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 political subdivisions 501 1,121 1,060 2,525 Mortgage-backed securities - 503 4,542 3,510 Other 39 - - - ------- ------- ------- ------- Total $9,774 $8,137 $5,602 $24,542 ======= ======= ======= ======= Weighted Average Yield: Held-to-maturity 6.82% 6.83% 7.53% 7.96% Available-for-sale - 6.74% 6.16% 6.86% -------------------------------------------------------------------------------- Average yield represents the weighted average yield to maturity. The yield on state and municipal obligations has been calculated on a fully taxable equivalent basis, assuming a 35% tax rate. Deposits averaged $878.6 million during 1998 compared to $691.8 million in 1997 and $632.2 million in 1996. Demand deposits were up 45.4% on average or $119.2 million from 1997. A significant portion of demand deposits is related to deposits at Irwin Union Bank which are associated with escrow accounts held on loans in the servicing portfolio of Irwin Mortgage. These escrow accounts averaged $342.4 million in 1998. Maturities of certificates of deposit of $100 thousand or more are set forth in the following table: At December 31, (In thousands) 1998 1997 1996 ------------------------------------------------------------------------------ Under 3 months $81,850 $60,379 $47,907 3 to 6 months 17,107 10,123 5,127 6 to 12 months 17,807 10,115 7,493 After 12 months 25,207 5,411 5,977 -------- -------- -------- Total $141,971 $86,028 $66,504 ------------------------------------------------------------------------------- Short-term borrowings averaged $568.8 million in 1998 compared to $365.0 million in 1997 and $334.3 million in 1996. The increase in 1998 is due to the increase in loan closings in 1998. The following table shows the distribution of the Corporation's short-term borrowings and the weighted average rates at the end of each of the last three years. Also provided are the maximum amount of borrowings and the average amounts of borrowings as well as weighted average interest rates for the last three years. Repurchase Agreements &Drafts Federal Payable Home Related to Loan Bank Mortgage Borrowings Lines Loan Commercial & Federal of (In thousands) Closings Paper Funds Credit ----------------------------------------------------------------------------- Year Ended 1998 $172,126 $26,617 $266,000 $180,118 December 31: 1997 240,659 16,375 142,650 112,591 1996 264,998 17,175 74,118 105,575 Weighted average 1998 5.43% 5.78% 4.93% 6.01% interest rates at 1997 5.88 6.00 6.18 6.87 year-end: 1996 6.45 5.95 5.80 6.68 Maximum amount 1998 $301,849 $26,691 $316,200 $249,519 outstanding at any 1997 274,363 16,375 142,650 151,111 month's end: 1996 270,516 27,214 121,000 135,442 Average amount 1998 $218,342 $26,166 $115,479 $208,785 outstanding during 1997 237,953 12,738 48,823 65,490 the year: 1996 218,810 23,794 44,139 47,561 Weighted average 1998 5.84% 6.05% 5.63% 6.20% interest rate during 1997 5.82 6.01 6.00 6.65 the year: 1996 5.66 6.02 5.80 6.80 -------------------------------------------------------------------------------- Capital: Shareholders' equity averaged $133.6 million in 1998, up 8.2% from 1997 and 22.6% from 1996. Year-end shareholders' equity of $145.2 million represented book value per share of $6.70 compared to $5.82 and $5.23 at December 31, 1997 and 1996, respectively. Prior to the adoption of a new mortgage banking accounting standard in the second quarter of 1995, mortgage banking accounting did not allow the full value of mortgage servicing rights to be reflected on the balance sheet. Since a portion of the Corporation's mortgage servicing portfolio was generated prior to the adoption of the new accounting standard, it represents economic value which is not recorded on the balance sheet. The following table demonstrates the estimated after-tax value of the servicing portfolio at December 31: (In thousands) 1998 1997 1996 ------------------------------------------------------------------------------- Total loans serviced $11,242,470 $10,713,549 $10,810,988 ----------- ----------- ----------- Value (@ 1.3% in 1998 and 1.5% in 1997 and 1996) $146,152 $160,703 $162,165 Less capitalized servicing 113,130 81,610 71,715 Tax liability (@ 40%) 13,209 31,637 36,180 ----------- ----------- ----------- Net value $19,813 $47,456 $54,270 =========== =========== =========== Per share of common stock $0.91 $2.16 $2.39 -------------------------------------------------------------------------------- With the implementation of the new accounting standard in 1995, this off-balance sheet value will decline over future years and eventually be reduced to zero. Total book value per share, including the value of the servicing portfolio, was $7.61 at December 31, 1998 compared with $7.98 and $7.62 at December 31, 1997 and 1996, respectively. Capital is a major focus of regulatory attention, with both book and risk-based capital standards used as capital adequacy measures. Unless an institution has adequate capital in the opinion of the regulators, they may withhold approval for new activities or force additions to capital. Therefore, the Corporation considers both the regulators' viewpoint and its own analysis of the capital structure and leverage amounts that are consistent with underlying business risks. (In thousands) 1998 1997 1996 -------------------------------------------------------------------------------- Tier 1 capital $191,806 $169,366 $117,416 Tier 2 capital 11,505 16,170 6,594 ----------- ----------- ----------- Total risk-based capital $203,311 $185,536 $124,010 =========== =========== =========== Risk-weighted assets $1,649,227 $1,249,385 $962,459 =========== =========== =========== Risk-based ratios: Tier 1 capital 11.63% 13.56% 12.20% Total capital 12.25 14.85 12.88 Tier 1 leverage ratio 10.51 12.06 9.84 Ending shareholders' equity to assets 7.46 8.55 9.15 Average shareholders' equity to assets 8.09 9.78 9.46 ------------------------------------------------------------------------------ At year-end 1998, the Corporation's total risk-adjusted capital ratio was 12.25% compared to 10.0% which is required in order to be considered well capitalized by the regulators. The Corporation's ending equity to assets ratio for 1998 was 7.46%. However, as previously discussed, temporary conditions which existed at year end make the average balance sheet ratio a more accurate measure of capital. The Corporation's average equity to assets for 1998 was 8.09%. In January 1997, the Corporation issued $50.0 million of trust preferred securities through a trust created and controlled by the Corporation. The securities, which are publicly traded, were issued at $25 per share with a cumulative dividend rate of 9.25%, payable quarterly. They have an initial maturity of 30 years with a 19-year extension option which the Corporation can exercise at any point during the first 30 years. The securities are callable at par after five years, or immediately, in the event of an adverse tax development affecting the Corporation's classification of the securities for federal income tax purposes. The securities are not convertible into common stock of the Corporation. Stock Prices and Dividends: The common stock of Irwin Financial is quoted on the National Association of Securities Dealers Automated Quotation System National Market System (NASDAQ-NMS- trading symbol, IRWN). The following table sets forth certain information regarding trading in, and cash dividends paid with respect to, the shares of the Corporation's common stock in each quarter of the three most recent calendar years. Total Quarter Cash Dividends 1996 *High *Low *End *Dividends *For Year -------------------------------------------------------------------------------- First quarter $11 3/8 $9 7/8 $11 $0.030 Second quarter 11 1/8 9 4/5 9 4/5 0.030 Third quarter 10 4/5 9 10 5/8 0.030 Fourth quarter 12 3/8 10 5/8 12 3/8 0.030 $0.12 1997 -------------------------------------------------------------------------------- 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 5/8 0.035 Fourth quarter 21 1/2 18 1/4 21 0.035 $0.14 1998 -------------------------------------------------------------------------------- First quarter $28 1/4 $19 1/2 $28 1/8 $0.040 Second quarter 30 25 1/8 29 0.040 Third quarter 37 20 1/2 24 5/8 0.040 Fourth quarter 31 20 1/8 27 1/5 0.040 $0.16 *Adjusted for December 31, 1996, and May 27, 1998, two- for-one stock splits. The Corporation expects to continue its policy of paying regular cash dividends, although there is no assurance as to future dividends because they are dependent on future earnings, capital requirements, and financial condition. On February 24, 1999, the Corporation's Board of Directors approved an increase in the first quarter dividend to $0.05 per share, payable in March 1999. Risk Management: As a financial intermediary, Irwin Financial Corporation is engaged in businesses which involve the assumption of financial risks including: - Credit risk - Liquidity risk - Interest rate risk Each line of business that assumes financial risk uses a formal process to manage this risk. In all cases, the objectives are to ensure that risk is contained within prudent levels and that the Corporation is adequately compensated for the level of risk assumed. The Chairman, the President, and the Chief Financial Officer of the parent company participate in each subsidiary's risk management process. Credit Risk: The assumption of credit risk is a key source of earnings for the community banking and home equity lending lines of business. In addition, the mortgage banking business assumes some credit risk despite the fact that its mortgages are typically insured. The credit risk in the loan portfolios of the community bank and the home equity lending business has the most potential to have a significant effect on consolidated financial performance. The community bank and home equity lending business manage credit risk through the use of lending policies, credit analysis and approval procedures, periodic loan reviews, and personal contact with borrowers. Loans over a certain size are reviewed by a loan committee prior to approval. An allowance for loan losses is established as an estimate of the probable credit losses on the loans held by the Corporation. A specific allowance is determined by evaluating those loans which are either substandard or have the potential to become substandard. In general, commerical loans, mortgage loans, and leases are evaluated individually. Consumer loans, including home equity loans, are generally evaluated as a group. A specific allowance is set at a level which management considers sufficient to cover probable losses on these loans. A general allowance is determined by analyzing historical loss experience by loan type and then adjusting these loss factors for current conditions not reflected in prior experience. The allowance for loan losses is an estimate which is based on management's judgement combined with a quantitative process of evaluation and analysis. Loans and leases that are determined by management to be uncollectible are charged against the allowance. The allowance is increased by provisions against income and recoveries of loans and leases previously charged off. The table on page 60 analyzes the consolidated allowance for loan and lease losses over the past five years. Net charge-offs in 1998 were $1.9 million, down 25.5% from 1997 and up 9.1% from 1996. The ratio of net charge- offs to average loans and leases was 0.33% compared to 0.46% in 1997 and 0.36% in 1996. The provision for loan and lease losses was $6.0 million, 308.5% of net charge-offs. The coverage ratio was 239.3% in 1997 and 255.6% in 1996. At year end, the allowance for loan losses was 1.78% of outstanding loans and leases compared to 1.44% in 1997 and 1.29% in 1996. This increase in the allowance for loan losses is the result of an increase in nonperforming loans experienced in 1998. Total nonperforming loans and leases at year end were $11.9 million compared to $7.7 million at the end of 1997 and $7.2 million at the end of 1996. Nonperforming loans and leases as a percent of total loans and leases were 2.13% at year-end 1998 compared to 1.26% in 1997 and 1.35% in 1996. Other real estate owned totaled $3.5 million at December 31, 1998, up from $1.8 million in 1997 and $2.2 in 1996. Total nonperforming assets were $15.4 million or 0.79% of total assets at December 31, 1998, as compared to $9.5 million or 0.64% at year-end 1997 and $9.4 million or 0.72% at the end of 1996. The increase in nonperforming assets occurred primarily at the Corporation's mortgage banking line of business as previously discussed on page 33. Analysis of Allowance for Loan and Lease Losses (In Thousands) 1998 1997 1996 1995 1994 -------------------------------------------------------------------------------- Loans and leases outstanding at end of period, net of unearned income $556,991 $611,093 $533,050 $412,525 $308,411 ======== ========= ======== ======== ======== Average loans and leases for the period, net of unearned income $585,025 $569,325 $496,729 $369,220 $279,389 ======== ========= ======== ======== ======== Allowance Balance beginning of period $8,812 $6,875 $5,033 $4,174 $3,293 for loan and lease losses: Charge-offs: Commercial, financial, and agricultural loans 246 800 495 845 266 Real estate mortgage loans 232 356 37 2 - Consumer loans 761 734 959 953 543 Lease financing 1,263 1,255 883 690 757 -------- -------- -------- -------- -------- Total charge-offs 2,502 3,145 2,374 2,490 1,566 -------- -------- -------- -------- -------- Recoveries: Commercial, financial, and agricultural loans 14 32 133 2 34 Real estate mortgage loans - 1 - - - Consumer loans 362 246 214 197 180 Lease financing 183 259 246 191 195 -------- -------- -------- -------- -------- Total recoveries 559 538 593 390 409 -------- -------- -------- -------- -------- Net charge-offs (1,943) (2,607) (1,781) (2,100) (1,157) Reduction due to sale of loans (2,976) (1,694) (930) (239) - Provision charged to expense 5,995 6,238 4,553 3,198 2,038 -------- -------- -------- -------- -------- Balance end of period $9,888 $8,812 $6,875 $5,033 $4,174 ======== ========= ======== ======== ======== Allowance for By category of loans and leases loan and Commercial, financial, and lease losses: agricultural loans $5,899 $5,118 $3,676 $2,349 $2,586 Real estate mortgage loans 2,774 2,170 281 413 311 Consumer loans 615 446 1,974 1,420 767 Lease financing 600 1,078 944 851 510 -------- -------- -------- -------- -------- Total $9,888 $8,812 $6,875 $5,033 $4,174 ======== ========= ======== ======== ======== Ratios: Net charge-offs to average loans and leases 0.33% 0.46% 0.36% 0.57% 0.41% Allowance for possible loan losses to average loans and leases 1.69% 1.55% 1.38% 1.36% 1.38% Allowance for possible loan losses to loans and leases outstanding 1.78% 1.44% 1.29% 1.22% 1.25% -------------------------------------------------------------------------------- Nonperforming Assets (In thousands) 1998 1997 1996 1995 1994 -------------------------------------------------------------------------------- Accruing loans past due 90 days or more: Commercial, financial, and agricultural loans $252 $382 $256 $418 $113 Real estate mortgages 