Item 1 Business
General
Irwin Financial Corporation (the "Registrant") is a diversified financial services company organized as an Indiana bank holding company in May, 1972. The Registrant's principal subsidiaries are Inland Mortgage Corporation ("Inland Mortgage"), a mortgage banking company; Irwin Union Bank and Trust Company ("Irwin Union Bank"), a commercial bank; Affiliated Capital Corp. ("Affiliated"), an equipment leasing company; Irwin Home Equity Corporation ("Home Equity"), a consumer home equity lending company; White River Capital Corporation, a small venture capital company; and Irwin Union Credit Insurance Corporation, a credit insurance company. Registrant is also the sole equity shareholder of IFC Capital Trust I ("Capital Trust"), a special purpose trust. Registrant is in the process of winding down Irwin Union Investor Services, Inc. ("Investor Services") an investment and financial counseling company.
Business of Subsidiaries
Inland Mortgage originates, purchases and services conventional or government agency backed (i.e., FHA and VA) residential mortgage loans. Most mortgages are either insured by an agency of the federal government, or in the case of a conventional mortgage, meet requirements for resale to the Federal National Mortgage Association or the Federal Home Loan Mortgage Corporation. Periodically, Inland Mortgage sells loans to private investors pursuant to their requirements. Inland also originates a small amount of commercial mortgages.
Inland Mortgage sells mortgage loans to institutional investors but may retain servicing rights to mortgage loans that it originates or purchases from correspondents. Inland 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. Inland Mortgage operates 106 production and satellite offices in 27 states. During 1996, Inland Mortgage established offices in Temecula, California; Colorado Springs, and Denver Central, Colorado; Marlton previously Cape May, New Jersey; Albuquerque, New Mexico; Austin, Texas. During 1996, Inland Mortgage closed offices in Fresno, Long Beach, Montclair, Orange, Pleasanton, San Francisco, San Mateo, San Rafael, and Selma, California; Prescott, Arizona; Bloomington and St. Louis Park, MN; Kalispell, Montana; Santa Fe, New Mexico; and Orting and Vancouver, Washington.
Inland Mortgage will enter the non-prime first mortgage lending market in 1997. This market is comprised of borrowers who do not qualify under the underwriting guidelines established by the government sponsored secondary market agencies for conforming first mortgages. Inland opened a non-prime lending office in Richmond, Virginia late in the fourth quarter of 1996 and will begin originating nonprime first mortgages in 1997.
Inland Mortgage and the Registrant have, for several years, been exploring opportunities to test the development of mortgage banking operations in markets outside the United States. In December, 1996, Inland Mortgage began taking applications from U. S. Borrowers for Dollar denominated loans to be secured by residential real estate located in Mexico. Inland does not expect to close any of these loans until the first quarter of 1997. The Registrant hopes to continue research of international opportunities to which Registrant might apply its knowledge and competencies.
Irwin Union Bank, organized in 1871, is a full service commercial bank offering a wide variety of services to individual, business, institutional, and governmental customers. Irwin Union Bank's services include personal and commercial checking accounts, savings and time deposit accounts, personal and business loans, credit card services, money transfer, financial counseling, property and casualty insurance agency services, trust services, securities brokerage and safe deposit facilities. Irwin Union Bank XXXPage 3XXX
is the largest of nine financial institutions operating in Bartholomew County, Indiana with eight locations throughout the county. Irwin Union Bank also has branch facilities in Seymour (Jackson County - 2), Shelbyville (Shelby County 2), Bloomington (Monroe County), Franklin (Johnson County), and Greensburg (Decatur County), Indiana. Irwin Union Bank has two trust custodial offices in Indianapolis, Indiana. The custodial locations are scheduled to close in January, 1997.
Affiliated, acquired in 1990 and located in Northbrook, Illinois, is engaged in the small-ticket equipment leasing and commercial lending business. Affiliated offers nonrecourse, non- operating, full payout leases and commercial lines of credit to physicians, medical clinics, veterinarians, dentists and chiropractors.
Home Equity was formed in 1994 and is located in San Ramon, California. Home Equity originates and services home equity loans. The loans are marketed through direct mail and telemarketing in sixteen states.
White River Capital Corporation ("White River"), a venture capital company, is located in Columbus, Indiana and currently holds one investment but has suspended making new investments.
Irwin Union Credit Insurance Corporation is located in Columbus, Indiana and provides credit life insurance to consumer loan customers of Irwin Union Bank.
IFC Capital Trust I ("Capital Trust"), is a statutory business trust created under the laws of Delaware. The Company owns all of the Common Securities of Capital Trust. Trust exists for the purpose of issuing the Preferred Securities and investing the proceeds thereof in an equivalent amount of 9.25% Subordinated Debentures of the Company. The Subordinated Debentures will mature on March 31, 2027, which date may be (i) shortened to a date not earlier than March 31, 2002, or (ii) extended to a date not later than March 31, 2046, in each case if certain conditions are met (including, in the case of shortening the Stated Maturity, the Company having received prior approval of the Board of Governors of the Federal Reserve System ("Federal Reserve") to do so if then required under applicable capital guidelines or policies of the Federal Reserve). The Preferred Securities, which are guaranteed by the Company, will have a preference under certain circumstances with respect to cash distributions and amounts payable on liquidation, redemption or otherwise over the Common Securities. Holders of Preferred Securities are entitled to receive preferential cumulative cash distributions, at the annual rate of 9.25% of the liquidation amount of $25 per Preferred Security accruing from the date of original issuance and payable quarterly in arrears on the last day of March, June, September and December of each year, commencing March 31, 1997.
No single part of the business of the Registrant is dependent upon a single customer or upon a very few customers and the loss of any one customer would not have a materially adverse effect upon the business of the Registrant. Inland Mortgage is registered as a Foreign Financial Institution in Mexico but has no foreign operations or export sales.
Competition
Inland Mortgage originates and services residential first mortgage loans from 106 production and satellite offices in Arizona, California, Colorado, Delaware, Florida, Georgia, Hawaii, Illinois, Indiana, Kentucky, Louisiana, Minnesota, Missouri, New Jersey, New Mexico, Nevada, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, Texas, Utah, Washington, Wisconsin and the Washington, D.C. metropolitan area, including offices in Maryland and Virginia. In each of these locations, competition for mortgage loans is vigorous, coming from other national, regional and local mortgage banking companies as well as commercial banks, savings banks and savings & loan associations. Inland Mortgage purchases mortgage loans from correspondents in these and other states as well.
The commercial banking business for Irwin Union Bank in the Bartholomew, Decatur, Jackson, Johnson, Monroe and Shelby County areas is very competitive. Within these counties, in addition XXXPAGE 4XXX
to the commercial banks, there are a number of savings banks, savings & loan associations and credit unions competing for deposits and loans. Irwin Union Bank also competes for the provision of banking services with banks located elsewhere in Indiana, primarily in south central Indiana, and with a number of nonbank companies located throughout the United States, including insurance companies, retailers, brokerage firms, companies offering money market accounts, and national credit card companies. As of December 31, 1996, Irwin Union Bank ranked first among commercial banking and savings bank institutions on the basis of Bartholomew County deposits. In addition to the above mentioned counties, Irwin Union Bank derives its business from several other counties in south central Indiana.
Affiliated provides, primarily, medical equipment leasing and commercial credit services to medical clinics, small groups of physicians, individual practitioners, chiropractors, dentists and veterinarians. Affiliated's primary competitors include other equipment leasing companies with operations that are national in scope, banks and other financial institutions which offer commercial credit products. Such competitors may be headquartered anywhere in the country.
Home Equity originates home equity loans for private home owners in several states. Home Equity's primary competitors include banks, thrifts, credit unions and other home equity lenders with operations that are either national, regional or local in scope. Such competitors may be headquartered anywhere in the country.
Supervision and Regulation
The Registrant is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended, and is registered with, regulated and examined by the Board of Governors of the Federal Reserve System (the "Board of Governors").
Subject to certain exceptions, a bank holding company is prohibited from acquiring direct or indirect ownership or control of more than five percent of the voting shares of any company which is not a bank and from engaging directly or indirectly in activities unrelated to banking or managing or controlling banks. One exception to this prohibition permits activities by a bank holding company or its subsidiary which the Board of Governors determines to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. The Board of Governors has adopted regulations prescribing those activities it presently regards as permissible which include the activities engaged in by Registrant and its subsidiaries.
The Bank Holding Company Act, the Federal Reserve Act and the Federal Deposit Insurance Act also subject bank holding companies and their subsidiaries to certain restrictions on extensions of credit by subsidiary banks to the bank holding company or any of its subsidiaries, or investments in the securities thereof, and on the taking of such securities as collateral for loans to any borrower. Further, the Bank Holding Company Act and the regulations of the Board of Governors thereunder, prohibit a bank holding company and its subsidiaries from engaging in certain tie-in arrangements in connection with any extension of credit, sale or lease of any property or furnishing of services.
