SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-K (Mark One) x Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 1997 or __ Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from _______ to ________ Commission file number 0-6835 IRWIN FINANCIAL CORPORATION (Exact Name of Registrant as Specified in its Charter) Indiana 35-1286807 (State or Other Jurisdiction of Incorporation (I.R.S. or Organization) Employer Identification No.) Organization) 500 Washington Street Columbus, Indiana 47201 (Address of Principal Executive Offices) (Zip Code) (812) 376-1020 (Registrant's Telephone Number, Including Area Code) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Shares (Title of Class) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x The aggregate market value of the voting stock held by non-affiliates of the Registrant was $253,131,710.94 as of March 12, 1998. As of March 12, 1998, there were outstanding 10,903,149 common shares of the Registrant. DOCUMENTS INCORPORATED BY REFERENCE Selected Portions of Part of Form 10-K Into Which the Following Documents Incorporated Annual Report to Shareholders Part I, Part II for the year ended December 31, 1997 Definitive Proxy Statement for Part III Annual Meeting of Shareholders to be held April 30, 1998 Exhibit Index on Pages 14 through 18 Page 1 Total Pages in This Filing: 124 FORM 10-K TABLE OF CONTENTS Part I Item 1 - Business 3 Item 2 - Properties 7 Item 3 - Legal Proceedings 8 Item 4 - Submission of Matters to a Vote of Security Holders 9 Part II Item 5 - Market for Registrant's Common Equity and Related Security Holder Matters 9 Item 6 - Selected Financial Data 10 Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations 10 Item 8 - Financial Statements and Supplementary Data 12 Item 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 13 Part III Item 10 - Directors and Executive Officers of the Registrant 13 Item 11 - Executive Compensation 13 Item 12 - Security Ownership of Certain Beneficial Owners and Management 13 Item 13 - Certain Relationships and Related Transactions 13 Part IV Item 14 - Exhibits, Financial Statement Schedules and Reports on Form 8-K 14 Signatures 19 PART I Item 1 Business General Irwin Financial Corporation (the "Registrant") is a diversified financial services company organized as an Indiana bank holding company in May, 1972. The Registrant's principal subsidiaries are Irwin Mortgage Corporation ("Irwin Mortgage", formerly Inland Mortgage Corporation), a mortgage banking company; Irwin Union Bank and Trust Company ("Irwin Union Bank"), a commercial bank; Irwin Equipment Finance Corp. (the new name of the parent company of Affiliated Capital Corp.) ("Irwin Equipment"), an equipment leasing company; Irwin Home Equity Corporation ("Home Equity"), a consumer home equity lending company; White River Capital Corporation, a small venture capital company; and Irwin Union Credit Insurance Corporation, a credit insurance company. Registrant is also the sole equity shareholder of IFC Capital Trust I ("Capital Trust"), a special purpose trust. The Registrant's 1997 Annual Report section on "Management's Discussion and Analysis of Results of Operations and Financial Condition" is included with this filing as Exhibit13(a). Page 53 of the Report states that Irwin Equipment Finance Corp. was previously Affiliated Capital Corp., and page 55 of the Report lists the Irwin Equipment Finance Corp. Senior Officers. This information is incorrect. Affiliated Capital Corp. did not change its name to Irwin Equipment Finance Corp.; the parent company of Affiliated Capital Corp. (formerly Irwin Union Leasing Corporation) changed its name to Irwin Equipment Finance Corp. The Officers listed on page 55 are those of Affiliated Capital Corp.; not Irwin Equipment Finance Corp., with the exception of Matthew Colasanti, who is President of both Irwin Equipment Finance Corp. and Affiliated Capital Corp. The Annual Report had already been published when the error was discovered. When referring to the leasing line of business, the Registrant now uses the name "Irwin Equipment Finance Corp." to include the activities of Affiliated Capital Corp. Business of Subsidiaries Irwin Mortgage originates, purchases and services conventional or government agency backed (i.e., FHA and VA) residential mortgage loans. Most mortgages are either insured by an agency of the federal government, or in the case of a conventional mortgage, meet requirements for resale to the Federal National Mortgage Association or the Federal Home Loan Mortgage Corporation. Irwin Mortgage also originates a small amount of commercial mortgages. Irwin Mortgage sells mortgage loans to institutional and private investors but may retain servicing rights to mortgage loans that it originates or purchases 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. Irwin Mortgage operates 95 production and satellite offices in 28 states. During 1997, Irwin Mortgage established offices in San Diego, California; Pueblo, Colorado; Farmington, Connecticut; Columbus, and Macon, Georgia; New Orleans, Louisiana; Braintree, Massachusetts; Wilmington and Burlington, North Carolina; and Columbia, South Carolina. During 1997, Irwin Mortgage closed offices in Albuquerque, New Mexico; Clackamas, Oregon; Denver and Fort Collins, Colorado; Hayes and Woodbridge, Virginia; Las Vegas, Nevada; LaPorte, Indiana; Montclair (Oakland), Pasadena, Santa Rosa, and West Lake Village, California; North Houston and Plano, Texas; Tempe, Arizona; Seattle/Kirkland and Snohomish, Washington; Crofton and Solomons, Maryland. Irwin Mortgage entered the non-prime first mortgage lending market in 1997. This market is composed of borrowers who do not qualify under the underwriting guidelines established by the government-sponsored secondary market agencies for conforming first mortgages. Irwin Mortgage opened a non-prime lending office in Richmond, Virginia late in the fourth quarter of 1996 and began originating non-prime first mortgages in 1997. Irwin Mortgage and the Registrant have, for several years, been exploring opportunities to test the development of mortgage banking operations in markets outside the United States. In December, 1996, Irwin Mortgage began taking applications from U. S. Borrowers for dollar denominated loans to be secured by residential real estate located in Mexico. The Registrant will continue research of international opportunities to which the Registrant might apply its knowledge and competencies. Irwin Union Bank, organized in 1871, is a full service commercial bank offering a wide variety of services to individual, business, institutional, and governmental customers. Irwin Union Bank's services include personal and commercial checking accounts, savings and time deposit accounts, personal and business loans, credit card services, money transfer, financial counseling, property and casualty insurance agency services, trust services, securities brokerage and safe deposit facilities. Irwin Union Bank is the largest of nine financial institutions operating in Bartholomew County, Indiana, with eight locations throughout the county. Irwin Union Bank also has branch facilities in Seymour (Jackson County - 2), Shelbyville (Shelby County), Bloomington (Monroe County), Franklin and Greenwood (Johnson County - 2), Carmel (Hamilton County), and Greensburg (Decatur County), Indiana. On August 13, 1997, Irwin Union Bank became a member of the Federal Reserve System. On August 29, 1997 Irwin Union Securities, formerly the brokerage Subsidiary of Irwin Union Investor Services, Inc., became a Subsidiary of Irwin Union Bank. As of February 1, 1998, Irwin Union Insurance, Inc., an insurance agency subsidiary of Irwin Union Bank, purchased substantially all the property and casualty assets of Maximum Benefits & Protection Co. Inc., an Indiana corporation. Irwin Equipment, located in Northbrook, Illinois, is the parent company of Affiliated Capital Corp., which is engaged in the small-ticket equipment leasing and commercial lending business. Irwin Equipment offers non-recourse, non-operating, full payout leases and commercial lines of credit to physicians, medical clinics, veterinarians, dentists and chiropractors. Home Equity was formed in 1994 and is located in San Ramon, California. Home Equity originates and services home equity loans and lines of credit. The loans are marketed through direct mail and telemarketing in twenty-two states. At year end, Home Equity began offering a first mortgage refinance program in selected states. White River Capital Corporation ("White River"), a venture capital company, is located in Columbus, Indiana and currently holds one investment but has suspended making new investments. Irwin Union Credit Insurance Corporation is located in Columbus, Indiana and provides credit life insurance to consumer loan customers of Irwin Union Bank. IFC Capital Trust I ("Capital Trust"), is a statutory business trust created under the laws of Delaware. The Company owns all of the Common Securities of Capital Trust. Capital Trust exists for the purpose of issuing the Preferred Securities and investing the proceeds thereof in an equivalent amount of 9.25% Subordinated Debentures of the Company. The Subordinated Debentures will mature on March 31, 2027, which date may be (i) shortened to a date not earlier than March 31, 2002, or (ii) extended to a date not later than March 31, 2046, in each case if certain conditions are met (including, in the case of shortening the Stated Maturity, the Company having received prior approval of the Board of Governors of the Federal Reserve System ("Federal Reserve") to do so if then required under applicable capital guidelines or policies of the Federal Reserve). The Preferred Securities will have a preference under certain circumstances with respect to cash distributions and amounts payable on liquidation, redemption or otherwise over the Common Securities. Holders of Preferred Securities are entitled to receive preferential cumulative cash distributions, at the annual rate of 9.25% of the liquidation amount of $25 per Preferred Security accruing from the date of original issuance and payable quarterly in arrears on the last day of March, June, September and December of each year, commencing March 31, 1997. No single part of the business of the Registrant 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 the business of the Registrant. Irwin Mortgage is registered as a Foreign Financial Institution in Mexico. Competition Irwin Mortgage originates and services residential first mortgage loans from 95 production and satellite offices in Arizona, California, Colorado, Connecticut, Delaware, Florida, Georgia, Hawaii, Illinois, Indiana, Kentucky, Louisiana, Massachusetts, Minnesota, Missouri, New Jersey, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, Texas, Utah, Washington, Wisconsin, and the Washington, D.C. metropolitan area, including offices in Maryland and Virginia. In each of these locations, competition for mortgage loans is vigorous, coming from other national, regional and local mortgage banking companies as well as commercial banks, savings banks, and savings & loan associations. Irwin Mortgage purchases mortgage loans from correspondents in these and other states as well. The commercial banking business for Irwin Union Bank in the Bartholomew, Decatur, Hamilton, Jackson, Johnson, Monroe and Shelby County areas is very competitive. Within these counties, in addition to the commercial banks, there are a number of savings banks, savings & loan associations, and credit unions competing for deposits and loans. Irwin Union Bank also competes for the provision of banking services with banks located elsewhere in Indiana, primarily in south central Indiana, and with a number of nonbank companies located throughout the United States, including insurance companies, retailers, brokerage firms, companies offering money market accounts, and national credit card companies. As of December 31, 1997, Irwin Union Bank ranked first among commercial banking and savings bank institutions on the basis of Bartholomew County deposits. In addition to the above mentioned counties, Irwin Union Bank derives its business from several other counties in south central Indiana. Irwin Equipment provides, primarily, medical equipment leasing and commercial credit services to medical clinics, small groups of physicians, individual practitioners, chiropractors, dentists, and veterinarians. Irwin Equipment's primary competitors include other equipment leasing companies with operations that are national in scope, banks, and other financial institutions which offer commercial credit products. Such competitors may be headquartered anywhere in the country. Home Equity originates and services home equity loans and lines of credit for private home owners in several states. Home Equity's primary competitors include banks, thrifts, credit unions and other home equity lenders with operations that are either national, regional or local in scope. Such competitors may be headquartered anywhere in the country. Supervision and Regulation The Registrant is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended, and is registered with, regulated and examined by the Board of Governors of the Federal Reserve System (the "Board of Governors"). Subject to certain exceptions, a bank holding company is prohibited from acquiring direct or indirect ownership or control of more than five percent of the voting shares of any company which is not a bank and from engaging directly or indirectly in activities unrelated to banking or managing or controlling banks. One exception to this prohibition permits activities by a bank holding company or its subsidiary which the Board of Governors determines to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. The Board of Governors has adopted regulations prescribing those activities it presently regards as permissible which include the activities engaged in by Registrant and its subsidiaries. The Bank Holding Company Act, the Federal Reserve Act, and the Federal Deposit Insurance Act also subject bank holding companies and their subsidiaries to certain restrictions on extensions of credit by subsidiary banks to the bank holding company or any of its subsidiaries, or investments in the securities thereof, and on the taking of such securities as collateral for loans to any borrower. Further, the Bank Holding Company Act and the regulations of the Board of Governors thereunder, prohibit a bank holding company and its subsidiaries from engaging in certain tie- in arrangements in connection with any extension of credit, sale or lease of any property or furnishing of services. In addition to the regulation of the Registrant, Irwin Union Bank is subject to extensive regulation and periodic examination, principally by the Indiana Department of Financial Institutions and the Federal Reserve Bank of Chicago. Irwin Mortgage is subject to audit and examination oversight by the federal department of Housing and Urban Development as well as the Government National Mortgage Association, the Federal National Mortgage Association, and the Federal Home Loan Mortgage Corporation. The insurance subsidiary of the Registrant and the insurance subsidiary of Irwin Union Bank are dependent upon state licenses and upon franchise agreements with private corporations for their continued existence. The home equity subsidiary of the Registrant is also dependent upon state licenses for its ability to extend credit in certain states. Finally, the securities brokerage activities of Irwin Union Bank's registered broker/dealer are regulated and examined by the Securities and Exchange Commission, the Indiana Securities Division, the securities divisions of the various states in which Irwin Union Securities, Inc. operates, and the National Association of Securities Dealers. Employees and Labor Relations As of December 31, 1997, the Registrant and its subsidiaries had a total of 1,969 employees, including full-time and part-time employees. The Registrant continues a commitment of equal employment opportunity for all job applicants and staff members, and management regards its relations with its employees as satisfactory. Further Information The following information responsive to Guide 3 promulgated under the Securities Exchange Act of 1934, is contained in the "Management's Discussion and Analysis of Financial Conditions and Results of Operations" section of the Annual Report to Shareholders for the year ending December 31, 1997 and is incorporated herein by reference: "Daily Average Consolidated Balance Sheet, Interest Rates and Interest Differential" (p. 74), "Investment Securities" (p. 60), "Short-Term Borrowings" (p. 60), "Summary of Net Interest Income Changes" (p. 57), "Deposits" (p. 60), "Loans and Leases" (p. 59), "Five-Year Selected Financial Data" (p. 28), and the discussion and tabular information under the caption "Credit Risk" on pages 64 to 68 of "Management's Discussion and Analysis of Financial Conditions and Results of Operations". Executive Officers of the Registrant The Executive Officers of the Registrant are elected annually by the Board of Directors and serve for a term of one year or until their successors are elected and qualified. There are no arrangements or understandings between any Executive Officer and any other person pursuant to which the Officer was or is to be selected as an Officer. Robert P. Albert (47) was President of Affiliated Capital Corp. from February 28, 1990 to March 3, 1998. Matthew Colasanti (57) is President of Irwin Equipment Finance Corp. and Affiliated Capital Corp. since March 3, 1998. From January through March 2, 1998, Mr. Colasanti was a consultant to Affiliated Capital Corp. From 1992 to 1995, Mr. Colasanti was President of Concord Commercial Corp. a North American subsidiary of Hong Kong Shanghai Bank. Mr. Colasanti has more than thirty years of equipment finance and leasing expertise and leadership, ranging in firm size from large organizations to start-up companies, and from work-outs to high growth. Claude E. Davis (37) is President of Irwin Union Bank since January 2, 1996. He has been an officer since 1988. Elena Delgado (42) is President of Irwin Home Equity Corporation since September 4, 1994. From March through August, 1994, Ms. Delgado was an independent consultant to Irwin Financial Corporation. From 1990 to 1993, Ms. Delgado was Vice President, Second Mortgage Lending of First Deposit Corporation. Gregory F. Ehlinger (35) is Vice President and Treasurer of the Registrant since August of 1992. Jose M. Gonzalez (39) is Vice President and Director of Internal Audit of the Registrant since October of 1995. From 1993 to 1995, Mr. Gonzalez was Senior Vice President, Audit & Compliance Services of Premier Bank and Trust. From 1991 to 1993, Mr. Gonzalez was Vice President and Senior Compliance Officer at First Empire State Corporation. Theresa L. Hall (45) is Vice President - Human Resources of the Registrant, since 1988. She has been an officer since 1980. Rick L. McGuire, (45) is President of Irwin Mortgage since January 1, 1996. He has been an officer since 1978. William I. Miller (41) is Chairman of the Board, since 1990, and has been a Director of the Registrant since 1985. Ellen Z. Mufson (49) is Vice President - Legal of the Registrant, since September, 1997. She was Vice President - Legal Counsel of Irwin Union Bank and Trust Company from July, 1996 through August, 1997; Corporate Counsel of Irwin Financial Corporation from January, 1995 through June, 1996; Deputy Director/General Counsel of the Indiana Development Finance Authority from March, 1992 through November, 1994. John A. Nash (60) is Chairman of the Executive Committee, since 1990, and President, since 1985, of the Registrant. He has been an officer and Director of the Registrant since 1972. Michael F. Ryan (52) is Vice President - Community Development of the Registrant since January 2, 1996. He was President of Irwin Union Bank from 1981 - 1995. He has been an officer since 1976. Matthew F. Souza (41) is Vice President and Secretary of the Registrant. He has been an officer since 1985. Marie C. Strack (35) is Vice President and Controller of the Registrant since May of 1992. Thomas D. Washburn (51) is Senior Vice President and Chief Financial Officer, since 1980, of the Registrant. He has been an officer since 1976. Item 2. Properties The location and general character of the materially important physical properties of the Registrant and its subsidiaries are as follows: The main office of Irwin Mortgage, 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. Irwin Mortgage also has loan production and satellite offices located in Flagstaff, Phoenix (2), Mesa, Scottsdale, and Tucson, Arizona; Antioch, Bakersfield, Concord, Covina, Fresno, Laguna Hills, Morgan Hill, Richmond, Sacramento, Salinas, San Diego, Temecula, Ventura, Visalia, Walnut Creek, Woodland, Yuba City, and Yreka, California; Castle Rock, Colorado Springs, Denver, Englewood, Woodland Park, and Pueblo, Colorado; Farmington, Connecticut; Newark, Delaware; Clearwater and Orlando/Longwood, Florida; Atlanta, Columbus, and Macon, Georgia; Aiea, Honolulu, Kailua, and Maui, Hawaii; Chicago and Decatur, Illinois; Indianapolis (5), Anderson, Ft. Wayne, Kokomo, Lafayette, South Bend, and Warsaw, Indiana; Lexington and Louisville, Kentucky; Baton Rouge and New Orleans, Louisiana; Columbia, Rockville, and Towson, Maryland; Braintree, Massachusetts; Arden Hills, Burnsville, and Minneapolis, Minnesota; St. Louis, Missouri; Marlton, New Jersey; Cary, Charlotte, Greensboro, Raleigh, Wilmington, and Burlington, North Carolina; Dayton and Independence/Cleveland, Ohio; Tulsa, Oklahoma; Beaverton and Lake Oswego, Oregon; Wyomissing, formerly West Chester, Pennsylvania; Columbia, South Carolina; Austin, Corpus Christi, Dallas, El Paso, and Houston, Texas; Salt Lake City, Utah; Fredericksburg, Glen Allen, Richmond, Springfield, and Suffolk, Virginia; Bellevue, Battleground, Everett, and Mount Lake Terrace, Washington; and Madison, Wisconsin. All offices occupied by Irwin Mortgage are leased. The main office of Irwin Union Bank is located in four connected buildings all at 500 and 520 Washington Street, Columbus, Indiana. These buildings and one branch building are owned in fee by Irwin Union Realty Corporation, a wholly-owned subsidiary of Irwin Union Bank, and are leased by Irwin Union Bank. Irwin Union Bank owns in fee three of its other fifteen relatively small branch banking premises. The other branch offices are leased. None of the properties owned by Irwin Union Bank are subject to any major encumbrances. The main office of Irwin Equipment, where administrative and lease servicing activities are centered, is located at 707 Skokie Boulevard, Northbrook, Illinois. This office location is leased. The main office of Irwin Home Equity is located at 12677 Alcosta Blvd., Suite 500, San Ramon, California. This office location is leased. The main offices of the Registrant, White River Capital Corporation and Irwin Union Credit Insurance Corporation are located at 500 Washington Street, Columbus, Indiana in space leased from Irwin Union Bank. Item 3. Legal Proceedings As a part of the ordinary course of business, the Registrant and its subsidiary companies 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 their regular business activities. In addition to such claims, the Registrant was involved, as of December 31, 1997, in the following actions: Basmoen, et al. v. Inland Mortgage Corporation. As of December 31, 1997, Irwin Mortgage was a defendant in a class action lawsuit initiated in the state of Minnesota in October, 1995. The case is currently pending before a federal Multidistrict Litigation Panel in Chicago, Illinois. Plaintiffs allege that they represent a nationwide class of persons who have or had mortgage escrow accounts allegedly improperly managed by Irwin Mortgage. This case is among a series of class action cases commenced against a number of mortgage servicers in several states challenging the practices used in connection with the administration of escrow accounts for single family residential mortgages. In January, 1997, the court denied a motion by the plaintiff for class certification; however, in September, 1997, the court granted a motion by the plaintiff to add a class representative and denied a motion by Irwin Mortgage for summary judgment. In December, 1997, Irwin Mortgage filed a supplemental memorandum in opposition to the plaintiffs' motion for class certification to which the plaintiffs replied. The court has not yet ruled on class certification. At this stage of the litigation, it is impossible to predict the likelihood of an unfavorable outcome or to establish the possible extent or amount of liability or potential loss, if any, to which Irwin Mortgage might be exposed in this or similar escrow individual or class action cases brought in the future. Howell, et al. v. Inland Mortgage Corporation. As of December 31, 1997, Irwin Mortgage was a defendant to a class action lawsuit initiated in the state of Indiana in January, 1995. The case is currently pending before the Marion County Superior Court. Plaintiffs allege that lenders do not have the right to require borrowers to pay premiums for private mortgage insurance. A decision has not yet been rendered with regard to class certification. Similar suits have been filed in Indianapolis and other jurisdictions against mortgage lenders. Irwin Mortgage filed a motion for summary judgment in this case, which was denied. Irwin Mortgage is aware that the Indiana court has ruled against two other lenders on their respective dismissal and summary judgment motions. One of these lenders has been permitted to appeal the decision against it to the Indiana Court of Appeals. Because the issues in the case before the Indiana Court of Appeals are very much like those in the Irwin Mortgage case, a decision by the Court of Appeals will have a significant effect on the Irwin Mortgage case. At present, however, it is impossible to predict the likelihood of an unfavorable outcome or to establish the possible extent or amount of liability loss exposure, if any, to which Irwin Mortgage might be exposed. Culpepper, et al. v. Inland Mortgage Corporation. As of December 31, 1997, Irwin Mortgage was a defendant to a class action lawsuit initiated in the state of Alabama in April, 1996. This action is one of a breed of "RESPA Section 8" class actions that have been filed against several mortgage lenders challenging the legality of the payment of broker fees by mortgage lenders to mortgage brokers. On January 9, 1998, the Court of Appeals for the Eleventh Circuit reversed the district court's grant of summary judgment in favor of Irwin Mortgage and vacated the district court's dismissal of class claims and denial of class certification. On January 30, 1998, Irwin Mortgage petitioned the court of appeals for rehearing. On February 4, 1998, the court of appeals issued an order giving plaintiffs a deadline to reply to the rehearing petition. The litigation is still at a stage where it is impossible to predict the likelihood of an unfavorable outcome or to establish the possible extent or amount of liability or potential loss exposure, if any, to which Irwin Mortgage might be exposed. Except as described above, there is no material pending litigation in which the Registrant or any of its subsidiaries is involved or of which any of their property is the subject. Furthermore, there is no pending legal proceeding that is adverse to the Registrant in which any director, officer or affiliate of the Registrant, or any associate of any such director or officer, is a party, or has a material interest. The following litigation, previously reported, was no longer pending as of December 31, 1997: Providian Bankcorp, Inc. v. Irwin Financial Corporation, et al. The parties agreed to dismiss the litigation in April, 1997. The suit, which alleged the misappropriation of trade secrets, was initiated in the State of California in May, 1995. Irwin Union Bank and Trust Company v. United States Trust Company of New York, et al. The parties agreed to dismiss the litigation in May, 1997. The suit, which arose from a wire transfer, was initiated in the United States District Court for the Southern District of New York in August, 1996. Item 4. Submission of Matters to a Vote of Security Holders During the fourth quarter of 1997, no matters were submitted to a vote of security holders of the Registrant, through the solicitation of proxies or otherwise. PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters The Common Stock of the Registrant is quoted on the Nasdaq National Marekt (NASDAQ-NMS - trading symbol, IRWN). The following table sets forth certain information regarding trading in, and cash dividends paid with respect to, the shares of the Registrant's Common Stock in each quarter of the two most recent calendar years. All data have been adjusted for stock splits. The approximate number of shareholders of record on March 12, 1998 was 1,590. Stock Prices and Dividends: High Low Quarter Cash Total $ $ End Dividend Dividends $ $ For Year 1996 (split adjusted) First Quarter 22 3/4 19 3/4 22 1/8 0.060 Second Quarter 22 1/4 19 5/8 19 5/8 0.060 Third Quarter 21 5/8 17 7/8 21 1/4 0.060 Fourth Quarter 24 3/4 21 1/4 24 3/4 0.060 0.24 1997 First Quarter 30 1/2 24 1/4 27 1/4 0.070 Second Quarter 29 1/2 24 29 1/2 0.070 Third Quarter 37 1/4 28 3/4 37 1/4 0.070 Fourth Quarter 43 36 1/2 41 7/8 0.070 0.28 The Registrant expects to continue its 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 19, 1997, the Registrant's Board of Directors approved an increase in the Registrant's quarterly dividend to $.07 per share which dividend rate was unchanged as of December 31, 1997. Dividends paid by Irwin Union Bank to the Registrant are restricted by banking law. See Note 14 of Notes to the Consolidated Financial Statements in the attached Annual Report to Shareholders. No sales of unregistered equity securities were made by the Registrant during the fourth quarter of 1997. Item 6. Selected Financial Data The information contained in the Annual Report to Shareholders for the year ended December 31, 1997, under the caption "Five- Year Selected Financial Data", is incorporated herein by reference in response to this item. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The information set forth under the caption "Management's Discussion and Analysis of Results of Operations and Financial Condition" in the Annual Report to Shareholders for the year ended December 31, 1997, is incorporated herein by reference in response to this item. Item 7A. Quantitative and Qualitative Disclosures About Market Risk. Interest Rate Risk: Interest rate risk refers to the potential for changes in market rates of interest to cause changes in net interest income. Since net interest income is a major source of income, it is important that potential changes are managed prudently. The Asset-Liability Management Committee of the commercial bank monitors the repricing structure of both assets and liabilities over various time horizons. Exposure to changes in interest rates is evaluated by modeling the repricing characteristics of the commercial bank's portfolio under multiple rate scenarios. Formal policies approved by the commercial bank's Board of Directors ensure that exposure to changes in net interest revenues is maintained within acceptable levels. The mortgage banking business assumes a form of interest rate risk by entering into commitments to extend loans to borrowers at a fixed price for a limited period of time. Loans are also held temporarily until a pool is formed. The home equity and equipment leasing businesses are exposed to potential interest rate risk that is similar to the lending operations of the commercial bank. Once again, formal policies ensure that this risk is controlled. Rate risk at the commercial bank can typically be managed by controlling the maturity of loans, securities, and deposits. The commercial bank may also use financial futures or interest rate swaps from time to time, although there were none in place at December 31, 1997. The mortgage bank buys commitments to deliver loans at a fixed price to manage risk. The policy at both the home equity lending business and the equipment leasing business is to match-fund all assets. In some cases, the Corporation uses internal hedges between companies to allow for the risk characteristics of one line of business to offset those of another line. The following table shows in summary form the Corporation's interest rate sensitivity based on expected interest rate repricing intervals for the balance sheet as of December 31, 1997 (a "gap" analysis). For example, a 30-year adjustable rate residential mortgage held in the portfolio of Irwin Union Bank is included in the "4-12 month" category since that is the time frame over which the asset will reprice. Some items, such as certain deposit accounts, are non-interest bearing, but will vary in balance due to interest rate changes. Since the Corporation relies on such accounts in its operations and would need to replace them with "at market" liabilities should the non-interest bearing ones be unavailable, they are included in the gap table and in simulations as "non-market" items. As the table shows, the consolidated one-year gap at December 31, 1997 was a positive $143.0 million. This compares to a positive gap of $133.2 million at December 31, 1996. Since the gap was positive at December 31, 1997, it means that the Corporation's net interest income was positioned to benefit from rising rates, or to be harmed by declining rates. While traditional interest rate risk focuses on the changes in net interest income due to interest rate changes, the Corporation engages in other activities which are also affected by interest rate changes. Principal among these are mortgage loan origination and servicing. Through the use of simulations using regression modeling and option-adjusted valuation techniques for modeling expected customer behavior, the Corporation attempts to analyze and mitigate the interest rate risks associated with the negatively correlated activities of mortgage loan origination and servicing. For example, if interest rates decline, management expects an increase in mortgage loan origination income and a decline in the value of mortgage servicing assets. Management attempts to monitor this exposure to traditional interest rate risk as well as interest rate influences on production and servicing value in a comprehensive manner. Interest Sensitivity: (Thousands) Within 3 4 to 12 1 to 5 Over 5 Non - Fair Months Months Years Years Market Total Value Assets - $3,511 $8,412 $10,211 $0 $0 $22,134 $22,134 Trading: Taxable investment securities Assets - Other than Trading: Interest- 10,920 4,027 3,293 0 0 18,240 18,240 bearing deposits with banks Taxable 16,682 9,477 18,021 6,213 0 50,393 51,041 investment securities Tax-exempt 100 500 962 3,252 0 4,814 4,853 investment securities Mortgages 528,739 0 0 0 0 528,739 530,207 held for sale Loans, 269,988 99,787 146,186 95,132 0 611,093 613,513 net of unearned income Total 829,940 122,203 178,673 104,597 01,235,413$1,239,988 interest- earning assets Liabilities - Other than Trading Non-interest 0 0 0 0 287,555 287,555 $287,555 bearing deposits Money 32,625 0 47,148 10,169 0 89,942 89,942 market checking Money 1,758 0 5,487 0 0 7,245 7,245 market savings Regular 25,565 1,939 10,343 7,992 0 45,839 45,839 savings Time 166,381 64,683 57,186 764 0 289,014 289,088 deposits Short- 512,276 0 0 0 0 512,276 512,276 term borrowings Long- 1,399 2,499 3,197 0 0 7,095 7,138 term debt Total 740,004 69,121 123,361 18,925 287,555 1,238,966 $1,239,083 interest- bearing liabilities Trust 0 0 0 50,000 0 50,000 $55,038 preferred securities Interes 89,936 53,082 55,312 35,672 (287,555) (53,553) sensitivity gap Cumu- lative $89,936 $143,018 $198,330 $234,002 $(53,553)$(53,553) interest sensitivity gap (Thousands) Weighted Average Interest Rate Assets - Trading: Taxable invesnment 8.50% securities Assets - Other than Trading: Interest-bearing 5.72 deposits with banks Taxable investment 6.31 securities Tax-exempt 8.88 Mortgages held for 7.36 sale Loans, net of 9.04 unearned income Total interest- 8.15% earning assets Liabilities - Other than Trading Non-Interest bearing n/a deposits Money market 2.07% checking Money market 2.39 savings Regular savings 3.15 Time deposits 5.65 Short-term 4.84 borrowings Long-term debt 7.67 Total interest- 4.74 bearing liabilities Trust preferred 9.25% securities Interest sensitivity gap Cumulitive interest sensitivity gap Note: This analysis is based on certain assumptions, including relative levels of market interest rates, and should not be relied upon as indicative of actual results. Item 8. Financial Statements and Supplementary Data Consolidated financial statements of the Registrant and its subsidiaries are contained in the Annual Report to Shareholders for the year ending December 31, 1997, under the caption "1997 Financial Statements", and are incorporated herein by reference in response to this item. Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure In connection with the audits of the Registrant for the two most recent fiscal years ended December 31, 1997, the Registrant has not changed its independent certified public accountants nor have there been any disagreements (as defined in Instruction 4 to Item 304 of Regulation S-K) with such accountants on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure. PART III Item 10. Directors and Executive Officers of the Registrant The information contained in the proxy statement of the Registrant for the 1998 Annual Meeting of Shareholders under the caption "Election of Directors", on pages 4 through 6, inclusive, is incorporated herein by reference in response to this item. Item 11. Executive Compensation The information contained in the proxy statement of the Registrant for the 1998 Annual Meeting of Shareholders under the captions "Election of Directors - Outside Director Compensation ", "Executive Compensation and Other Information" and "Board Compensation Committee Report on Executive Compensation" on pages 8 through 18, inclusive, is incorporated herein by reference in response to this item. Item 12. Security Ownership of Certain Beneficial Owners and Management The information contained in the proxy statement of the Registrant for the 1998 Annual Meeting of Shareholders, under the captions "Voting Securities and Principal Holders" and "Security Ownership of Management", on pages 2 and 3, inclusive, is incorporated herein by reference in response to this item. Item 13. Certain Relationships and Related Transactions The information contained in the proxy statement of the Registrant for the 1998 Annual Meeting of Shareholders under the caption "Interest of Management in Certain Transactions" on pages 19 and 20, is incorporated herein by reference in response to this item. PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K Page # a. Documents filed as a part of this Report: Form Annual 10-K Report 1. Financial Statements: A. Irwin Financial Corporation and Subsidiaries: Report of Coopers & Lybrand L.L.P., Independent Accountants 21 Consolidated Statement of Income for the years ended December 31, 1997, 1996, and 1995 81 Consolidated Balance Sheet as of December 31, 1997, and 1996 82 Consolidated Statement of Changes in Shareholders' Equity for the years ended December 31, 1997, 1996 and 1995 83 Consolidated Statement of Cash Flows for the years ended December 31, 1997, 1996, and 1995 84 Notes to Consolidated Financial Statements 85 The above listed report, financial statements, and the notes thereto, set forth on pages 81 through 105 of the Registrant's 1997 Annual Report to Shareholders are incorporated herein by reference. 2. Financial Statement Schedules None Schedules are omitted because they are not required or the information is included in the Notes to Consolidated Financial Statements. 3. Exhibits A. Exhibits to Form 10-K Sequential Numbering Number Assigned System Page in Regulation Number of S-K Item 601 Description of Exhibit Exhibit (2) No exhibit. (3) (i) 3(a) Amended Articles of Incorporation, dated December 29, 1972. (Incorporated by reference to Exhibit 3(a) to Form 10-K Report for year ended December 31, 1985, File No. 0-6835.) 3(b) Articles of Amendment, dated March 30, 1973. (Incorporated by reference to Exhibit 3(b) to Form 10-K Report for year ended December 31, 1985, File No. 0-6835.) 3(c) Articles of Amendment, dated September 4, 1990. (Incorporated by reference to Exhibit 3(d) to Form 10-K Report for year ended December 31, 1990, File No. 0-6835.) 3(d) Articles of Amendment, dated April 30, 1992. (Incorporated by reference to Exhibit 3(d) to Form 10-K Report for year ended December 31, 1992, File No. 0-6835.) 3(e) Articles of Amendment, dated April 26, 1994. (Incorporated by reference to Exhibit 3(e) to Form 10-K Report for year ended December 31, 1994, File No. 0-6835.) 3(f) Articles of Amendment, dated April 30, 1996. (Incorporated by reference to Exhibit 3(f) to Form 10-K Report for year ended December 31, 1996, File No. 0-6835.) (ii) 3(a) Code of By-Laws as 22 amended to date. (4) 4(a) Specimen stock certificate. (Incorporated by reference to Exhibit 4(a) to Form 10-K Report for year ended December 31, 1994, File No. 0-6835.) 4(b) Certain instruments defining the rights of the holders of long-term debt of the Registrant and certain of its subsidiaries, none of which authorize a total amount of indebtedness in excess of 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis, have not been filed as Exhibits. The Registrant hereby agrees to furnish a copy of any of these agreements to the Commission upon request. (9) No exhibit. (10) 10(a) Amended 1986 Stock Option Plan. (Incorporated by reference to Exhibit 10(b) to Form 10-K Report for year ended December 31, 1991, File No. 0- 6835.) 10(b) Amended and Restated Management Bonus Plan. (Incorporated by reference to Exhibit 19(a) to Form 10-K Report for year ended December 31, 1986, File No. 0- 6835.) 10(c) Long-Term Management Performance Plan. (Incorporated by reference to Exhibit 10(d) to Form 10-K Report for year ended December 31, 1986, File No. 0- 6835.) 10(d) Long-Term Incentive Plan - Summary of Terms. (Incorporated by reference to Exhibit 10(e) to Form 10-K Report for year ended December 31, 1986, File No. 0- 6835.) 10(e) Irwin Financial Corporation Employees' Stock Purchase Plan. (Incorporated by reference to Exhibit 10(f) to Form 10-K Report for year ended December 31, 1991, File No. 0- 6835.) 10(f) Employee Stock Purchase Plan II. (Incorporated by reference to Exhibit 10(f) to Form 10-K Report for year ended December 31, 1994, File No. 0- 6835.) 10(g) Amended Irwin Financial Corporation Outside Directors Restricted Stock Compensation Plan. (Incorporated by reference to Exhibit 10(g) to Form 10-K Report for year ended December 31, 1991, File No. 0- 6835.) 10(h) Irwin Financial Corporation 1992 Stock Option Plan. (Incorporated by reference to Exhibit 10(h) to Form 10-K report for year ended December 31, 1992, File No. 0- 6835.) 10(i) Amended Irwin Financial Corporation Outside Director Restricted Stock Compensation Plan. (Incorporated by reference to Exhibit 10(i) to Form 10-K report for year ended December 31, 1995, File No. 0- 6835.) 10(j) Inland Mortgage Corporation Long Term Incentive Plan. (Incorporated by reference to Exhibit (10)(j) to Form 10-K report for year ended December 31, 1996, File No. 0-6835.) 10(k) Irwin Financial Corporation 1997 Stock Option Plan. (Incorporated by reference to Exhibit (10) to Form 10-Q report for quarter ended June 30, 1997, File No. 0-6835.) 10(l) Amendment to Irwin 37 Financial Corporation 1997 Stock Option Plan. (Incorporated by reference to Exhibit (10) to Form 10-Q report for quarter ended June 30, 1997, File No. 0-6835.) (11) 11(a) Computation of Earnings 39 Per Share. (12) No exhibit. (13) 13(a) Registrant's 1997 Annual 40 Report to Shareholders. This exhibit contains such portions thereof that have been incorporated by reference into this Report. (16) No exhibit. (18) No exhibit. (21) 21(a) Subsidiaries of the 122 Registrant. (22) No exhibit. (23) 23(a) Consent of Independent 123 Accountants. (24) No exhibit. (27) Financial Data Schedule. 124 (99) 99(a) Annual Report on Form 11- K for the Irwin Financial Corporation Employees' Savings Plan for the year ending December 31, 1997.* 99(b) Annual Report on Form 11- K for the Inland Mortgage Corporation Retirement and Profit Sharing Plan for the year ending December 31, 1997.* * To be filed by amendment pursuant to Rule 15d-21. b. Reports on Form 8-K None. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the Undersigned, thereunto duly authorized. IRWIN FINANCIAL CORPORATION Date: March 26, 1998 By: /s/ William I. Miller William I. Miller, Chairman of the Board Pursuant to the requirements of the Securities Exchange Act of 1934, this report on Form 10-K has been signed below by the following persons on behalf of the Registrant and in the capacities on the dates indicated. Capacity with Signature Registrant Date /s/ Sally A. Dean Director March 26, 1998 Sally A. Dean /s/ David W. Goodrich Director March 26, 1998 David W. Goodrich /s/ John T. Hackett Director March 26, 1998 John T. Hackett /s/ William H. Kling Director March 26, 1998 William H. Kling /s/ Brenda J. Lauderback Director March 26, 1998 Brenda J. Lauderback /s/ John C. McGinty, Jr. Director March 26, 1998 John C. McGinty, Jr. /s/ Irwin Miller Director March 26, 1998 Irwin Miller /s/ William I. Miller Director, March 26, 1998 William I. Miller Chairman of the Board (Principal Executive Officer) /s/ John A. Nash Director, March 26, 1998 John A. Nash Chairman of the Executive Committee /s/ Lance R. Odden Director March 26, 1998 Lance R. Odden /s/ Theodore M. Solso Director March 26, 1998 Theodore M. Solso /s/ Thomas D. Washburn Senior Vice March 26, 1998 Thomas D. Washburn President (Principal Financial Officer) /s/ Marie C. Strack Vice President March 26, 1998 Marie C. Strack and Controller (Principal Accounting Officer) CODE OF BY-LAWS IRWIN FINANCIAL CORPORATION ARTICLE 1 Definitions 8.21.90 1.01. Corporation. As used in this Code of By-Laws, the term "Corporation" means IRWIN FINANCIAL CORPORATION. 1.02. Act. As used in this Code of By-Laws, the term "Act" means The Indiana General Corporation Act. 1.03. Articles of Incorporation. As used in this Code of By-Laws, the term "Articles of Incorporation" means the Articles of Incorporation of the Corporation, as amended from time to time. 1.04. By-Laws. As used in this Code of By-Laws, the term "By-Laws" means the Code of By-Laws of the Corporation, as amended from time to time. ARTICLE 2 Identification 8.20.90 2.01. Name. The name of the Corporation is IRWIN FINANCIAL CORPORATION. 2.02. Principal Office and Resident Agent -- Power to Change. The post-office address of the principal office of the Corporation is 500 Washington Street, Columbus, Indiana 47201, and the post -office address of its Resident Agent in charge of such office is John A. Nash, 500 Washington Street, Columbus, Indiana 47201. The location of its principal office, or the designation of its Resident Agent, or both, may be changed at any time or from time to time, when authorized by the Board of Directors, by filling with the Secretary of State of the State of Indiana, on or before the day any such change is to take effect, or within five (5) days after the death of the Resident Agent or other unforeseen termination of his agency, a certificate signed by the President or a Vice President, and the Secretary or an Assistant Secretary, of the Corporation, and Verified under oath by one of such officers signing the same, stating the change to be made and reciting that such change is made pursuant to authorization by the Board of Directors. 2.03. Seal. The seal of the Corporation shall be circular in form and mounted upon a metal die, suitable for impressing the same upon paper. About the upper periphery of the seal shall appear the name of the Corporation, and about the lower periphery thereof the word "Indiana". In the center of the seal shall appear the words "Seal" or " Corporate Seal". 2.04. Fiscal Year. The fiscal year of the Corporation shall be the calendar year. ARTICLE 3 Shares 3.01. Consideration for Shares. The Board of Directors shall cause the Corporation to issue the Shares of the Corporation for such consideration as may be fixed by such Board pursuant to the provisions of the Articles of Incorporation. 3.02. Subscription for Shares. Subscriptions for Shares of Corporation shall be paid to the Treasurer at such time or times, in such installments or calls, and upon such terms, as shall be determined, from time to time, by the board of Directors. Any call made by the Board of Directors for payment on subscriptions shall be uniform as to all shares of the same class or to all Shares of the same series, as the case may be. 3.03. Payment for Shares. Subject to the provisions of the Articles of Incorporation, the consideration for the issuance of Shares of the Corporation may be paid, in whole or in part, in money, in other property, tangible or intangible, or in labor actually performed for, or services actually rendered to, the Corporation; provided, however, that the part of the surplus of the Corporation which is transferred to stated capital upon the issuance of Shares as a Share dividend shall be deemed to be the consideration for the issuance of such Shares. When payment of the consideration for which a Share was authorized to be issued shall have been received by the Corporation, or when surplus shall have been transferred to stated capital upon the issuance of a Share dividend, such Share shall be declared and taken to be fully paid and not liable to any further call or assessment, and the holder thereof shall not be liable for any further payments thereon. In the absence of actual fraud in the transaction, the judgment of the Board of Directors as to the value of such property, labor, or services received as consideration, or the value placed by the Board of Directors upon the corporate assets in the event of a Share dividend, shall be conclusive. Promissory notes, uncertified checks, or future services shall not be accepted in payment or part payment of any of the capital stock of the Corporation. 3.04. Certificates for Shares. Each Shareholder of the Corporation shall be entitled to a certificate, signed by the President or a vice-president, and the Secretary or an Assistant Secretary of the Corporation stating the name of the registered holder, the number of Shares represented thereby and the kind and class thereof, the par value of each Share have been fully paid and are nonassessable. If such certificate is countersigned by the written signature of a registrar other than the Corporation or its employee, the signatures of the transfer agent and the officers of the Corporation may be facsimiles. In case any officer, transfer agent, or registrar who has signed or whose facsimile signature has been placed upon a certificate shall have ceased to be such officer, transfer agent, or registrar before such certificate is issued, it may be issued by the Corporation with the same effect as if he were such officer, transfer agent or registrar at the date of its issue. Such certificates shall be in such form as the Board of Directors may, from time to time, by resolution approve. 3.05. Transfer of Shares. The Shares of the Corporation shall be transferable only on the books of the Corporation upon surrender of the certificate or certificates representing the same, provided: 3.051. Endorsement. The certificate is properly endorsed by the registered holder or his duly authorized attorney; 3.052. Witnessing. The endorsement or endorsements are witnessed by one witness unless this requirement is waived in writing upon the form of endorsement by the President, a Vice-President, or the Secretary of the Corporation; 3.053. Adverse Claims. The Corporation has no notice of any adverse claims or has discharged any duty to inquire into any such claims; and 3.054. Collection and Taxes. Any applicable law related to the collection of taxes has been complied with. 3.06. Lost, Stolen, or Destroyed Certificates. The Corporation may issue a new certificate for Shares of the Corporation in the place of any certificate theretofore issued where the holder of record of the certificate: 3.061. Claim. Makes proof in affidavit form that it has been lost, destroyed, or wrongfully taken; 3.062. Timely Request. Timely Requests the issue of a new certificate before the Corporation has notice that the certificate has been acquired by a purchaser for value in good faith and without notice of any adverse claim; 3.063. Bond. Gives a bond in such form, and with such surety or sureties, with fixed or open penalty, as the Corporation may direct, to indemnify the Corporation against any claim that may be made on account of the alleged loss, destruction, or theft of the certificates; and 3.064. Other Requirements. Satisfies any other reasonable requirements imposed by the Corporation for the transfer or for a new certificate. When a certificate has been lost, apparently destroyed, or wrongfully taken and the holder of record fails to notify the Corporation within a reasonable time after he has notice of it, and the Corporation registers a transfer of Shares represented by the Certificate before receiving such notification, the holder of record is precluded from making any claim against the Corporation for the transfer or for a new certificate. 3.07. Closing of Books or Fixing of Record Dates. For the purpose of determining Shareholders entitled to receive payment of any dividend or in order to make a determination of Shareholders for any other proper purpose, except as otherwise provided in section 4.069 of these By-Laws, the Board of Directors may provide that the share transfer books shall be closed for a stated period, but not to exceed, in any case, fifty (50) days, or may fix in advance a record date for such purpose, such date in any case not to be more than fifty (50) days prior to the date in which the action requiring such determination of Shareholders, is to be taken. If the share transfer books are not closed and no record date is fixed for the determination of Shareholders entitled to receive payment of a dividend, the end of the day on which the resolution of the Board of Directors declaring such dividend is adopted shall be the record date for such determination. ARTICLE 4 Meetings of Shareholders 4.01. Place of Meetings. All meetings of Shareholders of the Corporation shall be held at such place, within or without the State of Indiana, as may be specified in the respective notices or waivers of notice thereof, or proxies to represent Shareholders thereat. 12.20.94 4.02. Annual Meeting. The annual meeting of the Shareholders for the election of Directors and for the transaction of such other business as may properly come before the meeting, shall be on or before the last day of May of each year, the date to be set by the Board of Directors of the Corporation. Failure to hold the annual meeting at the designated time shall not work any forfeiture or a dissolution of the Corporation. 12.20.94 4.03. Special Meeting. Special meetings of the Shareholders may be called by the President, by the Board of Directors, or by Shareholders holding of record not less than one- fourth (1/4/) of all of the Shares outstanding and entitled by the Articles of Incorporation to vote on the business proposed to be transacted thereat. 4.04. Notice of Meetings. A written or printed notice, stating the place, day and hour of the meeting, and in case of a special meeting, or when required by any other provision of the Act, or the Articles of Incorporation, or By-Laws, the purpose or purposes for which the meeting is called, shall be delivered or mailed by the Secretary, or by the officers or persons calling the meeting, to each Shareholder of record entitled by the Articles of Incorporation and by the Act to vote atsuch meeting, at such address as appears upon the records of the Corporation, at least ten (10) days before the date of the meeting. Notice of any such meeting may be waived in writing by any Shareholder, if the waiver sets forth in reasonable detail the purpose or purposes for which the meeting is called, and the time and place thereof. Attendance at any meeting in person, or by proxy when the instrument of proxy sets forth in reasonable detail the purpose for which the meeting is called, shall constitute a waiver of notice of such meeting. Each Shareholder, who has in the manner above provided waived notice of a Shareholders' meeting, or who personally attends a Shareholders' meeting, or is represented thereat by a proxy authorized to appear by an instrument of proxy complying with the requirements above set forth, shall be conclusively presumed to have been given due notice of such meeting. 4.05. Addresses of Shareholders. The address of any Shareholder appearing upon the records of the Corporation shall be deemed to be (i) the latest address of such Shareholder appearing on the records maintained by the transfer agent or registrar, as the case may be, for the class of Shares held by such Shareholder, if the Corporation has a transfer agent or registrar for such class of Shares and the Board of Directors has provided in the resolutions appointing the transfer agent or registrar that notices of change of address shall be given to one of such agents by Shareholders of such class; or (ii) the latest address of such Shareholder appearing on the records maintained by the Secretary for the class of Shares held by such Shareholder, if the Corporation has no transfer agent or registrar for such class of Shares or if it has a transfer agent or registrar for such class of Shares but the resolutions appointing the transfer agent or registrar do not provide that notice of changed of address shall be given to one of such agents by Shareholders of such class of shares. 4.06. Voting at Meetings. 4.061. Common Shares. Except as otherwise provided by law or by the provisions of the Articles of the Incorporation, every holder of Common Shares of the Corporation shall have the right, at every Shareholders' meeting, to one vote for each Common Share standing in his name on the books of the Corporation. Cumulative voting shall not be permitted. 4.062. Prohibition Against Voting Certain Shares. No Share shall be voted at any meeting upon which any installment is due and unpaid or which belongs to the Corporation. 4.063. Voting of Shares Owned by Other Corporations. Shares of the Corporation standing in the name of another corporation may be voted by such officer, agent or proxy as the board of directors of such other corporation may appoint, or as the by-laws of such other corporations may prescribe. 4.064. Voting of Shares owned by Fiduciaries. Shares held by fiduciaries may be voted by the fiduciaries in such manner as the instrument or order appointing such fiduciaries may direct. In the absence of such direction or the inability of the fiduciaries to act in accordance therewith, the following provisions shall apply: 4.0641. Joint Fiduciaries. Where Shares are held jointly by three (3) or more fiduciaries, such Shares shall be voted in accordance with the majority. 4.0642. Equally Divided Fiduciaries. Where the fiduciaries, or majority of them, cannot agree, or where they are equally divided, upon the question of voting such Shares, any court of general equity jurisdiction may, upon petition filed by any of such fiduciaries, or by any party in interest, direct the voting of such Shares as it may deem for the best interests of the beneficiaries, and such Shares shall be voted in accordance with such direction. 4.0643. Proxy of Fiduciary. The general proxy of a fiduciary shall be given the same weight and effect as the general proxy of an individual or corporation. 4.065. Voting of Pledged Shares. Shares that are pledged may, unless otherwise provided in the agreement of pledge, be voted by the Shareholder pledging the same until the Shares shall have been transferred to the pledgee on the books of the Corporation, and thereafter they may be voted by the pledgee. 4.066. Proxies. A Shareholder may vote, either in person or by proxy executed in writing by the Shareholder, or a duly authorized attorney-in-fact. No proxy shall be valid after eleven (11) months from the date of its execution, unless a longer time is expressly provided therein. 4.067. Quorum. At any meeting of the Shareholders, a majority of the Common Shares outstanding and entitled to vote, represented in person or by proxy, shall constitute a quorum. 4.068. Voting Lists. The officer or agent having charge of the share transfer books shall make, at least five (5) days before each election of directors, a complete list of the Shareholders entitled by the Articles of Incorporation to vote at such election, arranged in alphabetical order, with the address and number of Shares so entitled to vote held by each, which list shall be on file at the principal office of the Corporation and subject to inspection by any Shareholder. Such list shall be produced and kept open at the time and place of election and subject to the inspection of any Shareholder during the holding of such election. The original share register or transfer book or duplicate thereof, kept in the State of Indiana, shall be the only evidence as to who are the Shareholders entitled to examine such list, or share register or transfer book, or to vote at any meeting of the Shareholders. 