291 534 234 - - Consumer loans 89 86 205 202 93 -------- -------- ---------------- -------- 632 1,002 695 620 206 -------- -------- ---------------- -------- Nonaccrual loans and Commercial, financial, and leases: agricultural loans 1,052 777 2,739 670 1,523 Real estate mortgages 9,570 5,333 2,481 848 947 Consumer loans 174 63 - - - Lease financing receivables 426 506 1,261 415 363 -------- -------- ---------------- -------- 11,222 6,679 6,481 1,933 2,833 -------- -------- ---------------- -------- Total nonperforming loans and leases 11,854 7,681 7,176 2,553 3,039 -------- -------- ---------------- -------- Other real estate owned 3,506 1,828 2,239 295 489 -------- -------- ---------------- -------- Total nonperforming assets $15,360 $9,509 $9,415 $2,848 $3,528 ======== ======== ================ ======== Nonperforming loans and leases to total loans and leases 2.13% 1.26% 1.35% 0.62% 0.90% ======== ======== ================ ======== Nonperforming assets to total assets 0.79% 0.64% 0.72% 0.27% 0.50% -------------------------------------------------------------------------------- Loans which are past due 90 days or more are placed on nonaccrual status unless, in management's opinion, there is sufficient collateral value to offset both principal and interest. Renegotiated and Nonaccrual Loans (In thousands) 1998 1997 1996 ------------------------------------------------------------------------------- Interest which would have been recorded under original terms Renegotiated $- $- $- Nonaccrual 323 302 356 ----- ----- ----- 323 302 356 ----- ----- ----- Interest income actually recorded Renegotiated - - - Nonaccrual 47 36 150 ----- ----- ----- 47 36 150 ----- ----- ----- Reduction in interest income $276 $266 $206 -------------------------------------------------------------------------------- No loan concentrations existed of more than 10% of total loans to borrowers engaged in similar activities that would be similarly affected by economic or other conditions. Generally, the accrual of income is discontinued when the full collection of principal or interest is in doubt, or when the payment of principal or interest has become contractually 90 days past due unless the obligation is both well secured and in the process of collection. Liquidity: Liquidity is the availability of funds to meet the daily requirements of the business. For financial institutions, demand for funds comes principally from extensions of credit and withdrawal of deposits. Liquidity is provided by asset maturities or sales and through short-term borrowings. The objectives of liquidity management are to ensure that funds will be available to meet demands and that funds are available at a reasonable cost. As with other forms of financial risk, liquidity is managed separately at each of the Corporation's lines of business. Since loans are less marketable than securities, the ratio of total loans to total deposits is the traditional measure of liquidity for banks and bank holding companies. At year-end 1998, this ratio stood at 55.2%. The Corporation is able to maintain this position of high liquidity without a substantial sacrifice in the form of a lower net interest margin due to the position in mortgage loans held for sale. These loans carry an interest rate equal to the current market rate for mortgage loans. However, liquidity is significantly improved since nearly all mortgage loans held for sale are in the process of being securitized and sold. The holding period for an individual loan typically does not exceed 90 days. Interest Rate Risk: Interest rate risk refers to the potential for changes in market rates of interest to cause changes in net interest income and in the market value of assets and liabilities. The Asset-Liability Management Committee of the community bank monitors the repricing structure of both assets and liabilities over various time horizons. Exposure to changes in interest rates is evaluated by modeling the repricing characteristics of the community bank's portfolio under multiple rate scenarios. Rate sensitivity at the community bank can typically be managed by controlling the maturity of loans, securities, and deposits. The community bank may also use financial futures or interest rate swaps from time to time. Formal policies approved by the community bank's Board of Directors ensure that exposure to changes in net interest revenues is maintained within acceptable levels. The mortgage banking business assumes a form of interest rate 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 match-fund 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 Corporation uses internal hedges to allow for the risk characteristics of one line of business to offset those of another line. The following table shows in summary form the Corporation's interest rate sensitivity based on expected interest rate repricing intervals for the balance sheet as of December 31, 1998, (a "gap" analysis). Fixed rate assets and liabilities are analyzed based on their expected maturities which reflect estimated prepayment characteristics, rather than their maximum contractual maturities. For example, the majority of 30-year adjustable rate residential mortgages held in the portfolio of Irwin Union Bank are included in the "3 months to 1 year" category since that is the time frame over which the assets will reprice. Some items, such as certain deposit accounts, especially those associated with the escrows on mortgage servicing assets, are non-interest bearing, but will vary in balance due to interest rate changes. Since the Corporation relies on such accounts in its operations and would need to replace them with "at market" liabilities should the non-interest bearing ones be unavailable, they are included in the gap table and in simulations based on their expected maturities over interest rate cycles. As the table shows, the consolidated one-year gap at December 31, 1998, was a positive $135.0 million. This compares to a positive gap of $143.0 million at December 31, 1997. Interest Sensitivity Within 3 Months 1 to 5 Over 5 (In thousands) 3 Months to 1 Year Years Years Total ------------------------------------------------------------------------------ Assets: Interest-bearing deposits with banks $17,472 $772 $197 $- $18,441 Federal funds sold 8,580 - - - 8,580 Taxable investment securities and trading assets 42,839 16,538 12,528 3,091 74,996 Tax-exempt investment securities - 500 832 3,875 5,207 Loans held for sale 734,481 50,639 103,016 48,652 936,788 Loans, net of unearned income 328,301 19,624 99,572 109,494 556,991 --------- --------- --------- --------- --------- Total interest-earning assets 1,131,673 88,073 216,145 165,112 1,601,003 --------- --------- --------- --------- --------- Liabilities: Non-interest bearing deposits 16,492 41,398 190,178 229,656 477,724 Money market checking 47,349 - 53,888 14,138 115,375 Money market savings 1,685 - 5,539 - 7,224 Regular savings 21,242 1,835 9,785 7,560 40,422 Time deposits 221,551 90,097 56,430 388 368,466 Short-term borrowings 516,428 126,649 1,784 - 644,861 Long-term debt - - 2,839 50,000 52,839 --------- --------- --------- --------- --------- Total interest-bearing liabilities 824,747 259,979 320,443 301,742 1,706,911 Interest rate swaps - - - - - --------- --------- --------- --------- --------- Interest sensitivity gap 306,926 (171,906) (104,298) (136,630) (105,908) --------- --------- --------- --------- --------- Cumulative interest sensitivity gap $306,926 $135,020 $30,722 $(105,908) $(105,908) ------------------------------------------------------------------------------- Since the gap was positive at December 31, 1998, it means that the Corporation's net interest income was positioned to benefit from rising rates, or to be harmed by declining rates. While traditional interest rate risk focuses on the changes in net interest income due to interest rate changes, the Corporation engages in other activities which are also affected by interest rate changes. Principal among these are mortgage loan origination and servicing. Through the use of simulations using regression modeling, option-adjusted valuation techniques for estimating expected customer behavior, and Monte-Carlo based cash flow simulation, the Corporation attempts to analyze and mitigate total interest rate risk, that 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 Corporation'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. Present Value (In thousands) December 31, 1998 -2% -1% Current +1% +2% -------------------------------------------------------------------------------- Interest Sensitive Assets: Interest-bearing deposits with banks $18,528 $18,512 $18,495 $18,479 $18,463 Federal funds sold 8,651 8,651 8,651 8,651 8,651 Taxable investment securities 80,556 78,210 76,873 76,069 75,554 Tax-exempt investment securities 5,727 5,513 5,309 5,115 4,930 Loans held for sale 974,732 970,182 965,055 959,305 952,905 Mortgage servicing rights 41,930 77,595 117,728 152,402 174,714 Loans, net of unearned income 624,196 612,499 601,338 591,228 581,262 --------- --------- --------- --------- --------- Total Interest Sensitive Assets 1,754,320 1,771,162 1,793,449 1,811,249 1,816,479 --------- --------- --------- --------- --------- Interest Sensitive Liabilities: Non-interest bearing deposits 486,091 483,042 480,168 477,458 474,898 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 sensitive liabilities 1,718,077 1,706,072 1,695,506 1,686,121 1,677,725 --------- --------- --------- --------- --------- Interest sensitive off-balance sheet items 14,423 13,690 5,347 1,027 1,484 --------- --------- --------- --------- --------- Net sensitivity as of December 31, 1998 $50,666 $78,780 $103,290 $126,155 $140,238 ========= ========= ========= ========= ========= Potential change $(52,624) $(24,510) $- $22,865 $36,948 ========= ========= ========= ========= ========= Net sensitivity as of December 31, 1997 $(12,165) $6,895 $28,911 $47,188 $55,873 ========= ========= ========= ========= ========= Potential change $(41,076) $(22,016) $- $18,277 $26,962 ------------------------------------------------------------------------------ As previously noted, the analysis is based on discounted cash flows over the remaining estimated lives of the financial instruments. The total measurement of the Corporation's exposure to interest rate risk as presented in the 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 Corporation, designed in part to further mitigate the effect on the value of, and the net earnings generated from, the Corporation'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 Corporation'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 Corporation 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 Corporation would be the change in mortgage loan production and the earnings stream the Corporation derives therefrom. Derivative Financial Instruments: The Corporation manages its interest rate risk on mortgage loans held for sale using mandatory commitments to sell the loans at a future date. Changes in the economic value of mortgage servicing assets are offset using options on treasury futures. At December 31, 1998, these options had a fair value of $4.8 million and a net notional amount (which does not represent the amount at risk) of $0, consisting of $750.0 million of long positions and $750.0 million of short positions. Changes in the value of interest-only strips are offset using interest rate caps which had a fair value of $540.1 thousand at December 31, 1998, and a notional amount of $65.6 million. Options on treasury futures and interest rate caps are classified as trading assets on the balance sheet and carried at their market values. Adjustments to market values are recorded as net trading gains or losses on the income statement. In 1998, the Corporation recorded $4.2 million of net trading gains related to these derivative products. No gains or losses were reported in 1997. Daily Average Consolidated Balance Sheet, Interest Rates and Interest Differential For the year ended December 31, 1998 Average Yield/ (In thousands) Balance Interest Rate -------------------------------------------------------------------------------- Assets: Interest-earning assets: Interest-bearing deposits with banks $15,462 $707 4.57% Federal funds sold 13,317 731 5.49 Taxable investment securities 75,908 3,159 4.16 Tax-exempt investment securities (1) 5,291 453 8.56 Loans held for sale 758,640 65,160 8.59 Loans and leases, net of unearned income (1) (2) 585,025 52,444 8.96 --------- -------- ------ Total interest-earning assets 1,453,643 122,654 8.44% --------- -------- ====== Noninterest-earning assets: Cash and due from banks 50,754 Premises and equipment, net 18,944 Other assets 135,693 Less allowance for possible loan and lease losses (8,650) ---------- Total assets $1,650,384 ========== Liabilities and Shareholders' Equity: Interest-bearing liabilities: Money market checking $89,158 $1,845 2.07% Money market savings 7,281 197 2.70 Regular savings 45,414 1,500 3.30 Time deposits 355,431 19,798 5.57 Short-term borrowings 568,772 35,048 6.16 Long-term debt 10,245 814 7.94 --------- -------- ------ Total interest-bearing liabilities 1,076,301 59,202 5.50% --------- -------- ====== Noninterest-bearing Demand deposits 381,343 liabilities: Other liabilities 59,177 Shareholders' equity 133,563 ---------- Total liabilities and shareholders' equity $1,650,384 ========== Net interest income $63,452 ======== Net interest income to average interest-earning assets 4.37% ------------------------------------------------------------------------------- Notes: (1) Interest is reported on a fully taxable equivalent basis. The prevailing federal income tax rate was 35% in 1998 and 1997 and 34.5% in 1996. (2) For purposes of these computations, nonaccrual loans are included in daily average loan amounts outstanding. 