In addition to the regulation of the Registrant, Irwin Union Bank is subject to extensive regulation and periodic examination, principally by the Indiana Department of Financial Institutions and the Federal Deposit Insurance Corporation. Inland Mortgage is subject to audit and examination oversight by the federal department of Housing and Urban Development as well as the Government National Mortgage Association, the Federal National Mortgage Association, and the Federal Home Loan Mortgage Corporation. The insurance subsidiary of the Registrant and the insurance subsidiary of Irwin Union Bank are dependent upon state licenses and upon franchise agreements with private corporations for their continued existence. The home equity subsidiary of the Registrant is also dependent upon state licenses for its ability to extend credit in certain states. Finally, the securities brokerage activities of Registrant's registered broker/dealer are regulated and examined by the Securities and Exchange Commission, the Indiana Securities Division, the securities divisions of the various states in which Investor Services operates, and the National Association of Securities Dealers. XXXPAGE 5XXX
Employees and Labor Relations
As of December 31, 1996, the Registrant and its subsidiaries had a total of 1,998 employees, including full-time and parttime employees. The Registrant continues a commitment of equal employment opportunity for all job applicants and staff members, and management regards its relations with its employees as satisfactory.
Further Information
The following information responsive to Guide 3 promulgated under the Securities Exchange Act of 1934, is contained in the "Management's Discussion and Analysis of Financial Conditions and Results of Operations" section of the Annual Report to Shareholders for the year ending December 31, 1996 and is incorporated herein by reference: "Daily Average Consolidated Balance Sheet, Interest Rates and Interest Differential" (p. 70), "Investment Securities" (p. 57), "Short-Term Borrowings" (p. 59), "Summary of Net Interest Income Changes" (p. 55), "Deposits" (p. 58), "Loans and Leases" (p. 56), "Five-Year Selected Financial Data" (p. 28), and the discussion and tabular information under the caption "Credit Risk" on pages 62 to 66 of "Management's Discussion and Analysis of Financial Conditions and Results of Operations".
Executive Officers of the Registrant
The Executive Officers of the Registrant are elected annually by the Board of Directors and serve for a term of one year or until their successors are elected and qualified. There are no arrangements or understandings between any Executive Officer and any other person pursuant to which the Officer was or is to be selected as an Officer.
Robert P. Albert (46) is President of Affiliated Capital Corp. since February 28, 1990.
Claude E. Davis (36) is President of Irwin Union Bank since January 2, 1996. He has been an officer since 1988.
Elena Delgado (41) is President of Irwin Home Equity Corporation since September 4, 1994. From March through August, 1994, Ms. Delgado was an independent consultant to Irwin Financial Corporation. From 1990 to 1993, Ms. Delgado was Vice President, Second Mortgage Lending of First Deposit Corporation.
Gregory F. Ehlinger (34) is Vice President and Treasurer of the Registrant since August of 1992. From 1988 to 1992, Mr. Ehlinger was employed by Irwin Management Company, Inc. (A private management company).
Jose M. Gonzalez (38) is Vice President and Director of Internal Audit of the Registrant since October of 1995. From 1993 to 1995, Mr. Gonzalez was Senior Vice President, Audit & Compliance Services of Premier Bank and Trust. From 1991 to 1993, Mr. Gonzalez was Vice President and Senior Compliance Officer at First Empire State Corporation.
Theresa L. Hall (44) is Vice President of the Registrant, since 1988. She has been an officer since 1980.
Rick L. McGuire, (44) is President of Inland Mortgage since January 1, 1996. He has been an officer since 1978.
William I. Miller (40) is Chairman of the Board, since 1990, and has been a Director of the Registrant since 1985. XXXPAGE 6XXX
John A. Nash (59) is Chairman of the Executive Committee, since 1990, and President, since 1985, of the Registrant. He has been an officer and Director of the Registrant since 1972.
Michael F. Ryan (51) is Vice President Community Relations of the Registrant since January 2, 1996. He was President of Irwin Union Bank from 1981 - 1995. He has been an officer since 1976.
Matthew F. Souza (40) is Vice President and Secretary of the Registrant. He has been an officer since 1985.
Marie C. Strack (34) is Vice President and Controller of the Registrant since May of 1992. From 1985 to 1992, Ms. Strack was employed by the public accounting firm of Coopers & Lybrand L.L.P., as Audit Manager.
Thomas D. Washburn (50) is Senior Vice President and Chief Financial Officer, since 1980, of the Registrant. He has been an officer since 1976.
Item 2.

Item 2. Properties
The location and general character of the materially important physical properties of the Registrant and its subsidiaries are as follows:
The main office of Inland Mortgage, where administrative and servicing activities are centered, is located at 9265 Counselor's Row, Indianapolis, Indiana and a new servicing facility is located at 11800 Exit Five Parkway, Indianapolis, Indiana. Inland Mortgage also has loan production and satellite offices located in Flagstaff, Phoenix (3), Mesa, Scottsdale, Tempe, and Tucson, Arizona; Antioch, Bakersfield, Concord, Covina, Lake Forest, Morgan Hill, Pasadena, Porterville, Richmond, Sacramento, Salinas, Santa Rosa, Temecula, Ventura, Visalia, Walnut Creek, Westlake Village, Woodland, Yuba City, and Yreka, California; Castle Rock, Colorado Springs, Denver (2), Englewood, and Fort Collins , Colorado; Bethany Beach and Newark, Delaware; Clearwater, Longwood, and Orlando, Florida; Atlanta, Georgia; Aiea, Honolulu, Kailua, and Maui, Hawaii; Chicago, Decatur, and Tinley Park, Illinois; Indianapolis (5), Anderson, Ft. Wayne, Kokomo, Lafayette, LaPorte, South Bend, and Warsaw, Indiana; Lexington and Louisville, Kentucky; Baton Rouge, Louisiana; Columbia, Crofton, Rockville, Solomons, and Towson, Maryland; Arden Hills, Burnsville, and Minneapolis, Minnesota; St. Louis, Missouri; Las Vegas, Nevada; Marlton previously Cape May, New Jersey; Albuquerque, New Mexico; Cary, Charlotte, Greensboro, and Raleigh, North Carolina; Cleveland, Dayton, and Independence, Ohio; Tulsa, Oklahoma; Beaverton and Clackamas, Oregon; West Chester, Pennsylvania; Austin, Corpus Christi, Dallas, El Paso, Houston, North Houston, and Plano, Texas; Salt Lake City, Utah; Fredericksburg, Gloucester, Richmond, Springfield, Suffolk, and Woodbridge, Virginia; Bellevue, Battleground, Everett, Mount Lake Terrace, Seattle, and Snohomish, Washington; and Madison, Wisconsin. All offices occupied by Inland Mortgage are leased.
The main office of Irwin Union Bank is located in four connected buildings all at 500 and 520 Washington Street, Columbus, Indiana. These buildings and one branch building are owned in fee by Irwin Union Realty Corporation, a whollyowned subsidiary of Irwin Union Bank, and are leased by Irwin Union Bank. Irwin Union Bank owns in fee three of its other thirteen relatively small branch banking premises. The other branch offices are leased. None of the properties owned by Irwin Union Bank are subject to any major encumbrances.
The main office of Affiliated, where administrative and lease servicing activities are centered, is located at 707 Skokie Boulevard, Northbrook, Illinois. This office location is leased.
The main office of Irwin Home Equity is located at 12677 Alcosta Blvd., Suite 500, San Ramon, California. This office location is leased. XXXPAGE 7XXX
The main offices of the Registrant, White River Capital Corporation and Irwin Union Credit Insurance Corporation are located at 500 Washington Street, Columbus, Indiana in space leased from Irwin Union Bank.
Item 3.

Item 3. Legal Proceedings
As a part of the ordinary course of business, the Registrant and its subsidiary companies are parties to litigation involving claims to the ownership of funds in particular accounts, the collection of delinquent accounts, challenges to security interests in collateral, and foreclosure interests, that is incidental to their regular business activities.
As of December 31, 1996, Inland Mortgage was a defendant to a class action lawsuit initiated in the state of Minnesota. The case is currently pending before a federal Multidistrict Litigation Panel in Chicago, Illinois. Plaintiffs allege that they represent a nationwide class of persons who have or had mortgage escrow accounts allegedly improperly managed by Inland Mortgage. This case is among a series of class action cases commenced against a number of mortgage servicers in several states challenging the practices used in connection with the administration of escrow accounts for single family residential mortgages. Early in January, 1997, class certification was denied to the plaintiff by the court. The plaintiff may still pursue an action against Inland Mortgage as an individual and plaintiff's counsel may still seek to find another mortgagor who would support a new class action against Inland Mortgage so it is impossible to predict the likelihood of an unfavorable outcome or to establish possible extent or amount of liability or potential loss exposure, if any, to which Inland Mortgage might be exposed in this or similar escrow individual or class action cases brought in the future.
As of December 31, 1996, Inland Mortgage was a defendant to a class action lawsuit initiated in the state of Indiana. The case is currently pending before the Marion County Superior Court. Plaintiffs allege that lenders do not have the right to require borrowers to pay premiums for private mortgage insurance. This case is among a series of class action cases commenced against a number of mortgage lenders in several states challenging the right of mortgage lenders to collect private mortgage insurance payments from borrowers. In February, 1996, Inland Mortgage filed a motion for summary judgment with the court. In December, 1996, the court denied the motion. The litigation is still at a stage where it is impossible to predict the likelihood of an unfavorable outcome or to establish possible extent or amount of liability or potential loss exposure, if any, to which Inland Mortgage might be exposed.