4.069. Fixing of Record Date to Determine Shareholders Entitled to Vote. For the purpose of determining Shareholders entitled to vote at any meeting of Shareholders or any adjournment thereof, the Board of Directors, may fix in advance a date as the record date for any such determination of Shareholders, such date in any case to be not more than fifty (50) days prior to the date of such meeting. In the absence of such a determination by the Board of Directors, such date shall be ten (10) days prior to the date of such meeting. Any person who acquires title to a Share after the record date shall upon written request to the Shareholder of record be entitled to receive from the Shareholder of record a proxy, with power of substitution, to vote that Share. 4.07. Taking Action by Consent. Any action which may be taken at a meeting of the Shareholders, may be taken without a meeting if, prior to such action, a consent in writing, setting forth the action so taken, shall be signed by all of the Shareholders entitled to vote with respect to the subject matter thereof, and such written consent is filed with the minutes of the proceedings of the Shareholders. 4.08. Order of Business. The order of business at annual meetings, and so far as practicable, at all other meetings of Shareholders shall be: Proof of due notice of meeting; Reading and disposal of any unapproved minutes; Annual reports of officers and committees; Election of directors; New business; Adjournment ARTICLE 5 The Board of Directors 8.19.97 5.01. Election and Qualification. At the first annual meeting of the Shareholders, and at each annual meeting thereafter, directors shall be elected by the Shareholders entitled by the Articles of Incorporation to elect directors, for a term of one year; and they shall hold office until their respective successors are chosen and qualified. The Board shall consist of eleven (11) directors. Directors need not be Shareholders of the Corporation. At least a majority of the directors shall be citizens of the United States. The number of directors may be increased or decreased from time to time by amendment to the By-Laws, but no decrease shall have the effect of shortening the term of any incumbent director. 5.02. Vacancies. Any vacancy occurring in the Board of Directors caused by resignation, death or other incapacity, or increase in the number of directors may be filled by a majority vote of the remaining members of the Board of Directors, until the next annual or special meeting of the Shareholders or, at the discretion of the Board of Directors, such vacancy may be filled by vote of the Shareholders at a special meeting called for the purpose. Until any such vacancy is so filled, the existing directors shall constitute the Board of Directors. Shareholders shall be notified of any increase in the number of directors and the name, address, principle occupation, and other pertinent information about any director elected by the Board of Directors to fill any vacancy. 5.03. Annual Meeting. The Board of Directors shall meet each year after the annual meeting of Shareholders (either within or without the State of Indiana), for the purpose of organization, election of officers and consideration of any other business that may properly be brought before the meeting. The time of this meeting shall be no later than the first regular or special meeting of the Board of Directors, at which a quorum shall be present, held after the annual meeting of Shareholders. No additional notice of any kind to either old or new members of the Board of Directors shall be necessary. 5.04. Regular Meetings. Regular meetings of the Board of Directors may be held with notice by letter, telegram, cable, radiogram, telephone, or radiophone, or without any notice whatever, and at such place and times, as may be fixed from time to time by resolution of the Board of Directors. 5.05. Special Meetings. Special meetings of the Board of Directors may be called at any time by the Chairman of the Board, President or any Vice-President, and shall be called on the written request of one-fourth (1/4) of the directors. Notice of such a special meeting shall be sent by the Secretary or an Assistant Secretary to each director at his residence or usual place of business by letter, telegram, cable or radiogram, delivered for transmission not later than the second day immediately preceding the day for the meeting, or by word of mouth, telephone, or radiophone received not later than during the day immediately preceding the day for the meeting. In lieu of such notice, a director may sign a written waiver of notice either before the time of the meeting, at the time of the meeting, or after the time of the meeting. Neither the business to be transacted at, nor the purpose of, any meeting of the Board of Directors need be specified in the notice or waiver of notice of the meeting. Any meeting of the Board of Directors for which notice is required shall be a legal meeting, without notice thereof having been given, if all the directors, who have not waived notice thereof in writing, shall be present in person. 5.06. Place of Meetings. The directors may hold their meetings, have one or more offices, and keep the books of the Corporation, except as may be provided by law, within or without the State of Indiana, at any office or offices of the Corporation, or at any other place, as they may form time to time by resolution determine. If the resolution of the Board of Directors calling a regular meeting or the written request calling a special meeting expressly provides, a meeting of the Board of Directors may be held by conference telephone call or any other medium which allows each director to participate in discussions and to hear the views of the other directors. If a meeting is held, the directors connected to the conference telephone call or other medium shall be counted as present for the purpose of determining a quorum. 5.07. Quorum. One-third (1/3) of the actual number of directors elected and qualified, from time to time, shall be necessary to constitute a quorum for the transaction of any business except the filling of vacancies, and the act of a majority of the directors present at a meeting, at which a quorum is present, shall be the act of the Board of Directors, unless the act of a greater number is required by the Act, by the Articles of Incorporation, or by the By-Laws. A director who is present at a meeting of the Board of Directors at which action on any corporate matter is taken, shall be conclusively presumed to have assented to the action taken, unless (i) his dissent shall be affirmatively stated by him at and before the adjournment of such meeting (in which event the fact of such dissent shall be entered by the secretary of the meeting in the minutes of the meeting, or (ii) he shall forward such dissent by registered mail to the Secretary of the Corporation immediately after the adjournment of the meeting. The right of dissent provided for by either clause (i) or clause (ii) of the immediately preceding sentence shall not be available, in respect of any matter acted upon at any meeting, to a director who voted at the meeting in favor of such matter and did not change his vote prior to the time that the result of the vote on such matter was announced by the chairman of such meeting. 5.08. Action by Consent. Any action required or permitted to be taken at any meeting of the Board of Directors or of any committee thereof may be taken without a meeting, if prior to such action a written consent to such action is signed by all members of the Board of such committees as the case may be, and such written consent is filed with the minutes of proceedings of the Board or committee. 5.09. Removal. Any or all of the directors may be removed, with or without cause, at a meeting of the Shareholders called expressly for that purpose by a vote of the holders of a majority of the Shares then entitled to vote at an election of directors. 5.10. Powers of Directors. The Board of Directors shall exercise all the powers of the Corporation, subject to the restrictions imposed by law, by the Articles of Incorporation, or by these By-Laws. 5.11. Dividends. The Board of Directors shall have power, subject to any restrictions contained in the Articles of Incorporation, to declare and pay dividends upon the outstanding Shares of the Corporation, out of the unreserved and unrestricted capital and earned surplus of the Corporation. Dividends may be paid in cash, in property, or in Shares of the Corporation, but no dividend payable in cash or property shall be paid out of surplus due to or arising from unrealized appreciation in value or from revaluation of assets. 5.12. Compensation of Directors. The Board of Directors is empowered and authorized to fix and determine the compensation of directors as directors, and any additional compensation for such additional services any such directors may perform for the Corporation. 5.13. Resignation. A director may resign at any time by filing his written resignation with the Chairman of the Board, the President or the Secretary of the Corporation, or with the Board of Directors, and such resignation shall become effective upon such filing. 5.14. Reliance on Corporation Records. Each Director shall be fully protected in relying in good faith upon the books of account and records of the Corporation or upon statements prepared by any of its officers or employees. ARTICLE 6 Executive Committee 6.01. Designation of Executive Committee. The Board of Directors may, by resolution adopted by a majority of the actual number of directors elected and qualified, from time to time, designate two (2) or more of its number to constitute an executive committee which committee to the extent provided in such resolution, shall have and exercise all of the authority of the Board of Directors but the designation of such committee and the delegation thereto of authority shall not operate to relieve the Board of Directors, or any member thereof, of any responsibility imposed upon it or him by law. No member of the executive committee shall continue to be a member thereof after he ceases to be a director of the Corporation. The Board of Directors shall have the power at any time to increase or diminish the number of members of the executive committee, to fill vacancies thereon, to change any member thereof, and to change the functions or terminate the existence thereof. 6.02. Powers of the Executive Committee. During the intervals between meetings of the Board of Directors, and subject to such limitations as may be required by law or by resolution of the Board of Directors, the executive committee shall have and may exercise all of the powers of the Board of Directors in the management of the business and affairs of the Corporation, including power to authorize the seal of the Corporation to affixed to all papers which may require it . The executive committee may also from time to time formulate and recommend to the Board of Directors for approval general policies regarding the management of the business and affairs of the Corporation. All minutes of the meetings of the executive committee shall be submitted to the next succeeding meeting of the Board of Directors for approval; but failure to submit the same or to receive the approval thereof shall not invalidate any completed or incompleted action taken by the Corporation upon authorization by the executive committee prior to the time at which the same should have been, or were, submitted as above provided. The executive committee shall not have the authority of the Board of Directors in reference to amending the Articles of Incorporation, adopting an agreement or plan of merger or consolidation, proposing a Special Corporate Transaction as defined in the Act, recommending to the Shareholders a voluntary dissolution of the Corporation or a revocation thereof, or amending these By-Laws. 6.03 Procedure; Meetings; Quorum. The chairman of the executive committee of the Corporation shall, if present, act as chairman at all meetings of the executive committee, and the Secretary of the Corporation shall, if present, act as secretary of the meeting. In case of the absence from any meeting of the executive committee of the chairman of the executive committee or the Secretary of the Corporation, the executive committee shall appoint a chairman or secretary, as the case may be, of the meeting. The executive committee shall keep a record of its acts and proceedings. Regular meetings of the executive committee, of which no notice shall be held on such days and at such places as shall be fixed by resolution adopted by majority of the executive committee shall be called at the request of any member of the executive committee. Written notice of each special meeting of the executive committee shall be sent by the Secretary or an Assistant Secretary to each member of the executive committee at his residence or usual place of business by letter, telegram, cable or radiogram, delivered for transmission not later than during the second day immediately preceding the day for the meeting, or by word of mouth, telephone, or radiophone received not later than during the day immediately preceding the day for the meeting, or by word any such meeting need not be given to any member of the executive committee who has waived such notice either in writing or by telegram, cable or radiogram arriving either before or after such meeting, or who shall be present at the meeting. Any meeting of the executive committee shall be a legal meeting, without notice thereof having been given, if all members of the executive committee who have not waived notice thereof in writing or by telegram, cable or radiogram shall be present in person. Neither the business to be transacted at, nor the purpose of, any meeting of the executive committee need be specified in the notice or waiver of notice of the meeting. The executive committee may hold its meetings within or without the State of Indiana, as it may from time to time by resolution determine. If the resolution of the executive committee calling a regular meeting or the written request calling a special meeting expressly provides, a meeting of the executive committee may be held by the conference telephone call or any other medium which allows each member to participate in discussion and to hear the views of the other members. If a meeting is held, the members connected to the conference telephone call or other medium shall be counted as present for the purpose of determining a quorum. A majority of the executive committee, from time to time, shall be necessary to constitute a quorum for the transaction of any business, and the act of a majority of the members present shall be the act of the executive committee. The members of the executive committee shall act only as a committee, and the individual member shall have no power as such. The Board of Directors may vote to the members of the executive committee a reasonable fee as compensation for attendance at meetings of such committee. 6.04. Other Committees. From time to time the Board of Directors, by the affirmative vote of a majority of the actual number of directors elected and qualified, may appoint, from among their number, other committees for any purpose or purposes, and each such committee shall have such powers as shall be conferred by the resolution of appointment. 6.05. Audit Committee. The Board of Directors shall by resolution adopted by a majority of the actual number of directors elected and qualified, from time to time, designate two or more of its members who are not officers, to constitute an Audit Committee of the Board of Directors. The Audit Committee shall have, and may exercise the authority of the Board of Directors to the extent provided in such resolutions, as to matters relating to the appointment of independent certified public accountants, the reliability of financial statements, the adequacy of financial controls, the conduct of audits and such investigations of other financial or operational matters related to the Company as the Board of Directors shall direct. The Audit related to the Committee shall make appropriate reports and other related recommendations to the Board, (which reports may be relied upon by members of the Board of Directors who are not members of the Audit Committee, as to matters within the Audit Committee's designated authority, if the director reasonably feels the Committee merits confidence and has no knowledge concerning the matter in question that would cause such reliance to be unwarranted). A member of the Board of Directors who is not a member of the Audit Committee shall not be liable for any action taken by the Committee if the member has acted in good faith and in a manner reasonably believed to be in the best interests of the Corporation. ARTICLE 7 The Officers 7.01. Number. The officers of the Corporation shall consist of the Chairman of the Board of Directors, if elected, the President, one or more Vice-Presidents, if elected, (to be classified as determined by the Board of Directors, as Executive Vice-Presidents, Senior Vice-Presidents, Vice Presidents or Assistant Vice Presidents), the Treasurer, the Secretary, and such other officers (including a controller) and assistants as the Board of Directors may appoint. Any two or more offices may be held by the same person, except that the duties of the President and Secretary shall not be performed by the same person. 7.02. Election, Term of Office and Qualifications. The officers shall be chosen annually by the Board of Directors. Each officer shall hold office until his successor is chosen and qualified, or until his death, or until he shall have resigned, or shall have been removed in the manner hereinafter provided. 7.03. Removal. Any officer may be removed, either with or without cause, at any time, by the vote of a majority of the actual number of directors elected and qualified, from time to time, at any regular or special meeting of the Board of Directors. 7.04. Resignations. Any officer may resign at any time by giving written notice to the Board of Directors, or the President or the Secretary. Such resignation shall take effect at the time specified therein, and unless otherwise specified therein, the acceptance of such resignation shall not be necessary to make it effective. 7.05. Vacancies. Any vacancy in any office because of death, resignation, removal or any other cause may be filled for the unexpired portion of the term in the manner prescribed in the By-Laws for election or appointment to such office. 7.06. The Chairman of the Board. The Chairman of the Board, if elected, who shall be chosen from among the directors, shall preside at all meetings of the Board of Directors and the Shareholders and shall perform such other duties as the Board of Directors may from time to time assign to him. 7.07. The President. The President shall be chief executive and administrative officer of the Corporation. In the absence of the Chairman of the Board he shall preside at all meetings o f the Shareholders and at meetings of the Board of Directors. He shall exercise such duties as customarily pertain to the office of the President and shall have general and active supervision over the property, business and affairs of the Corporation and over its several Officers. He may appoint officers, agents or employees other than those appointed by the Board of Directors and shall perform such other duties as may be prescribed from time to time by the Board of Directors or by the By-Laws. 7.08. The Vice-Presidents. The Vice-Presidents (including Executive Vice-Presidents, Senior Vice-Presidents and Assistant Vice-Presidents) shall have such powers and perform such duties as the Board of directors may from time to time prescribe or as the President may from time to time delegate to them. At the request of the President, one such officer may, in the case of the absence or inability to act of the President, temporarily act in his place. In case of the death of the President, or in the case of his absence or inability to act without having designated an officer to act temporarily in his place, the officer so to perform the duties of the President shall be designated by the Chairman of the Board. 7.09. The Secretary. The Secretary shall have the custody and care of the Corporate seal, records, minutes and share books of the Corporation. He shall attend all meetings of the Shareholders and of the Board of Directors, and shall keep, or cause to be kept in a book provided for the purpose, a true and complete record of the proceedings of such meetings, and shall perform a like duty for all standing committees appointed by the Board of Directors, when of required. He shall attend to the giving and serving of all notices of the Corporation, shall file and take charge of all papers and documents belonging to the Corporation and shall perform such other duties as these By-Laws may require or the Board of Directors may prescribe. 7.10. The Treasurer. The Treasurer shall be the financial officer of the Corporation; shall have charge and custody of, and be responsible for, all funds of the Corporation, and deposit all such funds in the name of the Corporation in such banks, trust companies or other depositaries as shall be selected by the Board of Directors; shall receive, and give receipts for, moneys due and payable to the Corporation from any source whatsoever; and, in general, shall perform all duties as, from time to time, may be assigned to him by the Board of Directors or by the President. The Treasurer shall render to the President and the Board of Directors, whenever the same shall be required, an account of all of his transactions as Treasurer and of the financial condition of the Corporation. 7.11. The Controller. The Controller, if a controller is elected, shall be responsible to the Board of Directors and the President for all financial control and internal audit of the Corporation and its subsidiaries. He shall perform such other duties as may be assigned to him by the Board of Directors or the President. 7.12. The Assistant Secretaries. The Assistant Secretaries, as directed by the President or the Board of Directors, shall perform the duties of the Secretary during the absence or inability of the Secretary to perform such duties, or any of them. They shall perform such other duties as the President or the Board may prescribe. 7.13. The Assistant Treasurers. The Assistant Treasurers as directed by the President or the Board of Directors, shall perform the duties of the Treasurer during the absence or inability of the Treasurer to perform such duties as the President and the Board may prescribe. 7.14. Other Offices. The Board of Directors may create such other offices as it may from time to time deem desirable with such duties as it may determine. ARTICLE 8 Corporate Acts 8.01. Execution of Deeds, Contracts, etc. All deeds and mortgages made by the Corporation and all other written contracts and agreements to which the Corporation shall be a party shall be (i) executed in its name by the Chairman of the Board, the President or a Vice President and (ii) attested by any officer of the Corporation other than the officer executing the document. 8.02. Execution of Checks, Notes, etc. All checks, drafts, notes, bonds, bills of exchange and orders for the payment of money by the Corporation shall be signed by such officer or officers of the Corporation as the Board of Directors from time to time may authorize and direct. 8.03. Execution of Certain Securities. All assignments or endorsements of stock certificates, registered bonds, or other securities owned by the Corporation shall, unless, otherwise directed by the Board of Directors, or unless otherwise required by law, be (i) signed by the Chairman of the Board, the President or a Vice President and (ii) attested by any officer of the Corporation other than the officer signing the security. The Board of Directors may, however, authorize any one of such officers to sign any of such instruments, for and on behalf of the Corporation, without the necessity of counter-signatures; may designate officers or employees of the Corporation, other than those named above, who may, in the name of the Corporation, sign such instruments; and may authorize the use of facsimile signatures of any of such persons. 8.04. Voting of Shares Owned by Corporation. Subject always to the further orders and directions of the Board of Directors, any share or shares issued by any other corporation and owned or controlled by the Corporation may be voted at any shareholders' meeting of such other corporation by the Chairman of the Board, or in his absence by any Vice-President of the Corporation who may be present. Whenever, in the judgment of the Chairman of he Board or, in his absence, the President, it is desirable for the Corporation to execute a proxy or give a shareholders' consent in respect to any share or shares issued by any other corporation and owned by the Corporation, such proxy or consent shall be executed in the name of the Corporation by the Chairman of the Board, the President or a Vice-President of the Corporation and shall be attested by the Secretary or an Assistant Secretary of the corporate seal. Any person or persons designated in the manner above stated as the proxy or proxies of the Corporation shall have full right, power and authority to vote the share or shares issued by such other corporation and owned by the Corporation, the same as such share or shares might be voted by the Corporation. ARTICLE 9 Amendments The power to make, alter, amend or repeal these By-Laws is vested in the Board of Directors, but the affirmative vote of a majority of the actual number of directors elected and qualified from time to time, shall be necessary to effect any alteration, amendment or repeal of these By-Laws. ARTICLE 10 Miscellaneous 4.26.90 10.02 Control Share Opt-Out. Chapter 42 of the Indiana Business Corporation Law, as amended (the "IBCL"), shall not apply to " control share acquisitions" (as defined in the IBCL) of shares of the Corporation. Updated 8/20/97 IRWIN FINANCIAL CORPORATION AMENDMENT NUMBER ONE TO 1997 STOCK OPTION PLAN The terms and conditions of paragraph 8 of the Irwin Financial Corporation Stock Option Plan (the "Plan") shall be amended so as to read as follows, effective February 19, 1998: 8. Limitations on Exercise of Options/SARs. (a) Except with respect to those options granted under subparagraph (b) of this paragraph, each option and/or SAR granted under this Plan shall be exercisable by the grantee only in accordance with the following schedule: (i) During the first year following the grant of the option and/or SAR, up to 25% of the optioned Shares, or Shares represented by the SAR, may be exercised: (ii) During the second year following the grant of the option and/or SAR, up to an additional 25% of the optioned Shares, or Shares represented by the SAR, may be exercised; (iii) During the third year following the grant of the option and/or SAR, up to an additional 25% of the optioned Shares, or Shares represented by the SAR, may be exercised: and (iv) After the end of the third year following the grant of the option and/or SAR and until the expiration of the option and/or SAR, any and all remaining Shares under the option or Shares represented by the SAR, may be exercised. The limitations on exercise set forth above shall be cumulative; for example, during the second year after the grant a combined total of 50% of the optioned Shares, or Shares represented by the SAR, may be exercised if none were exercised during the first year. The limitations set forth in this paragraph 8 shall not apply in the event of the death of a grantee while serving on the Board of Directors or in the employ of IFC or its subsidiaries. (b) Options designated at the time of the grant as "Special Y2K Series Stock Options" shall be exercisable by the grantee only in accordance with the following terms, and the provisions of subparagraph (a) shall not apply thereto: (i) If the Board of Directors determines, in its sole discretion, that the Company's Year 2000 computer programming project has been brought to a successful conclusion, then the Special Y2K Series Options will be exercisable in full from and after March 31, 2001. (ii) If the Board of Directors determines, in its sole discretion that the Year 2000 project has not been brought to a successful conclusion, but that the remaining problems are not significant, then the Special Y2K Series Options will be exercisable as to one-half the shares subject to those options from and after March 31, 2001, and the remaining shares subject to the options will be forfeited. (iii) If the Board of Directors determines, in its sole discretion, that the Year 2000 project has not been brought to a successful conclusion, and that the remaining problems are significant, then none of the Special Y2K Series Options will be exercisable and all of the shares subject to the options will be forfeited. The determinations of the Board of Directors described in this subparagraph shall be made by it on or before March 31, 2001. Exhibit 11 (a) IRWIN FINANCIAL CORPORATION AND SUBSIDIARIES EXHIBIT 11(a) - COMPUTATION OF EARNINGS PER SHARE Year Ended December 31, 1997 1996 1995 [S] [C] [C] [C] AVERAGE NUMBER OF SHARES 11,163,155 11,358,121 11,279,870 OUTSTANDING NET INCOME $24,444,150 $22,428,337 $20,083,202 BASIC EARNINGS PER SHARE (Note 2) $2.19 $1.97 $1.78 DILUTED SHARES OUTSTANDING: Average number of shares 11,163,155 11,358,121 11,279,870 outstanding Assumed exercise of stock options 197,932 156,871 149,949 (Note 1) Total shares (Note 2) 11,361,087 11,514,992 11,429,819 NET INCOME $24,444,150 $22,428,337 $20,083,202 DILUTED EARNINGS PER SHARE (Note 2) $2.15 $1.95 $1.76 (1) The dilutive effect of stock options is based on the Treasury Stock method. Adjusted for the two-for-one stock split on December 30, 1996 Management's Discussion and Analysis of Results of Operations and Financial Condition Contents Management's Discussion and Analysis of Results of Operations and Financial Condition: 28 Five-Year Selected Financial Data and Graphs 31 Consolidated Overview 32 Mortgage Banking 40 Community Banking 46 Home Equity Lending 52 Equipment Leasing 56 Other Irwin Financial Businesses 56 Consolidated Income Statement Analysis 58 Consolidated Balance Sheet Analysis 61 Capital 64 Risk Management 64 Credit Risk 68 Liquidity 69 Interest Rate Risk Financial Statements: 79 Report of Management 80 Report of Independent Public Accountants 81 Consolidated Statement of Income 82 Consolidated Balance Sheet 83 Consolidated Statement of Changes in Shareholders' Equity 84 Consolidated Statement of Cash Flows 85 Notes to Financial Statements Five-Year Selected Financial Data 1997 1996 1995 1994 1993 ----------------------------------------------------------------------------------------------- Financial Data (in thousands) For the year: Net Revenues $223,185 $195,448 $148,239 $116,908 $119,366 