UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 0-6835
IRWIN FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
INDIANA 35-1286807
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
500 Washington Street, Columbus, IN 47201
(Address of principal executive offices)
(Zip Code)
812/376-1020
__________________________________________
Registrant's telephone number, including area code)
(Former name, former address and former fiscal year
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS
Indicate by check mark whether the registrant has filed all
documents and reports required to be filed by Sections 12, 13, or
15(d) of the Securities Exchange Act of 1934 subsequent to the
distribution of securities under a plan confirmed by a court.
Yes No
As of April 30, 1999, there were outstanding 21,701,859 common
shares, no par value, of the Registrant.,
PART I
Item 1
IRWIN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET (Unaudited)
<TABLE>
<C> <C> <C>
(In thousands, except for shares) March 31, December 31,
Assets: 1999 1998
Cash and due from banks $46,423 $68,942
Federal funds sold 12,000 8,580
Cash and cash equivalents 58,423 77,522
Interest-bearing deposits with financial institutions 18,318 18,441
Trading assets 42,772 32,148
Investment securities (Market value:$46,762
in 1999 and $48,537 in 1998)-Note 2 46,423 48,055
Loans held for sale - Note 3 616,302 936,788
Loans and leases, net of unearned income - Note 4 570,873 556,991
Less: Allowance for loan and lease losses - Note 5 (10,213) (9,888)
560,660 547,103
Servicing assets - Note 6 130,510 117,129
Accounts receivable 84,406 71,087
Accrued interest receivable 11,280 13,071
Premises and equipment 21,557 21,382
Other assets 39,814 50,418
$1,630,465 $1,933,144
Liabilities and Shareholders' Equity:
Deposits
Noninterest-bearing $401,477 $477,724
Interest-bearing 411,990 389,516
Certificates of deposit over $100,000 135,849 141,971
949,316 1,009,211
Short-term borrowings- Note 7 399,375 644,861
Long-term debt- Note 8 2,719 2,839
Other liabilities 77,472 83,001
Total liabilities 1,428,882 1,739,912
Company-obligated mandatorily redeemable
preferred securities of subsidiary trust- Note 9 48,017 47,999
Shareholders' equity
Preferred stock, no par value - authorized
50,000 shares; none issued -- --
Common stock; no par value - authorized 40,000,000
shares; issued 23,402,080 shares in 1999 and 1998;
including 1,706,292 and 1,729,324 shares in treasury
in 1999 and 1998, respectively 29,965 29,965
Additional paid-in capital 2,881 2,595
Unrealized gains on investment securities 44 85
Retained earnings 150,119 142,232
183,009 174,877
Less treasury stock, at cost (29,443) (29,644)
Total shareholders' equity 153,566 145,233
$1,630,465 $1,933,144
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
<TABLE>
<CAPTION>
IRWIN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME (Unaudited)
<C> <C> <C> <S>
Three Months Ended
March 31,
(In thousands, except for per share) 1999 1998
Interest income:
Loans and leases $11,658 $14,029
Investment securities:
Taxable 1,006 877
Tax exempt 72 75
Loans held for sale 17,563 9,862
Trading Account 1,286 893
Federal funds sold 144 347
Total interest income 31,729 26,083
Interest expense:
Deposits 5,661 5,310
Short-term borrowings 8,042 6,584
Long-term debt 100 213
Total interest expense 13,803 12,107
Net interest income 17,926 13,976
Provision for loan and lease losses - Note 5 1,201 1,638
Net interest income after provision for
loan and lease losses 16,725 12,338
Other income:
Loan origination fees 13,415 12,972
Gain from sales of loans 21,536 15,977
Loan servicing fees 15,431 13,877
Amortization and impairment of servicing assets 1,058 6,969
Net loan administration income 14,373 6,908
Gain on sale of mortgage servicing 12,126 9,956
Trading gains (losses) (9,746) 1,364
Brokerage fees and commissions 352 219
Trust fees 577 547
Service charges on deposit accounts 402 403
Insurance commissions, fees and premiums 488 397
Other 1,125 1,224
54,648 49,967
Other expense:
Salaries 28,600 25,505
Pension and other employee benefits 5,473 4,443
Office expense 3,356 2,919
Premises and equipment 5,668 4,719
Marketing and development 2,802 3,291
Other 9,212 8,310
55,111 49,187
Income before income taxes 16,262 13,118
