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, 1998 or __ Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from _______ to ________ Commission file number 0-6835 IRWIN FINANCIAL CORPORATION (Exact Name of Registrant as Specified in its Charter) Indiana 35-1286807 (State or Other Jurisdiction of Incorporation or (I.R.S. 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 ofdelinquent 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 nonaffiliates of the Registrant was $235,049,397 as of March 11, 1999. As of March 11, 1999, there were outstanding 21,689,574 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, 1998 Definitive Proxy Statement for Part III Annual Meeting of Shareholders to be held April 29, 1999 Exhibit Index on Pages 15 through 17 Page 1 Total Pages in This Filing: 120 ___ 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 12 Part III Item 10 - Directors and Executive Officers of the Registrant 12 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 Home Equity Corporation ("Home Equity"), a consumer home equity lending company; Irwin Equipment Finance Corp. ("Irwin Equipment"), a leasing 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. Business of Subsidiaries Irwin Mortgage, acquired in 1981, 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 engages in the nonprime first mortgage lending market. 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 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 103 production and satellite offices in twenty-eight states. During 1998, Irwin Mortgage established offices in Orinda and San Diego, California; Gary and New Albany, Indiana; Boca Raton, Florida; Jackson, Mississippi; Desloge, Missouri; Las Vegas (2), Nevada; Brick, New Jersey; Burlington, Madison and Greensboro, North Carolina; Broken Arrow and Bristow, Oklahoma; Hillsboro, Oregon; Columbia, South Carolina; Chattanooga, Tennessee; Austin, Texas; and Newport News and Virginia Beach, Virginia. During 1998, Irwin Mortgage closed offices in Phoenix, Arizona; Covina, Morgan Hill and Irvine, California; Farmington, Connecticut; Columbus and Macon, Georgia; Lexington, Kentucky; New Orleans, Louisiana; Marlton, New Jersey; Independence/Cleveland, Ohio; Columbia, South Carolina; and Chattanooga, Tennessee. Irwin Mortgage and the Registrant have,for several years, explored opportunities to test the development of mortgage banking operations in markets outside the United States. During 1998, Irwin Mortgage made a small number of loans on 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 eleven 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 - 3), Franklin and Greenwood (Johnson County 2), Carmel (Hamilton County), Avon (Hendricks County), and Greensburg (Decatur County), Indiana. In January, 1999, Irwin Union Bank opened loan production offices in Kalamazoo, Michigan and St. Louis, Missouri. 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. On December 10, 1998, Irwin Union Bank established Irwin Reinsurance Corporation as a subsidiary, incorporated in Vermont, to engage in the business of insuring and reinsuring primarily mortgage lending risks. 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-nine states. At year end, Home Equity began offering a first mortgage refinance program in selected states. Irwin Equipment, formed in 1990 and located in Columbus, Indiana, is the parent company of the former Affiliated Capital Corp., a small-ticket equipment leasing and commercial lending business. On September 30, 1998, substantially all of the assets of Affiliated Capital Corp. were sold to DVI Financial Services, Inc. After the asset sale, Affiliated Capital Corp. changed its name to Irwin Leasing Corporation, which continues to hold certain leases that were not part of the asset sale. 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 Registrant 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 Registrant. 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 Registrant 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 103 production and satellite offices in Arizona, California, Colorado, Delaware, Florida, Georgia, Hawaii, Illinois, Indiana, Kentucky, Louisiana, Massachusetts, Minnesota, Mississippi, Missouri, Nevada, New Jersey, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, 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, Hendricks, 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, 1998, 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 and is exploring the development of markets outside Indiana. 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. Irwin Equipment is inactive at present, except for managing the equipment leases that were not sold with the rest of the assets of the former Affiliated Capital Corp. in September of 1998. 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 reinsurance subsidiary of Irwin Union Bank is subject to examination by the state of Vermont. 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, 1998, the Registrant and its subsidiaries had a total of 2,401 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 Condition and Results of Operations" section of the Annual Report to Shareholders for the year ending December 31, 1998 and is incorporated herein by reference: "Daily Average Consolidated Balance Sheet, Interest Rates and Interest Differential" (p. 68), "Investment Securities" (p. 52), "Short-Term Borrowings" (p. 54), "Summary of Net Interest Income Changes" (p. 50), "Deposits" (p. 53), "Loans and Leases" (p. 51), "Five-Year Selected Financial Data" (p. 23), and the discussion and tabular information under the caption "Credit Risk" on pages 58 to 62. 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. Marie S. Ameis (36) is Vice President and Controller of the Registrant since May of 1992. Claude E. Davis (38) is President of Irwin Union Bank since January 2, 1996. He has been an officer since 1988. Elena Delgado (43) 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 (36) is Vice President and Treasurer of the Registrant since August of 1992. Jose M. Gonzalez (40) 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 (46) is Vice President - Human Resources of the Registrant, since 1988. She has been an officer since 1980. Rick L. McGuire, (46) is President of Irwin Mortgage since January 1, 1996. He has been an officer since 1978. William I. Miller (42) is Chairman of the Board, since 1990, and has been a Director of the Registrant since 1985. Ellen Z. Mufson (50) 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 (61) 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 (53) 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 (42) is Vice President and Ethics Officer/Secretary of the Registrant. He has been an officer since 1985. Thomas D. Washburn (52) 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, Mesa, Scottsdale, and Tucson, Arizona; Antioch, Bakersfield, Concord, Covina, Fresno, Laguna Hills, Orinda, Richmond, Sacramento, Salinas, San Diego, Temecula, Ventura, Visalia, Walnut Creek, Woodland, Yuba City, and Yreka, California; Castle Rock, Colorado Springs, Denver, Englewood, and Woodland Park, Colorado; Newark, Delaware; Boca Raton, Clearwater and Orlando/Longwood, Florida; Atlanta, Georgia; Aiea, Honolulu, Kailua, and Maui, Hawaii; Chicago and Decatur, Illinois; Indianapolis (5), Anderson, Gary, Ft. Wayne, Kendallville, Kokomo, Lafayette, New Albany, South Bend, and Warsaw, Indiana; Louisville, Kentucky; Baton Rouge, Louisiana; Columbia, Rockville, and Towson, Maryland; Braintree, Massachusetts; Arden Hills, Burnsville, and Minneapolis, Minnesota; Jackson, Mississippi; Desloge and St. Louis, Missouri; Las Vegas(2), Nevada; Brick, New Jersey; Cary, Charlotte, Greensboro (2), Raleigh, Wilmington, Madison and Burlington, North Carolina; Dayton, Ohio; Broken Arrow, Bristow and Tulsa, Oklahoma; Beaverton, Hillsboro and Lake Oswego, Oregon; Wyomissing, Pennsylvania; Austin (2), Corpus Christi, Dallas, El Paso, and Houston, Texas; Salt Lake City, Utah; Fredericksburg, Glen Allen, Newport News, Richmond, Springfield, Suffolk, and Virginia Beach, 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 Home Equity is located at 12677 Alcosta Blvd., Suite 500, San Ramon, California. This office location is leased. The main offices of the Registrant, Irwin Equipment, 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, 1998, in the following actions: Banda et al. v. City of Houston et al. Irwin Mortgage was -------------------------------------- served as a defendant in a class action lawsuit initiated in the district court of Harris County, Texas in March of 1998. The suit alleged that a Houston housing opportunity program, in which Irwin Mortgage was a participating lender, used inaccurate lead paint tests that resulted