenix, Arizona.
We discuss this line of business further in the Commercial Banking section of the MD&A of this report.
Equipment Leasing
We established this line of business in 1999 when we formed Irwin Business Finance, our United States equipment leasing company, headquartered in Bellevue, Washington. In our equipment leasing line of business, we originate transactions from an established North American network of brokers and vendors and through direct sales to franchisees. The majority of our leases are full payout (i.e., no residual), small-ticket assets secured by commercial equipment. We finance a variety of commercial and office equipment types and try to limit the industry and geographic concentrations in our lease portfolio.
In July 2000, the equipment leasing line of business acquired an ownership of approximately 78% of Onset Capital Corporation, a Canadian small-ticket equipment leasing company headquartered in Vancouver, British Columbia. In December 2001 Onset Capital established Onset Alberta Ltd. as a subsidiary to facilitate its leasing business. In October 2001 we formed Irwin Franchise Capital Corporation to conduct our franchise leasing business. We established Irwin Capital Holdings in April 2001 as a subsidiary of Irwin Union Bank and Trust to serve as the parent company for both our United States and Canadian equipment leasing companies.
We discuss this line of business further in the Equipment Leasing section of the MD&A of this report.
Venture Capital
We established this line of business when we formed Irwin Ventures Incorporated in August 1999. In our venture capital line of business, we make minority investments in early stage companies in the financial services industry and related fields that intend to use technology as a key component of their competitive strategy. We provide Irwin Ventures' portfolio companies the benefit of our management experience in the financial services industry. In addition, we expect that contacts made through venture activities may benefit management of our other lines of business through the sharing of technologies and market opportunities.
Other Subsidiaries
Irwin Union Credit Insurance Corporation has its home office in Columbus, Indiana and provides credit life insurance to consumer loan customers of Irwin Union Bank.
We continue to hold certain small-ticket equipment leases in our subsidiary, Irwin Leasing Corporation (the former Affiliated Capital Corp.). The leases were not part of the 1998 sale of substantially all of the assets of Affiliated Capital to DVI Financial Services, Inc. Irwin Leasing and its parent, Irwin Equipment Finance Corporation, are inactive except for the leases.
No single part of our business is dependent upon a single customer or upon a very few customers and the loss of any one customer would not have a materially adverse effect upon our business.
COMPETITION
In our commercial banking business, we compete with commercial banks, savings banks, thrifts and credit unions for deposits and loans in and around the counties surrounding our branch offices, and with a number of nonbank companies located throughout the United States, including insurance companies, retailers, securities firms, companies offering money market accounts, and national credit card companies.
In our mortgage banking business we compete for mortgage loans with other national, regional, local, and web-enabled mortgage banking companies, as well as commercial banks, savings banks, and savings and loan associations.
In our home equity lending business, our primary competitors for our home equity loans and lines of credit include banks, mortgage banks, large securities firms, credit unions, thrifts, credit card issuers, finance companies, and other home equity and mortgage lenders with operations that are either national, regional, local or web-enabled in scope. Competition can take many forms, including convenience in obtaining loans, customer service, marketing and distribution channels, terms provided and interest rates charged to borrowers.
In our equipment leasing business, our primary competitors include other finance companies that are independent or affiliated with banks or large equipment leasing companies that operate on a national or regional basis.
In our venture capital line of business, we compete primarily with other venture capital firms and individuals who invest in start-up companies.
Some of our competitors are not subject to the same degree of regulation as that imposed on bank holding companies, state banking organizations and federal saving banks. In addition, many larger banking organizations, mortgage companies, mortgage banks, insurance companies and securities firms have significantly greater resources than we do. As a result, some of our competitors have advantages over us in name recognition and market penetration.
GENERAL
The financial services business is highly regulated, primarily for the protection of depositors and other customers. The following is a summary of several applicable statutes and regulations that apply to us and to our subsidiaries. These summaries are not complete, and you should refer to the statutes and regulations for more information. Also, these statutes and regulations may change in the future, and we cannot predict what effect these changes, if made, will have on our operations.
We are registered as a bank holding company with the Board of Governors of the Federal Reserve System under the Bank Holding Company Act of 1956, as amended and the related regulations, referred to as the BHC Act. We are subject to regulation, supervision and examination by the Federal Reserve and as part of this process, we must file reports and additional information with the Federal Reserve.
Minimum Capital Requirements
The Federal Reserve has adopted risk-based capital guidelines for assessing bank holding company capital adequacy. These standards define capital and establish minimum capital ratios in relation to assets, both on an aggregate basis and as adjusted for credit risks and off-balance sheet exposures. Under the Federal Reserve's risk-based guidelines applicable to us, capital is classified into two categories for bank holding companies:
Tier 1 capital, or core capital, consists of:
- common stockholder's equity;
- qualifying noncumulative perpetual preferred stock;
- qualifying cumulative perpetual preferred stock (subject to some limitations); and
- minority interests in the common equity accounts of consolidated subsidiaries;
less
- goodwill;
- credit-enhancing interest-only strips (certain amounts only); and
- specified intangible assets.
Tier 2 capital, or supplementary capital, consists of:
- allowance for loan and lease losses;
- perpetual preferred stock and related surplus;
- hybrid capital instruments;
- unrealized holding gains on equity securities;
- perpetual debt and mandatory convertible debt securities;
- term subordinated debt, including related surplus; and
- intermediate-term preferred stock, including related securities.
The Federal Reserve's capital adequacy guidelines require bank holding companies to maintain a minimum ratio of qualifying total capital to risk-weighted assets of 8 percent, at least 4 percent of which must be in the form of Tier 1 capital. Risk-weighted assets include assets and credit equivalent amounts of off-balance sheet items of bank holding companies that are assigned to one of several risk categories, based on the obligor or the nature of the collateral. The Federal Reserve has established a minimum ratio of Tier 1 capital (less any intangible capital items) to total assets (less any intangible assets), or leverage ratio, of 3 percent for strong bank holding companies (those rated a composite "1" under the Federal Reserve's rating system). For all other bank holding companies, the minimum ratio of Tier 1 capital to total assets is 4 percent. Also, the Federal Reserve continues to consider the Tier 1 leverage ratio in evaluating proposals for expansion or new activities.
In its capital adequacy guidelines, the Federal Reserve emphasizes that the standards discussed above are minimums and that banking organizations generally are expected to operate well above these minimum levels.
As of December 31, 2001, we had regulatory capital in excess of the Federal Reserve's minimum levels. Our ratio of total capital to risk weighted assets at December 31, 2001 was 10.84% and our Tier 1 leverage ratio was 9.45%.
Residual Interests. On November 29, 2001, the four federal banking agencies jointly adopted revised regulatory capital standards regarding the treatment of certain recourse obligations, direct credit substitutes, residual interests in assets securitizations, and other securitized transactions that expose financial institutions primarily to credit risk. The agencies had previously published guidelines on securitization activities in December, 1999 (the "Securitization Guidance") which dealt with the risk management and regulatory oversight issues involved with asset securitizations and residual interests.
Residual interests generally include any on-balance sheet asset created by the sale of financial assets that results in the retention of any credit risks, directly or indirectly, associated with the transfer of assets, where the retained risk exceeds a pro rata share of the organization's claim on the assets, whether through subordination provisions or other credit enhancement techniques.
The revised rules (the "New Rules") became effective January 1, 2002 with respect to residual interests related to any transaction that settles on or after that date. For transactions that settled prior to the effective date of the New Rules, capital treatment prescribed by the application of the New Rules is delayed until December 31, 2002.
The New Rules amend the inter-agency regulatory capital standards in a number of respects. The key changes are as follows:
- Providing for more consistent risk-based capital treatment for recourse obligations and direct credit substitutes and adding new standards for residual interests;
- Applying a ratings-based approach that sets capital standards for positions in securitized transactions (excluding certain residual interests as discussed below) based upon their relative risk exposure, while using credit ratings from nationally-recognized statistical rating organizations;
- Deducting from Tier 1 capital the amount of credit-enhancing interest-only strips, referred to as CEIOS (a subset of residual interests), that exceeds 25% of Tier 1 capital for regulatory purposes, referred to as the concentration limit; and
- Requiring a dollar in risk-based capital for each dollar of residual interest, referred to as the dollar-for-dollar capital requirement, not deducted from Tier 1 capital except those qualifying under the ratings- based approach.
Capital Treatment of Residual Interests. The New Rules impose a concentration limit on credit-enhancing interest-only strips, or CEIOS, and a dollar-for-dollar capital requirement on residual interests not deducted from Tier 1 capital.
CEIOS are, generally, assets created from the excess interest on assets transferred (after reduction for administrative expenses, investor interest payments, servicing fees, and credit losses on investors' interests in these assets) that serve as credit enhancements for the investors. CEIOS include residual interests whether created by a securitization transaction or whether purchased from third parties. Under the New Rules, interest-only strips are limited to 25% of Tier 1 capital, with the excess deducted from Tier 1 capital. See "Recent Developments" for more information regarding our pro forma December 31, 2001 consolidated capital ratios giving effect to the New Rules assuming different potential outcomes of our pending evaluation as to whether a portion of our residual assets fall outside the definition of CEIOS.
CEIOS are the residual interests most often resulting from asset securitizations such as our securitization of home equity loans, in which the seller of loans accounts for the transaction using gain-on-sale accounting treatment. Recording gain on the sale allows the seller to leverage the capital created based on the current recognition of future cash flows. Because this capital may no longer be available to support these assets if write-downs later become necessary, the regulatory agencies adopted the amendments incorporated in the New Rules to limit the risk of residual asset concentrations. The New Rules will allow banking organizations the option of netting existing associated deferred tax liabilities against residual interests for regulatory capital purposes. CEIOS may not qualify for the more favorable treatment under the ratings-based approach referenced above.
The New Rules reflect the policy in the existing Securitization Guidance that imposes more frequent supervisory review, limitations on residual interest holdings, more stringent capital requirements, or other supervisory constraints on banking organizations found by the regulatory agencies to be lacking effective risk management programs or engaging in practices that present safety and soundness concerns. The Securitization Guidance provides that a bank's failure to understand the risks inherent in the securitization activities and to incorporate them into risk management systems and internal capital allocations may constitute an unsafe or unsound banking practice and may result in the down-grading of an organization's regulatory ratings.