Provision for income taxes 6,116 4,880
10,146 8,238
Distribution on company-obligated mandatorily
redeemable preferred securities of subsidiary trust 1,174 1,174
Net income available to common shareholders $8,972 $7,064
Earnings per share of common stock available to shareholders:
Basic - Note 10 $0.41 $0.33
Diluted - Note 10 $0.41 $0.32
Dividends per share of common stock $0.050 $0.040
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
IRWIN FINANCIAL CORPORATION AND SUBSIDIARIES
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 1998
(Unaudited)
<TABLE>
<CAPTION>
<S> <C> <C> <C> <S> <C> <S> <C>
Unrealized
Gains/Losses Additional
Retained on Investment Common Paid in Treasury
Total Earnings Securities Stock Capital Stock
(In thousands)
Balance at January 1, 1999 $145,233 $142,232 $85 $29,965 $2,595 ($29,644)
Comprehensive Income: Note 1
Net Income 8,972
Other Comprehensive Income (41)
Total 8,931
Cash dividends (1,085) (1,085)
Sales of treasury stock 487 286 201
Balance March 31, 1999 $153,566 $150,119 $44 $29,965 $2,881 ($29,443)
Balance at January 1, 1998 $127,983 $115,414 $55 $29,965 $780 ($18,231)
Comprehensive Income: Note 1
Net Income 7,064
Other Comprehensive Income 7
Total 7,071
Cash dividends (872) (872)
Purchase of treasury stock (4,446) (4,446)
Sales of treasury stock 361 206 155
Balance March 31, 1998 $130,097 $121,606 $62 $29,965 $986 ($22,522)
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
<TABLE>
<CAPTION>
IRWIN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited)
<S> <C> <C>
For the three months ended March 31, 1999 1998
(In thousands)
Net income $8,972 $7,064
Adjustments to reconcile net income to cash provided
by operating activities:
Depreciation and amortization 2,768 6,559
Provision for loan and lease losses 1,201 1,638
Amortization of premiums, less accretion of discounts 1,087 309
(Increase) decrease in loans held for sale 320,486 (35,210)
Gain on sale of mortgage servicing (12,126) (9,956)
Other, net (7,185) (19,771)
Net cash (used) provided by operating activities 315,203 (49,367)
Lending and investing activities:
Proceeds from maturities/calls of investment securities:
Held-to-Maturity 0 2,715
Available-for-Sale 0 3,792
Proceeds from sales of investment securities:
Available-for-Sale 0 1,000
Purchase of investment securities:
Held-to-Maturity 0 (3,640)
Available-for-Sale 65 (1,006)
Net increase in trading assets (10,624) (5,041)
Net decrease in interest-bearing
deposits with financial institutions 123 6,829
Net increase in loans, excluding sales (193,325) (133,523)
Sale of loans 178,567 128,827
Additions to mortgage servicing assets (37,895) (23,092)
Proceeds from sale of mortgage servicing assets 35,627 20,651
Other, net (1,221) 1,542
Net cash (used) provided by lending and investing
activities (28,683) (946)
Financing activities:
Net increase (decrease) in deposits (59,895) 112,327
Net decrease in short-term borrowings (245,486) (49,629)
Proceeds (repayment) of long-term debt (120) 3,633
Purchase of treasury stock 0 (4,446)
Proceeds from sale of stock for employee benefit plans 487 361
Dividends paid (1,085) (872)
Net cash provided by financing activities (306,099) 61,374
Net increase (decrease) in cash and cash equivalents (19,579) 11,061
Cash and cash equivalents at beginning of year 77,522 56,524
Cash and cash equivalents at end of year $57,943 $67,585
Supplemental disclosures of cash flow information:
Cash paid during the period:
Interest $13,704 $12,375
Income taxes $641 $642
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
NOTES TO THE FINANCIAL STATEMENTS (Unaudited)
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation: The unaudited financial statements included herein have
been prepared by the Corporation pursuant to the rules and regulations of the
Securities and Exchange Commission but do not include all information and
footnotes required by generally accepted accounting principles. In the opinion
of management, the financial statements reflect all material adjustments
necessary for a fair presentation. The accompanying financial statements
should be read in conjunction with the financial statements and related notes
included with the Corporation's Annual Report on Form 10-K for the year ended
December 31, 1998.