As of December 31, 1996, Inland Mortgage was a defendant to a class action lawsuit initiated in the state of Alabama. This action is one of a breed of "RESPA Section 8" class actions that have been filed against several mortgage lenders challenging the legality of the payment of broker fees by mortgage lenders to mortgage brokers. The litigation is still at an early stage and it is impossible to predict the likelihood of an unfavorable outcome or to establish possible extent or amount of liability loss exposure, if any, to which Inland Mortgage might be exposed.
As of December 31, 1996, the Registrant, Home Equity and certain officers of Home Equity were defendants to an action initiated in the State of California. The case is currently pending in the Superior Court of the State of California in and for the City and County of San Francisco. The plaintiff alleges that defendants misappropriated trade secrets of plaintiff due to the employment by Home Equity of former officers and employees of plaintiff. The plaintiff originally sought a preliminary injunction hearing but the hearing was vacated in April, 1996. It is impossible to predict the extent or amount of liability or potential loss exposure, if any, to which Home Equity and the other named defendants might be exposed.
As of December 31, 1996, Irwin Union Bank was plaintiff in an action initiated in the State of New York against another depository institution arising from a wire transfer of funds which occurred in September, 1995. The litigation is presently in the discovery stage and it is impossible to predict the likelihood of an unfavorable outcome or to establish the full extent of the potential loss exposure, if any, to which Irwin Union Bank may be exposed. XXXPAGE 8XXX
Except as described above, there is no material pending litigation in which the Registrant or any of its subsidiaries is involved or of which any of their property is the subject. Furthermore, there is no pending legal proceeding that is adverse to the Registrant in which any director, officer or affiliate of the Registrant, or any associate of any such director or officer, is a party, or has a material interest.
Item 4.

Item 4. Submission of Matters to a Vote of Security Holders
During the fourth quarter of 1996, no matters were submitted to a vote of security holders of the Registrant, through the solicitation of proxies or otherwise.
PART II
Item 5.

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The Common Stock of the Registrant is quoted on The Nasdaq National Market (NASDAQ-NMS - trading symbol, IRWN). The following table sets forth certain information regarding trading in, and cash dividends paid with respect to, the shares of the Registrant's Common Stock in each quarter of the two most recent calendar years. All data have been adjusted for stock splits. The approximate number of shareholders of record on March 11, 1997 was 1,550.
The Registrant expects to continue its policy of paying regular cash dividends, although there is no assurance as to future dividends because they are dependent on future earnings, capital requirements, and financial condition. On February 27, 1996, the Registrant's Board of Directors a pproved an increase in the Registrant's quarterly dividend to $.12 per share which dividend rate was adjusted to reflect the two-for-one stock split of December 30, 1996. Dividends paid by Irwin Union Bank to the Registrant are restricted by banking law. See Note 14 of Notes to the Consolidated Financial Statements in the attached Annual Report to Shareholders.
No sales of unregistered equity securities were made by the Registrant during the fourth quarter of 1996. XXXPAGE 9XXX
Item 6.

Item 6. Selected Financial Data
The information contained in the Annual Report to Shareholders for the year ended December 31, 1996, under the caption "Five-Year Selected Financial Data", is incorporated herein by reference in response to this item.
Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Forward Looking Statements. The Company desires to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995 as to "forward looking" statements in this Form 10-K. This section contains certain forward looking statements within the meaning of such Act, including the statements made under the "1997 Outlook" section for each line of business. Such statements are subject to risks and uncertainties and actual results for subsequent periods could differ materially from those addressed in forward looking statements as a result of various factors, including the following:
Economic Conditions. The Company's results are likely to be influenced by general economic conditions. Changes in local, regional or national economies could have a material impact on the credit quality of the Company's assets and the demand for its products and services.
Interest Rate Fluctuations. The Company actively manages its interest rate risk exposure as described below in "Interest Rate Sensitivity," but if interest rates should change rapidly or vary substantially from anticipated levels, the Company's results may be impacted in the shortterm.
Government Regulation and Monetary Policy. The financial services industry is subject to extensive federal and state regulations. There have been significant changes in the past in such regulations, and there may be future legislation or repeal of or changes in laws or regulations that could have a material impact on the Company's businesses. Further, federal monetary policy particularly as implemented through the Federal Reserve System, significantly affects credit conditions for the Company, primarily through open market operations in U.S. government securities, the discount rate for member bank borrowing and bank reserve requirements, and a material change in these conditions would be likely to have an impact on results.
Credit Quality and Liquidity Risk. As discussed below under "Risk Management," "Credit Risk" and "Liquidity," the Company's businesses involve the assumption of substantial financial risk. While the Company employs risk management policies and procedures intended to minimize such financial risk exposures as described below, such policies and procedures may not prevent unexpected losses if borrowers' nonperformance significantly exceeds the estimated loan loss levels anticipated by management in establishing loan and lease loss reserves.
Computation. The Company competes with numerous financial institutions and other non-depository financial intermediaries in each of its lines of business. Future results may be impacted if circumstances affecting the nature or level of competition change, such as the merger of competing financial institutions or aggressive expansion by existing competitors that may impact net interest margin.
Management's Discussion and Analysis of Results of Operations and Financial Condition:
*Adjusted for stock splits
Consolidated Overview:
Irwin Financial Corporation earned record net income in 1996. This performance was largely due to increased loan originations in the mortgage banking business, continued growth at the community bank, and improved results at the Corporation's newly formed home equity lending business.
Net income for 1996 totaled $22,428,338, up 11.7% from 1995 and 23.1% from 1994. Net income per share in 1996 was $1.93 compared to $1.75 in 1995 and $1.55 in 1994. Return on average equity for 1996 was 20.58% compared to 22.60% in 1995 and 23.91% in 1994. Return on average assets was 1.95% compared to 2.28% in 1995 and 2.43% in 1994.
Earnings By LineIrwin Financial Corporation is comprised of four lines of business: - Mortgage banking - Community banking XXXPAGE 11XXX
- Home equity lending - Equipment leasing
To provide an effective report on the Corporation's operations, the results of the activities of Irwin Union Bank which provide funding and invest in assets generated by other Irwin Financial companies have been included with the results of the other asset-generating companies. These combined figures are reported as the results of each line of business.
Business Profile: Mortgage Banking
XXXPAGE 12 XXX
Overview & Strategy:
The mortgage banking line of business consists of Inland Mortgage Corporation and the related activities of Irwin Union Bank. The business is headquartered in Indianapolis and originates, packages, sells, and services residential mortgage loans throughout the U.S. It has offices in 27 states and ranks among the top 25 mortgage loan originators in the country. Most of the loans originated and serviced are either government-insured through the Veterans' Administration (VA) or Federal Housing Administration (FHA) or conventional loans which conform to the underwriting guidelines of the two principal government-sponsored agencies which support the secondary mortgage markets, the Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corporation (FHLMC).
Mortgage loans are originated through both branches (retail) and third party sources (wholesale). Potential borrowers are identified principally through relationships maintained with housing intermediaries including realtors and home builders.
Loans are funded on a short-term basis through credit facilities provided by commercial banks including Irwin Union Bank. Repurchase agreements with investment banks are also used. Individual loans are pooled, securitized, and sold into the secondary mortgage market. Servicing rights are periodically sold for a variety of reasons including cash flow and servicing portfolio management. Over the past five years, servicing rights have been retained on a total of 67.8% of the loans originated by this line of business.
1996 Review: Net income from mortgage banking was $20.4 million in 1996, an increase of 5.6% over 1995 results of $19.3 million and 29.8% over 1994 results of $15.7 million.
Annual loan closings in 1996 of $5.1 billion were up 42.9% from 1995 and 80.8% from 1994. During 1996 the mortgage bank originated a greater portion of its loans through wholesale channels than had been done in previous years. Income from mortgage loan originations totaled $43.5 million which was $11.6 million over 1995 and $18.2 million over 1994. Mortgage loan applications in process at the end of 1996 totaled $1.5 billion, compared with $1.2 billion at the end of 1995 and $0.5 billion at the end of 1994. Refinances accounted for 19.0% of 1996 loan closings, compared to 11.6% in 1995 and 15.8% in 1994. XXXPAGE 13XXX
Gains from the sale of mortgage loans totaled $25.5 million in 1996, up from $18.0 million in 1995 and $2.2 million in 1994. Gains recognized in 1996 and for the last nine months of 1995 reflect the change in generally accepted accounting principles for mortgage banking (SFAS No. 122) which took effect April 1, 1995. Net revenues from loan sales were tempered somewhat by loan pricing concessions which totaled $2.5 million in 1996 compared to $3.8 million in 1995 and $0.1 million in 1994.
*Run-off is the reduction in principal balance of the servicing portfolio due to regular principal payments made by mortgagees and early repayment of an entire loan.