Expansion
The BHC Act requires prior Federal Reserve approval for certain activities, such as the acquisition by a bank holding company of control of another bank or bank holding company. Under the BHC Act, a bank holding company may engage in activities that the Federal Reserve has determined to be so closely related to banking or managing or controlling banks as to be a proper incident to those banking activities, such as operating a mortgage bank or a savings association, conducting leasing and venture capital investment activities, performing trust company functions, or acting as an investment or financial advisor. See the section on "Interstate Banking and Branching Legislation" below.
Dividends
The Federal Reserve has policies on the payment of cash dividends by bank holding companies. The Federal Reserve believes that a bank holding company experiencing earnings weaknesses should not pay cash dividends (1) exceeding its net income or (2) which only could be funded in ways that would weaken a bank holding company's financial health, such as by borrowing. Also, the Federal Reserve possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy unsafe or unsound practices or violations of applicable statutes and regulations. Among these powers is the ability to prohibit or limit the payment of dividends by banks and bank holding companies.
The Federal Reserve expects us to act as a source of financial strength to our banking subsidiaries and to commit resources to support them. In implementing this policy, the Federal Reserve could require us to provide financial support when we otherwise would not consider ourselves able to do so.
In addition to the restrictions on fundamental corporate actions such as acquisitions and dividends imposed by the Federal Reserve, Indiana law also places limitations on our authority with respect to such activities.
BANK AND THRIFT REGULATION
Indiana law subjects Irwin Union Bank and Trust and its subsidiaries to supervision and examination by the Indiana Department of Financial Institutions, or the DFI. Irwin Union Bank and Trust is a member of the Federal Reserve System and, along with its subsidiaries, is also subject to regulation, examination and supervision by the Federal Reserve. These subsidiaries include Irwin Home Equity and Irwin Capital Holdings. Irwin Union Bank, F.S.B. is a federally chartered savings bank. Accordingly, it is governed by and subject to regulation, examination and supervision by the Office of Thrift Supervision, or the OTS, and is required to comply with the rules and regulations of the OTS under the Home Owners' Loan Act, or HOLA.
The Federal Reserve also supervises Irwin Union Bank and Trust's compliance with federal law and regulations that restrict loans by member banks to their directors, executive officers, and other controlling persons.
Mortgage Banking and Residential Lending Regulation
The residential lending activities of Irwin Union Bank and Trust, the mortgage banking activities of Irwin Mortgage, and the home equity lending business of Irwin Home Equity are regulated by the Federal Reserve. The Federal Reserve has broad authority to oversee the banking activities of Irwin Union Bank and Trust as the bank's primary federal regulator pursuant to the FDIA and the nonbanking subsidiaries of both Irwin Financial Corporation and Irwin Union Bank and Trust pursuant to the BHC Act. Federal Reserve regulations, such as restrictions on affiliate transactions, asset quality and earnings performance, apply to our residential lending activities. The DFI has comparable supervisory and examination authority over Irwin Home Equity and Irwin Capital Holdings due to their status as subsidiaries of Irwin Union Bank and Trust.
Capital Requirements
The Federal Reserve has published regulations applicable to state member banks such as Irwin Union Bank and Trust regarding the maintenance of adequate capital. While retaining the authority to set capital ratios for individual banks, these regulations group banks into categories based upon total risk-based capital, Tier 1 risk-based capital and a leverage ratio (Tier 1 capital divided by average total assets). These categories, and the applicable capital ratios, are as follows:
The Federal Reserve requires banks to hold capital commensurate with the level and nature of all of the risks, including the volume and severity of problem loans, to which they are exposed. The Federal Reserve requires all state member banks to meet a minimum ratio of qualifying total capital to weighted risk assets of 8 percent, of which at least 4 percent should be in the form of Tier 1 capital. For purposes of this ratio, Tier 1 capital is defined as the sum of core capital elements less goodwill and other intangible assets.
The minimum ratio of Tier 1 capital to total assets for strong banking institutions (rated composite "1" under the uniform rating system of banks) is 3 percent. For all other institutions, the minimum ratio of Tier 1 capital to total assets is 4 percent. Banking institutions with supervisory, financial, operational, or managerial weaknesses are expected to maintain capital ratios well above the minimum levels, as are institutions with high or inordinate levels of risk. Banks experiencing or anticipating significant growth are also expected to maintain capital, including tangible capital positions, well above the minimum levels. For example, most such institutions generally have operated at capital levels ranging from 1 to 2 percent above the stated minimums. Higher capital ratios could be required if warranted by the particular circumstances to risk profiles of individual banks. The standards set forth above specify minimum supervisory ratios based primarily on broad credit risk considerations. The risk-based ratio does not take explicit account of the quality of individual asset portfolios or the range of other types of risks to which banks may be exposed, such as interest rate, liquidity, market or operational risks. For this reason, banks are generally expected to operate with capital positions above the minimum ratios.
At December 31, 2001, Irwin Union Bank and Trust had a total risk-based capital ratio of 10.38%, a Tier 1 capital ratio of 9.93%, and a leverage ratio of 12.39% and was considered well-capitalized. See "Bank Holding Company Regulation -- Minimum Capital Requirements -- Residual Interests" earlier in this section for a discussion of the impact of the new regulatory capital treatment rules. We transferred a portion, and plan to transfer an additional portion, of our residual assets held at Irwin Union Bank and Trust to our holding company in the form of dividends during the first quarter of 2002. Because of the amount of the residuals, we sought and received regulatory approval of these dividends as required. In connection with our decision in the fourth quarter of 2001 to dividend these residual assets out of Irwin Union Bank and Trust and after discussions with our regulators as well as consideration of the risk profile of our organization, our Board of Directors adopted resolutions regarding maintenance of capital levels above the well-capitalized minimum requirements beginning March 31, 2002. The benchmark levels we established are 12% total capital to risk-weighted assets at Irwin Union Bank and Trust, and 11% total capital to risk-weighted assets at Irwin Financial. Although the dividends of the residual assets will not have a meaningful impact on our consolidated capital ratios calculated under the New Rules, the dividends have the effect of increasing regulatory capital ratios at Irwin Union Bank and Trust.
The Federal Reserve, the OTS, the FDIC and other federal banking agencies also have adopted a final rule that modifies the risk-based capital standards to provide for consideration of interest rate risk when assessing capital adequacy of a bank or savings association. Under this rule, the Federal Reserve, the OTS and the FDIC must explicitly include a bank or savings association's exposure to declines in the economic value of their capital due to changes in interest rates as a factor in evaluating capital adequacy of a bank or savings association. The Federal Reserve, the OTS, the FDIC and other federal banking agencies also have adopted a joint agency policy statement providing guidance for managing interest rate risk. The policy statement emphasizes the importance of adequate management oversight and a sound risk management process. This assessment of interest rate risk management made by the banks' examiners will be incorporated into the banks' overall risk management rating and used to determine management's effectiveness.
Insurance of Deposit Accounts
Under the Federal Deposit Insurance Corporation Improvements Act of 1991, or the FDICIA, as FDIC-insured institutions, Irwin Union Bank and Trust and Irwin Union Bank, F.S.B. are required to pay deposit insurance premiums based on the risk they pose to BIF and SAIF, respectively. The FDIC also has authority to raise or lower assessment rates on insured deposits to achieve the statutorily required reserve ratios in insurance funds and to impose special additional assessments. Each depository institution is assigned to one of three capital groups: "well capitalized," "adequately capitalized" or "undercapitalized." An institution is considered well capitalized if it has a total risk-based capital ratio of 10% or greater, has a Tier 1 risk-based capital ratio of 6% or greater, has a leverage ratio of 5% or greater and is not subject to any order or written directive to meet and maintain a specific capital level. An "adequately capitalized" institution has a total risk-based capital ratio of 8% or greater, has a Tier 1 risk-based capital ratio of 4% or greater, has a leverage ratio of 4% or greater and does not meet the definition of a well capitalized bank. An institution is considered "undercapitalized" if it does not meet the definition of "well capitalized" or "adequately capitalized." Within each capital group, institutions are assigned to one of three supervisory subgroups: "A" (institutions with few minor weaknesses), "B" (institutions that demonstrate weaknesses which, if not corrected, could result in significant deterioration of the institution and increased risk of loss to the insurance funds), and "C" (institutions that pose a substantial probability of loss to the insurance funds unless effective corrective action is taken). There are nine combinations of capital groups and supervisory subgroups to which varying assessment rates may apply. An institution's assessment rate depends on the capital category and supervisory category to which it is assigned.
Dividend Limitations
As a state member bank, Irwin Union Bank and Trust may not, without the approval of the Federal Reserve, declare a dividend if the total of all dividends declared in a calendar year exceeds the total of its net income for that year, combined with its retained net income of the preceding two years, less any required transfers to the surplus account. Under Indiana law, certain dividends require notice to, or approval by, the DFI, and Irwin Union Bank and Trust may not pay dividends in an amount greater than its net profits then available, after deducting losses and bad debts. The amount of the residual assets that have or will be transferred to the holding company as a dividend from the bank exceed the amount that could have been dividended by the bank to us without regulatory approval as described above and, as a result, we sought and obtained regulatory approval for the dividend. Due to the limitations described above, we must now obtain prior approval from the DFI and the Federal Reserve Bank of Chicago before Irwin Union Bank and Trust can pay additional dividends to us.
Our ability and the ability of Irwin Union Bank and Trust and Irwin Union Bank, F.S.B. to pay dividends also may be affected by the various capital requirements and the capital and noncapital standards established under the FDICIA, as described above. Our rights and the rights of our shareholders and our creditors to participate in any distribution of the assets or earnings of our subsidiaries also is subject to the prior claims of creditors of our subsidiaries including the depositors of a bank subsidiary.
Interstate Banking and Branching Legislation
Under the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, or the Interstate Banking Act, banks are permitted, subject to being adequately or better capitalized, in compliance with CRA requirements and in compliance with state law requirements (such as age of bank limits and deposit caps), to merge with one another across state lines and to create a main bank with branches in separate states. After establishing branches in a state through an interstate merger transaction, a bank may establish and acquire additional branches at any location in the state where any bank involved in the interstate merger could have established or acquired branches under applicable federal and state law.