1997 1996 -------------------------------------------------------------------------------- Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate $16,887 $1,001 5.93% $10,282 $603 5.87% 12,454 674 5.41 24,370 1,290 5.29 77,590 6,309 8.13 67,654 6,273 9.27 4,336 438 10.10 5,348 504 9.43 433,275 34,691 8.01 379,027 30,943 8.16 569,325 56,629 9.95 496,729 52,391 10.55 --------- ----------- ------- ---------- ------- ------- 1,113,867 99,742 8.95% 983,410 92,004 9.36% --------- ----------- ======= ---------- ------- ======= 34,347 38,309 18,568 17,425 103,682 118,115 (7,750) (5,724) --------- ---------- $1,262,714 $1,151,535 ========== ========== $79,549 $1,643 2.07% $79,704 $1,571 1.97% 10,267 280 2.73 12,455 328 2.63 52,843 1,889 3.57 52,657 1,861 3.53 286,934 16,151 5.63 248,694 13,972 5.62 365,005 23,788 6.52 334,304 22,115 6.62 10,698 831 7.77 21,840 1,778 8.14 --------- ----------- ------- ---------- ------- ------- 805,296 44,582 5.54% 749,654 41,625 5.55% --------- ----------- ======= ---------- ------- ======= 262,190 238,673 71,745 54,238 123,483 108,970 --------- ---------- $1,262,714 $1,151,535 ========= ========== $55,160 $50,379 =========== ======= 4.95% 5.12% ---------------------------------------------------------------------------- Year 2000 Readiness: The Corporation is actively addressing its exposure to the Year 2000 issue and has four teams focusing on the issue (one at each of its three principal operating entities and at the parent company). The Corporation has developed a seven-stage project plan to achieve Year 2000 readiness by June 30, 1999 that includes: (i) an awareness campaign throughout the Corporation to raise the level of importance and attention beyond that of a typical "information technology" issue; (ii) assessment of the Corporation's Year 2000 problem, including contract review, a technical audit and an estimation of remediation costs; (iii) remediation of non-compliant systems through repairs, upgrades or replacements of computer programs and chips; (iv) testing of the Corporation's systems for Year 2000 compliance; (v) development of contingency plans to continue processes in the event of Year 2000 readiness failure by the Corporation or parties on whom it is dependent; (vi) implementation of the remediated systems; and (vii) auditing after January 1, 2000, of the completed processes for post-Year 2000 compliance. The Corporation has engaged a leading technology consulting firm to increase its level of confidence that the methods and standards it employs to address the Year 2000 issue are appropriate and comprehensive. The entire project is overseen by a Year 2000 Steering Committee which includes the Corporation's Chairman, President, and those in charge of Information Technology (IT) at each entity. Scope: The Corporation has developed a technology strategy that primarily uses systems developed by third parties and has very few internally developed applications. Consequently, the Corporation's principal focus is on assuring Year 2000 compliance from its commercial application vendors and other third-party service providers. In those instances where the Corporation believes a vendor may not be compliant in a timely manner, the Corporation is taking additional steps to address its needs with alternative systems, including replacement of existing vendor's systems. The project plan has addressed computer hardware and software as well as environmental systems used in the Corporation's work places to address readiness of both direct and indirect process support systems (i.e., IT and non-IT systems). An initial step in the implementation of the Year 2000 methodology involved the identification of all possible technologies that utilize date logic. To ensure completeness, the Corporation provided education and awareness to affected stakeholders. Once this step was completed, the Corporation engaged in a comprehensive inventory to identify technologies that utilize date logic by both business process and critical need. Progress: The Corporation is currently in varying stages of the remediation, testing, implementation, and contingency planning steps of its project and is generally on target to meet the milestones necessary to achieve Year 2000 readiness by June 30, 1999. However, as noted in the graphs below which illustrate current project progress against the work plan for each of the Corporation's principal entities, there have been delays in the testing phase of the project. In general, this is the result of delays brought upon by reliance on third parties who are late in their delivery of remediated programs and/or test documentation. The Corporation is paying close attention to this issue as it is approaching the point where it would not have time to change vendors if these issues are not resolved. When certain elements of the project plan are unexpectedly delayed (such as testing which is dependent on remediation efforts), the Corporation has accelerated progress on other areas of the project. For example, for certain systems, testing is behind schedule while for other systems implementation is ahead of schedule. Costs: The Year 2000 project has required a reallocation of business resources from other areas of the Corporation. However, to date, the consolidated cost of the project has not been material to the overall financial results of operations, liquidity, or capital, nor does the Corporation believe it will be material throughout the duration of the project. Additionally, the Corporation does not believe that the reallocation of resources necessary to address the Year 2000 issue has resulted in a material adverse change in the Corporation's ability to address other information technology projects critical to the Corporation's growth. The Corporation has incurred and expensed approximately $1.5 million pre- tax on the Year 2000 project since its inception. These costs have been funded through operating cash flows. The total cost of the project over the period 1997 to 2000 is anticipated to be in the range of $3.3 million pre- tax, excluding incentive stock-based compensation valued at approximately $311 thousand at the time of grant. The Corporation cannot guarantee that the current estimate of $3.3 million will be adequate to complete the project. If the costs increase significantly beyond the current estimate, they could have a material adverse effect on the Corporation's financial results. The graph below illustrates the amounts expensed on the project to date (excluding the cost of options which are not expensed under GAAP) and on a pro forma basis through 1999 and contains forward-looking estimates. Graph: Consolidated Project Expense (In millions (Pre-tax)) 1997--Actual $ 119 1998--Actual 1340 1999 * 1,863 * Estimate as of December 31, 1998. Risks: Financial services require exact calculations and prompt delivery. If the Corporation's products are not accurate and timely, there is increased exposure to risks such as client service failure, regulatory compliance problems and disruption of third party operations. The Corporation expects to implement the necessary changes to ensure that its internal operations are Year 2000 compliant prior to December 31, 1999. To achieve this goal, the Corporation is reliant upon its information system vendors to provide Year 2000 compliant systems sufficiently before December 31, 1999, to allow ample time to test the systems. The Corporation cannot guarantee that all of its key suppliers will achieve Year 2000 compliance in a timely manner. The failure of the Corporation's vendors to successfully address the Year 2000 issue in a timely manner could have a materially adverse effect on the Corporation's ability to successfully address its Year 2000 issue. Certain of the Corporation's vendors are already late in delivering remediated programs or test documentation. In addition, if the Year 2000 issue adversely affects the Corporation's customers, there could be a material adverse effect on the Corporation's ability to collect and service outstanding loans. Finally, even if the Corporation's internal operations and customers are Year 2000 compliant, the Corporation's operations can be materially adversely affected if agencies and third parties with which the Corporation interacts fail to address the Year 2000 issue successfully. Contingency Plans: The Corporation has not completed its assessment of the probability or cost of potential Year 2000 system failures, nor has it completed step five of its project plan, contingency planning. Therefore, it is difficult at this time to accurately estimate the cost to the Corporation of Year 2000 failures by third parties or the Corporation itself. Any of the failures mentioned above could have a material adverse effect on the financial condition and results of operations of the Corporation. Additional detail on the Year 2000 project at the Corporation's parent company and each of its principal subsidiaries is shown below. Irwin Financial Corporation (parent company) The operations of the parent company largely are intended to further the Corporation's strategic development, allocation of capital, planning for entering or exiting lines of business, certain support services for its operating companies, and external relations. There are few direct, ongoing revenue- producing interactions with end customers of the Corporation. Nonetheless, the services of the parent company are of sufficient size and importance to the overall condition of the Corporation that a separate project team is in place to assure Year 2000 readiness of its systems and operating environment. Scope: As with the Corporation's overall project plan, the parent company's plan included an assessment of computer hardware and software as well as environmental systems. The principal risk of failure to be Year 2000 compliant at the parent company lies in the failure or delay in providing its services to its constituents in a timely manner. In most cases, such failure would lead to increases in expenses, rather than in ultimate failure to deliver the service. Like the other units of the Corporation, the parent company has developed a technology strategy that primarily uses systems developed by third parties and has very few internally developed applications. Consequently, the parent company's principal focus is on assuring Year 2000 compliance from its commercial application vendors and other third-party service providers. Progress: The progress of this team in meeting the seven-stage requirements of its project plan to achieve Year 2000 readiness by June 30, 1999 is shown on the next page. Graph: Irwin Financial Parent Project Plan Status As of December 31, 1998 (Percent Completed) Projected Actual Target Completion * Actual Completion Completion Date Post-2000 Audit 0 0 During 2000 and 2001 Implementation 50 50 2Q99 Contingency Planning 10 10 On-going Testing 85 80 1Q99 Remediation 100 100 Done Assessment 100 100 Done Awareness 100 100 Done * Target is original plan to achieve Year 2000 Readiness by June 30, 1999. Costs: The parent company has expended approximately $136 thousand pre-tax since inception on the Year 2000 project. The graph below indicates the amounts expensed on the project to date and on a pro forma basis through 1999. Graph: Irwin Financial Parent Project Expenses (In millions (Pre-tax)) 1997--Actual $33 1998--Actual 103 1999 * 115 * Estimate as of December 31, 1998. Risks: The consequence of failure to achieve Year 2000 compliance at the parent company is likely to be increased labor expense as certain automated procedures are performed with additional human intervention. If such failures caused the parent company to miss deadlines for required filings, the company could face fines or penalties for late reporting of regulatory items. The company does not believe these risks pose a material monetary risk. Contingency Plans: At this time the parent company cannot accurately estimate the exact manner in which it would address likely worst case scenarios, nor the financial or operational impact of such scenarios. Irwin Mortgage Corporation Irwin Mortgage Corporation (IMC) is principally engaged in the business of originating, selling, and servicing mortgage loans. Its net income is dependent on information technology and support systems which allow the efficient production and servicing of loans. Scope: IMC has had teams addressing Year 2000 readiness since August of 1997, and it has adopted the same seven- phase plan to achieve readiness used by the Corporation as discussed above. IMC participates with the Corporation's Steering Committee and has specific internal personnel whose time is dedicated solely to the Year 2000 project. In addition, IMC has partnered with the local office of a national IT consulting firm that has assisted with staff augmentation and technical expertise in the areas of code renovation and testing applications. IMC has kept abreast of Year 2000 issues by participating in local Year 2000 user groups and national Year 2000 seminars. IMC is dependent on third parties in three principal areas. 1. IMC has developed a technology strategy that primarily uses systems developed by third parties and has very few internally developed applications. 2. IMC depends on several key business partners to successfully conduct operations (e.g., government sponsored enterprises, investors, title companies, mortgage brokers). 3. IMC needs a properly operating infrastructure (i.e. power, communications, transportation) in order to effectively conduct business. Consequently, IMC is focusing its Year 2000 readiness efforts on working with each of these groups. As with the Corporation's overall project plan, IMC's plan includes computer hardware, software, and environmental systems. IMC owns none of the properties in which it conducts business, so the principal focus of the environmental systems review has been to work with the management companies of the facilities it leases. Additionally, the company has worked with various user groups to address the Year 2000 issue with public service providers on which it depends. Progress: At present, IMC is generally on schedule with its existing plan to achieve Year 2000 readiness by June 30, 1999. The first three phases of the plan (awareness, assessment, and renovation) have been completed. Graph: Irwin Mortgage Project Plan Status As of December 31, 1998 (Percent Completed) Projected Actual Target Completion * Actual Completion Completion Date Post-2000 Audit 0 0 During 2000 and 2001 Implementation 50 80 2Q99 Contingency Planning 10 20 On-going Testing 75 65 1Q99 Remediation 100 100 Done Assessment 100 100 Done Awareness 100 100 Done * Target is original plan to achieve Year 2000 readiness by June 30,1999. Costs: IMC has expended approximately $1.1 million pre-tax since inception on the Year 2000 project. The graph below indicates the amounts expensed in the project to date and on a pro forma basis through 1999. Graph: Irwin Mortgage Project Expenses (In millions (Pre-tax)) 1997--Actual $40 1998--Actual 1,046 1999 * 1,370 * Estimate as of December 31, 1998. Risks: Failure to be Year 2000 compliant could cause the malfunctioning of the loan origination or servicing systems. If there were a failure within the loan origination system that prevented IMC from closing mortgage loans, the company could be adversely affected through delayed or failed loan closings. This failure would reduce current revenues and/or would increase the cost to originate loans as more processes are performed with alternative, less efficient processes. The company intends to develop contingency plans which should allow a certain amount of production to continue, thus mitigating the loss of revenues. Another risk to the company could involve a failure of one or more components in the loan servicing system. The loan servicing system is a high-volume, transactional system that makes logic decisions based on dates (both current and future). For example, if the payment posting module of the system fails, the company may be unable to remit payments and information to IMC's investors. The cost associated with this problem includes fines for late reporting that could range from a few hundred dollars to cease and desist orders that could cost IMC all revenue related to an individual investor's servicing portfolio. Contingency Plans: The company is in the early stages of its contingency planning efforts. Its approach is to review the most important business processes that were identified in the assessment phase and work with the key personnel to develop alternative plans in case the Year 2000 readiness