in a class of homeowners being subjected to harmful levels of lead and property devaluations. At present, it is difficult 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. Culpepper, et al. v. Inland Mortgage Corporation. As of December 31, 1998, ------------------------------------------------- Irwin Mortgage was a defendant in a class action lawsuit initiated in the United States District Court, Northern District of Alabama in April, 1996. This action is one of a number 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 June 22, 1998, the appeals court denied Irwin Mortgage's petition for rehearing, but issued an opinion clarifying its original opinion. Subsequently on remand, the district court granted a joint motion to consolidate Culpepper and Hiers (see below). At present, 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. Heifets, et al. v. Matrix Electromedical, et al. As of December 31, 1998, ------------------------------------------------ Affiliated Capital Corp. (now, Irwin Leasing Corporation) and Irwin Financial Corporation were defendants in a class action lawsuit initiated against them in August, 1998 in the Superior Court of Los Angeles County, California. The suit alleges that a manufacturer of certain medical devices made misrepresentations to induce doctors to acquire the devices, which Affiliated Capital Corp. financed by means of leases. The alleged misrepresentations concerned the ability to obtain Medicare coverage for treatments using the equipment, which coverage was subsequently denied. The doctors are seeking rescission of the leases and other damages allegedly caused by the doctors' reliance on the manufacturer's statements. The litigation is at an early stage and 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 Financial might be exposed. The leases affected by this lawsuit (the "Matrix Leases") were not transferred as part of the sale of assets of Affiliated Capital Corp. Irwin Financial retains liability, if any, in connection with the Matrix Leases. Hiers, et al. v. Irwin Mortgage Corporation et al. As of December 31, -------------------------------------------------- 1998, Irwin Mortgage was a defendant in a class action lawsuit initiated in August, 1998 in the United States District Court, Northern District of Alabama. As mentioned above, this suit was consolidated with Culpepper and is similar to other "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. The litigation is at an early stage and 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. Howell, et al. v. Inland Mortgage Corporation. As of December 31, 1998, ---------------------------------------------- Irwin Mortgage was a defendant in a class action lawsuit initiated in the state of Indiana in January 1995. Plaintiffs alleged that lenders do not have the right to require borrowers to pay premiums for private mortgage insurance. On February 2, 1999, the Marion County, Indiana Superior Court dismissed the case with prejudice. Kruta (formerly referred to as Basmoen), et al. v. Inland Mortgage Corporation. ------------------------------------------------------------------------------- As of December 31, 1998, 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. The court granted plaintiff's motion to add James Kruta as a class representative on September 8, 1997 and also granted a renewed motion for class certification on March 25, 1998. 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. 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. Item 4. Submission of Matters to a Vote of Security Holders During the fourth quarter of 1998, 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 National Association of Securities Dealers Automated Quotation/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 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 11, 1999 was 1,818. Stock Prices and Dividends: High Low Quarter Cash Total Dividens $ $ End Dividend For Year $ $ & 1997 (split adjusted) First Quarter 15 1/4 12 1/8 13 5/8 $0.035 Second Quarter 14 3/4 12 14 3/4 0.035 Third Quarter 18 5/8 14 3/8 18 0.035 Fourth Quarter 21 1/2 18 1/4 21 0.035 $0.14 1998 (split adjusted) First Quarter 28 1/4 19 1/2 28 1/8 $0.04 Second Quarter 30 25 1/8 29 $0.04 Third Quarter 37 20 1/2 24 5/8 $0.04 Fourth Quarter 31 20 1/8 27 1/5 $0.04 $0.16 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, 1998, the Registrant's Board of Directors approved an increase in the Registrant's quarterly dividend to $.04 per share (split adjusted) which dividend rate was unchanged as of December 31, 1998. Dividends paid by Irwin Union Bank to the Registrant are restricted by banking law. No sales of unregistered equity securities were made by the Registrant during the fourth quarter of 1998. Item 6. Selected Financial Data The information contained in the Annual Report to Shareholders for the year ended December 31, 1998, under the caption "FiveYear 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, 1998, is incorporated herein by reference in response to this item. Item 7a. Quantitative and Qualitative Disclosures About Market Risk--Interest Rate Sensitivity Interest rate sensitivity refers to the potential for changes in market rates of interest to cause changes in net interest income and in the market value of assets and liabilities. 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. Rate sensitivity 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. Formal policies approved by the 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 sensitivity 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 mortgage bank buys commitments to deliver loans at a fixed price to manage risk. The policy at the home equity lending business is to matchfund all loan assets. The mortgage bank and the home equity company are also exposed to interest rate risk through their ownership of servicing assets. As discussed in the analysis of each line of business earlier in this report, the companies also manage their risk using a variety of techniques including: maintaining a strong production operation which offsets the interest rate risk, selective sales of the servicing rights, and the use of financial hedges. In some cases, the Registrant uses internal hedges to allow for the risk characteristics of one line of business to offset those of another line. While traditional interest rate risk focuses on the changes in net interest income due to interest rate changes, the Registrant 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, option-adjusted valuation techniques for estimating expected customer behavior, and Monte Carlo based cash flow simulation, the Registrant attempts to analyze and mitigate total interest rate risk that is associated with both net interest income and non-interest income. 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. The following table shows management's estimate of the present value of interest-sensitive assets and liabilities, as well as off-balance sheet financial contracts as of December 31, 1998, at then current interest rates as well as simulated rates 1.0% and 2.0% above and below those interest rates. It does not take into account the book values of the Registrant's non-interest sensitive assets and liabilities, such as cash, accounts receivable, and fixed assets, the value of which is not directly determined by interest rates. As noted above, the analysis is based on discounted cash flows over the remaining estimated lives of the financial instruments. The total measurement of the Registrant's exposure to interest rate risk as presented in the following table may not be representative of the actual values which might result from a higher or lower rate environment. Such environments would likely result in different lending and borrowing strategies by the Registrant, designed in part to further mitigate the effect on the value of, and the net earnings generated from, the Registrant's net assets from any change in interest rates. The figures suggest, based on balance sheet and off balance sheet financial assets, that the present value of the Registrant's interest-sensitive assets and liabilities would decline in a falling rate environment and increase in a rising rate environment. The magnitude and direction of the present value rate sensitivity is largely unchanged from 1997. As previously noted, this present value sensitivity analysis does not account for potential earnings the Registrant would recognize due to strategic initiatives it would undertake if the interest rate scenarios model occurred, nor does it reflect activities not traditionally measured as financial assets or liabilities. Principal among these activities for the Registrant would be the change in mortgage loan production and the earnings stream the Registrant derives therefrom. PRESENT