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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, 2001
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 CORPORATION AS SPECIFIED IN ITS CHARTER)
INDIANA 35-1286807
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
500 WASHINGTON STREET COLUMBUS, INDIANA 47201
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(812) 376-1909
(CORPORATION'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
TITLE OF CLASS: COMMON STOCK*
TITLE OF CLASS: 9.25% CUMULATIVE TRUST PREFERRED SECURITIES ISSUED BY IFC
CAPITAL TRUST I AND THE GUARANTEE WITH RESPECT THERETO.
TITLE OF CLASS: 10.50% CUMULATIVE TRUST PREFERRED SECURITIES ISSUED BY IFC
CAPITAL TRUST II AND THE GUARANTEE WITH RESPECT THERETO.
TITLE OF CLASS: 8.75% CUMULATIVE TRUST PREFERRED SECURITIES ISSUED BY IFC
CAPITAL TRUST III AND THE GUARANTEE WITH RESPECT THERETO.
Indicate by check mark whether the Corporation: (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
Corporation was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Corporation's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the Corporation was $277,671,410 as of March 11, 2002. As of March 11, 2002,
there were outstanding 27,534,021 common shares of the Corporation.
* Includes associated rights.
DOCUMENTS INCORPORATED BY REFERENCE
SELECTED PORTIONS OF THE FOLLOWING DOCUMENTS PART OF FORM 10-K INTO WHICH INCORPORATED
-------------------------------------------- -----------------------------------------
DEFINITIVE PROXY STATEMENT FOR ANNUAL MEETING PART III
OF SHAREHOLDERS TO BE HELD APRIL 25, 2002
EXHIBIT INDEX ON PAGES 98 THROUGH 99
TOTAL PAGES IN THIS FILING: 104
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FORM 10-K
TABLE OF CONTENTS
Part I
Item 1 -- Business.................................................... 2
Item 2 -- Properties.................................................. 15
Item 3 -- Legal Proceedings........................................... 17
Item 4 -- Submission of Matters to a Vote of Security Holders......... 19
Part II
Item 5 -- Market for Corporation's Common Equity and Related Security
Holder Matters.............................................. 20
Item 6 -- Selected Financial Data..................................... 21
Item 7 -- Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 23
Item 7(A) -- Quantitative and Qualitative Disclosures about Market
Risk........................................................ 64
Item 8 -- Financial Statements and Supplementary Data................. 65
Item 9 -- Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 96
Part III
Item 10 -- Directors and Executive Officers of the Corporation......... 97
Item 11 -- Executive Compensation...................................... 97
Item 12 -- Security Ownership of Certain Beneficial Owners and
Management.................................................. 97
Item 13 -- Certain Relationships and Related Transactions.............. 97
Part IV
Item 14 -- Exhibits and Reports on Form 8-K............................ 98
Signatures...................................................................... 101
1
PART I
ITEM 1. BUSINESS
GENERAL
We are a diversified financial services company headquartered in Columbus,
Indiana with $3.1 billion in assets at December 31, 2001. We focus primarily on
the extension of credit to consumers and small businesses as well as providing
the ongoing servicing of those customer accounts. We currently operate five
major lines of business through our direct and indirect subsidiaries. Our major
lines of business are: commercial banking, mortgage banking, home equity
lending, equipment leasing and venture capital.
We are a regulated bank holding company and we conduct our consumer and
commercial lending businesses through various operating subsidiaries. Our
banking subsidiary, Irwin Union Bank and Trust, was organized in 1871 and we
formed the holding company in 1972. Our direct and indirect major subsidiaries
include Irwin Union Bank and Trust, a commercial bank, which together with Irwin
Union Bank, F.S.B., a federal savings bank, conducts our commercial banking
activities; Irwin Mortgage Corporation, a mortgage banking company; Irwin Home
Equity Corporation, a consumer home equity lending company; Irwin Capital
Holdings Corporation, an equipment leasing subsidiary; and Irwin Ventures LLC, a
venture capital company.
At the parent level, we work actively to add value to our lines of business
by interacting with the management teams, capitalizing on interrelationships,
providing centralized services and coordinating overall organizational
decisions. Under this organizational structure, our separate businesses hold and
fund the majority of their assets through Irwin Union Bank and Trust. This
provides additional liquidity and results in regulatory oversight of each of our
lines of business.
MAJOR LINES OF BUSINESS
Mortgage Banking
We established our mortgage banking line of business when we acquired our
subsidiary, Irwin Mortgage Corporation, formerly Inland Mortgage Corporation, in
1981. In this line of business, Irwin Mortgage, in conjunction with Irwin Union
Bank and Trust, originates, purchases, sells, and services conventional and
government agency-backed residential mortgage loans throughout the United
States. Most of our mortgage originations either are insured by an agency of the
federal government, such as the Federal Housing Authority, or FHA, or the
Veterans Administration, or VA, or, in the case of conventional mortgages, meet
requirements for resale to the Federal National Mortgage Association, or FNMA,
or the Federal Home Loan Mortgage Corporation, or FHLMC. We originate mortgage
loans through retail offices, direct marketing and our Internet website. We also
purchase mortgage loans through mortgage brokers. Our relationships with
realtors, homebuilders and brokers help us identify potential borrowers. We sell
mortgage loans to institutional and private investors but may retain servicing
rights to the loans we originate or purchase from correspondents. Irwin Mortgage
collects and accounts for the monthly payments on each loan serviced and pays
the real estate taxes and insurance necessary to protect the integrity of the
mortgage lien, for which it receives a servicing fee.
At December 31, 2001, Irwin Mortgage operated 100 production and satellite
offices in 27 states. We discuss this line of business further in the Mortgage
Banking section of Management's Discussion and Analysis of Financial Condition
and Results of Operations (MD&A) of this report.
Home Equity Lending
We established this line of business when we formed Irwin Home Equity
Corporation as our subsidiary in 1994, headquartered in San Ramon, California.
Irwin Home Equity became a subsidiary of Irwin Union Bank and Trust in 2001. In
conjunction with Irwin Union Bank and Trust, Irwin Home Equity originates,
purchases, securitizes and services home equity loans and lines of credit
nationwide. Our target customers are credit worthy, home owning consumers who
are active, unsecured credit card debt users. We market our home equity products
through direct mail, telemarketing, mortgage brokers and correspondent lenders
nationwide and through the Internet.
2
Irwin Home Equity's core competencies are credit risk management and
analysis, risk assessment, profit-based planning and specialized home loan
servicing, with particular expertise in product development, test management and
database analysis. Irwin Home Equity regularly develops and tests new product
offerings on a limited basis, and introduces those that prove successful on a
national basis. Current product offerings, in addition to traditional home
equity products, include first mortgage refinance programs.
We discuss this line of business further in the Home Equity Lending section
of the MD&A of this report.
Commercial Banking
Our commercial banking line of business provides credit, cash management
and personal banking products to small businesses and business owners. We offer
a full line of consumer, mortgage and commercial loans, as well as personal and
commercial checking accounts, savings and time deposit accounts, personal and
business loans, credit card services, money transfer services, financial
counseling, property, casualty, life and health insurance agency services, trust
services, securities brokerage and safe deposit facilities.
We offer commercial banking services through our banking subsidiaries,
Irwin Union Bank and Trust, an Indiana state-chartered commercial bank, and
Irwin Union Bank, F.S.B., a federal savings bank.
- Irwin Union Bank and Trust Company -- headquartered in Columbus, Indiana
and organized in 1871, is a full service Indiana state-chartered
commercial bank with offices currently located throughout nine counties
in central and southern Indiana, as well as in Kalamazoo, Grandville
(near Grand Rapids), Traverse City and Lansing, Michigan, and Carson
City, Nevada; and
- Irwin Union Bank, F.S.B. -- headquartered in Louisville, Kentucky, is a
full-service federal savings bank that began operations in December 2000.
Currently we have offices located in Brentwood, Missouri (near St.
Louis), Louisville, Kentucky, Salt Lake City, Utah, Las Vegas, Nevada and
Phoenix, Arizona.
We discuss this line of business further in the Commercial Banking section
of the MD&A of this report.
Equipment Leasing
We established this line of business in 1999 when we formed Irwin Business
Finance, our United States equipment leasing company, headquartered in Bellevue,
Washington. In our equipment leasing line of business, we originate transactions
from an established North American network of brokers and vendors and through
direct sales to franchisees. The majority of our leases are full payout (i.e.,
no residual), small-ticket assets secured by commercial equipment. We finance a
variety of commercial and office equipment types and try to limit the industry
and geographic concentrations in our lease portfolio.
In July 2000, the equipment leasing line of business acquired an ownership
of approximately 78% of Onset Capital Corporation, a Canadian small-ticket
equipment leasing company headquartered in Vancouver, British Columbia. In
December 2001 Onset Capital established Onset Alberta Ltd. as a subsidiary to
facilitate its leasing business. In October 2001 we formed Irwin Franchise
Capital Corporation to conduct our franchise leasing business. We established
Irwin Capital Holdings in April 2001 as a subsidiary of Irwin Union Bank and
Trust to serve as the parent company for both our United States and Canadian
equipment leasing companies.
We discuss this line of business further in the Equipment Leasing section
of the MD&A of this report.
Venture Capital
We established this line of business when we formed Irwin Ventures
Incorporated in August 1999. In our venture capital line of business, we make
minority investments in early stage companies in the financial services industry
and related fields that intend to use technology as a key component of their
competitive strategy. We provide Irwin Ventures' portfolio companies the benefit
of our management experience in the financial services industry. In addition, we
expect that contacts made through venture activities may benefit management of
our other lines of business through the sharing of technologies and market
opportunities.
3
In August 1999, Irwin Ventures established a subsidiary, Irwin Ventures
Incorporated-SBIC, which received a small business investment company license
from the Small Business Administration. In December 2000, Irwin Ventures and
Irwin Ventures-SBIC became Delaware limited liability companies. To date, the
primary geographic focus of this line of business and each of our investments
has been on the corridors of the east and west coasts between Washington, D.C.
and Boston, and Los Angeles and Seattle.
Other Subsidiaries
Irwin Union Credit Insurance Corporation has its home office in Columbus,
Indiana and provides credit life insurance to consumer loan customers of Irwin
Union Bank.
We continue to hold certain small-ticket equipment leases in our
subsidiary, Irwin Leasing Corporation (the former Affiliated Capital Corp.). The
leases were not part of the 1998 sale of substantially all of the assets of
Affiliated Capital to DVI Financial Services, Inc. Irwin Leasing and its parent,
Irwin Equipment Finance Corporation, are inactive except for the leases.
No single part of our business is dependent upon a single customer or upon
a very few customers and the loss of any one customer would not have a
materially adverse effect upon our business.
COMPETITION
In our commercial banking business, we compete with commercial banks,
savings banks, thrifts and credit unions for deposits and loans in and around
the counties surrounding our branch offices, and with a number of nonbank
companies located throughout the United States, including insurance companies,
retailers, securities firms, companies offering money market accounts, and
national credit card companies.
In our mortgage banking business we compete for mortgage loans with other
national, regional, local, and web-enabled mortgage banking companies, as well
as commercial banks, savings banks, and savings and loan associations.
In our home equity lending business, our primary competitors for our home
equity loans and lines of credit include banks, mortgage banks, large securities
firms, credit unions, thrifts, credit card issuers, finance companies, and other
home equity and mortgage lenders with operations that are either national,
regional, local or web-enabled in scope. Competition can take many forms,
including convenience in obtaining loans, customer service, marketing and
distribution channels, terms provided and interest rates charged to borrowers.
In our equipment leasing business, our primary competitors include other
finance companies that are independent or affiliated with banks or large
equipment leasing companies that operate on a national or regional basis.
In our venture capital line of business, we compete primarily with other
venture capital firms and individuals who invest in start-up companies.
Some of our competitors are not subject to the same degree of regulation as
that imposed on bank holding companies, state banking organizations and federal
saving banks. In addition, many larger banking organizations, mortgage
companies, mortgage banks, insurance companies and securities firms have
significantly greater resources than we do. As a result, some of our competitors
have advantages over us in name recognition and market penetration.
SUPERVISION AND REGULATION
GENERAL
The financial services business is highly regulated, primarily for the
protection of depositors and other customers. The following is a summary of
several applicable statutes and regulations that apply to us and to our
subsidiaries. These summaries are not complete, and you should refer to the
statutes and regulations for more information. Also, these statutes and
regulations may change in the future, and we cannot predict what effect these
changes, if made, will have on our operations.
4
BANK HOLDING COMPANY REGULATION
We are registered as a bank holding company with the Board of Governors of
the Federal Reserve System under the Bank Holding Company Act of 1956, as
amended and the related regulations, referred to as the BHC Act. We are subject
to regulation, supervision and examination by the Federal Reserve and as part of
this process, we must file reports and additional information with the Federal
Reserve.
Minimum Capital Requirements
The Federal Reserve has adopted risk-based capital guidelines for assessing
bank holding company capital adequacy. These standards define capital and
establish minimum capital ratios in relation to assets, both on an aggregate
basis and as adjusted for credit risks and off-balance sheet exposures. Under
the Federal Reserve's risk-based guidelines applicable to us, capital is
classified into two categories for bank holding companies:
Tier 1 capital, or core capital, consists of:
- common stockholder's equity;
- qualifying noncumulative perpetual preferred stock;
- qualifying cumulative perpetual preferred stock (subject to some
limitations); and
- minority interests in the common equity accounts of consolidated
subsidiaries;
less
- goodwill;
- credit-enhancing interest-only strips (certain amounts only); and
- specified intangible assets.
Tier 2 capital, or supplementary capital, consists of:
- allowance for loan and lease losses;
- perpetual preferred stock and related surplus;
- hybrid capital instruments;
- unrealized holding gains on equity securities;
- perpetual debt and mandatory convertible debt securities;
- term subordinated debt, including related surplus; and
- intermediate-term preferred stock, including related securities.
The Federal Reserve's capital adequacy guidelines require bank holding
companies to maintain a minimum ratio of qualifying total capital to
risk-weighted assets of 8 percent, at least 4 percent of which must be in the
form of Tier 1 capital. Risk-weighted assets include assets and credit
equivalent amounts of off-balance sheet items of bank holding companies that are
assigned to one of several risk categories, based on the obligor or the nature
of the collateral. The Federal Reserve has established a minimum ratio of Tier 1
capital (less any intangible capital items) to total assets (less any intangible
assets), or leverage ratio, of 3 percent for strong bank holding companies
(those rated a composite "1" under the Federal Reserve's rating system). For all
other bank holding companies, the minimum ratio of Tier 1 capital to total
assets is 4 percent. Also, the Federal Reserve continues to consider the Tier 1
leverage ratio in evaluating proposals for expansion or new activities.
In its capital adequacy guidelines, the Federal Reserve emphasizes that the
standards discussed above are minimums and that banking organizations generally
are expected to operate well above these minimum levels.
5
These guidelines also state that banking organizations experiencing growth,
whether internally or by making acquisitions, are expected to maintain strong
capital positions substantially above the minimum levels.
As of December 31, 2001, we had regulatory capital in excess of the Federal
Reserve's minimum levels. Our ratio of total capital to risk weighted assets at
December 31, 2001 was 10.84% and our Tier 1 leverage ratio was 9.45%.
Residual Interests. On November 29, 2001, the four federal banking
agencies jointly adopted revised regulatory capital standards regarding the
treatment of certain recourse obligations, direct credit substitutes, residual
interests in assets securitizations, and other securitized transactions that
expose financial institutions primarily to credit risk. The agencies had
previously published guidelines on securitization activities in December, 1999
(the "Securitization Guidance") which dealt with the risk management and
regulatory oversight issues involved with asset securitizations and residual
interests.
Residual interests generally include any on-balance sheet asset created by
the sale of financial assets that results in the retention of any credit risks,
directly or indirectly, associated with the transfer of assets, where the
retained risk exceeds a pro rata share of the organization's claim on the
assets, whether through subordination provisions or other credit enhancement
techniques.
The revised rules (the "New Rules") became effective January 1, 2002 with
respect to residual interests related to any transaction that settles on or
after that date. For transactions that settled prior to the effective date of
the New Rules, capital treatment prescribed by the application of the New Rules
is delayed until December 31, 2002.
The New Rules amend the inter-agency regulatory capital standards in a
number of respects. The key changes are as follows:
- Providing for more consistent risk-based capital treatment for recourse
obligations and direct credit substitutes and adding new standards for
residual interests;
- Applying a ratings-based approach that sets capital standards for
positions in securitized transactions (excluding certain residual
interests as discussed below) based upon their relative risk exposure,
while using credit ratings from nationally-recognized statistical rating
organizations;
- Deducting from Tier 1 capital the amount of credit-enhancing
interest-only strips, referred to as CEIOS (a subset of residual
interests), that exceeds 25% of Tier 1 capital for regulatory purposes,
referred to as the concentration limit; and
- Requiring a dollar in risk-based capital for each dollar of residual
interest, referred to as the dollar-for-dollar capital requirement, not
deducted from Tier 1 capital except those qualifying under the ratings-
based approach.
Capital Treatment of Residual Interests. The New Rules impose a
concentration limit on credit-enhancing interest-only strips, or CEIOS, and a
dollar-for-dollar capital requirement on residual interests not deducted from
Tier 1 capital.
CEIOS are, generally, assets created from the excess interest on assets
transferred (after reduction for administrative expenses, investor interest
payments, servicing fees, and credit losses on investors' interests in these
assets) that serve as credit enhancements for the investors. CEIOS include
residual interests whether created by a securitization transaction or whether
purchased from third parties. Under the New Rules, interest-only strips are
limited to 25% of Tier 1 capital, with the excess deducted from Tier 1 capital.
See "Recent Developments" for more information regarding our pro forma December
31, 2001 consolidated capital ratios giving effect to the New Rules assuming
different potential outcomes of our pending evaluation as to whether a portion
of our residual assets fall outside the definition of CEIOS.
CEIOS are the residual interests most often resulting from asset
securitizations such as our securitization of home equity loans, in which the
seller of loans accounts for the transaction using gain-on-sale accounting
treatment. Recording gain on the sale allows the seller to leverage the capital
created based on the current recognition of future cash flows. Because this
capital may no longer be available to support these assets if
6
write-downs later become necessary, the regulatory agencies adopted the
amendments incorporated in the New Rules to limit the risk of residual asset
concentrations. The New Rules will allow banking organizations the option of
netting existing associated deferred tax liabilities against residual interests
for regulatory capital purposes. CEIOS may not qualify for the more favorable
treatment under the ratings-based approach referenced above.
The New Rules reflect the policy in the existing Securitization Guidance
that imposes more frequent supervisory review, limitations on residual interest
holdings, more stringent capital requirements, or other supervisory constraints
on banking organizations found by the regulatory agencies to be lacking
effective risk management programs or engaging in practices that present safety
and soundness concerns. The Securitization Guidance provides that a bank's
failure to understand the risks inherent in the securitization activities and to
incorporate them into risk management systems and internal capital allocations
may constitute an unsafe or unsound banking practice and may result in the
down-grading of an organization's regulatory ratings.
Expansion
The BHC Act requires prior Federal Reserve approval for certain activities,
such as the acquisition by a bank holding company of control of another bank or
bank holding company. Under the BHC Act, a bank holding company may engage in
activities that the Federal Reserve has determined to be so closely related to
banking or managing or controlling banks as to be a proper incident to those
banking activities, such as operating a mortgage bank or a savings association,
conducting leasing and venture capital investment activities, performing trust
company functions, or acting as an investment or financial advisor. See the
section on "Interstate Banking and Branching Legislation" below.
Dividends
The Federal Reserve has policies on the payment of cash dividends by bank
holding companies. The Federal Reserve believes that a bank holding company
experiencing earnings weaknesses should not pay cash dividends (1) exceeding its
net income or (2) which only could be funded in ways that would weaken a bank
holding company's financial health, such as by borrowing. Also, the Federal
Reserve possesses enforcement powers over bank holding companies and their
non-bank subsidiaries to prevent or remedy unsafe or unsound practices or
violations of applicable statutes and regulations. Among these powers is the
ability to prohibit or limit the payment of dividends by banks and bank holding
companies.
The Federal Reserve expects us to act as a source of financial strength to
our banking subsidiaries and to commit resources to support them. In
implementing this policy, the Federal Reserve could require us to provide
financial support when we otherwise would not consider ourselves able to do so.
In addition to the restrictions on fundamental corporate actions such as
acquisitions and dividends imposed by the Federal Reserve, Indiana law also
places limitations on our authority with respect to such activities.
BANK AND THRIFT REGULATION
Indiana law subjects Irwin Union Bank and Trust and its subsidiaries to
supervision and examination by the Indiana Department of Financial Institutions,
or the DFI. Irwin Union Bank and Trust is a member of the Federal Reserve System
and, along with its subsidiaries, is also subject to regulation, examination and
supervision by the Federal Reserve. These subsidiaries include Irwin Home Equity
and Irwin Capital Holdings. Irwin Union Bank, F.S.B. is a federally chartered
savings bank. Accordingly, it is governed by and subject to regulation,
examination and supervision by the Office of Thrift Supervision, or the OTS, and
is required to comply with the rules and regulations of the OTS under the Home
Owners' Loan Act, or HOLA.
The Federal Reserve also supervises Irwin Union Bank and Trust's compliance
with federal law and regulations that restrict loans by member banks to their
directors, executive officers, and other controlling persons.
7
The deposits of Irwin Union Bank and Trust are insured by the Bank
Insurance Fund, or the BIF, and the deposits of Irwin Union Bank, F.S.B. are
insured by the Savings Association Insurance Fund, or SAIF, under the provisions
of the Federal Deposit Insurance Act, or the FDIA. As a result, Irwin Union Bank
and Trust and Irwin Union Bank, F.S.B. also are subject to supervision and
examination by the FDIC. The regulatory scheme applicable to Irwin Union Bank
and Trust is comparable to that imposed on Irwin Union Bank, F.S.B. by the OTS.
Mortgage Banking and Residential Lending Regulation
The residential lending activities of Irwin Union Bank and Trust, the
mortgage banking activities of Irwin Mortgage, and the home equity lending
business of Irwin Home Equity are regulated by the Federal Reserve. The Federal
Reserve has broad authority to oversee the banking activities of Irwin Union
Bank and Trust as the bank's primary federal regulator pursuant to the FDIA and
the nonbanking subsidiaries of both Irwin Financial Corporation and Irwin Union
Bank and Trust pursuant to the BHC Act. Federal Reserve regulations, such as
restrictions on affiliate transactions, asset quality and earnings performance,
apply to our residential lending activities. The DFI has comparable supervisory
and examination authority over Irwin Home Equity and Irwin Capital Holdings due
to their status as subsidiaries of Irwin Union Bank and Trust.
Capital Requirements
The Federal Reserve has published regulations applicable to state member
banks such as Irwin Union Bank and Trust regarding the maintenance of adequate
capital. While retaining the authority to set capital ratios for individual
banks, these regulations group banks into categories based upon total risk-based
capital, Tier 1 risk-based capital and a leverage ratio (Tier 1 capital divided
by average total assets). These categories, and the applicable capital ratios,
are as follows:
The Federal Reserve requires banks to hold capital commensurate with the
level and nature of all of the risks, including the volume and severity of
problem loans, to which they are exposed. The Federal Reserve requires all state
member banks to meet a minimum ratio of qualifying total capital to weighted
risk assets of 8 percent, of which at least 4 percent should be in the form of
Tier 1 capital. For purposes of this ratio, Tier 1 capital is defined as the sum
of core capital elements less goodwill and other intangible assets.
The minimum ratio of Tier 1 capital to total assets for strong banking
institutions (rated composite "1" under the uniform rating system of banks) is 3
percent. For all other institutions, the minimum ratio of Tier 1 capital to
total assets is 4 percent. Banking institutions with supervisory, financial,
operational, or managerial weaknesses are expected to maintain capital ratios
well above the minimum levels, as are institutions with high or inordinate
levels of risk. Banks experiencing or anticipating significant growth are also
expected to maintain capital, including tangible capital positions, well above
the minimum levels. For example, most such institutions generally have operated
at capital levels ranging from 1 to 2 percent above the stated minimums. Higher
capital ratios could be required if warranted by the particular circumstances to
risk profiles of individual banks. The standards set forth above specify minimum
supervisory ratios based primarily on broad credit risk considerations. The
risk-based ratio does not take explicit account of the quality of individual
asset portfolios or the range of other types of risks to which banks may be
exposed, such as interest rate, liquidity, market or operational risks. For this
reason, banks are generally expected to operate with capital positions above the
minimum ratios.
At December 31, 2001, Irwin Union Bank and Trust had a total risk-based
capital ratio of 10.38%, a Tier 1 capital ratio of 9.93%, and a leverage ratio
of 12.39% and was considered well-capitalized. See "Bank Holding Company
Regulation -- Minimum Capital Requirements -- Residual Interests" earlier in
this section for a discussion of the impact of the new regulatory capital
treatment rules. We transferred a portion, and plan to transfer an additional
portion, of our residual assets held at Irwin Union Bank and Trust to our
holding company in the form of dividends during the first quarter of 2002.
Because of the amount of the residuals, we sought and received regulatory
approval of these dividends as required. In connection with our decision in the
fourth quarter of 2001 to dividend these residual assets out of Irwin Union Bank
and Trust and after discussions with our regulators as well as consideration of
the risk profile of our organization, our Board
8
of Directors adopted resolutions regarding maintenance of capital levels above
the well-capitalized minimum requirements beginning March 31, 2002. The
benchmark levels we established are 12% total capital to risk-weighted assets at
Irwin Union Bank and Trust, and 11% total capital to risk-weighted assets at
Irwin Financial. Although the dividends of the residual assets will not have a
meaningful impact on our consolidated capital ratios calculated under the New
Rules, the dividends have the effect of increasing regulatory capital ratios at
Irwin Union Bank and Trust.
The Federal Reserve, the OTS, the FDIC and other federal banking agencies
also have adopted a final rule that modifies the risk-based capital standards to
provide for consideration of interest rate risk when assessing capital adequacy
of a bank or savings association. Under this rule, the Federal Reserve, the OTS
and the FDIC must explicitly include a bank or savings association's exposure to
declines in the economic value of their capital due to changes in interest rates
as a factor in evaluating capital adequacy of a bank or savings association. The
Federal Reserve, the OTS, the FDIC and other federal banking agencies also have
adopted a joint agency policy statement providing guidance for managing interest
rate risk. The policy statement emphasizes the importance of adequate management
oversight and a sound risk management process. This assessment of interest rate
risk management made by the banks' examiners will be incorporated into the
banks' overall risk management rating and used to determine management's
effectiveness.
Insurance of Deposit Accounts
Under the Federal Deposit Insurance Corporation Improvements Act of 1991,
or the FDICIA, as FDIC-insured institutions, Irwin Union Bank and Trust and
Irwin Union Bank, F.S.B. are required to pay deposit insurance premiums based on
the risk they pose to BIF and SAIF, respectively. The FDIC also has authority to
raise or lower assessment rates on insured deposits to achieve the statutorily
required reserve ratios in insurance funds and to impose special additional
assessments. Each depository institution is assigned to one of three capital
groups: "well capitalized," "adequately capitalized" or "undercapitalized." An
institution is considered well capitalized if it has a total risk-based capital
ratio of 10% or greater, has a Tier 1 risk-based capital ratio of 6% or greater,
has a leverage ratio of 5% or greater and is not subject to any order or written
directive to meet and maintain a specific capital level. An "adequately
capitalized" institution has a total risk-based capital ratio of 8% or greater,
has a Tier 1 risk-based capital ratio of 4% or greater, has a leverage ratio of
4% or greater and does not meet the definition of a well capitalized bank. An
institution is considered "undercapitalized" if it does not meet the definition
of "well capitalized" or "adequately capitalized." Within each capital group,
institutions are assigned to one of three supervisory subgroups: "A"
(institutions with few minor weaknesses), "B" (institutions that demonstrate
weaknesses which, if not corrected, could result in significant deterioration of
the institution and increased risk of loss to the insurance funds), and "C"
(institutions that pose a substantial probability of loss to the insurance funds
unless effective corrective action is taken). There are nine combinations of
capital groups and supervisory subgroups to which varying assessment rates may
apply. An institution's assessment rate depends on the capital category and
supervisory category to which it is assigned.
Dividend Limitations
As a state member bank, Irwin Union Bank and Trust may not, without the
approval of the Federal Reserve, declare a dividend if the total of all
dividends declared in a calendar year exceeds the total of its net income for
that year, combined with its retained net income of the preceding two years,
less any required transfers to the surplus account. Under Indiana law, certain
dividends require notice to, or approval by, the DFI, and Irwin Union Bank and
Trust may not pay dividends in an amount greater than its net profits then
available, after deducting losses and bad debts. The amount of the residual
assets that have or will be transferred to the holding company as a dividend
from the bank exceed the amount that could have been dividended by the bank to
us without regulatory approval as described above and, as a result, we sought
and obtained regulatory approval for the dividend. Due to the limitations
described above, we must now obtain prior approval from the DFI and the Federal
Reserve Bank of Chicago before Irwin Union Bank and Trust can pay additional
dividends to us.
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In most cases, savings and loan associations, such as Irwin Union Bank,
F.S.B., are required either to apply to or to provide notice to the OTS
regarding the payment of dividends. The savings association must seek approval
if it does not qualify for expedited treatment under OTS regulations, or if the
total amount of all capital distributions for the applicable calendar year
exceeds net income for that year to date plus retained net income for the
preceding two years, or the savings association would not be adequately
capitalized following the dividend, or the proposed dividend would violate a
prohibition in any statute, regulation or agreement with the OTS. In other
circumstances, a simple notice is sufficient.
Our ability and the ability of Irwin Union Bank and Trust and Irwin Union
Bank, F.S.B. to pay dividends also may be affected by the various capital
requirements and the capital and noncapital standards established under the
FDICIA, as described above. Our rights and the rights of our shareholders and
our creditors to participate in any distribution of the assets or earnings of
our subsidiaries also is subject to the prior claims of creditors of our
subsidiaries including the depositors of a bank subsidiary.
Interstate Banking and Branching Legislation
Under the Riegle-Neal Interstate Banking and Branching Efficiency Act of
1994, or the Interstate Banking Act, banks are permitted, subject to being
adequately or better capitalized, in compliance with CRA requirements and in
compliance with state law requirements (such as age of bank limits and deposit
caps), to merge with one another across state lines and to create a main bank
with branches in separate states. After establishing branches in a state through
an interstate merger transaction, a bank may establish and acquire additional
branches at any location in the state where any bank involved in the interstate
merger could have established or acquired branches under applicable federal and
state law.
Although Irwin Union Bank, F.S.B. has a different primary federal regulator
from Irwin Union Bank and Trust, most, if not all, of the federal statutes and
regulations applicable to Irwin Union Bank also apply to Irwin Union Bank,
F.S.B. However, as a federally chartered savings bank, Irwin Union Bank, F.S.B.
has greater flexibility in pursuing interstate branching than an Indiana state
bank. A federal savings association may establish or operate a branch in any
state outside the state of its home office if the association meets certain
statutory requirements. These requirements do not apply if the law of the state
where the branch is to be located offers reciprocal branching privileges with
the state where the savings association has its home office located. As Irwin
Union Bank and Trust does with its supervisory regulatory agencies, Irwin Union
Bank, F.S.B. must file reports with the OTS and the FDIC concerning its
activities and financial condition in addition to obtaining regulatory approvals
before establishing branches or entering into certain transactions such as
mergers with, or acquisitions of, other financial institutions.
Community Reinvestment
Under the Community Reinvestment Act, or the CRA, a financial institution
has a continuing and affirmative obligation, consistent with its safe and sound
operation, to help meet the credit needs of its entire community, including low-
and moderate-income neighborhoods. The CRA does not establish specific lending
requirements or programs for financial institutions, or limit an institution's
discretion to develop the types of products and services that it believes are
best suited to its particular community that are consistent with the CRA.
Institutions are rated on their performance in meeting the needs of their
communities. Performance is tested in three areas: (a) lending, which evaluates
the institution's record of making loans in its assessment areas; (b)
investment, which evaluates the institution's record of investing in community
development projects, affordable housing and programs benefiting low or moderate
income individuals and business; and (c) service, which evaluates the
institution's delivery of services through its branches, ATMs and other offices.
The CRA requires each federal banking agency, in connection with its examination
of a financial institution, to assess and assign one of four ratings to the
institution's record of meeting the credit needs of its community and to take
this record into account in evaluating certain applications by the institution,
including applications for charters, branches and other deposit facilities,
relocations, mergers, consolidations, acquisitions of assets or assumptions of
liabilities, and savings and loan holding company acquisitions. The CRA also
requires that all institutions publicly disclose their CRA ratings. Both Irwin
Union Bank and Trust and Irwin Union Bank, F.S.B. received a "satisfactory"
rating on their most recent CRA performance evaluations.
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Brokered Deposits
Brokered deposits include funds obtained, directly or indirectly, by or
through a deposit broker for deposit into one or more deposit accounts.
Well-capitalized institutions are not subject to limitations on brokered
deposits, while an adequately capitalized institution is able to accept, renew
or rollover brokered deposits only with a waiver from the FDIC and subject to
certain restrictions on the yield paid on such deposits. Undercapitalized
institutions are not permitted to accept brokered deposits. Irwin Union Bank and
Trust and Irwin Union Bank, F.S.B. are permitted to accept brokered deposits.
Gramm-Leach-Bliley Act
On November 12, 1999, the Gramm-Leach-Bliley Act, or the GLB Act, was
enacted, which amended or repealed certain provisions of the Glass-Steagall Act
and other legislation that restricted the ability of bank holding companies,
securities firms and insurance companies to affiliate with one another. The GLB
Act establishes a comprehensive framework to permit affiliations among
commercial banks, insurance companies and securities firms. The GLB Act contains
provisions intended to safeguard consumer financial information in the hands of
financial service providers by, among other things, requiring these entities to
disclose their privacy policies to their customers and allowing customers to
"opt out" of having their financial service providers disclose their
confidential financial information to non-affiliated third parties, subject to
certain exceptions. Final regulations implementing the new financial privacy
regulations became effective during 2001. Similar to most other
consumer-oriented laws, the regulations contain some specific prohibitions and
require timely disclosure of certain information. We have devoted what we
believe are sufficient resources to comply with these new requirements. We do
not anticipate that the GLB Act will have a material adverse effect on our
operations or prospects or those of our subsidiaries. However, to the extent the
GLB Act permits banks, securities firms and insurance companies to affiliate,
the financial services industry may experience further consolidation. This
consolidation could result in a growing number of larger financial institutions
that offer a wider variety of financial services than we currently offer and
that can aggressively compete in the markets we currently serve.
COMPLIANCE WITH CONSUMER PROTECTION LAWS
Our subsidiaries also are subject to many federal and state consumer
protection statutes and regulations including the Equal Credit Opportunity Act,
the Fair Housing Act, the Truth in Lending Act, the Truth in Savings Act, the
Real Estate Settlement Procedures Act and the Home Mortgage Disclosure Act.
Among other things, these acts:
- require lenders to disclose credit terms in meaningful and consistent
ways;
- prohibit discrimination against an applicant in any consumer or business
credit transaction;
- prohibit discrimination in housing-related lending activities;
- require certain lenders to collect and report applicant and borrower data
regarding loans for home purchases or improvement projects;
- require lenders to provide borrowers with information regarding the
nature and cost of real estate settlements;
- prohibit certain lending practices and limit escrow account amounts with
respect to real estate transactions; and
- prescribe possible penalties for violations of the requirements of
consumer protection statutes and regulations.
Equal Credit Opportunity Act
The federal Equal Credit Opportunity Act prohibits discrimination against
an applicant in any credit transaction, whether for consumer or business
purposes, on the basis of race, color, religion, national origin,
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sex, marital status, age (except in limited circumstances), receipt of income
from public assistance programs or good faith exercise of any rights under the
Consumer Credit Protection Act. In addition to prohibiting outright
discrimination on any of the impermissible bases listed above, an effects test
has been applied to determine whether a violation of the act has occurred. This
means that if a creditor's actions have had the effect of discriminating, the
creditor may be held liable, even when there is no intent to discriminate. In
addition to actual damages, the Equal Credit Opportunity Act permits regulatory
agencies to take enforcement action and provides for punitive damages.
Successful complainants also may be entitled to an award of court costs and
attorneys' fees.
Fair Housing Act
The federal Fair Housing Act regulates many lending practices, including
making it unlawful for any lender to discriminate in its housing-related lending
activities against any person because of race, color, religion, national origin,
sex, handicap or familial status. The Fair Housing Act is broadly written and
has been broadly interpreted by the courts. A number of lending practices have
been found to be, or may be considered, illegal under the Fair Housing Act,
including some that are not specifically mentioned in the act itself. Among
those practices that have been found to be, or may be considered, illegal under
the Fair Housing Act are declining a loan for the purposes of racial
discrimination, making excessively low appraisals of property based on racial
considerations and pressuring, discouraging, or denying applications for credit
on a prohibited basis.
The Fair Housing Act allows a person who believes that he or she has been
discriminated against to file a complaint with the Department of Housing and
Urban Development, or HUD. Aggrieved persons also may initiate a civil action.
The Fair Housing Act also permits the Attorney General of the United States to
commence a civil action if there is reasonable cause to believe that a person
has been discriminated against in violation of the Fair Housing Act. Penalties
for violation of the Fair Housing Act include actual damages suffered by the
aggrieved person and injunctive or other equitable relief. The courts also may
assess civil penalties.