Reclassifications: Certain amounts in the 1998 consolidated financial
statements have been reclassified to conform to the 1999 presentation.
Derivatives: On June 15, 1998, the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" (FAS 133). The Corporation will
adopt FAS 133 on January 1, 2000. FAS 133 requires that all derivative
instruments be recorded on the balance sheet at their fair value. Changes in
the fair value of derivatives are recorded each period in current earnings or
other comprehensive income, depending on whether a derivative is designated as
part of a hedge transaction and, if it is, the type of hedge transaction.
The Corporation does not expect the adoption of this standard to have a material
effect on its financial position or results of operation.
Derivative instruments on the Corporation's balance sheet are classified as
trading assets and carried at market value. Changes in market value are
recorded as trading gains or losses on the income statement.
NOTE 2 - INVESTMENT SECURITIES
The carrying amounts of investment securities, including net unrealized gains
of $72 thousand and $142 thousand on available-for-sale securities at March 31,
1999 and December 31, 1998, respectively, are summarized as follows:
<TABLE>
<S> <C> <C>
March 31, December 31,
(In thousands) 1999 1998
Held-to-Maturity
US Treasury and Government obligations $33,044 $32,158
Obligations of states and political subdivisions 5,207 5,207
Mortgage-backed securities 2,710 4,424
Total Held-to-Maturity 40,961 41,789
Available-for-Sale
US Treasury and Government obligations 2,088 2,096
Mortgage-backed securities 3,340 4,131
Other 34 39
Total Available for Sale 5,462 6,266
Total Investments $46,423 $48,055
</TABLE>
Securities which the Corporation has the positive intent and ability to hold
until maturity are classified as "held-to-maturity" and are stated at cost
adjusted for amortization of premium and accretion of discount. Securities
that might be sold prior to maturity are classified as "available-for-sale"
and are stated at fair value. Unrealized gains and losses on available-for-
sale securities, net of the future tax impact, are reported as a separate
component of shareholders' equity until realized.
NOTE 3 - LOANS HELD FOR SALE
Loans held for sale are stated at the lower of cost or market as of the balance
sheet date.
NOTE 4 - LOANS AND LEASES
<TABLE>
<CAPTION>
Loans and leases are summarized as follows:
<S> <C> <C>
March 31, December 31,
(In thousands) 1999 1998
Real estate-mortgage $117,664 $123,980
Commercial, financial and agricultural 314,683 278,834
Real estate-construction 93,166 97,253
Consumer 40,575 51,730
Lease financing 5,708 6,375
Unearned income (923) (1,181)
$570,873 $556,991
</TABLE>
NOTE 5 - ALLOWANCE FOR LOAN AND LEASE LOSSES
Changes in the allowance for loan and lease losses are summarized as follows:
<TABLE>
<S> <C> <C>
March 31, December 31,
(In thousands) 1999 1998
Balance at beginning of year $9,888 $8,812
Provision for loan and lease losses 1,201 5,995
Reduction due to sale of loans (438) (2,976)
Recoveries 76 559
Charge-offs (514) (2,502)
Balance at end of period $10,213 $9,888
</TABLE>
NOTE 6- SERVICING ASSETS
Included on the consolidated balance sheet at March 31, 1999 and December 31,
1998 are $130.5 million and $117.1 million, respectively, of servicing assets.