VALUE ($000) AT DECEMBER 31, 1998 -2% -1% CURRENT +1% +2% Interest Sensitive Assets Interest-bearing 18,528 18,512 18,495 18,479 18,463 deposits with banks Federal Funds Sold 8,651 8,651 8,651 8,651 8,651 Taxable investment 80,556 78,210 76,873 76,069 75,554 securities Tax-exempt investment 5,727 5,513 5,309 5,115 4,930 securities Mortgages held for sale 974,732 970,182 965,055 959,305 952,905 Mortgage Servicing 41,930 77,595 117,728 152,402 174,714 Rights Loans, net of unearned 624,196 612,499 601,338 591,228 581,262 discount Total Interest 1,754,320 1,771,162 1,793,449 1,811,249 1,816,479 Sensitive Assets Interest Sensitive Liabilities Non-Interest Bearing 486,091 483,042 480,168 477,458 474,898 Deposits Money Market Checking 122,395 122,317 122,239 122,162 122,084 Money Market Savings 6,509 6,504 6,499 6,494 6,489 Regular Savings 98,965 98,886 98,808 98,730 98,653 Time Deposits 295,576 292,831 290,152 287,566 285,123 Short term borrowings 637,654 637,272 636,890 636,512 636,134 Long Term Debt 70,887 65,220 60,750 57,199 54,344 Total Interest 1,718,077 1,706,072 1,695,506 1,686,121 1,677,725 Sensitive Liabilities Interest Sensitive Off 14,423 13,690 5,347 1,027 1,484 Balance Sheet Items Net Sensitivity as of 50,666 78,780 103,290 126,155 140,238 December 31, 1998 Potential Change -52,624 -24,510 22,865 36,948 Net Sensitivity as of -12,165 6,895 28,911 47,188 55,873 December 31, 1997 Potential Change -41,076 -22,016 18,277 26,962 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, 1998, under the caption "1998 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, 1998, 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 1999 Annual Meeting of Shareholders under the caption "Election of Directors", on pages 4 through 7, 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 1999 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 10 through 19, 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 1999 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 1999 Annual Meeting of Shareholders under the caption "Interest of Management in Certain Transactions" on pages 20 and 21, 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 PricewaterhouseCoopers LLP, Independent Accountants 88 Consolidated Statement of Income for the years ended December 31, 1998, 1997, and 1996 89 Consolidated Balance Sheet as of December 31, 1998, and 1997 90 Consolidated Statement of Changes in Shareholders' Equity for the years ended December 31, 1998, 1997 and 1996 91 Consolidated Statement of Cash Flows for the years ended December 31, 1998, 1997, and 1996 92 Notes to Consolidated Financial Statements 93 The above listed report, financial statements, and the notes thereto, set forth on pages 85 through 115 of the Registrant's 1998 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 Number Assigned in Sequential Numbering Regulation System Page Number S-K Item 601 Description of Exhibit of 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 (f) to Form 10-K Report for year ended December 31, 1996, File No. 0-6835.) (ii) 3(a) Code of By-Laws as 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 holers oflong- 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. 06835.) 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. 06835.) 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. 06835.) 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. 06835.) 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. 06835.) 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. 06835.) 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 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. 06835.) (11) 11(a) Computation of Earnings Per Share. 21 (12) No exhibit. (13) 13(a) Registrant's 1998 Annual 22 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 Registrant. 117 (22) No exhibit. (23) 23(a) Consent of Independent Accountants. 118 (24) No exhibit. (27) Financial Data Schedule. 119 (99) 99(a) Annual Report on Form 11-K for the Irwin Financial Corporation Employees' Savings Plan for the year ending December 31, 1998.* 99(b) Annual Report on Form 11-K for the Irwin Mortgage Corporation Retirement and Profit Sharing Plan for the year ending December 31, 1998.* * 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 30, 1999 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. Signature Capacity with Date Registrant /s/ Sally A. Dean Director March 30, 1999 ----------------- Sally A. Dean /s/ David W. Goodrich Director March 30, 1999 --------------------- David W. Goodrich /s/ John T. Hackett Director March 30, 1999 ------------------- John T. Hackett /s/ William H. Kling Director March 30, 1999 -------------------- William H. Kling /s/ Brenda J. Lauderback Director March 30, 1999 ------------------------ Brenda J. Lauderback /s/ John C. McGinty, Jr. Director March 30, 1999 ------------------------ John C. McGinty, Jr. /s/ Irwin Miller Director March 30, 1999 ---------------- Irwin Miller /s/ William I. Miller Director, Chairman March 30, 1999 -------------------- of the Board William I. Miller (Principal Executive Officer) /s/ John A. Nash Director, Chairman March 30, 1999 ---------------- of the Executive John A. Nash Committee /s/ Lance R. Odden Director March 30, 1999 ------------------ Lance R. Odden /s/ Theodore M. Solso Director March 30, 1999 --------------------- Theodore M. Solso /s/ Thomas D. Washburn Senior Vice President March 30, 1999 ---------------------- (Principal Financial Thomas D. Washburn Officer) /s/ Marie S. Ameis Vice President and March 30, 1999 ------------------ Controller Marie S. Ameis (Principal Accounting Officer) Exhibit 11 (a) IRWIN FINANCIAL CORPORATION AND SUBSIDIARIES EXHIBIT 11(a) - COMPUTATION OF EARNINGS PER SHARE Year Ended December 31, 1998 1997 1996 (In thousands except per share amounts) AVERAGE NUMBER OF SHARES 21,732 22,326 22,716 OUTSTANDING NET INCOME $30,503 $24,444 $22,428 BASIC EARNINGS PER SHARE $ 1.40 $ 1.09 $ 0.99 (Note 2) DILUTED SHARES OUTSTANDING: Average number of 21,732 22,326 22,716 shares outstanding Assumed exercise of 407 396 314 stock options (Note 1) Total shares (Note 2) 22,139 22,722 23,030 NET INCOME $30,503 $24,444 $22,428 DILUTED EARNINGS PER $ 1.38 $ 1.08 $ 0.97 SHARE (Note 2) (1) The dilutive effect of stock options is based on the Treasury Stock method. (2) Adjusted for the two-for-one stock splits effective May 27, 1998 and December 30, 1996. Previously reported per share data have been adjusted to reflect these splits. Management's Discussion and Analysis of Results of Operations and Financial Condition Irwin Financial Corporation Five-Year Selected Financial Data (In thousands, except per share amounts) Financial Data For the Year: 1998 1997 1996 1995 1994 Net revenues $300,918 $221,224 $195,448 $148,239 $116,908 Operating expenses 245,436 174,573 158,160 115,790 86,844 Net income 30,503 24,444 22,428 20,083 18,216 Mortgage loan closings 8,944,615 5,397,338 5,085,625 3,559,310 2,812,962 Return on average equity 22.84% 19.80% 20.58% 22.60% 23.91% Return on average assets 1.85 1.94 1.95 2.28 2.43 Dividend payout ratio 11.39 12.74 12.15 12.36 11.38 Per share:* Net income - Basic $1.40 $1.10 $0.99 $0.89 $0.79 Net income - Diluted 1.38 1.08 0.98 0.88 0.79 Cash dividends 0.16 0.14 0.12 0.11 0.09 Book value 6.70 5.82 5.23 4.38 3.60 Market value at December 31, 27.20 20.94 12.38 9.97 6.69 At year end: Assets $1,946,179 $1,496,794 $1,300,122 $1,037,541 $659,671 Deposits 1,009,211 719,596 640,153 563,999 439,918 Loans held for sale 936,788 528,739 446,898 378,658 154,964 Loans and leases, net 547,103 602,281 526,175 407,904 304,548 Shareholders' equity 145,233 127,983 118,903 99,216 81,104 Owned mortgage servicing portfolio 11,242,470 10,713,549 10,810,988 10,301,914 8,818,502 Equity to assets ratio 7.46% 8.55% 9.15% 9.56% 12.29% Risk-based capital ratio 12.25 14.85 12.88 14.49 19.18 Leverage ratio (Tier 1) 10.51 12.06 9.84 10.57 10.82 Averages: Assets $1,650,384 $1,262,714 $1,151,535 $882,164 $748,981 Equity 133,563 123,483 108,970 88,867 76,178 Shares outstanding* - Basic 21,732 22,326 22,716 22,560 23,094 Shares outstanding* - Diluted 22,139 22,722 23,030 22,860 23,278 ------------------------------------------------------------------------------ *Adjusted for stock splits (In thousands, except for per share amounts) Summary of Quarterly Financial Information 1998 -------------------------------------------------------------------------------- Fourth Third Second First Summary Income Information Quarter Quarter Quarter Quarter ------------------------------------------------------------------------------- Interest income $29,441 $34,558 $31,944 $26,443 Interest expense 13,070 18,240 15,425 12,467 Provision for loan and lease losses 1,350 1,951 1,056 1,638 Noninterest income 67,710 64,706 56,077 55,237 Noninterest