Other Operating Expense 176,534 158,160 115,790 86,844 93,803 Net Income 24,444 22,428 20,083 18,216 15,588 Mortgage Loan Closings 5,397,338 5,085,625 3,559,310 2,812,962 4,273,933 Return on Average Equity 19.80% 20.58% 22.60% 23.91% 24.91% Return on Average Assets 1.94 1.95 2.28 2.43 2.15 Dividend Payout Ratio 12.74 12.15 12.36 11.38 11.12 Per share:* Net Income - Basic $2.19 $1.97 $1.78 $1.58 $1.35 Net Income - Diluted 2.15 1.95 1.76 1.57 1.34 Cash Dividends 0.28 0.24 0.22 0.18 0.15 Book Value 11.23 10.46 8.76 7.21 6.03 Market Value at December 31, 41.88 24.75 19.94 13.38 12.50 At year end: Assets $1,496,794 $1,300,122 $1,037,541 $659,671 $881,864 Deposits 719,596 640,153 563,999 439,918 500,370 Mortgage Loans Held for Sale 528,739 446,898 378,658 154,964 370,755 Loans and Leases, Net 602,281 526,175 407,904 304,548 252,823 Shareholders' Equity 127,983 118,902 99,216 81,104 70,093 Owned Mortgage Servicing Portfolio 10,713,549 10,810,988 10,301,914 8,818,502 7,922,299 Equity to Assets Ratio 8.55% 9.15% 9.56% 12.29% 7.95% Risk-based Capital Ratio 17.54 14.23 14.49 19.18 15.68 Leverage Ratio (Tier 1) 12.06 9.84 10.57 10.82 9.63 Averages: Assets $1,262,714 $1,151,535 $882,164 $748,981 $725,846 Equity 123,483 108,970 88,867 76,178 62,586 Shares Outstanding* - Basic 11,163 11,358 11,280 11,547 11,545 Shares Outstanding* - Diluted 11,361 11,515 11,430 11,639 11,628 ----------------------------------------------------------------------------------------------- *Adjusted for stock splits Total Net Revenuew $ Millions 1990 43.3 1991 60.0 1992 94.9 1993 119.4 1994 116.9 1995 148.2 1996 195.4 1997 223.2 Net Income $ Millions 1990 4.6 1991 6.7 1992 12.9 1993 15.6 1994 18.2 1995 20.1 1996 22.4 1997 24.4 Return on Avernage Equity Percent 1990 13.50 1991 16.93 1992 26.51 1993 24.91 1994 23.91 1995 22.60 1996 20.58 1997 19.80 Management's Discussion Management's discussion and analysis should be read in conjunction with the accompanying consolidated financial statements, footnotes, and tables. Forward- looking statements contained in the following discussion are based on estimates and assumptions that are subject to significant business, economic and competitive uncertainties, many of which are beyond the Corporation's control and are subject to change. These uncertainties can affect actual results and could cause actual results to differ materially from those expressed in any forward-looking statements in this discussion. Consolidated Overview: Irwin Financial Corporation earned record net income in 1997 for the eighth consecutive year. This performance was due to improved results at each of the Corporation's lines of business. Net income for 1997 totaled $24,444,150, up 9.0% from 1996 and 21.7% from 1995. Basic earnings per share were $2.19 in 1997, up from $1.97 in 1996 and $1.78 in 1995. Diluted earnings per share in 1997 were $2.15 compared to $1.95 in 1996 and $1.76 in 1995. The Corporation has made investments to expand current operations and enter new segments of the financial services industry. These initiatives are evidenced by the growth in loan volume throughout the Corporation and the start up of Irwin Home Equity Corporation in 1995. Because the Corporation does not receive an immediate return on these long-term investments, the return on average equity and return on average assets have declined in recent years. However, the Corporation has achieved its objective of earning a return on average equity that exceeds its cost of capital, estimated to have been approximately 12.5% during the last three years. Return on average equity for 1997 was 19.80% compared to 20.58% in 1996 and 22.60% in 1995. Return on average assets was 1.94% compared to 1.95% in 1996 and 2.28% in 1995. Earnings By Line of Business: Irwin Financial Corporation is comprised of four principal lines of business: - Mortgage banking - Community banking - Home equity lending - Equipment leasing Earnings: (In thousands) 1997 1996 1995 ----------------------------------------------------------------------------------- Mortgage Banking $21,300 $20,422 $19,331 Community Banking 5,587 4,254 3,639 Home Equity Lending 1,710 (816) (3,220) Equipment Leasing 151 (141) (334) Parent (including consolidating entries) (4,304) (1,291) 667 ------- -------- ------- $24,444 $22,428 $20,083 ---------------------------------------------------------------------------------- Management's Discussion (continued) Business Profile: Mortgage Banking Selected Financial Data (In thousands) 1997 1996 1995 1994 1993 ----------------------------------------------------------------------------------------------- Selected Income Statement Data: Net interest income $17,577 $17,178 $13,415 $12,942 $15,103 Provision for loan losses (1,383) (455) (125) (240) (36) Loan origination fees 41,045 43,463 31,871 25,308 37,605 Gain on sale of loans 21,613 25,541 18,020 2,219 14,225 Loan servicing fees 50,194 45,573 36,087 32,426 24,428 Gain on sale of servicing 32,631 16,378 15,271 17,716 2,979 Other income 1,223 891 787 647 550 -------- -------- -------- -------- -------- Total net revenues 162,900 148,569 115,326 91,018 94,854 Operating expense 126,610 114,474 83,344 64,571 72,140 -------- -------- -------- -------- -------- Income before taxes 36,290 34,095 31,982 26,447 22,714 Income taxes 14,990 13,673 12,651 10,719 9,073 -------- -------- -------- -------- -------- Net income $21,300 $20,422 $19,331 $15,728 $13,641 ======== ======== ======== ======== ======== Selected Balance Sheet Data at End of Period: Mortgage loans held for sale $435,123 $372,855 $309,262 $131,543 $318,453 Mortgage servicing assets 81,610 71,715 51,783 18,834 11,505 Total assets 698,391 555,486 445,129 216,180 452,365 Short-term debt 335,835 265,646 227,021 68,259 215,014 Long-term debt 54 4,914 2,300 2,605 2,934 Shareholders' equity $81,058 $66,182 $55,811 $50,805 $42,355 Selected Operating Data: Mortgage loan closings $5,397,338 $5,085,625 $3,559,310 $2,812,962 $4,273,933 Servicing portfolio: Balance at December 31, 10,713,549 10,810,988 10,301,914 8,818,502 7,922,299 Weighted average coupon rate 7.85% 7.83% 7.83% 7.59% 7.51% Weighted average servicing fee 0.40 0.38 0.38 0.38 0.37 Servicing sold as a percent of production 71.8 6o.9 28.4 49.8 5.6 ----------------------------------------------------------------------------------------------- Overview & Strategy: The mortgage banking line of business consists of Irwin Mortgage Corporation (as of January 1,1998, Inland Mortgage Corporation changed its name to Irwin Mortgage Corporation) and the related activities of Irwin Union Bank and Trust. The business is headquartered in Indianapolis and originates, packages, sells, and services residential mortgage loans throughout the U.S. It has offices in 28 states and ranks among the top 30 mortgage loan originators in the country. The majority of the loans originated and serviced are either government-insured through the Veterans' Administration (VA) or Federal Housing Administration (FHA) or conventional loans which conform to the underwriting guidelines of the two principal government-sponsored agencies which support the secondary mortgage markets, the Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corporation (FHLMC). Mortgage loans are originated through both direct branches (retail) and third party sources (wholesale). Potential borrowers are identified principally through relationships maintained with housing intermediaries including realtors and home builders. Loans are funded on a short-term basis through credit facilities provided by commercial banks including Irwin Union Bank. Financing agreements with investment banks are also used. Individual loans are pooled, securitized, and sold into the secondary mortgage market. Servicing rights are periodically sold for a variety of reasons including cash flow and servicing portfolio management. Over the past five years, servicing rights have been retained on a total of 54.5% of the loans originated. 1997 Review: Net income from mortgage banking was $21.3 million in 1997, an increase of 4.3% over 1996 results of $20.4 million and 10.2% over 1995 results of $19.3 million. Return on average equity was 29.6% in 1997 compared to 33.4% in 1996 and 37.4% in 1995. Mortgage Closings: (In thousands) 1997 1996 1995 ------------------------------------------------------------------ Total closings $5,397,338 $5,085,625 $3,559,310 Percent retail loans 36.6% 41.8% 50.3% Percent wholesale loans 57.2 52.4 42.5 Percent brokered 6.2 5.8 7.2 ------------------------------------------------------------------ Annual loan originations in 1997 of $5.4 billion were up 6.1% from 1996 and 51.6% from 1995. During 1997 the mortgage bank originated a greater portion of its loans through wholesale channels than in previous years. Income from mortgage loan originations totaled $41.0 million which was $2.4 million less than 1996 and $9.2 million over 1995. The change in production mix resulted in this decline as lower fees are collected on wholesale originations. Mortgage loan applications in process and loans held for sale at the end of 1997 totaled $1.7 billion, compared with $1.8 billion at the end of 1996 and $1.6 billion at the end of 1995. Refinances accounted for 22.5% of 1997 loan closings, compared to 19.0% in 1996 and 11.6% in 1995. Gains from the sale of mortgage loans totaled $21.6 million in 1997, compared to $25.5 million in 1996 and $18.0 million in 1995. In early 1997 the mortgage bank entered into the nonprime mortgage market which is comprised of borrowers who do not qualify under the underwriting guidelines established by the government sponsored secondary market agencies for conforming first mortgages. Total originations in 1997 include $66.1 million of nonprime loans. These loans are sold on a non-recourse, service released basis to private investors. Mortgage Servicing: Servicing Portfolio: (In billions) 1997 1996 1995 --------------------------------------------------------------------------------- Beginning portfolio $10.8 $10.3 $8.8 Add: Loans originated 2.0 2.1 1.8 Loans purchased 3.4 3.0 1.8 Deduct: Sale of servicing rights (3.9) (3.1) (1.0) Run-off* (1.6) (1.5) (1.1) -------- -------- -------- Ending portfolio $10.7 $10.8 $10.3 ======== ======== ======== Number of loans 141,737 140,354 129,270 Average loan size $82,902 $83,540 $82,186 Percent GNMA 59% 51% 48% Percent FHLMC 11 15 21 Percent FNMA 19 16 17 Delinquency ratio: 5.99% 5.12% 4.55% Capitalized servicing as a percentage of servicing portfolio 0.76% 0.65% 0.50% -------------------------------------------------------------------------------- *Run-off is the reduction in principal balance of the servicing portfolio due to regular principal payments made by mortgagees and early repayment of an entire loan. The mortgage servicing portfolio was $10.7 billion at December 31, 1997, down 0.9% from the same date in 1996 and up 4.0% from 1995. The 1997 annual portfolio run-off rate was 12.3%. This is up from the 1996 rate of 10.7% and the 1995 rate of 10.4%. The following table sets forth certain information regarding the interest rates of loans in the servicing portfolio at December 31: Servicing Portfolio by Interest Rate: 1997 1996 1995 -------------------------------------------------------------- Less than 7% 8.4% 8.9% 10.3% 7.00 - 7.99% 42.5 44.3 39.8 8.00 - 8.99% 42.6 38.7 33.9 9% or greater 6.5 8.1 16.0 ----- ----- ----- Total 100% 100% 100% -------------------------------------------------------------- The value of mortgage servicing assets must be adjusted for impairment which could result from interest rate changes. Although impairment write-offs caused by declining interest rates would be accompanied by increased loan origination fees, management has implemented hedging alternatives from time to time to avoid significant impairment provisions. Expenses related to mortgage servicing rights impairment and hedging totaled $600.0 thousand in 1997 compared to $637.9 thousand in 1996 and $908.8 thousand in 1995. No hedges were in place at December 31, 1997. Servicing and Other Fees: (In thousands) 1997 1996 1995 -------------------------------------------------------------- Servicing fees $50,194 $45,573 $36,087 Other fees 1,223 891 787 ----- ----- ----- Total $51,417 $46,464 $36,874 -------------------------------------------------------------- Servicing fee income is recognized by collecting fees which normally range between 25 and 44 basis points annually on the principal amount of the underlying mortgages. A change in the portfolio mix to a higher percentage of government loans positively affected servicing income which increased 10.1% from 1996 and 39.1% from 1995. Sale of Mortgage Servicing: The mortgage banking business maintains the flexibility to either sell servicing assets for current cash flow or retain servicing for future cash flow. The decision to sell or retain servicing is based on current market conditions balanced with the interest rate risk tolerance of the business. Servicing assets totaling $3.9 billion were sold in 1997, generating a $32.6 million pre-tax gain on those sales. This compares to servicing sales of $3.1 billion in 1996 that produced $16.4 million pre-tax gain and $1.0 billion in 1995 that produced a $15.3 million pre-tax gain. The 1997 gain reflects improved market pricing and better margins on wholesale loans. Had all servicing been retained in 1997, gains on sales of loans would have been higher than what was recorded, with a corresponding reduction in gains from sales of servicing. Servicing sales in 1997 represented 71.8% of 1997 originations versus 1996 sales which were 60.9% of that year's originations and 1995 sales which were 28.4% of originations. Net Interest Income: Net interest income is generated from the interest earned on mortgage loans before they are sold to investors, less the interest expense incurred on borrowings to fund the loans. Net interest income totaled $17.6 million in 1997, compared to $17.2 million in 1996 and $13.4 million in 1995. Operating Expenses: (In thousands, except for number of employees) 1997 1996 1995 ----------------------------------------------------------------------------------------------- Salaries and employee benefits $71,389 $66,153 $51,737 Amortization of mortgage servicing rights 15,243 14,245 4,865 Other expenses 39,978 34,076 26,742 -------- -------- -------- Total operating expenses $126,610 $114,474 $83,344 ======== ======== ======== Number of employees at December 31, 1,411 1,474 1,316 ----------------------------------------------------------------------------------------------- Total operating expenses increased 10.6% from 1996 and 51.9% from 1995. The increase reflects the continued expansion of the production system. Also during 1997 the mortgage bank made significant technological improvements with the conversion to a new loan origination system, the installation of personal computer-based networks at branch locations, and an initiative to provide loan originators with laptop computers. The business has adopted a strategy of leasing all of its systems and related equipment. As a result, 1997 operating expenses include lease expense related to these technological improvements. Credit Quality: (In thousands) 1997 1996 1995 ----------------------------------------------------------------------------------------------- At December 31, Nonperforming loans $3,784 $2,221 $154 Other real estate owned 1,415 1,839 295 -------- -------- -------- Total nonperforming assets $5,199 $4,060 $449 ======== ======== ======== Allowance for loan losses $1,606 $633 $413 ======== ======== ======== Allowance for loan losses as a percentage of loans 6.0% 2.7% 2.1% For the year ended December 31, Provision for loan losses $1,383 $455 $125 ----------------------------------------------------------------------------------------------- Although most mortgages are either government-insured or conform to the underwriting guidelines of the government-sponsored agencies that support the secondary mortgage market, the mortgage bank has credit risk on those loans that do not get government insurance or that must be repurchased from agencies due to lack of conformity to underwriting guidelines. Over the last two years the government-sponsored agencies which provide credit enhancement on the loans underwritten by the mortgage bank have become more stringent in their adherence to their right to seek recourse from the originator of loans. As such, the mortgage bank has had an increase in the number of loans it has repurchased from the agencies. This has resulted in an increase in the nonperforming loans and other real estate owned at the mortgage bank. The mortgage bank seeks to cure the underwriting defect in these loans and resell them to the agencies or sell them to alternative investors. As a result of the increase in nonperforming loans in 1997, the allowance for loan losses and the provision for loan losses have increased from previous years. In providing for the loan loss allowance, management reviews each loan individually to assess expected future losses based on information about the borrower and the underlying collateral. 1998 Outlook: The mortgage bank is developing a strategy which will allow it to proceed with its expansion efforts in the current environment of consolidation in the mortgage banking industry. The business is focusing on ways that it can continue to be both a competitive loan originator and loan servicer. Production strategies include initiatives to enhance the profitability of both retail and wholesale channels. New production and underwriting technologies, the redesign of compensation systems, and new product offerings are anticipated in 1998. As noted earlier, during 1997 the mortgage bank entered the nonprime mortgage market. Management views this area as a potentially important source of growth. In addition, last year the mortgage bank began making dollar denominated mortgage loans to U.S. and Canadian citizens on selected properties in Mexico. Originations in 1997 totaled $1.1 million. In 1998, the mortgage bank plans to increase promotion and distribution efforts in Mexico in order to expand its presence in this new market. However, the ultimate potential for this product remains unclear, and it is not expected to be material in 1998. Industry competition for loan servicing combined with the volatility of servicing assets make the continual evaluation of servicing strategies critical to the mortgage banking business. The business must evaluate ways to service loans more efficiently and more profitably. And at the same time, it must evaluate alternatives to avoid large servicing asset impairment write-offs in the event of declining interest rates, including servicing sales and interest rate hedges. Employees: As of December 31, 1997, the mortgage banking line of business employed 1,411 people -- approximately 70% of the Corporation's total employee base. Total employment expense in 1997 was $71.4 million or 56.4% of operating expenses. Irwin Mortgage Corporation Directors and Senior Officers Directors: Rick L. McGuire President--Irwin Mortgage Corporation William I. Miller Chairman--Irwin Financial Corporation John A. Nash President--Irwin Financial Corporation Thomas D. Washburn Senior Vice President--Irwin Financial Corporation Senior Officers: Rick L. McGuire President Herbert B. Tasker Executive Vice President--All Pacific Region T. Lester Acree Senior Vice President--Wholesale Loan Purchasing Kenneth R. Block Senior Vice President--Loan Production Katrina J. Crubaugh Senior Vice President--Human Resources Robert H. Griffith, Jr. Senior Vice President and Legal Counsel Mark J. Lynch Senior Vice President--Consumer Lending William M. Meyer Senior Vice President--Loan Servicing Timothy L. Murphy Senior Vice President--Finance Erik J. Sorensen Senior Vice President--Secondary Marketing Scott G. Beer First Vice President--Secondary Marketing Mark E. Braden First Vice President--Information Technology Richard C. Cargill First Vice President--Metro Phoenix Renee M. Gunderson First Vice President--Underwriting/ Closing Post Closing Darla S. Habig First Vice President--Loan Control Allan D. Karlander First Vice President--Central Region John F. Macke First Vice President--Management Information Rachelle E. Mikosz First Vice President--Office Services Kevin M. Murphy First Vice President--Accounting Diana M. Rossetter First Vice President--Quality Control Suzanne C. Samson First Vice President--All Pacific Region Sherri K. Sanford First Vice President--Customer Service Debra J. Saviola First Vice President--Wholesale Loan Purchasing Lyle E. Shearer First Vice President--All Pacific Region Richard E. Skiles First Vice President--Appraisals Nicholas Vracas First Vice President--Mid-states Region Management's Discussion (continued) Business Profile: Community Banking Selected Financial Data: (In thousands) 1997 1996 1995 1994 1993 ----------------------------------------------------------------------------------------------- Selected Income Statement Data: Interest income $41,115 $35,645 $31,965 $23,808 $22,238 Interest expense 19,120 15,908 14,048 8,822 8,684 Provision for loan and lease losses 2,201 2,284 2,038 1,344 1,551 -------- -------- -------- -------- -------- Net interest income after provision for loan and lease losses 19,794 17,453 15,879 13,642 12,003 Noninterest income 9,434 9,384 7,187 5,719 6,192 -------- -------- -------- -------- -------- Total net revenues 29,228 26,837 23,066 19,361 18,195 Operating expenses 20,372 20,311 17,582 14,858 14,264 -------- -------- -------- -------- -------- Income before taxes 8,856 6,526 5,484 4,503 3,931 Income taxes 3,269 2,272 1,845 1,453 1,247 -------- -------- -------- -------- -------- Net income $5,587 $4,254 $3,639 $3,o50 $2,684 ======== ======== ======== ======== ======== Selected Balance Sheet Data at End of Period: Loans and leases, net $404,747 $331,790 $306,415 $252,226 $210,340 Total assets 539,233 503,507 440,035 370,462 334,148 Deposits 486,481 453,879 400,149 341,459 298,615 Shareholders' equity 38,390 33,967 28,722 24,686 23,882 Daily Averages: Assets $515,666 $459,893 $405,249 $344,691 $302,692 Deposits 463,851 413,935 358,343 315,229 275,956 Loans and leases, net 364,981 325,291 281,147 228,544 195,304 Shareholders' equity 36,232 31,863 27,661 23,580 20,326 Shareholders' equity to assets 7.03% 6.93% 6.83% 6.84% 6.72% ----------------------------------------------------------------------------------------------- Overview & Strategy: Community banking is conducted by Irwin Union Bank and Trust Company which is headquartered in Columbus, Indiana. It operates through 16 offices in seven counties in Indiana and holds a major share of the market in Bartholomew County where it has operated since 1871. Expansion into new markets has occurred in recent years and has been on a de novo basis. The community bank's strategy in these and other possible new markets is to position itself with local management and staff that can provide highly personalized, flexible service. The objective is to deliver services in the way customers would expect from a bank headquartered in that market. This means that every effort is made to staff the offices with local people and to give those people the authority to make key customer decisions. Credit, investment, trust, and insurance services are provided to individual and corporate customers. 1997 Review: Community banking net income in 1997 totaled $5.6 million, up 31.3% from 1996 net income of $4.3 million and 53.5% from 1995 net income of $3.6 million. The return on average equity was 15.42% in 1997 as compared to 13.35% in 1996 and 13.16% in 1995. Net interest revenue: (In thousands) 1997 1996 1995 ------------------------------------------------------------------------------- Net interest revenue on a taxable equivalent basis* $22,206 $20,095 $18,362 Average interest earning assets 481,707 429,520 373,784 Net interest margin 4.61% 4.67% 4.91% -------------------------------------------------------------------------------- *Reflects what net interest revenue would be if all interest income were subject to federal and state income taxes. Net interest revenue on a taxable equivalent basis increased 10.5% from 1996 and 20.9% from 1995 to a total of $22.2 million. Net interest revenue is the product of net interest margin and average earning assets. Net interest margin was 4.61% in 1997 compared to 4.67% in 1996 and 4.91% in 1995. Asset yields increased 0.16% on average in 1997, but funding costs were up 0.25%. This was due in large part to the fact that deposit growth occurred in higher cost time deposits. Noninterest Income: (In thousands) 1997 1996 1995 ---------------------------------------------------------------------------------------- Trust fees $2,178 $2,571 $2,470 Service charges on deposit accounts 1,831 1,820 1,596 Insurance commissions, fees, and premiums 1,044 1,105 1,016 Gain from sale of loans 1,088 909 - Loan servicing fees 972 690 210 Brokerage fees 757 736 571 Other 1,564 1,553 1,324 -------- -------- -------- Total noninterest income $9,434 $9,384 $7,187 ---------------------------------------------------------------------------------------- Noninterest income was up 0.5% from 1996 and 31.3% from 1995. During 1997 the community bank recorded $1.1 million of gains on the sale of consumer, commercial, and mortgage loans. This compares to $0.9 million in 1996. The community bank retained the right to service the sold loans, which contributed to increased loan servicing fees in 1997 and 1996. Operating Expenses: (In thousands, except for number of employees) 1997 1996 1995 ---------------------------------------------------------------------------------------- Salaries and employee benefits $11,333 $10,916 $9,656 Other expenses 9,039 9,395 7,926 -------- -------- -------- Total operating expenses $20,372 $20,311 $17,582 ======== ======== ======== Number of employees at December 31, 339 304 291 ---------------------------------------------------------------------------------------- Operating expenses increased 0.3% from 1996 and 15.9% from 1995. Costs associated with expanding new products and markets contributed to increases over the past two years. In addition, 1997 and 1996 operating expenses include $0.6 million and $1.5 million, respectively, of non-recurring expenses related to the restructuring of trust operations. Balance Sheet: Total assets averaged $515.7 million in 1997, compared to $459.9 million in 1996 and $405.2 million in 1995. Average earning assets for the year were $481.7 million, up $52.2 million or 12.2% from 1996 and up $107.9 million or 28.9% from 1995. The most significant component of the 1997 increase was loans and leases which were up $39.7 million on average in 1997 as a result of the community bank's expansion efforts into new markets. Average deposits were $463.9 million in 1997, 12.1% higher than 1996 and 29.4% higher than 1995. Credit Quality: (In thousands) 1997 1996 1995 ---------------------------------------------------------------------------------------- At December 31, Nonperforming loans $2,856 $3,434 $1,984 Other real estate owned 413 400 - -------- -------- -------- Total nonperforming assets $3,269 $3,834 $1,984 ======== ======== ======== Nonperforming assets as a percentage of total assets 0.60% 0.76% 0.45% ======== ======== ======== Allowance for loan losses $5,525 $4,790 $3,668 ======== ======== ======== Allowance for loan losses as a percentage of loans 1.35% 1.42% 1.18% ======== ======== ======== For the Year Ended December 31, Provision for loan losses $2,201 $2,284 $2,038 ======== ======== ======== Net charge-offs $1,277 $1,107 $1,598 ---------------------------------------------------------------------------------------- The community bank's equity to assets ratio averaged 7.03% for the year, compared to 6.93% in 1996 and 6.83% in 1995. 1998 Outlook: The community bank anticipates continued consolidation in the banking industry in 1998 which will present both opportunities and threats to the business. Opportunities will be created when other banks become more heavily centralized and decisions are not made locally. It is in this environment that the strategy of local management making decisions at the point of customer contact is the most effective. However, consolidation will enable larger institutions to become more efficient and increase pricing pressure on bank products. The community bank plans to continue its expansion through the opening of new offices during 1998. In late 1997 the community bank opened two offices with a focus on small business customers. The plan for 1998 is to evaluate this concept and consider expansion of small business offices in other markets. Employees: As of December 31, 1997 the community bank employed 339 people. Total employment expense in 1997 was $11.3 million or 55.6% of total operating expenses. Irwin Union Bank and Trust Company Directors Robert H. Claxton Senior Vice President-Finance, Knauf Fiber Glass Claude E. Davis President, Irwin Union Bank and Trust Company John T. Hackett Managing General Partner, CID Equity Partners, L.P. Robert W. Haddad Chairman and President, Columbus Container, Inc. Carolyn A. Lickerman Homemaker William I. Miller Chairman, Irwin Financial Corporation John A. Nash President, Irwin Financial Corporation Charles A. Rau, M.D. Physician Albert H. Shumaker II President, Coca-Cola Bottling Company of Columbus John S. Spangler President, Milestone Contractors, L.P. Christine M. Vujovich Vice President, Cummins Engine Company, Inc. Charles H. Watson President, Historic Columbus Development, Inc. Irwin Union Bank and Trust Company Senior Officers Claude E. Davis President Bradley J. Kime Executive Vice President Kevin P. Barr Senior Vice President and Chief Financial Officer William P. Guffey Senior Vice President and Senior Lending Officer Carrie K. Houston Senior Vice President--Human Resources Albert C. Roszczyk Senior Vice President--Bartholomew County William S. Beitler President--Shelby County Karen S. Coldiron President--Decatur County Brian D. Hall President--Monroe County J. Kevin Johnson President--Jackson County Mark C. Kugar President--Hendricks County Robert L. Phillips President--Johnson County William R. Redman President--Hamilton County Donald J. Stuart President--Irwin Union Advisory Services Selected Financial Data (In thousands) 1997 1996 1995 ------------------------------------------------------------------------------------------ Net interest income $7,129 $7,755 $1,828 Provision for loan losses (1,404) (983) (363) Gain on sale of loans 15,908 7,798 2,985 Loan servicing fees 2,145 710 13 Other income 294 140 10 -------- -------- -------- Total net revenues 24,072 15,420 4,473 Operating expenses 22,362 16,236 7,693 -------- -------- -------- Pre-tax income (loss) $1,710 (816) $(3,220) ======== ======== ======== Selected Balance Sheet Data at End of Period: Home equity loans net of loan loss allowance $111,779 $117,588 $36,225 Interest-only strips 22,134 12,661 4,446 Total assets 165,242 145,113 50,845 Short-term debt 146,219 129,627 24,981 Shareholders'equity 10,936 13,221 5,538 Selected Operating Data: Loan Volume: Lines of credit $115,274 $80,724 $87,420 Loans 99,244 88,396 - Servicing portfolio: Balance at December 31, 358,166 230,450 86,691 Weighted average coupon rate: Lines of credit 12.96% 12.80% 13.61% Loans 13.97% 14.08% - ------------------------------------------------------------------------------------------- Overview & Strategy: The home equity line of business includes Irwin Home Equity Corporation and the related activities of Irwin Union Bank and Trust. Irwin Home Equity is located in San Ramon, California, and was incorporated in late 1994. The company began marketing home equity loans in early 1995 through direct mail and telemarketing and currently markets in 22 states. The business has the option to either hold the loans in portfolio or securitize and service them. If the loans are held in portfolio, many costs incurred during the period to produce the loans are expensed immediately, whereas the revenue from the loans accrues over the lives of the loans. Alternatively, if the loans are securitized and sold on the secondary market to investors, a portion of the present value of the future net revenues from the loans will be recognized in the current period, helping to offset the expenses incurred in producing the loans. 