Although Irwin Union Bank, F.S.B. has a different primary federal regulator from Irwin Union Bank and Trust, most, if not all, of the federal statutes and regulations applicable to Irwin Union Bank also apply to Irwin Union Bank, F.S.B. However, as a federally chartered savings bank, Irwin Union Bank, F.S.B. has greater flexibility in pursuing interstate branching than an Indiana state bank. A federal savings association may establish or operate a branch in any state outside the state of its home office if the association meets certain statutory requirements. These requirements do not apply if the law of the state where the branch is to be located offers reciprocal branching privileges with the state where the savings association has its home office located. As Irwin Union Bank and Trust does with its supervisory regulatory agencies, Irwin Union Bank, F.S.B. must file reports with the OTS and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals before establishing branches or entering into certain transactions such as mergers with, or acquisitions of, other financial institutions.
Community Reinvestment
Under the Community Reinvestment Act, or the CRA, a financial institution
has a continuing and affirmative obligation, consistent with its safe and sound
operation, to help meet the credit needs of its entire community, including low-
and moderate-income neighborhoods. The CRA does not establish specific lending
requirements or programs for financial institutions, or limit an institution's
discretion to develop the types of products and services that it believes are
best suited to its particular community that are consistent with the CRA.
Institutions are rated on their performance in meeting the needs of their
communities. Performance is tested in three areas: (a) lending, which evaluates
the institution's record of making loans in its assessment areas; (b)
investment, which evaluates the institution's record of investing in community
development projects, affordable housing and programs benefiting low or moderate
income individuals and business; and (c) service, which evaluates the
institution's delivery of services through its branches, ATMs and other offices.
The CRA requires each federal banking agency, in connection with its examination
of a financial institution, to assess and assign one of four ratings to the
institution's record of meeting the credit needs of its community and to take
this record into account in evaluating certain applications by the institution,
including applications for charters, branches and other deposit facilities,
relocations, mergers, consolidations, acquisitions of assets or assumptions of
liabilities, and savings and loan holding company acquisitions. The CRA also
requires that all institutions publicly disclose their CRA ratings. Both Irwin
Union Bank and Trust and Irwin Union Bank, F.S.B. received a "satisfactory"
rating on their most recent CRA performance evaluations.
Brokered Deposits
Brokered deposits include funds obtained, directly or indirectly, by or through a deposit broker for deposit into one or more deposit accounts. Well-capitalized institutions are not subject to limitations on brokered deposits, while an adequately capitalized institution is able to accept, renew or rollover brokered deposits only with a waiver from the FDIC and subject to certain restrictions on the yield paid on such deposits. Undercapitalized institutions are not permitted to accept brokered deposits. Irwin Union Bank and Trust and Irwin Union Bank, F.S.B. are permitted to accept brokered deposits.
Gramm-Leach-Bliley Act
On November 12, 1999, the Gramm-Leach-Bliley Act, or the GLB Act, was enacted, which amended or repealed certain provisions of the Glass-Steagall Act and other legislation that restricted the ability of bank holding companies, securities firms and insurance companies to affiliate with one another. The GLB Act establishes a comprehensive framework to permit affiliations among commercial banks, insurance companies and securities firms. The GLB Act contains provisions intended to safeguard consumer financial information in the hands of financial service providers by, among other things, requiring these entities to disclose their privacy policies to their customers and allowing customers to "opt out" of having their financial service providers disclose their confidential financial information to non-affiliated third parties, subject to certain exceptions. Final regulations implementing the new financial privacy regulations became effective during 2001. Similar to most other consumer-oriented laws, the regulations contain some specific prohibitions and require timely disclosure of certain information. We have devoted what we believe are sufficient resources to comply with these new requirements. We do not anticipate that the GLB Act will have a material adverse effect on our operations or prospects or those of our subsidiaries. However, to the extent the GLB Act permits banks, securities firms and insurance companies to affiliate, the financial services industry may experience further consolidation. This consolidation could result in a growing number of larger financial institutions that offer a wider variety of financial services than we currently offer and that can aggressively compete in the markets we currently serve.
COMPLIANCE WITH CONSUMER PROTECTION LAWS
Our subsidiaries also are subject to many federal and state consumer protection statutes and regulations including the Equal Credit Opportunity Act, the Fair Housing Act, the Truth in Lending Act, the Truth in Savings Act, the Real Estate Settlement Procedures Act and the Home Mortgage Disclosure Act. Among other things, these acts:
- require lenders to disclose credit terms in meaningful and consistent ways;
- prohibit discrimination against an applicant in any consumer or business credit transaction;
- prohibit discrimination in housing-related lending activities;
- require certain lenders to collect and report applicant and borrower data regarding loans for home purchases or improvement projects;
- require lenders to provide borrowers with information regarding the nature and cost of real estate settlements;
- prohibit certain lending practices and limit escrow account amounts with respect to real estate transactions; and
- prescribe possible penalties for violations of the requirements of consumer protection statutes and regulations.
Equal Credit Opportunity Act
The federal Equal Credit Opportunity Act prohibits discrimination against an applicant in any credit transaction, whether for consumer or business purposes, on the basis of race, color, religion, national origin, sex, marital status, age (except in limited circumstances), receipt of income from public assistance programs or good faith exercise of any rights under the Consumer Credit Protection Act. In addition to prohibiting outright discrimination on any of the impermissible bases listed above, an effects test has been applied to determine whether a violation of the act has occurred. This means that if a creditor's actions have had the effect of discriminating, the creditor may be held liable, even when there is no intent to discriminate. In addition to actual damages, the Equal Credit Opportunity Act permits regulatory agencies to take enforcement action and provides for punitive damages. Successful complainants also may be entitled to an award of court costs and attorneys' fees.
Fair Housing Act
The federal Fair Housing Act regulates many lending practices, including making it unlawful for any lender to discriminate in its housing-related lending activities against any person because of race, color, religion, national origin, sex, handicap or familial status. The Fair Housing Act is broadly written and has been broadly interpreted by the courts. A number of lending practices have been found to be, or may be considered, illegal under the Fair Housing Act, including some that are not specifically mentioned in the act itself. Among those practices that have been found to be, or may be considered, illegal under the Fair Housing Act are declining a loan for the purposes of racial discrimination, making excessively low appraisals of property based on racial considerations and pressuring, discouraging, or denying applications for credit on a prohibited basis.
The Fair Housing Act allows a person who believes that he or she has been discriminated against to file a complaint with the Department of Housing and Urban Development, or HUD. Aggrieved persons also may initiate a civil action. The Fair Housing Act also permits the Attorney General of the United States to commence a civil action if there is reasonable cause to believe that a person has been discriminated against in violation of the Fair Housing Act. Penalties for violation of the Fair Housing Act include actual damages suffered by the aggrieved person and injunctive or other equitable relief. The courts also may assess civil penalties.
Home Mortgage Disclosure Act
The federal Home Mortgage Disclosure Act grew out of public concern over credit shortages in certain urban neighborhoods. One purpose of the Home Mortgage Disclosure Act is to provide public information that will help show whether financial institutions are serving the housing credit needs of the neighborhoods and communities in which they are located. The Home Mortgage Disclosure Act also includes a "fair lending" aspect that requires the collection and disclosure of data about applicant and borrower characteristics as a way of identifying possible discriminatory lending patterns and enforcing anti-discrimination statutes. The Home Mortgage Disclosure Act requires institutions to report data regarding applications for loans for the purchase or improvement of one-to-four family and multifamily dwellings, as well as information concerning originations and purchases of such loans. Federal bank regulators rely, in part, upon data provided under the Home Mortgage Disclosure Act to determine whether depository institutions engage in discriminatory lending practices.
The appropriate federal banking agency (that is, the Federal Reserve for Irwin Union Bank and Trust and the OTS for Irwin Union Bank, F.S.B.), or in some cases, HUD, enforces compliance with the Home Mortgage Disclosure Act and implements its regulations. Administrative sanctions, including civil money penalties, may be imposed by supervisory agencies for violations of this act.
Real Estate Settlement Procedures Act
The federal Real Estate Settlement Procedures Act, or RESPA, requires lenders to provide borrowers with disclosures regarding the nature and cost of real estate settlements. RESPA also prohibits certain abusive practices, such as kickbacks, and places limitations on the amount of escrow accounts. Violations of RESPA may result in imposition of penalties, including: (1) civil liability equal to three times the amount of any charge paid for the settlement services or civil liability of up to $1,000 per claimant, depending on the violation; (2) awards of court costs and attorneys' fees; and (3) fines of not more than $10,000 or imprisonment for not more than one year, or both. A significant number of individual claims and purported consumer class action claims have been commenced against financial institutions and other mortgage lending companies, including Irwin Mortgage, alleging violations of the escrow account rules and the prohibition against kickbacks and seeking civil damages, court costs and attorneys' fees. See the "Legal Proceedings" section of this report.
Truth in Lending Act
The federal Truth in Lending Act is designed to ensure that credit terms are disclosed in a meaningful way so that consumers may compare credit terms more readily and knowledgeably. As a result of the act, all creditors must use the same credit terminology and expressions of rates, the annual percentage rate, the finance charge, the amount financed, the total of payments and the payment schedule.
Violations of the Truth in Lending Act may result in regulatory sanctions and in the imposition of both civil and, in the case of willful violations, criminal penalties. Under certain circumstances, the Truth in Lending Act and Federal Reserve Regulation Z also provide a consumer with a right of rescission, which relieves the consumer of the obligation to pay amounts to the creditor or to a third party in connection with the offending transaction, including finance charges, application fee, commitment fees, title search fees and appraisal fees. Consumers may also seek actual and punitive damages for violations in the Truth in Lending Act. See the "Legal Proceedings" section of this report.