These amounts relate to the principal balances of loans serviced by the
Corporation for investors. Although they are not generally held for purposes
of sale, there is an active secondary market for servicing assets.
The Corporation has periodically sold servicing assets.
NOTE 7- SHORT-TERM BORROWINGS
<TABLE>
<CAPTION>
Short-term borrowings are summarized as follows:
<S> <C> <C>
March 31, December 31,
(In thousands) 1999 1998
Repurchase agreements and drafts payable related to
mortgage loan closings $118,040 $172,126
Lines of Credit 133,105 180,118
Federal funds 120,190 266,000
Commercial paper 28,040 26,617
Total $399,375 $644,861
</TABLE>
Repurchase agreements at March 31, 1999 and December 31, 1998, include
$3.1 million and $29.8 million respectively, in mortgage loans sold under
agreements to repurchase which are used to fund mortgage loans sold 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 $114.9 million
and $142.3 million at March 31, 1999 and December 31, 1998. These borrowings
are related to mortgage closings at the end of the period which have not
been presented to banks for payment. When presented for payment these
borrowings will be funded internally or by borrowing from the lines of credit.
The Corporation has lines of credit available to fund mortgage loans held
for sale. Interest on the lines of credit is payable monthly at variable
rates ranging from 4.82% to the lender's prime rate.
NOTE 8 -- LONG-TERM DEBT
Long-term debt at March 31, 1999 of $2.7 million consists of a note payable
with a variable interest rate averaging 7.4% and maturing on July 1, 2002.
Long-term debt as of December 31, 1998 of $2.8 million consisted of a note
payable with a variable interest rate averaging 7.94% and maturing on
July 1, 2002.
NOTE 9 -- COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES
OF SUBSIDIARY TRUST
In January 1997, the Corporation issued $50 million of trust preferred
securities through IFC Capital Trust I, a trust created and controlled
by the Corporation. The securities were issued at $25 per share with a
cumulative dividend rate of 9.25%, payable quarterly. They have an initial
maturity of 30 years with a 19-year extension option. The securities are
callable at par after five years, or immediately, in the event of an
adverse tax development affecting the Corporation's classification of
the securities for federal income tax purposes. They are not convertible
into common stock of the Corporation. The securities are shown on the
balance sheet net of capitalized issuance costs.
The sole assets of IFC Capital Trust I are subordinated debentures of the
Corporation with a principal balance of $51.5 million, an interest rate of
9.25% and an initial maturity of 30 years with a 19-year extension option.
NOTE 10 -- EARNINGS PER SHARE
Earnings per share calculations have been adjusted to reflect the 2 for 1
stock split on May 27, 1998.
<TABLE>
<CAPTION>
Earnings per share calculations are summarized as follows:
Basic Earnings Effects of Diluted Earnings
Per Share Stock Options Per Share
Three months ended March 31, 1999
<S> <C> <C> <C>
Net income available to common shareholders $8,972 $-- $8,972
Shares 21,683 447 22,130
Per-Share Amount available to common sharehold $0.41 $0.00 $0.41
</TABLE>
<TABLE>
Basic Earnings Effects of Diluted Earnings
Per Share Stock Options Per Share
Three months ended March 31, 1998
<S> <C> <C> <C>
Net income available to common shareholders $7,064 $-- $7,064
Shares 21,862 498 22,360
Per-Share Amount available to common sharehold $0.33 ($0.01) $0.32
</TABLE>
NOTE 11 -- CONTINGENCIES
In the normal course of business, Irwin Financial Corporation and its
subsidiaries are subject to various claims and other pending and possible
legal actions.
As of March 31, 1999, Irwin Mortgage Corporation (IMC) was a defendant in
three separate class action lawsuits relating to the following: IMC's
administration of mortgage escrow accounts, IMC's right to pay broker fees
to mortgage brokers, and IMC's participation in a housing opportunity program.
As of March 31, 1999, Irwin Union Leasing, (formerly Affiliated Capital Corp.
(ACC)), and Irwin Financial Corporation were defendants in a class action
lawsuit alleging misrepresentations by a manufacturer of certain equipment
financed by ACC.