The mortgage servicing portfolio was $10.8 billion at December 31, 1996, up 4.9% from the same date in 1995 and 22.6% from 1994. The 1996 annual portfolio run-off rate was 10.7%. This is up from the 1995 rate of 10.4% and the 1994 rate of 6.3%. The following table sets forth certain information regarding the interest rates of loans in the servicing portfolio at December 31:
The value of capitalized servicing rights must be adjusted for impairment which could result from interest rate changes. Although impairment write-offs caused by declining interest rates would be accompanied by increased loan origination fees, management has implemented hedging alternatives to avoid significant impairment provisions. Expenses related to mortgage servicing right impairment and hedging totaled $637.9 thousand in 1996 compared to $908.8 thousand in 1995. None were recorded in 1994.
The preceding information is related to the servicing portfolio owned by Inland. In addition to the owned servicing portfolio, the business subservices conventional loans for which it does not own XXXPAGE 14XXX
servicing rights. The subservicing portfolio totaled $1.7 billion at December 31, 1996, compared to $1.9 billion on the same date in 1995.
Servicing fee income is recognized by collecting fees which range between 25 and 44 basis points annually on the principal amount of the underlying mortgages. An increase in the average size of the servicing portfolio throughout the year positively affected servicing income which increased 23.6% from 1995 and 37.5% from 1994.
Sale of Mortgage Servicing:
The mortgage banking business maintains the flexibility to either sell servicing rights for current income and cash flow or retain servicing for future cash flow. The decision to sell or retain servicing is based on current market conditions balanced with the business' interest rate risk tolerance.
Servicing rights totaling $3.1 billion were sold in 1996, generating a $16.4 million pre-tax gain on those sales, net of any purchased servicing expense which had been capitalized. This compares to servicing sales of $1.0 billion in 1995 that produced a $15.3 million pre-tax gain and $1.4 billion in 1994 that produced a $17.7 million pretax gain. The lower margin recognized in 1996 reflects the impact of the change in mortgage accounting standards made in 1995. Had all servicing been retained in 1996, gains on sales of loans would have been higher than what was recorded, with a corresponding reduction in gains from sales of servicing. Therefore, the net increase in income as a result of the decision to sell servicing was insignificant. Servicing sales in 1996 represented 60.9% of 1996 closings versus 1995 sales which were 28.4% of that year's closings and 1994 sales which were 49.8% of closings.
Net Interest Income:
Net interest income is generated from the interest earned on mortgage loans before they are sold to investors, less the interest expense incurred on borrowings to fund the loans. Net interest income totaled $16.8 million in 1996, compared to $13.3 million in 1995 and $12.7 million in 1994. The increase is due primarily to the increased loan volume experienced in 1996.
Total operating expenses increased 36.3% from 1995 and 75.9% from 1994. The increase reflects the continued expansion of the production system and increased costs associated with technological improvements made during the year.
1997 Outlook: XXXPAGE 15XXX
The environment in which the mortgage bank operates is rapidly changing. As a result, technology will play an increasingly important role in the mortgage bank's strategic plans. Management believes that in order to remain competitive, the mortgage bank must advance its use of technology to reduce its costs of production and enhance its distribution methods or develop new channels of distribution. Significant technology initiatives which were started in 1996 will continue during the coming year.
Throughout much of its history, the mortgage banking business has concentrated on the origination of FHA and VA loans. As such, the company developed a reputation of effectively serving the mortgage origination needs of first time home buyers. These borrowers generally require more guidance through the origination process than do those borrowers who previously qualified for mortgage loans.
Inland Mortgage continues to be interested in leveraging its capabilities to serve those borrowers who have special needs. The business recently began two initiatives to expand its reach in special needs borrowing. Both are in their early stages and are not expected to add materially to results in 1997. They are indicative, however, of efforts the company is making to focus on defensible market segments where a sustainable competitive advantage can be created based upon a dedication to customer service, fast turnaround time, and product innovation.
The first such initiative is the mortgage bank's entrance into the non-prime first mortgage lending market which is comprised of borrowers who do not qualify under the underwriting guidelines established by the government sponsored secondary market agencies for conforming first mortgages. The second initiative to expand the company's reach involves making mortgage loans on selected resort properties located outside the United States. In December, 1996, Inland Mortgage began taking applications from U.S. borrowers for dollar denominated loans to be secured by residential real estate located in Mexico. The company is prepared to begin closing such loans during the first quarter of 1997.
Employees:
As of December 31, 1996, the mortgage banking line of business employed 1,474 people- approximately 74% of the Corporation's total employee base. Total employment expense in 1996 was $66.2 million or 58.2% of operating expenses.
Inland Mortgage Corporation Directors
John T. Hackett Managing General Partner, CID Equity Partners, L. P. (Venture Capital Partnership) William H. Kling President, Minnesota Public Radio Inland Mortgage Corporation William I. Miller Chairman, Irwin Financial Corporation John A. Nash President, Irwin Financial Corporation Lance R. Odden President and Headmaster, The Taft School James T. Sakai Former Chairman, Contour Hardening, Inc. (Metals Treatment Company) Thomas G. Shafran President, Better Homes Realty Thomas D. Washburn Senior Vice President, Irwin Financial Corporation XXXPage 16XXX
Darell E. Zink, Jr. Executive Vice President and Chief Financial Officer Duke Investments, Inc. (Real Estate Development Company)
Inland Mortgage Corporation Senior Officers
Rick L. McGuire President Herbert B. Tasker Executive Vice President-All Pacific Region T. Lester Acree Senior Vice President- Wholesale Loan Purchasing Kenneth R. Block Senior Vice President-Loan Production Katrina J. Crubaugh Senior Vice President-Human Resources Mark J. Lynch Senior Vice President- Nonconforming Lending William M. Meyer Senior Vice President-Loan Servicing Timothy L. Murphy Senior Vice President-Finance Erik J. Sorensen Senior Vice President-Secondary Marketing Scott G. Beer First Vice President-Secondary Marketing Mark E. Braden First Vice President-Information Technology Richard C. Cargill First Vice President-Metro Phoenix Robert H. Griffith, Jr. First Vice President and Legal Counsel Renee M. Gunderson First Vice President-Underwriting/Closing Post Closing Darla S. Habig First Vice President-Loan Control Allan D. Karlander First Vice President-Central Region John F. Macke First Vice President- Management Information David P. Matern First Vice President-Loan Administration Rachelle E. Mikosz First Vice President-Office Services Kevin M. Murphy First Vice President-Accounting Michael G. Plank First Vice President-Atlantic Coast Region Diana M. Rossetter First Vice President-Quality Control Suzanne C. Samson First Vice President-All Pacific Region Sherri K. Sanford First Vice President-Customer Service Lyle E. Shearer First Vice President-All Pacific Region Richard E. Skiles First Vice President-Appraisals Nicholas Vracas First Vice President-Mid-states Region
Business Profile: Community Banking
Overview & Strategy:
Community banking is conducted by Irwin Union Bank and Trust Company which is headquartered in Columbus, Indiana. At year-end 1996, it had 15 offices in six counties in south central Indiana. It holds a major share of the market in Bartholomew County where it has operated since 1871. Expansion into surrounding counties has occurred in recent years and has been on a de novo basis. The community bank's strategy in these and other possible new markets is to position itself as "the local bank." The objective is to deliver services in the way customers would expect from a bank headquartered in that market. This means that every effort is made to staff the offices with local people and to give those people the authority to make key customer decisions. Credit, investment, trust, and insurance services are provided to individual and corporate customers.
1996 Review:
Community banking net income in 1996 totaled $4.3 million, up 16.9% from 1995 net income of $3.6 million and 39.5% from 1994 net income of $3.1 million. The return on average equity was 13.35% in 1996 as compared to 13.16% in 1995 and 12.93% in 1994. Results include the income and expenses of trust operations and investment advisory services which were previously reported in the investor services line of business and are now managed and reported by the community bank. Also included are credit insurance income and expenses which were previously reported as a separate line of business. Results for previous years have been restated for comparability.
XXX PAGE 18XXX
*Reflects what net interest revenue would be if all interest income was subject to federal and state income taxes.
Net interest revenue on a taxable equivalent basis increased 9.4% from 1995 and 34.1% from 1994 to a total of $20.1 million. Net interest revenue is the product of net interest margin and average earning assets.
Net interest margin was down for the year, coming in at 4.71% for 1996 compared to 4.91% in 1995 and 4.79% in 1994. The decline was principally due to declines in yields in the community bank's loan portfolio. The average yield on all earning assets was 8.45% compared to 8.67% for 1995 and 7.61% for 1994.
Provision for Loan and Lease Losses: The provision for loan and lease losses in 1996 was $2.3 million, compared to $2.0 million in 1995 and $1.3 million in 1994. The provision was equal to 0.7% of average loans and leases outstanding in 1996, compared to 0.7% in 1995 and 0.6% in 1994. See the section on credit risk for additional information on asset quality and reserve adequacy.
Noninterest income was up 30.6% from 1995 and 64.1% from 1994. The increase is partially attributed to the sale of $59.5 million of consumer loans during 1996 which generated a pre-tax gain of $676.0 thousand. The community bank retained the right to service the sold loans which contributed to increased loan servicing fees in 1996.