Home Mortgage Disclosure Act
The federal Home Mortgage Disclosure Act grew out of public concern over
credit shortages in certain urban neighborhoods. One purpose of the Home
Mortgage Disclosure Act is to provide public information that will help show
whether financial institutions are serving the housing credit needs of the
neighborhoods and communities in which they are located. The Home Mortgage
Disclosure Act also includes a "fair lending" aspect that requires the
collection and disclosure of data about applicant and borrower characteristics
as a way of identifying possible discriminatory lending patterns and enforcing
anti-discrimination statutes. The Home Mortgage Disclosure Act requires
institutions to report data regarding applications for loans for the purchase or
improvement of one-to-four family and multifamily dwellings, as well as
information concerning originations and purchases of such loans. Federal bank
regulators rely, in part, upon data provided under the Home Mortgage Disclosure
Act to determine whether depository institutions engage in discriminatory
lending practices.
The appropriate federal banking agency (that is, the Federal Reserve for
Irwin Union Bank and Trust and the OTS for Irwin Union Bank, F.S.B.), or in some
cases, HUD, enforces compliance with the Home Mortgage Disclosure Act and
implements its regulations. Administrative sanctions, including civil money
penalties, may be imposed by supervisory agencies for violations of this act.
Real Estate Settlement Procedures Act
The federal Real Estate Settlement Procedures Act, or RESPA, requires
lenders to provide borrowers with disclosures regarding the nature and cost of
real estate settlements. RESPA also prohibits certain abusive practices, such as
kickbacks, and places limitations on the amount of escrow accounts. Violations
of RESPA may result in imposition of penalties, including: (1) civil liability
equal to three times the amount of any charge paid for the settlement services
or civil liability of up to $1,000 per claimant, depending on the violation; (2)
awards of court costs and attorneys' fees; and (3) fines of not more than
$10,000 or
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imprisonment for not more than one year, or both. A significant number of
individual claims and purported consumer class action claims have been commenced
against financial institutions and other mortgage lending companies, including
Irwin Mortgage, alleging violations of the escrow account rules and the
prohibition against kickbacks and seeking civil damages, court costs and
attorneys' fees. See the "Legal Proceedings" section of this report.
Truth in Lending Act
The federal Truth in Lending Act is designed to ensure that credit terms
are disclosed in a meaningful way so that consumers may compare credit terms
more readily and knowledgeably. As a result of the act, all creditors must use
the same credit terminology and expressions of rates, the annual percentage
rate, the finance charge, the amount financed, the total of payments and the
payment schedule.
Violations of the Truth in Lending Act may result in regulatory sanctions
and in the imposition of both civil and, in the case of willful violations,
criminal penalties. Under certain circumstances, the Truth in Lending Act and
Federal Reserve Regulation Z also provide a consumer with a right of rescission,
which relieves the consumer of the obligation to pay amounts to the creditor or
to a third party in connection with the offending transaction, including finance
charges, application fee, commitment fees, title search fees and appraisal fees.
Consumers may also seek actual and punitive damages for violations in the Truth
in Lending Act. See the "Legal Proceedings" section of this report.
State Consumer Protection Laws
In addition to the federal consumer protection laws discussed above, our
subsidiaries are also subject to state consumer protection laws that regulate
the mortgage origination and lending businesses of these subsidiaries. As part
of the home equity line of business in conjunction with its subsidiary, Irwin
Home Equity, Irwin Union Bank and Trust originates home equity loans through its
branch in Nevada. Irwin Union Bank and Trust uses interest rates and loan terms
in its home equity loans and lines of credit that are authorized by Nevada law,
but might not be authorized by the laws of the states in which the borrowers are
located. As a FDIC-insured, state member bank, Irwin Union Bank and Trust is
authorized by Section 27 of the FDIA to charge interest at rates allowed by the
laws of the state where the bank is located regardless of any inconsistent state
law, and to apply these rates to loans to borrowers in other states. The FDIC
has opined that a state bank with branches outside of the state in which it is
chartered may also be located in a state in which it maintains an interstate
branch. Irwin Union Bank and Trust relies on Section 27 of the FDIA and the FDIC
opinion in conducting its home equity lending business described above. From
time to time, state regulators have questioned the application of Section 27 of
the FDIA to credit practices affecting citizens of their states. Any change in
Section 27 of the FDIA or in the FDIC's interpretation of this provision, or any
successful challenge as to the permissibility of these activities, could require
that we change the terms of some of our loans or the manner in which we conduct
our home equity line of business.
EMPLOYEES AND LABOR RELATIONS
At December 31, 2001, we and our subsidiaries had a total of 2,941
employees, including full-time and part-time employees. We continue a commitment
of equal employment opportunity for all job applicants and staff members, and
management regards its relations with its employees as satisfactory.
EXECUTIVE OFFICERS
Our executive officers are elected annually by the Board of Directors and
serve for a term of one year or until their successors are elected and
qualified. In addition to our Chairman, Mr. Miller, and President, Mr. Nash,
both of whom also serve as directors, our executive officers are listed below.
Claude E. Davis (41) has been President of Irwin Union Bank and Trust since
January, 1996. He has been an officer since 1988.
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Elena Delgado (47) has been President and Chief Executive Officer of Irwin
Home Equity since September, 1994.
Gregory F. Ehlinger (39) has been our Senior Vice President and Chief
Financial Officer since August of 1999. He has been one of our officers since
August 1992.
Paul D. Freudenthaler (37) joined us as Vice President - Financial Risk
Management in December 2001. From September 2000 through November 2001, he was
Corporate Controller for America Online Latin America, an internet service
provider. From July 2000 to August 2000 he served as Senior Vice President -
Treasurer of Telscape International, Inc., a development stage
telecommunications company. Prior thereto, he held the position of Chief
Accounting Officer of Telscape from July 1999 until June 2000. Subsequent to his
departure from Telscape, Telscape filed a voluntary petition for relief under
Chapter 11 of the U.S. Bankruptcy Code on April 27, 2001. From February 1999
through June 1999, he was Director - International of Bank United, F.S.B. From
January 1994 through January 1999, he was Director - International of Irwin
Mortgage Corporation, our subsidiary.
Jose M. Gonzalez (43) has been our Vice President - Internal Audit since
October 1995.
Robert H. Griffith (44) has been President and Chief Executive Officer of
Irwin Mortgage since January, 2001. He has been an officer of Irwin Mortgage
since 1993.
Theresa L. Hall (49) has been our Vice President - Human Resources since
1988 and has been one of our officers since 1980.
Bradley J. Kime (41) has been President of Irwin Union Bank F.S.B. since
December 2000, and is also Chief Operating Officer and Executive Vice President
of Irwin Union Bank and Trust. He has been an officer of Irwin Union Bank and
Trust since 1987, and one of our officers since 1986.
Jody A. Littrell (34) has been our Vice President and Controller since
March 2000. He was employed with Arthur Andersen LLP from September 1990 to
March 2000.
Ellen Z. Mufson (53) has been our Vice President - Legal and Assistant
Secretary since September 1997. She was Vice President - Legal Counsel of Irwin
Union Bank and Trust from July 1996 through August 1997, and our Corporate
Counsel from January 1995 through June, 1996.
Steven R. Schultz (36) joined us as Vice President - Legal in January 2002.
From August 1999 through December 2001 he was an attorney in the London office
of Fried, Frank, Harris, Shriver & Jacobson, focusing primarily on mergers and
acquisitions, capital markets financings and private equity transactions. From
August 1993 until July 1999 he practiced corporate and securities law at Barnes
& Thornburg in Indianapolis, Indiana.
Matthew F. Souza (45) has been our Senior Vice President - Ethics since
August 1999 and our Secretary since 1986. He has been one of our officers since
1986.
Michael E. Taft (61) serves as President of Irwin Capital Holdings
Corporation, which comprises our leasing line of business. He has been President
of Irwin Business Finance since April 1999. From August 1998 to April 1999, he
was Executive Vice President of General Electric Capital Business Asset Funding
Corp., a subsidiary of General Electric Capital Corporation. From September 1984
to August 1998, he was Executive Vice President of MetLife Capital Corporation,
a subsidiary of Metropolitan Life Insurance Company (General Electric Capital
Corporation acquired MetLife Capital in August 1998).
Thomas D. Washburn (55) has been our Executive Vice President since August
1999 and has been one of our officers since 1976. From 1976 to August, 1999 he
served as our Senior Vice President and Chief Financial Officer.
Brett R. Vanderkolk (36) has been our Vice President - Treasurer since
September 2000. From August 1996, to September 2000, he served as Manager,
Corporate Finance for Arvin Industries, Inc. (manufacturer of automotive
products).
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ITEM 2. PROPERTIES
Our main office and the main offices of Irwin Ventures LLC, Irwin Ventures
SBIC LLC, and Irwin Union Credit Insurance Corporation are located at 500
Washington Street, Columbus, Indiana, in space leased from Irwin Union Bank and
Trust. The location and general character of the materially important physical
properties and our subsidiaries as of December 31, 2001 are as follows:
IRWIN MORTGAGE
The main office, where administrative and servicing activities are
centered, is located at 9265 Counselor's Row, Indianapolis, Indiana, and a
servicing facility is located at 11800 Exit Five Parkway, Indianapolis, Indiana.
Loan production and satellite offices are located in:
- Arizona -- Mesa, Phoenix, and Scottsdale;
- California -- Arroyo Grande, Avalon, Bakersfield, Carson, Citrus Heights,
Concord, Covina, LaMesa, Oxnard, Richmond, Sacramento, Salinas, San
Diego, Stockton, Temecula, Thousand Oaks, Ventura, Visalia, Walnut South,
West Concord, Yreka and Yuba City;
- Colorado -- Castle Rock, Colorado Springs, Denver, Englewood, and
Westminster;
- Connecticut -- Rocky Hill;
- Delaware -- Newark;
- Florida -- Apopka, Boca Raton, Clearwater, Jacksonville, Orlando, and
Port St. Lucie;
- Georgia -- Atlanta;
- Hawaii -- Honolulu;
- Illinois -- Chicago, Clocktower and Decatur;
- Indiana -- Carmel, Fishers, Ft. Wayne, Greenwood, Indianapolis (four
offices), Kokomo, Logansport, Muncie, Schererville, and South Bend;
- Louisiana -- Baton Rouge;
- Maryland -- Gaithersburg;
- Michigan -- Frankenmuth, Grand Rapids, Kalamazoo, Lansing, Roscommon and
Sunrise;
- Minnesota -- Arden Hills, Burnsville and Minneapolis;
- Missouri -- Urbana;
- New Jersey -- Deptford;
- North Carolina -- Durham, Greensboro, Hickory, Raleigh, Waynesville,
Wilmington and Winston-Salem;
- Ohio -- Columbus (three offices), Dayton, and Reynoldsburg;
- Oklahoma -- Oklahoma City and Tulsa;
- Oregon -- Damascus and Portland;
- Pennsylvania -- Mechanicsburg and York;
- Tennessee -- Brentwood;
- Texas -- Corpus Christi, Dallas, El Paso and Houston (two offices);
- Utah -- Salt Lake City;
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- Virginia -- Newport News;
- Washington -- Battle Ground, Everett (two offices) and Mount Lake
Terrace; and
- Wisconsin -- Madison.
All offices occupied by Irwin Mortgage are leased.
IRWIN UNION BANK AND TRUST
The main office is located in four connected buildings at 500 and 520
Washington Street, Columbus, Indiana. Irwin Union Realty Corporation, a
wholly-owned subsidiary of Irwin Union Bank and Trust, owns these buildings in
fee and leases them to Irwin Union Bank and Trust.
One or the other of Irwin Union Bank and Trust or Irwin Union Realty owns
the following branch properties in fee State Street and Eastbrook in Columbus,
Indiana
Hope, Taylorsville, and Franklin, Indiana (the Franklin building and a
portion of the land are owned; the remaining land is leased).
The other branches lease their offices:
- Indiana -- Avon, Bloomington (three offices), Carmel, Columbus (three
offices), Greensburg, Greenwood, Indianapolis, Seymour (two offices) and
Shelbyville;
- Michigan -- Grandville (near Grand Rapids), Kalamazoo, Lansing and
Traverse City; and
- Nevada -- Carson City.
The loan production office in Lansing, Michigan leases its space. The
properties owned by Irwin Union Bank and Trust or Irwin Union Realty have no
major encumbrances.
IRWIN UNION BANK, F.S.B.
The main office is located at 9300 Shelbyville Road, Louisville, Kentucky.
Branch offices are located in:
- Arizona -- Phoenix
- Missouri -- Brentwood (near St. Louis)
- Nevada -- Las Vegas; and
- Utah -- Salt Lake City
Irwin Union Bank, F.S.B. leases these offices.
IRWIN HOME EQUITY
The main office is located at 12677 Alcosta Boulevard, Suite 500, San
Ramon, California. Irwin Home Equity also occupies two other offices in San
Ramon, California. Irwin Home Equity leases all of it its offices.
IRWIN CAPITAL HOLDINGS CORPORATION
The main office of Irwin Capital Holdings Corporation is located at 500
Washington Street, Columbus, Indiana. The office location is lease.
The main office of Irwin Business Finance is located at 330 120th Avenue
NE, Suite 110, Bellevue, Washington. The office location is leased.
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The main office of Onset Capital Corporation is located at 666 Burrard
Street, Suite 300, Vancouver, British Columbia, Canada. All of the Onset
locations are leased and offices are located in Canada in:
- Alberta -- Calgary and Edmonton;
- Manitoba -- East St. Paul (near Winnipeg);
- Ontario -- Toronto (two offices); and
- Quebec -- St. Laurent (near Montreal) and Quebec City.
The main office of Onset Alberta Ltd. is located at 888 3rd Street SW in
Edmonton, Alberta. The office space is leased.
The main office of Irwin Franchise Capital Corporation is located at 2700
Westchester Avenue, Purchase, New York.
Irwin Franchise Capital also has offices (all leased) in:
- Illinois -- Hainesville;
- Nebraska -- Columbus (two offices) and Omaha;
- New Jersey -- Nutley;
- New York -- Metuchen;
- Texas -- Spring; and
- Washington -- Port Orchard.
ITEM 3. LEGAL PROCEEDINGS
Culpepper v. Inland Mortgage Corporation.
Borrowers purporting to represent a nationwide class have filed numerous
class action lawsuits against mortgage lenders, including our subsidiary, Irwin
Mortgage (formerly known as Inland Mortgage Corporation), alleging that certain
payments to mortgage brokers by those lenders violate the federal Real Estate
Settlement Procedures Act, commonly known as RESPA. These lawsuits have
generally alleged that various forms of direct and indirect payments to mortgage
brokers are referral fees or unearned fees, which are prohibited under RESPA, or
that consumers were not informed of the brokers' compensation, in violation of
law.
Our subsidiary, Irwin Mortgage, is a defendant in Culpepper, a lawsuit
alleging that Irwin Mortgage violated RESPA in connection with mortgages
originated by mortgage brokers. The initial action was filed in April 1996, in
the United States District Court, Northern District of Alabama. In January 1997,
the federal district court granted summary judgment in favor of Irwin Mortgage
and denied the plaintiff's motion to certify the case as a class action. The
plaintiff appealed, and in January 1998, the United States Court of Appeals for
the 11th Circuit reversed the district court's grant of summary judgment. The
court of appeals sent the case back to the district court to decide the merits
of the case and the class certification issue. A second lawsuit was filed
against Irwin Mortgage in August 1998 alleging similar RESPA violations and was
consolidated with the first case. In June 1999, the district court certified a
limited class of borrowers.
Irwin Mortgage appealed and submitted the class certification issue to the
court of appeals for review in December 1999. On June 15, 2001, a panel of the
United States Court of Appeals for the 11th Circuit denied the appeal of Irwin
Mortgage, and upheld the district court's certification of the borrower class in
an opinion unfavorable to us. On July 11, 2001, Irwin Mortgage filed a motion
seeking a rehearing before the court of appeals. On August 15, 2001, the court
of appeals denied this motion.
The case is now pending in the federal district court. The process of
notifying class members is not yet complete. Based on notices sent by the
plaintiffs to some potential class members, we believe the class is not likely
to exceed 32,000 borrowers. In July 2001, the plaintiffs filed a motion for
partial summary judgment
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asking the court to find that our subsidiary is liable for violating RESPA. We
filed an opposition to the motion, and the motions were fully briefed by the
parties.
On October 18, 2001, the Department of Housing and Urban Development, or
HUD, the agency responsible for interpreting and implementing RESPA, issued a
clarifying policy statement that explicitly disagreed with the ruling of the
court of appeals in Culpepper and with the court's interpretation of RESPA in
connection with the types of payments at issue in this case.
In response to an order of the district court, the parties filed
supplemental briefs analyzing the impact of the new HUD policy statement on
November 14, 2001. In addition to responding to the district court's order,
Irwin Mortgage filed a petition for certiorari with the United States Supreme
Court seeking review of the court of appeals' ruling, and on December 28, 2001,
also filed a motion in the district court seeking a stay of further proceedings
until the 11th Circuit renders decisions in the other three RESPA cases pending
in that court. On January 22, 2002, the Supreme Court denied Irwin Mortgage's
petition for certiorari. At a status conference on March 8, 2002, the district
court granted Irwin Mortgage's motion to stay the proceedings in this case until
the 11th Circuit rules on the other three RESPA cases pending before it.
The Culpepper case is the only case to date alleging similar RESPA
violations in which a federal court of appeals has upheld a lower court's grant
of class action certification in favor of the plaintiffs. While we continue to
believe that the plaintiffs should not prevail on the merits of the case and
that Irwin Mortgage has available numerous defenses to the alleged RESPA
violations and we intend to defend this lawsuit vigorously, we could lose this
lawsuit. Although we are unable at this stage of the litigation to determine the
outcome or a reasonable estimate of the amount of potential loss we could
suffer, we expect that an adverse outcome in this litigation could subject us to
substantial monetary damages that could be material to our financial position.
We have not established any reserves related to this case.
Beggs v. Irwin Mortgage Corporation.
In September, 2001, Irwin Mortgage received notice that it was named as a
defendant in Beggs, a lawsuit filed in the United States District Court for the
Northern District of Alabama. The plaintiff, purporting to represent a
nationwide class of borrowers, filed allegations similar to those in Culpepper,
above, but seeks inclusion of borrowers not covered in Culpepper (those with
mortgage loans since early 1999 through the date of class certification, if a
class is certified). The plaintiff is asking the court to certify a class and to
consolidate this case with Culpepper. On the basis of the HUD policy statement,
described above, management believes Irwin Mortgage has substantial defenses to
this case as well. In the event of an adverse outcome, however, the company
could suffer material losses. On December 10, 2001, the court granted an order
staying all the proceedings in the Beggs case until after the United States
Court of Appeals for the 11th Circuit renders decisions in the other three RESPA
cases pending in that court.
United States ex rel. Paranich v. Sorgnard et. al.
In January, 2001, we, Irwin Leasing Corporation (formerly Affiliated
Capital Corp.) and Irwin Equipment Finance Corporation (for purposes of this
paragraph, the Irwin companies) were served as defendants in Paranich, an action
filed in the U.S. District Court for the Middle District of Pennsylvania. The
suit alleges that a manufacturer/importer of certain medical devices (Matrix
Biokinetics, Inc., and others) made misrepresentations to health care
professionals and to government officials to improperly obtain Medicare
reimbursement for treatments using the devices, and that the Irwin companies,
through Affiliated Capital's financing activities, aided in making the alleged
misrepresentations. The Irwin companies filed a motion to dismiss on February
12, 2001. On August 10, 2001, the court granted our motion in part by dismissing
us and Irwin Equipment Finance as defendants in the suit. Irwin Leasing remains
a defendant. Because the case is in the early stages of litigation, we are
unable at this time to form a reasonable estimate of the amount of potential
loss, if any, that we could suffer. We intend to defend this lawsuit vigorously.
18
Thompson v. Irwin Union Bank and Trust Company and Irwin Home Equity
Corporation.
On May 9, 2001, Irwin Union Bank and Trust and Irwin Home Equity, (for
purposes of this paragraph, Irwin), received notice that they were named as
defendants in Thompson, a lawsuit filed in the U.S. District Court for the
District of Rhode Island. The suit alleges that Irwin's disclosures and closing
procedure for certain home equity loans did not comply with certain provisions
of the Truth in Lending Act. The suit also requests that the court certify a
plaintiff class in this action. On June 18, 2001, Irwin filed a motion with the
court to compel arbitration pursuant to the provisions in the home equity loan
agreement. On October 20, 2001, the Court entered judgment in favor of Irwin
compelling arbitration and dismissing the plaintiffs' complaint. The plaintiffs
have appealed, and we intend to defend this case vigorously. However, if
arbitration is ultimately upheld, we do not expect to suffer material loss in
this case.
McIntosh v. Irwin Home Equity Corporation.
On July 19, 2001, Irwin Home Equity Corporation was served with notice that
it was named as the defendant in McIntosh, a lawsuit filed in the U.S. District
Court for the District of Massachusetts. The suit relates to a loan purchased by
Irwin Union Bank and Trust and serviced by Irwin Home Equity. The plaintiff
alleges that the loan documents did not comply with certain provisions of the
Truth in Lending Act relating to high rate loans. The suit also requests that
the court certify a plaintiff class in this action. Irwin Home Equity filed an
answer on August 31, 2001. On October 17, 2001, the court granted plaintiff's
motion to file an amended complaint removing Irwin Home Equity and substituting
Irwin Union Bank and Trust as defendant. On November 2, 2001, Irwin Union Bank
and Trust filed an answer to the amended complaint denying plaintiff's
allegations. Because the case is in the early stages of litigation, we are
unable at this time to form a reasonable estimate of the amount of potential
loss, if any, that we could suffer. We intend to defend this lawsuit vigorously.
Stamper et.al. v. A Home of Your Own, Inc. et.al.
On January 25, 2002, a jury in Stamper awarded the plaintiffs damages of
$1.434 million jointly and severally against the defendants, including our
subsidiary Irwin Mortgage Corporation. The case was filed in August 1998 in the
Baltimore, Maryland, City Circuit Court. The nine plaintiffs alleged that A Home
of Your Own, Inc. and its principal, Robert Beeman, defrauded the plaintiffs by
selling them defective homes at inflated prices and that Irwin Mortgage, which
provided the plaintiff borrowers mortgage loans on the home purchases,
participated in the fraud. Prior to the outcome of the jury trial, we had no
reserves for this case. On February 6, 2002, plaintiffs filed a petition for
attorney's fees. On the same date, Irwin Mortgage filed post-trial motions for
judgment notwithstanding the verdict, new trial and/or remittitur, which is a
request for the court to reduce the amount of damages awarded by the jury. If
the court denies Irwin's post-trial motions, Irwin plans to appeal and will
continue to defend this case vigorously.
We and our subsidiaries are from time to time engaged in various matters of
litigation including the matters described above, other assertions of improper
or fraudulent loan practices or lending violations, and other matters, and we
have a number of unresolved claims pending. In addition, as part of the ordinary
course of business, we and our subsidiaries are parties to litigation involving
claims to the ownership of funds in particular accounts, the collection of
delinquent accounts, challenges to security interests in collateral, and
foreclosure interests, that is incidental to our regular business activities.
While the ultimate liability with respect to these other litigation matters and
claims cannot be determined at this time, we believe that damages, if any, and
other amounts relating to pending matters are not likely to be material to our
consolidated financial position or results of operations, except as described
above. Reserves have been established for these various matters of litigation,
when appropriate, based upon the advice of legal counsel.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 2001, no matters were submitted to a vote of
security holders of the Corporation, through the solicitation of proxies or
otherwise.
19
PART II
ITEM 5. MARKET FOR CORPORATION'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Until September 20, 2001, our common shares were quoted on the Nasdaq
National Market under the symbol "IRWN." Our common shares were approved for
listing on the New York Stock Exchange on September 5, 2001, and began trading
under the symbol "IFC" on September 21, 2001. The following table sets forth
certain information regarding trading in, and cash dividends paid with respect
to, the shares of our common stock in each quarter of the two most recent
calendar years. The approximate number of shareholders of record on March 11,
2002, was 1,805.
STOCK PRICES AND DIVIDENDS:
PRICE RANGE TOTAL
--------------- QUARTER CASH DIVIDENDS
HIGH LOW END DIVIDENDS FOR YEAR
------ ------ ------- --------- ---------
2000
First quarter................................... $18.31 $13.56 $15.00 $ 0.06
Second quarter.................................. 18.50 14.38 14.45 0.06
Third quarter................................... 17.00 13.44 16.38 0.06
Fourth quarter.................................. 22.00 13.25 21.19 0.06 $0.24
2001
First quarter................................... $24.88 $19.31 $21.13 $0.065
Second quarter.................................. 25.25 18.69 25.15 0.065
Third quarter................................... 27.70 16.00 20.90 0.065
Fourth quarter.................................. 22.08 14.49 17.00 0.065 $0.26
We expect to continue our policy of paying regular cash dividends, although
there is no assurance as to future dividends because they are dependent on
future earnings, capital requirements, and financial condition. On February 27,
2002, our Board of Directors approved an increase in the first quarter dividend
to $0.0675 per share, payable in March, 2002. Dividends paid by Irwin Union Bank
and Irwin Union Bank, F.S.B. to the Corporation are restricted by banking law.
SALES OF UNREGISTERED SECURITIES:
In 2001, we issued 5,466 shares of common stock pursuant to elections made
by six of our outside directors to receive board compensation under the 1999
Outside Director Restricted Stock Compensation Plan in lieu of cash fees. All of
these shares were issued in reliance on the private placement exemption from
registration provided in Section 4(2) of the Securities Act.
20
ITEM 6. SELECTED FINANCIAL DATA
FIVE-YEAR SELECTED FINANCIAL DATA
AT OR FOR YEAR ENDED DECEMBER 31,
------------------------------------------------------------------
2001 2000 1999 1998 1997
----------- ---------- ----------- ----------- -----------
(IN THOUSANDS EXCEPT PER SHARE DATA)
FOR THE YEAR:
Net revenues................... $ 401,035 $ 297,304 $ 266,748 $ 272,063 $ 200,996
Noninterest expense............ 327,420 237,962 214,111 221,206 158,818
----------- ---------- ----------- ----------- -----------
Income before income taxes..... 73,615 59,342 52,637 50,857 42,178
Provision for income taxes..... 28,624 23,676 17,481 20,354 17,734
Minority interest.............. (350) -- -- -- --
----------- ---------- ----------- ----------- -----------
Income before cumulative effect
of change in accounting
principle................... 45,341 35,666 33,156 30,503 24,444
Cumulative effect of change in
accounting principle, net of
tax......................... 175 -- -- -- --
----------- ---------- ----------- ----------- -----------
Net income..................... $ 45,516 $ 35,666 $ 33,156 $ 30,503 $ 24,444
=========== ========== =========== =========== ===========
Mortgage loan originations..... $ 9,225,991 $4,091,573 $ 5,876,750 $ 8,944,615 $ 5,397,338
Home equity loan
originations................ 1,149,410 1,225,955 439,507 389,673 214,518
COMMON SHARE DATA:
Earnings per share:(1)
Basic....................... $ 2.15 $ 1.70 $ 1.54 $ 1.40 $ 1.10
Diluted..................... 2.00 1.67 1.51 1.38 1.08
Cash dividends per share....... 0.26 0.24 0.20 0.16 0.14
Book value per share........... 10.84 8.97 7.55 6.70 5.82
Dividend payout ratio.......... 12.13% 14.13% 12.93% 11.39% 12.74%
Weighted average
shares -- basic............. 21,175 20,973 21,530 21,732 22,326
Weighted average
shares -- diluted........... 24,173 21,593 21,886 22,139 22,722
Shares outstanding -- end of
period...................... 21,305 21,026 21,105 21,673 22,001
AT YEAR END:
Assets......................... $ 3,439,795 $2,422,429 $ 1,680,847 $ 1,946,179 $ 1,496,794
Trading assets................. 216,684 154,921 59,025 32,148 22,133
Loans held for sale............ 503,757 579,788 508,997 936,788 528,739
Loans and leases............... 2,137,747 1,234,922 733,424 556,991 611,093
Allowance for loan and lease
losses...................... 22,283 13,129 8,555 9,888 8,812
Servicing assets............... 228,624 132,638 138,500 117,129 83,044
Deposits....................... 2,309,018 1,443,330 870,318 1,009,211 719,596
Short-term borrowings.......... 487,963 475,502 473,103 644,861 512,275
Long-term debt................. 29,654 29,608 29,784 2,839 7,096
Trust preferred securities..... 190,948 147,167 48,071 47,999 47,927
Shareholders' equity........... 232,323 189,925 159,296 145,233 127,983
Owned first mortgage servicing
portfolio................... 12,875,532 9,196,513 10,488,112 11,242,470 10,713,549
Managed home equity servicing
portfolio................... 2,317,975 1,825,527 842,403 581,241 358,166
21
AT OR FOR YEAR ENDED DECEMBER 31,
------------------------------------------------------------------
2001 2000 1999 1998 1997
----------- ---------- ----------- ----------- -----------
(IN THOUSANDS EXCEPT PER SHARE DATA)
SELECTED FINANCIAL RATIOS:
Performance Ratios:
Return on average assets....... 1.45% 1.76% 2.01% 1.85% 1.94%
Return on average equity....... 21.82 20.83 21.51 22.77 19.80
Net interest margin(2)(3)...... 5.35 5.36 5.03 4.33 5.15
Noninterest income to
revenues(4)................. 64.84 69.94 75.25 78.71 75.89
Efficiency ratio(5)............ 78.23 78.61 78.95 79.55 76.74
Loans and leases to
deposits(6)................. 79.10 85.56 84.27 55.19 84.92
Average interest-earning assets
to average interest-bearing
liabilities................. 117.17 113.51 127.36 121.02 124.00
Asset Quality Ratios:
Allowance for loan and lease
losses to:
Total loans and leases...... 1.04% 1.06% 1.17% 1.78% 1.45%
Non-performing loans and
leases.................... 116.34 181.79 189.86 84.28 115.02
Net charge-offs to average
loans and leases............ 0.53 0.28 0.27 0.33 0.46
Net home equity charge-offs to
managed home equity
portfolio................... 1.58 0.57 0.36 0.37 0.29
Non-performing assets to total
assets...................... 0.68 0.42 0.48 0.78 0.64
Non-performing assets to total
loans and leases and other
real estate owned........... 1.10 0.81 1.09 2.77 1.55
Ratio of Earnings to Fixed
Charges:
Including deposit interest..... 1.61x 1.63x 1.88x 1.79x 1.86x
Excluding deposit interest..... 2.54 2.46 2.54 2.25 2.45
Capital Ratios:
Average shareholders' equity to
average assets.............. 6.65% 8.46% 9.35% 8.09% 9.32%
Tier 1 capital ratio........... 6.81 8.87 11.39 11.63 13.56
Tier 1 leverage ratio.......... 9.36 12.41 12.77 10.51 12.06
Total risk-based capital
ratio....................... 10.82 13.59 13.50 12.25 14.85
---------------
(2) Net interest income divided by average interest-earning assets.
(3) Calculated on a tax-equivalent basis.
(4) Revenues consist of net interest income plus noninterest income.
(5) Noninterest expense divided by net interest income plus noninterest income.
(6) Excludes loans to be sold or securitized.
22
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
You should read the following discussion in conjunction with our
consolidated financial statements, footnotes, and tables. This discussion and
other sections of this report contain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. We intend such forward-looking statements to be
covered by the safe harbor provisions for forward-looking statements contained
in the Private Securities Litigation Reform Act of 1995, and are including this
statement for purposes of invoking these safe harbor provisions. Words such as
"will," "believe," "expect," "assume," "anticipate," "intend," "continue,"
"resume," "contemplating," "are likely," "estimate," "judgment," "outlook,"
"future," "forecasts," and similar expressions are intended to identify forward-
looking statements, which may include, among other things:
- statements and assumptions relating to projected growth, earnings,
earnings per share, and other financial performance measures as well as
management's short-term and long-term performance goals;
- statements relating to the anticipated effects on results of operations
or financial condition from recent and expected developments or events,
including the recently revised regulatory capital rules relating to
residual interests;
- statements relating to our business and growth strategies, including
potential acquisitions; and
- any other statements, projections or assumptions that are not historical
facts.
Forward-looking statements involve known and unknown risks, uncertainties
and other important factors that could cause our actual results, performance or
achievements, or industry results, to differ materially from our expectations of
future results, performance or achievements expressed or implied by these
forward-looking statements. In addition, our past results of operations do not
necessarily indicate our future results. Actual future results may differ
materially from what is projected due to a variety of factors, including, but
not limited to, unexpected changes in interest rates, which may affect consumer
demand for our products and the valuation of our servicing portfolio; borrowers'
refinancing opportunities, which may affect the prepayment assumptions used in
our valuation estimates; unanticipated deterioration in the credit quality of
our assets; difficulties in selling residual assets as contemplated;
difficulties in delivering home equity loans to the secondary market as planned
or in funding home equity loans through securitization transactions as planned;
difficulties in raising additional capital or expanding our businesses;
competition from other financial service providers for experienced managers as
well as for customers; changes in the value of technology-related companies;
legislative or regulatory changes, including changes in the interpretation of
new capital rules; changes in applicable accounting policies or principles or
their application to our business; or governmental changes in monetary or fiscal
policies. Further, uncertainty in the national economy may negatively impact the
financial services industry or cause changes in or exaggerate the effects of the
factors described above. We undertake no obligation to update publicly any of
these statements in light of future events, except as required in subsequent
periodic reports we file with the Securities and Exchange Commission, or SEC.
CONSOLIDATED OVERVIEW
2001 % CHANGE 2000 % CHANGE 1999
------ -------- ------ -------- ------
Net income (millions)...................... $ 45.5 27.6% $ 35.7 7.5% $ 33.2
Basic earnings per share(1)................ 2.15 26.5 1.70 10.4 1.54
Diluted earnings per share(1).............. 2.00 19.8 1.67 10.6 1.51
Return on average equity................... 21.82% -- 20.83% -- 21.51%
Return on average assets................... 1.45 -- 1.76 -- 2.01
---------------
(1) Earnings per share of common stock before cumulative effect of change in
accounting principle related to SFAS 133, "Accounting for Derivative
Instruments and Hedging Activities," for the year ended December 31, 2001
was $2.14 basic and $1.99 diluted.
23
We recorded net income of $45.5 million for the year ended December 31,
2001, up 27.6% from the $35.7 million for the year ended in 2000. Net income per
share (diluted) was $2.00 for the year ended December 31, 2001, up from $1.67
per share in 2000 and $1.51 per share in 1999. Return on equity was 21.82% for
the year ended December 31, 2001, 20.83% in 2000 and 21.51% in 1999.
Our mortgage banking line of business experienced a significant increase in
mortgage loan production as a result of declining interest rates, with
originations during 2001 exceeding $9.2 billion. During 2001, the mortgage
banking line of business grew its servicing portfolio to $12.9 billion. Our home
equity lending line of business continued to see steady growth in production and
in its managed portfolio during 2001, largely offsetting additional credit
reserves and increases in prepayment speeds. Our commercial banking line of
business continued to grow its loan portfolio during 2001, while its net
interest margin declined to 3.80% in 2001, compared to 4.25% and 4.82% in 2000
and 1999, respectively. Our equipment leasing line of business continued to
incur losses during the year, principally the result of difficult economic
conditions that led to higher levels of charge-offs and delinquencies during the
second half of the year. Our venture capital line of business recorded losses
during 2001 primarily attributable to net valuation write-downs in its portfolio
investments in order to reflect these investments at fair value.
Our mortgage banking line of business was negatively impacted in 2000 by
rising rates throughout most of the year followed by a sharp decline in interest
rates late in the fourth quarter. Our home equity lending line of business
experienced a significant improvement in earnings in 2000 as its managed
portfolio continued to grow and expand in its niche of prime credit quality,
high loan-to-value second mortgage loans. Results in our commercial banking line
of business were driven by strong commercial loan portfolio growth in 2000
reflecting continued geographic expansion into new markets in Midwestern and
Western states. Our new equipment leasing line of business incurred losses
throughout 2000 that were in line with management's expectations given the
start-up nature of the company. Our venture capital line of business contributed
favorably to the consolidated results in 2000 as a result of net valuation
increases in its portfolio investments.
A rising interest rate environment led to a reduction in loan originations
and lower net income at our mortgage banking line of business during 1999,
partially offsetting the improvements at our other lines of business. Our home
equity lending line of business experienced a significant improvement in
earnings in 1999 as a result of a more favorable competitive environment and a
reduction in loan prepayment activity. Results at our commercial banking line of
business during 1999 improved in connection with growth in our commercial loan
portfolio. Results in 1999 include a one-time after-tax gain of $1.1 million due
to a change in a tax law in Indiana.
Strategy
Our strategy is to maintain a diverse revenue stream by focusing on niches
in financial services where we believe we can optimize the productivity of our
capital and where our experience and expertise can provide a competitive
advantage. Our operational objectives are premised on simultaneously achieving
three goals: creditworthiness, profitability and growth. We refer to this as
creditworthy, profitable growth. We believe we must continually balance these
goals in order to deliver long-term value to all of our stakeholders. We have
developed a four-part business plan to meet these goals:
- Identify underserved niches. We focus on product or market niches in
financial services that we believe are underserved and where we believe
customers are willing to pay a premium for value-added services. We don't
believe it is necessary to be the largest or leading market share company
in any of our product lines, but we do believe it is important that we
are viewed as a preferred provider in niche segments of those product
offerings.
- Hire exceptional management with niche expertise. We enter niches only
when we have attracted senior managers who have proven track records in
the niche for which they are responsible. We structure our companies so
these managers are encouraged to focus only on their area of expertise
and lines of business. In addition, we believe our willingness to offer
minority ownership positions in our lines of business to these managers
provides them with the long-term incentive to achieve creditworthy,
profitable growth. We also employ a similar strategy when looking to
expand our lines of business.