expense 71,167 61,122 58,693 54,455 Income taxes 4,162 6,684 4,627 4,881 ------- ------- ------- ------- Net income 7,402 11,267 8,220 8,239 ------- ------- ------- ------- Distribution on company-obligated mandatorily redeemable preferred securities of subsidiary trust 1,102 1,174 1,174 1,175 ------- ------- ------- ------- Net income available to common shareholders $6,300 $10,093 $7,046 $7,064 ======= ======= ======= ======= Earnings per share of common stock: Basic* $0.29 $0.47 $0.32 $0.32 Diluted* $0.29 $0.46 $0.32 $0.31 1997 -------------------------------------------------------------------------------- Fourth Third Second First Summary Income Information Quarter Quarter Quarter Quarter -------------------------------------------------------------------------------- Interest income $27,597 $26,237 $23,127 $22,480 Interest expense 12,989 11,705 10,032 9,856 Provision for loan and lease losses 1,374 2,042 2,019 803 Noninterest income 44,270 46,439 43,299 38,595 Noninterest expense 44,758 45,454 43,585 40,776 Income taxes 5,404 4,989 3,851 3,490 ------- ------- ------- ------- Net income 7,342 8,486 6,939 6,150 ------- ------- ------- ------- Distribution on company-obligated mandatorily redeemable preferred securities of subsidiary trust 1,174 1,174 1,171 954 ------- ------- ------- ------- Net income available to common shareholders $6,168 $7,312 $5,768 $5,196 ======= ======= ======= ======= Earnings per share of common stock: Basic* $0.28 $0.33 $0.26 $0.23 Diluted* $0.28 $0.33 $0.26 $0.23 1996 ------------------------------------------------------------------------------- Fourth Third Second First Summary Income Information Quarter Quarter Quarter Quarter -------------------------------------------------------------------------------- Interest income $26,764 $23,062 $22,004 $19,815 Interest expense 12,230 10,591 9,886 8,918 Provision for loan and lease losses 1,199 1,126 1,227 1,001 Noninterest income 38,970 38,176 38,339 34,496 Noninterest expense 41,152 40,346 40,707 35,955 Income taxes 4,244 3,672 3,495 3,449 ------- ------- ------- ------- Net income $6,909 $5,503 $5,028 $4,988 ======= ======= ======= ======= Earnings per share of common stock: Basic* $0.31 $0.24 $0.22 $0.22 Diluted* $0.30 $0.24 $0.22 $0.22 ------------------------------------------------------------------------------ *Adjusted for stock splits Total Net Revenues ($Millions) 1990 $43.3 1991 60.0 1992 94.9 1993 119.4 1994 116.9 1995 148.2 1996 195.4 1997 221.2 1998 300.9 Net Income ($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 1998 30.5 Return on Average Equity (Percent) 1990 13.5% 1991 16.93 1992 26.51 1993 24.91 1994 23.91 1995 22.60 1996 20.58 1997 19.80 1998 22.84 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 1998. A favorable interest rate environment led to strong results at the Corporation's mortgage banking line of business. That, coupled with continued growth at the community bank, offset a decline in earnings at the home equity line of business. Additionally, in the third quarter of 1998, the Corporation sold the majority of the assets of its equipment leasing line of business, generating a one- time after-tax gain of $3.1 million. Net income for 1998 totaled $30.5 million, up 24.8% from 1997 and 36.0% from 1996. Basic earnings per share were $1.40 in 1998, up from $1.10 in 1997 and $0.99 in 1996. Diluted earnings per share in 1998 were $1.38 compared to $1.08 in 1997 and $0.98 in 1996. Return on average equity for 1998 was 22.84% compared to 19.80% in 1997 and 20.58% in 1996. Return on average assets was 1.85%, compared to 1.94% in 1997 and 1.95% in 1996. Excluding the aforementioned gain on the sale of leasing assets, net income totaled $27.4 million. Basic earnings per share were $1.26 and diluted earnings per share were $1.24 without the leasing gain. Return on average equity was 20.48%, and return on average assets was 1.66%. Earnings By Line of Business: Irwin Financial Corporation is comprised of three principal lines of business: - Mortgage banking - Community banking - Home equity lending Earnings: (In thousands) 1998 1997 1996 ------------------------------------------------------------------------------- Mortgage Banking $28,853 $21,300 $20,422 Community Banking 6,509 5,587 4,254 Home Equity Lending (6,668) 1,710 (816) Equipment Leasing (including gain on sale of assets in 1998) 2,898 151 (141) Parent (including consolidating entries) (1,089) (4,304) (1,291) ------- -------- -------- $30,503 $24,444 $22,428 ------------------------------------------------------------------------------- Business Profile: Mortgage Banking Selected Financial Data (In thousands) 1998 1997 1996 1995 1994 -------------------------------------------------------------------------------- Selected Income Statement Data: Net interest income $26,244 $17,577 $17,178 $13,415 $12,942 Provision for loan losses (1,721) (1,383) (455) (125) (240) Loan origination fees 59,328 41,045 43,463 31,871 25,308 Gain on sale of loans 44,124 21,613 25,541 18,020 2,219 Loan servicing fees 52,217 50,194 45,573 36,087 32,426 Gain on sale of servicing 43,308 32,631 16,378 15,271 17,716 Other income 6,740 1,223 891 787 647 -------- -------- -------- -------- -------- Total net revenues 230,240 162,900 148,569 115,326 91,018 Operating expense 182,194 126,610 114,474 83,344 64,571 -------- -------- -------- -------- -------- Income before taxes 48,046 36,290 34,095 31,982 26,447 Income taxes 19,193 14,990 13,673 12,651 10,719 -------- -------- -------- -------- -------- Net income $28,853 $21,300 $20,422 $19,331 $15,728 ======== ======== ======== ======== ======== Selected Balance Sheet Data at End of Period: Mortgage loans held for sale $555,197 $435,123 $372,855 $309,262 $131,543 Mortgage servicing assets 113,131 81,610 71,715 51,783 18,834 Total assets 877,904 698,391 555,486 445,129 216,180 Short-term debt 288,514 335,835 265,646 227,021 68,259 Long-term debt 2,839 54 4,914 2,300 2,605 Shareholder's equity 104,696 81,058 66,182 55,811 50,805 Selected Operating Data: Mortgage loan originations $8,944,615 $5,397,338 $5,085,625 $3,559,310 $2,812,962 Servicing portfolio: Balance at December 31, 11,242,470 10,713,549 10,810,988 10,301,914 8,818,502 Weighted average coupon rate 7.56% 7.85% 7.83% 7.83% 7.59% Weighted average servicing fee 0.43 0.40 0.38 0.38 0.38 Servicing sold as a percent of production 54.6 71.8 60.9 28.4 49.8 -------------------------------------------------------------------------------- Overview & Strategy: The mortgage banking line of business consists of Irwin Mortgage Corporation and the related activities of Irwin Union Bank and Trust. The business is headquartered in Indianapolis and originates, sells, and services residential mortgage loans throughout the U.S. It has offices in 28 states and ranks among the top 35 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. 1998 Review: Net income from mortgage banking was $28.9 million in 1998, an increase of 35.5% over 1997 results of $21.3 million and 41.3% over 1996 results of $20.4 million. Return on average equity was 31.8% in 1998 compared to 29.6% in 1997 and 33.4% in 1996. Mortgage Loan Originations: (In thousands) 1998 1997 1996 ------------------------------------------------------------------------- Total originations $8,944,615 $5,397,338 $5,085,625 Percent retail loans 35.9% 36.6% 41.8% Percent wholesale loans 59.7 57.2 52.4 Percent brokered 4.4 6.2 5.8 Percent refinances 49.5 22.5 19.0 ------------------------------------------------------------------------- As a result of a low interest rate environment, the mortgage banking line of business had record loan originations in 1998. Loan originations of $8.9 billion were up 65.7% from 1997 and 75.9% from 1996. Income from mortgage loan originations totaled $59.3 million which was 44.5% higher than 1997 and 36.5% over 1996. Refinances accounted for 49.5% of 1998 loan closings, and because certain fees are not collected for loan refinancings, loan origination fees did not increase at the same rate as loan production in 1998. Gains from the sale of mortgage loans totaled $44.1 million in 1998, compared to $21.6 million in 1997 and $25.5 million in 1996. Higher loan production levels combined with more favorable market pricing accounted for the 1998 increase. 