1997 Review: The home equity lending business recorded pre-tax income of $1.7 million in 1997 compared with pre-tax losses of $816.2 thousand in 1996 and $3.2 million in 1995. Loan Originations and Securitizations: During 1997 the home equity lending business originated $214.5 million of home equity loans, up 26.8% from 1996 volume of $169.1 million and 145.4% from 1995 volume of $87.4 million. The business securitized and delivered $210.1 million of loans in 1997 which generated a pre-tax gain of $15.9 million. This compares to a $7.8 million gain recognized in 1996 on the sale of $79.9 million of loans and a $3.0 million gain recognized in 1995 on the sale of $51.6 million of loans. The 1996 gain includes a one-time adjustment of $1.o million relating to the substitution of a letter of credit for the cash reserve on the 1995 securitization. In addition to the loans that were delivered in 1997, another $80.o million were securitized. These loans were delivered in the first quarter of 1998 and the gain was recognized at that time. Servicing Portfolio: (In thousands) 1997 1996 1995 ------------------------------------------------------------------------------------------ Balance at December 31, $358,166 $230,450 $86,691 Delinquency ratio 1.48% 0.67% 0.85% ------------------------------------------------------------------------------------------ The home equity lending business continues to service loans it has securitized. The servicing portfolio, which includes loans held on the balance sheet as well as securitized loans, increased 55.4% from 1996 and 313.2% from 1995. The business earns a servicing fee equal to one percent of the outstanding principal balance of the securitized loans. Servicing fee income increased to $2.1 million in 1997 from $0.7 million in 1996 and $12.9 thousand in 1995. The level of fees in 1995 reflects the fact that loans were not securitized until late in the year. When the home equity lending business securitizes loans, the business recognizes as an asset an interest-only strip equal to the discounted available cash flows of the interest paid by borrowers netted against servicing fees, expected losses, and interest remitted to investors. The interest-only strips had a balance of $22.1 million at December 31, 1997, compared with $12.7 million at the same date in 1996 and $4.4 million in 1995. In addition, the business recognizes on its balance sheet a servicing asset equal to the discounted cash flows of future servicing income. At December 31, 1997 net servicing assets totaled $1.3 million, compared with $0.7 million at the end of 1996 and $0.3 million at the end of 1995. Interest-only strips and servicing assets are carried at their market values which are determined using assumptions about the duration and performance of the securitized loans. Included in these assumptions are estimates of the lives of the loans, expected losses, and appropriate discount rates. Management continually evaluates these assumptions to determine the proper carrying values of these assets on the balance sheet. During 1997, the home equity lending business recorded a net adjustment of $1.8 million pre-tax to the carrying values of its interest-only strips and servicing assets to reflect a change in management's estimate of future prepayment activity. In light of declining interest rates and increased competition in this industry, prepayment speeds were increased to rates ranging from 30% to 40% CPR (conditional prepayment rate) per year, up from the previous estimate of 26%. Assumed annual loss rates range from 0.50% to 0.64%, and the discount rate used is 15.0%. Net Interest Income: Net interest income before loan loss provision was $7.1 million in 1997, compared to $7.8 million in 1996 and $1.8 million in 1995. Included in interest income is income earned on the interest-only strip, net of amortization expense. This amounted to $1.8 million in 1997, compared to $2.2 million in 1996 and $0.2 million in 1995. Operating Expenses (In thousands, except for number of employees) 1997 1996 1995 --------------------------------------------------------------------------------------- Salaries and employee benefits $11,175 $8,663 $3,995 Marketing and development 2,731 2,462 1,337 Unrealized loss on interest-only strips and servicing assets 1,828 - - Other 6,628 5,111 2,361 -------- -------- -------- Total operating expenses $22,362 $16,236 $7,693 ======== ======== ======== Number of employees at December 31, 189 159 107 ---------------------------------------------------------------------------------------- The increase in operating expenses reflects the continued growth of this business. Balance Sheet: The home equity lending business had $112.3 million of loans outstanding at December 31, 1997. This compares to $118.2 million at the end of 1996 and $36.4 million at the end of 1995. The allowance for loan losses for loans still on the balance sheet had a balance of $563.5 thousand at December 31, 1997, compared to $589.4 thousand at the end of 1996 and $146.6 thousand at the end of 1995. Credit Quality: (In thousands) 1997 1996 1995 --------------------------------------------------------------------------------------- At December 31, Nonperforming loans $535 $260 $- ======== ======== ======== Nonperforming assets as a percentage of total assets 0.32% 0.18% n/a ======== ======== ======== Allowance for loan losses $564 $589 $147 ======== ======== ======== Allowance for loan losses as a percentage of loans 0.50% 0.50% 0.40% ======== ======== ======== For the year ended December 31, Provision for loan losses $1,404 $983 $363 ======== ======== ======== Net charge-offs $335 $37 $2 --------------------------------------------------------------------------------------- 1998 Outlook: As noted above, competition in the high loan-to-value home equity business has intensified since Irwin Home Equity was organized. The company sees competition from three principal sources: (i) hundreds of small, localized lenders entering the home equity business, (ii) first mortgage loans in instances where underlying property has appreciated sufficiently such that the homeowner can combine a second mortgage loan with a newly financed first mortgage, and (iii) other consumer financial lenders which have entered this growing market. Taken alone, these factors tend to reduce originations of any one lender and accelerate the run-off of loans currently under management. The home equity business believes it is appropriate over the long term to maintain pricing discipline through this cycle of the market. In order to sustain market share, the company plans to focus expansion efforts on testing new markets, new products, and new delivery channels. The business will maintain the flexibility of either holding the loans it produces in portfolio or securitizing them. Management will evaluate these options throughout the year in light of market conditions and financial objectives. Employees: As of December 31, 1997, the home equity business employed 189 people. Total employment expense in 1997 was $11.2 million or 50.0% of total operating expenses. Irwin Home Equity Corporation Directors and Senior Officers -------------------------------------------------------------------------------- Directors Elena Delgado President, Irwin Home Equity Corporation William I. Miller Chairman, Irwin Financial Corporation John A. Nash President, Irwin Financial Corporation Thomas D. Washburn Senior Vice President, Irwin Financial Corporation Senior Officers Elena Delgado President Spencer J. Carlsen Vice President--Production Edwin K. Corbin Vice President--Finance Kathryn J. Diamond Vice President--Credit Risk Management J. Christopher Huseby Vice President--Marketing and Business Development Sunita Liggin Vice President--Human Resources Jocelyn Martin-Leano Vice President--Operations Support Jack Nichols Vice President--Information Services Fern Prosnitz Vice President--Legal Counsel Management's Discussion (continued) Business Profile: Equipment Leasing Selected Financial Data (In thousands) 1997 1996 1995 1994 1993 ----------------------------------------------------------------------------------------------- Net interest income $4,809 $4,413 $4,081 $4,722 $3,914 Provision for loan and lease losses (1,250) (791) (672) (383) (276) Noninterest income 713 418 300 123 47 -------- -------- -------- -------- -------- Total net revenues 4,272 4,040 3,709 4,462 3,685 Operating expenses 4,121 4,181 4,043 3,589 3,133 -------- -------- -------- -------- -------- Pre-tax income (loss) $151 $(141) $(334) $873 $552 ======== ======== ======== ======== ======== Lease and loan volume $42,707 $36,624 $24,951 $23,585 $22,922 Net leases and loans outstanding 63,185 53,632 45,765 42,989 37,401 Number of leases and loans outstanding 9.350 9.186 7.766 7.209 6.438 Average new lease and loan size $13.303 $9.298 $9.027 $9.152 $8.663 ----------------------------------------------------------------------------------------------- Overview & Strategy: The equipment leasing line of business is made up of Irwin Equipment Finance Corp. (previously known as Affiliated Capital Corp.) and the related activities of Irwin Union Bank and Trust. Irwin Equipment Finance is a small- ticket leasing company headquartered in Northbrook, Illinois, focused on the medical equipment industry. The company was started by Irwin Financial in 1990 when it hired the staff and acquired the rights to the customers and vendors of the predecessor company which had been in business since 1983. The strategy of the equipment leasing business is to establish relationships with manufacturers and distributors of medical equipment and to place leases with medical professionals through the sales representatives of these vendors. The business focuses on relatively low-cost equipment for health care professionals. 1997 Review: Equipment leasing recorded pre-tax income of $151.2 thousand in 1997, compared with a pre-tax loss of $140.8 thousand in 1996 and a pre-tax loss of $333.7 in 1995. Lease and loan volume increased to $42.7 million in 1997, up 16.6% from $36.6 million in 1996 and 71.2% from $25.0 million in 1995. However, because of increased competition in the equipment leasing industry which created margin pressures, net interest income did not increase commensurately. Net interest income totaled $4.8 million in 1997, an increase of $0.4 million or 9.0% from 1996 and $0.7 million or 17.9% from 1995. The provision for loan and lease losses totaled $1.3 million in 1997, up from $0.8 million in 1996 and $0.7 million in 1995. Operating expenses were $4.1 million for the year, 1.4% lower than 1996 and 1.9% higher than 1995. Credit Quality: (In thousands) 1997 1996 1995 ----------------------------------------------------------------------------------------------- At December 31, Nonperforming loans $506 $1,261 $415 ======== ======== ========= Nonperforming assets as a percentage of total assets 0.75% 2.18% 0.84% ======== ======== ========= Allowance for loan losses $1,078 $823 $806 ======== ======== ========= Allowance for loan losses as a percentage of loans 1.68% 1.51% 1.73% ======== ======== ========= For the year ended December 31, Provision for loan losses $1,250 $791 $672 ======== ======== ========= Net charge-offs $995 $637 $500 ----------------------------------------------------------------------------------------------- 1998 Outlook: In early 1998, Matt Colasanti joined Irwin Equipment Finance as its new President, bringing to the business over 30 years of asset-based lending experience. Under his leadership, equipment leasing intends to pursue opportunities to expand in 1998. Alternatives to be considered will include becoming more active in the upper end of the medical equipment price range, hiring additional field sales representatives to cover manufacturing accounts more effectively, and moving into new lines of equipment. Employees: As of December 31, 1997, equipment leasing employed 35 people.Total employment expense in 1997 was $2.3 million or 55.1% of total operating expenses. Irwin Equipment Finance Corp. Directors and Senior Officers ----------------------------------------------------------------------------- Directors Matthew Colasanti President, Irwin Equipment Finance Corp. William I. Miller Chairman, Irwin Financial Corporation John A. Nash President, Irwin Financial Corporation Thomas D. Washburn Senior Vice President, Irwin Financial Corporation ------------------------------------------------------------------------------ Senior Officers Matthew Colasanti President Robert P. Albert Executive Vice President David E. Levine Senior Vice President Vincent F. D'Andrea Vice President and Controller Stuart A. Simon Vice President--Sales Other Irwin Financial Businesses: The results of parent company and other subsidiary operations, net of consolidating entries, are summarized below: (In thousands) 1997 1996 1995 ----------------------------------------------------------------------------------------------- Net revenues $20,329 $15,494 $17,986 Operating expenses (6,030) (5,636) (3,891) Tax credit 632 903 2,275 -------- -------- -------- 14,931 10,761 16,370 Eliminations (14,762) (12,052) (15,703) -------- -------- -------- Income before preferred securities distribution 169 (1,291) $667 -------- -------- -------- Preferred securities distribution (4,473) - - -------- -------- -------- Net income $(4,304) $(1,291) $667 ----------------------------------------------------------------------------------------------- Dividends from subsidiaries are recorded as parent company revenues but are eliminated in determining consolidated net income. Tax benefits which resulted from the operating losses generated by the home equity and equipment leasing businesses were recorded by the parent company in previous years. In 1997, when these two lines of business recorded operating profits, the parent company recorded the related income tax expense. The parent company will continue to do so until all of the losses carried forward have been used. Each subsidiary pays taxes to the parent company at the statutory rate. Subsidiaries also pay fees to the parent company to cover direct and indirect services. In addition, services are provided from one subsidiary to another. Inter-company income and expenses are calculated on an arm's-length, external market basis and are eliminated in consolidation. In January 1997, the Corporation issued $50,000,000 of trust preferred securities through a trust created and controlled by the Corporation. Distribu- tions to security holders totaled $4.5 million in 1997. See the section on the consolidated balance sheet for further discussion of the trust preferred securities. Consolidated Income Statement Analysis: Pre-tax income for 1997 totaled $42.2 million, up 13.1% from 1996 and 30.0% Statement from 1995. The effective income tax rate was 42.0% in 1997, 39.8% in 1996, and 38.1% in 1995. Please see Note 18 of Notes to the Consolidated Financial Statements for more information on income taxes. Net interest revenue for 1997 totaled $54.9 million, up 9.7% from 1996 and 47.0% from 1995. The increase was due to increased lending volume at each of the lines of business. Net interest margin was 4.95% in 1997 compared to 5.12% in 1996 and 4.93% in 1995. See page 74 for further analysis of the net interest margin. The following table sets forth, for the periods indicated, a summary of the changes in interest earned and interest paid resulting from changes in volume and rates for the major components of interest-earning assets and interest- bearing liabilities on a fully taxable equivalent basis: 1997 Over 1996 1996 Over 1995 (In thousands) Volume Rate Total Volume Rate Total ----------------------------------------------------------------------------------------------- Interest Income: Loans and leases $7,657 $(3,419) $4,238 $13,248 $779 $14,027 Mortgage loans held for sale 4,429 (681) 3,748 6,760 3,456 10,216 Taxable investment securities 921 (885) 36 528 1,741 2,269 Tax-exempt securities (95) 29 (66) (171) (63) (234) Interest-bearing deposits with financial institutions 388 10 398 28 78 106 Federal funds sold (631) 15 (616) (619) (127) (746) -------- -------- -------- -------- -------- -------- Total 12,669 (4,931) 7,738 19,774 5,864 25,638 -------- -------- -------- -------- -------- -------- Interest Expense: Money market checking (3) 75 72 254 (233) 21 Money market savings (58) 10 (48) (88) (49) (137) Regular savings 7 21 28 (23) (134) (157) Time deposits 2,148 31 2,179 (268) 3,406 3,138 Short-term borrowings 2,031 (358) 1,673 6,451 3,685 10,136 Long-term debt (907) (40) (947) 78 (22) 56 -------- -------- -------- -------- -------- -------- Total 3,218 (261) 2,957 6,404 6,653 13,057 -------- -------- -------- -------- -------- -------- Net interest revenue $9,451 $(4,670) $4,781 $13,370 $(789) $12,581 ----------------------------------------------------------------------------------------------- Note: Variance not solely due to rate or volume is allocated on the basis of the absolute relationship between volume variances and rate variances. The consolidated provision for loan losses for 1997 was $6.2 million, up 37.0% from 1996 and 95.1% from 1995. More information on this subject is contained in the section on credit risk. Other income increased 16.4% in 1997 to $174.6 million. This compares to $150.0 million in 1996 and $114.1million in 1995. The most significant increases came in the categories related to mortgage banking and home equity lending activities which were previously discussed on pages 32 and 46. Other expenses in 1997 totaled $176.5 million, up 11.6% from 1996 and 52.5% from 1995. The 1997 increase in consolidated other expense of $18.4 million was mostly due to operating expenses associated with expanded mortgage and home equity loan production. The trust preferred securities issued in 1997 had a negative impact on 1997 earnings as the fixed 9.25% coupon on the securities is above the Corporation's marginal borrowing rate. The securities have, however, strengthened the Corporation's capital base to enable continued expansion in the coming years. Consolidated Balance Analysis: Total assets at year-end 1997 were $1.5 billion, up 15.1% from 1996 and 44.3% Sheet from 1995. However, changes in the average balance sheet are a more accurate reflection of the actual changes in the level of activity on the balance sheet. Average assets were $1.3 billion in 1997, up 9.7% from 1996 and 43.1% from 1995. Mortgage loans held for sale increased by $51.2 million, while loans and leases increased by $72.6 million on average in 1997. These increases are the result of the expansion of operations throughout the Corporation. The Corporation's commercial loans are extended primarily to local regional businesses and to local farming operations in the market area of Irwin Union Bank. The Corporation also extends credit to consumers through installment loans and revolving credit arrangements. The majority of the remaining portfolio consists of residential mortgage loans (1-4 family dwellings), mortgage loans on commercial property, and medical equipment leases. Loans by major category at the end of the last five years were as follows: Loans by Category: At December 31, (In thousands) 1997 1996 1995 1994 1993 ---------------------------------------------------------------------------------- Commercial, financial, and agricultural $212,095 $179,650 $150,312 $136,083 $121,024 Real estate construction 73,279 48,991 36,126 21,960 21,258 Real estate mortgage 222,818 214,696 108,351 47,423 30,805 Consumer 39,985 38,371 67,756 55,323 41,101 Direct lease financing 78,079 62,372 60,979 58,348 52,555 Unearned income (15,163) (11,030) (10,999) (10,726) (10,627) -------- -------- --------- ---------- --------- Total $611,093 $533,050 $412,525 $308,411 $256,116 ----------------------------------------------------------------------------------------------- Maturity Distribution of Loans: After One But Within Within After At December 31, 1997 (In thousands) One Year Five Years Five Years Total ----------------------------------------------------------------------------------------------- Commercial, financial, and agricultural $116,394 $83,059 $12,642 $212,095 Real estate construction 73,279 - - 73,279 Real estate mortgage 95,821 14,167 112,830 222,818 Consumer loans 8,120 26,458 5,407 39,985 Direct lease financing 58,510 19,374 195 78,079 -------- Total $626,256 ======== Loans due after one year with: Fixed interest rates $187,076 Variable interest rates 87,056 -------- Total $274,132 ----------------------------------------------------------------------------------------------- On average, investment securities increased $8.9 million in 1997 to $81.9 million. The carrying value of investments at December 31, 1997 includes $76.7 thousand of unrealized gains on available-for-sale securities. Maturity Distribution of Investment Securities: After After Five One But But Within Within Within After One Five Ten Ten At December 31, 1997 (In thousands) Year Years Years Years ---------------------------------------------------------------------------------------- U.S. Treasury and Government obligations $9,361 $12,259 $6,950 $13,216 Obligations of states and political subdivisions 600 1,454 955 1,805 Mortgage-backed securities - 2,029 1,863 4,694 Interest-only strips and other 22,155 -- -- -- -------- -------- -------- -------- Total $32,116 $15,742 $9,768 $19,715 ======== ======== ======== ======== Weighted Average Yield: Held-to-maturity 6.18% 6.86% 7.89% 6.64% Available-for-sale 8.50% 5.91% 6.70% 6.78% ---------------------------------------------------------------------------------------- The yield on state and municipal obligations has been calculated on fully taxable equivalent basis, assuming a 35% tax rate. Deposits averaged $691.8 million during 1997, compared to $632.2 million in 1996 and $526.1 million in 1995. Demand deposits were up 9.9% on average, or $23.5 million from 1996. A significant portion of demand deposits is related to deposits at Irwin Union Bank which are associated with escrow accounts held on loans in the servicing portfolio of Irwin Mortgage. These escrow accounts averaged $200.8 million in 1997. Maturities of certificates of deposit of $100 thousand or more are set forth in the following table: At December 31, (In thousands) 1997 1996 1995 ----------------------------------------------------------------------------------- Under 3 months $60,379 $47,907 $27,131 3 to 6 months 10,123 5,127 6,299 6 to 12 months 10,115 7,493 14,378 After 12 months 5,411 5,977 6,268 -------- -------- -------- Total $86,028 $66,504 $54,076 -------------------------------------------------------------------------------------- Short-term borrowings averaged $365.0 million in 1997, compared to $334.3 million in 1996 and $217.3 million in 1995. The increase in 1997 is due to the increase in mortgage loan closings in 1997. The following table shows the distribution of the Corporation's short-term borrowings and the weighted average rates at the end of each of the last three years. Also provided are the maximum amount of borrowings and the average amounts of borrowings as well as weighted average interest rates for the last three years. Repurchase Agreements & Drafts Federal Payable Home Related to Loan Bank Mortgage Borrowings Lines Loan Commercial & Federal of (In thousands) Closings Paper Funds Credit ---------------------------------------------------------------------------------------------- Year Ended 1997 $240,659 $16,375 $142,650 $112,591 December 31: 1996 264,998 17,175 74,118 105,575 1995 225,873 21,723 40,000 22,683 Weighted average 1997 3.60% 6.00% 6.18% 6.87% interest rates at 1996 4.65 5.95 5.80 6.68 year-end: 1995 4.32 6.32 6.02 7.35 Maximum amount 1997 $274,363 $16,375 $142,650 $151,111 outstanding at any 1996 270,516 27,214 121,000 135,442 month's end: 1995 271,694 21,723 52,448 38,596 Average amount 1997 $237,953 $12,738 $48,823 $65,490 outstanding during 1996 218,810 23,794 44,139 47,561 the year: 1995 155,726 19,125 20,497 6,109 Weighted average 1997 3.55% 6.01% 6.00% 6.65% interest rate during 1996 3.78 6.02 5.80 6.80 the year: 1995 4.12 6.41 6.03 8.06 --------------------------------------------------------------------------------------------- Capital: Shareholders' equity averaged $123.5 million in 1997 up 13.3% from 1996 and 39.0% from 1995. Year-end shareholders' equity of $128.0 million represented book value per share of $11.23, compared to $10.46 and $8.76 at December 31, 1996 and 1995, respectively. Prior to the adoption of a new mortgage banking accounting standard in the second quarter of 1995, mortgage banking accounting did not allow the full value of mortgage servicing rights to be reflected on the balance sheet. Since a significant portion of the Corporation's mortgage servicing portfolio was generated prior to the adoption of the new accounting standard, it represents substantial economic value which is not recorded on the balance sheet. The following table demonstrates the estimated after-tax value of the servicing portfolio at December 31: (In thousands) 1997 1996 1995 ------------------------------------------------------------------------ Total loans serviced $10,713,549 $10,810,988 $10,301,914 ----------- ----------- ----------- Value (@ 1.5%) $160,703 $162,165 $154,529 Less capitalized servicing 81,610 71,715 51,783 Tax liability (@ 40%) 31,637 36,180 41,098 ----------- ----------- ----------- Net value $47,456 $54,270 $61,648 =========== =========== =========== Per share of common stock $4.31 $4.77 $5.44 ------------------------------------------------------------------------ With the implementation of the new accounting standard in 1995, this off- balance sheet value will decline over future years and eventually be reduced to zero. Total book value per share including the value of the servicing portfolio was $15.54 at December 31, 1997, up from $15.23 and $14.20 at December 31, 1996 and 1995, respectively. Capital is a major focus of regulatory attention, with both book and risk- based capital standards used as capital adequacy measures. Unless an institution has adequate capital in the opinion of the regulators, they may withhold approval for new activities or force additions to capital. Therefore, the Corporation considers both the regulators' viewpoint and its own analysis of the capital structure and leverage amounts that are consistent with underlying business risks. (In thousands) 1997 1996 1995 ----------------------------------------------------------------------- Tier 1 capital $169,366 $117,416 $92,554 Tier 2 capital 16,170 6,594 4,620 ----------- ----------- ----------- Total risk-based capital $185,536 $124,010 $97,174 =========== =========== =========== Risk-weighted assets $1,057,497 $871,460 $670,675 =========== =========== =========== Risk-based ratios: Tier 1 capital 16.02% 13.47% 13.80% Total capital 17.54 14.23 14.49 Tier 1 leverage ratio 12.06 9.84 10.57 Ending shareholders' equity to assets 8.55 9.15 9.56 Average shareholders' equity to assets 9.78 9.46 10.07 ---------------------------------------------------------------------- At year-end 1997 the Corporation's total risk-adjusted capital ratio was 17.54% compared to 10.0 % which is required in order to be considered well capitalized by the regulators. The Corporation's ending equity to assets ratio for 1997 was 8.55%. However, as previously discussed, temporary conditions which existed at year-end make the average balance sheet ratio a more accurate measure of capital. The Corporation's average equity to assets for 1997 was 9.78%. In January 1997, the Corporation issued $50,000,000 of trust preferred securities through a trust created and controlled by the Corporation. The securities, which are publicly traded, were issued at $25 per share with a cumulative dividend rate of 9.25%, payable quarterly. They have an initial maturity of 30 years with a 19-year extension option which the Corporation can exercise at any point during the first 30 years. The securities are callable at par after five years, or immediately, in the event of an adverse tax development affecting the Corporation's classification of the securities for federal income tax purposes. The securities are not convertible into common stock of the Corporation. Stock Prices Dividends: The common stock of Irwin Financial is quoted on the National Association of and Securities Dealers Automated Quotation System National Market System (NASDAQ-NMS- trading symbol, IRWN). The following table sets forth certain information regarding trading in, and cash dividends paid with respect to, the shares of the Corporation's common stock in each quarter of the three most recent calendar years. Total Quarter Cash Dividends 1995 *High *Low *End *Dividends *For Year ----------------------------------------------------------------------------------------- First quarter $15-7/8 $13-3/4 $15-1/2 $0.055 Second quarter 17-5/8 15-1/2 17-1/4 0.055 Third quarter 18-1/4 17-1/4 17-3/4 0.055 Fourth quarter 20-1/8 17-5/8 20 0.055 $0.22 1996 ----------------------------------------------------------------------------------------- First quarter $22-3/4 $19-3/4 $22-1/8 $0.060 Second quarter 22-1/4 19-5/8 19-5/8 0.060 Third quarter 21-5/8 17-7/8 21-1/4 0.060 Fourth quarter 24-3/4 21-1/4 24-3/4 0.060 $0.24 1997 ----------------------------------------------------------------------------------------- First quarter $30-1/2 $24-1/4 $27-1/4 $0.070 Second quarter 29-1/2 24-5/8 29-1/2 0.070 Third quarter 37-1/4 28-3/4 37-1/4 0.070 