24
Each line of our five lines of business has a separate management team
that operates its niche as a separate business unit responsible for
performance goals specific to that particular line of business. Our
structure allows the senior managers of each line of business to focus
their efforts on understanding their customers and meeting the needs of
the markets they serve. This structure also promotes accountability among
managers of each enterprise. The senior managers at each of our lines of
business and at the parent company have significant experience with us and
in their respective industries.
- Diversify capital and earnings risk. We diversify our revenues and
allocate our capital across complementary lines of business as a key part
of our risk management. Our lines of business are cyclical, but when
combined in an appropriate mix, we believe they provide sources of
diversification and opportunities for growth in a variety of economic
conditions. For example, both the origination and servicing of
residential mortgage loans are very cyclical businesses, tied to changes
in interest rates. We believe our participation in these markets has been
profitable over time due to our dedication to participating in both
segments of the mortgage banking business, rather than one or the other,
which would otherwise leave us more susceptible to swings in interest
rates.
- Reinvest in new opportunities. We reinvest on an ongoing basis in the
development of new and existing opportunities. As a result of our
attention to long-term value creation, we believe it is important at
times to limit short-term growth by investing for future return. We are
biased toward seeking new growth through organic expansion of existing
lines of business or the initiation of a new line through a start-up,
utilizing highly qualified managers we select to focus on a single line
of business. Over the past 10 years, we have made only a few acquisitions
and those have typically been in non-competitive bidding situations.
We believe our historical growth and profitability is the result of our
endeavors to pursue complementary consumer and commercial lending niches through
our bank holding company structure, our experienced management, our diverse
product and geographic markets, and our willingness and ability to align the
compensation structure of each of our lines of business with the interests of
our stakeholders. Through various economic environments and cycles, we have had
a relatively stable revenue and earnings stream on a consolidated basis
generated primarily through internal growth rather than acquisitions. Over the
five-year and ten-year periods ending December 31, 2001, respectively, our
financial performance has been as follows:
- our return on average equity averaged 21.36% and 22.53%;
- our diluted earnings per common share compounded at an average annual
growth rate of 16.65% and 15.18%;
- our net revenues(1) compounded at an average annual growth rate of 18.85%
and 17.33%;
- our book value per common share compounded at an average annual growth
rate of 16.80% and 18.15%.
While our financial results in 2002 will likely be significantly different
than our historical performance for the reasons discussed in the "Recent
Developments" section below, management anticipates that after 2002, we can
again achieve our long-term financial objectives of at least 12% annual earnings
per share growth and greater than 15% return on common equity.
RECENT DEVELOPMENTS
Impact of Recent Change to Regulatory Capital Rules
The federal banking regulators, including the Federal Reserve, our
principal regulator, have adopted revised regulatory capital standards regarding
the treatment of certain recourse obligations, direct credit substitutes,
residual interests in asset securitizations, and other securitized transactions.
In general, the new rules require a banking institution that has certain
residual interests in an amount that exceeds 25% of its
---------------
(1) Net revenues consist of net interest income plus noninterest income.
25
Tier 1 capital, to deduct the after-tax excess amount of credit-enhancing
residual interests from Tier 1 capital for purposes of computing risk-based
capital ratios.
The new capital standards became effective on January 1, 2002, for new
residual interests related to any transaction covered by the revised rules that
settles after December 31, 2001. For transactions settled before January 1,
2002, application of the new capital treatment to the residuals created will be
delayed until December 31, 2002.
We believe these new rules apply to many, if not all, of the securitization
transactions historically done by our home equity line of business to fund loan
production. The residual assets we now own exceed the 25% concentration limit in
the new capital treatment rules. On a pro forma basis adjusted to give effect to
our recently completed public offering, and assuming conservatively that all of
our residual assets are subject to the new capital treatment, our residual
assets as of December 31, 2001, comprised 49% of our consolidated Tier 1
capital. We are taking steps to materially reduce the levels of our residuals as
a percentage of Tier 1 capital. On November 29, 2001, we sold $12.3 million of
our residual interests in our home equity loans previously securitized in
September 2000. This represents our fourth sale of residual assets in the last
two years. By the end of 2002, we expect our residual interests to have declined
to approximately 35% of Tier 1 capital, falling to approximately 20% by the end
of 2003.
We have financed the significant growth in our home equity lending line of
business to date using transaction structures that create residual interests
through "gain-on-sale" accounting -- sales transactions accounted for under SFAS
140. To mitigate the impact of the new rules, beginning in 2002 we will be
eliminating our use of these securitization structures that require gain-on-sale
accounting treatment. We believe using on-balance sheet financing rather than
using off-balance sheet gain-on-sale treatment under SFAS 140 will allow
continued access to the capital markets for cost-effective, matched funding of
our loan assets, while not meaningfully affecting or changing our cash flows,
nor changing the longer term profitability of our home equity lending operation.
Changing our securitization practices will significantly affect the
financial results of our home equity line of business in 2002. The key financial
impacts we expect include:
- By using on-balance sheet financing to fund our home equity loan
originations, we will be required to change the timing of revenue
recognition on these assets under generally accepted accounting
principles. For assets funded on-balance sheet, we will record interest
income over the life of the loans, as it is earned, net of interest
expense over the life of the bonds and a provision for credit losses
inherent in the portfolio. For assets funded through transactions
accounted for as a sale under SFAS 140, we have recorded revenue as
gain-on-sale at the time of loan sale based on the difference between
proceeds and allocated cost basis of the loans sold. We have also
recognized residual interests based on the discounted present value of
anticipated revenue stream over the expected lives of the loans. This
different accounting treatment does not, however, affect cash flows
related to the loans, and management expects that the ultimate total
receipt of revenues and profitability derived from our home equity loans
will be relatively unchanged by these different financing structures.
- Due to the extension of the period during which revenue would be
recognized under the new financing structures we intend to pursue, we
plan to reduce the rate of growth in production and related expenses in
the home equity lending line of business to more closely align
anticipated revenue recognition and expenses under this new model. This
process is now under way. However, while we anticipate continued
profitability on a consolidated basis, we currently expect to report a
loss in 2002 in our home equity lending line of business as we make this
transition.
- After the initial transition period, as the portfolio of on-balance sheet
home equity loans continues to grow, we should record increased levels of
net interest income sufficient to cover ongoing expenses and credit
losses. We would then expect to be in a position to resume profitable
growth in this line of business. We may also pursue selective
opportunities to sell whole loans in cash sale transactions if attractive
terms can be negotiated. We currently anticipate that our home equity
lending line of business will return to profitability in 2003.
26
PRO FORMA CAPITAL RELATIVE TO NEW REGULATION ON RESIDUALS
Our Tier 1 capital totaled $295.0 million as of December 31, 2001, or 6.8%
of risk-weighted assets. On a pro forma basis, giving full effect to the new
risk-weighted capital regulations regarding residual assets, as further adjusted
to give effect to the net proceeds from our recent public offering and prior to
any residual asset reduction steps we are contemplating to reduce our
concentration of residual assets or to reclassify for capital treatment purposes
any of those residual assets, or any other changes, our Tier 1 capital and total
capital to risk-weighted assets would be approximately 8.2% and 11.0%,
respectively, as of December 31, 2001. The new capital rules do not become fully
effective until December 31, 2002.
Earnings Outlook
Taking the factors discussed above into account, we expect consolidated net
income to decline in 2002 but then to increase significantly in 2003. Management
currently estimates that consolidated net income will be approximately $36
million in 2002 and approximately $54 million in 2003. These estimates include
$2.7 million of after-tax interest expense on our convertible trust preferred
securities, which would be added back to net income for purposes of calculating
fully diluted earnings per share under generally accepted accounting principles.
These estimates are based on various factors and current assumptions management
believes are reasonable, including current industry forecasts of a variety of
economic and competitive factors. However, projections are inherently uncertain,
and our actual earnings may differ significantly from these estimates due to
uncertainties and risks related to our business.
While our financial results in 2002 will likely be significantly different
than our historical performance for the reasons discussed above, management
anticipates that after 2002, we can again achieve our long-term financial
objectives of at least 12% annual earnings per share growth and greater than 15%
return on common equity.
CRITICAL ACCOUNTING POLICIES/MANAGEMENT JUDGMENTS AND ACCOUNTING ESTIMATES
Accounting estimates are an integral part of our financial statements and
are based upon our current judgments. Certain accounting estimates are
particularly sensitive because of their significance to the financial statements
and because of the possibility that future events affecting them may differ from
our current judgments or that our use of different assumptions could result in
materially different estimates. The following is a description of the critical
accounting policies we apply, all of which require the use of accounting
estimates and/or judgment:
Allowance for Loan and Lease Losses
The allowance for loan and lease losses (ALLL) reflects our estimate of the
adequacy of reserves needed to cover probable loan and lease losses and certain
risks inherent in our loan portfolio. In determining a proper level of loss
reserves, management periodically evaluates the adequacy of the allowance based
on our past loan loss experience, known and inherent risks in the loan
portfolio, levels of delinquencies, adverse situations that may affect a
borrower's ability to repay, trends in volume and terms of loans and leases,
estimated value of any underlying collateral, changes in underwriting standards,
changes in credit concentrations, and current economic and industry conditions.
In addition, various regulatory agencies, as an integral part of their
examination process, periodically review our allowance for loan and lease
losses. Such agencies may require us to recognize additions to the allowance for
loan and lease losses based on their judgments of information available to them
at the time of their examination.
Accounting for Private Equity Investments
It is our accounting policy to account for private equity investments held
by our venture capital line of business at fair value, with unrealized and
realized gains and losses included in noninterest income as investment
securities gains and losses. The fair value of private equity investments (which
by their nature are not publicly traded) is estimated based on the investees'
financial results, conditions and prospects, values of comparable public
companies, market liquidity and sales restrictions. We assume that cost
approximates fair
27
value, unless there is evidence suggesting a revaluation is appropriate.
Potential reasons for revaluation include: 1) an anticipated pricing of a
company's future equity financing that would be lower than the previous funding
round (although the reverse would not necessarily require an upward adjustment)
2) a significant deterioration in the company's performance 3) a significant
reduction in the company's potential realizable value -- for example, if market
conditions have caused a meaningful change in the value of peer companies. We
believe the values derived from the application of our policy represent a close
approximation of fair value for non-marketable securities.
Accounting for Deferred Taxes
Deferred tax assets and liabilities are determined based on temporary
differences between the time income or expense items are recognized for book
purposes and in our tax return. We make this measurement using the enacted tax
rates and laws that are expected to be in effect when the differences are
expected to reverse. We recognize deferred tax assets based on estimates of
future taxable income. Events may occur in the future that could cause the
realizability of these deferred tax assets to be in doubt, requiring the need
for a valuation allowance.
Valuation of Mortgage Servicing Rights
Mortgage servicing rights are recorded at the lower of their cost basis or
market value and a valuation allowance is recorded for any stratum that is
impaired. We estimate the market value of the servicing assets each month using
a cash flow model to project future expected cash flows based upon a set of
valuation assumptions we believe market participants would use for similar
assets. We review these assumptions on a regular basis to ensure that they
remain consistent with current market conditions. Additionally, we periodically
receive third party estimates of the portfolio value from an independent
valuation firm. Inaccurate assumptions in valuing mortgage servicing rights
could adversely affect our results of operations during a period in which
additional impairment occurs.
Valuation of Residual Interests
Residual interests from securitizations are classified as trading assets
and as such, we record them at fair value on the balance sheet. We record the
changes in fair value of these residuals as unrealized gains or losses in
results of operations in the period of change. We use a discounted cash flow
analysis to determine the fair value of these residuals. Cash flows are
projected over the lives of the residuals using prepayment, default, and
interest rate assumptions that we believe market participants would use for
similar financial instruments.
EARNINGS BY LINE OF BUSINESS
Irwin Financial Corporation is composed of five principal lines of
business:
- Mortgage Banking
- Home Equity Lending
- Commercial Banking
- Equipment Leasing
- Venture Capital
28
The following table summarizes our net income (loss) by line of business
for the periods indicated:
YEAR ENDED DECEMBER 31,
-----------------------------
2001 2000 1999
------- ------- -------
(IN THOUSANDS)
Net income (loss):
Mortgage Banking.......................................... $38,100 $13,006 $23,063
Home Equity Lending....................................... 16,248 18,494 12,606
Commercial Banking........................................ 8,918 7,090 7,345
Equipment Leasing......................................... (4,394) (2,563) (843)
Venture Capital........................................... (6,549) 2,723 656
Other (including consolidating entries)................... (6,807) (3,084) (9,671)
------- ------- -------
$45,516 $35,666 $33,156
======= ======= =======
Our financial results in 2002 will be significantly different than our
historical performance due to changes we have made in our operating plan to
address changes in regulatory capital rules associated with residual interests
on sold loans. Beginning in 2002, we will eliminate our use of securitization
structures that require gain-on-sale accounting treatment under SFAS 140. These
structures create the residual assets that are the focus of the new rules. See
the "Recent Developments" section of this report for a discussion of the
anticipated impact of these changes on our earnings.
SUMMARY OF QUARTERLY FINANCIAL DATA
2001
--------------------------------------------
FOURTH THIRD SECOND FIRST
QUARTER QUARTER QUARTER QUARTER
-------- -------- -------- --------
(DOLLARS IN THOUSANDS)
SUMMARY INCOME STATEMENT INFORMATION
Interest income............................... $ 69,412 $ 72,925 $ 65,174 $ 60,722
Interest expense.............................. (26,452) (31,909) (31,235) (31,488)
Provision for loan and lease losses........... (8,142) (5,006) (2,804) (1,553)
Noninterest income............................ 82,856 58,464 68,304 61,767
Noninterest expense........................... (98,751) (75,629) (78,367) (74,673)
Income taxes.................................. (6,924) (7,446) (8,475) (5,779)
-------- -------- -------- --------
Net income before minority interest and
cumulative effect of change in accounting
principle.................................. 11,999 11,399 12,597 8,996
Minority interest............................. 71 68 211 --
Cumulative effect of change in accounting
principle.................................. -- -- -- 175
-------- -------- -------- --------
$ 12,070 $ 11,467 $ 12,808 $ 9,171
======== ======== ======== ========
Earnings per share:
Basic(1)................................... $ 0.57 $ 0.54 $ 0.61 $ 0.44(1)
Diluted(1)................................. 0.53 0.50 0.56 0.41(1)
29
2000
----------------------------------------------
FOURTH THIRD SECOND FIRST
QUARTER QUARTER QUARTER QUARTER
---------- -------- -------- --------
(DOLLARS IN THOUSANDS)
SUMMARY INCOME STATEMENT INFORMATION
Interest income............................... $ 57,446 $ 48,034 $ 43,015 $ 36,035
Interest expense.............................. (27,755) (26,760) (22,354) (16,665)
Provision for loan and lease losses........... (1,793) (1,356) (1,119) (1,135)
Noninterest income............................ 51,174 58,075 52,589 49,873
Noninterest expense........................... (63,242) (62,748) (58,036) (53,936)
Income taxes.................................. (6,279) (6,117) (5,591) (5,689)
-------- -------- -------- --------
Net income.................................... $ 9,551 $ 9,128 $ 8,504 $ 8,483
======== ======== ======== ========
Earnings per share:
Basic...................................... $ 0.46 $ 0.43 $ 0.41 $ 0.40
Diluted.................................... $ 0.44 $ 0.43 $ 0.40 $ 0.40
---------------
(1) Earnings per share of common stock before cumulative effect of change in
accounting principle for the three month period ended March 31, 2001 was
$0.43 basic and $0.40 diluted.
MORTGAGE BANKING
The following table shows selected financial information for our mortgage
banking line of business:
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------
2001 2000 1999 1998 1997
----------- ---------- ----------- ----------- -----------
(IN THOUSANDS)
SELECTED INCOME STATEMENT DATA:
Net interest income...................... $ 30,261 $ 15,401 $ 21,745 $ 26,244 $ 17,577
Provision for loan losses................ 31 357 (1,998) (1,721) (1,383)
Loan origination fees.................... 61,917 34,688 46,311 59,328 41,045
Gain on sales of loans................... 113,140 45,601 72,395 97,724 53,332
Loan servicing fees...................... 52,837 50,309 54,247 52,217 50,194
Amortization of servicing assets......... (34,660) (23,712) (25,078) (23,002) (15,243)
Impairment of servicing assets........... (11,321) (13,802) 11,320 (11,121) (600)
Gain (loss) on derivatives............... 3,846 24 (10,808) 4,318 --
Gain on sales of bulk servicing rights... 8,394 27,528 9,005 829 1,512
Other income............................. 5,016 4,538 3,628 2,276 1,223
----------- ---------- ----------- ----------- -----------
Total net revenue...................... 229,461 140,932 180,767 207,092 147,657
Operating expense.......................... 167,624 119,387 144,915 159,046 111,367
----------- ---------- ----------- ----------- -----------
Income before taxes........................ 61,837 21,545 35,852 48,046 36,290
Income taxes............................... 23,912 8,539 12,789 19,193 14,990
----------- ---------- ----------- ----------- -----------
Net income before cumulative effect of
change in accounting principle........... 37,925 13,006 23,063 28,853 21,300
Cumulative effect of change in accounting
principle................................ 175 -- -- -- --
----------- ---------- ----------- ----------- -----------
Net income................................. $ 38,100 $ 13,006 $ 23,063 $ 28,853 $ 21,300
=========== ========== =========== =========== ===========
30
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------
2001 2000 1999 1998 1997
----------- ---------- ----------- ----------- -----------
(IN THOUSANDS)
SELECTED BALANCE SHEET DATA AT END OF
PERIOD:
Total assets............................. $ 926,946 $ 523,920 $ 549,966 $ 1,020,249 $ 792,007
Mortgage loans held for sale............. 503,757 249,580 277,614 697,542 528,739
Mortgage servicing assets................ 211,201 121,555 132,648 113,131 81,610
Short-term debt.......................... 385,640 215,826 217,691 430,859 429,451
Long-term debt........................... -- 3,951 223 2,839 54
Shareholders' equity..................... 63,150 47,828 98,556 104,696 81,058
SELECTED OPERATING DATA:
Mortgage loan originations............... $ 9,225,991 $4,091,573 $ 5,876,750 $ 8,944,615 $ 5,397,338
Servicing portfolio:
Balance at end of period................. 12,875,532 9,196,513 10,448,112 11,242,470 10,713,549
Weighted average coupon rate........... 7.23% 7.76% 7.51% 7.56% 7.85%
Weighted average servicing fee......... 0.45 0.43 0.44 0.43 0.40
Servicing sold as a % of production...... 25.1 99.4 79.9 57.0 71.8
Overview
In our mortgage banking line of business, Irwin Mortgage, in combination
with Irwin Union Bank and Trust, originates, purchases, sells and services
conventional and government agency-backed residential mortgage loans throughout
the United States Because most of our mortgage originations either are insured
by an agency of the federal government, such as the FHA or the VA, or, in the
case of conventional mortgages, meet requirements for sale to FNMA or the FHLMC,
we are able to remove substantially all of the credit risk of these loans from
our balance sheet. We sell mortgage loans to institutional and private investors
but may retain servicing rights to the loans we originate or purchase from
correspondents. We believe this balance between mortgage loan originations and
mortgage loan servicing provides us a partial natural hedge against interest
rate changes, which has helped stabilize our revenue stream.
Our mortgage banking line of business is currently our largest contributor
to revenue, comprising 57.2% of our total revenues in 2001, compared to 47.4% in
2000 and 67.8% in 1999. Our mortgage banking line of business contributed 83.7%
of our net income for 2001, compared to 36.5% and 69.6% in 2000 and 1999,
respectively.
We originate loans through retail branches, and, to a limited degree,
through our Internet website. We also purchase mortgage loans from third party
sources, such as wholesale loan brokers. We consider this part of our business
wholesale lending. We identify potential borrowers mainly through relationships
maintained with housing intermediaries, such as realtors, homebuilders and
brokers. We fund loans on a short-term basis on the balance sheet of Irwin Union
Bank and Trust using internal funding sources, through credit facilities
provided by third parties, and through repurchase agreements with investment
banks. Generally within a 30-day period, individual loans are pooled,
securitized and/or sold into the secondary mortgage market, which includes
government-sponsored mortgage entities, nationally sponsored mortgage conduits,
and institutional and private investors. Our mortgage banking line of business
may retain servicing rights to the loans that it originates or purchases from
correspondents.
We believe there is a balance between mortgage loan originations and
mortgage loan servicing that provides a partial natural hedge against interest
rate changes and the impact of rate changes on each part of the business. In
rising interest rate environments, originations typically decline, while the
unrealized value of our mortgage servicing portfolio generally increases as
prepayment expectations decline. In declining interest rate environments,
unrealized servicing values typically decrease as prepayment expectations
increase, while the value of our mortgage production franchise generally
increases. We sell servicing rights periodically for many reasons, including
income recognition, cash flow, and servicing portfolio management.
31
Strategy
Our mortgage banking line of business uses a niche strategy, focusing on
first-time homeowners, which we believe will increase in number in coming years
due to certain national demographic trends that are favorable to housing
formation in our target markets. The mortgage banking business is cyclical,
following changes in interest rates. In our mortgage banking line of business we
do not try to anticipate the timing of changes in interest rates, but instead we
have developed a strategy intended to maintain profitability across interest
rate cycles. Our strategy has three components:
- We manage our loan production activities through the expansion or
contraction of existing channels in geographic markets and demographic
groups that support our first-time home buyer strategy, and channels
(such as credit unions) that are thought to be underserved by the
mortgage industry and that value the mortgage bank's service-oriented
approach to lending.
- We have sought to improve profit margins through a process improvement
initiative, which we began in 1999 to significantly reduce fixed costs
associated with processing and securitizing mortgage loans. We are
re-designing our processes so that we process, underwrite, and close
loans in a more centralized environment.
- We are more likely to retain servicing rights in periods of low interest
rates and more likely to sell these servicing rights during periods of
high interest rates. This strategy gives us the flexibility to invest in
servicing rights during periods of relatively high production and sell
the servicing during periods of lower production.
Net Income
Net income from mortgage banking for the year ended December 31, 2001 was
$38.1 million, compared to $13.0 million during 2000, an increase of 192.9% and
an increase of 65.2% over 1999 results of $23.1 million. This increase primarily
relates to increased production as a result of a declining interest rate
environment. Both the 2000 and 1999 declines were the result of rising interest
rates which slowed production activity throughout the mortgage banking industry.
The following table shows the composition of our originations by loan
categories for the periods indicated:
YEAR ENDED DECEMBER 31,
------------------------------------
2001 2000 1999
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Total originations....................................... $9,225,991 $4,091,573 $5,876,750
Percent retail loans..................................... 35.7% 35.7% 37.4%
Percent wholesale loans.................................. 59.7 55.7 57.1
Percent brokered(1)...................................... 4.6 8.6 5.5
Percent refinances....................................... 54.1 16.4 28.6
---------------
(1) Brokered loans are loans we originate for which we receive loan origination
fees, but which are funded, closed and owned by unrelated third parties.
Mortgage loan originations for the year ended December 31, 2001 totaled
$9.2 billion, up 125.5% from the same period in 2000 as a result of the
declining interest rate environment. Refinanced loans accounted for 54.1% of
loan production for 2001 compared to 16.4% in 2000. Higher production volume
caused mortgage loan origination income to increase 78.5% in 2001 to $61.9
million.
As a result of rising interest rates during most of 2000, our mortgage
banking line of business experienced a decline in loan originations in 2000 as
compared to 1999. Loan originations in 2000 were $4.1 billion, down 30.4% from
1999. Income from mortgage loan originations in 2000 totaled $34.7 million,
25.1% lower than 1999. Refinances accounted for 16.4% of 2000 originations, as
compared to 28.6% in 1999. Because certain fees are not collected for loan
refinancings, loan origination fees, which are fees we charge the borrower to
32
initiate the loan application and/or to secure an interest rate, did not
decrease at the same rate as loan production in 2000 and 1999.
As a result of declining rates and resulting higher loan production in
2001, gains on the sale of loans during this period increased 148.1% compared to
2000 to $113.1 million. This compares to $45.6 million for the year 2000, and
$72.4 million for the year 1999. Lower loan production levels during a period of
rising rates accounted for the decline in 2000 compared to 1999.
Net Revenue
Net revenue for the year ended December 31, 2001 totaled $229.5 million,
compared to $140.9 million for the year ended December 31, 2000, and $180.8
million 1999. The following table sets forth certain information regarding net
revenue for the periods indicated:
YEAR ENDED DECEMBER 31,
------------------------------
2001 2000 1999
-------- -------- --------
(IN THOUSANDS)
Net interest income......................................... $ 30,261 $ 15,401 $ 21,745
Provision for loan losses................................... 31 357 (1,998)
Loan origination fees....................................... 61,917 34,688 46,311
Gain on sales of loans...................................... 113,140 45,601 72,395
Servicing fees.............................................. 52,837 50,309 54,247
Amortization expense........................................ (34,660) (23,712) (25,078)
Impairment expense.......................................... (11,321) (13,802) 11,320
Gain (loss) on derivatives.................................. 3,846 24 (10,808)
Gain on sales of bulk servicing............................. 8,394 27,528 9,005
Other income................................................ 5,016 4,538 3,628
-------- -------- --------
Total net revenue........................................... $229,461 $140,932 $180,767
======== ======== ========
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 for the year 2001 totaled
$30.3 million, compared to $15.4 million in 2000, and $21.7 million in 1999.
Included in interest income for 2000 was $2.2 million related to interest earned
from a refund of federal income taxes relating to a prior period tax return.
Excluding the impact of the tax refund in 2000, net interest income for the year
ended December 31, 2001 increased 129.2%, compared to 2000. The 2000 decline
resulted from decreased loan production during the year, which was driven by
rising interest rates throughout the majority of the year.
Loan origination fees for the year ended December 31, 2001 totaled $61.9
million, compared to $34.7 million for 2000, and $46.3 million in 1999, an
increase of 78.5% and 33.7%, respectively. The percentage increase in loan
origination fees is not proportionate to loan origination growth due to product
mix and the high percentage of refinances which have occurred in 2001.
Gain on sale of loans is income recognized when loans are pooled and sold
into the secondary mortgage market. Gain on sale of loans for the year ended
2001 totaled $113.1 million, compared to $45.6 million in 2000, an increase of
148.1%. Gain on sale of loans for the year ended December 31, 1999 totaled $72.4
million.
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. Servicing fee income totaled $52.8 million for the year of
2001, an increase of 5.0% from 2000 and a decrease of 2.6% from 1999, reflecting
the fluctuating size and mix of the servicing portfolio throughout the last two
years.
Amortization expense relates to mortgage servicing rights and is based on
the estimated lives of the underlying loans. Amortization expense totaled $34.6
million for the year ended December 31, 2001, compared to $23.7 million during
2000 and $25.1 million during 1999. This increase in 2001 compared to 2000
33
and 1999 relates to the increase in the underlying servicing portfolio and to
the prepayment trends increasing throughout the year.
Impairment is recorded when the book value of the mortgage servicing rights
exceeds the fair market value on a strata by strata basis. Impairment expense
totaled $11.3 million during the year of 2001, compared to $13.8 million during
the same period in 2000 and an impairment recovery of $11.3 million in 1999. The
line of business restratified its servicing assets on January 1, 2001 based upon
changing predominant risk characteristics inherent in the portfolio. The effect
of this change was to decrease the mortgage servicing asset and valuation
allowance by $12.0 million. Fluctuating interest rates impacted the impairment
recovery or loss recorded over these periods.
The impairment expense recorded in 2001 was offset by hedging gains of $3.8
million during the same period. Hedging gains of $24 thousand were recorded
during the same period in 2000. In 1999, we used options on treasury futures to
offset the interest rate risk associated with the mortgage servicing assets. By
December 31, 1999, these options had expired. In 1999, we recorded a $10.8
million hedging loss related to these options. At December 31, 2001, the
mortgage line of business held a $17.4 billion notional amount of Eurodollar
future contracts related to economically hedging these servicing assets. The
current hedging activities of the mortgage bank related to servicing assets do
not satisfy the criteria for "hedge accounting" under SFAS 133. As a result,
these derivatives are accounted for as trading assets, and changes in fair value
are adjusted through earnings as trading gains or losses, while the underlying
servicing asset being hedged is accounted for at the lower of cost or market.
Our mortgage banking business maintains the flexibility either to sell
servicing for current cash flow or to retain servicing for future cash flow,
whether through bulk sales or ongoing servicing fees. The decision to sell or
retain servicing is based on a balance of current market conditions and the
interest rate risk tolerance of the business. Total servicing sales represented
25.1% of the loan portfolio in 2001 based on loan originations, compared to
99.4% of the loan portfolio in 2000, and 79.9% of the loan portfolio in 1999.
The decrease in 2001 relates to both higher levels of servicing retained on
conventional servicing as well as a decrease in bulk servicing sales. The
increases in both 1999 and 2000 relate to increased bulk sales during each of
those years.
Bulk servicing sales of $1.0 billion of a total $2.3 billion of sold
servicing were sold during the year of 2001, generating an $8.4 million pre-tax
gain. This compares to bulk servicing sales of $2.5 billion of a total $4.1
billion of sold servicing in 2000, producing a $27.5 million pre-tax gain. In
1999, bulk servicing sales of $1.2 billion of a total $4.7 billion sold
servicing produced a $9.0 million pre-tax gain.
Operating Expenses
The following table sets forth operating expenses for our mortgage banking
line of business for the periods indicated:
YEAR ENDED DECEMBER 31,
------------------------------
2001 2000 1999
-------- -------- --------
(DOLLARS IN THOUSANDS)
Salaries and employee benefits.............................. $110,542 $ 72,818 $ 88,473
Other expenses.............................................. 57,083 46,569 56,442
-------- -------- --------
Total operating expenses.................................... $167,625 $119,387 $144,915
======== ======== ========
Number of employees(1)...................................... 1,533 1,226 1,492
---------------
(1) On a full time equivalent basis.
Operating expenses for the year ended December 31, 2001 totaled $167.6
million, a 40.4% increase over the year 2000, and 15.7% over 1999. Salaries and
employee benefits during 2001 increased 51.8% over 2000 and 24.9% over 1999.
These fluctuations reflect the decreased production activities throughout 1999
and 2000, followed by a significant increase in production activities in 2001.
34
Mortgage Servicing
The following table shows information about our mortgage servicing
portfolio for the periods indicated:
YEAR ENDED DECEMBER 31,
------------------------------
2001 2000 1999
-------- -------- --------
(PORTFOLIO IN BILLIONS)
Beginning portfolio......................................... $ 9.2 $ 10.5 $ 11.2
Mortgage loan closings.................................... 9.2 4.1 5.9
Sales of servicing rights................................. (2.3) (4.1) (4.7)
Run-off(1)................................................ (3.2) (1.3) (1.9)
-------- -------- --------
Ending portfolio............................................ $ 12.9 $ 9.2 $ 10.5
======== ======== ========
Number of loans (end of period)............................. 123,291 103,069 131,833
Average loan size........................................... $104,432 $ 89,200 $ 84,500
Percent GNMA and state housing programs..................... 60% 75% 75%
Percent conventional insured and other...................... 33 21 22
Percent warehouse........................................... 7 4 3
Delinquency ratio........................................... 7.8 9.6 6.8
Capitalized servicing to servicing portfolio................ 1.6 1.3 1.3
---------------
(1) Run-off is the reduction in principal balance of the servicing portfolio due
to regular principal payments made by mortgagees and early repayments of
entire loans.
Our mortgage servicing portfolio totaled $12.9 billion at December 31,
2001, a 40.0% increase from the December 31, 2000 balance of $9.2 billion, and
up 23.2% from the same date in 1999. Irwin Mortgage has followed a strategy of
managing interest rate risk associated with the servicing portfolio by selling
servicing rights on those loans that are most likely to refinance should
interest rates decline. This line of business sold servicing rights during these
periods to help manage its investment in the portfolio and to monetize existing
gains in its servicing portfolio. Consistent with our sales strategy, in recent
months the line of business has chosen to retain more conventional servicing in
its portfolio due to current market pricing.
We record mortgage servicing assets at the lower of their cost or market
value, and we record a valuation allowance for any impairment. At December 31,
2001, the market value of these assets was estimated to be $239.7 million in the
aggregate, or $28.5 million greater than the carrying value on the balance
sheet. At December 31, 2000, we estimated the market value of these assets to be
$165.1 million in the aggregate, or $43.6 million greater than the carrying
value on the balance sheet.
35
HOME EQUITY LENDING
The following table shows selected financial information for the home
equity lending line of business:
YEAR ENDED DECEMBER 31,
--------------------------------------------------------
2001 2000 1999 1998 1997
---------- ---------- -------- -------- --------
(DOLLARS IN THOUSANDS)
SELECTED INCOME STATEMENT DATA:
Net interest income.................. $ 61,754 $ 35,593 $ 18,852 $ 5,495 $ 7,129
Provision for loan losses............ (2,320) (461) -- (513) (1,404)
Gain on sales of loans............... 91,556 46,970 23,725 18,610 15,908
Loan origination fees................ 1,639 951 273 -- --
Loan servicing fees.................. 13,355 7,559 4,907 3,323 2,145
Amortization and impairment of
servicing assets................... (3,217) (1,583) (1,445) (842) (334)
Trading gains (losses)............... (38,420) 14,399 2,512 (2,952) (1,961)
Other income......................... 71 19 1,742 820 294
---------- ---------- -------- -------- --------
Total net revenues......... 124,418 103,447 50,566 23,941 21,777
Operating expenses................... 97,338 72,623 35,557 30,609 20,067
---------- ---------- -------- -------- --------
Income before taxes.................. 27,080 30,824 15,009 (6,668) 1,710
Income taxes....................... 10,832 12,330 2,403 -- --
---------- ---------- -------- -------- --------
Net income (loss).................... $ 16,248 $ 18,494 $ 12,606 $ (6,668) $ 1,710
========== ========== ======== ======== ========
SELECTED BALANCE SHEET DATA:
Total assets......................... $ 602,226 $ 550,526 $339,640 $311,974 $165,242
Home equity loans, net of allowance
for loan losses.................... 343,972 4,010 1,904 7,832 111,818
Home equity loans held for sale...... -- 330,208 231,382 242,702 --
Residual assets -- trading........... 199,071(1) 152,614 57,833 32,321 22,134
Short-term debt...................... 138,527 163,595 260,184 226,998 146,219
Shareholders' equity................. 135,493 99,586 58,733 40,272 10,936
SELECTED OPERATING DATA:
Loan volume:
Lines of credit.................... $ 317,579 $ 629,906 $ 93,185 $ 98,855 $115,274
Loans.............................. 831,830 596,049 346,322 290,818 99,244
Total managed portfolio balance at
end of period...................... 2,317,975 1,825,527 842,403 581,241 358,166
Weighted average coupon rate:
Lines of credit.................... 11.11% 14.04% 12.72% 11.89% 12.96%
Loans.............................. 13.38 13.09 12.33 11.86 13.97
Gain on sale of loans to loans
sold............................... 8.47 3.92 5.57 6.32 7.57
Net home equity charge-offs to
managed home equity portfolio...... 1.58 0.57 0.36 0.37 0.29
Delinquency ratio.................... 5.3 4.3 2.7 1.3 1.5
---------------
(1) Includes residuals derived from overcollateralization accounts and early
repayment fees totaling $36,292 and $21,126, respectively.
36
Overview
In our home equity lending line of business, we originate, purchase,
securitize and service home equity loans and lines of credit nationwide. We
generally sell the loans through securitization transactions. We continue to
service the loans we securitize. We target creditworthy, homeowning consumers
who are active, unsecured credit card debt users. Target customers are
underwritten using proprietary models based on several criteria, including the
customers' previous use of credit. We market our home equity products through
direct mail and telemarketing, mortgage brokers and correspondent lenders
nationwide and through Internet-based solicitations. To address the new capital
rules, beginning in 2002 we will begin using on-balance sheet financing and
eliminating our use of securitization structures requiring gain-on-sale
accounting. See the Recent Developments section of this report for further
discussion.
In 1997 and 1998, we largely redesigned our product offerings, introducing
new products with origination fees and early repayment options. We also
introduced home equity loans with combined loan-to-value (CLTV) ratios of up to
125% of their collateral value. Home equity loans with loan-to-value ratios
greater than 100% are priced with higher coupons than home equity loans with
loan-to-value ratios less than 100% to compensate for the increased risk. For
the year ended December 31, 2001, home equity loans with loan-to-value ratios
greater than 100% made up 57.7% of our loan originations and 51.8% of our
managed portfolio at December 31, 2001.
For most of our home equity product offerings, we offer customers the
choice to accept an early repayment fee in exchange for a lower interest rate. A
typical early repayment option provides for a fee equal to up to six months'
interest that is payable if the borrower chooses to repay the loan during the
first three to five years of its term. Approximately 83.3%, or $1.3 billion, of
our home equity loan servicing portfolio at December 31, 2001 has early
repayment fees. This portfolio does not include our floating rate lines of
credit.
Strategy
We expect to continue to originate new loans in our home equity lending
line of business through the development of new products, the extension of
existing products to new customers, and continued sales through our indirect
distribution channels. These include brokers, correspondent lenders and Internet
sites.
The environment for high loan-to-value home equity lending has become more
favorable for us during the past few years due to the exit of many home equity
lenders who did not survive the competitive pressures and significant
refinancing activity of 1998. This has helped our recent expansion in our home
equity lending line of business, although we expect the rate of growth in this
line of business to be slower in 2002 than in recent periods as we adjust to the
new capital rules as described in the "Recent Developments" section, and we
expect this line of business to show a loss in net income during 2002.