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 mortgage banking originations include $173.5 million and $66.1 million of nonprime loans in 1998 and 1997, respectively. These loans are sold on a non-recourse, service-released basis to private investors. Mortgage Servicing: Servicing Portfolio: (Portfolio balances in billions) 1998 1997 1996 ------------------------------------------------------------------------------ Beginning portfolio $10.7 $10.8 $10.3 Add: Loans originated 3.2 2.0 2.1 Loans purchased 5.7 3.4 3.0 Deduct: Sale of servicing rights (4.9) (3.9) (3.1) Run-off* (3.5) (1.6) (1.5) -------- -------- -------- Ending portfolio $11.2 $10.7 $10.8 ======== ======== ======== Number of loans 135,833 141,737 140,354 Average loan size $82,767 $82,902 $83,540 Percent GNMA 65% 59% 51% Percent FHLMC 5 11 15 Percent FNMA 13 19 16 Delinquency ratio: 5.0% 6.0% 5.1% Capitalized servicing as a percentage of servicing portfolio 1.0% 0.8% 0.7% ------------------------------------------------------------------------------- *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 $11.2 billion at December 31, 1998, up 4.9% from the same date in 1997 and 4.0% from 1996. The 1998 annual portfolio run-off rate was 27.6% compared with the 1997 rate of 12.3% and the 1996 rate of 10.7%. 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: 1998 1997 1996 Less than 7% 15.1% 8.4% 8.9% 7.00 - 7.99% 52.7 42.5 44.3 8.00 - 8.99% 27.6 42.6 38.7 9% or greater 4.6 6.5 8.1 ------ ----- ----- Total 100% 100% 100% ------------------------------------------------------------------ Mortgage servicing assets carried on the balance sheet totaled $113.1 million at December 31, 1998, up from $81.6 million at the end of 1997 and $71.7 million at the end of 1996. 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 likely be accompanied by increased loan origination fees, management has implemented hedging alternatives from time to time to offset potential impairment provisions. The company addresses its impairment risk by the selective selling of servicing rights it believes to be most at risk to refinancing. In 1998, it sold $4.9 billion of servicing for this reason. In addition, during 1998, the business purchased options on treasury futures to offset the interest rate risk associated with mortgage servicing assets. Gross impairment charges of $11.1 were recorded in 1998, up from $0.6 million in 1997 and 1996. Impairment charges in 1998 were partially offset by income from the options on treasury futures which totaled $4.3 million for the year. See page 67 for further discussion of derivative instruments. Servicing and Other Fees: (In thousands) 1998 1997 1996 ----------------------------------------------------------- Servicing fees $52,217 $50,194 $45,573 Other fees 2,422 1,223 891 -------- ------- ------- Total $54,639 $51,417 $46,464 ----------------------------------------------------------- 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. An increase in the average portfolio combined with a change in the portfolio mix to a higher percentage of government loans positively affected servicing income which increased 4.0% from 1997 and 14.6% from 1996. 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 for loans with principal balances totaling $4.9 billion was sold in 1998, generating a $43.3 million pre-tax gain. This compares to servicing sales of $3.9 billion in 1997 that produced a $32.6 million pre-tax gain and $3.1 billion in 1996 that produced a $16.4 million pre-tax gain. Had all servicing been retained, gains on sales of loans would have been higher than what was recorded, but gains from sales of servicing would have been reduced. Servicing sales in 1998 represented 54.6% of 1998 originations versus 1997 sales which were 71.8% of that year's originations and 1996 sales which were 60.9% 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 $26.2 million in 1998 compared to $17.6 million in 1997 and $17.2 million in 1996. The 1998 increase resulted from the increased loan production during the year. Operating Expenses: (In thousands, except for number of employees) 1998 1997 1996 -------------------------------------------------------------------------------- Salaries and employee benefits $101,477 $71,389 $66,153 Amortization of servicing assets 23,002 15,243 14,245 Other expenses 57,715 39,978 34,076 --------- -------- -------- Total operating expenses $182,194 $126,610 $114,474 ======== ======== ======== Number of employees at December 31, 1,752 1,411 1,474 -------------------------------------------------------------------------------- Amorization of servicing assets increased 50.9% from 1997 and 61.5% from 1996. The increase corresponds with the increase in servicing assets. Salaries and employee benefits were up 42.1% from 1997 and 53.4% from 1996. Other operating expenses were up 44.4% from 1997 and 69.4% from 1996. These increases reflect the increased production activities throughout 1998 and investments in technology. Credit Quality: (In thousands) 1998 1997 1996 -------------------------------------------------------------------------------- At December 31, Nonperforming loans $9,449 $3,784 $2,221 Other real estate owned 3,338 1,415 1,839 -------- ------- ------- Total nonperforming assets $12,787 $5,199 $4,060 ======== ======== ======= Allowance for loan losses $2,568 $1,606 $633 ======== ======== ======= Allowance for loan losses as a percentage of loans 8.9% 6.0% 2.7% For the year ended December 31, Provision for loan losses $1,721 $1,383 $455 -------------------------------------------------------------------------------- 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 qualify for government insurance or that must be repurchased from agencies due to lack of conformity to underwriting guidelines. In recent 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. In addition, during periods of high origination volume, due to delays in gathering documentation required for submission to the insuring agencies, the mortgage bank experiences an increase in the number of new loans which do not qualify for insurance prior to the borrower's first 30-day delinquency. As such, the mortgage bank has had an increase in the number of loans it has repurchased from or been unable to submit to the agencies and other investors. This increase 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 1998, 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 probable credit losses based on information about the borrower and the underlying collateral. 1999 Outlook: The mortgage bank expects the interest rate environment to remain favorable for mortgage loan production in 1999. However, it is anticipated that refinance activities will decline slightly from levels experienced in 1998. Should production levels decline in 1999, cost cutting strategies will be implemented to keep expenses in line with revenues. Additionally, the business will complete the rollout of technology initiatives which are expected to enhance efficiencies in the area of loan production. The business will continue to emphasize the growth of its other lending activities in 1999, such as nonprime, manufactured housing, and Internet originations. These activities are expected to be an integral part of the overall growth of the business in the coming year. Employees: As of December 31, 1998, the mortgage banking line of business employed 1,752 people -- approximately 73% of the Corporation's total employee base. Total employment expense in 1998 was $101.5 million or 55.7% 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: 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--Western Region Randall G. Chumley First Vice President--Atlanta Branch Renee M. Gunderson First Vice President--Underwriting/Closing Post Closing Darla S. Habig First Vice President--Loan Control Richard E. Hawkins First Vice President--Investor Reporting Allan D. Karlander First Vice President--Central Region Scott A. Korbin First Vice President--South Atlantic Region Kimberly M. Krick First Vice President--Orlando Branch 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 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 Carla L. Wise First Vice President--Default Administration Business Profile: Community Banking Selected Financial Data (In thousands) 1998 1997 1996 1995 1994 ------------------------------------------------------------------------------- Selected Income Statement Data: Interest income $46,056 $41,115 $35,645 $31,965 $23,808 Interest expense 20,957 19,120 15,908 14,048 8,822 Provision for loan and lease losses 1,820 2,201 2,284 2,038 1,344 -------- -------- -------- ------- -------- Net interest income after provision for loan and lease losses 23,279 19,794 17,453 15,879 13,642 Noninterest income 12,218 9,434 9,384 7,187 5,719 -------- -------- -------- ------- -------- Total net revenues 35,497 29,228 26,837 23,066 19,361 Operating expenses 25,021 20,372 20,311 17,582 14,858 -------- -------- -------- ------- -------- Income before taxes 10,476 8,856 6,526 5,484 4,503 Income taxes 3,967 3,269 2,272 1,845 1,453 -------- -------- -------- ------- -------- Net income $6,509 $5,587 $4,254 $3,639 $3,o50 ======== ======== ======== ======= ======== Selected Balance Sheet Data at End of Period: Loans $514,950 $410,272 $336,580 $310,083 $255,644 Allowance for loan losses 6,680 5,525 4,790 3,668 3,418 Total assets 607,992 539,233 503,507 440,035 370,462 Deposits 567,526 486,481 453,897 400,149 341,459 Shareholders' equity 46,990 38,390 33,967 28,722 24,686 Daily Averages: Assets $567,116 $515,666 $459,893 $405,249 $344,691 Deposits 514,694 463,851 413,935 358,343 315,229 Loans 462,319 370,313 329,658 284,713 231,592 Allowance for loan losses 6,308 5,332 4,367 3,566 3,048 Shareholder's equity 42,026 36,232 31,863 27,661 23,580 Shareholder's equity to assets 7.41% 7.03% 6.93% 6.83% 6.84% ------------------------------------------------------------------------------- Overview & Strategy: Community banking is conducted by Irwin Union Bank and Trust Company which is headquartered in Columbus, Indiana. At year-end 1998, it had 19 offices in 8 counties in Indiana. It 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. 