NOTE 12 -- Industry Segment Information
The Corporation has three principal segments that provide a broad range of
financial services throughout the United States. The Mortgage Banking line of
business originates, sells and services residential first mortgage loans.
The Community Banking line of business provides commercial banking services.
The Home Equity Lending line of business originates and services home equity
loans via direct mail and telemarketing. The Corporation's other segments
include equipment leasing and the parent company.
The accounting policies of each segment are the same as those decribed in the
"Summary of Significant Accounting Policies. " Below is a summary of each
segment's revenues, net income, and assets for 1999 and 1998:
<TABLE>
<CAPTION>
Mortgage Community Home Equity
(In thousands) Banking Banking Lending Other Consolidated
For the three months ended March 31, 1999
<S> <C> <C> <C> <C> <C>
Net interest income $7,211 $5,239 ($774) $5,049 $16,725
Intersegment interest ($1,972) $1,385 $5,735 ($5,148) 0
Other revenue 44,023 3,100 5,520 2,005 54,648
Intersegment revenues 0 42 564 (606) 0
Total net revenues 49,262 9,766 11,045 1,300 71,373
Other expense 38,597 6,252 7,872 2,394 55,115
Intersegment expenses 634 829 137 (1,600) 0
Net income before taxes 10,031 2,684 3,036 506 16,258
Income taxes 4,083 1,020 0 1,009 6,112
Net income 5,948 1,665 3,036 (503) 10,146
Distribution on Preferred
Securities 0 0 0 1,174 1,174
Net income available to
Shareholders $5,948 $1,665 $3,036 ($1,677) $8,972
Assets at March 31, 1999 $637,848 $633,479 $254,731 $104,407 $1,630,465
For the three months ended March 31, 1998
Net interest income $6,490 $2,938 $1,491 $1,419 $12,338
Intersegment interest (2,145) 2,497 (652) 300 0
Other revenue 39,695 2,744 6,805 723 49,967
Intersegment revenues 0 34 133 (167) 0
Total Net revenues 44,040 8,213 7,777 2,275 62,305
Other expense 34,041 5,367 6,955 2,824 49,187
Intersegment expenses 452 371 26 (849) 0
Net income before taxes 9,547 2,475 796 300 13,118
Income taxes 3,895 928 0 57 4,880
Net income 5,652 1,547 796 243 8,238
Distribution on Preferred
Securities 0 0 0 1,174 1,174
Net income available to
Shareholders 5,652 1,547 796 (931) 7,064
Assets at December 31, 1998 $877,904 $607,992 $311,974 $135,274 $1,933,144
</TABLE>
PART I
Item 2
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management's discussion and analysis should be read in
conjunction with the accompanying consolidated financial
statements and footnotes. Forward-looking statements contained
in the following discussion are based on estimates and
assumptions that are subject to significant business, economic
and competitive uncertainties, many of which are beyond the
Corporation's control and are subject to change. These
uncertainties can affect the actual results and could cause
actual results to differ materially from those expressed in any
forward-looking statements in this discussion.
Overview
Net income for the first quarter ended March 31, 1999, was
$9.0 million, up 27.0% from the first quarter 1998 net income of
$7.1 million. Diluted earnings per share were $0.41 for the
first quarter of 1999 as compared to $0.32 for the same period in
1998. Return on equity for the first quarter of 1999 was 24.31%,
up from 22.05% in 1998.