Servicing Mix
Our home equity lending line of business blends aspects of the credit card
and mortgage banking industries. The home equity products are designed to appeal
to homeowners who have high levels of unsecured (credit card) debt, who through
the use of a debt consolidating mortgage loan can meaningfully reduce their
after-tax monthly cash outflows. We underwrite our loans as if the credit is
unsecured, but we believe that the mortgage lien associated with the loan has a
meaningful, positive influence on the payment priority of our customers. We lend
nationally in our home equity lending line of business. The following table
shows the
37
geographic composition of our home equity lending portfolio on a percentage
basis as of December 31, 2001 and December 31, 2000:
DECEMBER 31, DECEMBER 31,
STATE 2001 2000
----- ------------ ------------
California.................................................. 23.6% 24.5%
Florida..................................................... 7.5 7.0
Virginia.................................................... 5.7 5.0
Ohio........................................................ 5.0 5.3
Illinois.................................................... 4.7 5.6
Michigan.................................................... 4.1 5.3
All other states............................................ 49.4 47.3
---------- ----------
Total..................................................... 100.0% 100.0%
========== ==========
Total servicing portfolio (in thousands).................... $2,317,975 $1,825,527
The following table provides a breakdown of our home equity lending
portfolio by product type, outstanding principal balance and weighted average
coupon as of December 31, 2001:
WEIGHTED
AVERAGE
AMOUNT % OF TOTAL COUPON
---------- ---------- --------
(IN THOUSANDS)
Home equity loans < = 100% CLTV............................. $ 510,001 22.00% 11.94%
Home equity lines of credit < = 100% CLTV................... 495,852 21.39 10.08
---------- ----- -----
Total < = 100% CLTV......................................... 1,005,853 43.39 11.02
---------- ----- -----
Home equity loans > 100% CLTV............................... 889,418 38.37 14.76
Home equity lines of credit > 100% CLTV..................... 225,122 9.71 12.50
---------- ----- -----
Total > 100% CLTV........................................... 1,114,540 48.08 14.31
---------- ----- -----
First mortgages............................................. 111,953 4.83 8.88
Other (immediate credit).................................... 85,629 3.70 13.44
---------- ----- -----
Total..................................................... $2,317,975 100% 12.59%
========== ===== =====
Securitizations
The securitization structures we have been using to date have involved
"true sales" of the loans, transferring them off of our balance sheet, and have
been accounted for using gain-on-sale treatment in accordance with SFAS 140 or
its predecessor SFAS 125. We have recognized gain on the sale of loans in the
period in which such loans were sold, although we receive cash (representing the
excess spread and servicing fees) over the lives of the loans. Concurrent with
recognizing such gain on sale, we have recorded the excess spread as a residual
interest which is indicated on our consolidated balance sheet as part of
"trading assets." We recognized gain on the sale of loans in an amount equal to
the difference between proceeds and allocated cost basis of the loans sold.
Residual interests are recorded at fair value with the resultant changes in fair
value recorded as unrealized gain or loss in our results of operations in the
period of the change. We determine fair value on a monthly basis based on a
discounted cash flow analysis. These cash flows are projected over the lives of
the receivables using prepayment, default, and interest rate assumptions that we
believe market participants would use for similar financial instruments.
Based on changes to our funding practices to adjust to the new capital
rules, we expect to use different securitization structures that will not be
accounted for using gain-on-sale treatment but rather as secured borrowings. For
assets funded on-balance sheet, we will record interest income over the life of
the loan as it is earned, net of interest expense over the life of the bonds and
a provision for credit losses inherent in the portfolio. For assets funded
through transactions accounted for as sales under SFAS 140, we recorded revenue
as gain on sale at the time of loan sale based on the difference between
proceeds and allocated cost basis of loans sold under SFAS 140. We have also
recognized residual interests based on the discounted present value of the
anticipated revenue stream over the expected life of the loans. This different
accounting treatment does not, however, affect cash flows related to the loans,
and management expects that the ultimate total receipt of revenues and
profitability derived from our home equity loans will be relatively unchanged by
these different financing structures.
38
SECURITIZATION TRANSACTIONS AND ASSUMPTIONS
The table below details information with respect to pool sizes and age for
the entire portfolio we service, including product for which we no longer retain
credit risk. The underlying assumptions included in this table are consistent
with the underlying assumptions for the portfolio for which we continue to
retain credit risk:
AGE OF ACTUAL ANNUALIZED
ORIGINAL CURRENT MONTH DEAL LOSS RATE AS A % OF
BALANCE SOLD BALANCE CLOSED (MONTHS) ORIGINAL BALANCE
------------ ---------- ------ -------- -------------------
HELOCS (LESS THAN= 100% CLTV)
95-2 HELOCs................................ $ 51,584 $ -- Nov-95 NA 0.40%
96-1 HELOCs................................ 75,999 7,476 Oct-96 63 0.25
97-1 HELOCs................................ 54,997 6,814 Jun-97 55 0.26
97-2 HELOCs................................ 69,998 10,448 Nov-97 50 0.28
98-1 HELOCs................................ 124,280 37,056 Jun-98 43 0.27
2000-1 HELOCs.............................. 66,803 42,944 Sep-00 16 0.11
2001-1 HELOCs.............................. 27,719 23,816 Mar-01 10 0.00
2001-2 HELOCs.............................. 64,018 58,833 Sep-01 4 0.00
---------- ----------
TOTAL/WEIGHTED AVERAGE..................... $ 535,398 $ 187,387 38 0.25%
========== ==========
HELS (LESS THAN= 100% CLTV)
96-1 HELs.................................. $ 63,997 $ -- Oct-96 NA 0.14%
97-1 HELs.................................. 44,999 4,303 Jun-97 55 0.20
97-2 HELs.................................. 60,000 8,891 Nov-97 50 0.25
98-1 HELs.................................. 70,005 15,696 Jun-98 43 0.13
99-1 HELs.................................. 89,999 26,559 Feb-99 35 0.27
99-2 HELs.................................. 45,000 17,236 May-99 32 0.56
99-3 HELs.................................. 107,657 50,777 Nov-99 26 0.49
2000-1 HELs................................ 123,971 78,515 Sep-00 16 0.30
2001-1 HELs................................ 124,951 95,247 Mar-01 10 0.08
2001-2 HELs................................ 196,052 200,479 Sep-01 4 0.00
---------- ----------
TOTAL/WEIGHTED AVERAGE..................... $ 926,631 $ 497,703 23 0.27%
========== ==========
FIRST MORTGAGES (LESS THAN= 100% CLTV)
98-1 First................................. $ 7,495 $ 2,943 Jun-98 43 0.00%
99-1 First................................. 60,001 36,706 Feb-99 35 0.09
99-2 First................................. 15,021 8,923 May-99 32 0.00
99-3 First................................. 25,246 18,146 Nov-99 26 0.22
2001-1 First............................... 4,058 3,377 Mar-01 10 0.00
---------- ----------
TOTAL/WEIGHTED AVERAGE..................... $ 111,821 $ 70,095 32 0.09%
========== ==========
HELOCS (LESS THAN= 125% CLTV)
98-1 HELOC125s............................. $ 7,499 $ 2,517 Jun-98 43 0.99%
99-3 HELOC125s............................. 38,320 24,182 Nov-99 26 2.23
2000-LB1 HELOC125s......................... 29,919 23,617 Jun-00 19 0.96
2001-1 HELOC125s........................... 30,812 27,956 Mar-01 10 1.12
2001-2 HELOC125s........................... 70,295 68,296 Sep-01 4 0.00
---------- ----------
TOTAL/WEIGHTED AVERAGE..................... $ 176,845 $ 146,568 14 1.39%
========== ==========
HELS (LESS THAN= 125% CLTV)
99-2 HEL125s............................... $ 119,978 $ 62,147 May-99 32 1.73%
99-3 HEL125s............................... 70,658 43,204 Nov-99 26 1.59
2000-A1 HEL125s............................ 123,698 78,384 Jun-00 19 1.20
2000-1 HEL125s............................. 166,330 128,145 Sep-00 16 1.11
2001-1 HEL125s............................. 219,765 188,294 Mar-01 10 0.50
2001-2 HEL125s............................. 313,368 307,693 Sep-01 4 0.13
---------- ----------
TOTAL/WEIGHTED AVERAGE..................... $1,013,797 $ 807,867 14 1.17%
========== ==========
PURCHASED PNB 99-1 HELOCS (LESS THAN= 100%
CLTV)
PNB 1999-1 HELOC........................... $ 500,000 $ 186,747 May-99 32 0.89%
IMMEDIATE CREDIT (Program discontinued)
99-3 HEL ImmedCredit....................... $ 524 $ 231 Nov-99 26 6.59%
99-3 HELOC ImmedCredit..................... 13,903 5,935 Nov-99 26 8.28
2000-LB1 HELOC ImmedCredit................. 69,267 41,669 Jun-00 19 5.48
---------- ----------
TOTAL/WEIGHTED AVERAGE..................... $ 83,694 $ 47,835 20 6.09%
========== ==========
GRAND TOTAL................................ $3,348,186 $1,944,202 24 0.72%
========== ========== === ====
ORIGINAL PROJECTED ORIGINAL PROJECTED REMAINING PROJECTED
ACTUAL CUMULATIVE CUMULATIVE LOSSES CUMULATIVE LOSSES CUMULATIVE LOSSES
LOSSES AS A % OF AS A % OF (LIFETIME) AS A % OF (LIFETIME) AS A % OF
ORIGINAL BALANCE ORIGINAL BALANCE ORIGINAL BALANCE ORIGINAL BALANCE
----------------- ------------------ -------------------- --------------------
HELOCS (LESS THAN= 100% CLTV)
95-2 HELOCs................................ 2.24% 1.35% 1.35% 0.00%
96-1 HELOCs................................ 1.30 1.35 1.36 0.01
97-1 HELOCs................................ 1.19 1.24 1.29 0.05
97-2 HELOCs................................ 1.16 1.20 1.32 0.12
98-1 HELOCs................................ 0.95 1.18 1.71 0.53
2000-1 HELOCs.............................. 0.15 0.64 2.45 1.82
2001-1 HELOCs.............................. 0.00 0.15 5.44 5.29
2001-2 HELOCs.............................. 0.00 0.00 4.37 4.37
TOTAL/WEIGHTED AVERAGE..................... 0.77% 0.93% 2.22% 1.29%
HELS (LESS THAN= 100% CLTV)
96-1 HELs.................................. 0.68% 1.29% 1.29% 0.00%
97-1 HELs.................................. 0.91 1.27 1.27 0.00
97-2 HELs.................................. 1.03 1.13 1.24 0.11
98-1 HELs.................................. 0.46 1.07 1.35 0.28
99-1 HELs.................................. 0.79 0.98 1.32 0.34
99-2 HELs.................................. 1.50 1.00 1.78 0.78
99-3 HELs.................................. 1.06 0.87 1.84 0.97
2000-1 HELs................................ 0.40 0.52 2.09 1.57
2001-1 HELs................................ 0.07 0.32 3.68 3.36
2001-2 HELs................................ 0.00 0.00 4.30 4.30
TOTAL/WEIGHTED AVERAGE..................... 0.52% 0.62% 2.53% 1.92%
FIRST MORTGAGES (LESS THAN= 100% CLTV)
98-1 First................................. 0.00% 0.71% 0.83% 0.11%
99-1 First................................. 0.26 0.61 0.85 0.24
99-2 First................................. 0.00 0.55 0.86 0.31
99-3 First................................. 0.47 0.46 0.89 0.43
2001-1 First............................... 0.00 0.14 0.87 0.73
TOTAL/WEIGHTED AVERAGE..................... 0.25% 0.56% 0.86% 0.30%
HELOCS (LESS THAN= 125% CLTV)
98-1 HELOC125s............................. 3.54% 5.11% 7.06% 1.95%
99-3 HELOC125s............................. 4.84 3.75 9.67 5.92
2000-LB1 HELOC125s......................... 1.52 2.67 11.08 8.41
2001-1 HELOC125s........................... 0.94 0.65 14.99 14.34
2001-2 HELOC125s........................... 0.00 0.00 11.20 11.20
TOTAL/WEIGHTED AVERAGE..................... 1.62% 1.59% 11.33% 9.74%
HELS (LESS THAN= 125% CLTV)
99-2 HEL125s............................... 4.62% 4.02% 6.72% 2.70%
99-3 HEL125s............................... 3.44 3.55 7.23 3.68
2000-A1 HEL125s............................ 1.89 2.45 5.26 2.82
2000-1 HEL125s............................. 1.48 2.18 9.08 6.90
2001-1 HEL125s............................. 0.42 1.21 12.21 11.00
2001-2 HEL125s............................. 0.04 0.00 11.70 11.70
TOTAL/WEIGHTED AVERAGE..................... 1.36% 1.64% 9.69% 8.05%
PURCHASED PNB 99-1 HELOCS (LESS THAN= 100%
CLTV)
PNB 1999-1 HELOC........................... 2.38% 2.70% 4.00% 1.30%
IMMEDIATE CREDIT (Program discontinued)
99-3 HEL ImmedCredit....................... 14.28% 7.91% 24.20% 16.28%
99-3 HELOC ImmedCredit..................... 17.95 8.06 23.11 15.05
2000-LB1 HELOC ImmedCredit................. 8.68 6.54 25.31 18.76
TOTAL/WEIGHTED AVERAGE..................... 10.26% 6.80% 24.93% 18.13%
GRAND TOTAL................................ 1.41% 1.52% 5.96% 4.44%
===== ==== ===== =====
WEIGHTED AVERAGE WEIGHTED
FUTURE PREPAYMENT AVERAGE
SPEED ASSUMPTION COUPON
----------------- --------
HELOCS (LESS THAN= 100% CLTV)
95-2 HELOCs................................ N/A N/A
96-1 HELOCs................................ 38% 11.17%
97-1 HELOCs................................ 32 11.02
97-2 HELOCs................................ 43 11.17
98-1 HELOCs................................ 47 9.72
2000-1 HELOCs.............................. 39 9.85
2001-1 HELOCs.............................. 19 9.67
2001-2 HELOCs.............................. 25 9.92
TOTAL/WEIGHTED AVERAGE..................... 34% 10.00%
HELS (LESS THAN= 100% CLTV)
96-1 HELs.................................. N/A N/A
97-1 HELs.................................. 33% 14.46%
97-2 HELs.................................. 36 13.76
98-1 HELs.................................. 50 12.41
99-1 HELs.................................. 50 11.71
99-2 HELs.................................. 43 11.35
99-3 HELs.................................. 45 12.40
2000-1 HELs................................ 41 12.48
2001-1 HELs................................ 24 12.39
2001-2 HELs................................ 22 11.37
TOTAL/WEIGHTED AVERAGE..................... 32% 11.99%
FIRST MORTGAGES (LESS THAN= 100% CLTV)
98-1 First................................. 65% 8.76%
99-1 First................................. 37 8.55
99-2 First................................. 29 8.56
99-3 First................................. 21 9.17
2001-1 First............................... 20 9.73
TOTAL/WEIGHTED AVERAGE..................... 32% 8.78%
HELOCS (LESS THAN= 125% CLTV)
98-1 HELOC125s............................. 44% 12.21%
99-3 HELOC125s............................. 23 12.25
2000-LB1 HELOC125s......................... 20 12.95
2001-1 HELOC125s........................... 15 13.41
2001-2 HELOC125s........................... 23 12.64
TOTAL/WEIGHTED AVERAGE..................... 21% 12.76%
HELS (LESS THAN= 125% CLTV)
99-2 HEL125s............................... 31% 13.67%
99-3 HEL125s............................... 29 14.78
2000-A1 HEL125s............................ 29 13.64
2000-1 HEL125s............................. 23 15.26
2001-1 HEL125s............................. 16 15.00
2001-2 HEL125s............................. 17 15.00
TOTAL/WEIGHTED AVERAGE..................... 21% 14.79%
PURCHASED PNB 99-1 HELOCS (LESS THAN= 100%
CLTV)
PNB 1999-1 HELOC........................... 29% 10.78%
IMMEDIATE CREDIT (Program discontinued)
99-3 HEL ImmedCredit....................... 14% 14.90%
99-3 HELOC ImmedCredit..................... 23 13.57
2000-LB1 HELOC ImmedCredit................. 28 13.76
TOTAL/WEIGHTED AVERAGE..................... 27% 13.74%
GRAND TOTAL................................ 26% 12.82%
=== =====
39
Home Equity Servicing
Our home equity lending business continues to service loans it has
securitized. We earn a servicing fee of approximately 75 to 100 basis points of
the outstanding principal balance of the securitized loans. The following table
shows certain information about our home equity servicing portfolio, which
includes loans held on the balance sheet as well as securitized loans:
2001 2000 1999
---------- ---------- --------
(IN THOUSANDS)
Balance................................................... $2,317,975 $1,825,527 $842,403
Delinquency ratio......................................... 5.25% 4.31% 2.70%
In our home equity lending business, we retain credit risk on loans we
originate whether funded on- or off-balance sheet. Delinquency rates and losses
on our managed portfolio result from a variety of factors, including loan
seasoning, portfolio mix, and general economic conditions. The 30-day and
greater delinquency ratio was 5.25% at December 31, 2001, and 4.31% at December
31, 2000, compared to 2.70% at December 31, 1999. As the average age of our
portfolio continues to increase and our product mix includes more high
loan-to-value loans, these factors, if coupled with continued declines in
general economic conditions, would cause delinquencies and losses to increase in
future quarters. We take this into consideration when determining our loss
reserves and valuation parameters used in valuing the loans and residual
interests on the balance sheet. The credit quality of the home equity loans
underlying previous securitizations continues to perform within management's
long term expectations, despite the current economic uncertainty.
Net Income
Our home equity lending business recorded net income of $16.2 million
during the year ended December 31, 2001, compared to net income in 2000 of $18.5
million, and $12.6 million in 1999. Results in 1999 are net of $2.4 million of
income taxes. In late 1999, the net operating losses carried forward by this
line of business were fully used and the business began recording income tax
expense. Until that time, income taxes for this line of business were recorded
at the parent level.
The improvement in 2001 and 2000 earnings over 1999 was the result of the
growth of the managed loan portfolio in both years. Actual credit performance
continues to meet management's expectations and remains within the forecasts
used for its loss reserve analysis. The decrease in net income in 2001 over 2000
principally reflects higher expected loss rates and prepayment speeds, and an
increased discount rate all of which are used to value future cash flows from
our portfolio of securitized loans. The assumptions were adjusted to reflect the
increased uncertainty in the national economy, and the anticipated effect the
current economic climate will have on portfolio performance.
Net Revenue
Net revenue for the year ended December 31, 2001 totaled $124.4 million,
compared to net revenue for the year ended December 31, 2000 of $103.4 million,
and $50.6 million in 1999.
During 2001, our home equity lending business produced (originated and
acquired) $1.1 billion of home equity loans, compared to $1.2 billion during
2000, a 6.2% decline. The 2001 loan production was up 161.5% from 1999 volume of
$0.4 billion. Included in the 2000 total is a fourth quarter acquisition of the
residual interest, servicing rights and related whole loans of an approximately
$400 million pool of previously securitized home equity lines of credit. The
collateral supporting the pool is comprised of seasoned lines of credit,
predominantly up to 100% combined loan-to-value and similar in credit quality
and yield to lines of credit originated by the business. Our home equity lending
business had $344.0 million of net loans at December 31, 2001, compared to net
loans and loans held for sale of $334.2 million at December 31, 2000, and $233.3
million at the same date in 1999.
40
The following table sets forth certain information regarding net revenue
for the periods indicated:
YEAR ENDED DECEMBER 31,
-----------------------------
2001 2000 1999
-------- -------- -------
(DOLLARS IN THOUSANDS)
Net interest income......................................... $ 61,754 $ 35,593 $18,852
Provision for loan losses................................... (2,320) (461) --
Gain on sales of loans...................................... 91,556 46,970 23,725
Loan origination fee income................................. 1,639 951 273
Loan servicing fees......................................... 13,355 7,559 4,907
Amortization and impairment of servicing assets............. (3,217) (1,583) (1,445)
Trading gains (losses)...................................... (38,420) 14,399 2,512
Other income................................................ 71 19 1,742
-------- -------- -------
Total net revenue........................................... $124,418 $103,447 $50,566
======== ======== =======
Net interest income increased to $61.8 million for the year ended December
31, 2001, compared to the year 2000 net interest income of $35.6 million, and
$18.9 million in 1999. This line of business earns interest income on loans held
on the balance sheet and the accretion of the discount applied to its residual
interests, which totaled $31.9 million during 2001 versus $15.9 million in 2000,
and $6.5 million in 1999.
Gains on sales of loans for the year ended December 31, 2001 totaled $91.6
million, compared to $47.0 million and $23.7 million during the same period in
2000 and 1999, respectively. In the home equity line of business, we securitized
$1.1 billion of loans in 2001 compared to $774.6 million and $430.7 million of
loans securitized in 2000 and 1999, respectively. The gain on sales of loans
relative to the principal balance of loans sold increased during 2001 due to
improvement in net funding costs. These improvements include a higher mix of
loans originated with fees for early repayment, a higher risk-adjusted interest
rate on the underlying collateral, a lower relative acquisition cost structure
due to continued expansion of new distribution channels, an ability to sell a
portion of the residual interest at inception of the securitization transaction,
and otherwise improved excess spread that we have been able to realize on the
basis of our consistent performance history to date.
Amortization and impairment of servicing assets includes amortization
expenses and valuation adjustments relating to the carrying value of servicing
assets. Our home equity lending business recognizes on its balance sheet a
servicing asset equal to the discounted cash flows of estimated future servicing
income and cost. At December 31, 2001, net servicing assets totaled $15.3
million, compared to a balance of $7.7 million at December 31, 2000, and $4.5
million at December 31, 1999. Servicing asset amortization and impairment
expense totaled $3.2 million during 2001, compared to $1.6 million for the year
ended December 31, 2000, and $1.4 million in 1999.
Trading gains (losses) of $38.4 million includes adjustments to the
carrying values of our residual interests, unrealized gains from securitizations
and derivative gains and losses. Residual interests had a balance of $199.1
million at December 31, 2001 and $152.6 million at December 31, 2000, compared
to $57.8 million at the same date in 1999. Included in the market valuation
assumptions are estimated 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. Loss experience
relative to assumptions to date has been favorable with respect to the
portfolio. During the year ended December 31, 2001, the line of business
recorded an unrealized trading loss of $45.8 million to adjust the carrying
value of residual interests to their estimated fair values. The increased
unrealized trading loss in 2001 principally reflects higher expected loss rates
and prepayment speeds, and a higher discount rate used to value future cash
flows from our portfolio of securitized loans.
Also included in trading gains (losses) for the year ended December 31,
2001 were unrealized trading gains on residual interests of $11.6 million and a
derivative loss of $4.2 million. During 2000, unrealized trading gains on
residual interests were $14.6 million, and derivative losses totaled $0.3
million. On November 29, 2001, we sold $12.3 million of residual interests on
previously sold loans representing
41
approximately $108.9 million of principal balance. This was approximately 40% of
our residual interest in home equity loans securitized in September 2000.
Consistent with our three previous residual sales, we sold these residual
interests for a price equal to the carrying value on our balance sheet. The sale
is one step in our on-going efforts to manage our investment in residual assets
and our capital position in light of the new federal banking regulations
regarding capital treatment of residual assets. We intend to pursue additional
sales of residual interests in 2002 and 2003. During 1999, the line of business
recorded a trading gain of $2.5 million which included an unrealized trading
loss on residual interests of $0.4 million, an unrealized gain on sale of
residual interests of $2.0 million, and a hedging gain of $0.9 million.
Operating Expenses
The following table shows operating expenses for our home equity lending
line of business for the periods indicated:
YEAR ENDED DECEMBER 31,
---------------------------
2001 2000 1999
------- ------- -------
(DOLLARS IN THOUSANDS)
Salaries and employee benefits.............................. $59,010 $39,180 $21,383
Other....................................................... 38,328 33,443 14,174
------- ------- -------
Total operating expenses.......................... $97,338 $72,623 $35,557
======= ======= =======
Number of employees at period end........................... 773 614 372
Operating expenses were $97.3 million for the year ended December 31, 2001,
compared to $72.6 for the year 2000, and an increase of 173.8% from 1999. These
increases reflect the growth in the managed portfolio and growth in production.
COMMERCIAL BANKING
The following table shows selected financial information for our commercial
banking line of business:
YEAR ENDED DECEMBER 31,
------------------------------------------------------------
2001 2000 1999 1998 1997
---------- ---------- -------- -------- --------
(DOLLARS IN THOUSANDS)
SELECTED INCOME STATEMENT DATA:
Interest income.................. $ 104,514 $ 82,680 $ 54,452 $ 46,056 $ 41,115
Interest expense................. 53,515 44,268 23,525 20,957 19,120
---------- ---------- -------- -------- --------
Net interest income.............. 50,999 38,412 30,927 25,099 21,995
Provision for loan and lease
losses......................... 7,900 2,933 1,813 1,820 2,201
Noninterest income............... 14,999 11,974 11,797 11,712 9,256
Operating expense................ 43,500 35,773 29,080 24,515 20,194
---------- ---------- -------- -------- --------
Income before taxes.............. 14,598 11,680 11,831 10,476 8,856
Income taxes..................... 5,680 4,590 4,486 3,967 3,269
---------- ---------- -------- -------- --------
Net income....................... $ 8,918 $ 7,090 $ 7,345 $ 6,509 $ 5,587
========== ========== ======== ======== ========
SELECTED BALANCE SHEET DATA AT
END OF PERIOD:
Total assets................... $1,648,294 $1,167,559 $789,560 $607,992 $539,233
Loans.......................... 1,514,957 1,067,980 720,493 514,950 410,272
Allowance for loan and lease
losses...................... 14,643 9,228 7,375 6,680 5,525
Deposits....................... 1,456,376 998,892 710,899 567,526 486,481
Shareholders' equity........... 129,179 68,539 63,678 46,990 38,390
42
YEAR ENDED DECEMBER 31,
------------------------------------------------------------
2001 2000 1999 1998 1997
---------- ---------- -------- -------- --------
(DOLLARS IN THOUSANDS)
DAILY AVERAGES:
Assets......................... $1,402,589 $ 956,744 $682,632 $567,116 $515,666
Loans.......................... 1,276,003 879,875 600,877 462,319 370,313
Allowance for loan and lease
losses...................... 11,038 8,133 7,317 6,308 5,332
Deposits....................... 1,253,725 851,386 619,308 514,694 463,851
Shareholders' equity........... 85,312 57,214 52,867 42,026 36,232
Shareholders' equity to
assets...................... 6.08% 5.98% 7.74% 7.41% 7.03%
OVERVIEW
Our commercial banking line of business focuses on providing credit, cash
management and personal banking products to small businesses and business
owners. We offer commercial banking services through our banking subsidiaries,
Irwin Union Bank and Trust, an Indiana state-chartered commercial bank, and
Irwin Union Bank, F.S.B., a federal savings bank. We formed the federal savings
bank to allow us the flexibility to expand our banking business into markets
where state-chartered banks like Irwin Union Bank and Trust are not permitted to
branch under current law. We sell a majority of the commercial loans we
originate at Irwin Union Bank, F.S.B. to Irwin Union Bank and Trust.
STRATEGY
Our strategy is to expand our commercial banking line of business into
selected new markets. We target metropolitan markets with strong economies where
we believe recent bank consolidation has negatively impacted customers. We
believe that this consolidation has led to disenchantment with the delivery of
financial services to the small business community among both the owners of
those small businesses and the senior banking officers who had been providing
services to them. In markets that management identifies as attractive
opportunities, the bank seeks to hire senior commercial loan officers and cash
management personnel who have strong local ties and who can focus on providing
personalized services to small businesses in that market. Our strategy is to
expand only in markets that satisfy the following criteria:
- the market is a metropolitan area with attractive business demographics
displaying evidence of sustainable growth;
- recent banking merger and acquisition activity has occurred in the market
where management believes that the acquiror is viewed by customers as an
outsider and/or not responsive to local small business needs; and
- we are able to attract experienced, senior banking staff to manage the
new market.
We expect consolidation to continue in the banking and financial services
industry and plan to capitalize on the opportunities brought about in this
environment by continuing the bank's growth strategy for small business banking
in new markets throughout the United States. Our focus will be to provide
personalized banking services to small businesses, using experienced staff with
a strong presence in cities affected by the industry-wide consolidations. In
addition to its market expansion, our commercial bank continues to develop
further its banking, insurance, and investment products to provide a full range
of financial services to its small business customers.
On average, we anticipate our new banking offices will break even
approximately 18 months after they are opened, and we estimate that a banking
office will achieve targeted levels of profitability in approximately five
years, in an average market. Some markets will experience growth and
profitability at greater or lesser rates than we currently expect because of
many factors, including execution of our strategy, accuracy in assessing market
potential, and success in recruiting senior lenders and other staff. Over time,
we may choose to leave certain markets if these factors limit profitability.
43
The following tables show the geographic composition of our commercial
banking loans and our deposits:
DECEMBER 31,
---------------------------------------------------------------------
2001 2000 1999
--------------------- --------------------- ---------------------
PERCENT PERCENT PERCENT
LOANS OF LOANS OF LOANS OF
OUTSTANDING TOTAL OUTSTANDING TOTAL OUTSTANDING TOTAL
----------- ------- ----------- ------- ----------- -------
(DOLLARS IN THOUSANDS)
Southern Indiana................. $ 566,601 37.4% $ 519,863 48.7% $469,991 65.3%
Indianapolis MSA................. 232,576 15.4 263,047 24.6 195,399 27.1
Markets entered since 1999(1).... 715,780 47.2 285,070 26.7 55,103 7.6
Total.................. $1,514,957 100.0% $1,067,980 100.0% $720,493 100.0%
PERCENT PERCENT PERCENT
OF OF OF
DEPOSITS TOTAL DEPOSITS TOTAL DEPOSITS TOTAL
----------- ------- ----------- ------- ----------- -------
Southern Indiana................. $ 796,019 70.0% $ 886,099 88.8% $659,803 92.8%
Indianapolis MSA................. 67,003 5.9 61,401 6.1 43,731 6.2
Markets entered since 1999(1).... 273,750 24.1 51,392 5.1 7,364 1.0
Total.................. $1,136,772 100.0% $ 998,892 100.0% $710,898 100.0%
---------------
(1) Includes offices in Kalamazoo, Grandville, Traverse City and Lansing,
Michigan; Brentwood, Missouri; Louisville, Kentucky; Salt Lake City, Utah;
Las Vegas, Nevada; and Phoenix, Arizona.
Net Income
Commercial banking net income increased to $8.9 million during 2001,
compared to $7.1 million in 2000, and 1999 net income of $7.3 million. Results
in 2001 and 2000 reflect the continued growth and expansion efforts of our
commercial banking business into new markets.
Net Interest Income
The following table shows information about net interest income for our
commercial banking line of business:
YEAR ENDED DECEMBER 31,
--------------------------------
2001 2000 1999
---------- -------- --------
Net interest income on a taxable equivalent basis(1)........ $ 51,224 $ 38,620 $ 31,151
Average interest earning assets............................. 1,347,327 908,739 645,809
Net interest margin......................................... 3.80% 4.25% 4.82%
---------------
(1) Reflects what net interest income would be if all interest income were
subject to federal and state income taxes.
Net interest income on a taxable equivalent basis was $51.2 million, an
increase of 32.6% over 2000 net interest income on a tax equivalent basis of
$38.6 million, and an increase of 64.4% from 1999. The 2001 and 2000 improvement
in net interest income resulted from an increase in our commercial banking loan
portfolio as a result of growth and expansion efforts.
Net interest margin is computed by dividing net interest income by average
interest earning assets. Net interest margin during 2001 was 3.80%, compared to
4.25% in 2000, and 4.82% in 1999. The reduction in 2001 is due primarily to the
fact that the commercial bank has been negatively impacted by repricing a
significant portion of its commercial loan portfolio, which is tied to the prime
rate, in advance of corresponding declines in its funding base, which is more
closely tied to London InterBank Offering Rate, or LIBOR, and similar market
driven rate indices. Also, since 1999, the expansion activities at the
commercial bank have resulted in an increased use of higher cost wholesale
deposit sources required to fund the growth in the loan
44
portfolio. In addition, during 2000 the parent company began allocating the cost
of interest-bearing capital to the commercial banking line of business.
Noninterest Income
The following table shows the components of noninterest income for our
commercial banking line of business:
YEAR ENDED DECEMBER 31,
---------------------------
2001 2000 1999
------- ------- -------
(DOLLARS IN THOUSANDS)
Trust fees.................................................. $ 2,212 $ 2,285 $ 2,257
Service charges on deposit accounts......................... 3,565 2,156 2,021
Insurance commissions, fees and premiums.................... 1,776 1,877 1,635
Gain from sales of loans.................................... 2,746 259 901
Loan servicing fees......................................... 708 1,006 1,458
Brokerage fees.............................................. 1,554 1,991 1,546
Other....................................................... 2,438 2,400 1,979
------- ------- -------
Total noninterest income.................................... $14,999 $11,974 $11,797
======= ======= =======
Total noninterest income to total net revenues.............. 25.8% 25.2% 28.8%
Due to our growth and expansion into new markets, increased mortgage
production and increased fee income on deposit accounts related to new fee
structures put into place mid-2001, noninterest income during 2001 increased
25.3% over 2000, and 27.1% from 1999.
Operating Expenses
The following table shows the components of operating expenses for our
commercial banking line of business:
YEAR ENDED DECEMBER 31,
---------------------------
2001 2000 1999
------- ------- -------
(DOLLARS IN THOUSANDS)
Salaries and employee benefits.............................. $25,411 $21,507 $16,881
Other expenses.............................................. 18,089 14,266 12,199
------- ------- -------
Total operating expenses.................................... $43,500 $35,773 $29,080
======= ======= =======
Number of employees at period end(1)........................ 470 432 395
---------------
(1) On a full time equivalent basis.
Operating expenses during 2001 were $43.5 million, an increase of 21.6%
over 2000, and an increase of 49.6% from 1999. Costs associated with growth and
expanding into new markets contributed to the increase.
Balance Sheet
Total assets for the year ended December 31, 2001 averaged $1.4 billion
compared to $1.0 billion in 2000, and $0.7 billion in 1999. Average earning
assets for the year ended December 31, 2001 were $1.3 billion compared to $0.9
billion in 2000, and $0.6 billion in 1999. The most significant component of the
increase in 2001 and 2000 was an increase in commercial loans as a result of the
commercial bank's growth and expansion efforts into new markets. Average
deposits for the year totaled $1.3 billion, an increase of 47.3% over average
deposits in 2000 of $0.9 billion, and an increase of 102.4% from 1999.
Credit Quality
Nonperforming loans, the allowance for loan losses and provision for loan
losses have increased in 2001 over 2000 reflecting general economic conditions,
portfolio growth and increased charge-offs. The recessionary
45
economic conditions were exacerbated by the events of September 11th, which
negatively impacted consumer confidence and deferred recovery from weakened
business conditions. Nonperforming loans are not significantly concentrated in
any industry category. The following table shows information about our
nonperforming assets in this line of business and our allowance for loan losses:
DECEMBER 31,
-------------------------
2001 2000 1999
------- ------ ------
(DOLLARS IN THOUSANDS)
Nonperforming loans......................................... $ 7,077 $2,469 $1,168
Other real estate owned..................................... 100 230 --
------- ------ ------
Total nonperforming assets.................................. $ 7,177 $2,699 $1,168
======= ====== ======
Nonperforming assets to total assets........................ 0.44% 0.23% 0.15%
Allowance for loan losses................................... $14,643 $9,228 $7,375
Allowance for loan losses to total loans.................... 0.97% 0.86% 1.02%
FOR THE PERIOD ENDED:
Provision for loan losses................................... $ 7,900 $2,933 $1,813
Net charge-offs............................................. $ 2,484 $1,080 $ 963
Net charge-offs to average loans............................ 0.19% 0.12% 0.16%
EQUIPMENT LEASING
The following table shows selected financial information for our equipment
leasing line of business for the periods indicated:
YEAR ENDED DECEMBER 31,
---------------------------
2001 2000 1999
-------- -------- -----
(DOLLARS IN THOUSANDS)
SELECTED INCOME STATEMENT DATA:
Net interest income......................................... $ 9,481 $ 3,196 $ (18)
Provision for loan and lease losses......................... (6,939) (1,513) --
Noninterest income.......................................... 1,695 799 --
-------- -------- -----
Total net revenues........................................ 4,237 2,482 (18)
Salaries, pension, and other employee expense............... 6,471 3,298 478
Other expense............................................... 2,467 1,747 347
-------- -------- -----
Income before taxes and minority interest................... (4,701) (2,563) (843)
Minority interest........................................... (307) -- --
-------- -------- -----
Loss before taxes........................................... $ (4,394) $ (2,563) $(843)
======== ======== =====
SELECTED BALANCE SHEET DATA AT END OF PERIOD:
Total assets................................................ $266,670 $159,773 $ 543
Leases...................................................... 264,827 154,934 --
Allowance for lease losses.................................. (4,587) (2,441) --
Shareholders' equity........................................ 17,819 20,291 386
Net charge-offs............................................. 4,653 961 n/a
Net interest margin......................................... 4.64% 4.50% n/a
Total fundings of loans and leases.......................... $190,716 $113,323 n/a
Overview
In our equipment leasing line of business, we originate transactions from
an established North American network of brokers and vendors and through direct
sales to franchisees. The majority of our leases are full payout (i.e., no
residual), small-ticket assets secured by commercial equipment. We finance a
variety of
46
commercial and office equipment types and try to limit the industry and
geographic concentrations in our lease portfolio.