1998 Review: Community banking net income in 1998 totaled $6.5 million, up 16.5% from 1997 net income of $5.6 million and 53.0% from 1996 net income of $4.3 million. The return on average equity was 15.49% in 1998 as compared to 15.42% in 1997 and 13.35% in 1996. Results in 1998 reflect the continued growth and expansion efforts of the community bank into new markets. Net interest revenue: (In thousands) 1998 1997 1996 ----------------------------------------------------------------------------- Net interest revenue on a taxable equivalent basis* $25,367 $22,206 $20,095 Average interest earning assets 534,439 481,707 429,520 Net interest margin 4.75% 4.61% 4.67% ----------------------------------------------------------------------------- *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 14.2% from 1997 and 26.2% from 1996 to a total of $25.4 million. Net interest revenue is the product of net interest margin and average earning assets. Net interest margin was up for the year, coming in at 4.75% for 1998 compared to 4.61% in 1997 and 4.67% in 1996. This improvement resulted from a change in mix of the community bank's assets in 1998 to a lower percentage of investments and federal funds sold and a higher percentage of loans. Noninterest Income: (In thousands) 1998 1997 1996 ------------------------------------------------------------------------------- Trust fees $2,136 $2,178 $2,571 Service charges on deposit accounts 2,076 1,831 1,820 Insurance commissions, fees, and premiums 1,265 1,044 1,105 Gain from sale of loans 1,346 1,088 909 Loan servicing fees 1,745 972 690 Brokerage fees 1,050 757 736 Loan origination fees 686 416 316 Other 1,914 1,148 1,237 -------- -------- -------- Total noninterest income $12,218 $9,434 $9,384 ------------------------------------------------------------------------------- As a result of the community bank's expansion efforts, noninterest income was up 29.5% from 1997 and 30.2% from 1996. During 1998, the community bank recorded $1.3 million of gains on the sale of consumer, commercial, and mortgage loans. This compares to $1.1 million in 1997 and $0.9 million recorded in 1996. The community bank retained the right to service the sold loans, which contributed to increased loan servicing fees in 1998. Other noninterest income includes $222.4 thousand of securities gains which were up from $56.1 thousand in 1997 and $9.0 thousand in 1996. Operating Expenses: (In thousands, except for number of employees) 1998 1997 1996 ------------------------------------------------------------------------------- Salaries and employee benefits $14,142 $11,333 $10,916 Other expenses 10,879 9,039 9,395 -------- -------- -------- Total operating expenses $25,021 $20,372 $20,311 ======== ======== ======== Number of employees at December 31, 353 339 304 ------------------------------------------------------------------------------- Operating expenses increased 22.8% from 1997 and 23.2% from 1996. Costs associated with expanding new products and markets contributed to the increase. Balance Sheet: Total assets averaged $567.1 million in 1998 compared to $515.7 million in 1997 and $459.9 million in 1996. Average earning assets for the year were $534.4 million, up $52.7 million or 10.9% from 1997 and up $104.9 million or 24.4% from 1996. The most significant component of the 1998 increase was loans and leases which were up $92.0 million on average in 1998 as a result of the community bank's expansion efforts into new markets. Average deposits were $514.7 million in 1998, 11.0% higher than 1997 and 24.3% higher than 1996. The community bank's equity to assets ratio averaged 7.41% for the year, compared to 7.03% in 1997 and 6.93% in 1996. Credit Quality: (In thousands) 1998 1997 1996 ------------------------------------------------------------------------------ At December 31, Nonperforming loans $1,858 $2,856 $3,434 Other real estate owned 48 413 400 ------- ------- ------- Total nonperforming assets $1,906 $3,269 $3,834 ======= ======= ======= Nonperforming assets as a percentage of total assets 0.31% 0.60% 0.76% ======= ======= ======= Allowance for loan losses $6,680 $5,525 $4,790 ======= ======= ======= Allowance for loan losses as a percentage of loans 1.30% 1.35% 1.42% ======= ======= ======= For the Year Ended December 31, Provision for loan losses $1,820 $2,201 $2,284 ======= ======= ======= Net charge-offs $592 $1,277 $1,107 ------------------------------------------------------------------------------ 1999 Outlook: During 1999, the community bank plans to continue its expansion efforts into new markets, including markets outside of Indiana. This expansion will be the first time the community bank has operated beyond its home state. The bank has developed a growth strategy for its small business lending unit which includes the opening of offices in Michigan and Missouri as well as other states yet to be determined. The focus will be to provide personalized banking services to small businesses in cities with good growth potential and those affected by consolidation in the banking industry. The community bank will continue to develop its infrastructure to support growth and expansion plans. Included is the implementation of new sales systems as well as the centralization of certain processes. Employees: As of December 31, 1998, the community bank employed 353 people. Total employment expense in 1998 was $14.1 million or 56.5% 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 Chairman, Milestone Contractors, L.P. Christine M. Vujovich Vice President, Cummins Engine Company, 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 Richard S. Barbercheck President--Decatur County William S. Beitler President--Shelby County Debora L. Cox Vice President--Operations Bradley R. Davis Vice President and Controller Brian D. Hall President--Monroe County Carrie K. Houston Senior Vice President--Human Resources J. Kevin Johnson President--Jackson County Timothy J. Kilmartin President--Kalamazoo Mark C. Kugar President--Hendricks County Gary S. Martin President--St. Louis Timothy S. Massey Senior Vice President--Indianapolis Robert L. Phillips President--Johnson County William R. Redman President--Hamilton County Timothy P. Robinson Vice President--Trust Albert C. Roszczyk Senior Vice President--Bartholomew County William R. Shomaker President--Irwin Union Insurance Donald J. Stuart President--Irwin Union Advisory Services Mark R. Willis President--Irwin Union Securities Business Profile: Home Equity Lending Selected Financial Data (In thousands) 1998 1997 1996 1995 -------------------------------------------------------------------------------- Net interest income $4,780 $7,129 $7,755 $1,828 Provision for loan losses (513) (1,404) (983) (363) Gain on sale of loans 18,604 15,908 7,798 2,985 Loan servicing fees 3,323 2,145 710 13 Trading losses (2,952) (1,961) - - Other income 1,431 294 140 10 -------- -------- -------- -------- Total net revenues 24,673 22,111 15,420 4,473 Operating expenses 31,341 20,401 16,236 7,693 -------- -------- -------- -------- Pre-tax income (loss) $(6,668) $1,710 $(816) $(3,220) ======== ======== ======== ======== Selected Balance Sheet Data at End of Period: Home equity loans net of loan loss allowance $7,832 $111,216 $117,588 $36,225 Home equity loans held for sale 239,613 - - - Interest-only strips 26,761 22,134 12,661 4,446 Total assets 311,974 165,242 145,113 50,845 Short-term debt 226,998 146,219 129,627 24,981 Shareholders' equity 40,272 10,936 13,221 5,538 Selected Operating Data: Loan Volume: Lines of credit $98,855 $115,274 $80,724 $87,420 Loans 290,818 99,244 88,396 - Servicing portfolio: Balance at December 31, 581,241 358,166 230,450 86,691 Weighted average coupon rate: Lines of credit 11.89% 12.96% 12.80% 13.61% Loans 11.86 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 29 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. 