State Consumer Protection Laws
In addition to the federal consumer protection laws discussed above, our subsidiaries are also subject to state consumer protection laws that regulate the mortgage origination and lending businesses of these subsidiaries. As part of the home equity line of business in conjunction with its subsidiary, Irwin Home Equity, Irwin Union Bank and Trust originates home equity loans through its branch in Nevada. Irwin Union Bank and Trust uses interest rates and loan terms in its home equity loans and lines of credit that are authorized by Nevada law, but might not be authorized by the laws of the states in which the borrowers are located. As a FDIC-insured, state member bank, Irwin Union Bank and Trust is authorized by Section 27 of the FDIA to charge interest at rates allowed by the laws of the state where the bank is located regardless of any inconsistent state law, and to apply these rates to loans to borrowers in other states. The FDIC has opined that a state bank with branches outside of the state in which it is chartered may also be located in a state in which it maintains an interstate branch. Irwin Union Bank and Trust relies on Section 27 of the FDIA and the FDIC opinion in conducting its home equity lending business described above. From time to time, state regulators have questioned the application of Section 27 of the FDIA to credit practices affecting citizens of their states. Any change in Section 27 of the FDIA or in the FDIC's interpretation of this provision, or any successful challenge as to the permissibility of these activities, could require that we change the terms of some of our loans or the manner in which we conduct our home equity line of business.
EMPLOYEES AND LABOR RELATIONS
At December 31, 2001, we and our subsidiaries had a total of 2,941 employees, including full-time and part-time employees. We continue a commitment of equal employment opportunity for all job applicants and staff members, and management regards its relations with its employees as satisfactory.
EXECUTIVE OFFICERS
Our executive officers are elected annually by the Board of Directors and serve for a term of one year or until their successors are elected and qualified. In addition to our Chairman, Mr. Miller, and President, Mr. Nash, both of whom also serve as directors, our executive officers are listed below.
Claude E. Davis (41) has been President of Irwin Union Bank and Trust since January, 1996. He has been an officer since 1988.
Gregory F. Ehlinger (39) has been our Senior Vice President and Chief Financial Officer since August of 1999. He has been one of our officers since August 1992.
Paul D. Freudenthaler (37) joined us as Vice President - Financial Risk Management in December 2001. From September 2000 through November 2001, he was Corporate Controller for America Online Latin America, an internet service provider. From July 2000 to August 2000 he served as Senior Vice President - Treasurer of Telscape International, Inc., a development stage telecommunications company. Prior thereto, he held the position of Chief Accounting Officer of Telscape from July 1999 until June 2000. Subsequent to his departure from Telscape, Telscape filed a voluntary petition for relief under Chapter 11 of the U.S. Bankruptcy Code on April 27, 2001. From February 1999 through June 1999, he was Director - International of Bank United, F.S.B. From January 1994 through January 1999, he was Director - International of Irwin Mortgage Corporation, our subsidiary.
Jose M. Gonzalez (43) has been our Vice President - Internal Audit since October 1995.
Robert H. Griffith (44) has been President and Chief Executive Officer of Irwin Mortgage since January, 2001. He has been an officer of Irwin Mortgage since 1993.
Theresa L. Hall (49) has been our Vice President - Human Resources since 1988 and has been one of our officers since 1980.
Bradley J. Kime (41) has been President of Irwin Union Bank F.S.B. since December 2000, and is also Chief Operating Officer and Executive Vice President of Irwin Union Bank and Trust. He has been an officer of Irwin Union Bank and Trust since 1987, and one of our officers since 1986.
Jody A. Littrell (34) has been our Vice President and Controller since March 2000. He was employed with Arthur Andersen LLP from September 1990 to March 2000.
Ellen Z. Mufson (53) has been our Vice President - Legal and Assistant Secretary since September 1997. She was Vice President - Legal Counsel of Irwin Union Bank and Trust from July 1996 through August 1997, and our Corporate Counsel from January 1995 through June, 1996.
Steven R. Schultz (36) joined us as Vice President - Legal in January 2002. From August 1999 through December 2001 he was an attorney in the London office of Fried, Frank, Harris, Shriver & Jacobson, focusing primarily on mergers and acquisitions, capital markets financings and private equity transactions. From August 1993 until July 1999 he practiced corporate and securities law at Barnes & Thornburg in Indianapolis, Indiana.
Matthew F. Souza (45) has been our Senior Vice President - Ethics since August 1999 and our Secretary since 1986. He has been one of our officers since 1986.
Michael E. Taft (61) serves as President of Irwin Capital Holdings Corporation, which comprises our leasing line of business. He has been President of Irwin Business Finance since April 1999. From August 1998 to April 1999, he was Executive Vice President of General Electric Capital Business Asset Funding Corp., a subsidiary of General Electric Capital Corporation. From September 1984 to August 1998, he was Executive Vice President of MetLife Capital Corporation, a subsidiary of Metropolitan Life Insurance Company (General Electric Capital Corporation acquired MetLife Capital in August 1998).
Thomas D. Washburn (55) has been our Executive Vice President since August 1999 and has been one of our officers since 1976. From 1976 to August, 1999 he served as our Senior Vice President and Chief Financial Officer.
Brett R. Vanderkolk (36) has been our Vice President - Treasurer since September 2000. From August 1996, to September 2000, he served as Manager, Corporate Finance for Arvin Industries, Inc. (manufacturer of automotive products).
Our main office and the main offices of Irwin Ventures LLC, Irwin Ventures SBIC LLC, and Irwin Union Credit Insurance Corporation are located at 500 Washington Street, Columbus, Indiana, in space leased from Irwin Union Bank and Trust. The location and general character of the materially important physical properties and our subsidiaries as of December 31, 2001 are as follows:
IRWIN MORTGAGE
The main office, where administrative and servicing activities are centered, is located at 9265 Counselor's Row, Indianapolis, Indiana, and a servicing facility is located at 11800 Exit Five Parkway, Indianapolis, Indiana.
Loan production and satellite offices are located in:
- Arizona -- Mesa, Phoenix, and Scottsdale;
- California -- Arroyo Grande, Avalon, Bakersfield, Carson, Citrus Heights, Concord, Covina, LaMesa, Oxnard, Richmond, Sacramento, Salinas, San Diego, Stockton, Temecula, Thousand Oaks, Ventura, Visalia, Walnut South, West Concord, Yreka and Yuba City;
- Colorado -- Castle Rock, Colorado Springs, Denver, Englewood, and Westminster;
- Connecticut -- Rocky Hill;
- Delaware -- Newark;
- Florida -- Apopka, Boca Raton, Clearwater, Jacksonville, Orlando, and Port St. Lucie;
- Georgia -- Atlanta;
- Hawaii -- Honolulu;
- Illinois -- Chicago, Clocktower and Decatur;
- Indiana -- Carmel, Fishers, Ft. Wayne, Greenwood, Indianapolis (four offices), Kokomo, Logansport, Muncie, Schererville, and South Bend;
- Louisiana -- Baton Rouge;
- Maryland -- Gaithersburg;
- Michigan -- Frankenmuth, Grand Rapids, Kalamazoo, Lansing, Roscommon and Sunrise;
- Minnesota -- Arden Hills, Burnsville and Minneapolis;
- Missouri -- Urbana;
- New Jersey -- Deptford;
- North Carolina -- Durham, Greensboro, Hickory, Raleigh, Waynesville, Wilmington and Winston-Salem;
- Ohio -- Columbus (three offices), Dayton, and Reynoldsburg;
- Oklahoma -- Oklahoma City and Tulsa;
- Oregon -- Damascus and Portland;
- Pennsylvania -- Mechanicsburg and York;
- Tennessee -- Brentwood;
- Texas -- Corpus Christi, Dallas, El Paso and Houston (two offices);
- Utah -- Salt Lake City;
- Washington -- Battle Ground, Everett (two offices) and Mount Lake Terrace; and
- Wisconsin -- Madison.
All offices occupied by Irwin Mortgage are leased.
IRWIN UNION BANK AND TRUST
The main office is located in four connected buildings at 500 and 520 Washington Street, Columbus, Indiana. Irwin Union Realty Corporation, a wholly-owned subsidiary of Irwin Union Bank and Trust, owns these buildings in fee and leases them to Irwin Union Bank and Trust.
One or the other of Irwin Union Bank and Trust or Irwin Union Realty owns the following branch properties in fee State Street and Eastbrook in Columbus, Indiana
Hope, Taylorsville, and Franklin, Indiana (the Franklin building and a portion of the land are owned; the remaining land is leased).
The other branches lease their offices:
- Indiana -- Avon, Bloomington (three offices), Carmel, Columbus (three offices), Greensburg, Greenwood, Indianapolis, Seymour (two offices) and Shelbyville;
- Michigan -- Grandville (near Grand Rapids), Kalamazoo, Lansing and Traverse City; and
- Nevada -- Carson City.
The loan production office in Lansing, Michigan leases its space. The properties owned by Irwin Union Bank and Trust or Irwin Union Realty have no major encumbrances.
IRWIN UNION BANK, F.S.B.
The main office is located at 9300 Shelbyville Road, Louisville, Kentucky.
Branch offices are located in:
- Arizona -- Phoenix
- Missouri -- Brentwood (near St. Louis)
- Nevada -- Las Vegas; and
- Utah -- Salt Lake City
Irwin Union Bank, F.S.B. leases these offices.
IRWIN HOME EQUITY
The main office is located at 12677 Alcosta Boulevard, Suite 500, San Ramon, California. Irwin Home Equity also occupies two other offices in San Ramon, California. Irwin Home Equity leases all of it its offices.
IRWIN CAPITAL HOLDINGS CORPORATION
The main office of Irwin Capital Holdings Corporation is located at 500 Washington Street, Columbus, Indiana. The office location is lease.
The main office of Irwin Business Finance is located at 330 120th Avenue NE, Suite 110, Bellevue, Washington. The office location is leased.
- Alberta -- Calgary and Edmonton;
- Manitoba -- East St. Paul (near Winnipeg);
- Ontario -- Toronto (two offices); and
- Quebec -- St. Laurent (near Montreal) and Quebec City.
The main office of Onset Alberta Ltd. is located at 888 3rd Street SW in Edmonton, Alberta. The office space is leased.
The main office of Irwin Franchise Capital Corporation is located at 2700 Westchester Avenue, Purchase, New York.