Operating expenses increased 15.5% from 1995 and 36.7% from 1994. Costs associated with expanding new products and markets contributed to increases over the past two years. In addition, during 1996 the community bank changed its strategy for offering employee benefits services to customers of the trust department. The decision was made to simplify and streamline the product offering. Also during 1996, the community bank exited the mortgage document custody business. As a result of these two changes, the community bank recorded $1.5 million of restructuring expenses during the year. XXXPAGE 19XXX
Balance Sheet:
Total assets averaged $459.9 million in 1996, compared to $405.2 million in 1995 and $344.7 million in 1994. Average earning assets for the year were $426.3 million, up $52.5 million or 14.0% from 1995 and up $113.4 million or 36.2% from 1994. The most significant component of the 1996 increase was loans and leases which were up $44.1 million on average in 1996 as a result of the community bank's expansion efforts into new markets. Average deposits were $413.9 million or 15.5% higher in 1996 than 1995 and $98.7 million or 31.3% higher than 1994.
The community bank's equity to assets ratio averaged 6.93% for the year, compared to 6.83% in 1995 and 6.84% in 1994.
1997 Outlook:
During 1997, the community bank plans to take advantage of the opportunities created by further consolidation in the banking industry. It plans to enter two new markets in which it can become the "local banking" alternative. The community bank will continue to expand its offering of non-traditional services in all of its markets. In addition, the community bank plans a test in certain markets of a new personal banker service made possible by the integration of information systems and new customer delivery channels through the use of new technology.
Employees:
As of December 31, 1996 the community bank employed 304 people. Total employment expense in 1996 was $10.9 million or 53.7% of total operating expenses.
Irwin Union Bank and Trust Company Directors
Robert H. Claxton Senior Vice President- Finance, Knauf Fiber Glass (Manufacturer of Fiberglass Insulation) Claude E. Davis President, Irwin Union Bank and Trust Company John T. Hackett Managing General Partner, CID Equity Partners, L.P. (Venture Capital Partnership) Robert W. Haddad Chairman and President, Columbus Container, Inc. (Manufacturer of Corrugated Shipping Containers) Carolyn A. Lickerman Homemaker John C. McGinty, Jr. President, Southeastern Indiana Health Management, Inc. President, Columbus Regional Hospital William I. Miller Chairman, Irwin Financial Corporation John A. Nash President, Irwin Financial Corporation Charles A. Rau, M.D. Physician John S. Spangler President, Milestone Contractors, L.P. Christine M. Vujovich Vice President, Cummins Engine Company, Inc. Charles H. Watson President, Historic Columbus Development, Inc. (Community Development Organization) XXXPAGE 20XXX
Irwin Union Bank and Trust Company Senior Officers
Claude E. Davis President Bradley J. Kime Executive Vice President Kevin P. Barr Senior Vice President and Chief Financial Officer William P. Guffey Senior Vice President and Senior Lending Officer Albert C. Roszczyk Senior Vice President-Bartholomew County William S. Beitler President-Shelby County Karen S. Coldiron President-Decatur County Brian D. Hall President-Monroe County Robert L. Phillips President-Johnson County William R. Redman President-Hamilton County Donald J. Stuart President-Irwin Union Advisory Services Gloria C. Bennett Vice President-Investments and Funds Management David S. Brooks Vice President- Bartholomew County Debora L. Cox Vice President-Operations Patrick K. Crimmins Vice President- Bartholomew County Bradley R. Davis Vice President-Controller Dyar Forkert Vice President- Decatur County Joseph B. Hauersperger Vice President-Shelby County William A. Helmbrecht Vice President-Bartholomew County Carrie K. Houston Vice President-Human Resources James D. Keller Vice President-Bartholomew County Dianne Kelly Vice President-Jackson County Jay N. Morris Vice President-Johnson County Ellen Z. Mufson Vice President-Legal Counsel and Assistant Secretary James D. Parcell Vice President-Bartholomew County Rick L. Smith Vice President- Jackson County Barbara A. Smitherman Vice President-Bartholomew County Jill A. Stanton Vice President-Mortgage Lending Jerrie H. Suckow Vice President-Bartholomew County Craig Teegarden Vice President-Johnson County
XXXPAGE 21XXX
Overview & Strategy:
The home equity line of business includes Irwin Home Equity and the related activities of Irwin Union Bank. Irwin Home Equity is located in San Ramon, California and was incorporated in late 1994. The company began marketing home equity loans in early 1995 through direct mail and telemarketing and currently markets in 16 states.
The business has the option to either hold the loans in portfolio or securitize and service them. If the loans are held in portfolio, many costs incurred during the period to produce the loans are expensed immediately, whereas the revenue from the loans accrues over the lives of the loans. Alternatively, if the loans are securitized and sold on the secondary market to investors, a portion of the present value of the future net revenues from the loans will be recognized in the current period, helping to offset the expenses incurred in producing the loans.
1996 Review:
The home equity lending business recorded a pre-tax loss of $0.8 million in 1996, compared to a $3.2 million pre-tax loss in 1995.
Loan Originations:
During 1996 the home equity lending business originated $169.1 million of home equity loans, up 93.5% from 1995 volume of $87.4 million.
The business securitized and delivered $79.9 million of loans in 1996 which generated a pre-tax gain of $6.8 million. This compares to a $3.0 million gain recognized in 1995 on the sale of $51.6 million of loans. In addition to the $79.9 million of loans that were delivered in 1996, another $60.1 million were securitized. These loans will be delivered in the first quarter of 1997, and the gain on the sale will be recognized at that time. During 1996, the business also recorded a one-time $1.0 million pre-tax adjustment to the gain recorded on the 1995 securitization. The adjustment resulted from the substitution of a letter of credit in 1996 for the cash reserve which had been in place when the transaction was recorded. This revised approach to providing for reserves caused the 1995 gain to be higher than it would have been under the previous approach. If the business uses letters of credit in future transactions, the resulting gains are expected to be similarly affected.
XXXPAGE 22XXX
The home equity lending business continues to service loans it has securitized. The servicing portfolio, which includes loans held on the company's books as well as securitized loans, increased 165.8% from 1995. The business earns a servicing fee equal to one percent of the outstanding principal balance of the securitized loans. Servicing fee income increased to $4.6 million in 1996 from $12.9 thousand in 1995. The level of fees in 1995 reflects the fact that loans were not securitized until late in the year.
Net Interest Income:
As a result of the increased loan volume in 1996, net interest income before loan loss provision was up 234.6% to $5.6 million. The loan loss provision also increased to $983.5 thousand from $363.0 thousand. Net charge- offs for the home equity lending business were $37.0 thousand in 1996 as compared to $2.1 thousand in 1995.
Balance Sheet:
The home equity lending business had $118.2 million of loans outstanding at December 31, 1996. This compares to $36.4 million at the end of 1995. The loan loss allowance also increased to $589.4 thousand at December 31, 1996 from $146.6 thousand in 1995.
1997 Outlook:
During 1997, the home equity lending business looks to develop its business further and to increase its loan production volume. The business plans to continue exploring new products, funding alternatives, and markets where its skills in identifying customers well served by direct marketing of products uniquely tailored to their needs can be best applied.
The business will maintain the flexibility of either holding the loans it produces in portfolio or securitizing them in order to accelerate the recognition of income. Management will evaluate these options throughout the year in light of market conditions and financial objectives.
Employees:
As of December 31, 1996, the home equity business employed 159 people. Total employment expense in 1996 was $8.6 million or 48.4% of total operating expenses.
Irwin Home Equity Corporation Directors and Senior Officers
Directors
Elena Delgado President, Irwin Home Equity Corporation William I. Miller Chairman, XXXPAGE 23XXX
Irwin Financial Corporation John A. Nash President, Irwin Financial Corporation Thomas D. Washburn Senior Vice President, Irwin Financial Corporation Senior Officers
Elena Delgado President Spencer J. Carlsen Vice President- Production Edwin K. Corbin Vice President-Finance and Servicing Kathryn J. Diamond Vice President-Credit Risk Management J. Christopher Huseby Vice President- Marketing and Business Development Sunita Liggin Vice President-Human Resources Jocelyn Martin-Leano Vice President- Operations Support Jack Nichols Vice President-Information Services Fern Prosnitz Vice President-Legal Counsel
Business Profile: Equipment Leasing
Overview & Strategy:
The equipment leasing line of business is made up of Affiliated Capital Corp. and the related activities of Irwin Union Bank. Affiliated is a small-ticket leasing company headquartered in Northbrook, Illinois, focused on the medical equipment industry. The company was started by Irwin Financial in 1990 when it hired the staff and acquired the rights to the customers and vendors of the predecessor company which had been in business since 1983.
The strategy of the equipment leasing business is to establish relationships with manufacturers and distributors of medical equipment and to place leases with medical professionals through the sales representatives of these vendors. This allows the business to place leases nationwide despite the fact that all employees are located in Northbrook. In response to changing customer needs, in 1995 the business XXXPAGE 24XXX
began entering into private-label financing agreements with several equipment manufacturers and began offering a revolving credit product to complement its lease products.
The business focuses on relatively low cost (under $50,000) equipment for health care professionals. In general, this equipment provides low cost treatment that is often preventative in nature. Markets covered include both hospitals and alternate care sites.