We established this line of business in 1999 when we formed Irwin Business
Finance, our United States equipment leasing company, headquartered in Bellevue,
Washington. On July 14, 2000, the equipment leasing line of business completed
an acquisition of an ownership position of approximately 78% in Onset Capital
Corporation, a Canadian small-ticket equipment leasing company headquartered in
Vancouver, British Columbia. Principals of Onset own the remaining approximately
22%. The Onset acquisition added approximately $60 million in leases to our
equipment leasing portfolio. In December 2001, Onset Capital established Onset
Alberta Ltd. as a subsidiary to facilitate its leasing business. To begin our
franchise finance operations, we acquired a portfolio of approximately $22
million in leases and loans in August 2001, and in October 2001 we established
Irwin Franchise Capital Corporation. We established Irwin Capital Holdings in
April 2001 as a subsidiary of Irwin Union Bank and Trust to serve as the parent
company for both our United States and Canadian equipment leasing companies.
The leasing industry experienced strong growth in new business volume in
1999 and through the first three quarters of 2000, with an overall softening in
the fourth quarter and in 2001 reflecting the general decline in the U.S.
economy during that period. Margins increased in the latter half of 2000 and
continuing into 2001 as lessors in the small-ticket market were able to hold
rates despite a general decline in cost of funds. Because it is in a development
stage, management anticipates that our equipment leasing line of business will
not break even until at least mid-2002.
During the year ended December 31, 2001, the equipment leasing line of
business incurred a pre-tax loss of $4.3 million, compared to a pre-tax loss of
$2.6 for the year 2000 and a pre-tax loss of $0.8 million in 1999. The increased
loss in 2001 relates primarily to higher loss provisions taken during the year.
These losses also reflect expenses related to staffing, systems development and
portfolio growth initiatives in excess of portfolio revenues. This line of
business originated $190.7 million in leases during 2001, compared to $113.3
million in 2000. The 2001 periods include an acquisition of leases of
approximately $22.0 million related to the formation of Irwin Franchise Capital
Corporation in October 2001. The line of business portfolio at year end was
$264.8 million compared to its portfolio at December 31, 2000 which totaled
$154.9 million.
We had nonperforming leases at December 31, 2001 totaling $3.9 million,
compared to non-performing leases at December 31, 2000 totaling $2.7 million.
Allowance for lease losses at December 31, 2001 was $4.6 million, representing
1.73% of total leases, compared to a balance at December 31, 2000 of $2.4
million, representing 1.58% of total leases. The increased nonperformings and
allowance was principally the result of difficult economic conditions that led
to higher levels of net charge-offs and delinquencies, primarily on the domestic
leases originated in 2000. Net charge-offs recorded by the leasing line of
business during 2001 were $4.7 million. Net charge-offs for the year ended
December 31, 2000 were $0.9 million.
The following table provides certain information about our lease portfolio
since the creation of our leasing line of business at the dates shown:
DECEMBER 31,
----------------------
2001 2000
---------- ---------
(DOLLARS IN THOUSANDS)
Domestic leases............................................. $186,560 $91,946
Weighted average yield.................................... 10.60% 10.84%
Delinquency ratio......................................... 2.16 0.66
Canadian leases(1).......................................... $ 78,267 $62,988
Weighted average yield.................................... 11.17% 12.52%
Delinquency ratio......................................... 1.69 1.61
---------------
(1) In U.S. dollars.
47
VENTURE CAPITAL
The following table shows selected financial information for our venture
capital line of business for the periods indicated:
YEAR ENDED DECEMBER 31,
---------------------------
2001 2000 1999
-------- ------- ------
(IN THOUSANDS)
SELECTED INCOME STATEMENT DATA:
Net interest expense........................................ $ (404) $ (598) $ (109)
Mark-to-market adjustment on investments.................... (10,444) 5,202 1,306
Noninterest income.......................................... 592 364 --
-------- ------- ------
Total net revenues........................................ (10,256) 4,968 1,197
Operating expense........................................... 661 431 78
-------- ------- ------
Income (loss) before taxes.................................. (10,917) 4,537 1,119
Income taxes (benefit)...................................... (4,368) 1,814 463
-------- ------- ------
Net income (loss)........................................... $ (6,549) $ 2,723 $ 656
======== ======= ======
SELECTED BALANCE SHEET DATA AT END OF PERIOD:
Investment in portfolio companies (cost).................... $ 10,696 $ 5,206 $1,759
Mark-to-market adjustment................................... (3,936) 6,508 1,306
-------- ------- ------
Carrying value of portfolio companies....................... $ 6,760 $11,714 $3,065
======== ======= ======
OVERVIEW
In our venture capital line of business, we make minority investments in
early stage companies in the financial services industry and related fields that
intend to use technology as a key component of their competitive strategy. We
provide Irwin Ventures' portfolio companies the benefit of our management
experience in the financial services industry. In addition, we expect that
contacts made through venture activities may benefit management of our other
lines of business through the sharing of technologies and market opportunities.
Our venture capital line of business had investments in six private companies as
of December 31, 2001, with an aggregate investment cost of $10.7 million and a
carrying value of $6.8 million.
In August 1999, Irwin Ventures established a subsidiary, Irwin Ventures
Incorporated-SBIC, which received a small business investment company license
from the Small Business Administration. In December 2000, Irwin Ventures and
Irwin Ventures-SBIC became Delaware limited liability companies. To date, the
primary geographic focus of this line of business and each of our investments
has been on the corridors of the east and west coasts between Washington, D.C.
and Boston, and Los Angeles and Seattle.
In 1999, our Board of Directors approved an allocation of up to $20 million
to support this subsidiary. We carry venture capital investments held by Irwin
Ventures at fair value, with changes in market value recognized in other income.
The investment committee of Irwin Ventures determines the value of the
investments at the end of each reporting period. We adjust the values based upon
review of the investee's financial results, condition, and prospects. Changes in
estimated market values can also be made when an event such as a new funding
round from other private equity investors would cause a change in estimated
market value. In the future, should Irwin Ventures have investments in
publicly-traded securities, it would look to the traded market value of the
investments as the basis of its mark-to-market.
Despite the recent sharp reduction in values of technology companies, Irwin
Ventures continues to see opportunities in emerging technologies applied to the
financial services industry. Irwin Ventures believes this will continue as
improvements in technology and entrepreneurial innovation continue to change the
manner in which financial services are delivered to businesses and consumers.
During the year ended December 31, 2001, the venture capital line of
business recorded a net loss of $6.5 million, compared to net income of $2.7
million in 2000, and $0.7 million in 1999. The fluctuation in
48
results in the venture capital line of business is primarily due to valuation
adjustments to reflect the company's portfolio investments at market value.
OTHER
Results at our other businesses totaled a net loss of $6.8 million for the
year ended December 31, 2001, compared to a loss of $3.1 million during the same
period in 2000 and $9.7 million in 1999. The components of these other results
are as follows:
YEAR ENDED DECEMBER 31,
---------------------------
2001 2000 1999
------- ------- -------
(IN THOUSANDS)
Parent company operating results............................ $(9,073) $(4,375) $(6,269)
Income tax expense generated at home equity line of
business.................................................. -- -- (3,601)
Income tax benefit generated at equipment leasing line of
business.................................................. 1,758 1,025 335
------- ------- -------
Total parent company...................................... (7,315) (3,350) (9,535)
Other, net.................................................. 508 266 (136)
------- ------- -------
$(6,807) $(3,084) $(9,671)
======= ======= =======
Our operating losses increased in 2001 compared to 2000 primarily because
of increased operating expenses at the parent. These expenses include interest
expense associated with a portion of the trust preferred securities issued
during 2001 relating to capital not yet allocated to our lines of business. Also
included in the increased operating expenses at the parent is a one-time
compensation charge of $3.2 million related to the estimated future cost of key
employee retention initiatives at our home equity lending line of business. A
portion of the parent company operating results variance relates to allocations
to our subsidiaries of interest expense related to our interest-bearing capital
obligations. During the year ended December 31, 2001, we allocated $9.2 million
of these expenses to our subsidiaries, compared to $5.4 million during the same
period in 2000. Before 2000, we did not allocate these expenses to our
subsidiaries. Included in 2000 was a $2.7 million compensation expense recorded
during the fourth quarter of 2000 to reflect the increase in minority ownership
interests at the home equity lending line of business. There are currently
minority interests in our home equity lending, venture capital, and equipment
leasing lines of business and similar long-term incentive plans are contemplated
for other lines of business as necessary to attract and retain key executives.
Each subsidiary pays taxes to us at the statutory rate. Subsidiaries also
pay fees to us to cover direct and indirect services. In addition, services are
provided from one subsidiary to another. Intercompany income and expenses are
calculated on an arm's-length, external market basis and are eliminated in
consolidation.
CONSOLIDATED INCOME STATEMENT ANALYSIS
Net Income
We recorded net income of $45.5 million for the year ended December 31,
2001, up 27.6% from net income of $35.7 million for the year ended December 31,
2000, and compared to $33.2 million in 1999. Net income per share (diluted) was
$2.00 for the year ended December 31, 2001, up from $1.67 per share in 2000 and
$1.51 per share in 1999. Return on equity was 21.82% for the year ended December
31, 2001, 20.83% in 2000 and 21.51% in 1999. The effective income tax rate for
2001 was 39%, compared to 40% and 37% in 2000 and 1999, respectively. The lower
rate in 1999 was the result of a change in the Indiana Financial Institutions
Tax which took effect in 1999. The change in tax law resulted in a reduction in
our deferred Indiana income tax liability.
Net Interest Income
Net interest income for the year ended December 31, 2001 totaled $147.1
million, up 61.7% from 2000 net interest income of $91.0 million and up 119.2%
from 1999. Net interest margin for the year ended December 31, 2001 was 5.35%
compared to 5.36% in 2000 and 5.03% in 1999. The improvement in margin
49
from 1999 to 2000 was primarily due to a shift in composition of mortgage loans
held for sale from a concentration in first mortgage loans to a greater share of
higher-yielding second mortgage loans.
The following tables show our daily average consolidated balance sheet,
interest rates and interest differential at the dates indicated:
DECEMBER 31,
------------------------------------------------------------------------------------------------
2001 2000 1999
------------------------------ ------------------------------ ------------------------------
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
---------- -------- ------ ---------- -------- ------ ---------- -------- ------
(DOLLARS IN THOUSANDS)
ASSETS
Interest-earning assets:
Interest-bearing deposits
with banks................. $ 64,290 $ 2,235 3.48% $ 31,654 $ 1,567 4.95% $ 22,343 $ 771 3.45%
Federal funds sold........... 17,973 258 1.44 2,265 143 6.31 12,293 652 5.30
Trading assets............... 188,166 31,979 17.00 91,334 15,584 17.06 45,957 6,275 13.65
Taxable investment
securities................. 30,523 2,678 8.77 32,068 2,594 8.09 39,210 2,984 7.61
Tax-exempt investment
securities(1).............. 4,794 374 7.80 4,974 378 7.60 4,916 410 8.34
Loans held for sale.......... 911,949 104,662 11.48 578,758 71,141 12.29 587,411 66,682 11.35
Loans and leases, net of
unearned income(1)(2)...... 1,534,502 126,274 8.23 960,848 93,342 9.71 628,018 49,063 7.81
---------- -------- ----- ---------- -------- ------ ---------- -------- -----
Total interest-earning
assets............... $2,752,197 $268,460 9.75% $1,701,901 $184,749 10.86% $1,340,148 $126,837 9.46%
---------- -------- ----- ---------- -------- ------ ---------- -------- -----
Noninterest-earning assets:
Cash and due from banks...... $ 85,242 $ 47,752 $ 44,803
Premises and equipment,
net........................ 32,727 27,412 22,070
Other assets................. 282,954 256,807 250,623
Less allowance for loan and
lease losses............... (15,601) (10,892) (9,643)
---------- ---------- ----------
Total assets........... $3,137,519 $2,022,980 $1,648,001
========== ========== ==========
LIABILITIES AND SHAREHOLDERS'
EQUITY
Interest-bearing liabilities:
Money market checking........ $ 105,564 $ 1,283 1.22% $ 96,028 $ 1,334 1.39% $ 104,641 $ 1,430 1.37%
Money market savings......... 388,432 13,209 3.40 6,428 201 3.13 6,801 165 2.43
Regular savings.............. 52,650 1,996 3.79 207,823 10,665 5.13 135,438 5,183 3.83
Time deposits................ 1,015,105 56,852 5.60 629,179 40,616 6.46 339,934 18,442 5.43
Short-term borrowings........ 596,071 29,657 4.98 465,353 32,608 7.01 403,770 28,425 7.04
Long-term debt............... 25,517 2,320 9.09 29,629 2,433 8.21 13,654 1,149 8.42
Trust preferred securities
distribution............... 165,500 15,767 9.53 64,885 5,677 8.75 48,044 4,697 9.78
Total interest-bearing
liabilities.......... $2,348,839 $121,084 5.16% $1,499,325 $ 93,534 6.24% $1,052,282 $ 59,491 5.65%
---------- -------- ----- ---------- -------- ------ ---------- -------- -----
Noninterest-bearing
liabilities:
Demand deposits.............. $ 419,512 $ 260,348 $ 357,771
Other liabilities............ 160,590 92,111 83,805
Shareholders' equity........... 208,578 171,196 154,143
---------- ---------- ----------
Total liabilities and
shareholders'
equity............... $3,137,519 $2,022,980 $1,648,001
========== ========== ==========
Net interest income.......... $147,376 $ 91,215 $ 67,346
======== ======== ========
Net interest income to
average interest-earning
assets..................... 5.35% 5.36% 5.03%
===== ====== =====
---------------
(1) Interest is reported on a fully taxable equivalent basis using a federal
income tax rate of 35%.
(2) For purposes of these computations, nonaccrual loans are included in daily
average loan amounts outstanding.
50
The following table sets forth, for the periods indicated, a summary of the
changes in interest earned and interest paid resulting from changes in volume
and rates for the major components of interest-earning assets and
interest-bearing liabilities on a fully taxable equivalent basis:
FOR THE YEAR ENDED DECEMBER 31,
-----------------------------------------------------------
2001 OVER 2000 2000 OVER 1999
----------------------------- ---------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
-------- -------- ------- ------- ------- -------
(IN THOUSANDS)
INTEREST INCOME
Loans and leases.................. $ 55,728 $(22,796) $32,932 $25,994 $18,285 $44,279
Mortgage loans held for sale...... 40,956 (7,435) 33,521 (982) 5,441 4,459
Taxable investment securities..... (125) 1,058 933 (544) 154 (390)
Tax-exempt securities............. (14) 10 (4) 5 (37) (32)
Trading assets.................... 16,522 (127) 16,395 6,194 3,115 9,309
Interest-bearing deposits with
financial institutions.......... 1,616 (1,797) (181) 321 475 796
Federal funds sold................ 992 (877) 115 (531) 22 (509)
-------- -------- ------- ------- ------- -------
Total................... 115,675 (31,964) 83,711 30,457 27,455 57,912
-------- -------- ------- ------- ------- -------
INTEREST EXPENSE
Money market checking............. 132 (183) (51) (118) 22 (96)
Money market savings.............. 11,945 1,063 13,008 (9) 45 36
Regular savings................... (7,963) (706) (8,670) 2,772 2,710 5,482
Time deposits..................... 24,913 (8,677) 16,236 15,706 6,468 22,174
Short-term borrowings............. 9,160 (12,111) (2,951) 4,335 (152) 4,183
Long-term debt.................... (338) 225 (113) 1,345 (61) 1,284
Trust preferred securities
distribution.................... 8,803 1,287 10,090 1,647 (667) 980
-------- -------- ------- ------- ------- -------
Total................... 46,652 (19,102) 27,550 25,678 8,365 34,043
-------- -------- ------- ------- ------- -------
Net interest income............. $ 69,023 $(12,862) $56,161 $ 4,779 $19,090 $23,869
======== ======== ======= ======= ======= =======
The variance not due solely to rate or volume has been allocated on the
basis of the absolute relationship between volume and rate variances.
Provision for Loan and Lease Losses
The consolidated provision for loan and lease losses for the year 2001 was
$17.5 million, compared to $5.4 million and $4.4 million in 2000 and 1999,
respectively. More information on this subject is contained in the section on
credit risk.
Noninterest Income
Noninterest income during the year of 2001 totaled $271.4 million, compared
to $211.7 million for 2000 and $204.1 million in 1999. The increase in 2001
versus 2000 was primarily a result of higher revenues at the mortgage banking
line of business due to the lower interest rate environment, which increased
loan production activity.
Noninterest Expense
Noninterest expenses for the year ended December 31, 2001 totaled $327.4
million, compared to $238.0 million and $214.1 million in 2000 and 1999,
respectively. The increase in consolidated other expense is a result of the
growth at each of our asset generating lines of business.
51
CONSOLIDATED BALANCE SHEET ANALYSIS
Total assets at December 31, 2001 were $3.4 billion, up 42.0% from December
31, 2000. However, we believe that 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 for 2001 were $3.1 billion up 55.1% from December
31, 2000, and up 90.4% from December 31, 1999. The growth in the consolidated
balance sheet reflects increases in portfolio loans and leases at the commercial
banking and equipment leasing lines of business. Also, there was significant
growth in loans held for sale at the mortgage banking line of business.
Loans
Our commercial loans are extended primarily to Midwest regional businesses
and our leases are originated throughout the United States and Canada. We also
extend credit to consumers nationally through mortgages, 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. As of December 31, 2001, $342.6 million of loans held for
sale at the home equity lending line of business were reclassified to loans held
for investment. These loans are included in the real estate mortgage category in
the tables below. This reclassification was the result of a management decision
during the quarter to eliminate securitization structures that require gain on
sale accounting treatment under SFAS No. 140. Loans by major category for the
periods presented were as follows:
YEAR ENDED DECEMBER 31,
--------------------------------------------------------
2001 2000 1999 1998 1997
---------- ---------- -------- -------- --------
(IN THOUSANDS)
Commercial, financial and
agricultural........................ $1,055,307 $ 677,066 $443,985 $278,834 $212,095
Real estate construction.............. 287,228 220,485 121,803 97,253 73,279
Real estate mortgage.................. 490,111 122,301 115,265 123,980 222,818
Consumer.............................. 38,489 56,785 48,936 51,730 39,985
Direct lease financing:
Domestic............................ 232,527 116,867 3,890 6,375 78,079
Canadian............................ 91,816 72,864 -- -- --
Unearned income:
Domestic............................ (44,183) (21,570) (455) (1,181) (15,163)
Canadian............................ (13,548) (9,876) -- -- --
---------- ---------- -------- -------- --------
Total....................... $2,137,747 $1,234,922 $733,424 $556,991 $611,093
========== ========== ======== ======== ========
52
The following table shows our maturity distribution of loans at December
31, 2001:
AFTER ONE
WITHIN BUT WITHIN AFTER FIVE
ONE YEAR FIVE YEARS YEARS TOTAL
-------- ---------- ---------- ----------
(IN THOUSANDS)
Commercial, financial and agricultural........ $322,188 $415,154 $317,965 $1,055,307
Real estate construction...................... 161,733 82,755 42,740 287,228
Real estate mortgage.......................... 360,234 22,575 107,302 490,111
Consumer loans................................ 5,492 21,206 11,791 38,489
Direct lease financing:
Domestic.................................... 2,873 144,743 40,728 188,344
Canadian.................................... 7,115 65,767 5,386 78,268
-------- -------- -------- ----------
Total............................... $859,635 $752,200 $525,912 $2,137,747
======== ======== ======== ==========
Loans due after one year with:
Fixed interest rates........................ $ 607,856
Variable interest rates..................... 670,256
----------
Total............................... $1,278,112
==========
Investment Securities
The following table shows the composition of our investment securities at
the dates indicated:
DECEMBER 31,
-----------------------------
2001 2000 1999
------- ------- -------
(IN THOUSANDS)
U.S. Treasury and government obligations.................... $29,329 $25,999 $26,172
Obligations of states and political subdivisions............ 4,425 4,586 4,706
Mortgage-backed securities.................................. 4,224 5,152 6,051
Other....................................................... 818 1,358 579
------- ------- -------
Total............................................. $38,796 $37,095 $37,508
======= ======= =======
The following table shows maturity distribution of our investment
securities at December 31, 2001:
AFTER ONE
WITHIN ONE BUT WITHIN FIVE TO AFTER
YEAR FIVE YEARS TEN YEARS TEN YEARS TOTAL
---------- ---------- --------- --------- -------
(DOLLARS IN THOUSANDS)
U.S. Treasury and government
obligations............................ $3,075 $ -- $ -- $26,254 $29,329
Obligations of states and political
subdivisions........................... 135 1,095 1,215 1,980 4,425
Mortgage-backed securities............... 344 133 2,803 944 4,224
Other.................................... 818 -- -- -- 818
------ ------ ------ ------- -------
Total.......................... $4,372 $1,228 $4,018 $29,178 $38,796
====== ====== ====== ======= =======
Weighted average yield:
Held-to-maturity....................... 6.57 8.44 8.44 7.50 8.22
Available-for-sale..................... 6.15 5.87 5.95 5.78 6.03
Average yield represents the weighted average yield to maturity computed
based on average historical cost balances. The yield information on
available-for-sale securities does not give effect to changes in fair value that
are reflected as a component of shareholders' equity. The yield on state and
municipal obligations has been calculated on a fully taxable equivalent basis,
assuming a 35% tax rate. Expected maturities will
53
differ from contractual maturities because borrowers may have the right to call
or prepay obligations with or without call or prepayment penalties.
Deposits
Total deposits as of December 31, 2001 averaged $2.0 billion compared to
average deposits in 2000 of $1.2 billion, and average deposits in 1999 of $0.9
billion. Demand deposits at December 31, 2001 averaged $419.5 million, a 61.1%
increase over the December 31, 2000 balance. Demand deposits in 2001 were up
17.3% on average, or $61.7 million, from 1999. A significant portion of demand
deposits is related to deposits at Irwin Union Bank and Trust, which are
associated with escrow accounts held on loans in the servicing portfolio at the
mortgage banking line of business. During 2001, these escrow accounts averaged
$294.8 million compared to a 2000 average of $175.8 million, and a 1999 average
of $283.9 million. Irwin Union Bank and Trust utilizes institutional
broker-sourced deposits as funding from time to time to supplement deposits
solicited through branches and other wholesale funding sources. At December 31,
2001, institutional broker-sourced deposits totaled $577.3 million compared to a
balance of $494.3 million at December 31, 2000.
The following table shows maturities of certificates of deposit of $100,000
or more and brokered deposits at the dates indicated:
DECEMBER 31,
--------------------------------
2001 2000 1999
-------- -------- --------
(IN THOUSANDS)
under 3 months............................................. $335,420 $133,804 $ 92,965
3 to 6 months.............................................. 151,924 164,904 28,387
6 to 12 months............................................. 260,184 120,476 40,292
after 12 months............................................ 138,059 243,860 78,872
-------- -------- --------
Total CDs........................................ $885,587 $663,044 $240,516
======== ======== ========
Brokered deposits.......................................... $577,297 $494,316 $ 89,236
======== ======== ========
SHORT-TERM BORROWINGS
Short-term borrowings during 2001 averaged $596.1 million compared to an
average of $465.4 million in 2000, and $403.8 million in 1999. The increase in
2001 and 2000 relates to the growth at the home equity lending line of business
and the increased production at the mortgage banking line of business.
The following table shows the distribution of our short-term borrowings and
the weighted average rates at the dates shown. Also provided are the maximum
amount of borrowings and the average amounts of borrowings as well as weighted
average interest rates.
2001 2000 1999
--------------- --------------- ---------------
AMOUNT RATE AMOUNT RATE AMOUNT RATE
-------- ---- -------- ---- -------- ----
(DOLLARS IN THOUSANDS)
Lines of Credit and other Borrowings:
At December 31.......................... $ 75,483 2.95% $226,599 7.19% $231,413 6.02%
Weighted average during the year........ 130,901 5.30 227,564 6.95 167,665 5.45
Maximum month-end balance during the
year................................. 335,223 293,100 308,422
Federal Home Loan Bank Borrowings and
Federal Funds:
At December 31.......................... $247,200 2.64% $173,000 6.32% $173,000 5.46%
Weighted average during the year........ 231,119 3.98 148,975 6.54 108,422 5.40
Maximum month-end balance during the
year................................. 455,400 250,000 249,500
54
2001 2000 1999
--------------- --------------- ---------------
AMOUNT RATE AMOUNT RATE AMOUNT RATE
-------- ---- -------- ---- -------- ----
(DOLLARS IN THOUSANDS)
Repurchase Agreements & Drafts Payable
Related to Mortgage Loan Closings:
At December 31....................... $154,157 2.48% $ 64,557 7.35% $ 46,796 5.35%
Weighted average during the year..... 216,442 4.96 68,028 6.86 105,591 5.40
Maximum month-end balance during the
year............................... 497,655 95,094 162,251
Commercial Paper:
At December 31....................... $ 11,123 2.59% $ 11,346 6.85% $ 21,894 6.00%
Weighted average during the year..... 17,609 4.65 20,786 6.60 24,810 5.82
Maximum month-end balance during the
year............................... 27,965 31,774 28,309
CAPITAL
Shareholders' equity averaged $208.6 million during 2001, up 21.8% compared
to 2000, and up 35.3% from 1999. Shareholders' equity balance of $232.3 million
at December 31, 2001 represented $10.84 per common share, compared to $8.97 per
common share at December 31, 2000, and compared to $7.55 per common share at
year end 1999. We paid an aggregate of $5.5 million in dividends during 2001,
compared to $5.0 million during 2000 and $4.3 million during 1999.
Before 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 our mortgage servicing portfolio was generated before the adoption of
the new accounting standard, it represents economic value that is not recorded
on the balance sheet. We estimated this value to be approximately $6.9 million
after-tax or $0.28 per common share at December 31, 2001, compared to $15.4
million after-tax or $0.73 per common share at December 31, 2000. This estimate
was based on the market value of servicing assets related to loans with similar
interest rates and servicing fees. With the implementation of the new accounting
standard in 1995, this off-balance sheet value will decline over future periods
and eventually be reduced to zero as the servicing rights are sold, the
underlying loans pay off, servicing fees are collected, and the income from
servicing the loans is fully accreted into earnings.
The following table sets forth our capital and capital ratios at the dates
indicated:
DECEMBER 31,
------------------------------------
2001 2000 1999
---------- ---------- ----------
(IN THOUSANDS)
Tier 1 capital........................................... $ 295,021 $ 250,825 $ 207,627
Tier 2 capital........................................... 173,316 133,319 38,556
---------- ---------- ----------
Total risk-based capital....................... $ 468,337 $ 384,144 $ 246,183
========== ========== ==========
Risk-weighted assets..................................... $4,329,973 $2,979,376 $1,819,045
Risk-based ratios:
Tier 1 capital......................................... 6.81% 8.42% 11.41%
Total capital.................................. 10.82 12.89 13.53
Tier 1 leverage ratio.................................... 9.36 12.41 12.77
Ending shareholders' equity to assets.................... 6.75 7.84 9.48
Average shareholders' equity to assets................... 6.65 8.46 9.33
At December 31, 2001, our total risk-adjusted capital ratio was 10.82%
compared to 10.0%, which is required to be considered "well-capitalized" by the
regulators. At year-end 2000, our total risk-adjusted capital ratio was 12.89%.
Our ending equity to assets ratio at December 31, 2001 was 6.75% compared to
7.84% at December 31, 2000. However, as previously discussed, temporary
conditions that existed at year end
55
make the average balance sheet ratio a more accurate measure of capital. Our
average equity to assets for the year ended December 31, 2001 was 6.65% compared
to 8.46% for the year 2000.
In February 2002, we completed a public offering which raised $82.2
million, net of expenses, on the sale of 6,210,000 shares of common stock. Our
Tier 1 capital totaled $295.0 million as of December 31, 2001, or 6.8% of
risk-weighted assets. On a pro forma basis, giving full effect to the new
risk-weighted capital regulations regarding residual assets, as further adjusted
to give effect to the net proceeds from this offering and prior to any residual
asset reduction steps we are contemplating to reduce our concentration of
residual assets or to reclassify for capital treatment purposes any of those
residual assets, or any other changes, our Tier 1 capital and total capital to
risk-weighted assets would be approximately 7.8% and 10.7%, respectively, as of
December 31, 2001. The new capital rules do not become fully effective until
December 31, 2002.
In November 2001, we issued $30 million of trust preferred securities in a
private placement transaction through IFC Capital Trust V, a wholly statutory
business trust subsidiary created under the laws of Delaware. In connection with
the issuance of the trust preferred securities, we sold an equivalent amount of
subordinated debentures to the trust. These subordinated debentures will mature
in 2031, with an option to call them at par after five years. The securities are
held on the balance sheet at December 31, 2001, net of $0.9 million of
capitalized issuance costs. The cumulative dividend rate payable on the trust
preferred securities and the subordinated debentures is 9.95%, payable
semiannually on June 8 and December 8 of each year. These funds are considered
Tier 1 qualifying capital.
In July 2001, we issued $15 million of trust preferred securities in a
private placement transaction through IFC Capital Trust IV, our wholly-owned
statutory business trust subsidiary created under the laws of Delaware. In
connection with the issuance of the trust preferred securities, we sold an
equivalent amount of subordinated debentures to the trust. These subordinated
debentures will mature on July 25, 2031, which date may be shortened to a date
not before July 25, 2006 if certain conditions are met. The securities are shown
on the balance sheet at December 31, 2001, net of $0.5 million of capitalized
issuance costs. The cumulative dividend rate payable on the trust preferred
securities and the subordinated debentures is 10.25%, payable semiannually on
January 25 and July 25 of each year. These funds are Tier 1 qualifying capital.
In November 2000, we issued $51.75 million of trust preferred securities
through IFC Capital Trust II and $51.75 million of convertible trust preferred
securities through IFC Capital Trust III, wholly-owned statutory business trust
subsidiaries created under the laws of Delaware. The securities were issued at
$25 per share with cumulative dividend rates of 10.50% and 8.75%, respectively,
payable quarterly. They have an initial maturity of 30 years. The trust
preferred securities of IFC Capital Trust II are not convertible into our common
shares. The convertible trust preferred securities of IFC Capital Trust III have
an initial conversion ratio of 1.261 common shares for each convertible
preferred security (equivalent to an initial conversion price of $19.825 per
common share). The securities are shown on our balance sheet net of $4.4 million
of capitalized issuance costs. The sole assets of IFC Capital Trusts II and III
are our subordinated debentures with principal balances of $53.35 million each,
interest rates of 10.5% and 8.75%, respectively, and an initial maturity of 30
years. The subordinated debentures of IFC Capital II are callable at par after
five years. Both issues are Tier 1 qualifying capital elements.
In July 1999, we raised $30 million of 7.58%, 15-year subordinated debt
which is callable in 10 years at par, to strengthen and add flexibility in the
management of our capital base. The debt was privately placed. These funds
qualify as Tier 2 capital. The securities are not convertible into our common
shares.
To assist Irwin Union Bank and Trust in generating deposits in new markets,
we began a program in 1999 to issue our non-coupon, convertible preferred shares
to certain qualified investors thought to be in a position to support deposit
growth. Under the program, each preferred share is issued for cash at
approximately the market price of one common share. A preferred share
automatically converts into one common share at a determined future date. If a
banking branch reaches a specified level of deposits prior to the conversion
date, the number of common shares into which a preferred share converts is
increased by as much as 25%, depending upon the date on which the deposit level
was attained. A maximum of approximately 400,000 shares of preferred stock are
issuable under the program. Approximately $1.4 million in non-coupon
56
bearing convertible preferred shares of our stock have been issued under this
program. These funds are Tier 1 qualifying capital.
In January 1997, we issued $50 million of trust preferred securities
through IFC Capital Trust I, a wholly-owned statutory business trust subsidiary
created under the laws of Delaware. 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. The securities are shown on the balance sheet
at December 31, 2001 net of $1.8 million of capitalized issuance costs. The sole
assets of IFC Capital Trust I are our subordinated debentures 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. These funds are Tier 1 qualifying
capital.
Anticipated Impact of New Regulatory Capital Rules
As discussed in the "Recent Developments" section, revised regulatory
capital rules will be effective January 1, 2002 with respect to residual
interests related to any transaction covered by the revised rules that settles
on or after that date. For transactions that settle prior to January 1, 2002,
application of the capital treatment prescribed by the rules will be delayed
until December 31, 2002. In general, the new rules require that capital be held
on a dollar-for-dollar basis against our residual assets, net of any associated
deferred tax liability.
The new rules define a term called "Credit-Enhancing Interest-Only Strips,"
or CEIOS, as a subset of the assets known as residuals. We are in the process of
determining whether some portion of our residuals (specifically our
over-collateralization accounts and our prepayment penalties) would fall outside
the CEIOS definition. If they would, then the capital treatment for these assets
would be different, and we believe more favorable, than that for CEIOS. See
"Recent Developments" for a discussion of steps we intend to pursue to reduce
our concentration of residual assets.
Inflation
Since substantially all of our assets and liabilities are monetary in
nature, such as cash, securities, loans and deposits, their values are less
sensitive to the effects of inflation than to changes in interest rates. We
attempt to control the impact of interest rate fluctuations by managing the
relationship between interest rate sensitive assets and liabilities.
RISK MANAGEMENT
We are engaged in businesses that involve the assumption of financial risks
including:
- Credit risk
- Liquidity risk
- Interest rate risk
Each line of business that assumes financial risk uses a formal process to
manage this risk. In all cases, the objectives are to ensure that risk is
contained within prudent levels and that we are adequately compensated for the
level of risk assumed. Our Chairman, President, and Chief Financial Officer
participate in each of our subsidiaries' risk management process. We have
recently implemented certain steps designed to enhance our consolidated risk
management function. We have instituted a company-wide risk management system at
the holding company level and have adopted board policies that establish
specified growth and residual asset concentration limits. In addition to
strengthening our overall operational and financial risk management, these
changes are designed to provide independent review and enhancement of our home
equity valuation models, ensure consistency in the business modeling
methodologies we use relating to our different lines of business, and establish
independent control of our risk reporting, surveillance and model parameter
changes.
57
Credit Risk. The assumption of credit risk is a key source of earnings for
the home equity lending, commercial banking and equipment leasing lines of
business. In addition, the mortgage banking line of business assumes some credit
risk although its mortgages typically are insured.
The credit risk in the loan portfolios of the home equity lending line of
business and commercial bank have the most potential to have a significant
effect on our consolidated financial performance. These lines of business manage
credit risk through the use of lending policies, credit analysis and approval
procedures, periodic loan reviews, and personal contact with borrowers. Loans
over a certain size are reviewed by a loan committee prior to approval.
The allowance for loan and lease losses is an estimate based on our
judgement. The allowance is maintained at a level we believe is adequate to
absorb probable losses inherent in the loan and lease portfolio. We compute the
allowance based on an analysis which incorporates both a quantitative and
qualitative element. The quantitative component of the allowance reflects
expected losses resulting from analysis developed through specific credit
allocations for individual loans and historical loss experience for each loan
category. The specific credit allocations are based on a regular analysis of all
loans over a fixed-dollar amount where the internal credit rating is at or below
a predetermined classification. The historical loan loss component is applied to
all loans that do not have a specific reserve allocated to them. Loans are
segregated by major product type, with an estimated loss ratio applied against
each. The loss ratio is generally based upon the previous three years loss
experience for each loan type.
The qualitative portion of the allowance reflects management's estimate of
probable inherent but undetected losses within the portfolio. This assessment is
performed via the evaluation of eight specific qualitative factors as outlined
in regulatory guidance. We perform the quantitative and qualitative assessments
on a quarterly basis.
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
below analyzes the consolidated allowance for loan and lease losses over the
periods presented. Qualitative reserves are allocated to individual loan
categories in the table.
Net charge-offs for the year ended December 31, 2001 were $8.2 million, or
0.53% of average loans, compared to $2.7 million, or 0.28% of average loans
during 2000. Net charge-offs in 2000 were up 56.4% from 1999. Higher net
charge-offs in 2001 relate in part to the loan growth at the commercial bank. In
addition, difficult economic conditions led to higher charge-offs at the
equipment leasing line of business in 2001. At December 31, 2001, the allowance
for loan and lease losses was 1.04% of outstanding loans and leases, compared to
1.06% at year end 2000, and 1.17% at year end 1999.
Total nonperforming loans and leases at December 31, 2001, were $19.2
million, compared to $7.2 million at December 31, 2000, and $4.3 million at
December 31, 1999. Nonperforming loans and leases as a percent of total loans
and leases at December 31, 2001 were 0.90%, compared to 0.58% at December 31,
2000, and 0.59% in 1999. The 2001 increase occurred primarily at our home equity
lending line of business in connection with a change in the classification of
nonperforming loans from the "loans held for sale" category to "loans held for
investment" to reflect more accurately management's intent regarding ultimate
disposition of these assets. Prior to this reclassification in 2001, these loans
were carried at the lower of their cost or market value. Any impairment
provision was recorded through the markdown of the loans to their market value.
Other real estate we owned totaled $4.4 million at December 31, 2001, up
from $2.8 million at December 31, 2000, which was down from $3.8 million at the
same date in 1999. The increase in 2001 was primarily attributable to both the
home equity lending and mortgage banking lines of business. Total nonperforming
assets at December 31, 2001 were $23.5 million, or 0.68% of total assets.
Nonperforming assets at December 31, 2000, totaled $10.1 million, or 0.42% of
total assets, compared to $8.1 million, or 0.48%, in 1999.