1998 Review: The home equity lending business recorded a pre-tax loss of $6.7 million in 1998 compared with pre-tax income of $1.7 million in 1997 and a pre-tax loss of $0.8 million in 1996. Low interest rates throughout 1998 and competitive pressures caused increased loan prepayment speeds. Additionally, unfavorable market conditions late in 1998 caused the business to delay the securitization of loans produced in the last half of the year. Loan Originations and Securitizations: During 1998, the home equity lending business originated $389.7 million of home equity loans, up 81.7% from 1997 volume of $214.5 million and 130.4% from 1996 volume of $169.1 million. The business securitized $294.3 million of loans, or 75.5% of originations in 1998 which generated a pre-tax gain of $18.6 million. These results compare with a $15.9 million gain recognized in 1997 on the sale of $210.1 million of loans, or 97.9% of originations, and a $7.8 million gain recognized in 1996 on the sale of $79.9 million of loans, or 47.3% of originations. Servicing Portfolio: (In thousands) 1998 1997 1996 ----------------------------------------------------------------- Balance at December 31, $581,241 $358,166 $230,450 Delinquency ratio 1.3% 1.5% 0.7% ----------------------------------------------------------------- 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 62.3% from 1997 and 152.2% from 1996. The business earns a servicing fee equal to 1% of the outstanding principal balance of the securitized loans. Servicing fee income increased to $3.3 million in 1998 from $2.1 million in 1997 and $0.7 million in 1996. The home equity lending business recognizes on its balance sheet a servicing asset equal to the discounted cash flows of future servicing income. At December 31, 1998, net servicing assets totaled $3.1 million compared with $1.3 million at the end of 1997 and $0.7 million at the end of 1996. Servicing asset amortization and impairment expense totaled $0.8 million in 1998 and $0.3 million in 1997, the increase resulting from the increase in the asset. When the home equity lending business securitizes loans, the business recognizes an interest-only strip equal to the discounted available future cash flows of the interest paid by borrowers less servicing fees, expected losses, and interest remitted to investors. The interest-only strip had a balance of $26.8 million at December 31, 1998, compared with $22.1 million at the same date in 1997 and $12.7 million in 1996. Interest-only strips are recorded on the balance sheet as trading assets and are carried at their market values. Market values 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 items on the balance sheet. Adjustments to carrying values are recorded as trading gains or losses. During 1998, the home equity lending business recorded a trading loss of $2.8 million compared with a trading loss of $2.0 million recorded in 1997. No adjustments were recorded in 1996. At the end of 1998, the home equity lending business owned rights to excess interest in five securitizations. The prepayment speeds, annual credit losses and discount rates used in the calculation of carrying value for these interest- only strips were as follows: Constant Annual Prepayment Credit Discount Pool (Product Type) Rate (CPR) Loss Rate ------------------------------------------------------------------------------- 1995-2 (Line of credit) 39% 1.00% 15% 1996-1 (Line of credit) 43 0.64 15 1996-1 (Fixed rate second mortgages) 51 0.64 15 1997-1 (Line of credit) 47 0.50 15 1997-1 (Fixed rate second mortgages) 46 0.50 15 1997-2 (Line of credit) 44 0.50 15 1997-2 (Fixed rate second mortgages) 41 0.50 15 1998-1 (Line of credit) 25 2.00 15 1998-1 (Fixed rate second mortgages) 27 0.50 15 1998-1 (Fixed rate first mortgages) 10 0.50 15 -------------------------------------------------------------------------------- A summary of assumptions in place at the end of 1998 and the two previous years follows: December 31, 1998 1997 1996 ---------------------------------------------------------------------------- CPR 10%-51% 30%-40% 26% Annual credit losses 0.50%-2.00% 0.50%-0.64% .050% Discount rate 15% 15% 15% Net Interest Income: Net interest income before loan loss provision was $4.8 million in 1998, compared to $7.1 million in 1997 and $7.8 million in 1996. Included in interest income is income earned on the interest-only strip, net of amortization expense, which amounted to $0.4 million in 1998 compared to $1.8 million in 1997 and $2.2 million in 1996. The decline resulted from increases in prepayment speed assumptions which caused the interest-only strip to amortize more quickly. Operating Expenses: (In thousands, except for number of employees) 1998 1997 1996 ------------------------------------------------------------------------------- Salaries and employee benefits $15,480 $11,175 $8,663 Marketing and development 5,314 2,731 2,462 Other 10,547 6,495 5,111 -------- ------- ------- Total operating expenses $31,341 $20,401 $16,236 ======== ======= ======= Number of employees at December 31, 266 189 159 -------------------------------------------------------------------------------- Operating expenses increased 53.6% from 1997 and 93.0% from 1996. The increase results from growth of this business as evidenced by the increase in loan production in 1998. Balance Sheet: The home equity lending business had $247.5 million of loans and loans held for sale at December 31, 1998, compared to $111.8 million at the end of 1997 and $118.2 million at the end of 1996. During 1998, the business changed the classification of the majority of loans on its balance sheet to "held for sale" to reflect better management's intent to securitize the loans. Loans held for sale are carried at the lower of cost or market value, with market value reflecting any expected loan losses. Loans that will not be securitized are still classified as portfolio loans. The loan loss allowance for portfolio loans totaled $39.4 thousand December 31, 1998, compared to $563.5 thousand at the end of 1997 and $589.4 thousand at the end of 1996. The decrease reflects the reduction of loans classified as portfolio loans. Credit Quality: (In thousands) 1998 1997 1996 -------------------------------------------------------------------------------- At December 31, Nonperforming assets $240 $535 $260 ======= ======= ======= Nonperforming assets as a percentage of total assets 0.08% 0.32% 0.18% ======= ======= ======= Allowance for loan losses $39 $564 $589 ======= ======= ======= Allowance for loan losses as a percentage of loans 0.50% 0.50% 0.50% ======= ======= ======= For the year ended December 31, Provision for loan losses $513 $1,404 $983 ======= ======= ======= Net charge-offs $- $335 $37 -------------------------------------------------------------------------------- 1999 Outlook: The change in the competitive environment for home equity lending that took place in the second half of 1998 altered the competitive landscape. There are fewer independent home equity lenders, and some that remain are weaker. In addition, management believes it is unlikely that there will be as many new entrants as there were in the previous two years. These factors should tend to reduce competitive pressure on this line of business. Offsetting these trends is consolidation which is producing larger competitors with access to significant resources. Management believes that its experience base and strategy will allow it to compete effectively. In addition, consumer demand for home equity loans is expected to remain high. A more stable interest rate environment, combined with new product features that include prepayment penalties, points, and fees, should reduce the speed at which its loans and interest in sold loans prepay. At year-end 1998, 40% of the company's servicing portfolio had prepayment fees, compared with 2% and 0% at the end of 1997 and 1996, respectively. The strategy for 1999 includes an increase in fee income, including loan origination and prepayment fees. The business will continue to explore new product market and distribution channel opportunities in order to increase loan volume in 1999. In addition, there will be a significant effort to improve operating efficiency and limit the growth of expenses. Employees: As of December 31, 1998, the home equity business employed 266 people. Total employment expense in 1998 was $15.5 million or 49.4% 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 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 P. Prosnitz Vice President--Legal Counsel Other Irwin Financial Businesses In the third quarter of 1998, the Corporation sold the majority of the assets of its equipment leasing line of business. This line of business consisted of small-ticket medical equipment leases. The decision to sell the assets was based