1996 Review:
Equipment leasing recorded a pre-tax loss of $140.8 thousand in 1996, compared with a pre-tax loss of $333.7 thousand in 1995 and pre-tax income of $872.6 in 1994. As a result of the strategy changes implemented in late 1995, lease and loan volume increased to $36.6 million in 1996, up 46.8% from $25.0 million in 1995 and 55.3% from $23.6 million in 1994. However, because of increased competition in the equipment leasing industry which created margin pressures, net interest income did not increase commensurately. Net interest income totaled $3.6 million in 1996, an increase of $212.9 thousand or 6.2% from 1995 and a decrease of $717.4 thousand or 16.5% from 1994. Operating expenses were $4.2 million for the year, 3.4% higher than 1995 and 16.5% higher than 1994.
1997 Outlook:
Competition in the small-ticket leasing industry is expected to remain strong in 1997. The equipment leasing business will strive to remain competitive with larger lessors using a strategy that focuses on adding value through product differentiation to targeted business partners. The challenge for the business is to demonstrate that this strategy can achieve an attractive rate of return on equity in the long run.
Employees:
As of December 31, 1996, equipment leasing employed 38 people. Total employment expense in 1996 was $2.0 million or 48.0% of total operating expenses.
Affiliated Capital Corp. Directors and Senior Officers
Directors Robert P. Albert President, Affiliated Capital Corp. David E. Levine Senior Vice President, Affiliated Capital Corp. William I. Miller Chairman, Irwin Financial Corporation John A. Nash President, Irwin Financial Corporation Thomas D. Washburn Senior Vice President, Irwin Financial Corporation
Senior Officers Robert P. Albert President David E. Levine Senior Vice President Vincent F. D'Andrea Vice President and Controller Stuart A. Simon Vice President-Sales David M. Tustison Vice President-Strategic Planning
Other Irwin Financial Businesses XXXPAGE 25XXX
During the third quarter of 1996, the Corporation exited the brokered certificate of deposit and institutional brokerage businesses which were the sole businesses operated by the Investor Services line of business. A sale of selected assets of the brokered certificate of deposit program was completed in the third quarter, and its impact on earnings was not material. Parent company results in each period include the results of investor services.
The results of parent company operations combined with Investor Services results and consolidating entries are summarized below:
Dividends from subsidiaries are recorded as parent company revenues but are eliminated in determining consolidated net income. Tax benefits result from the operating losses generated by the home equity and equipment leasing businesses whose results have been reported pre-tax.
Each subsidiary pays taxes to the parent company at the statutory rate. Subsidiaries also pay fees to the parent company to cover direct and indirect services. In addition, services are provided from one subsidiary to another. Intercompany income and expenses are calculated on an arm's length, external market basis.
Consolidated Income Statement Analysis: Pre-tax income for 1996 totaled $37.3 million, up 14.9% from 1995 and 24.0% from 1994. The effective income tax rate was 39.8% in 1996, 38.1% in 1995, and 39.4% in 1994. Please see Note 16 of Notes to the Consolidated Financial Statements for more information on income taxes.
Net interest revenue for 1996 totaled $47.8 million, up 28.1% from 1995 and 45.9% from 1994. The increase was due to a combination of increased loan volume at the community bank and home equity lending business and higher mortgage loan originations at the mortgage bank. Net interest margin was 4.94% in 1996, compared to 4.93% in 1995 and 5.03% in 1994. See page 70 for further analysis of the net interest margin.
The following table sets forth, for the periods indicated, a summary of the changes in interest earned and interest paid resulting from changes in volume and rates for the major components of interest-earning assets and interest-bearing liabilities on a fully taxable equivalent basis:
Note: Variance not solely due to rate or volume is allocated on the basis of the absolute relationship between volume variances and rate variances.
The consolidated provision for loan losses for 1996 was $4.5 million, up 44.8% from 1995 and 157.7% from 1994. More information on this subject is contained in the section on credit risk.
Other income increased 34.6% in 1996 to $153.6 million. This compares to $114.1 million in 1995 and $85.9 million in 1994. The most significant increases came in the categories related to mortgage banking and home equity lending activities which were previously discussed on pages 32 and 46.
Other expenses in 1996 totaled $159.7 million, up 37.8% from 1995 and 83.9% from 1994. The 1996 increase in consolidated other expense of $43.8 million was mostly due to operating expenses associated with expanded mortgage and home equity loan production.
Consolidated Balance Sheet Analysis:
Total assets at year-end 1996 were $1.3 billion, up 25.6% from 1995 and 97.7%:from 1994. However, changes in the average balance sheet are a more accurate reflection of the actual changes in the level of activity on the balance sheet. Average assets were $1.2 billion in 1996, up 30.5% from 1995 and 53.7% from 1994. Mortgage loans held for sale increased by $93.2 million, while loans and leases increased by $127.5 million or 34.5% on average in 1996.
The Corporation's commercial loans are extended primarily to local regional businesses and to local farming operations in the market area of Irwin Union Bank. The Corporation also extends credit to consumers through installment loans and revolving credit arrangements. The majority of the remaining XXXPAGE 27XXX
portfolio consists of residential mortgage loans (1-4 family dwellings) and mortgage loans on commercial property. Loans by major category at the end of the last five years were as follows:
On average, investment securities decreased $1.3 million in 1996 to $65.4 million. The carrying value of investments at December 31, 1996 includes $51.2 thousand of unrealized losses on available-for-sale securities.
The book value of investment securities at the end of the last three years is as follows:
XXXPAGE 28XXX
The weighted average yield on state and municipal obligations has been calculated on a fully taxable equivalent basis, assuming a 34.5% tax rate.
Deposits averaged $632.2 million during 1996, compared to $526.1 million in 1995 and $467.1 million in 1994. Demand deposits were up 78.2% on average, or $104.7 million from 1995. A significant portion of demand deposits is related to deposits at Irwin Union Bank which are associated with escrow accounts held on loans in the servicing portfolio of Inland Mortgage. These escrow accounts averaged $179.0 million in 1996.
Maturities of certificates of deposit of $100 thousand or more are set forth in the following table:
Short-term borrowings averaged $334.3 million in 1996, compared to $217.3 million in 1995 and $167.8 million in 1994. The increase in 1996 is due to the increase in mortgage loan closings in 1996. XXXPAGE 29XXX
The following table shows the distribution of the Corporation's short-term borrowings and the weighted average rates at the end of each of the last three years. Also provided are the maximum borrowings and the average borrowings as well as weighted average interest rates for the last three years.
Capital:
Shareholders' equity averaged $109.0 million in 1996, up 22.6% from 1995 and 43.0% from 1994. Year-end shareholders' equity of $118.9 million represented book value per share of $10.46, compared to $8.76 and $7.21 at December 31, 1995 and 1994, respectively.
Prior to the adoption of SFAS No. 122 in the second quarter of 1995, mortgage banking accounting did not allow the full value of mortgage servicing rights to be reflected on the balance sheet. Since a significant portion of the Corporation's mortgage servicing portfolio was generated prior to the adoption of the new accounting standard, it represents substantial economic value which is not recorded on the balance sheet. The following table demonstrates the estimated after-tax value of the servicing portfolio at December 31:
With the implementation of the new accounting standard in 1995, this off-balance sheet value will decline over future years and eventually be reduced to zero.
Total book value per share including the value of the servicing portfolio was $15.30 at December 31, 1996, up from $14.20 and $13.18 at December 31, 1995 and 1994, respectively.
Capital is a major focus of regulatory attention, with both book and risk-based capital standards used as capital adequacy measures. Unless an institution has adequate capital in the opinion of the regulators, they may withhold approval for new activities or force additions to capital. Therefore, the Corporation considers both the regulator's viewpoint and its own analysis of the capital structure and leverage amounts that are consistent with underlying business risks.
At year-end 1996, the Corporation's total risk-adjusted capital ratio was 14.23% compared to a current regulatory minimum of 8.0%. The Corporation's ending equity to assets ratio for 1996 was 9.12%. However, as previously discussed, temporary conditions which existed at year end make the average balance sheet ratio a more accurate measure of capital. The Corporation's average equity to assets ratio for 1996 was 9.46%.
In January 1997, the Corporation issued $50,000,000 of trust preferred securities through a trust created and controlled by the Corporation. The securities, which are publicly traded, were issued at $25 per share with a cumulative dividend rate of 9.25%, payable quarterly. They have an initial maturity of 30 years with a 19-year extension option which the Corporation can exercise at any point during the first 30 years. The securities are callable at par after five years, or immediately, in the event of an adverse tax development affecting the Corporation's classification of the securities for federal income tax purposes. The securities are not convertible into common stock of the Corporation.
Stock Prices and Dividends:
The common stock of Irwin Financial is quoted on the National Association of Securities Dealers Automated Quotation System National Market System (NASDAQ-NMS- trading symbol, IRWN). The following table sets forth certain information regarding trading in, and cash dividends paid with respect to, the shares of the Corporation's common stock in each quarter of the three most recent calendar years. XXXPAGE 31XXX
*Adjusted for December 30, 1996 two-for-one stock split.