Irwin Franchise Capital also has offices (all leased) in:
- Illinois -- Hainesville;
- Nebraska -- Columbus (two offices) and Omaha;
- New Jersey -- Nutley;
- New York -- Metuchen;
- Texas -- Spring; and
- Washington -- Port Orchard.
ITEM 3. LEGAL PROCEEDINGS
Culpepper v. Inland Mortgage Corporation.
Borrowers purporting to represent a nationwide class have filed numerous class action lawsuits against mortgage lenders, including our subsidiary, Irwin Mortgage (formerly known as Inland Mortgage Corporation), alleging that certain payments to mortgage brokers by those lenders violate the federal Real Estate Settlement Procedures Act, commonly known as RESPA. These lawsuits have generally alleged that various forms of direct and indirect payments to mortgage brokers are referral fees or unearned fees, which are prohibited under RESPA, or that consumers were not informed of the brokers' compensation, in violation of law.
Our subsidiary, Irwin Mortgage, is a defendant in Culpepper, a lawsuit alleging that Irwin Mortgage violated RESPA in connection with mortgages originated by mortgage brokers. The initial action was filed in April 1996, in the United States District Court, Northern District of Alabama. In January 1997, the federal district court granted summary judgment in favor of Irwin Mortgage and denied the plaintiff's motion to certify the case as a class action. The plaintiff appealed, and in January 1998, the United States Court of Appeals for the 11th Circuit reversed the district court's grant of summary judgment. The court of appeals sent the case back to the district court to decide the merits of the case and the class certification issue. A second lawsuit was filed against Irwin Mortgage in August 1998 alleging similar RESPA violations and was consolidated with the first case. In June 1999, the district court certified a limited class of borrowers.
Irwin Mortgage appealed and submitted the class certification issue to the court of appeals for review in December 1999. On June 15, 2001, a panel of the United States Court of Appeals for the 11th Circuit denied the appeal of Irwin Mortgage, and upheld the district court's certification of the borrower class in an opinion unfavorable to us. On July 11, 2001, Irwin Mortgage filed a motion seeking a rehearing before the court of appeals. On August 15, 2001, the court of appeals denied this motion.
The case is now pending in the federal district court. The process of notifying class members is not yet complete. Based on notices sent by the plaintiffs to some potential class members, we believe the class is not likely to exceed 32,000 borrowers. In July 2001, the plaintiffs filed a motion for partial summary judgment asking the court to find that our subsidiary is liable for violating RESPA. We filed an opposition to the motion, and the motions were fully briefed by the parties.
On October 18, 2001, the Department of Housing and Urban Development, or HUD, the agency responsible for interpreting and implementing RESPA, issued a clarifying policy statement that explicitly disagreed with the ruling of the court of appeals in Culpepper and with the court's interpretation of RESPA in connection with the types of payments at issue in this case.
In response to an order of the district court, the parties filed supplemental briefs analyzing the impact of the new HUD policy statement on November 14, 2001. In addition to responding to the district court's order, Irwin Mortgage filed a petition for certiorari with the United States Supreme Court seeking review of the court of appeals' ruling, and on December 28, 2001, also filed a motion in the district court seeking a stay of further proceedings until the 11th Circuit renders decisions in the other three RESPA cases pending in that court. On January 22, 2002, the Supreme Court denied Irwin Mortgage's petition for certiorari. At a status conference on March 8, 2002, the district court granted Irwin Mortgage's motion to stay the proceedings in this case until the 11th Circuit rules on the other three RESPA cases pending before it.
The Culpepper case is the only case to date alleging similar RESPA violations in which a federal court of appeals has upheld a lower court's grant of class action certification in favor of the plaintiffs. While we continue to believe that the plaintiffs should not prevail on the merits of the case and that Irwin Mortgage has available numerous defenses to the alleged RESPA violations and we intend to defend this lawsuit vigorously, we could lose this lawsuit. Although we are unable at this stage of the litigation to determine the outcome or a reasonable estimate of the amount of potential loss we could suffer, we expect that an adverse outcome in this litigation could subject us to substantial monetary damages that could be material to our financial position. We have not established any reserves related to this case.
Beggs v. Irwin Mortgage Corporation.
In September, 2001, Irwin Mortgage received notice that it was named as a defendant in Beggs, a lawsuit filed in the United States District Court for the Northern District of Alabama. The plaintiff, purporting to represent a nationwide class of borrowers, filed allegations similar to those in Culpepper, above, but seeks inclusion of borrowers not covered in Culpepper (those with mortgage loans since early 1999 through the date of class certification, if a class is certified). The plaintiff is asking the court to certify a class and to consolidate this case with Culpepper. On the basis of the HUD policy statement, described above, management believes Irwin Mortgage has substantial defenses to this case as well. In the event of an adverse outcome, however, the company could suffer material losses. On December 10, 2001, the court granted an order staying all the proceedings in the Beggs case until after the United States Court of Appeals for the 11th Circuit renders decisions in the other three RESPA cases pending in that court.
United States ex rel. Paranich v. Sorgnard et. al.
In January, 2001, we, Irwin Leasing Corporation (formerly Affiliated Capital Corp.) and Irwin Equipment Finance Corporation (for purposes of this paragraph, the Irwin companies) were served as defendants in Paranich, an action filed in the U.S. District Court for the Middle District of Pennsylvania. The suit alleges that a manufacturer/importer of certain medical devices (Matrix Biokinetics, Inc., and others) made misrepresentations to health care professionals and to government officials to improperly obtain Medicare reimbursement for treatments using the devices, and that the Irwin companies, through Affiliated Capital's financing activities, aided in making the alleged misrepresentations. The Irwin companies filed a motion to dismiss on February 12, 2001. On August 10, 2001, the court granted our motion in part by dismissing us and Irwin Equipment Finance as defendants in the suit. Irwin Leasing remains a defendant. Because the case is in the early stages of litigation, we are unable at this time to form a reasonable estimate of the amount of potential loss, if any, that we could suffer. We intend to defend this lawsuit vigorously.
On May 9, 2001, Irwin Union Bank and Trust and Irwin Home Equity, (for purposes of this paragraph, Irwin), received notice that they were named as defendants in Thompson, a lawsuit filed in the U.S. District Court for the District of Rhode Island. The suit alleges that Irwin's disclosures and closing procedure for certain home equity loans did not comply with certain provisions of the Truth in Lending Act. The suit also requests that the court certify a plaintiff class in this action. On June 18, 2001, Irwin filed a motion with the court to compel arbitration pursuant to the provisions in the home equity loan agreement. On October 20, 2001, the Court entered judgment in favor of Irwin compelling arbitration and dismissing the plaintiffs' complaint. The plaintiffs have appealed, and we intend to defend this case vigorously. However, if arbitration is ultimately upheld, we do not expect to suffer material loss in this case.
McIntosh v. Irwin Home Equity Corporation.
On July 19, 2001, Irwin Home Equity Corporation was served with notice that it was named as the defendant in McIntosh, a lawsuit filed in the U.S. District Court for the District of Massachusetts. The suit relates to a loan purchased by Irwin Union Bank and Trust and serviced by Irwin Home Equity. The plaintiff alleges that the loan documents did not comply with certain provisions of the Truth in Lending Act relating to high rate loans. The suit also requests that the court certify a plaintiff class in this action. Irwin Home Equity filed an answer on August 31, 2001. On October 17, 2001, the court granted plaintiff's motion to file an amended complaint removing Irwin Home Equity and substituting Irwin Union Bank and Trust as defendant. On November 2, 2001, Irwin Union Bank and Trust filed an answer to the amended complaint denying plaintiff's allegations. Because the case is in the early stages of litigation, we are unable at this time to form a reasonable estimate of the amount of potential loss, if any, that we could suffer. We intend to defend this lawsuit vigorously.
Stamper et.al. v. A Home of Your Own, Inc. et.al.
On January 25, 2002, a jury in Stamper awarded the plaintiffs damages of $1.434 million jointly and severally against the defendants, including our subsidiary Irwin Mortgage Corporation. The case was filed in August 1998 in the Baltimore, Maryland, City Circuit Court. The nine plaintiffs alleged that A Home of Your Own, Inc. and its principal, Robert Beeman, defrauded the plaintiffs by selling them defective homes at inflated prices and that Irwin Mortgage, which provided the plaintiff borrowers mortgage loans on the home purchases, participated in the fraud. Prior to the outcome of the jury trial, we had no reserves for this case. On February 6, 2002, plaintiffs filed a petition for attorney's fees. On the same date, Irwin Mortgage filed post-trial motions for judgment notwithstanding the verdict, new trial and/or remittitur, which is a request for the court to reduce the amount of damages awarded by the jury. If the court denies Irwin's post-trial motions, Irwin plans to appeal and will continue to defend this case vigorously.
We and our subsidiaries are from time to time engaged in various matters of litigation including the matters described above, other assertions of improper or fraudulent loan practices or lending violations, and other matters, and we have a number of unresolved claims pending. In addition, as part of the ordinary course of business, we and our subsidiaries are parties to litigation involving claims to the ownership of funds in particular accounts, the collection of delinquent accounts, challenges to security interests in collateral, and foreclosure interests, that is incidental to our regular business activities. While the ultimate liability with respect to these other litigation matters and claims cannot be determined at this time, we believe that damages, if any, and other amounts relating to pending matters are not likely to be material to our consolidated financial position or results of operations, except as described above. Reserves have been established for these various matters of litigation, when appropriate, based upon the advice of legal counsel.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 2001, no matters were submitted to a vote of security holders of the Corporation, through the solicitation of proxies or otherwise.
ITEM 5. MARKET FOR CORPORATION'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Until September 20, 2001, our common shares were quoted on the Nasdaq National Market under the symbol "IRWN." Our common shares were approved for listing on the New York Stock Exchange on September 5, 2001, and began trading under the symbol "IFC" on September 21, 2001. The following table sets forth certain information regarding trading in, and cash dividends paid with respect to, the shares of our common stock in each quarter of the two most recent calendar years. The approximate number of shareholders of record on March 11, 2002, was 1,805.