efforts fail. As these plans are developed, the company will be better able to quantify the dollar costs of non-compliance. Irwin Union Bank Irwin Union Bank and Trust (the Bank) is engaged in providing consumer and commercial banking, trust, insurance, and brokerage services throughout central and south central Indiana. The Year 2000 technology compliance issue poses a significant challenge to the organization as technology has been integrated with all major business processes. The methodology is based on the Corporation's seven-stage implementation plan. Consistent with the Corporation's goal to be Year 2000 ready by June 30, 1999, the Bank is scheduled to complete all Year 2000 technology testing by the end of March 1999. Scope: Recognizing the impact of non-compliance, the Bank began a formalized compliance program in 1997. The Bank has adopted the same seven-phase plan to achieve readiness used by the Corporation as discussed above. The Bank participates with the Corporation's Steering Committee. The Bank's plan includes computer hardware, software, and environmental systems. The Bank's applications are primarily commercial, off- the-shelf applications, including its core banking technologies, facility controls, and desktop applications. In addition, the Bank utilizes third-party providers for retail brokerage and trust/employee benefits account processing. Finally, the Bank has two internally developed technologies, those for certificate of deposit servicing and insurance originations that require remediation due to non-compliance. Progress: The Bank involved over 25 staff members to participate in Year 2000 technology discussions, vendor appraisals, and compliance testing. A multi-level testing strategy has been deployed within the Bank. Depending on the level of vendor and third party testing, the Bank has determined whether additional testing is warranted. For those applications that were certified by either a third party or vendor, the Bank has requested and reviewed the test results and scripts. An exception to this policy of reviewing the testing procedures of others was deemed necessary for those applications that were critical to the Bank's continued operation. These "Hot List" technologies were, or are currently in process of being, tested by the Bank staff using either proxy testing, vendor scripts, or actual date scenario testing with internally developed scripts. The testing procedures for third party providers are more challenging for the Bank to assess Year 2000 compliance. The Bank has two critical technologies that are provided through a service bureau environment: retail brokerage and trust/employee benefits account processing. The vendors of these services are both industry-leading providers who have committed significant resources to ensure Year 2000 compliance. The providers have documented their efforts to the Bank through ongoing disclosure of testing plans and results. Both vendors targeted December 1998 for full compliance and intend to complete on-site client testing within the first quarter of 1999. The Bank's progress against each stage of its plan is shown below. Graph: Irwin Union Bank Project Plan Status As of December 31, 1998 Percent Completed Projected Actual Target Completion * Actual Completion Completion Date Post-2000 Audit 0 0 During 2000 and 2001 Implementation 25 50 2Q99 Contingency Planning 30 80 On-going Testing 55 25 1Q99 Remediation 80 75 1Q99 Assessment 100 100 Done Awareness 100 100 Done * Target is original plan to achieve Year 2000 readiness by June 20, 1999. As noted on the previous graph, the Bank is behind on testing due to its reliance on third parties on which it is dependent for remediated applications. Conversely, the Bank is ahead of schedule in implementation, having taken advantage of delays in areas such as testing and remediation to make additional implementation progress. Costs: The focus on commercial, off-the-shelf applications has allowed the Bank to avoid major programming costs that are required with proprietary systems. However, the impact of testing existing systems has added significant time requirements to the Bank's IT department. In 1998, the Bank added a fifth IT professional to allow the department to continue support of its 350 users while conducting Year 2000 activities. In addition, the Bank has incurred expense in the replacement and repair of specific non-compliant systems. To date, expenditures for the Year 2000 effort have totaled $165 thousand as shown in the graph below. Irwin Union Bank Project Expenses (In millions (Pre-tax)) 1997--Actual $46 1998--Actual 119 1999 * 165 * Estimate as of December 31, 1998. Risks: The impact of specific technologies utilized by the Bank not being Year 2000 compliant could be significant, although the risk has not yet been quantified by the Bank. The inability to process, reconcile, and report customer account information could create concern for the safety and security of the customer funds. However, customer funds which are eligible for FDIC insurance will continue to be insured against loss regardless of any Year 2000 disruption. Contingency Plans: The Bank's contingency planning approach identifies core processes and corresponding critical activities to develop alternative approaches to accomplishing the desired outputs. The Bank has formed teams comprised of the departmental managers and members of the IT department to evaluate the impact of technology non- compliance for each critical process. The IT manager of the Bank is responsible for collecting the contingency plans and ensuring completeness. At present, the Bank is approximately 80% complete with completion targeted for the second quarter of 1999. Irwin Home Equity The primary products of Irwin Home Equity (IHE) are second mortgage and line of credit loans secured by real estate. Since IHE relies on third-party processors and off-the-shelf software, its efforts are mainly directed to the testing of these applications. Principal remediation efforts, therefore, have been the responsibility of its vendors. Scope: The company's Year 2000 project plan was developed within the guidelines set forth by the Corporation to achieve Year 2000 readiness by June 30, 1999. When compiling the plan, all functions of the organization were considered, including computer software, hardware, data communications, environmental facilities, third party vendors, and other companies with whom data is exchanged. IHE's team to manage the Year 2000 effort consists of individuals representing senior management, information systems, networks, loan origination, loan servicing, accounting, and finance. In addition, telecommunications, building, and office services personnel are involved in various phases of the project. A full-time project manager oversees the effort. Progress: The company identified its mission-critical applications and is proceeding on schedule with testing of those modules first. Applications were considered mission critical if they have an impact on customers or could have a negative impact on the continued operation of the company. The company has completed the installation of the remediated versions of software for the majority of its mission-critical applications and certain non-critical software. Installation dates have been scheduled for the remediated version of its loan origination system and conversion to a new loan servicing system. The progress of the IHE Year 2000 team in meeting the requirements of its project plan to achieve Year 2000 readiness by June 30, 1999, is shown below. Graph: Irwin Home Equity Project Plan Status As of December 31, 1998 (Percent Completed) Projected Actual Target Completion * Actual Completion Completion Date Post-2000 Audit 0 0 During 2000 and 2001 Implementation 80 80 2Q99 Contingency Planning 10 10 On-going Testing 70 60 1Q99 Remediation 100 80 1Q99 Assessment 100 100 Done Awareness 100 100 Done * Target is original plan to achieve Year 2000 readiness by June 30, 1999. Costs: Few direct Year 2000 costs have been expended to date, since all software and hardware upgrades were planned as part of the normal business plan. Year 2000 costs have largely been limited to internal staff time. Costs directly associated with the Year 2000 remediation have thus far totaled $72 thousand. Those costs and anticipated future costs for the project are displayed on the next page. Graph: Irwin Home Equity Project Expenses (In millions (Pre-tax)) 1997--Actual $ - 1998--Actual 72.3 1999 * 213.4 * Estimate as of December 31, 1998. Risks: As a result of IHE's dependence on third-party providers, there is no assurance that all vendors will achieve Year 2000 compliance in a timely manner. For instance, should the loan origination system be unavailable due to software problems or environmental outages, the closing and funding processes would be delayed. The loan servicing system could be unavailable, requiring manual payment or billing methods to be implemented, thereby incurring increased expenses. The company anticipates that any Year 2000 failure would lead principally to increased expenses rather than failure to perform the origination, servicing, and support functions of the company. Contingency Plans: IHE is in the early stages of its contingency planning phase for Year 2000. It has determined that the most likely worst case scenario would be environmental in nature (lack of power, telephone, data center communications). As contingency planning progresses, the company will complete a detailed plan addressing the potential impact a Year 2000 compliance failure by it or its service providers could have on the company. 1998 Financial Statements Irwin Financial Corporation and Subsidiaries Management Report on Responsibility for Financial Reporting The management of Irwin Financial Corporation and its subsidiaries has the responsibility of preparing the accompanying financial statements and for their integrity and objectivity. The statements were prepared in conformity with generally accepted accounting principles and are not misstated due to material fraud or error. The financial statements include amounts that are based on management's best estimates and judgments. Management also prepared the other information in the annual report and is responsible for its accuracy and consistency with the financial statements. The Corporation's financial statements have been audited by PricewaterhouseCoopers LLP, independent certified public accountants elected by the shareholders. Management has made available to PricewaterhouseCoopers all the Corporation's financial records and related data, as well as the minutes of stockholders' and directors' meetings. Furthermore, management believes that all representations made to PricewaterhouseCoopers during its audit were valid and appropriate. Management of the Corporation has established and maintains a system of internal control that provides reasonable assurance as to the integrity and reliability of the financial statements, the protection of assets from unauthorized use or disposition, and the prevention and detection of fraudulent financial reporting. Assessments of the system of internal control are based on criteria for effective internal control over financial reporting described in "Internal Control-Integrated Framework" issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management continually monitors the system of internal control for compliance. The Corporation maintains a strong internal auditing program that independently assesses the effectiveness of the internal controls and recommends possible improvements thereto. In addition, as part of its audit of the Corporation's financial statements, PricewaterhouseCoopers completed an assessment of selected internal accounting controls to establish a basis for reliance thereon in determining the nature, timing, and extent of audit tests to be applied. Management has considered the internal auditor's and PricewaterhouseCoopers' recommendations concerning the Corporation's system of internal control and has taken actions to respond appropriately to these recommendations that we believe are cost effective in the circumstances. Management believes that the Corporation's system of internal control is adequate to accomplish the objectives discussed herein. Management also recognizes its responsibility for fostering a strong ethical climate so that the Corporation's affairs are conducted according to the highest standards of personal and corporate conduct. This responsibility is characterized and reflected in the Corporation's Guiding Philosopy, which is publicized throughout the Corporation. This responsibility is also reflected in the individual Codes of Conduct of each major operating subsidiary of the Corporation, which are publicized throughout each respective subsidiary. These Codes of Conduct address, among other things, the necessity of ensuring open communication within the Corporation; potential conflicts of interests; compliance with all domestic and foreign laws, including those related to financial disclosures; and a confidentiality of proprietary information. The Corporation maintains a systematic program to assess compliance with these policies. John A. Nash, President Thomas D. Washburn, Chief Financial Officer Report of PricewaterhouseCoopers LLP Independent Accountants To the Shareholders and Board of Directors Irwin Financial Corporation Columbus, Indiana In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, of shareholders' equity and of cash flows present fairly, in all material respects, the financial position of Irwin Financial Corporation and its subsidiaries (the "Company") at December 31, 1998 and 1997, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PricewaterhouseCoopers LLP Cincinnati, Ohio January 21, 1999 Consolidated Statement of Income For year ended December 31, 1998 (In thousands, except for per share amounts) 1998 1997 1996 Interest income: Loans held for sale $65,160 $34,691 $30,943 Loans and leases 52,329 56,490 52,203 Investment securities: Taxable 3,867 7,311 6,876 Tax-exempt 299 275 333 Federal funds sold 731 674 1,290 ----------- -------- -------- Total interest income 122,386 99,441 91,645 ----------- -------- -------- Interest expense: Deposits 23,340 19,963 17,732 Short-term borrowings 35,048 23,788 22,115 Long-term debt 814 831 1,778 ----------- -------- -------- Total interest expense 59,202 44,582 41,625 ----------- -------- -------- Net interest income 63,184 54,859 50,020 Provision for loan and lease losses - Note 5 5,995 6,238 4,553 Net interest income after provision for loan and lease losses 57,189 48,621 45,467 ----------- -------- -------- Other income: Loan origination income 60,013 41,370 43,779 Gain on sale of loans 64,074 38,610 34,248 Loan servicing fees 57,284 53,257 46,877 Gain on sale of servicing assets 43,308 32,631 16,378 Trading gains (losses) 1,366 (1,961) - Gain from sale of leasing assets 5,241 - - Other 12,443 8,696 8,699 ----------- -------- -------- 243,729 172,603 149,981 ----------- -------- -------- Other expense: Salaries 120,780 86,533 79,017 Employee benefits 16,757 13,724 12,579 Office expense 12,868 10,583 10,387 Premises and equipment 20,216 16,621 13,903 Amortization