Fourth quarter 43-3/4 36-1/2 41-7/8 0.070 $0.28 ----------------------------------------------------------------------------------------- *Adjusted for December 30, 1996 two-for-one stock split. The Corporation expects to continue its 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 19, 1998, the Corporation's Board of Directors approved an increase in the first quarter dividend to $0.08 per share, payable in March, 1998. Risk Management: As a financial intermediary, Irwin Financial Corporation is engaged in businesses which involve the assumption of financial risks including: Credit risk Liquidity risk Interest rate risk Each line of business that assumes financial risk uses a formal process to manage this risk. In all cases, the objectives are to ensure that risk is contained within prudent levels and that we are adequately compensated for the level of risk assumed. The Chairman, the President, and the Chief Financial Officer of the parent company participate in each subsidiary's risk management process. Credit Risk: The assumption of credit risk is a key source of earnings for the community bank, home equity lending, and equipment leasing businesses. In addition, the mortgage banking business assumes some credit risk despite the fact that its mortgages are typically insured. The credit risk in the loan portfolios of the community bank and the home equity lending business has the most potential to have a significant effect on consolidated financial performance. The community bank and home equity lending business manage credit risk through the use of lending policies, credit analysis and approval procedures, periodic loan reviews, and personal contact with borrowers. Loans over a certain size are reviewed by a loan committee prior to approval. The equipment leasing business manages credit risk in a manner similar to that used by the community bank and the home equity business. It uses lending policies, credit analysis procedures, and personal contact with lessees. An allowance for loan and lease losses is established as an estimate of the potential credit risk of the loans and leases held by the Corporation. In determining the adequacy of this allowance, management evaluates the creditworthiness of significant borrowers, past loan and lease loss experience, and current and anticipated economic conditions. The allowance is increased by provisions against income and recoveries of loans and leases previously charged off. Loans and leases that are determined by management to be uncollectible are charged against the allowance. The table on page 66 analyzes the consolidated allowance for loan and lease losses over the past five years. Net charge-offs in 1997 were $2.6 million, up 46.4% from 1996, and up 24.1% from 1995. Net charge-offs to average loans and leases was 0.46% compared to 0.36% in 1996 and 0.57% in 1995. The provision for loan and lease losses was $6.2 million, 239.3% of net charge- offs. The coverage ratio was 255.6% in 1996 and 152.3% in 1995. At year end, the allowance for loan and lease losses was 1.44% of loans and leases, compared to 1.29% in 1996 and 1.22% in 1995. Total nonperforming loans and leases at year end were $7.7 million, compared to $7.2 million at the end of 1996 and $2.6 million at the end of 1995. Nonperforming loans and leases as a percent of total loans and leases were 1.26% at year-end 1997 compared to 1.35% in 1996 and 0.62% in 1995. Other real estate owned totaled $1.8 million at December 31, 1997, up from $2.2 million in 1996 and $0.3 in 1995. Total nonperforming assets were $9.5 million, or 0.64% of total assets at December 31, 1997, as compared to $9.4 million, or 0.72%, at year-end 1996 and $2.8 million, or 0.27% at the end of 1995. Analysis of Allowance for Loan and Lease Losses (In Thousands) 1997 1996 1995 1994 1993 ------------------------------------------------------------------------------------------------- Loans and leases outstanding at end of period, net of unearned income $611,093 $533,050 $412,525 $308,411 $256,116 ======== ======== ======== ======== ======== Average loans and leases for the period, net of unearned income $569,325 $496,729 $369,220 $279,389 $232,898 ======== ======== ======== ======== ======== Allowance Balance beginning of period $6,875 $5,033 $4,174 $3,293 $3,220 for loan and lease losses: Charge-offs: Commercial, financial, and agricultural loans 800 495 845 266 1,074 Real estate mortgage loans 356 37 2 - - Consumer loans 734 959 953 543 387 Lease financing 1,255 883 690 757 323 -------- -------- -------- -------- -------- Total charge-offs 3,145 2,374 2,490 1,566 1,784 -------- -------- -------- -------- -------- Recoveries: Commercial, financial, and agricultural loans 32 133 2 34 82 Real estate mortgage loans 1 - - - - Consumer loans 246 214 197 180 94 Lease financing 259 246 191 195 104 -------- -------- -------- -------- -------- Total recoveries 538 593 390 409 280 -------- -------- -------- -------- -------- Net charge-offs (2,607) (1,781) (2,100) (1,157) (1,504) Reduction due to sale of loans (1,694) (930) (239) - - Provision charged to expense 6,238 4,553 3,198 2,038 1,577 -------- -------- -------- -------- -------- Balance end of period $8,812 $6,875 $5,033 $4,174 $3,293 ======== ======== ======== ======== ======== Allowance for By category of loans and leases loan and Commercial, financial, and lease losses: agricultural loans $5,118 $3,676 $2,349 $2,586 $2,031 Real estate mortgage loans 2,170 281 413 311 - Consumer loans 446 1,974 1,420 767 650 Lease financing 1,078 944 851 510 612 -------- -------- -------- -------- -------- Total $8,812 $6,875 $5,033 $4,174 $3,293 ======== ======== ======== ======== ======== Ratios: Net charge-offs to average loans and leases 0.46% 0.36% 0.57% 0.41% 0.65% Allowance for loan losses to average loans and leases 1.55% 1.38% 1.36% 1.38% 1.41% Allowance for loan losses to loans and leases outstanding 1.44% 1.29% 1.22% 1.25% 1.29% ---------------------------------------------------------------------------------------------- Nonperforming Assets (In thousands) 1997 1996 1995 1994 1993 ----------------------------------------------------------------------------------------------- Accruing loans past due Commercial, financial, and 90 days or more: agricultural loans $382 $256 $418 $113 $800 Real estate mortgages 534 234 - - 141 Consumer loans 86 205 202 93 88 ------ ------ ------ ------ ------ 1,002 695 620 206 1,029 ------ ------ ------ ------ ------ Nonaccrual loans and Commercial, financial, and leases: agricultural loans 777 2,739 670 1,523 1,373 Real estate mortgages 5,333 2,481 848 947 848 Consumer loans 63 - - - 39 Lease financing receivables 506 1,261 415 363 242 ------ ------ ------ ------ ------ 6,679 6,481 1,933 2,833 2,502 ------ ------ ------ ------ ------ Total nonperforming loans and leases 7,681 7,176 2,553 3,039 3,531 Other real estate owned 1,828 2,239 295 489 623 ------ ------ ------ ------ ------ Total nonperforming assets $9,509 $9,415 $2,848 $3,528 $4,154 ======= ====== ====== ====== ====== Nonperforming loans and leases to total loans and leases 1.26% 1.35% 0.62% 0.90% 1.38% ======= ====== ====== ====== ====== Nonperforming assets to total assets 0.64% 0.72% 0.27% 0.50% 0.47% ----------------------------------------------------------------------------------------------- Loans which are past due 90 days or more are placed on nonaccrual status unless, in management's opinion, there is sufficient collateral value to offset both principal and interest. Renegotiated and Nonaccrual Loans (In thousands) 1997 1996 1995 ----------------------------------------------------------------------------------- Interest which would have been recorded under original terms Renegotiated $- $- $- Nonaccrual 302 356 194 ------ ------ ------ 302 356 194 ------ ------ ------ Interest income actually recorded Renegotiated - - - Nonaccrual 36 150 55 ------ ------ ------ 36 150 55 ------ ------ ------ Reduction in interest income $266 $206 $139 ----------------------------------------------------------------------------------- No loan concentrations existed of more than 10% of total loans to borrowers engaged in similar activities that would be similarly affected by economic or other conditions. Generally, the accrual of income is discontinued when the full collection of principal or interest is in doubt, or when the payment of principal or interest has become contractually 90 days past due unless the obligation is both well secured and in the process of collection. Liquidity: Liquidity is the availability of funds to meet the daily requirements of the business. For financial institutions, demand for funds comes principally from extensions of credit and withdrawal of deposits. Liquidity is provided by asset maturities or sales and through short-term borrowings. The objectives of liquidity management are to ensure that funds will be available to meet demands and that funds are available at a reasonable cost. As with other forms of financial risk, liquidity is managed separately at each of the lines of business. In the case of Irwin Union Bank, this occurs at the monthly meeting of the Asset-Liability Management Committee. Since loans and leases are less marketable than securities, the ratio of total loans to total deposits is the traditional measure of liquidity for banks and bank holding companies. At year-end 1997 this ratio stood at 83.7%. The Corporation is able to maintain this position of high liquidity without a substantial sacrifice in the form of a lower net interest margin due to the position in mortgage loans held for sale. These loans carry an interest rate equal to the current market rate for mortgage loans. However, liquidity is significantly improved since all mortgage loans held for sale are in the process of being securitized and sold. The holding period for an individual loan typically does not exceed 90 days. Interest Rate Risk: Interest rate risk refers to the potential for changes in market rates of interest to cause changes in net interest income. Since net interest income is a major source of income, it is important that potential changes are managed prudently. The Asset-Liability Management Committee of the community bank monitors the repricing structure of both assets and liabilities over various time horizons. Exposure to changes in interest rates is evaluated by modeling the repricing characteristics of the community bank's portfolio under multiple rate scenarios. Formal policies approved by the community bank's Board of Directors ensure that exposure to changes in net interest revenues is maintained within acceptable levels. The mortgage banking business assumes a form of interest rate risk by entering into commitments to extend loans to borrowers at a fixed price for a limited period of time. Loans are also held temporarily until a pool is formed. Once again, a formal policy ensures that this risk is controlled. The home equity and equipment leasing businesses are exposed to potential interest rate risk that is similar to the lending operations of the community bank. Rate risk at the community bank can typically be managed by controlling the maturity of loans, securities, and deposits. The community bank may also use financial futures or interest rate swaps from time to time, although there were none in place at December 31, 1997. The mortgage bank buys commitments to deliver loans at a fixed price to manage risk. The policy at both the home equity lending business and the equipment leasing business is to match-fund all assets. In some cases, the Corporation uses internal hedges between companies to allow for the risk characteristics of one line of business to offset those of another line. The following table shows in summary form the Corporation's interest rate sensitivity based on expected interest rate repricing intervals for the balance sheet as of December 31, 1997 (a "gap" analysis). For example, a 30- year adjustable rate residential mortgage held in the portfolio of Irwin Union Bank is included in the "4-12 month" category since that is the time frame over which the asset will reprice. Some items, such as certain deposit accounts, are non-interest bearing, but will vary in balance due to interest rate changes. Since the Corporation relies on such accounts in its operations and would need to replace them with "at market" liabilities should the non- interest bearing ones be unavailable, they are included in the gap table and in simulations as "non-market" items. As the table shows, the consolidated one-year gap at December 31, 1997 was a positive $143.0 million. This compares to a positive gap of $133.2 million at December 31, 1996. Since the gap was positive at December 31, 1997, it means that the Corporation's net interest income was positioned to benefit from rising rates, or to be harmed by declining rates. While traditional interest rate risk focuses on the changes in net interest income due to interest rate changes, the Corporation engages in other activities which are also affected by interest rate changes. Principal among these are mortgage loan origination and servicing. Through the use of simulations using regression modeling and option-adjusted valuation techniques for modeling expected customer behavior, the Corporation attempts to analyze and mitigate the interest rate risks associated with the negatively correlated activities of mortgage loan origination and servicing. For example, if interest rates decline, management expects an increase in mortgage loan origination income and a decline in the value of mortgage servicing assets. Management attempts to monitor this exposure to traditional interest rate risk as well as interest rate influences on production and servicing value in a comprehensive manner. Interest Sensitivity: Within 4 to 12 1 to 5 Over 5 Non- (In thousands) 3 Months Months Years Years Market Total ----------------------------------------------------------------------------------------------- Assets: Interest-bearing deposits with banks $10,920 $4,027 $3,293 $- $- $18,240 Taxable investment securities 20,193 17,889 28,232 6,213 - 72,527 Tax-exempt investment securities 100 500 962 3,252 - 4,814 Mortgages held for sale 528,739 - - - - 528,739 Loans, net of unearned income 269,988 99,787 146,186 95,132 - 611,093 -------- -------- --------- --------- -------- -------- Total interest- earning assets 829,940 122,203 178,673 104,597 - 1,235,413 -------- -------- --------- --------- -------- -------- Liabilities: Non-interest bearing deposits - - - - 287,555 287,555 Money market checking 32,625 - 47,148 10,169 - 89,942 Money market savings 1,758 - 5,487 - - 7,245 Regular savings 25,565 1,939 10,343 7,992 - 45,839 Time deposits 166,381 64,683 57,186 764 - 289,014 Short-term borrowings 512,276 - - - - 512,276 Long-term debt 1,399 2,499 3,197 - - 7,095 -------- -------- --------- --------- -------- -------- Total interest- bearing liabilities 740,004 69,121 123,361 18,925 287,555 $1,238,966 Trust preferred securities - - - 50,000 - 50,000 -------- -------- --------- --------- -------- -------- Interest sensitivity gap 89,936 53,082 55,312 35,672 (287,555) (53,553) -------- -------- --------- --------- -------- -------- Cumulative interest sensitivity gap $89,936 $143,018 $198,330 $234,002 $(53,553) $(53,553) ------------------------------------------------------------------------------------------------ Note: This analysis is based on certain assumptions, including relative levels of market interest rates, and should not be relied upon as indicative of actual results. Year 2000: The year 2000 issue is the result of practices within the information technology industry to program software and computer chips to store dates in a six digit, shortcut format. For example, January 15, 1998, may be written as 01/15/98 and the computer is programmed to assume that the first two digits of the year are ''19''. As a result, certain computer systems will not accurately interpret dates beyond December 31, 1999, and will consider dates beginning January 1, 2000 to represent January 1, 1900. This could result in a computer failure or miscalculations, causing operating disruptions, including an inability to process transactions, send invoices or engage in similar normal business activities. The Year 2000 issue exists across all industries and could affect all businesses that use computers, but is particularly relevant in the financial services industry served by the Corporation. The Company's Year 2000 Strategy: The Corporation is actively addressing its exposure to the Year 2000 issue and has five teams (one at each of its four operating entities and at the parent company) focusing on the issue. The Corporation has developed a six-stage project plan that is expected to culminate in final testing and implementation by mid-1999. The six stages include: (i) an awareness campaign throughout the Corporation to raise the level of importance and attention beyond that of a typical ''information technology'' issue; (ii) assessment of the Corporation's Year 2000 problem, including contract review, a technical audit and an estimation of remediation costs; (iii) remediation of non-compliant systems through repairs, upgrades or replacements of computer programs and chips; (iv) testing of the Corporation's systems for Year 2000 compliance; (v) implementation of the remediated systems and (vi) auditing of the completed processes and remediation for post-year 2000 compliance. The Corporation has engaged a leading technology-consulting firm to increase its level of confidence that the methods and standards it employs to address the Year 2000 issue are appropriate and comprehensive. The Corporation, together with its consultants, is currently in varying stages of the assessment, remediation and testing steps of its plan and cannot definitively estimate the extent of the problem for the Corporation or the cost to remedy it. However, the Corporation does not currently believe that the costs of the remediation will have a material impact on the Corporation's results of operations, liquidity and capital. The Corporation has developed a technology strategy that primarily uses systems developed by third parties and has very few internally developed applications. Consequently, the Corporation's principal focus is on assuring Year 2000 compliance from its commercial application vendors. In those instances where the Corporation believes a vendor may not be compliant in a timely manner, the Corporation is taking additional steps to address its needs with alternative systems. The Risks of Unsuccessful Year 2000 Remediation: Financial services require exact calculations and prompt delivery. If the Corporation's products are not accurate and timely, it increases its exposure to risks such as client service failure, regulatory compliance problems and disruption of third party operations when it interacts with third parties. The Corporation currently expects to implement the necessary changes to ensure that its internal operations are Year 2000 compliant prior to December 31, 1999. To achieve this goal, the Corporation is reliant upon its information system vendors to provide Year 2000 compliant systems sufficiently before December 31, 1999 to allow ample time to test the systems. There can be no assurance that all of the Corporation's key suppliers will achieve Year 2000 compliance in a timely manner. The failure of the Corporation's vendors to successfully address the Year 2000 issue in a timely manner would have a materially adverse effect on the Corporation's ability to successfully address the Year 2000 issue. In addition, if the Year 2000 issue adversely affects the Corporation's customers, this in turn could have a material adverse effect on the Corporation's ability to collect and service outstanding loans. Finally, even if the Corporation's internal operations and customers are Year 2000 compliant, the Corporation's operations can be materially adversely affected if agencies and third parties with whom the Corporation interacts fail to address the Year 2000 issue successfully. Any of the failures mentioned above could have a material adverse effect on the financial condition and results of operations of the Corporation. Daily Average Consolidated Balance Sheet, Interest Rates and Interest Differential For the year ended December 31, 1997 ------------------------------------------------------------------------------------------------------------ Average Yield/ (In thousands) Balance Interest Rate ------------------------------------------------------------------------------------------------------------ Assets: Interest-earning assets: Interest-bearing deposits with banks $16,887 $1,001 5.93% Federal funds sold 12,454 674 5.41 Taxable investment securities 77,590 6,309 8.13 Tax-exempt investment securities (1) 4,336 438 10.10 Mortgage loans held for sale 433,275 34,691 8.01 Loans and leases, net of unearned income (1) (2) 569,325 56,629 9.95 --------- -------- ------ Total interest-earning assets 1,113,867 99,742 8.95 --------- -------- ====== Noninterest-earning assets: Cash and due from banks 34,347 Premises and equipment, net 18,568 Other assets 103,682 Less allowance for possible loan and lease losses (7,750) --------- Total assets $1,262,714 ========= Liabilities and Shareholders' Equity: Interest-bearing liabilities: Money market checking $79,549 1,643 2.07% Money market savings 10,267 280 2.73 Regular savings 52,843 1,889 3.57 Time deposits 286,934 16,151 5.63 Short-term borrowings 365,005 23,788 6.52 Long-term debt 10,698 831 7.77 --------- -------- ------ Total interest-bearing liabilities 805,296 44,582 5.54 --------- -------- ====== Noninterest-bearing Demand deposits 262,190 liabilities: Other liabilities 71,745 Shareholders' equity 123,483 --------- Total liabilities and shareholders' equity $1,262,714 ========= Net interest income $55,160 ========= Net interest income to average interest-earning assets 4.95% -------------------------------------------------------------------------------------------------------------- Notes: (1) Interest is reported on a fully taxable equivalent basis. The prevailing federal income tax rate was 35% in 1997, 34.5% in 1996, and 34% in 1995. (2) For purposes of these computations, nonaccrual loans are included in daily average loan amounts outstanding. 1996 1995 Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate ------------------------------------------------------------------------------------------- $10,282 $603 5.87% $9,737 $497 5.10% 24,370 1,290 5.29 35,006 2,036 5.82 67,654 6,273 9.27 59,765 4,004 6.70 5,348 504 9.43 6,961 738 10.60 379,027 30,943 8.16 285,808 20,727 7.25 496,729 52,391 10.55 369,220 38,364 10.39 --------- -------- -------- -------- -------- -------- 983,410 92,004 9.36 766,497 66,366 8.66 --------- -------- -------- -------- -------- ======== 38,309 36,263 17,425 15,011 118,115 68,677 (5,724) (4,284) --------- -------- $1,151,535 $882,164 ======== ======== $79,704 1,571 1.97% $68,491 1,552 2.27% 12,455 328 2.63 15,376 465 3.02 52,657 1,861 3.53 53,255 2,016 3.79 248,694 13,972 5.62 255,004 10,834 4.25 334,304 22,115 6.62 217,289 11,979 5.51 21,840 1,778 8.14 20,896 1,722 8.24 --------- -------- -------- -------- -------- -------- 749,654 41,625 5.55 630,311 28,568 4.53 --------- -------- ======== -------- -------- ======== 238,673 133,936 54,238 29,050 108,970 88,867 --------- -------- $1,151,535 $882,164 ======== ======== $50,379 $37,798 ======== ======== 5.12% 4.93% ----------------------------------------------------------------------------------------------- Summary of Quarterly Financial Information 1997 Fourth Third Second First Summary Income Information Quarter Quarter Quarter Quarter -------------------------------------------------------------------------------------------------------------- Interest income $27,596,711 $26,237,031 $23,126,857 $22,480,656 Interest expense 12,988,884 11,705,079 10,031,950 9,856,575 Provision for loan and lease losses 1,374,000 2,042,000 2,019,000 803,000 Noninterest income 46,231,066 46,438,620 43,299,845 38,594,795 Noninterest expense 46,718,928 45,453,560 43,585,192 40,775,885 Income taxes 5,404,000 4,989,000 3,851,000 3,490,000 Distribution on company-obligated mandatorily redeemable preferred securities of subsidiary trust 1,174,250 1,174,250 1,171,163 953,715 ----------- ----------- ---------- ---------- Net income available to common shareholders $6,167,715 $7,311,762 $5,768,397 $5,196,276 =========== =========== ========== ========== Earnings per share of common stock: Basic $0.56 $0.66 $0.52 $0.46 Diluted $0.55 $0.65 $0.40 $0.45 -------------------------------------------------------------------------------------------------------------- 1996 Fourth Third Second First Summary Income Information Quarter Quarter Quarter Quarter -------------------------------------------------------------------------------------------------------------- Interest income $26,764,136 $23,062,016 $22,003,722 $19,815,562 Interest expense 12,230,332 10,591,010 9,885,847 8,918,120 Provision for loan and lease losses 1,199,000 1,126,000 1,227,000 1,001,000 Noninterest income 38,970,187 38,175,755 38,338,607 34,496,076 Noninterest expense 41,152,175 40,346,212 40,706,745 35,955,282 Income taxes 4,243,000 3,672,000 3,495,000 3,449,000 ----------- ----------- ---------- ---------- Net income $6,909,816 $5,502,549 $5,027,737 $4,988,236 =========== =========== ========== ========== Earnings per share of common stock: Basic $0.61 $0.48 $0.44 $0.44 Diluted $0.60 $0.48 $0.43 $0.33 ------------------------------------------------------------------------------------------------------------- 1995 Fourth Third Second First Summary Income Information Quarter Quarter Quarter Quarter -------------------------------------------------------------------------------------------------------------- Interest income $20,631,271 $17,990,434 $14,713,938 $12,552,550 Interest expense 9,919,789 8,020,339 5,926,174 4,701,985 Provision for loan and lease losses 1,016,000 962,000 571,000 649,000 Noninterest income 33,761,560 30,861,480 24,774,257 24,719,834 Noninterest expense 34,040,371 30,532,492 27,258,576 23,958,396 Income taxes 4,117,000 3,298,000 1,480,000 3,471,000 ----------- ----------- ---------- ---------- Net income $5,299,671 $6,039,083 $4,252,445 $4,492,003 =========== =========== ========== ========== Earnings per share of common stock: Basic $0.47 $0.53 $0.38 $0.40 Diluted $0.46 $0.53 $0.37 $0.40 --------------------------------------------------------------------------------------------------------------- 1997 Financial Statements Irwin Financial Corporation and Subsidiaries Management Report on Responsibility for Financial Reporting The management of Irwin Financial Corporation and its subsidiaries has the responsibility of preparing the accompanying financial statements and for their integrity and objectivity. The statements were prepared in conformity with generally accepted accounting principles and are not misstated due to material fraud or error. The financial statements include amounts that are based on management's best estimates and judgments. Management also prepared the other information in the annual report and is responsible for its accuracy and consistency with the financial statements. The Corporation's financial statements have been audited by Coopers & Lybrand L.L.P., independent certified public accountants elected by the shareholders. Management has made available to Coopers & Lybrand all the Corporation's financial records and related data, as well as the minutes of stockholders' and directors' meetings. Furthermore, management believes that all representations made to Coopers & Lybrand during its audit were valid and appropriate. Management of the Corporation has established and maintains a system of internal control that provides reasonable assurance as to the integrity and reliability of the financial statements, the protection of assets from unauthorized use or disposition, and the prevention and detection of fraudulent financial reporting. Assessments of the system of internal control are based on criteria for effective internal control over financial reporting described in ''Internal Control-Integrated Framework'' issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management continually monitors the system of internal control for compliance. The Corporation maintains a strong internal auditing program that independently assesses the effectiveness of the internal controls and recommends possible improvements thereto. In addition, as part of its audit of the Corporation's financial statements, Coopers & Lybrand completed an assessment of selected internal accounting controls to establish a basis for reliance thereon in determining the nature, timing, and extent of audit tests to be applied. Management has considered the internal auditor's and Coopers & Lybrand's recommendations concerning the Corporation's system of internal control and has taken actions to respond appropriately to these recommendations that we believe are cost effective in the circumstances. Management believes that the Corporation's system of internal control is adequate to accomplish the objectives discussed herein. Management also recognizes its responsibility for fostering a strong ethical climate so that the Corporation's affairs are conducted according to the highest standards of personal and corporate conduct. This responsibility is characterized and reflected in the Corporation's Guiding Philosopy, which is publicized throughout the Corporation. This responsibility is also reflected in the individual Codes of Conduct of each major operating subsidiary of the Corporation, which are publicized throughout each respective subsidiary. These Codes of Conduct address, among other things, the necessity of ensuring open communication within the Corporation; potential conflicts of interests; compliance with all domestic and foreign laws, including those related to financial disclosures; and a confidentiality of proprietary information. The Corporation maintains a systematic program to assess compliance with these policies. John A. Nash, President Thomas D. Washburn, Chief Financial Officer Report of Coopers & Lybrand L.L.P. Independent Accountants To the Shareholders and Board of Directors Irwin Financial Corporation Columbus, Indiana We have audited the accompanying consolidated balance sheet of Irwin Financial Corporation and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Irwin Financial Corporation and subsidiaries as of December 31, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. Indianapolis, Indiana January 21, 1998 Consolidated Statements of Income: For the year ended December 31, 1997 1996 1995 ---------------------------------------------------------------------------------------------------------- Interest income: Loans and leases $56,490,102 $52,202,866 $38,176,878 Investment securities: Taxable 7,310,668 6,876,348 4,501,359 Tax-exempt 