STOCK PRICES AND DIVIDENDS:
PRICE RANGE TOTAL
--------------- QUARTER CASH DIVIDENDS
HIGH LOW END DIVIDENDS FOR YEAR
------ ------ ------- --------- ---------
2000
First quarter................................... $18.31 $13.56 $15.00 $ 0.06
Second quarter.................................. 18.50 14.38 14.45 0.06
Third quarter................................... 17.00 13.44 16.38 0.06
Fourth quarter.................................. 22.00 13.25 21.19 0.06 $0.24
2001
First quarter................................... $24.88 $19.31 $21.13 $0.065
Second quarter.................................. 25.25 18.69 25.15 0.065
Third quarter................................... 27.70 16.00 20.90 0.065
Fourth quarter.................................. 22.08 14.49 17.00 0.065 $0.26
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We expect to continue our policy of paying regular cash dividends, although there is no assurance as to future dividends because they are dependent on future earnings, capital requirements, and financial condition. On February 27, 2002, our Board of Directors approved an increase in the first quarter dividend to $0.0675 per share, payable in March, 2002. Dividends paid by Irwin Union Bank and Irwin Union Bank, F.S.B. to the Corporation are restricted by banking law.
SALES OF UNREGISTERED SECURITIES:
In 2001, we issued 5,466 shares of common stock pursuant to elections made by six of our outside directors to receive board compensation under the 1999 Outside Director Restricted Stock Compensation Plan in lieu of cash fees. All of these shares were issued in reliance on the private placement exemption from registration provided in Section 4(2) of the Securities Act.
AT OR FOR YEAR ENDED DECEMBER 31,
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2001 2000 1999 1998 1997
----------- ---------- ----------- ----------- -----------
(IN THOUSANDS EXCEPT PER SHARE DATA)
FOR THE YEAR:
Net revenues................... $ 401,035 $ 297,304 $ 266,748 $ 272,063 $ 200,996
Noninterest expense............ 327,420 237,962 214,111 221,206 158,818
----------- ---------- ----------- ----------- -----------
Income before income taxes..... 73,615 59,342 52,637 50,857 42,178
Provision for income taxes..... 28,624 23,676 17,481 20,354 17,734
Minority interest.............. (350) -- -- -- --
----------- ---------- ----------- ----------- -----------
Income before cumulative effect
of change in accounting
principle................... 45,341 35,666 33,156 30,503 24,444
Cumulative effect of change in
accounting principle, net of
tax......................... 175 -- -- -- --
----------- ---------- ----------- ----------- -----------
Net income..................... $ 45,516 $ 35,666 $ 33,156 $ 30,503 $ 24,444
=========== ========== =========== =========== ===========
Mortgage loan originations..... $ 9,225,991 $4,091,573 $ 5,876,750 $ 8,944,615 $ 5,397,338
Home equity loan
originations................ 1,149,410 1,225,955 439,507 389,673 214,518
COMMON SHARE DATA:
Earnings per share:(1)
Basic....................... $ 2.15 $ 1.70 $ 1.54 $ 1.40 $ 1.10
Diluted..................... 2.00 1.67 1.51 1.38 1.08
Cash dividends per share....... 0.26 0.24 0.20 0.16 0.14
Book value per share........... 10.84 8.97 7.55 6.70 5.82
Dividend payout ratio.......... 12.13% 14.13% 12.93% 11.39% 12.74%
Weighted average
shares -- basic............. 21,175 20,973 21,530 21,732 22,326
Weighted average
shares -- diluted........... 24,173 21,593 21,886 22,139 22,722
Shares outstanding -- end of
period...................... 21,305 21,026 21,105 21,673 22,001
AT YEAR END:
Assets......................... $ 3,439,795 $2,422,429 $ 1,680,847 $ 1,946,179 $ 1,496,794
Trading assets................. 216,684 154,921 59,025 32,148 22,133
Loans held for sale............ 503,757 579,788 508,997 936,788 528,739
Loans and leases............... 2,137,747 1,234,922 733,424 556,991 611,093
Allowance for loan and lease
losses...................... 22,283 13,129 8,555 9,888 8,812
Servicing assets............... 228,624 132,638 138,500 117,129 83,044
Deposits....................... 2,309,018 1,443,330 870,318 1,009,211 719,596
Short-term borrowings.......... 487,963 475,502 473,103 644,861 512,275
Long-term debt................. 29,654 29,608 29,784 2,839 7,096
Trust preferred securities..... 190,948 147,167 48,071 47,999 47,927
Shareholders' equity........... 232,323 189,925 159,296 145,233 127,983
Owned first mortgage servicing
portfolio................... 12,875,532 9,196,513 10,488,112 11,242,470 10,713,549
Managed home equity servicing
portfolio................... 2,317,975 1,825,527 842,403 581,241 358,166
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AT OR FOR YEAR ENDED DECEMBER 31,
------------------------------------------------------------------
2001 2000 1999 1998 1997
----------- ---------- ----------- ----------- -----------
(IN THOUSANDS EXCEPT PER SHARE DATA)
SELECTED FINANCIAL RATIOS:
Performance Ratios:
Return on average assets....... 1.45% 1.76% 2.01% 1.85% 1.94%
Return on average equity....... 21.82 20.83 21.51 22.77 19.80
Net interest margin(2)(3)...... 5.35 5.36 5.03 4.33 5.15
Noninterest income to
revenues(4)................. 64.84 69.94 75.25 78.71 75.89
Efficiency ratio(5)............ 78.23 78.61 78.95 79.55 76.74
Loans and leases to
deposits(6)................. 79.10 85.56 84.27 55.19 84.92
Average interest-earning assets
to average interest-bearing
liabilities................. 117.17 113.51 127.36 121.02 124.00
Asset Quality Ratios:
Allowance for loan and lease
losses to:
Total loans and leases...... 1.04% 1.06% 1.17% 1.78% 1.45%
Non-performing loans and
leases.................... 116.34 181.79 189.86 84.28 115.02
Net charge-offs to average
loans and leases............ 0.53 0.28 0.27 0.33 0.46
Net home equity charge-offs to
managed home equity
portfolio................... 1.58 0.57 0.36 0.37 0.29
Non-performing assets to total
assets...................... 0.68 0.42 0.48 0.78 0.64
Non-performing assets to total
loans and leases and other
real estate owned........... 1.10 0.81 1.09 2.77 1.55
Ratio of Earnings to Fixed
Charges:
Including deposit interest..... 1.61x 1.63x 1.88x 1.79x 1.86x
Excluding deposit interest..... 2.54 2.46 2.54 2.25 2.45
Capital Ratios:
Average shareholders' equity to
average assets.............. 6.65% 8.46% 9.35% 8.09% 9.32%
Tier 1 capital ratio........... 6.81 8.87 11.39 11.63 13.56
Tier 1 leverage ratio.......... 9.36 12.41 12.77 10.51 12.06
Total risk-based capital
ratio....................... 10.82 13.59 13.50 12.25 14.85
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(2) Net interest income divided by average interest-earning assets.
(3) Calculated on a tax-equivalent basis.
(4) Revenues consist of net interest income plus noninterest income.
(5) Noninterest expense divided by net interest income plus noninterest income.
(6) Excludes loans to be sold or securitized.
You should read the following discussion in conjunction with our consolidated financial statements, footnotes, and tables. This discussion and other sections of this report contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and are including this statement for purposes of invoking these safe harbor provisions. Words such as "will," "believe," "expect," "assume," "anticipate," "intend," "continue," "resume," "contemplating," "are likely," "estimate," "judgment," "outlook," "future," "forecasts," and similar expressions are intended to identify forward- looking statements, which may include, among other things:
- statements and assumptions relating to projected growth, earnings, earnings per share, and other financial performance measures as well as management's short-term and long-term performance goals;
- statements relating to the anticipated effects on results of operations or financial condition from recent and expected developments or events, including the recently revised regulatory capital rules relating to residual interests;
- statements relating to our business and growth strategies, including potential acquisitions; and
- any other statements, projections or assumptions that are not historical facts.
Forward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause our actual results, performance or achievements, or industry results, to differ materially from our expectations of future results, performance or achievements expressed or implied by these forward-looking statements. In addition, our past results of operations do not necessarily indicate our future results. Actual future results may differ materially from what is projected due to a variety of factors, including, but not limited to, unexpected changes in interest rates, which may affect consumer demand for our products and the valuation of our servicing portfolio; borrowers' refinancing opportunities, which may affect the prepayment assumptions used in our valuation estimates; unanticipated deterioration in the credit quality of our assets; difficulties in selling residual assets as contemplated; difficulties in delivering home equity loans to the secondary market as planned or in funding home equity loans through securitization transactions as planned; difficulties in raising additional capital or expanding our businesses; competition from other financial service providers for experienced managers as well as for customers; changes in the value of technology-related companies; legislative or regulatory changes, including changes in the interpretation of new capital rules; changes in applicable accounting policies or principles or their application to our business; or governmental changes in monetary or fiscal policies. Further, uncertainty in the national economy may negatively impact the financial services industry or cause changes in or exaggerate the effects of the factors described above. We undertake no obligation to update publicly any of these statements in light of future events, except as required in subsequent periodic reports we file with the Securities and Exchange Commission, or SEC.
CONSOLIDATED OVERVIEW
2001 % CHANGE 2000 % CHANGE 1999
------ -------- ------ -------- ------
Net income (millions)...................... $ 45.5 27.6% $ 35.7 7.5% $ 33.2
Basic earnings per share(1)................ 2.15 26.5 1.70 10.4 1.54
Diluted earnings per share(1).............. 2.00 19.8 1.67 10.6 1.51
Return on average equity................... 21.82% -- 20.83% -- 21.51%
Return on average assets................... 1.45 -- 1.76 -- 2.01
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(1) Earnings per share of common stock before cumulative effect of change in accounting principle related to SFAS 133, "Accounting for Derivative Instruments and Hedging Activities," for the year ended December 31, 2001 was $2.14 basic and $1.99 diluted.