of servicing assets 24,267 15,755 14,331 Marketing and development 11,789 7,697 7,365 Other 38,759 23,660 20,578 ----------- -------- -------- 245,436 174,573 158,160 ----------- -------- -------- Income before income taxes 55,482 46,651 37,288 Income taxes 20,354 17,734 14,860 ----------- -------- -------- 35,128 28,917 22,428 Distribution on company-obligated mandatorily redeemable preferred securities of subsidiary trust - Note 15 4,625 4,473 - ----------- -------- -------- Net income available to common shareholders $30,503 $24,444 $22,428 ----------- -------- -------- Earnings per Basic - Note 17 $1.40 $1.10 $0.99 share of common =========== ======== ======== stock: Diluted - Note 17 $1.38 $1.08 $0.98 =========== ======== ======== Dividends per share of common stock $0.16 $0.14 $0.12 =========== ======== ======== The accompanying notes are an integral part of the consolidated financial statements. ------------------------------------------------------------------------------- Consolidated Balance Sheet December 31, 1998 (In thousands, except for shares) 1998 1997 ------------------------------------------------------------------------------ Assets: Cash and due from banks $68,942 $56,524 Federal funds sold 8,580 - ----------- ---------- Cash and cash equivalents 77,522 56,524 Interest-bearing deposits with financial institutions 18,441 18,240 Trading assets 32,148 22,133 Investment securities - Note 3 48,055 55,208 Loans held for sale 936,788 528,739 Loans and leases, net of unearned income - Note 4 556,991 611,093 Less: Allowance for loan and lease losses - Note 5 (9,888) (8,812) 547,103 602,281 Servicing assets - Note 6 117,129 83,044 Accounts receivable 71,087 54,261 Accrued interest receivable 13,071 14,779 Premises and equipment - Note 7 21,382 21,040 Other assets 63,453 40,545 ----------- ---------- $1,946,179 $1,496,794 =========== ========== Liabilities and Shareholders' Equity: Deposits Noninterest-bearing $477,724 $287,556 Interest-bearing 389,516 346,012 Certificates of deposit over $100 141,971 86,028 ----------- ---------- 1,009,211 719,596 Short-term borrowings - Note 9 644,861 512,275 Long-term debt - Note 10 2,839 7,096 Other liabilities 96,036 81,917 ----------- ---------- Total liabilities 1,752,947 1,320,884 =========== ========== Company-obligated mandatorily redeemable preferred securities of subsidiary trust - Note 15 47,999 47,927 Shareholders' equity Preferred stock, no par value - authorized 50,000 shares; none issued - - Common stock; no par value - authorized 40,000,000 shares; issued 23,402,080 shares in 1998 and 1997; including 1,729,324 and 1,401,280 shares in treasury in 1998 and 1997, respectively 29,965 29,965 Additional paid-in capital 2,595 780 Net unrealized gain on investment securities net of deferred income taxes of $57 in 1998 and $31 in 1997. 85 55 Retained earnings 142,232 115,414 ----------- ---------- 174,877 146,214 Less treasury stock, at cost (29,644) (18,231) Total shareholders' equity 145,233 127,983 ----------- ---------- $1,946,179 $1,496,794 =========== ========== The accompanying notes are an integral part of the consolidated financial statements. Consolidated Statement of Changes in Shareholders' Equity Net Unrealized Gain (Loss) Additional (In thousands, except share Retained on Investment Common Paid-In Treasury and per share amounts) Total Earnings Securities Stock Capital Stock -------------------------------------------------------------------------------- Balance at January 1, 1996 $99,216 $74,648 $(10) $29,965 $- $(5,387) -------- -------- ------- --------- ------ -------- Comprehensive Income: Note 1 Net income 22,428 - - - - - Other Comprehensive Income - 66 - - - - Total 22,494 - - - - - Cash dividends - $.012 per share* (2,726) (2,726) - - - - Tax benefit on exercise of stock options 516 516 Purchase of 178,875 shares of treasury stock* (1,931) - - - - (1,931) Sale of 256,736 shares of treasury stock* 1,333 (266) - - (516) 2,115 -------- -------- ------- --------- ------ -------- Balance at December 31, 1996 118,902 94,084 56 29,965 - (5,203) ======== ======== ======= ========= ====== ======== Comprehensive Income: Note 1 Net income 24,444 - - - - Other Comprehensive Income - (1) - - - Total 24,443 - - - - - Cash dividends - $.014 per share* (3,114) (3,114) - - - - Tax benefit on exercise of stock options 576 576 Purchase of 940,082 shares of treasury stock* (14,412) - - - - (14,412) Sale of 204,238 shares of treasury stock* 1,588 - - - 204 1,384 -------- -------- ------- --------- ------ -------- Balance at December 31, 1997 127,983 115,414 55 29,965 780 (18,231) ======== ======== ======= ========= ====== ======== Comprehensive Income: Note 1 Net income 30,503 - - - - Other Comprehensive Income - 30 - - Total 30,533 - - - - - Cash dividends - $.016 per share* (3,473) (3,473) - - - - Tax benefit on exercise of stock options 1,027 1,027 Purchase of 496,455 shares of treasury stock* (12,593) - - - - (12,593) Sale of 168,411 shares of treasury stock* 1,756 (212) - - 788 1,180 -------- -------- ------- --------- ------ -------- Balance at December 31, 1998 $145,233 $142,232 $85 $29,965 $2,595 $(29,644) ======== ======== ======= ========= ====== ======== *Adjusted for the two-for-one stock splits December 30,1996 and May 27 ,1998. The accompanying notes are an integral part of the consolidated financial statements. Consolidated Statement of Cash Flows For the year ended December 31, 1998 1998 1997 1996 ------------------------------------------------------------------------------- Net Income $30,503 $24,444 $22,428 ------------------------------------------------------------------------------- Adjustments to Depreciation and amortization 5,802 3,910 5,398 reconcile net Amortization and impairment of income to cash servicing assets 36,498 16,355 14,969 provided by Provision for loan and lease losses 5,995 6,238 4,553 operating Amortization of premiums, less accretion activities: of discounts 3,210 1,716 1,589 Increase in loans held for sale (408,049) (81,841) (66,442) Gain on sale of mortgage servicing (43,308) (32,631) (16,378) Net increase in trading assets (10,015) (9,472) (12,661) Other, net (24,773) (21,823) (9,064) ---------- --------- ---------- Net cash used by operating activities (404,137) (93,104) (55,608) ---------- --------- ---------- Lending and Proceeds from maturities/calls of investing activities: investment securities: Held-to-maturity 10,645 6,542 5,045 Available-for-sale 280 7,534 29,741 Proceeds from sales of available-for-sale securities 6,000 26,309 2,028 Purchase of investment securities: Held-to-maturity (8,932) (3,868) (14,286) Available-for-sale (4,051) (20,315) (36,371) Net increase in interest-bearing deposits with financial institutions (201) (6,897) (3,406) Net increase in loans, excluding sales (131,632) (414,205) (258,412) Sale of loans 175,574 331,861 139,410 Gain on sale of leasing assets 5,241 - - Additions to servicing assets (165,910) (84,781) (81,045) Proceeds from sale of servicing assets 138,635 90,734 65,163 Other, net (4,148) (5,930) (5,651) ---------- --------- ---------- Net cash provided (used) by lending and investing activities 21,501 (73,016) (157,784) ---------- --------- ---------- Financing activities:Net increase in deposits 289,615 79,443 76,154 Net increase in short-term borrowings 132,586 50,409 151,604 Repayment of long-term debt (11,871) (10,563) (12,772) Proceeds from long-term debt 7,614 - 8,840 Sale of company-obligated manditorily redeemable preferred securities of ` subsidiary trust - -47,927 - Purchase of treasury stock (12,593) (14,412) (1,931) Proceeds from sale of stock for employee benefit plans 1,756 1,588 1,332 Dividends paid (3,473) (3,114) (2,726) ---------- --------- ---------- Net cash provided by financing activities 403,634 151,278 220,501 ---------- --------- ---------- Net increase (decrease) in cash and cash equivalents 20,998 (14,842) 7,109 Cash and cash equivalents at beginning of year $56,524 71,366 64,257 ---------- --------- ---------- Cash and cash equivalents at end of year $77,522 $56,524 $71,366 ========== ========= ========== Supplemental Cash paid during the period: disclosures of cash Interest $58,689 $45,554 $41,248 ========== ========= ========== flow information: Income taxes $18,947 $9,912 $6,230 ========== ========= ========== The accompanying notes are an integral part of the consolidated financial statements. Notes to Consolidated Financial Statements Note 1: Summary of Significant Accounting Policies Consolidation: Irwin Financial Corporation and its subsidiaries (the Corporation) provide financial services throughout the United States. The Corporation is engaged in the mortgage banking, community banking, and home equity lending lines of business. Intercompany balances and transactions have been eliminated in consolidation. Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires the Corporation to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Trading Assets: Trading assets are stated at fair value. Unrealized gains and losses are included in earnings. Gains and losses are based on the adjusted cost of the specific asset. Securities: Those securities which the Corporation has the positive intent and ability to hold until maturity are classified as "held-to-maturity" and are stated at cost adjusted for amortization of premium and accretion of discount. Securities that might be sold prior to maturity are classified as "available-for-sale" and are stated at fair value. Unrealized gains and losses, net of the future tax impact, are reported as a separate component of shareholders' equity until realized. Investment gains and losses are based on the adjusted cost of the specific security. Loans Held for Sale: Loans held for sale are carried at the lower of cost or market, determined on an aggregate basis. Loans: Loan origination fees and costs are deferred and the net amounts are amortized as an adjustment to yield. When loans are sold, deferred fees and costs are included with outstanding principal balances to determine gains or losses. Interest income on loans is computed daily based on the principal amount of loans outstanding. The accrual of interest income is discontinued when a loan becomes 90 days past due as to principal or interest. Management may elect to continue the accrual of interest when the estimated net realizable value of collateral is sufficient to cover the principal balance and accrued interest. Direct Financing Leases: Interest and service charges, net of initial direct costs, are deferred and reported as income in decreasing amounts over the life of the lease, which averages three to four years, so as to provide an approximate constant yield on the outstanding principal balance. Allowance for Loan and Lease Losses: The allowance for loan and lease losses is maintained at a level considered adequate to provide for future loan and lease losses and is based on management's evaluation of expected losses in the portfolio. Loans are considered impaired if it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is generally based on the present value of expected future cash flows discounted at the historical effective interest rate, except that all collateral-dependent loans are measured for impairment based on the fair value of the collateral. Loan Securitizations: In 1997 the Corporation adopted Statement of Financial Accounting Standards No 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" (SFAS No. 125). This standard established the accounting treatment to be used for the securitization of all financial assets. The adoption of this standard did not have a material effect on the Corporation's financial position or results of operations in 1997. When the Corporation securitizes loans, it retains servicing assets and interest-only strips. SFAS No. 125 requires that a portion of the cost of originating a loan be allocated to the servicing asset and interest-only strip based on their fair values relative to the loan as a whole. To determine the fair value of the servicing assets, the Corporation uses the market prices under comparable servicing sale contracts, when available, or alternatively uses a valuation model that calculates the present value of future cash flows to determine the fair value of the servicing assets. In using this valuation method, the Corporation incorporates assumptions that it is believed market participants would use in estimating future net servicing income which include estimates of the cost of servicing per loan, the discount rate, float value, an inflation rate, ancillary income per loan, prepayment speeds, and default rates. Servicing assets are amortized over the estimated lives of the related loans, which are grouped based on loan characteristics, in proportion to estimated net servicing income. Servicing assets are recorded at the lower of their cost or fair value. In determining servicing value impairment at the end of the year, the servicing portfolio was disaggregated into its predominant risk characteristics. The Corporation has determined those risk characteristics to be interest rate, loan type and investor type. These segments of the portfolio were valued, using market prices under comparable servicing sale contracts, when available, or alternatively, using the same model as was used to originally determine the fair value at origination, using current market assumptions. The calculated value was then compared with the book value of each segment to determine the required reserve for impairment. It is reasonably possible that a change in the impairment reserve will occur in the near term. No reasonable estimate can be made of the range of amounts of loss or gain. Gains and losses on the sale of servicing assets are recognized when the related sales contracts have been executed, an adequate down payment has been received from the buyer, and legal title and substantially all risks and rewards of ownership have passed to the buyer. Gains and losses are determined as the difference between the net sales proceeds and the carrying value of the servicing assets. In the fourth quarter of 1998, the Corporation adopted Statement of Financial Accounting Standards No. 134, "Accounting for Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise" (SFAS No. 134). The adoption of this standard had no effect on the Corporation's financial position or results of operations in 1998. Under the provisions of SFAS No. 134, the Corporation carries interest-only strips at fair value. To determine the fair value, the Corporation uses a valuation model that calculates the present value of future cash flows. In using this valuation method, the Corporation incorporates assumptions that it is believed market participants would use in estimating future cash flows. Such assumptions include estimates of credit losses, prepayment speeds, forward yield curves, and discount rates commensurate with risks involved. Changes in the fair value of interest-only strips are included in the Corporation's earnings as they occur. Derivative Instruments: The Corporation uses derivative instruments to offset changes in the value of servicing assets and interest-only strips. Derivative instruments on the Corporation's balance sheet are classified as trading