Lines of Business
Irwin Financial Corporation is comprised of three lines of
business:
Mortgage banking (includes Irwin Mortgage Corporation and
the related activities of Irwin Union Bank and Trust)
Community banking (Irwin Union Bank and Trust)
Home equity lending (includes Irwin Home Equity and the
related activities of Irwin Union Bank and Trust)
Listed below are the earnings by line of business for the three
months ended March 31, 1999, as compared to the same period in
1998:
Three Months Ended
March 31,
(In thousands) 1999 1998
Mortgage banking $5,948 $5,652
Community banking 1,665 1,547
Home equity lending 3,036 796
Parent (including consolidating (1,677) (931)
entries)
$8,972 $7,064
Mortgage Banking
Selected Financial Data (shown in thousands):
Three months
ended March 31,
1999 1998
Selected Income Statement
Data:
Loan origination fees $13,215 $12,844
Gain from sales of loans 14,739 10,516
Loan servicing fees 14,068 12,740
Amortization and impairment of
servicing assets (669) (6,740)
Trading gains (losses) (9,981) 0
Net interest income 5,699 4,648
Provision for loan losses (460) (302)
Gain on sale of servicing 12,126 9,956
Other income 525 379
Net revenues 49,262 44,041
Salaries and benefits 24,020 21,474
Other expenses 15,211 13,020
Income before tax 10,031 9,547
Income tax 4,083 3,895
Net income 5,948 $5,652
Return on average equity 21.70% 27.60%
Mortgage loan closings $1,776,895 $1,996,541
Selected Operating Data: March 31, December 31,
1999 1998
Servicing portfolio $10,892,953 $11,242,470
Mortgage loans held for sale 330,711 555,197
Mortgage servicing assets 125,316 113,131
Mortgage banking activities are conducted by Irwin
Mortgage Corporation which originates, sells, and services
residential mortgage loans throughout the United States.
Net income for the first quarter was $5.9 million, up 5.2%
from the same period in 1998. Rising interest rates resulted in
a slow-down in refinance activity during the first quarter of
1999. Total mortgage originations were $1.8 billion, down 11.0%
from the same period a year earlier. Refinanced loans originated
in the first quarter of 1999 accounted for 47.9% of total
originations, down from 55.1% during the same period in 1998.
Despite the decline in loan originations, loan origination fees
increased $0.4 million or 2.9% from the first quarter of 1998.
This increase is a result of a lower proportion of originations
being from loan refinancings which typically earn lower
origination fees.
Gains from the sales of mortgage loans were $14.7 million
in the first quarter of 1999, up from $10.5 million in 1998.
This increase was due to better market pricing than in the
previous year as a result of a change in pricing strategy and
less market volatility.
Mortgage servicing fees increased $1.3 million or 10.4%
from the first quarter of 1998. During the first quarter of
1999, the servicing portfolio contained a greater percentage of
government loans which earn higher servicing fees than
conventional loans. The servicing portfolio totaled $10.9
billion at March 31, 1999 compared with $11.2 billion at December
31, 1998.
Revenues from the sale of mortgage servicing totaled $12.1
million, up $2.2 million or 21.8% from the same period a year
earlier. The increase was primarily due to a sale of servicing
related to $256.0 million of loans originated prior to the
adoption of a new accounting standard in 1995. Because the loans
were originated before the adoption of this standard, their value
was not reflected on the balance sheet of the mortgage line of
business. As a result, the sale generated a gain of $2.4
million.
The rising interest rate environment caused a significant
decrease in expenses related to the amortization and impairment
of mortgage servicing assets, as the value of mortgage servicing
assets increases when interest rates rise. Amortization and
impairment totaled $0.7 million in the first quarter of 1999,
down from $6.7 million in the previous year.
During the first quarter of 1999, the mortgage bank made
changes to its method of estimating the value of mortgage
servicing assets. The first change involved modifying the way
loans were segregated when evaluating them for impairment. The
second change involved a different method of estimating
prepayment speeds of loans in the servicing portfolio. Had these
changes in methodology not occurred, the expenses related to
amortization and impairment of servicing assets would have been
$4.3 million lower than what was recorded.
The improvement in mortgage servicing asset amortization
and impairment was offset by $10.0 million of losses on hedging
activities. At March 31, 1999, the mortgage bank had recorded on
its balance sheet $0.8 million of options on treasury futures
that were purchased to hedge the interest rate risk associated
with mortgage servicing assets. The mortgage bank currently does
not satisfy the criteria for "hedge accounting." As a result,
options are accounted for as trading assets, and changes in fair
value of the options are adjusted through earnings. The mortgage
bank had no hedging instruments in the first quarter of 1998.