58
The following table shows an analysis of our consolidated allowance for
loan and lease losses:
AT OR FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------------
2001 2000 1999 1998 1997
---------- ---------- -------- -------- --------
(IN THOUSANDS)
Loans and leases outstanding at end
of period, net of unearned
income............................. $2,137,747 $1,234,922 $733,425 $556,991 $611,093
========== ========== ======== ======== ========
Average loans and leases for the
period, net of unearned income..... $1,534,502 $ 960,848 $642,435 $585,025 $569,325
========== ========== ======== ======== ========
ALLOWANCE FOR LOAN AND LEASE LOSSES:
Balance beginning of period.......... $ 13,129 $ 8,555 $ 9,888 $ 8,812 $ 6,875
CHARGE-OFFS:
Commercial, financial and
agricultural loans.............. 1,638 1,210 646 246 800
Real estate mortgage loans......... 600 -- -- 232 356
Consumer loans..................... 1,489 818 813 761 734
Lease financing:
Domestic........................ 3,624 363 772 1,263 1,255
Canadian........................ 2,402 777 -- -- --
---------- ---------- -------- -------- --------
Total charge-offs............. 9,753 3,168 2,231 2,502 3,145
---------- ---------- -------- -------- --------
RECOVERIES:
Commercial, financial and
agricultural loans.............. 144 76 32 14 32
Real estate mortgage loans......... -- -- -- -- 1
Consumer loans..................... 193 221 307 362 246
Lease financing:
Domestic........................ 334 84 164 183 259
Canadian........................ 877 85 -- -- --
---------- ---------- -------- -------- --------
Total recoveries.............. 1,548 466 503 559 538
---------- ---------- -------- -------- --------
Net charge-offs...................... (8,205) (2,702) (1,728) (1,943) (2,607)
Acquisition of Onset Capital......... -- 1,908 -- -- --
Reduction due to sale of loans....... (6) -- (3,126) (2,976) (1,694)
Reduction due to reclassification of
loans.............................. -- (16) (922) -- --
Foreign currency adjustment.......... (140) (19) -- -- --
Provision charged to expense......... 17,505 5,403 4,443 5,995 6,238
---------- ---------- -------- -------- --------
Balance end of period................ $ 22,283 $ 13,129 $ 8,555 $ 9,888 $ 8,812
========== ========== ======== ======== ========
ALLOWANCE FOR LOAN AND LEASE LOSSES
BY CATEGORY:
Commercial, financial and
agricultural loans.............. $ 11,198 $ 4,370 $ 5,634 $ 4,240 $ 5,118
Real estate mortgage loans......... 2,872 2,462 1,194 3,299 2,170
Consumer loans..................... 2,309 2,226 1,270 1,747 446
Lease financing:
Domestic........................ 4,527 2,325 457 602 1,078
Canadian........................ 1,377 1,746 -- -- --
---------- ---------- -------- -------- --------
Totals........................ $ 22,283 $ 13,129 $ 8,555 $ 9,888 $ 8,812
========== ========== ======== ======== ========
RATIOS:
Net charge-offs to average loans and
leases............................. 0.53% 0.28% 0.27% 0.33% 0.46%
Allowance for loan losses to loans
and leases outstanding............. 1.04% 1.06% 1.17% 1.78% 1.44%
59
The following table shows information about our nonperforming assets at the
dates shown:
DECEMBER 31,
---------------------------------------------
2001 2000 1999 1998 1997
------- ------- ------ ------- ------
(IN THOUSANDS)
ACCRUING LOANS PAST DUE 90 DAYS OR MORE:
Commercial, financial and agricultural loans... $ 1,146 $ 324 $ 58 $ 252 $ 382
Real estate mortgages.......................... -- -- -- 291 534
Consumer loans................................. 157 510 89 89 66
Lease financing:
Domestic..................................... 1,624 627 -- -- --
Canadian..................................... 68 -- -- -- --
------- ------- ------ ------- ------
2,995 1,461 147 632 982
------- ------- ------ ------- ------
NONACCRUAL LOANS AND LEASES:
Commercial, financial and agricultural loans... 5,066 752 748 1,052 777
Real estate mortgages.......................... 8,115 1,922 3,250 9,710 5,333
Consumer loans................................. 708 918 273 174 63
Lease financing:
Domestic..................................... 1,180 960 88 426 506
Canadian..................................... 1,088 1,209 -- -- --
------- ------- ------ ------- ------
16,157 5,761 4,359 11,362 6,679
------- ------- ------ ------- ------
Total nonperforming loans and leases...... 19,152 7,222 4,506 11,994 7,661
------- ------- ------ ------- ------
OTHER REAL ESTATE OWNED:
Other real estate owned........................ 4,388 2,833 3,752 3,506 1,828
------- ------- ------ ------- ------
Total nonperforming assets................ $23,540 $10,055 $8,258 $15,500 $9,489
======= ======= ====== ======= ======
Nonperforming loans and leases to total loans
and leases................................... 0.90% 0.58% 0.59% 2.15% 1.25%
======= ======= ====== ======= ======
Nonperforming assets to total assets........... 0.68% 0.42% 0.49% 0.80% 0.63%
======= ======= ====== ======= ======
Loans that 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. The $23.5 million of nonperforming assets at
December 31, 2001, were concentrated at our lines of business as follows:
- Mortgage banking $3.2 million
- Home equity lending 9.2 million
- Commercial banking 7.2 million
- Equipment leasing 3.9 million
For the periods presented, the year-end balances of any restructured loans
are reflected in the table above either in the amounts shown for "accruing loans
past due 90 days or more" or in the amounts shown for "nonaccrual loans and
leases."
Interest income of approximately $1.0 million would have been recorded
during 2001 on nonaccrual and renegotiated loans if such loans had been accruing
interest throughout the year in accordance with their original terms. The amount
of interest income actually recorded during the year of 2001 on nonaccrual and
restructured loans was approximately $0.5 million.
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.
60
Liquidity Risk. Liquidity is the availability of funds to meet the daily
requirements of our business. For financial institutions, demand for funds
results principally from extensions of credit and withdrawal of deposits.
Liquidity is provided by asset maturities or sales and through deposits and
short-term and long-term borrowings.
The objectives of liquidity management are to ensure that funds will be
available to meet current and future demands and that funds are available at a
reasonable cost. We manage liquidity via daily interaction with the lines of
business and periodic liquidity planning sessions. Since loans are less
marketable than securities, the ratio of total loans to total deposits is a
traditional measure of liquidity for banks and bank holding companies. At
December 31, 2001, the ratio of loans and loans held for sale to total deposits
was 114.4%. We are comfortable with this relatively high level due to our
position in mortgage loans that will be sold or securitized. These loans carry
an interest rate at or near current market rates for first and second lien
mortgage loans. Since we sell and/or securitize the majority of these mortgage
loans within a 30-day period, our liquidity is significantly higher than the
ratio would suggest by traditional standards. Excluding mortgage loans to be
sold or securitized, the loan-to-deposit ratio was 79.1% at December 31, 2001.
Interest Rate Risk. Because assets are not perfectly match funded with
like-term liabilities, our earnings are affected by interest rate changes.
Interest rate risk is measured by the sensitivity of both net interest income
and fair market value of net interest sensitive assets to changes in interest
rates.
An asset/liability management committee (ALMC) at each of our lines of
business monitors the repricing structure of assets, liabilities and off-balance
sheet items and uses a financial simulation model to measure interest rate risk
over multiple interest rate scenarios. Our parent company ALMC oversees the
interest rate risk profile of all of our lines of business as a whole and is
represented on each of the line of business ALMC. We incorporate many factors
into the financial model, including prepayment speeds, net interest margin, fee
income and a comprehensive mark-to-market valuation process. We reevaluate risk
measures and assumptions regularly and enhance modeling tools as needed.
Our commercial banking, home equity lending, and leasing lines of business
assume interest rate risk in the pricing of their loans and leases, and manage
this risk by adjusting the duration of their interest sensitive liabilities and
through the use of off-balance sheet hedging.
Our mortgage banking line of business assumes interest rate risk by
entering into commitments to extend loans to borrowers at a fixed rate for a
limited period of time. We hold closed loans only temporarily until a pool is
formed and sold in a securitization or under a flow sale arrangement. To
mitigate the risk that interest rates will rise between loan origination and
sale, the mortgage bank buys commitments to deliver loans at a fixed price.
Our mortgage and home equity lending lines of business also are exposed to
the risk that interest rates will decline, increasing prepayment speeds on loans
and decreasing the value of servicing assets and residual interests. Some
offsets to these exposures exist in the form of strong production operations,
selective sales of servicing rights, match funded asset-backed securities sales
and the use of financial instruments to hedge the economic performance of the
assets.
The following tables reflect our management's estimate of the present value
of interest sensitive assets, liabilities, and off-balance sheet items at
December 31, 2001. In addition to showing the estimated fair market value at
current rates, they also provide estimates of the fair market values of interest
sensitive items based upon a hypothetical move both up and down 100 and 200
basis points in the entire yield curve.
The first table is an economic analysis showing the present value impact of
changes in interest rates, assuming a comprehensive mark-to-market environment.
The second table is an accounting analysis showing the same net present value
impact, adjusted for expected GAAP treatment. Neither analysis takes into
account the book values of the noninterest sensitive assets and liabilities
(such as cash, accounts receivable, and fixed assets), the values of which are
not directly determined by interest rates.
The analyses are based on discounted cash flows over the remaining
estimated lives of the financial instruments. The interest rate sensitivities
apply only to transactions booked as of December 31, 2001. The net
61
asset value sensitivities do not necessarily represent the changes in the lines
of business' net asset value that would actually occur under the given interest
rate scenarios, as sensitivities do not reflect changes in value of the
companies as a going concern nor consider potential rebalancing or other hedging
actions that might be taken in the future under asset/liability management.
The volume of derivative contracts entered into to economically hedge
mortgage servicing rights, or MSRs, fluctuates from quarter to quarter,
depending upon market conditions. We monitor hedge positions frequently and
rebalance them as needed. It is unlikely that the volume of hedge positions
would remain constant over large fluctuations in interest rates. In the tables
below, therefore, we have included the assumption that the volume of hedge
contracts will decline as interest rates rise. MSR hedge contracts appear under
the category "Interest Sensitive Financial Derivatives" in the tables below.
ECONOMIC VALUE CHANGE METHOD
PRESENT VALUE AT DECEMBER 31, 2001,
CHANGE IN INTEREST RATES OF:
-------------------------------------------------------------------
-2% -1% CURRENT +1% +2%
----------- ----------- ----------- ----------- -----------
(IN THOUSANDS)
INTEREST SENSITIVE ASSETS
Loans and other assets.......... $ 2,026,219 $ 1,998,329 $ 1,971,227 $ 1,945,210 $ 1,920,298
Loans held for sale............. 700,695 695,220 690,426 685,278 679,983
Mortgage servicing rights....... 101,076 149,179 242,334 306,838 332,683
Residual interests.............. 174,425 185,867 199,071 213,240 227,196
Interest sensitive financial
derivatives................... 103,143 60,133 17,162 278 781
----------- ----------- ----------- ----------- -----------
Total interest sensitive
assets........................ 3,105,558 3,088,728 3,120,220 3,150,844 3,160,941
----------- ----------- ----------- ----------- -----------
INTEREST SENSITIVE LIABILITIES
Deposits........................ (1,455,010) (1,444,850) (1,434,670) (1,424,868) (1,415,422)
Short-term borrowings........... (1,009,594) (1,006,220) (1,002,532) (998,905) (995,335)
Long-term debt.................. (277,793) (265,808) (251,243) (236,797) (221,685)
----------- ----------- ----------- ----------- -----------
Total interest sensitive
liabilities................... (2,742,397) (2,716,878) (2,688,445) (2,660,570) (2,632,442)
----------- ----------- ----------- ----------- -----------
Net market value as of December
31, 2001...................... $ 363,161 $ 371,850 $ 431,775 $ 490,274 $ 528,499
=========== =========== =========== =========== ===========
Change from current............. $ (68,614) $ (59,925) $ -- $ 58,499 $ 96,724
=========== =========== =========== =========== ===========
Net market value as of December
31, 2000...................... $ 303,443 $ 312,277 $ 338,895 $ 353,270 $ 348,506
=========== =========== =========== =========== ===========
Potential change................ $ (35,452) $ (26,618) $ -- $ 14,375 $ 9,611
=========== =========== =========== =========== ===========
62
GAAP-BASED VALUE CHANGE METHOD
PRESENT VALUE AT DECEMBER 31, 2001,
CHANGE IN INTEREST RATES OF:
--------------------------------------------------------------
-2% -1% CURRENT +1% +2%
---------- ---------- ---------- ---------- ----------
(IN THOUSANDS)
INTEREST SENSITIVE ASSETS
Loans and other assets(1)........ $ -- $ -- $ -- $ -- $ --
Loans held for sale.............. 690,426 690,426 690,426 685,278 679,983
Mortgage servicing rights........ 114,572 162,674 237,893 250,216 252,316
Residual interests............... 174,425 185,867 199,071 213,240 227,196
Interest sensitive financial
derivatives.................... 105,653 62,095 18,588 1,182 1,179
---------- ---------- ---------- ---------- ----------
Total interest sensitive
assets......................... 1,085,076 1,102,062 1,145,978 1,149,916 1,160,674
---------- ---------- ---------- ---------- ----------
INTEREST SENSITIVE LIABILITIES
Deposits(1)...................... -- -- -- -- --
Short-term borrowings(1)......... -- -- -- -- --
Long-term debt(1)................ -- -- -- -- --
---------- ---------- ---------- ---------- ----------
Total interest sensitive
liabilities(1)................. -- -- -- -- --
---------- ---------- ---------- ---------- ----------
Net market value as of December
31, 2001....................... $1,085,076 $1,101,062 $1,145,978 $1,149,916 $1,160,674
========== ========== ========== ========== ==========
Potential change................. $ (60,902) $ (44,915) $ -- $ 3,938 $ 14,697
========== ========== ========== ========== ==========
Net market value as of December
31, 2000....................... $ 818,322 $ 837,172 $ 856,432 $ 859,801 $ 849,783
========== ========== ========== ========== ==========
Potential change................. $ (38,110) $ (19,260) $ -- $ 3,369 $ (6,649)
========== ========== ========== ========== ==========
---------------
(1) Value does not change in GAAP presentation.
Derivative Financial Instruments
We utilize certain derivative instruments that do not qualify for hedge
accounting treatment under SFAS No. 133. These derivatives are accounted for as
trading securities and marked to market on the income statement. While we do not
seek GAAP hedge accounting treatment for most of these instruments, their
economic purpose is to hedge existing exposures to either interest rate risk or
foreign currency risk.
We enter into forward contracts to protect against interest rate
fluctuations from the date of mortgage loan commitment until the loans are sold.
At December 31, 2001, we designated the portion of these transactions hedging
the closed mortgage loans as hedges that qualify for hedge accounting treatment
under SFAS 133. The basis of the hedged closed loans is adjusted for change in
value associated with the risk being hedged. The effect of these hedging
activities, which did not have a material impact on our net income, was recorded
through earnings as gain from sale of loans. Hedge ineffectiveness recorded in
gains from sale of loans related to these hedging activities was immaterial.
Additionally, we enter into commitments to originate loans whereby the interest
rate on the loan is determined prior to funding (rate lock commitments). Rate
lock commitments on loans intended to be sold are considered to be derivatives.
At the time interest rate lock commitments are originally recorded on the
balance sheet, no gain or loss is recognized. Any subsequent changes in fair
value are recorded in earnings. These derivatives are recorded on the balance
sheet at fair value at period end.
We hedge the fixed versus floating component of certain of our residual
interests with interest rate caps, which had a fair value of $0.1 million and a
notional amount of $16.9 million at December 31, 2001. We classify interest rate
caps as trading securities on the balance sheet and carry them at their fair
values. We record adjustments to fair values as trading gains or losses on the
income statement. For the year ended December 31, 2001, we recorded losses of
$13 thousand related to these derivative products.
63
We hedged our mortgage servicing rights through the use of Eurodollar
futures contracts, U.S. Treasury futures contracts and interest rate options.
For the year ended December 31, 2001, we recorded gains of $3.8 million on these
hedges. Both the futures contracts and options were marked-to-market as trading
securities with changes in value recorded in the income statement as trading
gains. Hedge gains or losses recorded in 2000 were immaterial. At December 31,
2001, we held $17.4 billion in notional amount of Eurodollar contracts, with
expirations ranging from the first quarter of 2002 to the fourth quarter of
2008. The index underlying these Eurodollar futures contracts is the three-month
LIBOR rate.
During the third quarter of 2001, we entered into an interest rate collar
with a notional value of $150 million to economically hedge home equity loans
that had been originated by our home equity lending line of business, but not
yet securitized. The collar consisted of a purchased option and a sold option on
the 4-year swap, which were cash settled at a cost of $2.0 million during the
quarter to coincide with the completion of the home equity loan securitization.
Onset Capital Corporation uses two interest rate swaps to reduce repricing
risk associated with one of its funding sources. The interest rate risk is
created due to a repricing mismatch between the fixed-rate payment stream from
leasing assets and floating rate funding. The notional amounts of the swaps were
$16.0 million and $14.3 million as of December 31, 2001. The notional values of
both interest rate swaps amortize on a schedule designed to approximate the
principal pay down of the loan portfolio, and have a final maturity date of May
25, 2004. Onset has the option to reduce the notional value of the swaps by up
to 10% if early prepayments on the loans are greater than originally
anticipated.
We own foreign currency forward contracts to protect the value of
intercompany loans made to Onset Capital Corporation against changes in the
Canadian-U.S. exchange rate. We had a notional amount of $38.1 million in
forward contracts outstanding as of December 31, 2001. For the year ended
December 31, 2001, gains related to these contracts totaled $1.6 million. There
were no foreign currency hedge gains or losses in the comparable period of 2000.
These contracts are marked-to-market with gains and losses included in other
expense on the income statement.
ITEM 7(A). QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The quantitative and qualitative disclosures about market risk are reported
in the Interest Rate Risk section of Item 7, Management's Discussion and
Analysis of Financial Condition and Results of Operations found on pages 23
through 95.
64
ITEM 8. FINANCIAL STATEMENTS
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.
Our financial statements have been audited by PricewaterhouseCoopers LLP,
independent certified public accountants. Management has made available to
PricewaterhouseCoopers all of Irwin Financial'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 Irwin Financial 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. Irwin Financial maintains a strong
internal auditing program that independently assesses the effectiveness of the
internal controls and recommends possible improvements. In addition, as part of
its audit of our financial statements, PricewaterhouseCoopers completed an
assessment of selected internal accounting controls to establish a basis for
reliance on these controls in determining the nature, timing, and extent of
audit-tests to be applied. Management has considered the internal auditor's and
PricewaterhouseCoopers' recommendations concerning our 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 our system of internal control is adequate to accomplish the objectives
discussed herein.
Management also recognized its responsibility for fostering a strong
ethical climate so that our affairs are conducted according to the highest
standards of personal and corporate conduct. This responsibility is
characterized and reflected in our Guiding Philosophy, which is publicized
throughout Irwin Financial Corporation. This responsibility is also reflected in
the individual Codes of Conduct of each major operating subsidiary. These Codes
of Conduct address, among other things, the necessity of ensuring open
communication within Irwin Financial; potential conflicts of interests;
compliance with all domestic and foreign laws, including those related to
financial disclosures; and a confidentiality of proprietary information. Irwin
Financial maintains a systematic program to assess compliance with these
policies.
/s/ John A. Nash /s/ Gregory F. Ehlinger
65
REPORT OF 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 changes in shareholders' equity
and of cash flows present fairly, in all material respects, the financial
position of Irwin Financial Corporation and its subsidiaries at December 31,
2001 and 2000, and the results of their operations and their cash flows for each
of the three years in the period ended December 31, 2001, in conformity with
accounting principles generally accepted in the United States of America. 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
auditing standards generally accepted in the United States of America, 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 our opinion.
/s/ PricewaterhouseCoopers LLP
Chicago, Illinois
January 22, 2002, except as to Note 23, which is as of February 25, 2002.
66
IRWIN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
DECEMBER 31, DECEMBER 31,
2001 2000
-------------- --------------
(IN THOUSANDS, EXCEPT FOR SHARES)
ASSETS:
Cash and cash equivalents................................... $ 158,291 $ 83,493
Interest-bearing deposits with financial institutions....... 14,247 36,400
Trading assets -- Note 3.................................... 216,684 154,921
Investment securities -- Note 4............................. 38,796 37,095
Loans held for sale......................................... 503,757 579,788
Loans and leases, net of unearned income -- Note 5.......... 2,137,747 1,234,922
Less: Allowance for loan and lease losses -- Note 6......... (22,283) (13,129)
---------- ----------
2,115,464 1,221,793
Servicing assets -- Note 7................................ 228,624 130,522
Accounts receivable......................................... 41,996 69,224
Accrued interest receivable................................. 14,063 12,979
Premises and equipment -- Note 8............................ 34,988 29,409
Other assets................................................ 72,885 66,805
---------- ----------
Total assets...................................... $3,439,795 $2,422,429
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Deposits
Noninterest-bearing....................................... $ 533,983 $ 263,159
Interest-bearing.......................................... 889,448 517,127
Certificates of deposit over $100,000..................... 885,587 663,044
---------- ----------
2,309,018 1,443,330
Short-term borrowings -- Note 10............................ 487,963 475,502
Long-term debt -- Note 11................................... 29,654 29,608
Other liabilities........................................... 189,889 136,897
Company-obligated mandatorily redeemable preferred
securities of subsidiary trust -- Note 12................. 190,948 147,167
---------- ----------
Total liabilities................................. 3,207,472 2,232,504
---------- ----------
Commitments and contingencies -- Note 13
Shareholders' equity
Preferred stock, no par value -- authorized 4,000,000
shares; issued 96,336 shares as of December 31, 2001
and December 31, 2000.................................. 1,386 1,386
Common stock, no par value -- authorized 40,000,000
shares; issued 23,402,080 shares as of December 31,
2001 and December 31, 2000; including 2,096,947 and
2,376,119 shares in treasury as of December 31, 2001
and December 31, 2000, respectively.................... 29,965 29,965
Additional paid-in capital................................ 4,426 4,331
Minority interest......................................... 658 1,055
Deferred compensation..................................... (449) (503)
Accumulated other comprehensive loss, net of deferred
income tax benefit of $130 and $305 in 2001 and 2000,
respectively........................................... (325) (459)
Retained earnings......................................... 241,725 201,729
---------- ----------
277,386 237,504
Less treasury stock, at cost...................... (45,063) (47,579)
---------- ----------
Total shareholders' equity........................ 232,323 189,925
---------- ----------
Total liabilities and shareholders' equity........ $3,439,795 $2,422,429
========== ==========
The accompanying notes are an integral part of the consolidated financial
statements.
67
IRWIN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------
2001 2000 1999
---------- ---------- ----------
(IN THOUSANDS, EXCEPT FOR PER SHARE)
INTEREST INCOME:
Loans and leases............................................ $128,157 $ 93,251 $ 48,978
Loans held for sale......................................... 102,679 71,141 66,682
Trading account............................................. 31,980 15,584 6,275
Investment securities:
Taxable................................................... 4,913 4,161 3,755
Tax-exempt................................................ 247 250 271
Federal funds sold.......................................... 257 143 652
-------- -------- --------
Total interest income............................... 268,233 184,530 126,613
-------- -------- --------
INTEREST EXPENSE:
Deposits.................................................... 73,340 52,815 25,220
Short-term borrowings....................................... 29,656 32,610 28,425
Long-term debt.............................................. 2,320 2,348 1,149
Preferred securities distribution........................... 15,768 5,761 4,697
-------- -------- --------
Total interest expense.............................. 121,084 93,534 59,491
-------- -------- --------
Net interest income......................................... 147,149 90,996 67,122
Provision for loan and lease losses......................... 17,505 5,403 4,443
-------- -------- --------
Net interest income after provision for loan and lease
losses.................................................... 129,644 85,593 62,679
-------- -------- --------
OTHER INCOME:
Loan origination fees....................................... 64,303 52,696 41,024
Gain from sales of loans.................................... 207,538 77,047 74,834
Loan servicing fees......................................... 67,362 58,939 60,581
Amortization and impairment of servicing assets............. (50,134) (39,529) (15,702)
-------- -------- --------
Net loan administration income............................ 17,228 19,410 44,879
-------- -------- --------
Gain on sale of mortgage servicing assets................... 8,394 27,528 37,801
Trading gains/(losses)...................................... (32,412) 14,399 (8,296)
Other....................................................... 6,340 20,631 13,827
-------- -------- --------
271,391 211,711 204,069
-------- -------- --------
OTHER EXPENSE:
Salaries.................................................... 184,427 124,639 114,303
Pension and other employee benefits......................... 26,616 20,359 18,402
Office expense.............................................. 16,862 13,783 13,181
Premises and equipment...................................... 30,702 26,812 24,052
Marketing and development................................... 4,202 13,071 8,962
Professional Fees........................................... 11,192 7,013 4,684
Other....................................................... 53,419 32,285 30,527
-------- -------- --------
327,420 237,962 214,111
-------- -------- --------
Income before income taxes.................................. 73,615 59,342 52,637
Provision for income taxes.................................. 28,624 23,676 19,481
-------- -------- --------
Income before minority interest............................. 44,991 35,666 33,156
Minority interest in losses of subsidiaries................. (350) -- --
-------- -------- --------
Income before cumulative effect of change in accounting
principle................................................. 45,341 35,666 33,156
Cumulative effect of change in accounting principle, net of
tax....................................................... 175 -- --
-------- -------- --------
Net income.................................................. $ 45,516 $ 35,666 $ 33,156
======== ======== ========
Earnings per share before cumulative effect of change in
accounting principle:
Basic -- Note 18.......................................... $ 2.14 $ 1.70 $ 1.54
======== ======== ========
Diluted -- Note 18........................................ $ 1.99 $ 1.67 $ 1.51
======== ======== ========
Earnings per share:
Basic -- Note 18.......................................... $ 2.15 $ 1.70 $ 1.54
======== ======== ========
Diluted -- Note 18........................................ $ 2.00 $ 1.67 $ 1.51
======== ======== ========
Dividends per share......................................... $ 0.26 $ 0.24 $ 0.20
======== ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
68
IRWIN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
ACCUMULATED
OTHER ADDITIONAL
RETAINED COMPREHENSIVE DEFERRED MINORITY PAID IN COMMON PREFERRED
TOTAL EARNINGS INCOME (LOSS) COMPENSATION INTEREST CAPITAL STOCK STOCK
-------- -------- ------------- ------------ -------- ---------- ------- ---------
Balance at January 1,
1999...................... $145,233 $142,232 $ 85 -- $ -- $2,595 $29,965 $ --
Net income................ 33,156 33,156
Unrealized gain on
investment securities
net of $104 tax
benefit................. (155) (155)
--------
Total comprehensive
income............ 33,001
--------
Cash dividends.............. (4,287) (4,287)
Tax benefit on stock option
exercises................. 1,055 1,055
Treasury stock:
Purchase of 800,052
shares.................. (18,314)
Sales of 232,073 shares... 2,608 600
-------- -------- ----- ----- ------ ------ ------- ------
Balance December 31, 1999... $159,296 $171,101 $ (70) -- $ -- $4,250 $29,965 $ --
======== ======== ===== ===== ====== ====== ======= ======
Net income................ 35,666 35,666
Unrealized gain on
investment securities
net of $43 tax
liability............... 64 64
Foreign currency adjustment
net of $43 tax benefit.... (66) (66)
Minimum pension liability
net of $257 tax benefit... (387) (387)
--------
Total comprehensive
income............ 35,277
Deferred compensation....... (503) (503)
Cash dividends.............. (5,038) (5,038)
Tax benefit on stock option
exercises................. 136 136
Treasury stock:
Purchase of 220,948
shares.................. (3,414)
Sales of 142,132 shares... 1,730 (55)
Issuance of 96,336 shares of
preferred stock........... 1,386 1,386
Minority Interest........... 1,055 1,055
-------- -------- ----- ----- ------ ------ ------- ------
Balance December 31, 2000... $189,925 $201,729 $(459) $(503) $1,055 $4,331 $29,965 $1,386
======== ======== ===== ===== ====== ====== ======= ======
Net income................ 45,516 45,516
Unrealized gain on
investment securities
net of $53 tax
liability............... 80 80
Foreign currency
adjustment net of $221
tax benefit............. (333) (333)
Minimum pension liability
net of $257 tax
liability............... 387 387
--------
Total comprehensive
income............ 45,650
Deferred compensation....... 54 54
Cash dividends.............. (5,520) (5,520)
Tax benefit on stock option
exercises................. 2,451 2,451
Treasury stock:
Purchase of 136,089
shares.................. (3,223)
Sales of 415,261 shares... 3,383 (2,356)
Minority Interest........... (397) (397)
-------- -------- ----- ----- ------ ------ ------- ------
Balance December 31, 2001... $232,323 $241,725 $(325) $(449) $ 658 $4,426 $29,965 $1,386
======== ======== ===== ===== ====== ====== ======= ======
TREASURY
STOCK
--------
Balance at January 1,
1999...................... $(29,644)
Net income................
Unrealized gain on
investment securities
net of $104 tax
benefit.................
Total comprehensive
income............
Cash dividends..............
Tax benefit on stock option
exercises.................
Treasury stock:
Purchase of 800,052
shares.................. (18,314)
Sales of 232,073 shares... 2,008
--------
Balance December 31, 1999... $(45,950)
========
Net income................
Unrealized gain on
investment securities
net of $43 tax
liability...............
Foreign currency adjustment
net of $43 tax benefit....
Minimum pension liability
net of $257 tax benefit...
Total comprehensive
income............
Deferred compensation.......
Cash dividends..............
Tax benefit on stock option
exercises.................
Treasury stock:
Purchase of 220,948
shares.................. (3,414)
Sales of 142,132 shares... 1,785
Issuance of 96,336 shares of
preferred stock...........
Minority Interest...........
--------
Balance December 31, 2000... $(47,579)
========
Net income................
Unrealized gain on
investment securities
net of $53 tax
liability...............
Foreign currency
adjustment net of $221
tax benefit.............
Minimum pension liability
net of $257 tax
liability...............
Total comprehensive
income............
Deferred compensation.......
Cash dividends..............
Tax benefit on stock option
exercises.................
Treasury stock:
Purchase of 136,089
shares.................. (3,223)
Sales of 415,261 shares... 5,739
Minority Interest...........
--------
Balance December 31, 2001... $(45,063)
========
The accompanying notes are an integral part of the consolidated financial
statements.
69
IRWIN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------
2001 2000 1999
------------ ----------- -----------
(IN THOUSANDS)
NET INCOME.................................................. $ 45,516 $ 35,666 $ 33,156
ADJUSTMENTS TO RECONCILE NET INCOME TO CASH PROVIDED (USED)
BY OPERATING ACTIVITIES:
Depreciation, amortization, and accretion, net.............. 9,097 9,114 8,535
Amortization and impairment of servicing assets............. 50,134 39,529 15,702
Provision for loan and lease losses......................... 17,505 5,403 4,443
Deferred income tax......................................... 26,245 21,702 15,543
Gain on sale of mortgage servicing assets................... (8,394) (27,528) (37,801)
Gain from sale of loans..................................... (207,538) (77,047) (74,834)
Originated and purchased mortgage servicing assets.......... (151,821) (57,165) (84,653)
Originations of loans held for sale......................... (10,375,401) (5,317,528) (6,316,257)
Proceeds from sale of mortgage servicing assets............. 11,979 53,142 85,380
Proceeds from the sale of loans held for sale............... 10,331,270 5,323,784 6,818,882
Net increase in trading assets.............................. (61,763) (95,896) (26,877)
Decrease (increase) in accounts receivable.................. 27,228 (49,415) 21,672
Other, net.................................................. 14,160 23,160 (1,828)
------------ ----------- -----------
Net cash provided (used) by operating activities.......... (271,783) (113,079) 461,063
------------ ----------- -----------
LENDING AND INVESTING ACTIVITIES:
Proceeds from maturities/calls of investment securities:
Held-to-maturity.......................................... 4,114 1,286 12,058
Available-for-sale........................................ 2,441 26 159
Proceeds from sales of investment securities:
Available-for-sale........................................ -- -- 3,118
Purchase of investment securities:
Held-to-maturity.......................................... (437) (781) (34)
Available-for-sale........................................ (7,692) -- (5,899)
Net increase (decrease) in interest-bearing deposits with
financial institutions.................................... 22,153 (9,615) (8,344)
Net increase in loans, excluding sales...................... (733,433) (533,848) (205,137)
Sale of mortgage loans by commercial bank................... 149,957 31,521 22,928
Acquisition of Onset Capital Corporation, net of cash
acquired.................................................. -- (837) --
Other, net.................................................. (10,760) (11,922) (6,520)
------------ ----------- -----------
Net cash used by lending and investing activities......... (573,657) (524,170) (187,671)
------------ ----------- -----------
FINANCING ACTIVITIES:
Net increase (decrease) in deposits......................... 865,688 573,012 (138,893)
Net increase (decrease) in short-term borrowings............ 12,461 2,399 (171,758)
Proceeds from issuance long-term debt....................... -- -- 30,000
Repayments of long-term debt................................ -- (176) (3,055)
Proceeds from the issuance of trust preferred securities.... 45,000 103,500
Proceeds from issuance of preferred stock................... -- 1,386 --
Purchase of treasury stock for employee benefit plans....... (3,223) (3,414) (18,314)
Proceeds from sale of stock for employee benefit plans...... 5,834 1,866 2,608
Dividends paid.............................................. (5,520) (5,038) (4,287)
------------ ----------- -----------
Net cash provided (used) by financing activities.......... 920,240 673,535 (303,699)
------------ ----------- -----------
Effect of exchange rate changes on cash..................... (2) (8) --
------------ ----------- -----------
Net increase in cash and cash equivalents................... 74,798 36,278 (30,307)
Cash and cash equivalents at beginning of period............ 83,493 47,215 77,522
------------ ----------- -----------
Cash and cash equivalents at end of period.................. $ 158,291 $ 83,493 $ 47,215
============ =========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period:
Interest.................................................. $ 123,058 $ 81,989 $ 52,456
============ =========== ===========
Income taxes.............................................. $ 7,357 $ 13,864 $ 14,328
============ =========== ===========
Non cash Transactions:
Mortgage loans held for sale transferred to loans and
leases.................................................. $ 327,700 $ -- $ --
============ =========== ===========
The accompanying notes are an integral part of the consolidated financial
statements.
70
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Consolidation: Irwin Financial Corporation and its subsidiaries provide
financial services throughout the United States and Canada. We are engaged in
the mortgage banking, home equity lending, commercial banking, equipment
leasing, and venture capital 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 us 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.
Foreign Currency: Assets and liabilities denominated in Canadian dollars
are translated into U.S. dollars at rates prevailing on the balance sheet date;
income and expenses are translated at average rates of exchange for the year.
Unrealized foreign currency translation gains and losses (net of hedging
activities and related income taxes) are recorded in accumulated other
comprehensive income in shareholders' equity.
Securities: Those securities that we have 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 on available for sale
investments, 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.
Trading Assets: Trading assets are stated at fair value. Unrealized gains
and losses are included in earnings. Included in trading assets are residual
interests. When we sell receivables in securitizations of home equity loans and
lines of credit, we retain residual interests, a servicing asset, one or more
subordinated tranches, and in some cases a cash reserve account, all of which
are retained interests in the securitized receivables. Gain or loss on the sale
of the receivables depends in part on the previous carrying amount of the
financial assets involved in the transfer, allocated between the assets sold and
the retained interests based on their relative fair value at the date of
transfer.
To obtain fair value of residual interests, quoted market prices are used
if available. However, quotes are generally not available for residual
interests, so we generally estimate fair value based on the present value of
expected cash flows estimated using management's best estimates of the key
assumptions -- prepayment speeds, credit losses, forward yield curves, and
discount rates commensurate with the risks involved. Adjustments to carrying
values are recorded as trading gains or losses.
Loans Held For Sale: Loans held for sale are carried at the lower of cost
or market, determined on an aggregate basis for both performing and
nonperforming loans. Market value is determined by outstanding commitments or by
current investor yield requirements.
Loans: Loans are carried at cost. 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 loan and
lease losses and is based on management's evaluation of inherent losses in the
portfolio. Loans are considered impaired if it is probable that we will be
unable to collect the scheduled payments of principal or interest when due
according to the contractual terms of the loan
71
agreement. The measurement of impaired loans is generally based on the present
value of expected future cash flows discounted at the historical effective
interest rate, except that all collateral-dependent loans are measured for
impairment based on the fair value of the collateral.
Servicing Assets: When we securitize or sell loans, we generally retain
the right to service the underlying loans sold. A portion of the cost basis is
allocated to this servicing asset based on its fair value relative to the loan
as a whole. We use the market prices under comparable servicing sale contracts,
when available, or alternatively use 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, we incorporate assumptions that we
believe 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.
In determining servicing value impairment, the servicing portfolio was
stratified into its predominant risk characteristics, principally by interest
rate. These segments of the portfolio are 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 is then compared with the
book value of each stratum to determine the required reserve for impairment. The
impairment reserve fluctuates as interest rates change and, therefore, no
reasonable estimate can be made as to future increases or declines in reserve
levels.
Derivative Instruments: Effective January 1, 2001, we adopted the
provisions of Statement of Financial Accounting Standards ("SFAS") No. 133,
"Accounting for Derivative Instruments and Hedging Activities," as amended.
Under the provisions of this standard, all derivative instruments have been
recorded at fair value as assets or liabilities in the December 31, 2001
consolidated balance sheet. Unrealized holding gains and losses from all
derivative instruments classified as fair value hedges or freestanding
derivative instruments have been recorded in the consolidated statement of
income. The adoption of SFAS 133 resulted in a cumulative change in accounting
principle, increasing net income by $175 thousand in 2001.