assets and carried at market value. Changes in market value are recorded as trading gains or losses on the income statement. The Corporation uses forward contracts to reduce its interest rate exposure associated with mortgage banking activities. On June 15, 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS No. 133). The Corporation will adopt SFAS No. 133 on January 1, 2000. SFAS No. 133 requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives will be recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction. The Corporation does not expect the adoption of this standard to have a material effect on its financial position or results of operations. Premises and Equipment: Premises and equipment are recorded at cost. Depreciation is determined by the straight-line method. Earnings Per Share: In 1997 the Corporation adopted Statement of Financial Accounting Standards No. 128, "Earnings Per Share" (SFAS No. 128). Under this standard, earnings per share are calculated as "basic" and "diluted" based on the weighted average number of common shares outstanding during the year. Previous year earnings per share calculations have been restated to reflect the adoption of SFAS No. 128. Income Taxes: A consolidated tax return is filed for all eligible entities. Deferred income taxes are computed using the liability method which establishes a deferred tax asset or liability based on temporary differences between the tax basis of an asset and liability and the basis recorded in the financial statements. Rehabilitation tax credits and low-income housing tax credits are recorded as a reduction to the provision for federal income taxes in the year the eligible buildings are placed in service. Cash and Cash Equivalents Defined: For purposes of the statement of cash flows, the Corporation considers cash and due from banks to be cash equivalents. Comprehensive Income: On January 1, 1998, the Corporation adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income." This statement established standards for reporting comprehensive income in financial statements. Comprehensive income is defined as the change in equity during a period from transactions and other events from nonowner sources. Reclassifications: Certain amounts in the 1997 and 1996 consolidated financial statements have been reclassified to conform to the 1998 presentation. Note 2: Restrictions on Cash and Interest-Bearing Deposits with Financial Institutions Irwin Union Bank and Trust Company is required to maintain a reserve balance with the Federal Reserve Bank. The amount of the reserve balance at December 31, 1998 was $149.7 thousand. Additionally, the Corporation is required to maintain reserve funds in connection with its loan securitization activities. Included in interest- bearing deposits with financial institutions at December 31, 1998, is $671.6 thousand of these reserve funds. Note 3: Investment Securities The amortized cost, fair value, and carrying value of investments held at December 31, 1998 are as follows: Gross Gross Amortized Unrealized Unrealized Fair Carrying December 31, 1998 Cost Gains Losses Value Value --------------------------------------------------------------------------------------------------- (In thousands) Held-to-Maturity: U.S. Treasury and Government obligations $32,158 $235 $- $32,393 $32,158 Obligations of states and political subdivisions 5,207 117 - 5,324 5,207 Mortgage-backed securities 4,424 130 - 4,554 4,424 -------- ------- ----- ------- -------- Total held-to-maturity 41,789 482 - 42,271 41,789 -------- ------- ----- ------- -------- Available-for-Sale: U.S. Treasury and Government obligations 2,051 46 (1) 2,096 2,096 Mortgage-backed securities 4,074 57 - 4,131 4,131 Other - 39 - 39 39 -------- ------- ----- ------- -------- Total available-for-sale 6,125 142 (1) 6,266 6,266 -------- ------- ----- ------- -------- Total investments $47,914 $624 $(1) $48,537 $48,055 ======== ======= ===== ======= ======== The amortized cost, fair value, and carrying value of investments held at December 31,1997 are as follows: Gross Gross Amortized Unrealized Unrealized Fair Carrying December 31, 1997 Cost Gains Losses Value Value --------------------------------------------------------------------------------------------------- (In thousands) Held-to-Maturity: U.S. Treasury and Government obligations $35,733 $204 $- $35,937 $35,733 Obligations of states and political subdivisions 4,814 286 (5) 5,095 4,814 Mortgage-backed securities 5,968 202 - 6,170 5,968 ------- ------ ----- -------- -------- Total held-to-maturity 46,515 692 (5) 47,202 46,515 ------- ------ ----- -------- -------- Available-for-Sale: U.S. Treasury and Government obligations 6,010 43 - 6,053 6,053 Mortgage-backed securities 2,606 13 (1) 2,618 2,618 Other - 22 - 22 22 ------- ------ ----- -------- -------- Total available-for-sale 8,616 78 (1) 8,693 8,693 ------- ------ ----- -------- -------- Total investments $55,131 $770 $(6) $55,895 $55,208 ======= ====== ===== ======== ======== The amortized cost and estimated value of debt securities at December 31, 1998, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Amortized Fair (In thousands) Cost Value ------------------------------------------------------------------- Held-to-Maturity: Due in one year or less $9,683 $9,814 Due after one year through five years 5,590 5,732 Due after five years through ten years 1,060 1,104 Due after ten years 21,032 21,067 -------- -------- 37,365 37,717 Mortgage-backed securities 4,424 4,554 -------- -------- 41,789 42,271 -------- -------- Available-for-Sale: Due in one year or less 52 91 Due after one year through five years 1,999 2,044 -------- -------- 2,051 2,135 Mortgage-backed securities 4,074 4,131 -------- -------- 6,125 6,266 -------- -------- Total investments $47,914 $48,537 ======== ======== Investment securities amounting to $8.0 million were pledged as collateral for borrowings and for other purposes on December 31, 1998. During 1998, 1997 and 1996, sales of "available for sale" investments with proceeds of $6.0 million, $26.3 million, and $2.0 million resulted in a gross gains of $58.9 thousand and $56.1 thousand, and gross loss of $9.0 thousand, respectively. Additionally in 1998, 1997, and 1996, "held-to-maturity" investments totaling $2.8 million, $7.0 million, and $1.5 million, respectively, were called. Calls in 1998 resulted in a gross gain of $54.3 thousand. Calls in 1997 and 1996 were at par. Gains and losses on investment securities are recorded as other income. Note 4: Loans and Leases Loans and leases are summarized as follows: December 31, 1998 1997 ------------------------------------------------------------------------------------ (In thousands) Commercial, financial, and agricultural $278,834 $212,095 Real estate-construction 97,253 73,279 Real estate-mortgage 123,980 222,818 Consumer 51,730 39,985 Direct financing leases 6,375 78,079 Unearned income (1,181) (15,163) --------- --------- Total $556,991 $611,093 ========= ======== Commercial loans are extended primarily to local regional businesses and to local farming operations in the market area of Irwin Union Bank. The Corporation also provides consumer loans to the customers in that market. Real estate loans and direct financing leases are extended throughout the United States. The Bank, in the normal course of business, makes loans to directors, officers, and organizations and individuals with which they are associated. Such loans amounted to approximately $1.7 million and $1.9 million at December 31, 1998 and 1997, respectively. During 1998, $24.3 million of new loans were made and repayments totaled $26.5 million. Note 5: Allowance for Loan and Lease Losses Changes in the allowance for loan and lease losses are summarized below: December 31, 1998 1997 1996 ------------------------------------------------------------------------------------- (In thousands) Balance at beginning of year $8,812 $6,875 $5,033 Provision for loan and lease losses 5,995 6,238 4,553 Reduction due to sale of loans and leases (2,976) (1,694) (930) Recoveries 559 538 593 Charge-offs (2,502) (3,145) (2,374) -------- -------- -------- Balance at end of year $9,888 $8,812 $6,875 ======== ======== ======== At December 31, 1998, 1997 and 1996, the recorded investment in loans for which impairment has been recognized in accordance with SFAS No. 114 and SFAS No. 118 totaled $1.6 million, $2.7 million, and $4.3 million, respectively. These loans had a corresponding valuation allowance of $0.5 million, $0.7 million and $1.2 million determined based on the fair value of the loans' collateral. The Corporation recognized $102.9 thousand, $155.4 thousand, and $356.9 thousand of interest income on these loans in 1998, 1997, and 1996, respectively. Note 6: Servicing Assets Included on the consolidated balance sheet at December 31,1998 and 1997 are $117.1 million and $83.0 million, respectively, of capitalized servicing assets. These amounts relate to the principal balances of loans serviced by the Corporation for investors which totaled $11.8 billion, $11.1 billion, and $11.0 billion at December 31, 1998, 1997, and 1996, respectively. The estimated fair value of servicing assets was $121.7 million at December 31, 1998. Carrying value approximated fair value at December 31, 1997. The Corporation has established a valuation allowance to record servicing assets at their fair market value. Changes in the allowance are summarized below: December 31, 1998 1997 1996 ------------------------------------------------------------------------------------------ (In thousands) Balance at beginning of year $600 $- $909 Valuation changes during the period 11,120 600 (255) Reductions due to sales of servicing assets - - (654) --------- ------- ------- Balance at end of year $11,720 $600 $- ========= ======= ====== Note 7: Premises and Equipment Premises and equipment are summarized as follows: December 31, 1998 1997 Useful lives ------------------------------------------------------------------------------- (In thousands) Land $1,734 $1,651 n/a Building and leasehold improvements 13,231 13,375 7-40 years Furniture and equipment 29,693 27,368 3-10 years -------- -------- 44,658 42,394 Less accumulated depreciation (23,276) (21,354) -------- -------- Total $21,382 $21,040 ======== ======== Note 8: Lease Obligations At December 31, 1998, the Corporation and its subsidiaries leased certain branch locations and office equipment used in its operations. Operating lease rental expense was $13.7 million in 1998, $11.2 million in 1997, and $8.7 million in 1996. The future minimum rental payments required under noncancellable operating leases with initial or remaining terms of one year or more are summarized as follows: Year ended December 31 (In thousands): 1999 $7,301 2000 6,258 2001 4,894 2002 2,486 2003 483 Thereafter 254 -------- Total minimum rental payments $21,676 ======== Note 9: Short-Term Borrowings Short-term borrowings are summarized as follows: December 31, 1998 1997 ------------------------------------------------------------------------------------ (In thousands) Repurchase agreements and drafts payable related to mortgage loan closings $172,126 $240,659 Commercial paper 26,617 16,375 Federal funds 266,000 142,650 Lines of credit 180,118 112,591 --------- --------- Total $644,861 $512,275 ========= ========= Weighted average interest rate 5.34% 6.17% Repurchase agreements at December 31, 1998 and 1997 include $29.8 million and $141.9 million in mortgages sold under agreements to repurchase, which are used to fund mortgages prior to sale in the secondary market. These repurchase agreements are collateralized by mortgage loans held for sale. Drafts payable related to mortgage loan closings totaled $142.3 million and $93.6 million at December 31, 1998 and 1997. These borrowings are related to mortgage closings at the end of December which have not been presented to the banks for payment. When presented for payment, these borrowings will be funded internally or by borrowing from the lines of credit. Commercial paper includes $18.8 million and $10.8 million at December 31, 1998 and 1997, respectively, payable to a company owned by a significant shareholder and director of the Corporation. The Corporation has lines of credit available of $312.8 million to fund loan originations and operations. Interest on the lines of credit is payable monthly or quarterly with rates ranging from 4.82% to 8.06%. Note 10: Long-Term Debt Long-term debt at December 31, 1998 consists of a note payable with a variable interest rate averaging 7.94% and maturing on July 1, 2002. Long-term debt as of December 31, 1997 of $7.1 million consisted of various notes payable at annual interest rates ranging from 6.3% to 9.6% and maturity dates through April 3o, 2002. Maturities of long-term debt are as follows: (In thousands) 1999 $730 2000 788 2001 853 2002 468 ------- Total $2,839 ======= Note 11 : Commitments and Contingencies In the normal course of business, Irwin Financial Corporation and its subsidiaries are subject to various claims and other pending and possible legal actions. As of December 31, 1998, Irwin Mortgage Corporation (IMC) was a defendant to class action lawsuits relating to the following: IMC's administration of mortgage escrow accounts, IMC's right to require its borrowers to pay premiums for private mortgage insurance, IMC's right to pay broker fees to mortgage brokers, and IMC's participation in a housing opportunity program. As of December 31, 1998, Irwin Leasing Corporation (ILC) and Irwin Financial Corporation were defendants in a class action lawsuit alleging misrepresentations by a manufacturer of certain equipment financed by ILC. At present, it is not possible for the Corporation to predict the likelihood of an unfavorable outcome or to establish the possible extent or amount of liability or potential exposure with respect to the litigation. Note 12: Financial Instruments with Off-Balance Sheet Risk The Corporation is party to certain financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include loan commitments, standby letters of credit, and forward commitments relating to mortgage banking activities. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheet. The Corporation's exposure to credit loss, in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit, is represented by the contractual amount of those instruments. The collateral pledged for standby letters of credit and commitments varies but may include accounts receivable, inventory, property, plant, and equipment, and residential real estate. Total outstanding commitments to extend credit at December 31, 1998, were $394.8 million. These loan commitments include $126.1 million of floating rate loan commitments and $268.7 million of fixed rate loan commitments related to commercial and mortgage banking activities. The Corporation had approximately $14.2 million and $15.1 million in irrevocable standby letters of credit outstanding at December 31, 1998 and 1997, respectively. Forward commitments are used in mortgage banking activities to offset the interest rate risk associated with mortgage loan commitments and loans held for sale. The contract amount for forward contracts does not represent exposure to credit loss. Forward commitments related to mortgage banking activities were $810.5 million and $407.9 million at December 31, 1998 and 1997, respectively. Derivative instruments are used to offset changes in the value of servicing assets against the effects of increased prepayment activity that generally results from declining interest rates. To the extent that interest rates increase, the value of servicing assets increases while the value of these instruments declines. The Corporation's servicing asset derivative instruments consist entirely of long and short call options on U.S. Treasury futures. At December 31, 1998, the carrying value of these options was $4.8 million and the net notional amount was $0, consisting of $750.0 million of long positions and $750.0 million of short positions, all of which related to 1998 additions and no dispositions. Derivative instruments are also used to offset changes in the value of interest-only strips. Interest rate caps are used when interest is received on fixed rate securitized loans and the resulting security pays interest at a variable rate. As interest rates change, the values of the interest-only strips and interest rate caps move in opposite directions. At December 31, 1998, the carrying value of the interest rate caps was $540.1 thousand and the notional amount was $65.6 million, all of which related to 1998 additions and no dispositions. In 1998 the Corporation recorded $4.2 million of net trading gains related to derivative instruments. The Corporation is not exposed to loss on derivative instruments beyond its initial outlay to acquire them. There can be no assurance that the Corporation's derivative instruments will generate gains in the future. Note 13: Regulatory Matters The Corporation and its bank subsidiary, Irwin Union Bank (IUB), are subject to various regulatory capital requirements administered by the federal and state banking agencies. Under capital adequacy guidelines, the Corporation and IUB must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Corporation's and IUB's capital amounts and classification are also subject to qualitative judgements by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Corporation to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and Tier 1 capital to average assets (as defined). Management believes, as of December 31, 1998, that the Corporation and IUB meet all capital adequacy requirements to which they are subject. As of December 31, 1998 the Corporation and IUB were categorized as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Corporation and IUB must significantly exceed minimum total risk-based, Tier 1 risk-based, and Tier 1 capital to average assets ratios. There have been no conditions or events that management believes have changed this category. The Corporation's and IUB's actual capital amounts and ratios are presented in the following table: Adequately Well Actual Capitalized Capitalized (In thousands) Amount Ratio Amount Ratio Amount Ratio --------------------------------------------------------------------------------------------------- As of December 31, 1998: Total Capital (to Risk- Weighted Assets) Irwin Financial Corporation $203,311 12.3% $132,742 8.0% $165,927 10.0% Irwin Union Bank 111,935 10.1 88,712 8.0 110,890 10.0 Tier 1 Capital (to Risk- Weighted Assets) Irwin Financial Corporation 191,806 11.6 66,371 4.0 99,556 6.0 Irwin Union Bank 105,215 9.5 44,356 4.0 66,534 6.0 Tier 1 Capital (to Average Assets) Irwin Financial Corporation 191,806 10.5 73,032 4.0 91,290 5.0 Irwin Union Bank 105,215 7.9 53,162 4.0 66,452 5.0 Adequately Well Actual Capitalized Capitalized (In thousands) Amount Ratio Amount Ratio Amount Ratio -------------------------------------------------------------------------------- As of December 31, 1997: Total Capital (to Risk- Weighted Assets) Irwin Financial Corporation $185,536 14.9% $99,951 8.0% $124,939 10.0% Irwin Union Bank 72,150 10.3 55,949 8.0 69,936 10.0 Tier 1 Capital (to Risk- Weighted Assets) Irwin Financial Corporation 169,366 13.6 49,975 4.0 74,963 6.0 Irwin Union Bank 65,549 9.4 27,974 4.0 41,961 6.0 Tier 1 Capital (to Average Assets) Irwin Financial Corporation 169,366 12.1 56,192 4.0 70,240 5.0 Irwin Union Bank 65,549 7.3 36,088 4.0 45,110 5.0 As of December 31, 1996: Total Capital (to Risk- Weighted Assets) Irwin Financial Corporation $124,010 12.9% $76,997 8.0% $96,246 10.0% Irwin Union Bank 62,479 11.0 45,842 8.0 57,302 10.0 Tier 1 Capital (to Risk- Weighted Assets) Irwin Financial Corporation 117,416 12.2 38,498 4.0 57,748 6.0 Irwin Union Bank 56,697 10.0 22,921 4.0 34,381 6.0 Tier 1 Capital (to Average Assets) Irwin Financial Corporation 117,416 9.8 47,741 4.0 59,676 5.0 Irwin Union Bank 56,697 6.9 31,775 4.0 39,719 5.0 Note 14: Fair Value of Financial Instruments Fair value estimates, methods and assumptions are set forth below for the Corporation's financial instruments: Cash and cash equivalents: The carrying amounts reported in the balance sheet for cash and cash equivalents approximate those assets' fair values. Interest-bearing deposits with financial institutions: The carrying amounts reported in the balance sheet for interest-bearing deposits with financial institutions approximate those assets' fair values. Trading assets: The carrying amounts reported in the balance sheet for trading assets approximate those assets' fair values. Investment securities: Fair values for investment securities were based on quoted market prices when available. For securities which had no quoted market prices, fair values were estimated by discounting future cash flows using current rates on similar securities. Loans: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values were based on carrying values. The fair values of commercial, consumer, real estate-mortgage, and real estate-construction loans were estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality and for the same remaining maturities. Deposit liabilities: The fair value of demand deposits, including interest and non-interest checking, passbook savings, and certain types of money market accounts, were assumed to be equal to the amount payable on demand at the reporting date. The carrying amounts for variable- rate money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposit were estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates with similar remaining maturities. Short-term borrowings: For variable-rate short-term borrowings that reprice frequently, fair values were based on carrying values. Long-term debt: The fair values of variable-rate long- term debt, which reprices frequently, were based on carrying values. For fixed-rate long-term debt, fair values were estimated using discounted cash flow analyses, based on current incremental borrowing rates for similar types of borrowing arrangements. Company-obligated mandatorily redeemable preferred securities of subsidiary trust: Fair values were estimated by discounting future cash flows using the current rate offered on similar securities. Forward contract commitments: The unrealized gains and losses of forward contract commitments is based on the difference between the settlement values of those commitments and the quoted market values of the underlying securities. The estimated fair values of the Corporation's financial instruments at December 31 are as follows: 1998 1997 Carrying Estimated Carrying Estimated (In thousands) Amount Fair Value Amount Fair Value ---------------------------------------------------------------------------------------------- Financial assets: Cash and cash equivalents $77,522 $77,522 $56,524 $56,524 Interest-bearing deposits with financial institutions 18,441 18,441 18,240 18,240 Trading assets 32,148 32,148 22,133 22,133 Investment securities 48,055 48,537 55,208 55,895 Loans held for sale 936,788 959,300 528,739 530,207 Loans, net of allowance for loan losses $542,509 $542,631 $539,931 $540,785 1998 1997 Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value ---------------------------------------------------------------------------------------------- Financial liabilities: Deposits $1,009,211 $1,009,349 $719,596 $719,669 Short-term borrowings 644,861 644,861 512,275 512,275 Long-term debt 2,839 2,839 7,096 7,138 Company-obligated mandatorily redeemable preferred securities of subsidiary trust 50,000 57,757 50,000 55,038 Forward contract commitments $- $(551) $- $(396) The fair value estimates consider relevant market information when available. Because no market exists for a significant portion of the Corporation's financial instruments, fair value estimates are determined judgmentally and consider various factors, including current economic conditions and risk characteristics of certain financial instruments. Changes in factors, or the weight assumed for the various factors, could significantly affect the estimated values. The fair value estimates are presented for existing on- and off-balance sheet financial instruments without attempting to estimate the value of the Corporation's long-term relationships with depositors and the benefit that results from the low cost funding provided by deposit liabilities. In addition, significant assets which were not considered financial instruments and were therefore not a part of the fair value estimates include lease receivables, servicing assets, and premises and equipment. Note 15: Company-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust In January 1997, the Corporation issued $50.0 million of trust preferred securities through IFC Capital Trust I, a trust created and controlled by the Corporation. The securities were issued at $25 per share with a cumulative dividend rate of 9.25%, payable quarterly. They have an initial maturity of 30 years with a 19-year extension option. The securities are callable at par after five years, or immediately, in the event of an adverse tax development affecting the Corporation's classification of the securities for federal income tax purposes. They are not convertible into common stock of the Corporation. The securities are shown on the balance sheet net of capitalized issuance costs. The sole assets of IFC Capital Trust I are subordinated debentures of the Corporation with a principal balance of $51.5 million, an interest rate of 9.25% and an initial maturity of 30 years with a 19-year extension option. Note 16: Shareholders' Equity The board of directors of the Corporation approved a two- for-one stock split May 27, 1998 and December 30, 1996. Previously reported shares and per share data have been changed to reflect these splits. The shareholders of the Corporation previously approved an increase in common shares authorized from 7,500,000 to 40,000,000 as of April 30, 1996. The Corporation has a stock plan to compensate directors of the Corporation with the Corporation's common stock, if so elected, in lieu of cash for their annual retainer fee and meeting fees. The number of shares issued under the plan is based on the current market value of the Corporation's common stock. The Corporation also has an employee stock purchase plan for all qualified employees. The plan provides for employees to purchase common stock through payroll deduction at approximately 85% of the current market value. The Corporation has three stock option plans (established in 1997, 1992, and 1986) which provide for the issuance of 4,280,000 shares of non-qualified and incentive stock options. The exercise price of each option, which has a ten year life and a vesting period of four years beginning the year granted, is equal to the market price of the Corporation's stock on the grant date. Vested outstanding stock options have been considered as common stock equivalents in the computation of diluted earnings per share. Activity in the above plans for 1998, 1997 and 1996 is summarized as follows (adjusted for the two-for-one stock splits on December 30, 1996 and May 27, 1998): 1998 1997 1996 Weighted Weighted Weighted average average average Number exercise Number exercise Number exercise of shares price of shares price of shares price ----------------------------------------------------------------------------------------------- Outstanding at the beginning of the year 1,231,220 $7.40 1,246,600 $5.83 1,237,600 $4.60 Granted 133,710 27.23 178,220 13.69 209,400 10.66 Exercised (103,880) 4.74 (187,400) 2.89 (175,896) 2.51 Cancelled (4,000) 15.92 (6,200) 9.62 (24,504) 8.93 ----------- --------- ---------- Outstanding at the end of year 1,257,050 9.71 1,231,220 7.40 1,246,600 5.83 =========== ========= ========== Exercisable at the end of year 1,014,420 $7.48 948,506 $6.16 922,600 $4.82 =========== ========= ========== Available for future grants 1,560,878 1,694,588 472,808 =========== ========= ========== The Corporation has not recognized compensation cost for the three non-qualified and incentive stock option plans or the employee stock purchase plan. Had compensation cost been determined based on the fair value at the grant dates, the Corporation's net income and earnings per share would have been reduced to the pro forma amounts indicated as follows: (In thousands, except per share amounts) 1998 1997 1996 ------------------------------------------------------------------------------------------ Net income As reported $30,503 $24,444 $22,428 Pro forma 29,746 23,913 22,071 Basic earnings per share As reported $1.40 $1.10 $0.99 Pro forma 1.37 1.07 0.97 Diluted earnings per share As reported $1.38 $1.08 $0.98 Pro forma 1.34 1.06 0.97 ------------------------------------------------------------------------------- The fair value of each option was estimated to be $12.25, $6.35 and $4.57 on the date of the grant using the binomial option-pricing model with the following assumptions for 1998, 1997 and 1996, respectively: risk free interest rates of 5.85%, 6.89% and 6.75%; dividend yield of 1.00% for 1998 and 1997, and 1.25% for 1996; and volatility of 0.250 for 1998 and 1997, and 0.228 for 1996. As of December 31, 1998, 1,253,050 options were outstanding under these plans with exercise prices that range between $1.26 and $28.56 and a remaining weighted average contractual life of 5.83 years. Note 17 : Earnings Per Share Earnings per share calculations are summarized as follows: Basic Earnings Effects of Diluted Earnings (In thousands, except per share amounts) Per Share Stock Options Per Share --------------------------------------------------------------------------------------------------- 1998: Net income $30,503 $- $30,503 Shares 21,732 407 22,139 --------- --------- -------- Per-Share Amount $1.40 $(0.02) $1.38 ========= ========= ======== 1997: Net income $24,444 $- $24,444 Shares 22,326 396 22,722 --------- --------- -------- Per-Share Amount $1.09 $(0.01) $1.08 ========= ========= ======== 1996: Net income $22,428 $- $22,428 Shares 22,716 314 23,030 --------- --------- -------- Per-Share Amount $0.99 $(0.02) $0.97 ========= ========= ======== The Board of Directors of the Corporation approved a two- for-one stock split effective May 27, 1998 and December 30, 1996. Previously reported per share data have been adjusted to reflect these splits. Note 18 : Income Taxes Income tax expense is summarized as follows: (In thousands) 1998 1997 1996 --------------------------------------------------------------------------- Current: Federal $6,963 $8,086 $4,980 State 2,048 2,268 1,574 ------- -------- -------- 9,011 10,354 6,554 ------- -------- -------- Deferred: Federal 9,256 6,162 6,750 State 2,087 1,218 1,555 ------- -------- -------- 11,343 7,380 8,305 ------- -------- -------- Income tax expense: Federal 16,219 14,248 11,730 State 4,135 3,486 3,130 ------- -------- -------- $20,354 $17,734 $14,860 ======= ======== ======== The Corporation's net deferred tax liability, which is included in other liabilities on the consolidated balance sheet, consisted of the following: December 31, 1998 1997 -------------------------------------------------------------------------- (In thousands) Mortgage servicing $(13,170) $(31,025) Lease financing income 3,188 (5,654) Deferred securitization income (2,664) (555) Loan and lease loss reserve 1,625 6,313 Deferred origination fees and costs (2,274) (1,454) Deferred compensation 596 2,626 Fixed assets (46) (1,085) Other, net (36) (978) ---------- ---------- Net deferred tax liability $(12,781) $(31,812) ========== ========== A reconciliation of income tax expense to the amount computed by applying the statutory income tax rate to income before income taxes is summarized as follows: (In thousands) 1998 1997 1996 ----------------------------------------------------------------------------------------------- Income taxes computed at the statutory rate $17,800 $14,762 $12,864 Increase (decrease) resulting from: Nontaxable interest from investment securities and loans (484) (198) (231) State franchise tax, net of federal benefit 2,810 2,330 2,076 Change in deferred tax asset or liability resulting from tax rate change - 292 191 Other items - net 228 548 (40) -------- -------- -------- $20,354 $17,734 $14,860 ======== ======== ======== Note 19: Employee Retirement Plan The Corporation has a defined benefit plan covering eligible employees of adopting subsidiaries. The benefits are based on years of service and the employees' compensation during their employment. Contributions are intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future. Plan assets are primarily invested in corporate and U.S. bonds, mutual funds, and cash equivalents. The mutual funds are invested primarily in common stocks and bonds. The following table sets forth amounts recognized in the Corporation's balance sheet: December 31, 1998 1997 -------------------------------------------------------------------------- (In thousands) Funded status $31 $68 Unrecognized prior service cost 136 155 Unrecognized net actuarial loss 164 455 ------ ------- Prepaid pension cost $331 $678 ====== ======= Weighted average assumptions: Discount rate 6.75% 7.00% Return on plan assets 9.00% 9.00% Rate of compensation increase 3.75% 4.00% A reconciliation of the change in projected benefit obligation and plan assets is presented below: 1998 1997 ------------------------------------------------------------------------- (In thousands) Benefit obligation at January 1, $9,046 $7,748 Service cost 568 475 Interest cost 622 566 Actuarial loss 192 493 Benefits paid (245) (236) ------- ------- Benefit obligation at December 31, $10,183 $9,046 ======= ======= Fair value of plan assets at January 1, $9,114 $8,161 Return on plan assets 1,345 974 Employer contributions - 215 Benefits paid (245) (236) ------ ------- Fair value of plan assets at December 31, $10,214 $9,114 ======= ======= The net pension cost for 1998, 1997, and 1996 included the following components: 1998 1997 1996 ----------------------------------------------------------------------------------------- Service cost $568 $475 $444 Interest cost 622 566 519 Return on plan assets (863) (745) (631) Amortization of transition obligation - (83) (130) Amortization of prior service cost 20 20 20 Amortization of actuarial loss - - 20 ------- ------- ------- Net pension cost $347 $233 $242 ======= ======= ======= Note 20: Irwin Financial Corporation (Parent Only) Financial Information The condensed financial statements of the parent company as of December 31, 1998 and 1997, and for the three years ended December 31, 1998 are presented below: Condensed Balance Sheet (In thousands) December 31, 1998 1997 -------------------------------------------------------------------------------- Assets: Cash and short-term investments $799 $744 Investment in bank subsidiary 105,807 65,673 Investments in non-bank subsidiaries 81,308 69,901 Loans to non-bank subsidiaries 60,221 97,688 Other assets 16,305 2,615 --------- --------- $264,440 $236,621 ========= ========= Liabilities: Short-term borrowings $118,513 $103,722 Other liabilities 694 4,916 --------- --------- 119,207 108,638 --------- --------- Shareholders' equity: Common stock 29,965 29,965 Other shareholders' equity 115,268 98,018 --------- --------- 145,233 127,983 --------- --------- $264,440 $236,621 Condensed Statement of Income (In thousands) For the year ended December 31, 1998 1997 1996 ----------------------------------------------------------------------------------------------- Income: Cash dividends from non-bank subsidiaries $18,331 $10,062 $10,053 Cash dividends from bank subsidiary 1,000 4,750 2,000 Interest income 5,348 5,666 2,376 Other 3,002 2,219 2,507 -------- -------- ------- 27,681 22,697 16,936 -------- -------- ------- Expenses: Interest expense 7,825 7,210 2,065 Salaries and benefits 4,548 4,009 3,429 Other 2,056 1,799 1,963 -------- -------- ------- 14,429 13,018 7,457 -------- -------- ------- Income before income taxes and equity in undistributed income of subsidiaries 13,252 9,679 9,479 Income taxes (credits), less amounts charged to subsidiaries (14,079) (2,590) (2,666) -------- -------- ------- 27,331 12,269 12,145 Equity in undistributed income of subsidiaries 3,172 12,175 10,283 -------- -------- ------- Net income $30,503 $24,444 $22,428 ======== ======== ======= Condensed Statement of Cash Flows (In thousands) For the year ended December 31, 1998 1997 1996 -------------------------------------------------------------------------------------------------------- Net income $30,503 $24,444 $22,428 Adjustments to reconcile Equity in undistributed income of net income to cash provided subsidiaries (3,172) (12,175) (10,283) by operating activities: Depreciation and amortization 209 160 89 Increase (decrease) in taxes payable (17,244) 1,046 315 Increase (decrease) in interest receivable 217 (314) (39) Increase (decrease) in interest payable (4) 146 164 Net change in other assets and other liabilities 1,529 (2,321) 1,393 -------- -------- -------- Net cash provided by operating activities 12,038 10,986 14,067 -------- -------- -------- Lending and investing Net decrease (increase) in loans to activities: subsidiaries 37,467 (51,571) (8,603) Investments in subsidiaries (48,550) (5,858) (11,500) Net additions to premises and equipment (1,381) (42) (22) -------- -------- -------- Net cash used by lending and investing activities (12,464) (57,471) (20,125) -------- -------- -------- Financing activities: Net increase in borrowings 14,791 62,547 9,732 Payments to acquire treasury stock (12,593) (14,411) (1,931) Proceeds from sale for employee benefit plans 1,756 1,588 1,332 Dividends paid (3,473) (3,114) (2,726) -------- -------- -------- Net cash provided by financing activities 481 46,610 6,407 -------- -------- -------- Net increase in cash and cash equivalents 55 125 349 Cash and cash equivalents at beginning of year 744 619 270 -------- -------- -------- Cash and cash equivalents at end of year $799 $744 $619 ======== ======== ======== Supplemental disclosures Cash paid during the year: of cash flow information: Interest $7,503 $7,064 $1,900 ======== ======== ======== Income taxes $18,947 $9,912 $6,230 ======== ======== ======== Note 21: Industry Segment Information The Corporation has three principal segments that provide a broad range of financial services throughout the United States. The mortgage banking line of business originates, sells and services residential first mortgage loans. The community banking line of business provides local banking services. The home equity lending line of business originates and services home equity loans via direct mail and telemarketing.The Corporation's other segments include equipment leasing and the parent company. The accounting policies of each segment are the same as those described in the "Summary of Significant Accounting Policies." Below is a summary of each segment's revenues, net income, and assets for 1998, 1997, and 1996: Mortgage Community Home Equity (In thousands) Banking Banking Lending Other Consolidated --------------------------------------------------------------------------------------------------- 1998: Net interest income $37,088 $13,797 $(3,260) $9,564 $57,189 Intersegment interest (12,565) 9,482 7,527 (4,444) - Other revenue 205,487 12,063 19,151 1,787 238,488 Gain on sale of leases - - - 5,241 5,241 Intersegment revenues 230 155 1,255 (1,640) - -------- -------- -------- -------- ---------- Total net revenues 230,240 35,497 24,673 10,508 300,918 Other expense 180,384 22,820 27,896 14,336 245,436 Intersegment expenses 1,810 2,201 3,445 (7,456) - -------- -------- -------- -------- ---------- Net income before taxes 48,046 10,476 (6,668) 3,628 55,482 Taxes 19,193 3,967 - (2,806) 20,354 -------- -------- -------- -------- -------- Net income 28,853 6,509 (6,668) 6,434 35,128 Distribution on preferred securities - - - 4,625 4,625 -------- -------- -------- -------- -------- Net income $28,853 $6,509 $(6,668) $1,809 $30,503 -------- -------- -------- -------- ---------- Assets at December 31, $877,904 $607,992 $311,974 $148,309 $1,946,179 ======== ======== ======== ======== ========== 1997: Net interest income $19,325 $19,678 $7,379 $2,239 $48,621 Intersegment interest (3,131) 116 (1,654) 4,669 - Other revenue 146,655 9,076 16,386 486 172,603 Intersegment revenues 51 358 - (409) - -------- -------- -------- ------- --------- Total net revenues 162,900 29,228 22,111 6,985 221,224 Other expense 125,005 19,674 20,372 9,522 174,573 Intersegment expenses 1,605 698 29 (2,332) - -------- -------- -------- ------- ----------- Net income before taxes 36,290 8,856 1,710 (205) 46,651 Taxes 14,990 3,269 - (525) 17,734 -------- -------- -------- ------- --------- Net income 21,300 5,587 1,710 320 28,917 Distribution on preferred securities - - - 4,473 4,473 -------- -------- -------- ------- ----------- Net income $21,300 $5,587 $1,710 $(4,153) $24,444 ======== ======== ======== ======== ========== Assets at December 31, $698,391 $539,233 $165,242 $93,928 $1,496,794 ======== ======== ======== ======== ========== 1996: Net interest income $18,164 $17,400 $7,340 $2,563 $45,467 Intersegment interest (1,441) 53 (568) 1,956 - Other revenue 131,749 9,250 8,648 334 149,981 Intersegment revenues 97 134 - (231) - -------- -------- -------- -------- ---------- Total net revenues 148,569 26,837 15,420 4,622 195,448 Other expense 112,447 19,678 16,236 9,799 158,160 Intersegment expenses 2,027 633 - (2,660) - -------- -------- -------- ------- ----------- Net income before taxes 34,095 6,526 (816) (2,517) 37,288 Taxes 13,673 2,272 - (1,085) 14,860 -------- -------- -------- -------- ---------- Net income $20,422 $4,254 $(816) $(1,432) $22,428 ======== ======== ======== ======== ========== Assets at December 31, $555,486 $503,507 $145,113 $96,016 $1,300,122 ======== ======== ======== ======= =========== Irwin Financial Corporation Directors Sally Abrams Dean Consultant, Retired Senior Vice President, Dillon, Read &Co. Inc. David W. Goodrich President-Indianapolis Operations Colliers Turley Martin Tucker John T. Hackett Managing General Partner, CID Equity Partners, L.P. William H. Kling President, Minnesota Public Radio Brenda J. Lauderback Former President, Footwear Wholesale Group, Nine West Group John C. McGinty, Jr. President, Peregrine Associates, Inc. Irwin Miller Former Chairman, Cummins Engine Company, Inc. William I. Miller Chairman, Irwin Financial Corporation John A. Nash President, Irwin Financial Corporation Lance R. Odden President and Headmaster, The Taft School Theodore M. Solso President and Chief Operating Officer, Cummins Engine Company, Inc. Irwin Financial Corporation Senior Officers William I. Miller Chairman John A. Nash President Thomas D. Washburn Senior Vice President and Chief Financial Officer Marie S. Ameis Vice President and Controller Gregory F. Ehlinger Vice President and Treasurer Jose M. Gonzalez Vice President--Internal Audit Theresa L. Hall Vice President--Human Resources Ellen Z. Mufson Vice President--Legal Michael F. Ryan Vice President--Community Development Matthew F. Souza Vice President and Secretary EXHIBIT 21(a). SUBSIDIARIES OF THE REGISTRANT State of Name Organization Irwin Union Bank and Trust Company Indiana Irwin Union Collateral, Inc. Indiana Irwin Union Realty Corporation Indiana Irwin Union Insurance, Inc. Indiana Irwin Union Securities, Inc. Indiana Irwin Funding Corp. Delaware Irwin Union Advisory Services, Inc. Indiana Irwin Reinsurance Corporation Vermont IFC Mortgage Corporation Indiana Irwin Mortgage Corporation Indiana Irwin Union Investor Services, Inc. Indiana Irwin Home Equity Corporation Indiana IHE Funding Corp. Delaware Irwin Equipment Finance Corp. Indiana Irwin Leasing Corporation (formerly Affiliated Capital Corp.) Illinois Irwin Union Credit Insurance Corporation Arizona White River Capital Corporation Indiana IFC Capital Trust I Delaware Consent of Independent Public Accountants We consent to the incorporation by reference in Registration Statement No. 33-8506 on Form S-8 effective September 25, 1986; in Registration Statement No. 33-25931 on Form S-8 effective December 28, 1988; in Registration Statement No. 33- 6880 on Form S-8 as amended by Post-Effective Amendment No. 1 effective December 22, 1989; in Registration Statement No. 33-32783 on Form S-8 effective January 11, 1990; in Registration Statement No. 2-72249 on Form S-3 as amended by Post- Effective Amendment No. 3 to Form S-16 effective January 17, 1990; in PostEffective Amendment No. 2 to Registration Statement No. 33-6880 on Form S-8 effective April 9, 1990; in Registration Statement No. 33-32783 on Form S-8 as amended by Post- Effective Amendment No. 1 effective April 9, 1990; in Registration Statement No. 33-47680 on Form S-8 effective May 5, 1992 in Registration Statement No. 2-72249 on Form S- 3 as amended by Post-Effective Amendment No. 4 to Form S-16 effective April 7, 1994; in Registration Statement No. 33-29493 on Form S-8 as amended by Post-Effective Amendment No. 2 effective September 27, 1994; in Registration Statement No. 33-62671 on Form S-8 effective September 15, 1995; in Registration Statement No. 33-62669 on Form S-8 effective September 15, 1995; and in Registration Statement No. 333-26197 on Form S-8 effective April 30, 1997 by Irwin Financial Corporation of our report, dated January 21, 1999, on our audits of the consolidated financial statements of Irwin Financial Corporation as of December 31, 1998 and 1997 and for each of the three years in the period ended December 31, 1998, which report is incorporated by reference in this Annual Report on Form 10-K. /s/ PricewaterhouseCoopers LLP Cincinnati, Ohio March 26, 1999