The Corporation expects to continue its policy of paying regular cash dividends, although there is no assurance as to future dividends because they are dependent on future earnings, capital requirements, and financial condition. On February 19, 1997, the Corporation's Board of Directors approved an increase in the first quarter dividend to $0.07 per share, payable in March 1997. Dividends by the Irwin Union Bank to the Corporation are restricted by banking law. See Note 15 of Notes to the Consolidated Financial Statements.
Risk Management:
As a financial intermediary, Irwin Financial Corporation is engaged in businesses which involve the assumption of financial risks including:
- Credit risk - Liquidity risk - Interest rate risk
Each line of business that assumes financial risk uses a formal process to manage this risk. In all cases, the objectives are to ensure that risk is contained within prudent levels and that we are adequately compensated for the level of risk assumed. The Chairman, the President, and the Chief Financial Officer of the parent company participate in each subsidiary's risk management process.
Credit Risk:
The assumption of credit risk is a key source of earnings for the community bank, home equity lending, and equipment leasing businesses. In addition, the mortgage banking business assumes some credit risk despite the fact that its mortgages are typically insured. The credit risk in the loan portfolio of the community bank and home equity lending business has the most potential to have a significant effect on consolidated financial performance. XXXPAGE 32XXX
The community bank and home equity lending business manage credit risk through the use of lending policies, credit analysis and approval procedures, periodic loan reviews, and personal contact with borrowers. Loans over a certain size are reviewed by a loan committee prior to approval.
The equipment leasing business manages credit risk in a manner similar to that used by the community bank and the home equity business. It uses lending policies, credit analysis procedures and personal contact with lessees.
An allowance for loan and lease losses is established as an estimate of the potential credit risk of the loans and leases held by the Corporation. In determining the adequacy of this allowance, management evaluates the creditworthiness of significant borrowers, past loan and lease loss experience, and current and anticipated economic conditions. The allowance is increased by provisions against income and recoveries of loans and leases previously charged off. Loans and leases that are determined by management to be uncollectible are charged against the allowance. The table on page 64 analyzes the consolidated allowance for possible loan and lease losses over the past five years.
Net charge-offs in 1996 were $1.8 million, down 15.2% from 1995, and up 53.9% from 1994. Net charge-offs to average loans and leases was 0.36%, compared to 0.57% in 1995 and 0.41% in 1994. The provision for loan and lease losses was $4.5 million, 249.9% of net charge-offs. The coverage ratio was 146.3% in 1995 and 149.3% in 1994.
At year end, the allowance for possible loan and lease losses was 1.25% of loans and leases, compared to 1.12% in 1995 and 1.25% in 1994.
Total nonperforming loans and leases at year end were $5.0 million, compared to $2.4 million at the end of 1995 and $2.8 million at the end of 1994. Nonperforming loans and leases as a percent of total loans and leases were 0.94% at year-end 1996, compared to 0.58% in 1995 and 0.90% in 1994. Other real estate owned totaled $2.2 million at December 31, 1996, up from $0.3 million in 1995 and $0.5 in 1994. Total nonperforming assets were $7.2 million, or 0.55% of total assets at December 31, 1996, as compared to $2.7 million or 0.26% at year-end 1994 and $3.3 million or 0.50% at the end of 1994.
XXXPAGE 34XXX
Loans which are past due 90 days or more are placed on nonaccrual status unless, in management's opinion, there is sufficient collateral value to offset both principal and interest.
No loans were made to foreign borrowers and 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.
Further information regarding the balance of nonaccrual loans at December 31, 1996 and related payment information is as follows:
Liquidity:
Liquidity is the availability of funds to meet the daily requirements of the business. For financial institutions, demand for funds comes principally from extensions of credit and withdrawal of deposits. Liquidity is provided by asset maturities or sales and through short-term borrowings.
The objectives of liquidity management are to ensure that funds will be available to meet demands and that funds are available at a reasonable cost. As with other forms of financial risk, liquidity is managed separately at each of our lines of business. In the case of Irwin Union Bank, this occurs at the monthly meeting of the Asset-Liability Management Committee.
Since loans and leases are substantially less marketable than securities, the ratio of total loans to total deposits is the traditional measure of liquidity for banks and bank holding companies. At year-end 1996, this ratio stood at 81.6%. The Corporation is able to maintain this position of high liquidity without a substantial sacrifice in the form of a lower net interest margin due to the position in mortgage loans held for sale. These loans carry an interest rate equal to the current market rate for mortgage loans. However, liquidity is significantly improved since all mortgage loans held for sale are in the process of being securitized and sold. The holding period for an individual loan typically does not exceed 90 days.
Interest Rate Sensitivity:
Interest rate sensitivity refers to the potential for changes in market rates of interest to cause changes in net interest income. Since net interest income is a major source of income, it is important that potential changes are managed prudently.
The Asset-Liability Management Committee of Irwin Union Bank monitors the repricing structure of both assets and liabilities over various time horizons. Exposure to changes in interest rates is evaluated by modeling the repricing characteristics of the portfolio under multiple rate scenarios. Formal policies approved by the Bank's Board of Directors ensure that exposure to changes in net interest revenues is maintained within acceptable levels.
The mortgage banking business assumes a form of interest rate risk by entering into commitments to extend loans to borrowers at a fixed price for a limited period of time. Loans are also held temporarily until a pool is formed. Once again, a formal policy ensures that this risk is controlled. The home equity and equipment leasing businesses are exposed to potential interest rate risk that is similar to the lending operations of the community bank.
Rate sensitivity at the community bank can typically be managed by controlling the maturity of loans, securities, and deposits. The community bank may also use financial futures or interest rate swaps from time to time. The mortgage bank buys commitments to deliver loans at a fixed price to manage risk. The policy at both the home equity lending business and the equipment leasing business is to match-fund all assets. In some cases, the Corporation uses internal hedges to allow for the risk characteristics of one line of business to offset those of another. XXXPAGE 36XXX
As the following table shows, the consolidated one-year gap at year-end 1996 was a positive $133.2 million. This compares to a positive gap of $153.6 million at year-end 1995. The large positive gaps have been due to levels of escrow deposits from the servicing portfolio of the mortgage bank. These deposits are generally held in noninterest-bearing accounts at Irwin Union Bank. However, they are invested in earning assets with rate maturities of less than one year, including mortgage loans held for sale.
Since the gap was positive, it means that with respect to net interest income, the Corporation was positioned to benefit from rising interest rates, or to be harmed by declining rates. While traditional interest rate risk focuses on the changes in net interest income due to interest rate changes, the Corporation engages in other activities which are also affected by interest rate changes. Principal among these are mortgage loan origination and servicing. For example, if interest rates decline, management expects an increase in mortgage loan origination income and a decline in the value of mortgage servicing rights. Management attempts to monitor this exposure to traditional interest rate risk as well as interest rate influences on production and servicing value in a comprehensive manner.
In addition, the static one-year gap is not a reliable measure of actual exposure to changes in market interest rates. Consequently, management uses simulations of the behavior of net interest revenue to determine exposure and to develop hedging strategies.
Effects of Inflation:
The Corporation is affected by inflation primarily as it impacts interest rates. We believe that a financial institution's ability to react to changing interest rates is an indicator of its ability to perform in an inflationary environment. Please see the section on interest rate sensitivity for a discussion on this subject.
Daily Average Consolidated Balance Sheet, Interest Rates and Interest Differential XXXPAGE 37XXX
Notes: (1) Interest is reported on a fully taxable equivalent basis. The prevailing federal income tax rate was 34.5% in 1996, 34% in 1995 and 35% in 1994. (2) For purposes of these computations, nonaccrual loans are included in daily average loan amounts outstanding.
Summary of Quarterly Financial Information XXXPAGE 40XXX
XXXPAGE 41XXX
*restated for the two-for one-stock split December 30,1996
Item 8.

Item 8. Financial Statements and Supplementary Data
Consolidated financial statements of the Registrant and its subsidiaries are contained in the Annual Report to Shareholders for the year ending December 31, 1996, under the caption "1996 Financial Statements ", and are incorporated herein by reference in response to this item. The financial statement schedules required under Regulation S-X are filed as "Financial Statement Schedules" pursuant to Item 14 hereof.
Item 9.

Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
In connection with the audits of the Registrant for the two most recent fiscal years ended December 31, 1996, the Registrant has not changed its independent certified public accountants nor have there been any disagreements (as defined in Instruction 4 to Item 304 of Regulation S-K) with such accountants on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure.
PART III
Item 10.

Item 10. Directors and Executive Officers of the Registrant
The information contained in the proxy statement of the Registrant for the 1997 Annual Meeting of Shareholders under the caption "Election of Directors", on pages 4 through 6, inclusive, is incorporated herein by reference in response to this item.
Item 11.

Item 11. Executive Compensation
The information contained in the proxy statement of the Registrant for the 1997 Annual Meeting of Shareholders under the captions "Election of Directors - Outside Director Restricted Stock Compensation Plan", "Executive Compensation and Other Information" and "Board Compensation Committee Report on Executive Compensation" on pages 7 through 13, inclusive, is incorporated herein by reference in response to this item.
Item 12.

Item 12. Security Ownership of Certain Beneficial Owners and Management
The information contained in the proxy statement of the Registrant for the 1997 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.