Net interest income increased 22.6% or $1.1 million from
the first quarter of 1998 due to higher levels of loans held for
sale throughout the first quarter of 1999.
Operating expenses increased 13.7% or $4.7 million from the
first quarter of 1998. Salaries and employee benefits were $2.5
million higher than the previous year, reflecting a 17.5%
increase in the number of employees from the first quarter of
1998 to the first quarter of 1999. Staffing levels had grown
throughout 1998 to keep pace with increasing loan demand. Other
increases in operating expenses include a $0.7 million increase
in expenses related to the foreclosure of loans. As discussed
further in the section on credit losses, the mortgage bank has
seen an increase in nonperforming loans and other real estate
owned which resulted in higher foreclosure costs.
Community Banking
Selected Financial Data (shown in thousands):
Three months
ended March 31,
1999 1998
Selected Income Statement Data:
Net interest income $7,076 $6,005
Provision for loan losses (452) (570)
Other income 3,142 2,778
Operating expense 7,081 5,738
Income before tax 2,685 2,475
Income tax 1,020 928
Net income $1,665 $1,547
Return on average equity 14.02% 15.95%
March 31, December 31,
Selected Balance Sheet Data: 1999 1998
Securities and short-term $82,720 $62,411
investments
Loans and leases 537,219 514,950
Allowance for loan losses 6,858 6,680
Deposits 580,104 567,526
Community banking activities are conducted by Irwin Union
Bank through locations in eight counties in Indiana as well as
offices in St. Louis, Missouri and Kalamazoo, Michigan. Net
income was $1.7 million for the first quarter of 1999, up 7.6%
from the same period a year earlier. Net interest income
improved $1.1 million or $17.8% from 1998, reflecting a 25.1%
increase in the loan portfolio from the first quarter of 1998.
The growth results from the community bank's continued expansion
into new markets. The provision for loan and lease losses was
$0.5 million, down 20.7% from a year earlier.
Following is an analysis of the community bank's net
interest income and net interest margin computed on a tax
equivalent basis:
<TABLE>
<CAPTION>
For the Three
Months ended
March 31, 1999 1998
Average Yield/ Average Yield/
(In thousands) Balance Interest Rate Balance Interest Rate
<S> <C> <C> <C> <C> <C> <C>
Interest -
earning assets $578,362 $12,032 8.44% $514,123 $11,123 8.77%
Interest -
bearing $483,655 $4,897 4.11% $435,879 $5,044 4.69%
liabilities
Net interest * $7,135 * * $6,079 *
income
Net interest * * 5.00% * * 4.80%
margin
</TABLE>
Other income in the first quarter was up $13.1% to $3.1
million. Operating expenses increased 23.4% from the first
quarter of 1998 to $7.1 million. The continued expansion of
operations in new markets led to the increases in both other
income and operating expenses.
Home Equity Lending
Selected Financial Data (shown in thousands):
Three months
ended March 31,
1999 1998
Selected Income Statement Data:
Net interest revenue $4,962 $839
Gain on sale of loans 4,863 4,822
Loan servicing income, net of
amortization of servicing assets 651 628
Trading gains 235 1,364
Other income 334 124
Total net revenues 11,045 7,777
Operating expenses 8,009 6,981
Pre-tax income $3,036 $796
March 31, December 31,
Other Selected Financial Data: 1999 1998
Home equity loans (portfolio and
held for sale) $177,829 $247,445
Interest-only strips 41,946 26,761
Servicing portfolio 633,832 581,241
The home equity lending business originates home equity
loans through direct mail and telemarketing and currently markets
in 29 states. The home equity lending business recorded pre-tax
income of $3.0 million during the first quarter of 1999, compared
to $0.8 million in the first quarter of 1998.
Net interest revenue was $4.1 million higher than the first
quarter of 1998 due to increased loan outstandings during the
period. As a result of delaying a fourth quarter 1998
securitization and higher loan production in the first quarter of
1999, average loans during the quarter were $233.4 million in the
first quarter of 1999, up from $64.4 million in 1998.