Our mortgage banking line of business experienced a significant increase in mortgage loan production as a result of declining interest rates, with originations during 2001 exceeding $9.2 billion. During 2001, the mortgage banking line of business grew its servicing portfolio to $12.9 billion. Our home equity lending line of business continued to see steady growth in production and in its managed portfolio during 2001, largely offsetting additional credit reserves and increases in prepayment speeds. Our commercial banking line of business continued to grow its loan portfolio during 2001, while its net interest margin declined to 3.80% in 2001, compared to 4.25% and 4.82% in 2000 and 1999, respectively. Our equipment leasing line of business continued to incur losses during the year, principally the result of difficult economic conditions that led to higher levels of charge-offs and delinquencies during the second half of the year. Our venture capital line of business recorded losses during 2001 primarily attributable to net valuation write-downs in its portfolio investments in order to reflect these investments at fair value.
Our mortgage banking line of business was negatively impacted in 2000 by rising rates throughout most of the year followed by a sharp decline in interest rates late in the fourth quarter. Our home equity lending line of business experienced a significant improvement in earnings in 2000 as its managed portfolio continued to grow and expand in its niche of prime credit quality, high loan-to-value second mortgage loans. Results in our commercial banking line of business were driven by strong commercial loan portfolio growth in 2000 reflecting continued geographic expansion into new markets in Midwestern and Western states. Our new equipment leasing line of business incurred losses throughout 2000 that were in line with management's expectations given the start-up nature of the company. Our venture capital line of business contributed favorably to the consolidated results in 2000 as a result of net valuation increases in its portfolio investments.
A rising interest rate environment led to a reduction in loan originations and lower net income at our mortgage banking line of business during 1999, partially offsetting the improvements at our other lines of business. Our home equity lending line of business experienced a significant improvement in earnings in 1999 as a result of a more favorable competitive environment and a reduction in loan prepayment activity. Results at our commercial banking line of business during 1999 improved in connection with growth in our commercial loan portfolio. Results in 1999 include a one-time after-tax gain of $1.1 million due to a change in a tax law in Indiana.
Strategy
Our strategy is to maintain a diverse revenue stream by focusing on niches in financial services where we believe we can optimize the productivity of our capital and where our experience and expertise can provide a competitive advantage. Our operational objectives are premised on simultaneously achieving three goals: creditworthiness, profitability and growth. We refer to this as creditworthy, profitable growth. We believe we must continually balance these goals in order to deliver long-term value to all of our stakeholders. We have developed a four-part business plan to meet these goals:
- Identify underserved niches. We focus on product or market niches in financial services that we believe are underserved and where we believe customers are willing to pay a premium for value-added services. We don't believe it is necessary to be the largest or leading market share company in any of our product lines, but we do believe it is important that we are viewed as a preferred provider in niche segments of those product offerings.
- Hire exceptional management with niche expertise. We enter niches only
when we have attracted senior managers who have proven track records in
the niche for which they are responsible. We structure our companies so
these managers are encouraged to focus only on their area of expertise
and lines of business. In addition, we believe our willingness to offer
minority ownership positions in our lines of business to these managers
provides them with the long-term incentive to achieve creditworthy,
profitable growth. We also employ a similar strategy when looking to
expand our lines of business.
Each line of our five lines of business has a separate management team that operates its niche as a separate business unit responsible for performance goals specific to that particular line of business. Our structure allows the senior managers of each line of business to focus their efforts on understanding their customers and meeting the needs of the markets they serve. This structure also promotes accountability among managers of each enterprise. The senior managers at each of our lines of business and at the parent company have significant experience with us and in their respective industries.
- Diversify capital and earnings risk. We diversify our revenues and allocate our capital across complementary lines of business as a key part of our risk management. Our lines of business are cyclical, but when combined in an appropriate mix, we believe they provide sources of diversification and opportunities for growth in a variety of economic conditions. For example, both the origination and servicing of residential mortgage loans are very cyclical businesses, tied to changes in interest rates. We believe our participation in these markets has been profitable over time due to our dedication to participating in both segments of the mortgage banking business, rather than one or the other, which would otherwise leave us more susceptible to swings in interest rates.
- Reinvest in new opportunities. We reinvest on an ongoing basis in the development of new and existing opportunities. As a result of our attention to long-term value creation, we believe it is important at times to limit short-term growth by investing for future return. We are biased toward seeking new growth through organic expansion of existing lines of business or the initiation of a new line through a start-up, utilizing highly qualified managers we select to focus on a single line of business. Over the past 10 years, we have made only a few acquisitions and those have typically been in non-competitive bidding situations.
We believe our historical growth and profitability is the result of our endeavors to pursue complementary consumer and commercial lending niches through our bank holding company structure, our experienced management, our diverse product and geographic markets, and our willingness and ability to align the compensation structure of each of our lines of business with the interests of our stakeholders. Through various economic environments and cycles, we have had a relatively stable revenue and earnings stream on a consolidated basis generated primarily through internal growth rather than acquisitions. Over the five-year and ten-year periods ending December 31, 2001, respectively, our financial performance has been as follows:
- our return on average equity averaged 21.36% and 22.53%;
- our diluted earnings per common share compounded at an average annual growth rate of 16.65% and 15.18%;
- our net revenues(1) compounded at an average annual growth rate of 18.85% and 17.33%;
- our book value per common share compounded at an average annual growth rate of 16.80% and 18.15%.
While our financial results in 2002 will likely be significantly different than our historical performance for the reasons discussed in the "Recent Developments" section below, management anticipates that after 2002, we can again achieve our long-term financial objectives of at least 12% annual earnings per share growth and greater than 15% return on common equity.
RECENT DEVELOPMENTS
Impact of Recent Change to Regulatory Capital Rules
The federal banking regulators, including the Federal Reserve, our principal regulator, have adopted revised regulatory capital standards regarding the treatment of certain recourse obligations, direct credit substitutes, residual interests in asset securitizations, and other securitized transactions. In general, the new rules require a banking institution that has certain residual interests in an amount that exceeds 25% of its
(1) Net revenues consist of net interest income plus noninterest income.
Tier 1 capital, to deduct the after-tax excess amount of credit-enhancing residual interests from Tier 1 capital for purposes of computing risk-based capital ratios.
The new capital standards became effective on January 1, 2002, for new residual interests related to any transaction covered by the revised rules that settles after December 31, 2001. For transactions settled before January 1, 2002, application of the new capital treatment to the residuals created will be delayed until December 31, 2002.
We believe these new rules apply to many, if not all, of the securitization transactions historically done by our home equity line of business to fund loan production. The residual assets we now own exceed the 25% concentration limit in the new capital treatment rules. On a pro forma basis adjusted to give effect to our recently completed public offering, and assuming conservatively that all of our residual assets are subject to the new capital treatment, our residual assets as of December 31, 2001, comprised 49% of our consolidated Tier 1 capital. We are taking steps to materially reduce the levels of our residuals as a percentage of Tier 1 capital. On November 29, 2001, we sold $12.3 million of our residual interests in our home equity loans previously securitized in September 2000. This represents our fourth sale of residual assets in the last two years. By the end of 2002, we expect our residual interests to have declined to approximately 35% of Tier 1 capital, falling to approximately 20% by the end of 2003.
We have financed the significant growth in our home equity lending line of
business to date using transaction structures that create residual interests
through "gain-on-sale" accounting -- sales transactions accounted for under SFAS
140. To mitigate the impact of the new rules, beginning in 2002 we will be
eliminating our use of these securitization structures that require gain-on-sale
accounting treatment. We believe using on-balance sheet financing rather than
using off-balance sheet gain-on-sale treatment under SFAS 140 will allow
continued access to the capital markets for cost-effective, matched funding of
our loan assets, while not meaningfully affecting or changing our cash flows,
nor changing the longer term profitability of our home equity lending operation.
Changing our securitization practices will significantly affect the financial results of our home equity line of business in 2002. The key financial impacts we expect include:
- By using on-balance sheet financing to fund our home equity loan originations, we will be required to change the timing of revenue recognition on these assets under generally accepted accounting principles. For assets funded on-balance sheet, we will record interest income over the life of the loans, as it is earned, net of interest expense over the life of the bonds and a provision for credit losses inherent in the portfolio. For assets funded through transactions accounted for as a sale under SFAS 140, we have recorded revenue as gain-on-sale at the time of loan sale based on the difference between proceeds and allocated cost basis of the loans sold. We have also recognized residual interests based on the discounted present value of anticipated revenue stream over the expected lives of the loans. This different accounting treatment does not, however, affect cash flows related to the loans, and management expects that the ultimate total receipt of revenues and profitability derived from our home equity loans will be relatively unchanged by these different financing structures.
- Due to the extension of the period during which revenue would be recognized under the new financing structures we intend to pursue, we plan to reduce the rate of growth in production and related expenses in the home equity lending line of business to more closely align anticipated revenue recognition and expenses under this new model. This process is now under way. However, while we anticipate continued profitability on a consolidated basis, we currently expect to report a loss in 2002 in our home equity lending line of business as we make this transition.
- After the initial transition period, as the portfolio of on-balance sheet home equity loans continues to grow, we should record increased levels of net interest income sufficient to cover ongoing expenses and credit losses. We would then expect to be in a position to resume profitable growth in this line of business. We may also pursue selective opportunities to sell whole loans in cash sale transactions if attractive terms can be negotiated. We currently anticipate that our home equity lending line of business will return to profitability in 2003.
Our Tier 1 capital totaled $295.0 million as of December 31, 2001, or 6.8% of risk-weighted assets. On a pro forma basis, giving full effect to the new risk-weighted capital regulations regarding residual assets, as further adjusted to give effect to the net proceeds from our recent public offering and prior to any residual asset reduction steps we are contemplating to reduce our concentration of residual assets or to reclassify for capital treatment purposes any of those residual assets, or any other changes, our Tier 1 capital and total capital to risk-weighted assets would be approximately 8.2% and 11.0%, respectively, as of December 31, 2001. The new capital rules do not become fully effective until December 31, 2002.
Earnings Outlook
Taking the factors discussed above into account, we expect consolidated net income to decline in 2002 but then to increase significantly in 2003. Management currently estimates that consolidated net income will be approximately $36 million in 2002 and approximately $54 million in 2003. These estimates include $2.7 million of after-tax interest expense on our convertible trust preferred securities, which would be added back to net income for purposes of calculating fully diluted earnings per share under generally accepted accounting principles. These estimates are based on various factors and current assumptions management believes are reasonable, including current industry forecasts of a variety of economic and competitive factors. However, projections are inherently uncertain, and our actual earnings may differ significantly from these estimates due to uncertainties and risks related to our business.