Item 13. Certain Relationships and Related Transactions
The information contained in the proxy statement of the Registrant for the 1997 Annual Meeting of Shareholders under the caption "Interest of Management in Certain Transactions" on pages 18 and 19, is incorporated herein by reference in response to this item. XXXPAGE 42XXX
PART IV
Item 14.

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
Page # a. Documents filed as a part of this Report: Form Annual 10-K Report
1. Financial Statements: A. Irwin Financial Corporation and Subsidiaries:
Report of Coopers & Lybrand L.L.P., Independent Accountants 76
Consolidated Statement of Income for the years ended December 31, 1996, 1995, and 1994 77
Consolidated Balance Sheet as of December 31, 1996, and 1995 78
Consolidated Statement of Changes in Shareholders' Equity for the years ended December 31, 1996, 1995 and 1994 79
Consolidated Statement of Cash Flows for the years ended December 31, 1996, 1995, and 1994 80 Notes to Consolidated Financial Statements 81
The above listed report, financial statements,and the notes thereto, set forth on pages 76 through 101 of the Registrant's 1996 Annual Report to Shareholders are incorporated herein by reference.
2. Financial Statement Schedules Report of Independent Accountants, Coopers & Lybrand L.L.P. 50
Schedule I - Indebtedness to Related Parties 51
Schedules other than that listed above are omitted because they are not required or the information is included in the Notes to Consolidated Financial Statements. XXXPAGE 43XXX
3. Exhibits A. Exhibits to Form 10-K
Number Assigned Sequential Numbering in Regulation System Page Number of S-K Item 601 Description of Exhibit Exhibit
(2) No exhibit.
(3) (i) 3(a) Amended Articles of Incorporation, dated December 29, 1972. (Incorporated by reference to Exhibit 3(a) to Form 10-K Report for year ended December 31, 1985, File No. 0-6835.)
3(b) Articles of Amendment, dated March 30, 1973. (Incorporated by reference to Exhibit 3(b) to Form 10-K Report for year ended December 31, 1985, File No. 0-6835.)
3(c) Articles of Amendment, dated September 4, 1990. (Incorporated by reference to Exhibit 3(d) to Form 10-K Report for year ended December 31, 1990, File No. 0-6835.)
3(d) Articles of Amendment, dated April 30, 1992. (Incorporated by reference to Exhibit 3(d) to Form 10-K Report for year ended December 31, 1992, File No. 0-6835.)
3(e) Articles of Amendment, dated April 26, 1994. (Incorporated by reference to Exhibit 3(e) to Form 10-K Report for year ended December 31, 1994, File No. 0-6835.)
3(f) Articles of Amendment, 52 dated April 30, 1996. (ii) 3(a) Code of By-Laws as 114 amended to date.
(4) 4(a) Specimen stock certificate. (Incorporated by reference to Exhibit 4(a) to Form 10-K Report for year ended December 31, 1994, File No. 0-6835.) XXXPAGE 44XXX
4(b) Certain instruments defining the rights of the holders oflong-term debt of the Registrant and certain of its subsidiaries, none of which authorize a total amount of indebtedness in excess of 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis, have not been filed as Exhibits. The Registrant hereby agrees to furnish a copy of any of these agreements to the Commission upon request.
(9) No exhibit.
(10) 10(a) Amended 1986 Stock Option Plan.@ (Incorporated by reference to Exhibit 10(b) to Form 10-K Report for year ended December 31, 1991, File No. 06835.)
10(b) Amended and Restated Management Bonus Plan.@ (Incorporated by reference to Exhibit 19(a) to Form 10-K Report for year ended December 31, 1986, File No. 06835.)
10(c) Long-Term Management Performance Plan.@ (Incorporated by reference to Exhibit 10(d) to Form 10-K Report for year ended December 31, 1986, File No. 06835.)
10(d) Long-Term Incentive Plan - Summary of Terms.@ (Incorporated by reference to Exhibit 10(e) to Form 10-K Report for year ended December 31, 1986, File No. 0-6835.) 10(e) Irwin Financial Corporation Employees' Stock Purchase Plan.@ (Incorporated by reference to Exhibit 10(f) to Form 10-K Report for year ended December 31, 1991, File No. 06835.)
10(f) Employee Stock Purchase Plan II.@ Incorporated by reference to Exhibit 10(f) to Form 10-K Report for year ended December 31, 1994, File No. 06835.)
10(g) Amended Irwin Financial Corporation Outside Directors Restricted Stock Compensation Plan.@ (Incorporated by reference to Exhibit 10(g) to Form 10-K Report for year ended December 31, 1991, File No. 06835.) XXXPAGE 45XXX 10(h) Irwin Financial Corporation 1992 Stock Option Plan.@ (Incorporated by reference to Exhibit 10(h) to Form 10-K report for year ended December 31, 1992, File No. 06835.)
10(i) Amended Irwin Financial Corporation Outside Director Restricted Stock Compensation Plan.@ (Incorporated by reference to Exhibit 10(i) to Form 10-K report for year ended December 31, 1995, File No. 06835.)
10(j) Inland Mortgage 129 Corporation Long Term Incentive Plan.@
(11) 11(a) Computation of Earnings 137 Per Share.
(12) No exhibit.
(13) 13(a) Registrant's 1996 Annual 138 Report to Shareholders. This exhibit contains such portions thereof that have been incorporated by reference into this Report.
(16) No exhibit.
(18) No exhibit.
(21) 21(a) Subsidiaries of the 205 Registrant.
(22) No exhibit.
(23) 23(a) Consent of Independent 206 Accountants.
(24) No exhibit.
(27) Financial Data Schedule. 207
(28) No exhibit.
(99) 99(a) Annual Report on Form 11-K for the Irwin Union Corporation Employees' Savings Plan for the year ending December 31, 1996.*
99(b) Annual Report on Form 11K for the Inland Mortgage Corporation Employees' Savings Plan for the year ending December 31, 1996.*
@ Denotes management contract or compensatory plan.
* To be filed by amendment pursuant to Rule 15d-21.
b. Reports on Form 8-K XXXPAGE 46XXX None. XXXPAGE 47XXX SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the Undersigned, thereunto duly authorized.
IRWIN FINANCIAL CORPORATION
Date: March 27, 1997 By: /s/ William I. Miller ----------------------------- William I. Miller, Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of 1934, this report on Form 10-K has been signed below by the following persons on behalf of the Registrant and in the capacities on the dates indicated.
Capacity with Signature Registrant Date
/s/ Sally A. Dean Director March 27, 1997 - ------------------- Sally A. Dean
/s/ David W. Goodrich Director March 27, 1997 - ---------------------- David W. Goodrich
/s/ John T. Hackett Director March 27, 1997 - ------------------- John T. Hackett
/s/ William H. Kling Director March 27, 1997 - ----------------------- William H. Kling
/s/ Brenda J. Lauderback Director March 27, 1997 - ----------------------- Brenda J. Lauderback
/s/ John C. McGinty,Jr. Director March 27, 1997 - ----------------------- John C. McGinty, Jr.
/s/ Irwin Miller Director March 27, 1997 - ----------------------- Irwin Miller
/s/ William I. Miller Director, Chairman March 27, 1997 - ----------------------- of the Board William I. Miller (Principal Executive Officer)
/s/ John A. Nash Director, Chairman March 27, 1997 - ----------------------- of the Executive John A. Nash Committee XXXPAGE 48XXX
/s/ Lance R. Odden Director March 27, 1997 - ----------------------- Lance R. Odden
/s/ James T. Sakai Director March 27, 1997 - ----------------------- James T. Sakai
/s/ Theodore M. Solso Director March 27, 1997 - ----------------------- Theodore M. Solso
/s/ Thomas D. Washburn Senior Vice President March 27, 1997 - ----------------------- (Principal Financial Officer) Thomas D. Washburn
/s/ Marie C. Strack Vice President and March 27, 1997 - ----------------------- Controller Marie C. Strack (Principal Accounting Officer)
XXXPAGE 49XXX
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors Irwin Financial Corporation Columbus, Indiana
We have audited the consolidated financial statements of Irwin Financial Corporation and Subsidiaries as of December 31, 1996 and 1995, and for each of the three years in the period ended December 31, 1996, which financial statements are included on pages 77 through 101 of the 1996 Annual Report to Shareholders of Irwin Financial Corporation and incorporated by reference herein. We have also audited the financial statement schedules listed in the index on page 43 of this Form 10-K. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Irwin Financial Corporation and Subsidiaries as of December 31, 1996 and 1995, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1996 in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.
As described in Note 1 to the financial statements, the Corporation adopted Statement of Financial Accounting Standards No. 122, Accounting for Mortgage Servicing Rights, as of April 1, 1995.
/s/ Coopers & Lybrand L.L.P.
Indianapolis, Indiana January 17, 1997 XXXPAGE 50XXX
Schedule I
(1) The indebtedness disclosed is the purchase of Irwin Financial Corporation commercial paper by Irwin Management Company. Irwin Management Company is owned by a principal shareholder and director. Commercial paper borrowings generally mature within three months from the date of issuance.
(2) No deductions occurred that were other than a disbursement of cash.
XXXPAGE 51XXX