We utilize certain derivative instruments that do not qualify for hedge
accounting treatment under SFAS No. 133. These derivatives are accounted for as
trading securities and marked to market on the income statement. While we do not
seek GAAP hedge accounting treatment for most of these instruments, their
economic purpose is to hedge existing exposures to either interest rate risk or
foreign currency risk.
We enter into forward contracts to protect against interest rate
fluctuations from the date of mortgage loan commitment until the loans are sold.
At December 31, 2001, we designated the portion of these transactions hedging
the closed mortgage loans as hedges that qualify for hedge accounting treatment
under SFAS 133. The basis of the hedged closed loans is adjusted for changes in
value associated with the risk being hedged. The effect of these hedging
activities, which do not have a material impact on our net income, was recorded
through earnings as gain from sale of loans. Hedge ineffectiveness recorded in
gains from sale of loans related to these hedging activities was immaterial.
Additionally, we enter into commitments to originate loans whereby the
interest rate on the loan is determined prior to funding (rate lock
commitments). Rate lock commitments on loans intended to be sold are currently
considered to be derivatives. At the time of interest rate lock commitment, no
gain or loss is recognized. Any subsequent changes in fair value are recorded in
earnings. These derivatives are recorded on the balance sheet at fair value at
period end.
Premises and Equipment: Premises and equipment are recorded at cost.
Depreciation is determined by the straight-line method.
Venture Capital Investments: Venture capital investments held by Irwin
Ventures, LLC are carried at fair value with changes in fair value recognized in
other income. The investment committee of Irwin Ventures determines the value of
these nonpublicly traded investments at the end of each reporting period based
upon review of the investee's financial results, condition, and prospects.
Changes in estimated fair values can also be made when an event such as a new
round of funding from other private equity investors would cause a change
72
in estimated market value. In the future, should the company have investments in
publicly-traded securities, it would look to the traded market value of the
investments as the basis of its mark-to-market.
Other Assets: Included in other assets at December 31, 2001 and 2000 are
$4.4 million and $2.8 million of real estate properties acquired as a result of
foreclosure. Other real estate owned is carried at the lower of the recorded
investment in the related loan or fair value of the property less estimated
costs to sell.
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 or liability and the basis recorded in the
financial statements.
Cash and Cash Equivalents Defined: For purposes of the statement of cash
flows, we consider cash and due from banks to be cash equivalents.
Recent Accounting Developments: In September 2000, the FASB issued SFAS
No. 140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities." SFAS No 140, which replaces SFAS No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities," provides accounting and reporting standards for securitizations
and other transfers of assets. The Standard is based on the application of a
financial components approach that focuses on control, and provides consistent
standards for distinguishing transfers of financial assets that are sales from
transfers that are secured borrowings. The Standard requires disclosure of
information about securitized assets, including principal outstanding of
securitized and other managed assets, accounting policies, key assumptions
related to the determination of the fair value of residual interests,
delinquencies and credit losses. The accounting requirements of this Standard
were effective for transfers and servicing of financial assets and
extinguishments of liabilities occurring after March 31, 2001. Adoption of this
statement did not have a material impact on our financial position or results of
operations.
On June 29, 2001 the FASB approved SFAS No. 141, "Business Combinations,"
and No. 142 "Goodwill and Other Intangible Assets." SFAS 141 eliminates the
pooling-of-interests method of accounting -- requiring that purchase accounting,
with its recognition of intangible assets separately from goodwill, be applied
to all business combinations initiated after June 30, 2001.
Under the provisions of SFAS 142, goodwill will no longer be amortized
against earnings. Instead, goodwill and intangible assets deemed to have an
indefinite life will be reviewed for impairment at least annually. The
amortization period of intangible assets with finite lives will no longer be
limited to forty years. This standard became effective January 1, 2002. We
discontinued the amortization of goodwill with a net carrying value of $1.8
million on the date of adoption and annual amortization of $0.2 million that
resulted from business combinations prior to the adoption of SFAS 141. In
addition, we will record an after tax benefit of $0.5 million, as a cumulative
effect of a change in accounting principle, representing the write-off of
negative goodwill at January 1, 2002 arising from a prior business combination.
The FASB has also issued SFAS No. 143, "Accounting for Asset Retirement
Obligations," and SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets." SFAS 143 addresses accounting for the retirement of tangible
long-lived assets and the associated asset retirement costs. The effective date
is for fiscal years beginning after June 15, 2002. SFAS 144, effective for
fiscal years beginning after December 15, 2001, supersedes FASB No. 121
"Accounting for the Impairment of long-Lived Assets to Be Disposed Of" and APB
Opinion No. 30, "Reporting the Results of Operations -- Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions," for the disposal of a segment of a business.
Management does not believe the implementation of SFAS 143 or SFAS 144 will have
a material effect on our earnings or financial condition.
Reclassifications: Certain amounts in the 2000 and 1999 consolidated
financial statements have been reclassified to conform to the 2001 presentation.
These changes had no impact on previously reported net income or shareholders'
equity.
73
NOTE 2 -- RESTRICTIONS ON CASH AND INTEREST-BEARING DEPOSITS WITH FINANCIAL
INSTITUTIONS
Irwin Union Bank and Trust Company and Irwin Union Bank, F.S.B. are
required to maintain reserve balances with the Federal Reserve Bank. The amount
of the reserve balance at December 31, 2001 was $7.5 million. Additionally, we
are required to maintain reserve funds in connection with our loan
securitization activities. Included in accounts receivable at December 31, 2001
is $0.5 million of these reserve funds.
NOTE 3 -- SALES OF RECEIVABLES
During 2001 and 2000, we sold home equity loans and lines of credit in
securitization transactions resulting in the creation of residual interests and
a servicing asset. Residual interests totaling $199.1 million and $152.6
million, respectively, are included in trading assets at December 31, 2001 and
2000, respectively. We receive annual servicing fees of approximately 0.75% to
1.0% of the outstanding balance and rights to future cash flows arising after
the investors in the securitization trust have received the return for which
they contracted. The investors and the securitization trusts have no recourse to
our other assets for failure of debtors to pay when due. Our residual interests
are subordinate to investors' interests. The value of the residual interests are
subject to prepayment, credit, and interest rate risks in the transferred
financial assets.
We recognized pretax gains of $91.6 million, $47.0 million, and $23.7
million on the securitization of home equity loans and lines of credit at our
home equity line of business during 2001, 2000, and 1999, respectively.
Key economic assumptions used in measuring the fair value of residual
interests at the date of securitization resulting from securitizations completed
during the year 2001 (weighted based on principal amounts securitized) were as
follows:
Prepayment speed (annual rate)................ 18.78%
Weighted-average life (in years).............. 3.57
Expected credit losses (annual rate).......... 2.27%
Residual cash flows discounted at............. 16.85
Interest rates on adjustable notes............ LIBOR plus contractual spread ranging from 18
to 200 basis points
The table shown above aggregates each of the securitization transactions by
the line of business completed in 2001 into a single set of assumptions. In
accounting for the residual assets, we analyze interests on a security by
security basis and perform analysis at the loan level.
At December 31, 2001, key economic assumptions and the sensitivity of the
current fair value of residual cash flows to immediate 10 percent and 25 percent
adverse changes in those assumptions are as follows:
HOME EQUITY LOANS AND LINES OF CREDIT
-------------------------------------
(DOLLARS IN THOUSANDS)
Balance sheet carrying value of residual interests -- fair
value..................................................... $199,071
Weighted-average life (in years)............................ 2.72
Prepayment speed assumptions (annual rate).................. 24.84%
Impact on fair value of 10% adverse change (27.32%)......... $ (3,395)
Impact on fair value of 25% adverse change (31.05%)......... (7,919)
Expected credit losses (annual rate)........................ 2.83%
Impact on fair value of 10% adverse change (3.11%).......... $ (8,731)
Impact on fair value of 25% adverse change (3.54%).......... (21,135)
Residual cash flows discount rate (annual).................. 18.54%
Impact on fair value of 10% adverse change (20.39%)......... $ (8,124)
Impact on fair value of 25% adverse change (23.18%)......... (19,243)
These sensitivities are hypothetical and should be considered with caution.
As the figures indicate, changes in fair value based on a 10 percent and 25
percent variation in assumptions generally cannot be
74
extrapolated because the relationship of the change in assumption to the change
in fair value may not be linear. Also, in this table, the effect of a variation
in a particular assumption on the fair value of the retained interest is
calculated without changing any other assumption; in reality, changes in one
factor may result in changes in another (for example, increases in market
interest rates may result in lower prepayments and increased credit losses),
which might magnify or counteract the sensitivities.
Static pool credit losses are calculated by summing the actual and
projected future credit losses and dividing them by the original balance of each
pool of assets. The amount shown here for each year is calculated based on all
securitizations occurring in that year.
Actual and projected credit losses (%) as of:
HOME EQUITY LOANS AND LINES OF CREDIT SECURITIZED IN
---------------------------------------------------------------------------
1995 1996 1997 1998 1999 2000 2001
------- -------- -------- -------- -------- -------- ----------
DECEMBER 31, 2001 (DOLLARS IN THOUSANDS)
Actual to date........... 2.29% 1.04% 1.12% 0.90% 2.19% 2.11% 0.14%
Projected remaining...... -- -- 0.08 0.48 1.4 4.13 8.62
------- -------- -------- -------- -------- -------- ----------
Total losses............. 2.29 1.04 1.20 1.38 3.59 6.24 8.76
Original balance
securitized............ $51,584 $139,996 $229,994 $160,470 $433,606 $781,914 $1,042,462
The table below summarizes the cash flows received from (paid to)
securitization trusts during the year ended December 31, 2001 ($ in thousands):
Proceeds from new securitizations........................... $1,072,177
Collections used by the trust to purchase new home equity
loan balances............................................. 6,501
Servicing fees received..................................... 10,741
Cash flows received on residual interests*.................. 45,645
Cash received upon release from reserve accounts............ 135
Purchases of delinquent or foreclosed assets................ (701)
Servicing advances.......................................... (42,483)
Reimbursements of servicing advances........................ 43,319
---------------
* Cash flows received on residual interests are net of $31.9 million used to
over-collateralize the trusts. During 2001, $6.0 million was paid to
over-collateralize the trusts at the time of securitization.
75
Historical loss and delinquency amounts for the managed portfolio for the
year ended December 31, 2001 were as follows (dollars in thousands):
DELINQUENT
TOTAL PRINCIPAL PRINCIPAL
AMOUNT OF OVER 60 DAYS***
LOANS AT -----------------
DECEMBER 31, YEAR ENDED
2001 DECEMBER 31, 2001
--------------- -----------------
Home equity loans and lines of credit....................... $2,317,975 $121,666
Comprised of:
Loans owned*:
Loans....................................................... $ 350,433 $ 15,198
Loans securitized, servicing and residual retained**........ 1,714,109 89,422
---------- --------
Total owned portfolio....................................... 2,064,542 104,620
---------- --------
Loans managed but not owned:
Loans securitized, servicing retained, residual sold**...... $ 216,512 $ 17,046
Loans and residual sold, servicing retained................. 36,921 --
Total managed but not owned................................. 253,433 17,046
---------- --------
Total managed loans......................................... $2,317,975 $121,666
========== ========
---------------
* Loans owned are loans held for investment or loans in which we retain a
subordinate interest and retain a risk of loss
** Represents the principal amount of the loan. Residual interests held for
securitized assets are excluded from this table because they are recognized
separately.
*** Includes bankruptcies, foreclosures and other real estate owned.
Actual credit losses, net of recoveries, on the managed portfolios during the
year ended December 31, 2001 were $35.4 million related to loans securitized and
loans held for investment. Of this amount, $10.0 million relates to unsold loans
while $25.4 million relates to securitized loans.
NOTE 4 -- INVESTMENT SECURITIES
The amortized cost, fair value, and carrying value of investments held at
December 31, 2001 are as follows:
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR CARRYING
COST GAINS LOSSES VALUE VALUE
--------- ---------- ---------- ------- --------
(IN THOUSANDS)
Held-to-maturity:
Obligations of states and political
subdivisions................................. $ 4,425 $113 $ -- $ 4,538 $ 4,425
Mortgage-backed securities..................... 1,507 28 -- 1,535 1,507
Other.......................................... 133 -- -- 133 133
------- ---- ----- ------- -------
Total held-to-maturity....................... 6,065 141 -- 6,206 6,065
------- ---- ----- ------- -------
Available-for-sale:
U.S. Treasury and government obligations....... 29,251 78 -- 29,329 29,329
Mortgage-backed securities..................... 2,671 46 -- 2,717 2,717
Other.......................................... 685 -- -- 685 685
------- ---- ----- ------- -------
Total available-for-sale..................... 32,607 124 -- 32,731 32,731
------- ---- ----- ------- -------
Total investments............................ $38,672 $265 $ -- $38,937 $38,796
======= ==== ===== ======= =======
76
The amortized cost, fair value, and carrying value of investments held at
December 31, 2000 are as follows:
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR CARRYING
COST GAINS LOSSES VALUE VALUE
--------- ---------- ---------- ------- --------
(IN THOUSANDS)
Held-to-maturity:
U.S. Treasury and government obligations....... $21,006 $-- $ (1) $21,005 $21,006
Obligations of states and political
subdivisions................................. 4,586 71 (1) 4,656 4,586
Mortgage-backed securities..................... 2,059 (1) -- 2,058 2,059
------- --- ---- ------- -------
Total held-to-maturity....................... 27,651 70 (2) 27,719 27,651
------- --- ---- ------- -------
Available-for-sale:
U.S. Treasury and government obligations....... 4,992 -- 1 4,993 4,993
Mortgage-backed securities..................... 3,103 -- (10) 3,093 3,093
Other.......................................... 1,358 -- -- 1,358 1,358
------- --- ---- ------- -------
Total available-for-sale..................... 9,453 -- (9) 9,444 9,444
------- --- ---- ------- -------
Total investments............................ $37,104 $70 $(11) $37,163 $37,095
======= === ==== ======= =======
The amortized cost and estimated value of debt securities at December 31,
2001, by contractual maturity, are shown below. Expected maturities will differ
from contractual maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties.
AMORTIZED FAIR
COST VALUE
--------- -------
(IN THOUSANDS)
Held-to-maturity:
Due in one year or less................................... $ 268 $ 268
Due after one year through five years..................... 1,095 1,095
Due after five years through ten years.................... 1,215 1,258
Due after ten years....................................... 1,980 2,050
------- -------
4,558 4,671
Mortgage-backed securities.................................. 1,507 1,535
------- -------
6,065 6,206
------- -------
Available-for-sale:
Due in one year or less................................... $ 3,682 $ 3,760
Due after ten years....................................... 26,254 26,254
------- -------
29,936 30,014
Mortgage-backed securities.................................. 2,671 2,717
------- -------
32,607 32,731
------- -------
Total investments...................................... $38,672 $38,937
======= =======
Investment securities amounting to $12.8 million were pledged as collateral
for borrowings and for other purposes on December 31, 2001. During 2001 and 2000
there were no sales of "available for sale" investments. During 1999, sales of
"available for sale" investments with proceeds of $3.1 million resulted in a
gross loss of $1.2 thousand. Additionally in 2001, 2000, and 1999,
"held-to-maturity" investments totaling $0.3 million, $2.9 million and $1.8
million, respectively, were called. Calls in 2001 and 2000 resulted in gross
losses of $0.4 thousand and $23.1 thousand, respectively. Calls in 1999 were at
par.
77
NOTE 5 -- LOANS AND LEASES
Loans and leases are summarized as follows:
DECEMBER 31,
------------------------
2001 2000
---------- ----------
(IN THOUSANDS)
Commercial, financial and agricultural...................... $1,055,307 $ 677,066
Real estate-construction.................................... 287,228 220,485
Real estate-mortgage........................................ 490,111 122,301
Consumer.................................................... 38,489 56,785
Direct financing leases
Domestic.................................................. 232,527 116,867
Foreign................................................... 91,816 72,864
Unearned income
Domestic.................................................. (44,183) (21,570)
Foreign................................................... (13,548) (9,876)
---------- ----------
Total............................................. $2,137,747 $1,234,922
========== ==========
In 2001, $327.7 million of loans held for sale at the home equity lending
line of business were reclassified to loans and leases. These loans are included
in the real estate-mortgage category above.
Commercial loans are extended primarily to local regional businesses in the
market areas of Irwin Union Bank. We also provide consumer loans to the
customers in those markets. Real estate loans and direct financing leases are
extended throughout the United States and Canada.
Irwin Union Bank and Trust, in the normal course of business, makes loans
to directors, officers, and organizations and individuals with which they are
associated at market rates. Such loans amounted to $1.9 million and $2.4 million
at December 31, 2001 and 2000, respectively. During 2001, $0.9 million of new
loans were made and repayments totaled $1.0 million.
NOTE 6 -- ALLOWANCE FOR LOAN AND LEASE LOSSES
Changes in the allowance for loan and lease losses are summarized below:
DECEMBER 31,
------------------------------
2001 2000 1999
-------- ------- -------
(IN THOUSANDS)
Balance at beginning of year................................ $ 13,129 $ 8,555 $ 9,888
Acquisition of Onset Capital................................ -- 1,908 --
Provision for loan and lease losses......................... 17,505 5,403 4,443
Reduction due to sale of loans and leases................... (6) -- (3,126)
Reduction due to reclassification of loans.................. -- (16) (922)
Foreign currency adjustment................................. (140) (19) --
Recoveries.................................................. 2,236 466 503
Charge-offs................................................. (10,441) (3,168) (2,231)
-------- ------- -------
Balance at end of year...................................... $ 22,283 $13,129 $ 8,555
======== ======= =======
At December 31, 2001, 2000, and 1999, the recorded investment in loans for
which impairment has been recognized in accordance with SFAS No. 114 and SFAS
No. 118 totaled $33.1 million, $7.4 million, and $0.9 million, respectively.
These loans had a corresponding valuation allowance of $4.2 million, $820
thousand, and $204 thousand, respectively, based on the fair value of the loans'
collateral. We recognized $2.3 million, $521 thousand, and $38 thousand of
interest income on these loans in 2001, 2000, and 1999, respectively.
78
NOTE 7 -- SERVICING ASSETS
Included on the consolidated balance sheet at December 31, 2001 and 2000
are $228.6 million and $130.5 million, respectively, of capitalized servicing
assets. These amounts relate to the principal balances of loans serviced by us
for investors. Although they are not generally held for purposes of sale, there
is an active secondary market for servicing assets.
MORTGAGE SERVICING ASSET:
DECEMBER 31,
--------------------
2001 2000
-------- --------
(IN THOUSANDS)
Beginning Balance........................................... $130,522 $138,500
Additions................................................... 151,821 57,165
Amortization and impairment................................. (50,134) (39,529)
Reduction for servicing sales............................... (3,585) (25,614)
-------- --------
$228,624 $130,522
======== ========
We have established a valuation allowance to record servicing assets at
their fair market value. Changes in the allowance are summarized below:
DECEMBER 31,
-------------------------------
2001 2000 1999
-------- ------- --------
(IN THOUSANDS)
Balance at beginning of year................................ $ 14,204 $ 401 $ 11,720
Provision for impairment.................................... 11,321 13,803 (11,319)
Permanent impairment*....................................... (12,030) -- --
-------- ------- --------
Balance at end of year...................................... $ 13,495 $14,204 $ 401
======== ======= ========
---------------
* Permanent impairment was recorded in conjunction with a portfolio
restratification change made when we updated predominant risk characteristics
inherent in the portfolio of servicing rights during 2001.
At December 31 2001, key economic assumptions and the sensitivity of the
current carrying value of mortgage servicing rights to immediate 10% and 20%
adverse changes in those assumptions are as follows ($ in thousands):
Carrying amount of mortgage servicing rights................ $228,624
Constant prepayment speeds.................................. 13.86%
Impact on fair value of 10% adverse change (15.2%).......... (9,723)
Impact on fair value of 20% adverse change (16.6%).......... (18,238)
Discount Rate............................................... 10.47%
Impact on fair value of 10% adverse change (11.51%)......... (6,474)
Impact on fair value of 20% adverse change (12.55%)......... (12,332)
These sensitivities are hypothetical and should be used with caution. As
the figures indicate, changes in value based on a 10% and 20% variation in
assumptions generally cannot be extrapolated because the relationship of the
change in assumption to the change in value may not be linear. Also, in this
table, the effect of a variation in a particular assumption on the value of the
residual interest is calculated without changing any other assumption; in
reality, changes in one factor may result in changes in another (for example,
increases in market interest rates may result in lower prepayments and increased
credit losses), which might magnify or counteract the sensitivities.
Included in the servicing assets are $211.2 million and $121.6 million of
servicing assets related to the mortgage bank at December 31, 2001 and 2000,
respectively. The servicing assets at the mortgage bank had a
79
fair value of $239.7 million and $165.1 million at December 31, 2001 and 2000,
respectively. Below is a rollforward of the mortgage bank's servicing portfolio
balance:
SERVICING PORTFOLIO:
DECEMBER 31,
-----------------------
2001 2000 1999
----- ----- -----
(IN BILLIONS)
Beginning Portfolio......................................... $ 9.2 $10.5 $11.2
Add:
Originations of servicing rights.......................... 9.2 3.7 5.9
Deduct:
Sale of servicing rights.................................. (2.3) (4.1) (4.7)
Run-off................................................... (3.2) (0.9) (1.9)
----- ----- -----
Ending Portfolio............................................ $12.9 $ 9.2 $10.5
===== ===== =====
Key economic assumptions used in measuring the carrying value of mortgage
servicing rights at the mortgage bank at the date of securitization resulting
from deliveries completed during the year 2001 (weighted based on principal
amount of deliveries) were as follows:
Weighted average prepayment rate (annual rate).............. 13.86%
Weighted average life (in years)............................ 8.24
Weighted average discount rate.............................. 9.89%
NOTE 8 -- PREMISES AND EQUIPMENT
Premises and equipment are summarized as follows:
DECEMBER 31,
----------------------------------
USEFUL
2001 2000 LIVES
-------- -------- ----------
(IN THOUSANDS)
Land...................................................... $ 2,263 $ 1,737 n/a
Building and leasehold improvements....................... 19,742 17,410 7-40 years
Furniture and equipment................................... 49,001 40,660 3-10 years
-------- --------
71,006 59,807
Less accumulated depreciation............................. (36,018) (30,398)
-------- --------
Total........................................... $ 34,988 $ 29,409
======== ========
Amounts charged to non-interest expense for depreciation amounted to $5.2
million, $5.9 million, and $4.5 million in 2001, 2000, and 1999, respectively.
NOTE 9 -- LEASE OBLIGATIONS
At December 31, 2001, we leased certain branch locations and office
equipment used in our operations.
Operating lease rental expense was $19.8 million in 2001, $17.8 million in
2000, and $16.5 million in 1999.
80
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)
2002...................................................... $17,076
2003...................................................... 11,206
2004...................................................... 9,481
2005...................................................... 7,427
2006...................................................... 5,526
Thereafter................................................ 2,031
-------
Total minimum rental payments..................... $52,747
=======
NOTE 10 -- SHORT-TERM BORROWINGS
Short-term borrowings are summarized as follows:
DECEMBER 31,
--------------------
2001 2000
-------- --------
(IN THOUSANDS)
Repurchase agreements & drafts payable related to mortgage
loan closings............................................. $154,157 $ 64,557
Commercial paper............................................ 11,123 11,346
Federal Home Loan Bank borrowings........................... 212,000 153,000
Federal funds............................................... 35,200 20,000
Lines of credit and other borrowings........................ 75,483 226,599
-------- --------
$487,963 $475,502
======== ========
Weighted average interest rate.............................. 4.64% 6.79%
Repurchase agreements at December 31, 2001 and 2000, include $0.1 million
and $0.1 million in mortgages sold under agreements to repurchase that 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 $154.0 million and
$64.5 million at December 31, 2001 and 2000. 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 $11.1 million and $5.7 million at December 31,
2001 and 2000, respectively, payable to a company controlled by a significant
shareholder and director of Irwin Financial.
Federal funds and Federal Home Loan Bank borrowings are collateralized by
mortgage loans held for sale.
We also have lines of credit available of $813.3 million to fund loan
originations and operations. Interest on the lines of credit is payable monthly
or quarterly with rates ranging from 1.9% to 7.4%.
NOTE 11 -- LONG-TERM DEBT
Long-term debt consists of a note payable for $30.0 million with an
interest rate of 7.58%. This debt is carried on the balance sheet net of
capitalized fees of $0.3 million and $0.4 million as of December 31, 2001, and
2000, respectively. The entire principle of this note will mature on July 7,
2014.
NOTE 12 -- COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF
SUBSIDIARY TRUSTS
In January 1997, we issued $50.0 million of trust preferred securities
through IFC Capital Trust I, our wholly-owned statutory business trust
subsidiary created under the laws of Delaware. The securities were
81
issued at $25 per share with a cumulative dividend rate of 9.25%, payable
quarterly. In connection with the issuance of the securities, we sold an
equivalent amount of subordinated debentures to the trust. The securities have
an initial maturity of 30 years with a 19-year extension option. The securities
are callable at par after five years. The securities are shown on the balance
sheet at December 31, 2001 net of $1.8 million of capitalized issuance costs.
The sole assets of IFC Capital Trust I are our subordinated debentures 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. These funds are considered
Tier 1 qualifying capital.
In November 2000, we issued $51.75 million of trust preferred securities
through IFC Capital Trust II and $51.75 million of convertible trust preferred
securities through IFC Capital Trust III, wholly-owned statutory business trust
subsidiaries created under the laws of Delaware. The securities were issued at
$25 per share with cumulative dividend rates of 10.5% and 8.75%, respectively,
payable quarterly. They have an initial maturity of 30 years. The trust
preferred securities are not convertible into our common shares. The convertible
trust preferred securities have an initial conversion ratio of 1.261 shares of
common stock for each convertible preferred security (equivalent to an initial
conversion price of $19.825 per share of common stock). The securities are shown
on the balance sheet at December 31, 2001, net of $4.4 million of capitalized
issuance costs. The sole assets of IFC Capital Trust II and III are our
subordinated debentures with principal balances of $53.35 million each, interest
rates of 10.5% and 8.75%, respectively, and an initial maturity of 30 years. The
subordinated debentures of IFC Capital Trust II are callable at par after five
years. Both issues are Tier 1 qualifying capital elements.
In July 2001, we issued $15 million of trust preferred securities in a
private placement transaction through IFC Capital Trust IV, our wholly-owned
statutory business trust subsidiary created under the laws of Delaware. In
connection with the issuance of the trust preferred securities, we sold an
equivalent amount of subordinated debentures to the trust. These subordinated
debentures will mature on July 25, 2031, which date may be shortened to a date
not before July 25, 2006, if certain conditions are met. The securities are
shown on the balance sheet at December 31, 2001, net of $0.5 million of
capitalized issuance costs. The cumulative dividend rate payable on the trust
preferred securities and the subordinated debentures is 10.25%, payable
semiannually on January 25 and July 25 of each year. These funds are considered
Tier 1 qualifying capital.
In November 2001, we issued $30 million of trust preferred securities in a
private placement transaction through IFC Capital Trust V, a wholly-owned
statutory business trust subsidiary created under the laws of Delaware. In
connection with the issuance of the trust preferred securities, we sold an
equivalent amount of subordinated debentures to the trust. These subordinated
debentures will mature in 2031, with an option to call them at par after five
years. The securities are held on the balance sheet at December 31, 2001, net of
$0.9 million of capitalized issuance costs. The cumulative dividend rate payable
on the trust preferred securities and the subordinated debentures is 9.95%,
payable semiannually on June 8 and December 8 of each year. These funds are
considered Tier 1 qualifying capital.
NOTE 13 -- COMMITMENTS AND CONTINGENCIES
Our subsidiary, Irwin Mortgage Corporation is a defendant in a class action
lawsuit in the United States District Court for the northern District of Alabama
alleging that Irwin Mortgage violated the federal Real Estate Settlement
Procedures Act (RESPA) relating to Irwin Mortgage's payment of broker fees to
mortgage brokers. A second suit was filed September, 2001 seeking consolidation
with this case. In July, 2001, the plaintiffs filed a motion for partial summary
judgment asking the court to find Irwin Mortgage summarily liable for violating
RESPA. Irwin Mortgage filed a motion in opposition and these motions are now
pending before the district court.
In November, 2001, by order of the district court, the parties filed
supplemental briefs analyzing the impact of a new HUD policy statement that
explicitly disagrees with the judicial interpretation of RESPA by the Court of
Appeals for the 11th Circuit in its ruling upholding class certification in this
case. Irwin Mortgage filed a petition for certiorari with the United States
Supreme Court seeking review of the 11th Circuit's class certification ruling
and also filed a motion in the district court seeking a stay of further
proceedings until the 11th Circuit renders decisions in the other three RESPA
cases pending before it. The Supreme Court denied
82
Irwin Mortgage's petition. On March 8, 2002, the district court granted Irwin
Mortgage's motion to stay proceedings in this case.
At this stage of the litigation we are unable to determine the outcome or a
reasonable estimate of potential loss. However, we expect that an adverse
outcome in this lawsuit could result in substantial monetary damages that could
be material to our financial position. We have not established any reserves for
this case or for the second suit that seeks consolidation with this one. The
second case, which seeks class action status and contains allegations similar to
those in the first case, has been stayed until the 11th Circuit renders
decisions in the other three RESPA cases pending before it. An adverse outcome
in the second case could cause the company to suffer material losses.
In January, 2001, we and two subsidiaries, Irwin Leasing Corporation
(formerly Affiliated Capital Corp.) and Irwin Equipment Finance Corporation, our
indirect and direct subsidiaries, respectively (for purposes of this paragraph,
the Irwin companies), were served as defendants in an action filed in the U.S.
District Court for the Middle District of Pennsylvania. The suit alleges that a
manufacturer/importer of certain medical devices made misrepresentations to
health care professionals and to government officials to improperly obtain
Medicare reimbursement for treatment using the devices, and that the Irwin
companies, through Affiliated Capital's financing activities, aided in making
the alleged misrepresentations. The Irwin companies filed a motion to dismiss on
February 12, 2001. On August 10, 2001, the court granted our motion in part by
dismissing us and Irwin Equipment Finance as defendants in the suit. Irwin
Leasing remains a defendant. We have not established any reserves for this case.
Because the case is in the early stages of litigation, we are unable at this
time to form a reasonable estimate of the amount of potential loss, if any, that
we could suffer.
In May, 2001, Irwin Union Bank and Trust and Irwin Home Equity, our direct
and indirect subsidiaries, respectively (for purposes of this paragraph, Irwin),
received notice that they were named as defendants in a lawsuit filed in the
U.S. District Court for the District of Rhode Island. The suit alleges that
Irwin's disclosures and closing procedure for certain home equity loans did not
comply with certain provisions of the Truth in Lending Act. The suit also
requests that the court certify a plaintiff class in this action. On June 18,
2001, Irwin filed a motion with the court to compel arbitration pursuant to the
provisions in the home equity loan agreement. On October 20, 2001, the Court
entered judgment in favor of Irwin compelling arbitration and dismissing the
plaintiffs' complaint. The plaintiffs have appealed. We have not established any
reserves for this case. If arbitration is ultimately upheld, we do not expect to
suffer material loss in this case.
In an amended complaint, our subsidiary Irwin Union Bank and Trust was
named in place of our indirect subsidiary, Irwin Home Equity, as a defendant in
a suit originally filed in July, 2001 in the U.S. District Court for the
District of Massachusetts. The suit relates to a loan purchased by Irwin Union
Bank and Trust and serviced by Irwin Home Equity. The plaintiff alleges that the
loan documents did not comply with certain provisions of the Truth in Lending
Act relating to high rate loans. The suit also requests that the court certify a
plaintiff class in this action. Irwin Union Bank and Trust filed an answer to
the amended complaint denying plaintiff's allegations. Because the case is in
the early stages of litigation, we are unable at this time to form a reasonable
estimate of the amount of potential loss, if any, that we could suffer. We have
not established any reserves for this case.
On January 25, 2002, a jury awarded the plaintiffs damages of $1.434
million jointly and severally against defendants, including our subsidiary Irwin
Mortgage, in a case filed in August 1998 in the Baltimore, Maryland, City
Circuit Court. The nine plaintiffs alleged that a home rehabilitation company
defrauded them by selling them defective homes at inflated prices and that Irwin
Mortgage, which provided the plaintiff borrowers mortgage loans on the home
purchases, participated in the fraud. Prior to the outcome of the jury trial, we
had no reserves for this case. On February 6, 2002, plaintiffs filed a petition
for attorney's fees. On the same date, Irwin Mortgage filed post-trial motions
for judgment notwithstanding the verdict, new trial and/or remittitur, which is
a request for the court to reduce the amount of damages awarded by the jury. If
the court denies Irwin's post-trial motion, Irwin plans to appeal and will
continue to defend this case vigorously.
We and our subsidiaries are from time to time engaged in various matters of
litigation including the matters described above, other assertions of improper
or fraudulent loan practices or lending violations, and other matters, and we
have a number of unresolved claims pending. In addition, as part of the ordinary
course
83
of business, we and our subsidiaries are parties to litigation involving claims
to the ownership of funds in particular accounts, the collection of delinquent
accounts, challenges to security interests in collateral, and foreclosure
interests, that is incidental to our regular business activities. While the
ultimate liability with respect to these other litigation matters and claims
cannot be determined at this time, we believe that damages, if any, and other
amounts relating to pending matters are not likely to be material to our
consolidated financial position, results of operations, or cash flows, except as
described above. Reserves have been established for these various matters of
litigation, when appropriate, based upon the advice of legal counsel.
NOTE 14 -- FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
In the normal course of business we are party to certain financial
instruments with off-balance sheet risk to meet the financial needs of our
customers. These financial instruments include loan commitments and standby
letters of credit. Those instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amounts recognized on the
consolidated balance sheet.
Our exposure to credit loss, in the form of nonperformance by the
counterparty on commitments to extend credit and standby letters of credit, is
represented by the contractual amount of those instruments. 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, 2001,
were $157.6 million. These loan commitments include $120.8 million of floating
rate loan commitments and $36.8 million of fixed rate loan commitments related
to commercial banking activities. We had approximately $26.1 million and $14.6
million in irrevocable standby letters of credit outstanding at December 31,
2001 and 2000, respectively.
NOTE 15 -- DERIVATIVE FINANCIAL INSTRUMENTS
Financial derivatives are used as part of the overall asset/liability
management process. These instruments are used to manage risk-related to changes
in interest and foreign currency fluctuations. Our portfolio of derivative
financial instruments generally consist of forward contracts and interest rate
lock commitments relating to mortgage banking activities, financial futures
contracts, interest rate caps, forward foreign exchange contracts, and interest
rate swaps.
We enter into forward contracts to protect against interest rate
fluctuations from the date of mortgage loan commitment until the loans are sold.
At December 31, 2001, we designated the portion of these transactions hedging
the closed mortgage loans as hedges that qualify for hedge accounting treatment
under SFAS 133. The notional amount of these contracts (which does not represent
the amount at risk) totaled $646.7 million and $308.2 million at December 31,
2001 and 2000, respectively. The basis of the hedged closed loans is adjusted
for changes in value associated with the risk being hedged. We value these
contracts at period end based upon the current secondary market value of
securities with similar characteristics. The carrying amount and fair value of
these derivatives at December 31, 2001 was $0.7 million. Hedge ineffectiveness
recorded in gains from sales of loans related to these hedging activities was
immaterial. The effect of these hedging activities was recorded through earnings
as gain from sale of loans.
We enter into commitments to originate loans whereby the interest rate on
the loan is determined prior to funding (rate lock commitments). Rate lock
commitments on loans intended to be sold are considered to be derivatives and
are recorded at fair value. We value these commitments at period end based upon
the current secondary market value of securities with similar characteristics.
At December 31, 2001, we had a notional amount of rate lock commitments
outstanding totaling $326.5 million with a fair value of $0.9 million. Changes
in fair value of these derivatives are recorded in earnings.
Financial futures contracts or interest rate floors are used periodically
to hedge the value of servicing assets against declining interest rates which
increase prepayment activity and decrease the value of the servicing asset. To
the extent that interest rates increase, the value of servicing assets increases
while the value of these derivative instruments declines. As of December 31,
2001, our servicing asset derivative instruments had a positive fair value of
$17.5 million on a notional amount of $17.4 billion.
84
Derivative instruments are also used to protect the value of residual
interests. Interest rate caps are used when interest on securitized loans is
received at a fixed rate and paid to mortgage backed security holders at a
variable rate of interest. As interest rates change, the value of the residual
interests and interest rate caps move in opposite directions. At December 31,
2001, the carrying value of the interest rate caps was $0.1 million and the
notional amount was $16.9 million.
We enter into foreign currency contracts to protect the value of
intercompany loans made to Onset, our Canadian leasing company, against changes
in the exchange rate. We had a notional amount of $38.1 million in forward
contracts outstanding as of December 31, 2001.
The Canadian leasing company uses interest rate swaps to neutralize
repricing risk associated with its funding source. At December 31, 2001, we had
two interest rate swaps with a notional value of $16.0 million and $14.3
million. The interest rate swaps amortize on a schedule that is designed to
match the principal pay down of the loan portfolio and have a final maturity of
May 25, 2004. We can reduce the notional value of the swaps by up to 10% if
prepayments on the loans are greater than originally anticipated.
NOTE 16 -- REGULATORY MATTERS
Irwin Financial and our bank subsidiaries, Irwin Union Bank and Trust and
Irwin Union Bank, F.S.B. are subject to various regulatory capital requirements
administered by the federal and state banking agencies. Under capital adequacy
guidelines, Irwin Financial, Irwin Union Bank and Trust, and Irwin Union Bank,
F.S.B., 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. Capital amounts and classification are
also subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require minimum amounts and ratios (set forth in the following table) 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). We believe, as of
December 31, 2001, that we have met all capital adequacy requirements to which
we are subject.