While our financial results in 2002 will likely be significantly different than our historical performance for the reasons discussed above, management anticipates that after 2002, we can again achieve our long-term financial objectives of at least 12% annual earnings per share growth and greater than 15% return on common equity.
CRITICAL ACCOUNTING POLICIES/MANAGEMENT JUDGMENTS AND ACCOUNTING ESTIMATES
Accounting estimates are an integral part of our financial statements and are based upon our current judgments. Certain accounting estimates are particularly sensitive because of their significance to the financial statements and because of the possibility that future events affecting them may differ from our current judgments or that our use of different assumptions could result in materially different estimates. The following is a description of the critical accounting policies we apply, all of which require the use of accounting estimates and/or judgment:
Allowance for Loan and Lease Losses
The allowance for loan and lease losses (ALLL) reflects our estimate of the adequacy of reserves needed to cover probable loan and lease losses and certain risks inherent in our loan portfolio. In determining a proper level of loss reserves, management periodically evaluates the adequacy of the allowance based on our past loan loss experience, known and inherent risks in the loan portfolio, levels of delinquencies, adverse situations that may affect a borrower's ability to repay, trends in volume and terms of loans and leases, estimated value of any underlying collateral, changes in underwriting standards, changes in credit concentrations, and current economic and industry conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review our allowance for loan and lease losses. Such agencies may require us to recognize additions to the allowance for loan and lease losses based on their judgments of information available to them at the time of their examination.
Accounting for Private Equity Investments
It is our accounting policy to account for private equity investments held by our venture capital line of business at fair value, with unrealized and realized gains and losses included in noninterest income as investment securities gains and losses. The fair value of private equity investments (which by their nature are not publicly traded) is estimated based on the investees' financial results, conditions and prospects, values of comparable public companies, market liquidity and sales restrictions. We assume that cost approximates fair value, unless there is evidence suggesting a revaluation is appropriate. Potential reasons for revaluation include: 1) an anticipated pricing of a company's future equity financing that would be lower than the previous funding round (although the reverse would not necessarily require an upward adjustment) 2) a significant deterioration in the company's performance 3) a significant reduction in the company's potential realizable value -- for example, if market conditions have caused a meaningful change in the value of peer companies. We believe the values derived from the application of our policy represent a close approximation of fair value for non-marketable securities.
Accounting for Deferred Taxes
Deferred tax assets and liabilities are determined based on temporary differences between the time income or expense items are recognized for book purposes and in our tax return. We make this measurement using the enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. We recognize deferred tax assets based on estimates of future taxable income. Events may occur in the future that could cause the realizability of these deferred tax assets to be in doubt, requiring the need for a valuation allowance.
Valuation of Mortgage Servicing Rights
Mortgage servicing rights are recorded at the lower of their cost basis or market value and a valuation allowance is recorded for any stratum that is impaired. We estimate the market value of the servicing assets each month using a cash flow model to project future expected cash flows based upon a set of valuation assumptions we believe market participants would use for similar assets. We review these assumptions on a regular basis to ensure that they remain consistent with current market conditions. Additionally, we periodically receive third party estimates of the portfolio value from an independent valuation firm. Inaccurate assumptions in valuing mortgage servicing rights could adversely affect our results of operations during a period in which additional impairment occurs.
Valuation of Residual Interests
Residual interests from securitizations are classified as trading assets and as such, we record them at fair value on the balance sheet. We record the changes in fair value of these residuals as unrealized gains or losses in results of operations in the period of change. We use a discounted cash flow analysis to determine the fair value of these residuals. Cash flows are projected over the lives of the residuals using prepayment, default, and interest rate assumptions that we believe market participants would use for similar financial instruments.
EARNINGS BY LINE OF BUSINESS
Irwin Financial Corporation is composed of five principal lines of business:
- Mortgage Banking
- Home Equity Lending
- Commercial Banking
- Equipment Leasing
- Venture Capital
YEAR ENDED DECEMBER 31,
-----------------------------
2001 2000 1999
------- ------- -------
(IN THOUSANDS)
Net income (loss):
Mortgage Banking.......................................... $38,100 $13,006 $23,063
Home Equity Lending....................................... 16,248 18,494 12,606
Commercial Banking........................................ 8,918 7,090 7,345
Equipment Leasing......................................... (4,394) (2,563) (843)
Venture Capital........................................... (6,549) 2,723 656
Other (including consolidating entries)................... (6,807) (3,084) (9,671)
------- ------- -------
$45,516 $35,666 $33,156
======= ======= =======
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Our financial results in 2002 will be significantly different than our historical performance due to changes we have made in our operating plan to address changes in regulatory capital rules associated with residual interests on sold loans. Beginning in 2002, we will eliminate our use of securitization structures that require gain-on-sale accounting treatment under SFAS 140. These structures create the residual assets that are the focus of the new rules. See the "Recent Developments" section of this report for a discussion of the anticipated impact of these changes on our earnings.
SUMMARY OF QUARTERLY FINANCIAL DATA
2001
--------------------------------------------
FOURTH THIRD SECOND FIRST
QUARTER QUARTER QUARTER QUARTER
-------- -------- -------- --------
(DOLLARS IN THOUSANDS)
SUMMARY INCOME STATEMENT INFORMATION
Interest income............................... $ 69,412 $ 72,925 $ 65,174 $ 60,722
Interest expense.............................. (26,452) (31,909) (31,235) (31,488)
Provision for loan and lease losses........... (8,142) (5,006) (2,804) (1,553)
Noninterest income............................ 82,856 58,464 68,304 61,767
Noninterest expense........................... (98,751) (75,629) (78,367) (74,673)
Income taxes.................................. (6,924) (7,446) (8,475) (5,779)
-------- -------- -------- --------
Net income before minority interest and
cumulative effect of change in accounting
principle.................................. 11,999 11,399 12,597 8,996
Minority interest............................. 71 68 211 --
Cumulative effect of change in accounting
principle.................................. -- -- -- 175
-------- -------- -------- --------
$ 12,070 $ 11,467 $ 12,808 $ 9,171
======== ======== ======== ========
Earnings per share:
Basic(1)................................... $ 0.57 $ 0.54 $ 0.61 $ 0.44(1)
Diluted(1)................................. 0.53 0.50 0.56 0.41(1)
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2000
----------------------------------------------
FOURTH THIRD SECOND FIRST
QUARTER QUARTER QUARTER QUARTER
---------- -------- -------- --------
(DOLLARS IN THOUSANDS)
SUMMARY INCOME STATEMENT INFORMATION
Interest income............................... $ 57,446 $ 48,034 $ 43,015 $ 36,035
Interest expense.............................. (27,755) (26,760) (22,354) (16,665)
Provision for loan and lease losses........... (1,793) (1,356) (1,119) (1,135)
Noninterest income............................ 51,174 58,075 52,589 49,873
Noninterest expense........................... (63,242) (62,748) (58,036) (53,936)
Income taxes.................................. (6,279) (6,117) (5,591) (5,689)
-------- -------- -------- --------
Net income.................................... $ 9,551 $ 9,128 $ 8,504 $ 8,483
======== ======== ======== ========
Earnings per share:
Basic...................................... $ 0.46 $ 0.43 $ 0.41 $ 0.40
Diluted.................................... $ 0.44 $ 0.43 $ 0.40 $ 0.40
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(1) Earnings per share of common stock before cumulative effect of change in accounting principle for the three month period ended March 31, 2001 was $0.43 basic and $0.40 diluted.
MORTGAGE BANKING
The following table shows selected financial information for our mortgage banking line of business:
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------
2001 2000 1999 1998 1997
----------- ---------- ----------- ----------- -----------
(IN THOUSANDS)
SELECTED INCOME STATEMENT DATA:
Net interest income...................... $ 30,261 $ 15,401 $ 21,745 $ 26,244 $ 17,577
Provision for loan losses................ 31 357 (1,998) (1,721) (1,383)
Loan origination fees.................... 61,917 34,688 46,311 59,328 41,045
Gain on sales of loans................... 113,140 45,601 72,395 97,724 53,332
Loan servicing fees...................... 52,837 50,309 54,247 52,217 50,194
Amortization of servicing assets......... (34,660) (23,712) (25,078) (23,002) (15,243)
Impairment of servicing assets........... (11,321) (13,802) 11,320 (11,121) (600)
Gain (loss) on derivatives............... 3,846 24 (10,808) 4,318 --
Gain on sales of bulk servicing rights... 8,394 27,528 9,005 829 1,512
Other income............................. 5,016 4,538 3,628 2,276 1,223
----------- ---------- ----------- ----------- -----------
Total net revenue...................... 229,461 140,932 180,767 207,092 147,657
Operating expense.......................... 167,624 119,387 144,915 159,046 111,367
----------- ---------- ----------- ----------- -----------
Income before taxes........................ 61,837 21,545 35,852 48,046 36,290
Income taxes............................... 23,912 8,539 12,789 19,193 14,990
----------- ---------- ----------- ----------- -----------
Net income before cumulative effect of
change in accounting principle........... 37,925 13,006 23,063 28,853 21,300
Cumulative effect of change in accounting
principle................................ 175 -- -- -- --
----------- ---------- ----------- ----------- -----------
Net income................................. $ 38,100 $ 13,006 $ 23,063 $ 28,853 $ 21,300
=========== ========== =========== =========== ===========
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YEAR ENDED DECEMBER 31,
------------------------------------------------------------------
2001 2000 1999 1998 1997
----------- ---------- ----------- ----------- -----------
(IN THOUSANDS)
SELECTED BALANCE SHEET DATA AT END OF
PERIOD:
Total assets............................. $ 926,946 $ 523,920 $ 549,966 $ 1,020,249 $ 792,007
Mortgage loans held for sale............. 503,757 249,580 277,614 697,542 528,739
Mortgage servicing assets................ 211,201 121,555 132,648 113,131 81,610
Short-term debt.......................... 385,640 215,826 217,691 430,859 429,451
Long-term debt........................... -- 3,951 223 2,839 54
Shareholders' equity..................... 63,150 47,828 98 |