on the conclusion that the medical equipment leasing operation would benefit strategically from being a part of a company with broader health care leasing activities. The sale excluded certain leases that the Corporation intends to sell at a future date. These leases totaled $4.4 million at December 31, 1998, net of a $600.0 thousand lease loss allowance. A summary of results for this line of business follows: (In thousands) 1998 1997 1996 -------------------------------------------------------------------------------- Net interest revenue $4,534 $4,809 $4,413 Provision for lease losses (1,941) (1,250) (791) Other income 602 713 418 ------- ------- ------- Total net revenues 3,195 4,272 4,040 Other expenses 3,686 4,121 4,181 ------- ------- ------- Income (loss) before gain on sale of assets (491) 151 (141) Gain on sale of assets 5,241 - - ------- ------- ------- Income before income taxes 4,750 151 (141) Income taxes 1,852 - - ------- ------- ------- Net income $2,898 $151 $(141) -------------------------------------------------------------------------------- The Corporation continues to investigate new opportunites in the equipment leasing industry and other niches in the financial services industry. The results of parent company and other subsidiary operations are summarized below: (In thousands) 1998 1997 1996 -------------------------------------------------------------------------------- Net revenues $24,806 $20,329 $15,494 Operating expenses (6,702) (6,030) (5,636) Tax credit 4,657 632 903 --------- --------- --------- 22,761 14,931 10,761 Eliminations (19,225) (14,762) (12,052) --------- --------- --------- Income before preferred securities distribution 3,536 169 (1,291) Preferred securities distribution (4,625) (4,473) - --------- --------- --------- Net income $(1,089) $(4,304) $(1,291) -------------------------------------------------------------------------------- Dividends from subsidiaries are recorded as parent company revenues but are eliminated in determining consolidated net income. Tax benefits resulting from the operating losses generated by the home equity line of business are recorded by the parent company. 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 $50.0 million of trust preferred securities through a trust created and controlled by the Corporation. Distributions to security holders totaled $4.6 million in 1998. See the section on capital for further discussion of the trust preferred securities. Consolidated Income Statement Analysis: Pre-tax income for 1998 totaled $50.9 million, up 20.6% from 1997 and 36.4% from 1996. The effective income tax rate was 40.0% in 1998, 42.0% in 1997, and 39.8% in 1996. Please see Note 18 of Notes to the Consolidated Financial Statements for more information on income taxes. The Corporation's return on average equity for 1998 was 22.84% compared to 19.80% in 1997 and 20.58% in 1996. The return on average assets was 1.85% in 1998 compared to 1.94% in 1997 and 1.95% in 1996. The Corporation has experienced a decline in its return on average assets in recent years. An important factor in the 1998 decline was that, because of capital market volatility in 1998, the Corporation did not securitize as great a percentage of its home equity loan production as it did in the previous year. As a result, the Corporation incurred production expenses without recognizing securitization revenues at levels similar to previous years. Additionally, these assets remained on the balance sheet throughout the year. Net interest revenue for 1998 totaled $63.2 million, up 15.2% from 1997 and 26.3% from 1996. The increase was due to increased lending volume at each of the lines of business. The net interest margin was 4.37% in 1998 compared to 4.95% in 1997 and 5.12% in 1996. The decline was primarily due to increased mortgage production activities which caused the Corporation to seek a greater proportion of its funding from more expensive sources than had been done in previous years. See page 68 for further analysis of the net interest margin. The following table sets forth, for the periods indicated, a summary of the changes in interest income and interest expense 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: 1998 Over 1997 1997 Over 1996 ------------------------------------------------------------------------------- (In thousands) Volume Rate Total Volume Rate Total ------------------------------------------------------------------------------- Interest Income: Loans and leases $1,562 $(5,747) $(4,185) $7,657 $(3,419) $4,238 Loans held for sale 26,051 4,419 30,470 4,429 (681) 3,748 Taxable investment securities (137) (3,013) (3,150) 921 (885) 36 Tax-exempt securities 96 (81) 15 (95) 29 (66) Interest-bearing deposits with financial institutions (85) (209) (294) 388 10 398 Federal funds sold 47 10 57 (631) 15 (616) ------- ------- ------- ------- -------- ------- Total 27,534 (4,621) 22,913 12,669 (4,931) 7,738 ------- ------- ------- ------- -------- ------- Interest Expense: Money market checking 199 4 203 (3) 75 72 Money market savings (82) (2) (84) (58) 10 (48) Regular savings (265) (124) (389) 7 21 28 Time deposits 3,856 (209) 3,647 2,148 31 2,179 Short-term borrowings 13,280 (2,020) 11,260 2,031 (358) 1,673 Long-term debt (35) 17 (18) (907) (40) (947) ------- ------- ------- ------- -------- ------- Total 16,953 (2,334) 14,619 3,218 (261) 2,957 ------- ------- ------- ------- -------- ------- Net interest revenue $10,581 $(2,287) $8,294 $9,451 $(4,670) $4,781 ------------------------------------------------------------------------------- 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 1998 was $6.0 million, down 3.9% from 1997 and up 31.7% from 1996. More information on this subject is contained in the section on credit risk. Other income increased 41.2% in 1998 to $243.7 million, compared to $172.6 million in 1997 and $150.0 million in 1996. The most significant increases came in the categories related to mortgage banking activities which were previously discussed on pages 29 through 32. Other expenses in 1998 totaled $245.4 million, up 40.6% from 1997 and 55.2% from 1996. The 1998 increase in consolidated other expense of $70.9 million was mostly due to operating expenses associated with higher mortgage and home equity loan production. Consolidated Balance Sheet Analysis: Total assets at year-end 1998 were $1.9 billion, up 30.0% from 1997 and 49.7% Sheet from 1996. 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 $1.7 billion in 1998, up 30.7% from 1997 and 43.3% from 1996. The increase is due to increased loans and loans held for sale as a result of the increased production activities throughout the Corporation. The Corporation's commercial loans are extended primarily to local regional businesses and to local farming operations. 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) and mortgage loans on commercial property. Loans by major category at the end of the last five years were as follows: Loans by Category: At December 31, (In thousands) 1998 1997 1996 1995 1994 ------------------------------------------------------------------------------- Commercial, financial, and agricultural $278,834 $212,095 $179,650 $150,312 $136,083 Real estate construction 97,253 73,279 48,991 36,126 21,960 Real estate mortgage 123,980 222,818 214,696 108,351 47,423 Consumer 51,730 39,985 38,371 67,756 55,323 Direct lease financing 6,375 78,079 62,372 60,979 58,348 Unearned income (1,181) (15,163) (11,030) (10,999) (10,726) -------- -------- -------- -------- -------- Total $556,991 $611,093 $533,050 $412,525 $308,411 ------------------------------------------------------------------------------- Maturity Distribution of Loans: After One But Within Within After At December 31, 1998 (In thousands) One Year Five Years Five Years Total --------------------------------------------------------------------------------------- Commercial, financial, and agricultural $77,727 $49,094 $152,013 $278,834 Real estate construction 97,253 - - 97,253 Real estate mortgage 30,265 40,559 53,156 123,980 Consumer loans 7,226 17,707 26,797 51,730 Direct lease financing 249 4,945 - 5,194 -------- Total $556,991 ======== Loans due after one year with: Fixed interest rates $172,694 Variable interest rates 171,577 -------- Total $344,271 -------------------------------------------------------------------------------- On average, trading and investment securities decreased $0.7 million in 1998 to $81.2 million. The carrying value of investments at December 31, 1998, includes $142.0 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, 1998 (In thousands) Year Years Years Years ------------------------------------------------------------------------------- U.S. Treasury and Government obligations $9,234 $6,513 - $18,507 Obligations of states and