As of December 31, 2001, we were categorized as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized, Irwin Financial, Irwin Union Bank and Trust, and Irwin Union Bank,
F.S.B., must exceed minimum total risk-based, Tier 1 risk-based, and Tier 1
capital to average assets ratios. There have been no conditions or events
subsequent to December 31, 2001 that we believe have changed our being well
capitalized.
85
The actual capital amounts and ratios of Irwin Financial, Irwin Union Bank
and Trust, and Irwin Union Bank, F.S.B. are presented in the following table:
ADEQUATELY WELL
ACTUAL CAPITALIZED CAPITALIZED
----------------- ----------------- -----------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
-------- ----- -------- ----- -------- -----
(IN THOUSANDS)
AS OF DECEMBER 31, 2001:
Total Capital (to Risk-Weighted
Assets):
Irwin Financial Corporation....... $468,337 10.8% $346,408 8.0% $433,010 10.0%
Irwin Union Bank and Trust........ 363,735 10.8 268,663 8.0 335,829 10.0
Irwin Union Bank, F.S.B........... 17,135 34.8 3,939 8.0 4,923 10.0
Tier 1 Capital (to Risk-Weighted
Assets):
Irwin Financial Corporation....... 295,021 6.8 173,204 4.0 259,806 6.0
Irwin Union Bank and Trust........ 342,153 10.2 134,332 4.0 201,497 6.0
Irwin Union Bank, F.S.B........... 17,074 34.7 N/A 2,954 6.0
Tier 1 Capital (to Average Assets):
Irwin Financial Corporation....... 295,021 9.4 126,091 4.0 157,613 5.0
Irwin Union Bank and Trust........ 342,153 10.9 125,344 4.0 156,680 5.0
Core Capital (to Adjusted Tangible
Assets)
Irwin Union Bank, F.S.B........... 17,074 9.4 7,293 4.0 9,117 5.0
Tangible Capital (to Tangible
Assets)
Irwin Union Bank, F.S.B........... 17,074 9.4 2,735 1.5 N/A
AS OF DECEMBER 31, 2000:
Total Capital (to Risk-Weighted
Assets):
Irwin Financial Corporation....... $384,144 12.9% $226,153 8.0% $282,691 10.0%
Irwin Union Bank and Trust........ 283,611 10.3 220,180 8.0 275,225 10.0
Irwin Union Bank, F.S.B........... 6,636 105.9 501 8.0 627 10.0
Tier 1 Capital (to Risk-Weighted
Assets):
Irwin Financial Corporation....... 250,825 8.4 113,076 4.0 169,614 6.0
Irwin Union Bank and Trust........ 271,037 9.9 110,090 4.0 165,135 6.0
Irwin Union Bank, F.S.B........... 6,636 105.9 N/A 376 6.0
Tier 1 Capital (to Average Assets):
Irwin Financial Corporation....... 250,825 12.4 80,823 4.0 101,028 5.0
Irwin Union Bank and Trust........ 271,037 12.7 85,600 4.0 106,999 5.0
Core Capital (to Adjusted Tangible
Assets)
Irwin Union Bank, F.S.B........... 12,738 51.9 510 4.0 637 5.0
Tangible Capital (to Tangible
Assets)
Irwin Union Bank, F.S.B........... 12,738 51.9 191 1.5 N/A
86
ADEQUATELY WELL
ACTUAL CAPITALIZED CAPITALIZED
----------------- ----------------- -----------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
-------- ----- -------- ----- -------- -----
(IN THOUSANDS)
AS OF DECEMBER 31, 1999:
Total Capital (to Risk-Weighted
Assets):
Irwin Financial Corporation....... $246,183 13.5% 145,891 8.0% 182,363 10.0%
Irwin Union Bank and Trust........ 144,305 10.0 115,295 8.0 144,119 10.0
Tier 1 Capital (to Risk-Weighted
Assets):
Irwin Financial Corporation....... 207,627 11.4 72,945 4.0 109,418 6.0
Irwin Union Bank and Trust........ 136,864 9.5 57,647 4.0 86,471 6.0
Tier 1 Capital (to Average Assets):
Irwin Financial Corporation....... 207,627 12.8 65,046 4.0 81,307 5.0
Irwin Union Bank and Trust........ 136,864 11.0 50,349 4.0 62,936 5.0
NOTE 17 -- FAIR VALUES OF FINANCIAL INSTRUMENTS
Fair value estimates, methods and assumptions are set forth below for our
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, Loans, Loans held
for sale, Deposit liabilities, Short-term borrowings, Long-term debt, and
Company-obligated mandatorily redeemable preferred securities of subsidiary
trust: The fair values were estimated using discounted cash flow analyses,
using interest rates currently being offered for like assets with similar terms,
to borrowers with similar credit quality, and for the same remaining maturities.
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 that had no quoted market
prices, fair values were estimated by discounting future cash flows using
current rates 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.
Derivative instruments: The carrying amounts reported in the balance sheet
for derivative instruments approximate those assets' fair values. The estimated
fair values of derivative instruments are determined using methodologies
discussed in Note 15.
Loan commitments -- commercial bank: No value is assigned for unfunded
commitments as these primarily represent commitments to land at market rates
tied to short term indices.
87
The estimated fair values of our financial instruments at December 31, are
as follows:
2001 2000
---------------------------- ----------------------------
CARRYING ESTIMATED FAIR CARRYING ESTIMATED FAIR
AMOUNT VALUE AMOUNT VALUE
---------- -------------- ---------- --------------
(IN THOUSANDS)
FINANCIAL ASSETS:
Cash and cash equivalents.............. $ 158,291 $ 158,291 $ 83,493 $ 83,493
Interest-bearing deposits with
financial institutions............... 14,247 14,257 36,400 36,442
Trading assets......................... 216,684 216,684 154,921 154,921
Investment securities.................. 38,796 38,937 37,095 37,163
Loans held for sale.................... 503,757 505,076 579,788 579,788
Loans, net of unearned discount........ 1,871,135 1,919,336 1,078,604 1,145,129
Servicing asset........................ 257 257
FINANCIAL LIABILITIES:
Deposits............................... 2,309,018 2,296,929 1,443,330 1,452,024
Short-term borrowings.................. 487,963 488,361 475,502 478,342
Long-term debt......................... 29,654 30,334 29,608 30,597
Company-obligated mandatorily
redeemable preferred securities of
subsidiary trust..................... 190,948 208,102 147,167 157,681
2001 2000
-------------------------- --------------------------
NOTIONAL ESTIMATED FAIR NOTIONAL ESTIMATED FAIR
AMOUNT VALUE AMOUNT VALUE
-------- -------------- -------- --------------
OFF BALANCE SHEET:
Loan commitments -- commercial bank...... $157,576 $ -- $ 36,521 $ --
Interest rate lock commitments(1)........ N/A N/A 643,289 --
Standby letters of credit................ 22,661 -- 14,649 --
Forward contract commitments(1).......... N/A N/A 308,208 704
---------------
(1) Due to the adoption of SFAS 133, these commitments are considered
derivatives and are included on balance sheet at December 31, 2001.
The fair value estimates consider relevant market information when
available. Because no market exists for a significant portion of our financial
instruments, fair value estimates are determined based on present value of
estimated cash flows 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 our
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, and premises and
equipment.
NOTE 18 -- SHAREHOLDERS' EQUITY
We have a stock plan that provides up to 300,000 shares to be used to
compensate Business Development Board members of Irwin Union Bank and Trust and
Irwin Union Bank, F.S.B. As of December 31, 2001 and 2000, 8,071 shares and
7,378 shares were issued at a weighted average price of $22.13 and $16.17,
respectively.
We also have a stock plan to compensate our Directors with our common
stock, if so elected, in lieu of cash for their annual retainer and meeting
fees. The number of shares issued under the plan is based on the current market
value of our common stock. In 2001 and 2000, respectively, we granted 5,466 and
8,678 shares
88
under the 1999 plan at a weighted average fair value of $21.89 and $19.63. In
addition, we have 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.
We have two stock option plans (established in 1997 and 1992) that provide
for the issuance of 2,840,000 shares of non-qualified and incentive stock
options. In addition, the 2001 stock plan provides for the issuance of 2,000,000
of non-qualified and incentive stock options, stock appreciation rights,
restricted stock, and phantom stock units. An additional 2,000,000 of stock
appreciation rights may be granted under this plan For all plans, 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 our stock on
the grant date. Vested outstanding stock options have been considered as common
stock equivalents in the computation of diluted earnings per share. In 2001, we
awarded 3,952 shares of common stock in restricted stock grants at a weighted
average fair value of $25.30 through this plan.
Activity in the above plans for 2001, 2000, and 1999 is summarized as
follows:
2001 2000 1999
-------------------------- -------------------------- --------------------------
WEIGHTED- WEIGHTED- WEIGHTED-
NUMBER OF AVERAGE NUMBER OF AVERAGE NUMBER OF AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE
--------- -------------- --------- -------------- --------- --------------
Outstanding at the
beginning of the year.... 1,616,259 $13.37 1,328,090 $12.50 1,257,050 $ 9.68
Granted.................. 416,197 22.13 351,934 16.67 216,155 24.02
Exercised................ (329,053) 5.25 (32,400) 5.56 (137,600) 4.19
Canceled................. (19,095) 20.87 (31,365) 21.60 (7,515) 24.59
--------- --------- ---------
Outstanding at the of the
year..................... 1,684,308 17.04 1,616,259 13.37 1,328,090 12.50
========= ========= =========
Exercisable at the end of
the year................. 1,162,817 $15.46 1,210,356 $11.30 1,045,659 $ 9.64
========= ========= =========
The table below shows options outstanding and exercisable by price range as
of December 31, 2001:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------------------- ---------------------------------
WEIGHTED
NUMBER AVERAGE WEIGHTED NUMBER WEIGHTED
RANGE OF OUTSTANDING REMAINING AVERAGE EXERCISABLE AVERAGE
EXERCISE PRICES AS OF 12/31/2001 CONTRACTUAL LIFE EXERCISE PRICE AS OF 12/31/2001 EXERCISE PRICE
------------------------------ ---------------- ---------------- -------------- ---------------- --------------
$ 5.53 - $10.66............... 454,343 3.35 $ 8.27 454,343 $ 8.27
$13.69 - $16.50............... 220,111 6.07 $14.03 194,853 $13.89
$16.97 - $21.28............... 311,401 8.37 $17.26 153,731 $17.18
$21.38 - $23.97............... 357,388 9.15 $21.83 106,737 $22.13
$24.09 - $28.56............... 341,065 7.39 $25.44 253,153 $25.71
--------- ---- ------ --------- ------
$ 5.53 - $28.56............... 1,684,308 6.68 $17.04 1,162,817 $15.46
The fair value of each option was estimated to be $11.43, $9.32, and $10.97
on the date of the grant using the binomial option-pricing model with the
following assumptions for 2001, 2000, and 1999, respectively: risk free interest
rates of 5.22%, 6.13%, and 5.20%; dividend yield of 1.00% for 2001 and 2000, and
0.83% for 1999; and volatility of 40% for 2001 and 2000, and 28.7% for 1999.
We have 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
89
grant dates, our net income and earnings per share would have been reduced to
the pro forma amounts indicated below:
2001 2000 1999
------- ------- -------
(IN THOUSANDS)
Net income
As reported............................................... $45,516 $35,666 $33,156
Pro forma................................................. 43,629 34,365 32,176
Basic earnings per share
As reported............................................... 2.15 1.70 1.54
Pro forma................................................. 2.06 1.64 1.49
Diluted earnings per share
As reported............................................... 2.00 1.67 1.51
Pro forma................................................. 1.90 1.61 1.49
NOTE 19 -- EARNINGS PER SHARE
Earnings per share calculations are summarized as follow:
BASIC EFFECT OF EFFECT OF EFFECT OF DILUTED
EARNINGS STOCK PREFERRED CONVERTIBLE EARNINGS
PER SHARE OPTIONS SHARES SHARES PER SHARE
--------- --------- --------- ----------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
2001
Net income before cumulative effect of change
in accounting principle.................... $45,341 $ -- $ -- $2,801 $48,142
Shares........................................ 21,175 292 96 2,610 24,173
------- ------ ------ ------ -------
Per-Share Amount.............................. 2.14 (0.03) (0.01) (0.11) 1.99
------- ====== ====== ====== -------
Cumulative effect of change in accounting
principle.................................. 175 175
------- -------
Per-Share Amount.............................. 0.01 0.01
------- -------
Net income.................................... 45,516 48,317
------- -------
Per-Share Amount.............................. $ 2.15 $ 2.00
======= =======
2000
Net income.................................... $35,666 $ -- $ -- $ 295 $35,961
Shares........................................ 20,973 281 78 261 21,593
------- ------ ------ ------ -------
Per-Share Amount.............................. $ 1.70 $(0.02) $(0.01) $ -- $ 1.67
======= ====== ====== ====== =======
1999
Net income.................................... $33,156 $ -- $33,156
Shares........................................ 21,530 356 N/A N/A 21,886
------- ------ -------
Per-Share Amount.............................. $ 1.54 $(0.03) $ 1.51
======= ====== =======
In 2001, 562,764 shares related to stock options were not included in the
dilutive earnings per share calculation because they were antidilutive.
90
NOTE 20 -- INCOME TAXES
Income tax expense is summarized as follows:
2001 2000 1999
------- ------- -------
(IN THOUSANDS)
CURRENT:
Federal................................................... $ 2,578 $ 1,374 $ 3,251
State..................................................... (199) 600 687
------- ------- -------
2,379 1,974 3,938
======= ======= =======
DEFERRED:
Federal................................................... 22,876 18,000 14,580
State..................................................... 3,369 3,702 963
------- ------- -------
26,245 21,702 15,543
======= ======= =======
INCOME TAX EXPENSE:
Federal................................................... 25,454 19,374 17,831
State..................................................... 3,170 4,302 1,650
------- ------- -------
$28,624 $23,676 $19,481
======= ======= =======
Our net deferred tax liability, which is included in other liabilities on
the consolidated balance sheet, consisted of the following:
DECEMBER 31,
-------------------
2001 2000
-------- --------
(IN THOUSANDS)
Mortgage servicing.......................................... $(83,974) $(48,912)
Deferred securitization income.............................. (43,023) (34,438)
Loan and lease loss reserve................................. 13,499 4,958
Deferred origination fees and costs......................... 2,090 1,786
Deferred compensation....................................... 7,779 5,097
Retirement benefits......................................... 310 1,155
Fixed assets................................................ (3,096) (1,919)
Net operating loss carryforwards............................ 6,001 --
Other, net.................................................. 2,075 179
-------- --------
Net deferred tax liability.................................. $(98,339) $(72,094)
======== ========
At December 31, 2001, we have a deferred tax asset of $6.0 million relating
to net operating loss carry forwards. These loss carryforwards, if not utilized,
expire beginning in 2020.
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:
2001 2000 1999
------- ------- -------
(IN THOUSANDS)
Income taxes computed at the statutory rate................. $25,765 $20,770 $18,423
Increase (decrease) resulting from:
Nontaxable interest from investment securities and
loans.................................................. (141) (136) (410)
State franchise tax, net of federal benefit............... 2,060 2,796 2,121
Change in deferred tax asset or liability resulting from
tax rate change........................................ -- -- (1,055)
Other items -- net........................................ 940 246 402
------- ------- -------
$28,624 $23,676 $19,481
======= ======= =======
91
NOTE 21 -- EMPLOYEE RETIREMENT PLANS
We have a contributory retirement and savings plan that covers all
employees and meets requirements of Section 401(k) of the Internal Revenue Code.
Employees may contribute up to 14% of their compensation to the plan which is
matched by 60% by us up to 5% of the employee's compensation.
The matching vests 20% after one year, 40% after two years, 60% after three
years, 80% after four years, and 100% after 5 years. The expense to match
employee contributions for the years ended December 31, 2001, 2000 and 1999 was
approximately $1.0 million, $1.1 million and $1.0 million, respectively.
We have 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 our balance sheet:
DECEMBER 31,
-----------------
2001 2000
------- -------
(IN THOUSANDS)
Funded status............................................... $(2,140) $(2,775)
Unrecognized prior service cost............................. 131 156
Unrecognized net actuarial loss............................. 5,287 2,578
Adjustment for minimum liability............................ -- (800)
------- -------
Accrued pension cost........................................ $ 3,278 $ (841)
======= =======
Weighted average assumptions:
Discount rate............................................. 7.00% 7.25%
Return on plan assets..................................... 8.50% 8.50%
Rate of compensation increase
Bank Employees......................................... 3.75% 3.75%
All Other Employees.................................... 4.00% 4.00%
A reconciliation of the change in projected benefit obligation and plan
assets is presented below:
2001 2000
------- -------
(IN THOUSANDS)
Benefit obligation at January 1,............................ $13,441 $10,531
Service cost................................................ 750 623
Interest cost............................................... 971 819
Actuarial loss.............................................. 669 1,811
Benefits paid............................................... (330) (343)
------- -------
Benefit obligation at December 31,.......................... $15,501 $13,441
======= =======
Fair value plan assets at January 1,........................ $10,666 $11,602
Actual return on plan assets................................ (1,275) (1,135)
Benefits paid............................................... (330) (343)
Employer contributions...................................... 4,300 542
------- -------
Fair value plan assets at December 31,...................... $13,361 $10,666
======= =======
92
The net pension cost for 2001, 2000 and 1999 included the following
components:
2001 2000 1999
----- ------- -----
(IN THOUSANDS)
Service cost................................................ $ 750 $ 650 $ 627
Interest cost............................................... 971 819 713
Expected return on plan assets.............................. (888) (1,040) (906)
Amortization of prior service cost.......................... 25 25 25
Amortization of actuarial loss.............................. 123 -- --
----- ------- -----
Net pension cost............................................ $ 981 $ 454 $ 459
===== ======= =====
NOTE 22 -- INDUSTRY SEGMENT INFORMATION
We have five principal segments that provide a broad range of financial
services throughout the United States and Canada. The Mortgage Banking line of
business originates, sells, and services residential first mortgage loans. The
Home Equity Lending line of business originates and services home equity loans.
The Commercial Banking line of business provides commercial banking services.
The Equipment Leasing line of business leases commercial equipment. The Venture
Capital line of business invests in early-stage companies that could transform
the way financial services are delivered. Our other segment primarily includes
the parent company and eliminations.
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 2001, 2000, and 1999:
MORTGAGE HOME EQUITY COMMERCIAL EQUIPMENT VENTURE
BANKING LENDING BANKING LEASING CAPITAL OTHER CONSOLIDATED
-------- ----------- ---------- --------- -------- -------- ------------
(IN THOUSANDS)
2001
Net interest income......... $ 30,959 $ 60,706 $ 43,293 $ 2,584 $ (404) $ (7,494) $ 129,644
Intersegment interest....... (667) (1,272) (194) (42) -- 2,175 $ --
Other revenue............... 199,169 64,984 14,789 1,695 (10,482) 1,236 $ 271,391
Intersegment revenues....... -- -- 210 -- 630 (840) $ --
-------- -------- ---------- -------- -------- -------- ----------
Total net revenues...... 229,461 124,418 58,098 4,237 (10,256) (4,923) 401,035
Other expense............... 166,233 96,776 40,923 8,938 661 13,889 $ 327,420
Intersegment expenses....... 1,391 562 2,577 -- -- (4,530) $ --
-------- -------- ---------- -------- -------- -------- ----------
Net income before
taxes................. 61,837 27,080 14,598 (4,701) (10,917) (14,282) 73,615
Income taxes................ 23,912 10,832 5,680 -- (4,368) (7,432) $ 28,624
-------- -------- ---------- -------- -------- -------- ----------
Income before minority
interest.............. 37,925 16,248 8,918 (4,701) (6,549) (6,850) 44,991
Minority interest........... 307 43 350
-------- -------- ---------- -------- -------- -------- ----------
Income before cumulative
effect of change in
accounting
principle............. 37,925 16,248 8,918 (4,394) (6,549) (6,807) 45,341
Cumulative effect of change
in accounting principle... 175 175
-------- -------- ---------- -------- -------- -------- ----------
Net income (loss)........... $ 38,100 $ 16,248 $ 8,918 $ (4,394) $ (6,549) $ (6,807) $ 45,516
======== ======== ========== ======== ======== ======== ==========
Assets at December 31,...... $926,946 $602,226 $1,648,294 $266,670 $ 7,421 $(11,597) $3,439,960
======== ======== ========== ======== ======== ======== ==========
93
MORTGAGE HOME EQUITY COMMERCIAL EQUIPMENT VENTURE
BANKING LENDING BANKING LEASING CAPITAL OTHER CONSOLIDATED
-------- ----------- ---------- --------- -------- -------- ------------
(IN THOUSANDS)
2000
Net interest income......... $ 18,477 $ 36,921 $ 35,774 $ 1,737 $ (597) $ (6,719) $ 85,593
Intersegment interest....... (2,719) (1,789) (295) (54) (1) 4,858 $ --
Other revenue............... 125,174 68,315 11,808 799 5,146 469 $ 211,711
Intersegment revenues....... -- -- 166 -- 420 (586) $ --
-------- -------- ---------- -------- -------- -------- ----------
Total net revenues...... 140,932 103,447 47,453 2,482 4,968 (1,978) 297,304
Other expense............... 117,188 71,479 33,327 5,024 431 10,513 $ 237,962
Intersegment expenses....... 2,199 1,144 2,446 21 -- (5,810) $ --
-------- -------- ---------- -------- -------- -------- ----------
Net income before
taxes................. 21,545 30,824 11,680 (2,563) 4,537 (6,681) 59,342
Income taxes................ 8,539 12,330 4,590 -- 1,814 (3,597) $ 23,676
-------- -------- ---------- -------- -------- -------- ----------
Net income (loss)....... $ 13,006 $ 18,494 $ 7,090 $ (2,563) $ 2,723 $ (3,084) $ 35,666
======== ======== ========== ======== ======== ======== ==========
Assets at December 31,...... $523,920 $550,526 $1,167,559 $159,773 $ 15,198 $ 5,453 $2,422,429
======== ======== ========== ======== ======== ======== ==========
1999
Net interest income......... $ 22,984 $ 20,276 $ 29,114 $ -- $ (109) $ (9,587) $ 62,678
Intersegment interest....... (3,237) (1,424) -- (18) -- 4,679 $ --
Other revenue............... 161,020 31,714 11,622 -- 1,306 (1,592) $ 204,070
Intersegment revenues....... -- -- 175 -- -- (175) $ --
-------- -------- ---------- -------- -------- -------- ----------
Total net revenues...... 180,767 50,566 40,911 (18) 1,197 (6,675) 266,748
Other expense............... 142,439 34,672 28,024 825 78 8,073 $ 214,111
Intersegment expenses....... 2,476 885 1,056 -- -- (4,417) $ --
-------- -------- ---------- -------- -------- -------- ----------
Net income before
taxes................. 35,852 15,009 11,831 (843) 1,119 (10,331) 52,637
Income taxes................ 12,789 2,403 4,486 -- 463 (660) $ 19,481
-------- -------- ---------- -------- -------- -------- ----------
Net income (loss)....... $ 23,063 $ 12,606 $ 7,345 $ (843) $ 656 $ (9,671) $ 33,156
======== ======== ========== ======== ======== ======== ==========
Assets at December 31,...... $549,966 $339,640 $ 789,560 $ 543 $ 8,096 $ (6,958) $1,680,847
======== ======== ========== ======== ======== ======== ==========
NOTE 23 -- IRWIN FINANCIAL CORPORATION (PARENT ONLY) FINANCIAL INFORMATION
The condensed financial statements of the parent company as of December 31,
2001 and 2000, and for the three years ended December 31, 2001 are presented
below:
CONDENSED BALANCE SHEET
DECEMBER 31,
--------------------
2001 2000
-------- --------
(IN THOUSANDS)
ASSETS:
Cash and short-term investments........................... $ 1,293 $ 1,127
Investment in bank subsidiary............................. 361,289 277,571
Investments in non-bank subsidiaries...................... 146,336 41,344
Loans to bank subsidiaries................................ 31,000 30,000
Loans to non-bank subsidiaries............................ 556 48,278
Other assets.............................................. 2,342 6,464
-------- --------
$542,816 $404,784
======== ========
LIABILITIES:
Short-term borrowings..................................... $ 71,123 $ 34,346
Long-term debt............................................ 225,349 181,522
Other liabilities......................................... 14,928 (1,009)
-------- --------
$311,400 $214,859
======== ========
94
DECEMBER 31,
--------------------
2001 2000
-------- --------
(IN THOUSANDS)
SHAREHOLDERS' EQUITY:
Preferred stock........................................... $ 1,386 $ 1,386
Common stock.............................................. 29,965 29,965
Other shareholders' equity................................ 200,065 158,574
-------- --------
231,416 189,925
-------- --------
$542,816 $404,784
======== ========
CONDENSED STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------
2001 2000 1999
-------- -------- --------
(IN THOUSANDS)
INCOME
Dividends from non-bank subsidiaries..................... $ 451 $ 87,269 $ 15,500
Dividends from bank subsidiary........................... 10,000 37,153 14,147
Interest income.......................................... 2,221 4,949 4,800
Other.................................................... 6,555 6,635 3,200
-------- -------- --------
19,227 136,006 37,647
-------- -------- --------
EXPENSES
Interest expense......................................... 20,069 12,643 9,891
Salaries and benefits.................................... 9,111 7,906 5,398
Other.................................................... 5,874 2,933 2,672
-------- -------- --------
35,054 23,482 17,961
-------- -------- --------
Income before income taxes and equity in undistributed
income of subsidiaries................................... (15,827) 112,524 19,686
Income taxes (credits), less amounts charged to
subsidiaries............................................. (10,738) (5,966) (10,482)
-------- -------- --------
(5,089) 118,490 30,168
Equity in undistributed income of subsidiaries............. 50,605 (82,824) 2,988
-------- -------- --------
Net income....................................... $ 45,516 $ 35,666 $ 33,156
======== ======== ========
95
CONDENSED STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31,
----------------------------------
2001 2000 1999
--------- --------- --------
(IN THOUSANDS)
Net income............................................... $ 45,516 $ 35,666 $ 33,156
Adjustments to reconcile net income to cash provided by
operating activities:
Equity in undistributed income of subsidiaries......... (50,605) 82,824 (2,988)
Depreciation and amortization.......................... 448 505 408
Increase (decrease) in taxes payable................... 10,130 (1,102) 4,695
Decrease in interest receivable........................ (360) (122) (159)
Increase (decrease) in interest payable................ (577) 986 763
Net change in other assets and other liabilities....... 8,268 (4,077) 4,322
--------- --------- --------
Net cash provided by operating activities...... 12,820 114,680 40,197
--------- --------- --------
Lending and investing activities:
Net decrease (increase) in loans to subsidiaries....... 46,722 7,245 (25,302)
Investments in subsidiaries............................ (138,314) (172,409) (39,122)
Net sales of premises and equipment.................... 72 314 286
--------- --------- --------
Net cash used by lending and investing
activities................................... (91,520) (164,850) (64,138)
--------- --------- --------
Financing activities:
Net increase (decrease) in borrowings.................. 36,777 (46,398) 13,778
Proceeds from long-term debt........................... 45,000 102,260 30,000
Issuance of preferred stock............................ -- 1,386 --
Purchase of treasury stock............................. (3,223) (3,414) (18,314)
Proceeds from sale of stock for employee benefit
plans............................................... 5,834 1,866 2,608
Dividends paid......................................... (5,520) (5,038) (4,287)
--------- --------- --------
Net cash provided by financing activities...... 78,868 50,662 23,785
--------- --------- --------
Net increase in cash and cash equivalents.............. 168 492 (156)
Effect of exchange rate changes on cash................ (2) (8) --
Cash and cash equivalents at beginning of year......... 1,127 643 799
--------- --------- --------
Cash and cash equivalents at end of year............... $ 1,293 $ 1,127 $ 643
========= ========= ========
Supplemental disclosures of cash flow information:
Cash paid during the year:
Interest............................................ $ 20,646 $ 11,657 $ 9,056
========= ========= ========
Income taxes........................................ $ 5,235 $ 13,769 $ 14,328
========= ========= ========
NOTE 24 -- SUBSEQUENT EVENT
In February 2002, we successfully completed a public offering that raised
$82.2 million, net of expenses, on the sale of 6,210,000 shares of common stock.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
See our Current Report on Form 8-K dated June 29, 2001, with respect to
disclosures required by this item.
96
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE CORPORATION
The information contained in our proxy statement for the 2002 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. See also the "Executive Officers" section in Part I, Item 1.
ITEM 11. EXECUTIVE COMPENSATION
The information contained in our proxy statement for the 2002 Annual
Meeting of Shareholders under the captions "Election of Directors -- Outside
Director Compensation," "Executive Compensation and Other Information,"
"Compensation Committee Interlocks and Insider Participation" and "Board
Compensation Committee Report on Executive Compensation" on pages 9 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 our proxy statement for the 2002 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 our proxy statement for the 2002 Annual
Meeting of Shareholders under the caption "Interest of Management in Certain
Transactions" on pages 20 through 23, inclusive, is incorporated herein by
reference in response to this item.
97
PART IV
ITEM 14.
3. Exhibits
A. Exhibits to Form 10-K
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
------- ----------------------
3.1 Restated Articles of Incorporation of Irwin Financial
Corporation. (Incorporated by reference to Exhibit 3(a) to
Form 10-K Report for year ended December 31, 2000, File No.
0-06835.)
3.2 Articles of Amendment to Restated Articles of Incorporation
of Irwin Financial Corporation dated March 2, 2001.
(Incorporated by reference to Exhibit 3(b) to Form 10-K
Report for year ended December 31, 2000, File No. 0-06835.)
3.3 Code of By-laws of Irwin Financial Corporation.
(Incorporated by reference to Exhibit 3 to Form 10-Q for
period ended March 31, 2001, File No. 0-06835.)
4.1 Specimen Common Stock Certificate. (Incorporated by
reference to Exhibit 4(a) to Form 10-K report for year ended
December 31, 1994, File No. 0-06835.)
4.2 Certain instruments defining the rights of the holders of
long-term debt of Irwin Financial Corporation and certain of
its subsidiaries, none of which authorize a total amount of
indebtedness in excess of 10% of the total assets of the
Corporation and its subsidiaries on a consolidated basis,
have not been filed as Exhibits. The Corporation hereby
agrees to furnish a copy of any of these agreements to the
Commission upon request.
4.3 Rights Agreement, dated as of March 1, 2001, between Irwin
Financial Corporation and Irwin Union Bank and Trust.
(Incorporated by reference to Exhibit 4.1 to Form 8-A filed
March 2, 2001, File No. 0-06835.)
4.4 Appointment of Successor Rights Agent dated as of May 11,
2001 between Irwin Financial Corporation and National City
Bank. (Incorporated by reference to Exhibit 4.5 to Form S-8
filed on September 7, 2001, File No. 333-69156.)
10.1 *Amended 1986 Stock Option Plan. (Incorporated by reference
to Exhibit 10(b) to Form 10-K Report for year ended December
31, 1991, File No. 0-06835.)
10.2 *Irwin Financial Corporation 1992 Stock Option Plan.
(Incorporated by reference to Exhibit 10(h) to Form 10-K
Report for year ended December 31, 1992, File No. 0-06835.)
10.3 *Irwin Financial Corporation 1997 Stock Option Plan.
(Incorporated by reference to Exhibit 10 to Form 10-Q Report
for period ended June 30, 1994, File No. 0-06835.)
10.4 *Amendment to Irwin Financial Corporation 1997 Stock Option
Plan. (Incorporated by reference to Exhibit 10(i) to Form
10-Q Report for period ended June 30, 1997, File No.
0-06835.)
10.5 *Irwin Financial Corporation 2001 Stock Plan. (Incorporated
by reference to Exhibit 10.18 to Form S-1/A filed February
14, 2002, File No. 333-69586.)
10.6 *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. 0-06835.)
10.7 *Irwin Financial Corporation Outside Directors Restricted
Stock Compensation Plan. (Incorporated by reference to
Exhibit 10(i) to Form 10-K Report for year ended December
31, 1995, File No. 0-06835.)
98
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
------- ----------------------
10.8 *1999 Outside Director Restricted Stock Compensation Plan.
(Incorporated by reference to Exhibit 10(b) to Form 10-Q
Report for period ended June 30, 1999, File No. 0-06835.)
10.9 *Irwin Financial Corporation Employees' Stock Purchase Plan.
(Incorporated by reference to Exhibit 10(d) to Form 10-K
Report for year ended December 31, 1991, File No. 0-06835.)
10.10 *Employee Stock Purchase Plan II. (Incorporated by reference
to Exhibit 10(f) to Form 10-K Report for year ended December
31, 1994, File No. 0-06835.)
10.11 *Employee Stock Purchase Plan III. (Incorporated by
reference to Exhibit 10(a) to Form 10-Q Report for period
ended June 30, 1999, File No. 0-06835.)
10.12 *Long-Term Management Performance Plan. (Incorporated by
reference to Exhibit 10(a) to Form 10-K Report for year
ended December 31, 1986, File No. 0-06835.)
10.13 *Long-Term Incentive Plan-Summary of Terms. (Incorporated by
reference to Exhibit 10(a) to Form 10-K Report for year
ended December 31, 1986, File No. 0-06835.)
10.14 *Inland Mortgage Corporation Long-Term Incentive Plan.
(Incorporated by reference to Exhibit 10(j) to Form 10-K
Report for year ended December 31, 1995, File No. 0-06835.)
10.15 *Amended and Restated Management Bonus Plan. (Incorporated
by reference to Exhibit 10(a) to Form 10-K Report for year
ended December 31, 1986, File No. 0-06835.)
10.16 *Limited Liability Company Agreement of Irwin Ventures LLC.
(Incorporated by reference to Exhibit 10(a) to Form 10-Q/A
Report for period ended March 31, 2001, File No. 0-06835.)
10.17 *Limited Liability Company Agreement of Irwin Ventures
Co-Investment Fund LLC, effective as of April 20, 2001.
(Incorporated by reference to Exhibit 10.17 to Form S-1/A
filed February 14, 2002, File No. 333-69586.)
10.18 *Irwin Home Equity Corporation Shareholder Agreement and
Amendments. (Incorporated by reference to Exhibit 10(b) to
Form 10-Q/A Report for period ended March 31, 2001, File No.
0-06835.)
10.19 *Promissory Note dated January 30, 2002 from Elena Delgado
to Irwin Financial Corporation. (Incorporated by reference
to Exhibit 10.19 to Form S-1/A filed February 14, 2002, File
No. 333-69586.)
10.20 *Consumer Pledge Agreement dated January 30, 2002 between
Elena Delgado and Irwin Financial Corporation. (Incorporated
by reference to Exhibit 10.20 to Form S-1/A filed February
14, 2002, File No. 333-69586.)
11.1 Computation of Earnings Per Share.
12.1 Computation of Ratio of Earnings to Fixed Charges.
21.1 Subsidiaries of Irwin Financial Corporation. (Incorporated
by reference to Exhibit 21.1 to Form S-1/A filed February
14, 2002, File No. 333-69586.)
23.1 Consent of Independent Accountants.
---------------
* Indicates management contract or compensatory plan or arrangement.
99
B. Reports on Form 8-K:
8-K October 18, 2001 Attaching news release announcing third quarter earnings.
8-K October 19, 2001 Attaching news release announcing fourth quarter dividend.
8-K/A November 1, 2001 Amendment to 8-K filed 10-18-01 correcting and updating
certain income statement and balance sheet items.
8-K November 20, 2001 Attaching news release announcing plans to address
anticipated new regulations on residual interests.
8-K December 3, 2001 Attaching news release announcing sale of home equity
residual interest.
100
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Corporation has duly caused this report to be signed
on its behalf by the Undersigned, thereunto duly authorized.
IRWIN FINANCIAL CORPORATION
Date: March 20, 2002 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 Corporation and in the capacities on the dates indicated.
CAPACITY WITH
SIGNATURE CORPORATION DATE
--------- ------------- ----
/s/ SALLY A. DEAN Director March 20, 2002
-----------------------------------------------------
Sally A. Dean
/s/ DAVID W. GOODRICH Director March 20, 2002
-----------------------------------------------------
David W. Goodrich
/s/ JOHN T. HACKETT Director March 20, 2002
-----------------------------------------------------
John T. Hackett
/s/ WILLIAM H. KLING Director March 20, 2002
-----------------------------------------------------
William H. Kling
/s/ BRENDA J. LAUDERBACK Director March 20, 2002
-----------------------------------------------------
Brenda J. Lauderback
/s/ JOHN C. MCGINTY, JR. Director March 20, 2002
-----------------------------------------------------
John C. McGinty, Jr
/s/ WILLIAM I. MILLER Director, Chairman of the Board March 20, 2002
----------------------------------------------------- (Principal Executive Officer)
William I. Miller
/s/ JOHN A. NASH Director, Chairman of the March 20, 2002
----------------------------------------------------- Executive Committee
John A. Nash
/s/ LANCE R. ODDEN Director March 20, 2002
-----------------------------------------------------
Lance R. Odden
/s/ THEODORE M. SOLSO Director March 20, 2002
-----------------------------------------------------
Theodore M. Solso
/s/ GREGORY F. EHLINGER Senior Vice President March 20, 2002
----------------------------------------------------- (Principal Financial Officer)
Gregory F. Ehlinger
/s/ JODY A. LITTRELL Vice President and Controller March 20, 2002
----------------------------------------------------- (Principal Accounting
Jody A. Littrell Officer)
101