275,351 332,866 447,353 Loans held for sale 34,690,675 30,943,144 20,726,833 Federal funds sold 674,459 1,290,212 2,035,770 ----------- ----------- ----------- Total interest income 99,441,255 91,645,436 65,888,193 ----------- ----------- ----------- Interest expense: Deposits 19,962,887 17,732,481 14,868,026 Short-term borrowings 23,788,247 22,115,307 11,978,591 Long-term debt 831,354 1,777,521 1,721,670 ----------- ----------- ----------- Total interest expense 44,582,488 41,625,309 28,568,287 ----------- ----------- ----------- Net interest income 54,858,767 50,020,127 37,319,906 Provision for loan and lease losses - Note 5 6,238,000 4,553,000 3,198,000 ----------- ----------- ----------- Net interest income after provision for possible loan and lease losses 48,620,767 45,467,127 34,121,906 ----------- ----------- ----------- Other income: Loan origination income 41,370,257 43,779,433 32,133,179 Gain on sale of loans 38,609,567 34,247,800 21,005,875 Loan servicing fees 53,257,304 46,876,741 36,155,560 Gain on sale of mortgage servicing 32,630,789 16,378,230 15,271,081 Brokerage fees and commissions 703,218 1,219,310 2,792,436 Trust fees 2,109,001 1,995,153 2,009,864 Service charges on deposit accounts 1,490,806 1,444,669 1,238,731 Insurance commissions, fees and premiums 1,615,311 1,544,053 1,304,625 Other 2,778,073 2,495,236 2,205,780 ----------- ----------- ----------- 174,564,326 149,980,625 114,117,131 ----------- ----------- ----------- Other expense: Salaries 86,532,643 79,016,893 61,082,725 Pension and other employee benefits 13,723,509 12,579,018 10,638,338 Office expense 10,582,520 10,387,037 7,859,511 Premises and equipment 16,621,449 13,902,901 12,307,288 Amortization of servicing assets 15,754,963 14,331,423 4,865,340 Marketing and development 7,697,141 7,364,604 6,845,335 Other 25,621,340 20,578,538 12,191,298 ----------- ----------- ----------- 176,533,565 158,160,414 115,789,835 ----------- ----------- ----------- Income before income taxes 46,651,528 37,287,338 32,449,202 Income taxes 17,734,000 14,859,000 12,366,000 28,917,528 22,428,338 20,083,202 ----------- ----------- ----------- Distribution on company-obligated mandatorily redeemable preferred securities of subsidiary trust - Note 15 4,473,378 - - ----------- ----------- ----------- Net income available to common shareholders $24,444,150 $22,428,338 $20,083,202 =========== =========== =========== Earnings per Basic - Note 17 $2.19 $1.97 $1.78 =========== =========== =========== share of common Diluted - Note 17 $2.15 $1.95 $1.76 =========== =========== =========== stock: Dividends per share of common stock $0.28 $0.24 $0.22 The accompanying notes are an integral part of the consolidated financial statements. Consolidated Balance Sheet: December 31, 1997 1996 --------------------------------------------------------------------------------------------------------- Assets: Cash and due from banks $56,523,723 $71,365,788 Interest-bearing deposits with financial institutions 18,240,229 11,343,546 Investment securities - Note 3 77,341,443 85,785,764 Mortgage loans held for sale - Note 9 528,738,820 446,897,525 Loans and leases, net of unearned income - Note 4 611,092,809 533,050,282 Less: Allowance for loan and lease losses - Note 5 (8,811,645) (6,874,944) -------------- ------------ 602,281,164 526,175,338 Servicing assets - Note 6 83,043,939 72,121,663 Accounts receivable 54,260,792 37,941,660 Accrued interest receivable 14,778,885 6,724,973 Premises and equipment - Note 7 21,040,206 18,687,620 Other assets 40,544,715 23,078,227 -------------- ------------ $1,496,793,916 $1,300,122,104 ============== ============ Liabilities and Shareholders' Equity: Deposits Noninterest-bearing $287,555,280 $371,911,039 Interest-bearing 346,012,401 201,737,661 Certificates of deposit over $100,000 86,027,844 66,504,205 -------------- ------------ 719,595,525 640,152,905 Short-term borrowings - Note 9 512,275,185 461,866,326 Long-term debt - Note 10 7,095,718 17,658,925 Other liabilities 81,917,591 61,541,868 -------------- ------------ Total liabilities 1,320,884,019 1,181,220,024 -------------- ------------ Company-obligated mandatorily redeemable preferred securities of subsidiary trust - Note 15 47,926,556 - Shareholders' equity Preferred stock, no par value - authorized 50,000 shares; none issued - - Common stock; no par value - authorized 40,000,000 shares; issued 11,701,040 shares in 1997 and 1996; including 700,640 and 332,268 shares in treasury in 1997 and 1996, respectively 29,965,287 29,965,287 Additional paid-in capital 779,976 - Net unrealized gain on investment securities net of deferred income taxes of $30,683 in 1997 and $20,463 in 1996. 54,895 56,523 Retained earnings 115,413,986 94,083,540 -------------- ------------ 146,214,144 124,105,350 Less treasury stock, at cost (18,230,803) (5,203,270) -------------- ------------ Total shareholders' equity 127,983,341 118,902,080 -------------- ------------ $1,496,793,916 $1,300,122,104 ============== ============== Net Unrealized Additional Gain (Loss) Common Paid-In on Investment Retained Treasury Stock Capital Securities Earnings Stock ----------------------------------------------------------------------------------------------------------- Balance at January 1, 1995 $29,965,287 $- $(279,063) $57,080,536 $5,662,814 Net income - - - 20,083,202 - Cash dividends - $.022 per share* - - - (2,482,705) - Unrealized losses on investment securities - - 269,406 - - Tax benefit on exercise of stock options 704,394 Purchase of 177,570 shares of treasury stock* - - - - 2,887,611 Sale of 247,826 shares of treasury stock* - (704,394) - (33,322) (3,163,565) ------------ ----------- ----------- ------------ ----------- Balance at December 31, 1995 29,965,287 - (9,657) 74,647,711 5,386,860 Net income - - - 22,428,338 - Cash dividends - $0.24 per share* - - - (2,725,921) - Unrealized gains on investment securities - - 66,180 - - Tax benefit on exercise of stock options 516,431 Purchase of 89,428 shares of treasury stock* - - - - 1,930,831 Sale of 128,368 shares of treasury stock* - (516,431) - (266,588) (2,114,421) ------------ ----------- ----------- ------------ ----------- Balance at December 31, 1996 29,965,287 - 56,523 94,083,540 5,203,270 Net income - - - 24,444,150 - Cash dividends - $0.28 per share - - - (3,113,704) - Unrealized loss on investment securites - - (1,628) - - Tax benefit on exercise of stock options - 575,702 - - - Purchase of 470,491 shares of treasury stock - - - - 14,411,445 Sale of 102,119 shares of treasury stock - 204,274 - - (1,383,912) ------------ ----------- ----------- ------------ ----------- Balance at December 31, 1997 $29,965,287 $779,976 $54,895 $115,413,986 $18,230,803 ============ =========== =========== ============ =========== *Adjusted for the two-for-one stock split on December 30,1996. The accompanying notes are an integral part of the consolidated financial statements. For the year ended December 31, 1997 1996 1995 ------------------------------------------------------------------------------------------------------------------- Net Income $24,444,150 $22,428,338 $20,083,202 Adjustment to Depreciation and amortization 20,265,379 20,367,079 9,605,234 reconcile net Provision for loan and lease losses 6,238,000 4,553,000 3,198,000 income to cash Amortization of premiums, less accretion used by operating of discounts 1,715,575 1,588,570 574,956 activities: Mortgage loan originations (5,397,338,225) (5,085,625,446) (3,559,310,152) Sale of mortgage loans 5,315,496,930 5,019,183,189 3,335,616,389 Gain on sale of mortgage servicing (32,630,789) (16,378,230) (15,271,081) Other, net (31,294,699) (22,240,852) (5,906,443) --------------- --------------- --------------- Net cash used by operating activities (93,103,679) (56,124,352) (211,409,895) Lending and Proceeds from maturities/calls of investing activities: investment securities: Held-to-maturity 6,541,560 5,045,000 53,491,466 Available-for-sale 7,534,330 29,740,946 9,507,979 Proceeds from sales of investment securities: Available-for-sale 26,309,090 2,028,462 3,008,031 Purchase of investment securities: Held-to-maturity (3,868,050) (14,286,470) (35,814,475) Available-for-sale (20,315,675) (36,371,550) (14,280,795) Net (increase) decrease in interest-bearing deposits with financial institutions (6,896,683) (3,405,806) 4,226,466 Net increase in loans, excluding sales (414,204,601) (258,412,078) (158,013,297) Sale of loans 331,860,775 139,409,589 51,583,722 Additions to mortgage servicing assets (63,175,866) (81,044,704) (49,486,423) Proceeds from sale of mortgage servicing assets 69,129,416 65,163,338 30,190,930 Other, net (5,930,547) (5,650,679) (5,270,777) --------------- --------------- --------------- Net cash used by lending and investing activities (73,016,251) (157,783,952) (110,857,173) Financing activities: Net increase in deposits 79,442,620 76,154,258 124,080,673 Net increase in short-term borrowings 50,408,859 151,604,066 216,297,587 Repayment of long-term debt (10,563,207) (12,771,802) (7,747,676) Proceeds from long-term debt - 8,839,536 5,293,058 Sale of company-obligated manditorily redeemable preferred securities of ` subsidiary trust 47,926,556 - - Purchase of treasury stock (14,411,445) (1,930,831) (2,887,611) Proceeds from sale of stock for employee benefit plans 1,588,186 1,847,833 3,130,243 Dividends paid (3,113,704) (2,725,921) (2,482,705) --------------- --------------- --------------- Net cash provided by financing activities 151,277,865 221,017,139 335,683,569 --------------- --------------- --------------- Net increase (decrease) in cash and cash equivalents (14,842,065) 7,108,835 13,416,501 Cash and cash equivalents at beginning of year 71,365,788 64,256,953 50,840,452 --------------- --------------- --------------- Cash and cash equivalents at end of year $56,523,723 $71,365,788 $64,256,953 =============== =============== =============== Supplemental disclosures of cash flow information: Cash paid during the year: Interest $45,554,266 $41,248,019 $27,551,606 =============== =============== =============== Income taxes $9,912,325 $26,230,350 $23,829,990 =============== =============== =============== The accompanying notes are an integral part of the consolidated financial statements. Notes to Consolidated Financial Statements Note 1: Summary of Significant Accounting Policies Consolidation: Irwin Financial Corporation and its subsidiaries (the Corporation) provide financial services throughout the United States. The Corporation is engaged in the mortgage banking, commercial banking, home equity lending, and equipment leasing lines of business. Intercompany balances and transactions have been eliminated in consolidation. Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires the Corporation to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Securities: Those securities which the Corporation has the positive intent and ability to hold until maturity are classified as ''held-to-maturity'' and are stated at cost adjusted for amortization of premium and accretion of discount. Securities that might be sold prior to maturity are classified as "available- for-sale'' and are stated at fair value. Unrealized gains and losses, net of the future tax impact, are reported as a separate component of shareholders' equity until realized. Securities that are bought and held for the purpose of selling them in the near term are classified as ''trading'' and are stated at fair value. Unrealized gains and losses are included in earnings. Investment gains and losses are based on the adjusted cost of the specific security. Mortgage Loans Held for Sale: Mortgage loans held for sale are carried at the lower of cost or market, determined on an aggregate basis. Loans: Loan origination fees and costs are deferred and the net amounts are amortized as adjustments of the loans' yields. When loans are sold, deferred fees and costs are included with outstanding principal balances and the resulting gain or loss is recognized in income. Interest income on loans is computed daily based on the principal amount of loans outstanding. The accrual of interest income is discontinued when a loan becomes 90 days past due as to principal or interest. Management may elect to continue the accrual of interest when the estimated net realizable value of collateral is sufficient to cover the principal balance and accrued interest. Direct Financing Leases: Interest and service charges, net of initial direct costs, are deferred and reported as income in decreasing amounts over the life of the lease, which averages three to four years, so as to provide an approximate constant yield on the outstanding principal balance. Allowance for Loan and Lease Losses: The allowance for loan and lease losses is maintained at a level considered adequate to provide for future loan and lease losses and is based on management's evaluation of expected losses in the portfolios, as well as prevailing and anticipated economic conditions. Loans are considered impaired if it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is generally based on the present value of expected future cash flows discounted at the historical effective interest rate, except that all collateral-dependent loans are measured for impairment based on the fair value of the collateral. Servicing Assets: On May 12, 1995, the Financial Accounting Standards Board issued SFAS No. 122, "Accounting for Mortgage Servicing Rights" (SFAS No. 122), an amendment to SFAS No. 65. The Corporation elected to adopt this standard for its financial statement reporting in the second quarter of 1995. SFAS No. 122 prohibits retroactive application. Accordingly, the Corporation's first quarter 1995 mortgage banking activities reported in the financial statements were accounted for under the original SFAS No. 65. The effect of the change in accounting standards to 1995 results was an increase to net income of approximately $11,800,000 for the last three quarters of 1995 over what would have been earned under SFAS 65. In 1997 the Corporation adopted Statement of Financial Accounting Standards No 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" (SFAS No. 125). This standard established the accounting treatment to be used for the securitization of all financial assets and superseded SFAS No. 122. The adoption of this standard did not have a material effect on the Corporation's financial position or results of operations in 1997. SFAS No. 125 requires that when a loan is sold and servicing is retained a portion of the cost of originating a loan be allocated to the servicing asset based on its fair value relative to the loan as a whole. To determine the fair value of the servicing assets created since the second quarter of 1995, the Corporation used the market prices under comparable servicing sale contracts, when available, or alternatively used a valuation model that calculates the present value of future cash flows to determine the fair value of the servicing assets. In using this valuation method, the Corporation incorporated assumptions that it is believed market participants would use in estimating future net servicing income which included estimates of the cost of servicing per loan, the discount rate, float value, an inflation rate, ancillary income per loan, prepayment speeds, and default rates. Servicing assets are amortized over the estimated lives of the related loans, which are grouped based on loan characteristics, in proportion to estimated net servicing income. In determining servicing value impairment at the end of the year, the servicing portfolio was disaggregated into its predominant risk characteristics. The Corporation has determined those risk characteristics to be interest rate, loan type and investor type. These segments of the portfolio were valued using market prices under comparable servicing sale contracts, when available, or alternatively, using the same model as was used to originally determine the fair value at origination, using current assumptions. The calculated value was then compared with the book value of each segment to determine the required reserve for impairment. It is reasonably possible that a change in the impairment reserve will occur in the near term. No reasonable estimate can be made of the range of amounts of loss or gain. Premises and Equipment: Premises and equipment are recorded at cost. Depreciation is determined by the straight-line method. Earnings Per Share: In 1997 the Corporation adopted Statement of Financial Accounting Standards No. 128, "Earnings Per Share" (SFAS No. 128). Under this standard, earnings per share are calculated as "basic" and "diluted" based on the weighted average number of common shares outstanding during the year. Previous years earnings per share calculations have been restated to reflect the adoption of SFAS No. 128. Income Taxes: A consolidated tax return is filed for all eligible entities. Deferred income taxes are provided for temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities. Rehabilitation tax credits and low-income housing tax credits are recorded as a reduction to the provision for federal income taxes in the year the eligible buildings are placed in service. Postretirement Benefits: The Corporation provides health insurance benefits to its retirees and accrues the costs as incurred. Cash and Cash Equivalents Defined: For purposes of the statement of cash flows, the Corporation considers cash and due from banks to be cash equivalents. Forward Commitments: The Corporation uses forward contracts to reduce its interest rate exposure associated with mortgage banking activities. Reclassifications: Certain amounts in the 1996 and 1995 consolidated financial statements have been reclassified to conform to the 1997 presentation. Note 2: Restrictions on Cash And Due From Banks Irwin Union Bank and Trust Company is required to maintain a reserve balance with the Federal Reserve Bank. The amount of the reserve balance at December 31, 1997 was approximately $5,271,000. Note 3: Investment Securities The amortized cost, fair value, and carrying value of investments held at December 31, 1997 are as follows: Gross Gross Amortized Unrealized Unrealized Fair Carrying December 31, 1997 Cost Gains Losses Value Value --------------------------------------------------------------------------------------------------------------- Held-to-Maturity: U.S. Treasury and Government obligations $35,732,672 $204,004 $- $35,936,676 $35,732,672 Obligations of states and political subdivisions 4,813,919 286,725 (5,650) 5,094,994 4,813,919 Mortgage-backed securities 5,968,340 202,150 - 6,170,490 5,968,340 ----------- --------- ------------ ------------ ------------ Total held-to-maturity 46,514,931 692,879 (5,650) 47,202,160 46,514,931 ----------- --------- ------------ ------------ ---------- Trading: Interest-only strips 23,961,793 - (1,828,000) 22,133,793 22,133,793 ----------- --------- ------------ ------------ ---------- Available-for-Sale: U.S. Treasury and Government obligations 6,010,129 42,823 - 6,052,952 6,052,952 Mortgage-backed securities 2,605,882 12,748 (826) 2,617,804 2,617,804 Other - 21,963 - 21,963 21,963 ----------- --------- ------------ ------------ ------------ Total available-for-sale 8,616,011 77,534 (826) 8,692,719 8,692,719 ----------- --------- ------------ ------------ ----------- Total investments $79,092,735 $770,413 $(1,834,476) $78,028,672 $77,341,443 ============ ========= ============ ============ ============ The amortized cost, fair value, and carrying value of investments held at December 31, 1996 are as follows: Gross Gross Amortized Unrealized Unrealized Fair Carrying December 31, 1996 Cost Gains Losses Value Value ------------------------------------------------------------------------------------------------------------- Held-to-Maturity: U.S. Treasury and Government obligations $38,317,039 $249,615 $(47,039) $38,519,615 $38,317,039 Obligations of states and political subdivisions 4,466,043 299,937 (1,106) 4,764,874 4,466,043 Mortgage-backed securities 7,153,865 193,341 - 7,347,206 7,153,865 ----------- --------- ------------ ------------ ---------- Total held-to-maturity 49,936,947 742,893 (48,145) 50,631,695 49,936,947 ----------- --------- ------------ ------------ ----------- Trading: Interest-only strips 12,661,284 - - 12,661,284 12,661,284 ----------- --------- ------------ ------------ ---------- Available-for-Sale: U.S. Treasury and Government obligations 19,886,179 64,280 (26,412) 19,924,047 19,924,047 Mortgage-backed securities 3,224,342 15,418 (2,127) 3,237,533 3,237,533 Other 25 25,828 - 25,853 25,853 ----------- --------- ------------ ------------ ----------- Total available-for-sale 23,110,546 105,526 (28,539) 23,187,533 23,187,533 ----------- --------- ------------ ------------ ----------- Total investments $85,708,777 $848,419 $(76,684) $86,480,512 $85,785,764 ============ ========= ============ ============ ============ The amortized cost and fair value of debt securities at December 31, 1997, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Amortized Fair Cost Value ------------------------------------------------------------------------- Held-to-Maturity: Due in one year or less $9,908,721 $9,929,714 Due after one year through five years 12,673,252 12,875,206 Due after five years through ten years 2,943,468 3,052,247 Due after ten years 1,805,000 1,958,353 ------------ ------------ 27,330,441 27,815,520 Mortgage-backed securities 5,968,340 6,170,490 Federal Reserve Bank stock 1,030,550 1,030,550 Federal Home Loan Bank stock 12,185,600 12,185,600 ------------ ------------ 46,514,931 47,202,160 Trading: Interest-only strips 23,961,793 22,133,793 ------------ ------------ Available-for-Sale: Due in one year or less 51,921 73,884 Due after one year through five years 3,031,872 3,053,532 Due after five years through ten years 2,926,336 2,947,499 ------------ ------------ 6,010,129 6,074,915 Mortgage-backed securities 2,605,882 2,617,804 ------------ ------------ 8,616,011 8,692,719 ------------ ------------ Total investments $79,092,735 $78,028,672 ============ ============ Investment securities amounting to $14,381,699 were pledged as collateral for borrowings and for other purposes on December 31, 1997. During 1997, 1996, and 1995, sales of "available for sale" investments with proceeds of $26,253,000, $2,028,462, and $3,008,031 resulted in a gross gain of $56,090 and gross losses of $8,899 and $15,786, respectively. Additionally in 1997, 1996, and 1995, "held-to-maturity" investments totaling $7,020,000, $1,499,000 and $4,446,100, respectively, were called at their par value. As permitted by the November 1995 FASB Special Report on the accounting for investments, the Corporation transferred $8,850,000 of investment securities from the ''held-to-maturity'' category to the ''available-for-sale''category in 1995. These investments had a market value of $8,862,955 at the time of transfer. Note 4: Loans and Leases Loans and leases are summarized as follows: December 31, 1997 1996 ------------------------------------------------------------------------ Commercial, financial, and agricultural $212,094,742 $179,650,053 Real estate-construction 73,279,176 48,990,519 Real estate-mortgage 222,817,979 214,696,617 Consumer 39,984,692 38,371,100 Direct financing leases 78,079,206 62,371,808 Unearned income (15,162,986) (11,029,815) ------------ ------------ Total $611,092,809 $533,050,282 ============ ============ Commercial loans are extended primarily to local regional businesses and to local farming operations in the market area of Irwin Union Bank. The Corporation also provides consumer loans to the customers in that market. Real estate loans and direct financing leases are extended throughout the United States. The Bank, in the normal course of business, makes loans to directors, officers, and organizations and individuals with which they are associated. These transactions are consistent with sound banking practices and are within applicable bank regulatory guidelines and limitations. Such loans amounted to approximately $1,862,000 and $4,277,000 at December 31, 1997 and 1996, respectively. During 1997, $17,244,000 of new loans were made and repayments totaled $19,448,000. The Corporation leases small-ticket medical and other equipment under direct financing leases generally with terms from one to five years. At December 31, 1997, information pertaining to the Corporation's investment in direct financing leases is as follows: Future minimum lease payments receivable $70,975,564 Estimated unguaranteed residual value of leased assets 7,103,642 ------------ Investment in direct financing leases 78,079,206 Unearned income (15,162,986) ------------ Net investment in direct financing leases $62,916,220 ============ Future minimum lease payments receivable during the next five years are as follows: 1998 $26,615,003 1999 20,588,909 2000 14,464,985 2001 7,623,507 2002 1,683,160 ------------ Total $70,975,564 ============ Note 5: Allowance for Loan and Lease Losses: Changes in the allowance for loan and lease losses are summarized below: December 31, 1997 1996 1995 ------------------------------------------------------------------------------------- Balance at beginning of year $6,874,944 $5,033,181 $4,174,323 Provision for loan and lease losses 6,238,000 4,553,000 3,198,000 Reduction due to sale of loans (1,694,316) (931,101) (238,919) Recoveries 538,213 593,421 389,674 Charge-offs (3,145,196) (2,373,557) (2,489,897) ------------ ------------ ------------ Balance at end of year $8,811,645 $6,874,944 $5,033,181 ============ ============ ============ At December 31, 1997, 1996 and 1995, the recorded investment in loans for which impairment has been recognized in accordance with SFAS No. 114 and SFAS No. 118 totaled $2,714,098, $4,334,968, and $6,543,932, respectively. These loans had a corresponding valuation allowance of $726,614, $1,167,184, and $742,901 determined based on the fair value of the loans' collateral. The Corporation recognized $155,414, $356,917, and $260,886 of interest income on these loans in 1997, 1996 and 1995, respectively. Note 6: Servicing Assets Included on the consolidated balance sheet at December 31, 1997 and 1996 are $83,043,939 and $72,121,663, respectively, of servicing assets. These amounts relate to the principal balances of loans serviced by the Corporation for investors. Although they are not generally held for purposes of sale, there is an active secondary market for servicing assets. The Corporation has established a valuation allowance to record servicing assets at their fair market value. Changes in the allowance are summarized below: December 31, 1997 1996 1995 ------------------------------------------------------------------------------------- Balance at beginning of year $- $908,778 $- Valuation changes during the period 600,000 (254,427) 908,778 Reductions due to sales of servicing assets - (654,351) - ------------ ------------ ------------ Balance at end of year $600,000 $- $908,778 ============ ============ ============ Note 7: Premises and Equipment Premises and equipment are summarized as follows: December 31, 1997 1997 Useful lives ------------------------------------------------------------------------------------- Land $1,651,149 $1,221,918 n/a Building and leasehold improvements 13,375,410 10,824,250 7-40 years Furniture and equipment 27,367,664 24,524,817 3-10 years ------------ ------------ ------------ 42,394,223 36,570,985 Less accumulated depreciation (21,354,017) (17,883,365) ------------ ------------ Total $21,040,206 $18,687,620 ============ ============ Note 8: Lease Obligations At December 31, 1997, the Corporation and its subsidiaries leased certain branch locations and office equipment used in its operations. Operating lease rental expense was $11,214,770 in 1997, $8,699,930 in 1996, and $7,754,388 in 1995. The future minimum rental payments required under noncancellable operating leases with initial or remaining terms of one year or more are summarized as follows: Year ended December 31: 1998 $6,044,815 1999 4,615,412 2000 3,624,629 2001 2,897,314 2002 1,819,979 Thereafter 322,705 ------------ Total minimum rental payments $19,324,854 ============ Note 9: Short-Term Borrowings Short-term borrowings are summarized as follows: December 31, 1997 1996 ------------------------------------------------------------------------------------- Repurchase agreements and drafts payable related to mortgage loan closings $240,659,463 $264,998,449 Commercial paper 16,375,238 17,174,751 Federal funds 142,650,000 74,118,000 Lines of credit 112,590,484 105,575,126 ------------ ------------ Total $512,275,185 $461,866,326 ============ ============ Weighted average interest rate 4.84% 5.34% Repurchase agreements at December 31, 1997 and 1996 include $141,919,483 and $183,869,533 in mortgages sold under agreements to repurchase, which are used to fund mortgages prior to sale in the secondary market. These repurchase agreements are collateralized by mortgage loans held for sale. Drafts payable related to mortgage loan closings totaled $93,615,694 and $74,042,188 at December 31, 1997 and 1996, respectively. These borrowings are related to mortgage closings at the end of December which have not been presented to the banks for payment. When presented for payment, these borrowings will be funded internally or by borrowing from available lines of credit. Commercial paper includes $10,755,019 and $14,963,694 at December 31, 1997 and 1996, respectively, payable to a company owned by a significant shareholder and director of the Corporation. The Corporation also has lines of credit available of $254,000,000 to fund loan originations and other operations. Interest on the lines of credit is payable monthly or quarterly with rates ranging from 6.35% to 7.65%. Note 10: Long-Term Debt Long-term debt at December 31, 1997 of $7,095,718 consists of various notes payable at annual interest rates ranging from 6.3% to 9.6% and maturity dates through April 30, 2002. Long-term debt as of December 31, 1996 of $17,658,925 consisted of various notes payable at annual interest rates ranging from 6.3% to 9.6% and maturity dates through April 3o, 2002. Maturities of long-term debt at December 31, 1997 are as follows: 1998 $3,952,103 1999 2,029,467 2000 938,522 2001 175,229 2002 397 ----------- Total $7,095,718 =========== Note 11 : Contingencies In the normal course of business, Irwin Financial Corporation and its subsidiaries are subject to various claims and other pending and possible legal actions. As of December 31, 1997, Irwin Mortgage Corporation (IMC) was a defendant to three separate class action lawsuits relating to the following: IMC's administration of mortgage escrow accounts, IMC's right to require its borrowers to pay premiums for private mortgage insurance, and IMC's right to pay broker fees to mortgage brokers. At present, it is not possible for the Corporation to predict the likelihood of an unfavorable outcome or to establish the possible extent or amount of liability or potential loss exposure with respect to the litigation. Note 12: Financial Instruments with Off-Balance Risk The Corporation is party to certain financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of its customers and to Sheet reduce its own exposure to fluctuations in interest rates. These financial instruments include loan commitments, standby letters of credit, and forward commitments relating to mortgage banking activities. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheet. The Corporation's exposure to credit loss, in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit, is represented by the contractual amount of those instruments. The collateral pledged for standby letters of credit and commitments varies but may include accounts receivable, inventory, property, plant, and equipment, and residential real estate. Total outstanding commitments to extend credit at December 31, 1997, were $267,830,000. These loan commitments include $114,235,000 of floating rate loan commitments and $153,595,000 of fixed rate loan commitments related to commercial and mortgage banking activities. The Corporation had approximately $15,125,000 and $14,710,000 in irrevocable standby letters of credit outstanding at December 31, 1997 and 1996, respectively. Forward commitments are used in mortgage banking activities to hedge the interest rate risk associated with mortgage loan commitments and loans held for sale. The contract amount for forward contracts does not represent exposure to credit loss. Forward commitments related to mortgage banking activities were $407,907,000 and $364,876,000 at December 31, 1997 and 1996, respectively. Note 13: Regulatory Matters The Corporation and its bank subsidiary, Irwin Union Bank, are subject to various regulatory capital requirements administered by federal banking agencies. Quantitative measures established by regulation to ensure capital adequacy require the Corporation to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital to average assets (as defined). Management believes, as of December 31, 1997, that the Corporation meets all capital adequacy requirements to which it is subject. As of December 31, 1997 the Corporation was categorized as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Corporation must significantly exceed minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios. There have been no conditions or events that management believes have changed this category. The Corporation's actual capital amounts and ratios are presented in the following table: Adequately Well Actual Capitalized Capitalized --------------------------------------------------------------------------------------------------------- Amount Ratio Amount Ratio Amount Ratio --------------------------------------------------------------------------------------------------------- As of December 31, 1997: Total Capital (to Risk- Weighted Assets) $185,536 17.5% $84,163 8.0% $105,204 10.0% Tier 1 Capital (to Risk- Weighted Assets) 169,366 16.0 42,082 4.0 63,123 6.0 Tier 1 Capital (to Average Assets) 169,366 12.1 56,192 4.0 70,240 5.0 As of December 31, 1996: Total Capital (to Risk- Weighted Assets) $124,010 14.3% $69,716 8.0% $87,146 10.0% Tier 1 Capital (to Risk- Weighted Assets) 117,416 13.5 34,858 4.0 52,288 6.0 Tier 1 Capital (to Average Assets) 117,416 9.8 47,730 4.0 59,663 5.0 As of December 31, 1995: Total Capital (to Risk- Weighted Assets) $97,174 14.5% $53,654 8.0% $67,068 10.0% Tier 1 Capital (to Risk- Weighted Assets) 92,554 13.8 26,827 4.0 40,241 6.0 Tier 1 Capital (to Average Assets) 92,554 10.6 35,025 4.0 43,781 5.0 At December 31, 1997 and 1996 Irwin Union Bank's ratio of total capital to risk-weighted assets was 10.3% and 11.0%, respectively. The ratio of Tier 1 capital to risk-weighted assets was 9.4% and 10.0%, and the ratio of Tier 1 capital to average assets was 6.7% and 6.9% at December 31, 1997 and 1996, respectively. Note 14: Fair Value of Financial Instruments Fair value estimates, methods and assumptions are set forth below for the Corporation's financial instruments: Cash and cash equivalents: The carrying amounts reported in the balance sheet for cash and cash equivalents approximate those assets' fair values. Interest-bearing deposits with financial institutions: Fair values were estimated by discounting future cash flows using the current rates offered on similar deposits. Investment securities: Fair values for investment securities were based on quoted market prices when available. For securities which had no quoted market prices, fair values were estimated by discounting future cash flows using current rates on similar securities. Mortgage loans held for sale: The current market price of similar loans sold was used to estimate the fair value of mortgage loans held for sale. Loans: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values were based on carrying values. The fair values of commercial, consumer, real estate-mortgage, and real estate- construction loans were estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality and for the same remaining maturities. Deposit liabilities: The fair value of demand deposits, including interest and non-interest checking, passbook savings, and certain types of money market accounts, are assumed to be equal to the amount payable on demand at the reporting date. The carrying amounts for variable-rate money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates with similar remaining maturities. Short-term borrowings: For variable-rate short-term borrowings that reprice frequently, fair values were based on carrying values. Fair values for fixed- rate short-term borrowings were estimated using a discounted cash flow calculation that applies interest rates currently being offered on borrowings with similar remaining terms. Long-term debt: The fair values of variable-rate long-term debt, which reprices frequently, were based on carrying values. For fixed-rate long-term debt, fair values were estimated using discounted cash flow analyses, based on current incremental borrowing rates for similar types of borrowing arrangements. Company-obligated mandatorily redeemable preferred securities of subsidiary trust: Fair values were estimated by discounting future cash flows using the current rate offered on similar securities. Commitments to extend credit and standby letters of credit: The carrying values of these financial instruments are based on fees charged to enter into the agreements and approximate their fair values. The carrying values are insignificant to the Corporation's balance sheet and have been included in the carrying values of loans. The estimated fair values of the Corporation's financial instruments at December 31 are as follows: 1997 1996 Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value ----------------------------------------------------------------------------------------------- Financial assets: Cash and cash equivalents $56,523,723 $56,524,000 $71,365,788 $71,366,000 Interest-bearing deposits with financial institutions 18,240,229 18,240,000 11,343,546 11,344,000 Investment securities 77,341,443 78,029,000 85,785,764 86,481,000 Mortgage loans held for sale 528,738,820 530,207,000 446,897,525 446,898,000 Loans, net of allowance for loan losses 539,930,807 540,785,000 472,058,689 470,208,000 Financial liabilities: Deposits 719,595,525 719,669,000 640,152,905 640,505,000 Short-term borrowings 512,275,185 512,275,000 461,866,326 461,935,000 Long-term debt 7,095,718 7,138,000 17,658,925 17,711,000 Company-obligated mandatorily redeemable preferred securities of subsidiary trust $50,000,000 $55,038,000 $- $- The fair value estimates consider relevant market information when available. Because no market exists for a significant portion of the Corporation's financial instruments, fair value estimates are determined judgmentally and consider various factors, including current economic conditions and risk characteristics of certain financial instruments. Changes in factors, or the weight assumed for the various factors, could significantly affect the estimated values. The fair value estimates are presented for existing on- and off-balance sheet financial instruments without attempting to estimate the value of the Corporation's long-term relationships with depositors and the benefit that results from the low cost funding provided by deposit liabilities. In addition, significant assets which were not considered financial instruments and were therefore not a part of the fair value estimates include lease receivables, servicing assets, and premises and equipment. Note 15: Company-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust In January 1997, the Corporation issued $50,000,000 of trust preferred securities through IFC Capital Trust I, a trust created and controlled by the Corporation. The securitie were issued at $25 per share with a cumulative dividend rate of 9.25%, payable quarterly. They have an initial maturity of 30 years with a 19-year extension option. The securities are callable at par after five years, or immediately, in the event of an adverse tax development affecting the Corporation's classification of the securities for federal income tax purposes. They are not convertible into common stock of the Corporation. The securities are shown on the balance sheet net of capitalized issuance costs. The sole assets of IFC Capital Trust I are subordinated debentures of the Corporation with a principal balance of $51,546,400, an interest rate of 9.25% and an initial maturity of 30 years with a 19-year extension option. Note 16: Shareholders' Equity The shareholders of the Corporation approved an increase in common shares authorized from 7,500,000 to 40,000,000 as of April 30, 1996. The Corporation has a stock plan to compensate directors of the Corporation with the Corporation's common stock, if so elected, in lieu of cash for their annual retainer fee and meeting fees. The number of shares issued under the plan is based on the current market value of the Corporation's common stock. The Corporation also has an employee stock purchase plan for all qualified employees. The plan provides for employees to purchase common stock through payroll deduction at approximately 85% of the current market value. The Corporation has three stock option plans (established in 1997, 1992, and 1986) which provide for the issuance of 2,140,000 shares of non-qualified and incentive stock options. The exercise price of each option, which has a ten year life and a vesting period of four years beginning the year granted, is equal to the market price of the Corporation's stock on the grant date. The 1986 plan also provides for stock appreciation rights (SARs) that may be granted with respect to options issued. The holder of an SAR has the right to surrender the related option at any time the option could be exercised (subject to limitations described in the plan) and to receive its value at that date in cash or common stock. Vested outstanding stock options have been considered as common stock equivalents in the computation of diluted earnings per share. Activity in the above plans for 1997, 1996 and 1995 is summarized as follows adjusted for the 1996 two-for-one stock split: 1997 1996 1995 ---------------------------------------------------------------------------------------------- Weighted Weighted Weighted average average average Number exercise Number exercise Number exercise of shares price of shares price of shares price ------------------------------------------------------------------------------------------------ Outstanding at the beginning of the year 623,300 $9.19 618,800 $9.19 650,804 $6.51 Granted 89,110 27.38 104,700 21.31 120,700 15.69 Exercised (93,700) 5.77 (87,948) 5.01 (151,754) 2.85 Cancelled (3,100) 19.23 (12,252) 17.85 (950) 11.21 --------- --------- -------- Outstanding at the end of year 615,610 14.79 623,300 11.65 618,800 9.19 ========= ========= ======== Exercisable at the end of year 474,253 $12.31 461,300 $9.63 429,426 $7.34 ========= ========= ======== Available for future grants 847,294 236,404 341,104 ========= ========= ======== The Corporation has not recognized compensation cost for the three non- qualified and incentive stock option plans or the employee stock purchase plan. Had compensation cost been determined based on the fair value at the grant dates the Corporation's net income and earnings per share would have been reduced to the pro forma amounts indicated below: 1997 1996 1995 ----------------------------------------------------------------------------------- Net income As reported $24,444,150 $22,428,338 $20,083,202 Pro forma 23,912,522 22,071,004 19,885,813 Basic earnings per share As reported $2.19 $1.97 $1.78 Pro forma 2.14 1.94 1.77 Diluted earnings per share As reported $2.15 $1.95 $1.76 Pro forma 2.11 1.93 1.75 ----------------------------------------------------------------------------------- The fair value of each option was estimated to be $12.69, $9.13 and $7.41 on the date of the grant using the binomial option-pricing model with the following assumptions for 1997, 1996 and 1995, respectively: risk free interest rates of 6.89%, 6.75% and 7.25%; dividend yield of 1.00% for 1997 and 1.25% for both previous years; and volatility of 0.250, 0.228, and 0.275. As of December 31, 1997, 613,610 options were outstanding under these plans with exercise prices that range between $2.52 and $27.38 and a remaining weighted average contractual life of 7.3 years. Note 17 : Earnings Per Share Earnings per share calculations are summarized as follows: Basic Earnings Effects of Diluted Earnings Per Share Stock Options Per Share ---------------------------------------------------------------------------------- 1997: Net income $24,444,150 $- $24,444,150 Shares 11,163,155 197,932 11,361,087 ----------- ---------- ------------ Per-Share Amount $2.19 $(0.04) $2.15 =========== ========== ============ 1996: Net income $22,428,337 $- $22,428,337 Shares 11,358,121 156,871 11,514,992 ----------- ---------- ------------ Per-Share Amount $1.97 $(0.02) $1.95 =========== ========== ============ 1995: Net income $20,083,202 $- $20,083,202 Shares 11,279,870 149,949 11,429,819 ----------- ---------- ------------ Per-Share Amount $1.78 $(0.02) $1.76 =========== ========== ============ The Board of Directors of the Corporation approved a two-for-one stock split effective December 30, 1996. Previously reported per share data have been adjusted to reflect this split. Note 18 : Income Taxes Income tax expense is summarized as follows: 1997 1996 1995 ---------------------------------------------------------------------------------- Current: Federal $8,086,000 $4,980,000 $(773,000) State 2,268,000 1,574,000 286,000 ----------- ----------- ----------- 10,354,000 6,554,000 (487,000) ----------- ----------- ----------- Deferred: Federal 6,162,000 6,750,000 10,645,000 State 1,218,000 1,555,000 2,208,000 ----------- ----------- ----------- 7,380,000 8,305,000 12,853,000 ----------- ----------- ----------- Income tax expense: Federal 14,248,000 11,730,000 9,872,000 State 3,486,000 3,129,000 2,494,000 ----------- ----------- ----------- $17,734,000 $14,859,000 $12,366,000 =========== =========== ============ The Corporation's net deferred tax liability, which is included in other liabilities on the consolidated balance sheet, consisted of the following: December 31, 1997 1996 --------------------------------------------------------------------------------- Mortgage servicing $(31,025,090) $(25,965,001) Deferred compensation 2,625,791 2,763,430 Loan and lease loss allowance 6,312,690 4,047,304 Deferred origination fees and costs (1,454,131) 709,498 Lease financing income (5,653,674) (4,639,948) Fixed assets (1,084,652) (1,017,670) Other, net (1,532,867) (135,813) -------------- ------------- Net deferred tax liability $(31,811,933) $(24,238,200) ============== ============= A reconciliation of income tax expense to the amount computed by applying the statutory income tax rate to income before income taxes is summarized as follows: 1997 1996 1995 ----------------------------------------------------------------------------------------------- Income taxes computed at the statutory rate $14,762,353 $12,864,133 $11,032,729 Increase (decrease) resulting from: Nontaxable interest from investment securities and loans (198,677) (230,942) (308,157) State franchise tax, net of federal benefit 2,330,343 2,075,973 1,820,400 Change in deferred tax asset or liability resulting from tax rate change 291,655 (191,335) (131,180) Other items - net 548,326 (41,499) (310,152) ------------ ----------- ----------- $17,734,000 $14,859,000 $12,366,000 ============ =========== =========== Note 19: Employee Retirement Plans The Corporation has a defined benefit plan covering eligible employees of adopting subsidiaries. The benefits are based on years of service and the employees' compensation during their employment. The Corporation's funding policy is consistent with the funding requirements of federal laws and regulations. Contributions are intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future. Plan assets are primarily invested in corporate and U.S. bonds, mutual funds, and cash equivalents. The mutual funds are invested primarily in common stocks and bonds. The following table sets forth the plan's funded status and amounts recognized in the Corporation's consolidated balance sheet: December 31, 1997 1996 ----------------------------------------------------------------------------------------------- Actuarial present value of benefits based on service to date and present pay levels: Accumulated benefit obligation Vested $7,153,298 $6,090,545 Non-vested 277,468 251,938 ----------- ----------- 7,430,766 6,342,483 Additional amounts related to projected pay increases 1,614,808 1,405,887 ----------- ----------- Projected benefit obligation 9,045,574 7,748,370 Plan assets at fair value 9,113,575 8,160,620 ----------- ----------- Excess of assets over projected benefit obligation 68,001 412,250 Prior service cost not yet recognized in net periodic pension cost 155,407 175,224 Unrecognized net loss from past experience different from that assumed 454,659 191,707 Unrecognized net transition asset -- (83,298) ----------- ----------- Prepaid pension costs included in other assets $678,067 $695,883 =========== =========== The net pension cost for 1997, 1996, and 1995 included the following components: 1997 1996 1995 ----------------------------------------------------------------------------------------------- Service cost -- benefits earned during the period $474,547 $443,865 $344,825 Interest cost on projected benefit obligation 566,059 519,358 483,011 Actual (return) loss on plan assets (833,227) (926,681) (916,317) Net amortization and deferral 25,360 205,364 249,940 ---------- ---------- ---------- Net pension cost $232,739 $241,906 $161,459 ========== ========== ========== The weighted average discount rate used in determining the actuarial present value of the projected benefit obligation was 7.0% and 7.5% at December 31, 1997 and 1996, respectively. The expected rate of increase in future compensation levels was 4.00% and 4.25% at December 31, 1997 and 1996, respectively. The expected long-term rate of return on plan assets was 9.0% at December 31, 1997 and 1996. In addition to the defined benefit plan, the Corporation also provides certain health care and life insurance benefits to eligible retirees and their dependents. The plan is contributory, with retirees' contributions determined based on their years of service with the Corporation. The following sets forth the plan's funded status reconciled with amounts reported in the Corporation's consolidated balance sheet at December 31, 1997 and 1996. 1997 1996 ----------------------------------------------------------------------------------------------- Accumulated postretirement benefit obligation (APBO): Retirees $1,046,950 $1,099,334 Fully eligible active plan participants 143,230 112,913 Other active plan participants 198,733 172,610 ----------- ----------- Total APBO 1,388,913 1,384,857 Plan assets at fair value - - ----------- ----------- Accumulated postretirement benefit obligation in excess of plan assets 1,388,913 1,384,857 Less: Unrecognized transition obligation 947,269 1,002,018 Unrecognized net gain (82,687) (53,847) ----------- ----------- Accrued postretirement benefit liability $524,331 $436,686 =========== =========== Net periodic postretirement benefit cost for 1997 and 1996 included the following components: Service cost $21,506 $24,217 Interest cost 100,521 96,323 Amortization of transition obligation 54,749 54,749 ----------- ----------- Net periodic postretirement benefit cost $176,776 $175,289 =========== =========== For 1997, an 11.0% and 9.5% annual rate of increase in the per capita costs of covered health care benefits was assumed for participants under 65 and over 65, respectively. It was assumed that those rates would gradually decrease to 5.0% by the year 2011. Increasing the assumed health care cost trend rate by one percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1997 by $65,453 and increase the aggregate of the service cost and interest cost components of net periodic postretirement benefit cost for 1997 by $6,129. The rate of increase in future compensation levels used in determining the accumulated postretirement benefit obligation was 5.0% at December 31, 1997 and 1996. The weighted average discount rate was 7.0% and 7.5% at December 31, 1997 and 1996, respectively. Note 20: Irwin Financial Corporation (Parent Only) Financial Information The condensed financial statements of the parent company as of December 31, 1997 and 1996, and for the three years ended December 31, 1997 are presented below: Condensed Balance Sheet ----------------------------------------------------------------------------------------------- December 31, 1997 1996 ----------------------------------------------------------------------- Assets: Cash and short-term investments $743,738 $618,516 Investment in bank subsidiary 65,673,404 56,672,845 Investments in non-bank subsidiaries 69,901,441 60,866,068 Loans to non-bank subsidiaries 97,687,873 46,117,124 Other assets 2,614,878 2,167,152 ------------- ------------- $236,621,334 $166,441,705 ============= ============= Liabilities: Short-term borrowings $103,721,638 $41,174,751 Other liabilities 4,916,355 6,364,874 ------------- ------------- 108,637,993 47,539,625 Shareholders' equity: Common stock 29,965,287 29,965,287 Other shareholders' equity 98,018,054 88,936,793 ------------- ------------- 127,983,341 118,902,080 ------------- ------------- $236,621,334 $166,441,705 ============= ============= Condensed Statement of Income -------------------------------------------------------------------------------------------------------------- For the year ended December 31, 1997 1996 1995 --------------------------------------------------------------------------------------- Income: Cash dividends from non-bank subsidiaries $10,062,287 $10,053,000 $14,431,000 Cash dividends from bank subsidiary 4,750,000 2,000,000 1,200,000 Interest income 5,665,636 2,376,154 1,806,896 Other 2,218,885 2,507,041 2,000,573 ------------ ------------ ------------ 22,696,808 16,936,195 19,438,469 ------------ ------------ ------------ Expenses: Interest expense 7,210,379 2,064,651 1,491,873 Salaries 3,101,539 2,549,195 2,163,509 Deferred compensation and employee benefits 907,158 879,616 875,533 Other 1,798,234 1,963,287 1,028,813 ------------ ------------ ------------ 13,017,310 7,456,749 5,559,728 ------------ ------------ ------------ Income before income taxes and equity in undistributed income of subsidiaries 9,679,498 9,479,446 13,878,741 Income taxes (credits), less amounts charged to subsidiaries (2,590,000) (2,665,745) (2,844,056) ------------ ------------ ------------ 12,269,498 12,145,191 16,722,797 Equity in undistributed income of subsidiaries 12,174,652 10,283,147 3,360,405 ------------ ------------ ------------ Net income $24,444,150 $22,428,338 $20,083,202 ============ ============ ============ --------------------------------------------------------------------------------------------------------------------------- Condensed Statement of Cash Flows ---------------------------------------------------------------------------------------------------------------------------- For the year ended December 31, 1997 1996 1995 ----------------------------------------------------------------------------------------------- Net income $24,444,150 $22,428,338 $20,083,202 Adjustments to reconcile Equity in undistributed income of subsidiaries (12,174,652) (10,283,147) (3,360,405) net income to cash provided Depreciation and amortization 159,704 88,571 80,077 Increase (decrease) in taxes payable 1,046,126 314,595 (1,159,924) Increase in interest receivable (314,011) (39,301) (75,606) Increase in interest payable 146,526 164,279 41,276 Net change in other assets and other liabilities (2,321,136) 1,393,636 (27,117) ------------- ------------- ------------- Net cash provided by operating activities 10,986,707 14,066,971 15,581,503 ------------- ------------- ------------- Lending and investing Net increase in loans to subsidiaries (51,570,749) (8,603,320) (19,640,805) activities: Net increase in investments in subsidiaries (5,858,624) (11,500,000) (7,260,000) Net (additions) disposals to premises and equipment (42,036) (21,548) 192,206 ------------- ------------- ------------- Net cash used by lending and investing activities (57,471,409) (20,124,868) (26,708,599) ------------- ------------- ------------- Financing activities: Net increase in borrowings 62,546,887 9,731,816 13,434,195 Payments to acquire treasury stock (14,411,445) (1,930,831) (2,887,611) Proceeds from sale of treasury stock 1,588,186 1,331,402 3,130,243 Dividends paid (3,113,704) (2,725,921) (2,482,705) ------------- ------------- ------------- Net cash provided by financing activities 46,609,924 6,406,466 11,194,122 ------------- ------------- ------------- Net increase in cash and cash equivalents equivalents 125,222 348,569 67,026 Cash and cash equivalents at beginning of year 618,516 269,947 202,921 ------------- ------------- ------------- Cash and cash equivalents at end of year $743,738 $618,516 $269,947 ============= ============= ============= Supplemental disclosures Cash paid during the year: of cash flow information: Interest $7,063,853 $1,900,372 $1,450,597 ============= ============= ============= Income taxes $9,912,325 $6,230,350 $3,829,990 ============= ============= ============= Irwin Financial Corporation Directors Sally Abrams Dean Consultant, Retired Senior Vice President, Dillon, Read & Co. Inc. David W. Goodrich Executive Vice President, F. C. Tucker Company, Inc. John T. Hackett Managing General Partner, CID Equity Partners, L.P. William H. Kling President, Minnesota Public Radio Brenda J. Lauderback President, Footwear Wholesale Group, Nine West Group John C. McGinty, Jr. President, Peregrine Associates, Inc. Irwin Miller Former Chairman, Cummins Engine Company, Inc. William I. Miller Chairman, Irwin Financial Corporation John A. Nash President, Irwin Financial Corporation Lance R. Odden President and Headmaster, The Taft School Theodore M. Solso President and Chief Operating Officer, Cummins Engine Company, Inc. Irwin Financial Corporation Senior Officers William I. Miller Chairman John A. Nash President Thomas D. Washburn Senior Vice President and Chief Financial Officer Gregory F. Ehlinger Vice President and Treasurer Jose M. Gonzalez Vice President--Internal Audit Theresa L. Hall Vice President--Human Resources Ellen Z. Mufson Vice President--Legal Michael F. Ryan Vice President--Community Development Matthew F. Souza Vice President and Secretary Marie C. Strack Vice President and Controller EXHIBIT 21(a). SUBSIDIARIES OF THE REGISTRANT State of Name Organization Irwin Union Bank and Trust Company Indiana Irwin Union Collateral, Inc. Indiana Irwin Union Realty Corporation Indiana Irwin Union Insurance, Inc. Indiana Irwin Union Securities, Inc. Indiana IFC Mortgage Corporation Indiana Irwin Mortgage Corporation Indiana Irwin Union Investor Services, Inc. Indiana Irwin Union Advisory Services, Inc. Indiana Irwin Home Equity Corporation Indiana IHE Funding Corp. Delaware Irwin Equipment Finance Corp. Indiana Affiliated Capital Corp.(1) Illinois Irwin Union Credit Insurance Corporation Arizona White River Capital Corporation Indiana IFC Capital Trust I Delaware (1)80% owned by Registrant CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS We consent to the incorporation by reference in Registration Statement No. 33-8506 on Form S-8 effective September 25, 1986 in Registration Statement No. 33-25931 on Form S-8 effective December 28, 1988 in Registration Statement No. 33- 29493 on Form S-8 as amended by Post-Effective Amendment No. 1 effective December 22, 1989; in Registration Statement No. 33-32783 on Form S-8 effective January 11, 1990; in Registration Statement No. 2-72249 on Form S-3 as amended by Post-Effective Amendment No. 3 to Form S-16 effective January 17, 1990; in Post-Effective Amendment No. 2 to Registration Statement No. 33-6880 on Form S-8 effective April 9, 1990; in Registration Statement No. 33-32783 on Form S-8 as amended by Post-Effective Amendment No. I effective April 9, 1990; in Registration Statement No. 33- 47680 on Form S-8 effective May 5, 1992 in Registration Statement 2-72249 on Form S-3 as amended by Post-Effective Amendment No. 4 to Form S-16 effective April 7, 1994; in Registration Statement No. 33-80800 on Form S-8 effective June 28, 1994; in Registration Statement No. 33-29493 on Form S-8 as amended by Post-Effective Amendment No. 2 effective September 27, 1994; in Registration Statement No. 33-62671 on Form S-8 effective September 15, 1995; in Registration Statement No. 33-62669 on Form S-8 effective September 15, 1995; and in Registration Statement No. 333- 26197 on Form S-8 effective April 30, 1997 by Irwin Financial Corporation of our report, dated January 21, 1998 on our audits of the consolidated financial statements and financial statement schedule of Irwin Financial Corporation as of December 31, 1997 and 1996 and for each of the three years in the period ended December 31, 1997, which report is included in this Annual Report on Form 10-K. /s/ Coopers & Lybrand L.L.P. Indianapolis, Indiana March 26, 1998 EX-27 8 FINANCIAL DATA SCHEDULE
9 0000052617 IRWIN FINANCIAL CORPORATION 1000 12-MOS DEC-31-1997 DEC-31-1997 56,524 18,240 0 22,134 8,693 46,515 47,202 611,093 8,812 1,496,794 719,596 512,275 81,918 7,096 47,927 0 29,965 98,018 1,496,794 56,490 7,586 35,365 99,441 19,963 44,582 54,859 6,238 0 176,533 42,179 42,179 0 0 24,444 2.19 2.15 .05 7,681 1,002 0 0 6,875 3,145 538 8,812 8,812 0 3,755 INFORMATION NOT IN 1,000 EARNINGS PER SHARE REPORTED IN BASIC AND DILUTED. INFORMTAION NOT IN 1,000