During the first quarter of 1999, the home equity lending
business originated $95.0 million of loans, up 72.2% from the
same period a year earlier. Gains from the securitization of
loans totaled $4.9 million, up 0.9% from 1998.
The home equity lending business services the loans it has
securitized and collects an annual fee equal to 1% of the
outstanding principal balance of the securitized loans.
Servicing fee income totaled $0.7 million in the first quarter of
1999, up 3.7% from a year earlier.
Interest-only strips are carried at their market values
which are determined using assumptions about the duration and
performance of the securitized loans. At March 31, 1999, the
assumed annual loss rates ranged from 0.25% to 2.00%, prepayment
speeds ranged from 10% to 46% CPR (constant prepayment rate) per
year, and the discount rate was 15.0%. Included in income
during the first quarter of 1999 was an unrealized trading gain
of $0.2 million recorded to adjust the carrying value of interest-
only strips to their market value. This compares to an
unrealized gain of $1.4 million recorded in the same period in
1998.
Operating expenses were $8.0 million in the first quarter
of 1999, up 14.7% from 1998. The increase reflects the increased
production activities of the company.
Parent Company (including Consolidating Entries)
For the period ended March 31, 1999, the parent company
recorded a net loss of $1.7 million compared with $0.9 million a
year earlier. The parent company records the income tax expense
or benefit generated at the home equity lending business until
such time that all net operating losses are fully used. In the
first quarter of 1999, the parent company recorded $1.2 million
of income tax expense related to this line of business. During
the same period a year earlier, the parent company recorded an
expense of $0.3 million.
Consolidated Income Statement Analysis
Net interest income for the first quarter of 1999 totaled
$17.9 million, up $3.9 million or 28.3% from the first quarter of
1998. The increase was the result of increased levels of loan
outstandings throughout the Corporation.
The loan loss provision was $1.2 million for the first
quarter of 1999, compared to $1.6 million for the same period in
1998. Please refer to the section on credit risk for further
discussion.
Noninterest income was $54.6 million, up $4.7 million from
1998. Gains from the sale of loans at the mortgage bank and home
equity lending business were $5.6 million higher than the
previous year, and net servicing revenues were $7.5 million
higher. However, these improvements were partially offset by
mark-to-market adjustments on trading assets which resulted in a
$9.7 million net trading loss in 1999, compared with a $1.4
million net trading gain in 1998.
Operating expenses also increased in 1999 as the first
quarter was up $5.9 million or 12.0% from 1998. This increase is
due to the increased loan production activities throughout the
Corporation.
The effective income tax rate for the Corporation was 40.5%
in the first quarter of 1999 compared to 40.9% in 1998.
Consolidated Balance Sheet Analysis
Total assets of the Corporation at March 31, 1999 were $1.6
billion, down from December 31, 1998 total assets of $1.9
billion. The decrease was due to a decline in loans held for
sale which totaled $616.3 million at March 31, 1999, down from
$936.8 million at the end of 1998 as a result of mortgage and
home equity loan sales during the first quarter of 1999. The
decrease in assets was accompanied by a decrease in short-term
borrowings of $245.5 million. Deposits totaled $949.3 million at
March 31, 1999, down $59.8 million from December 31, 1998. A
portion of noninterest bearing deposits is associated with escrow
accounts held on loans in the servicing portfolio of Irwin
Mortgage. These escrow accounts totaled $327.2 million at March
31, 1999, down from $399.6 million at December 31, 1998.
Shareholders' equity grew to $153.6 million, or $7.08 per
share, a 5.7% increase over the $145.2 million, or $6.70 per
share at the end of 1998. The Corporation's equity to assets
ratio ended the quarter at 9.42%, compared to 7.46% at the end of
1998.
Prior to the adoption of a new mortgage banking standard in
the second quarter of 1995, authoritative accounting guidance
precluded recognition of the full value of mortgage servicing
assets 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,
the Corporation's mortgage loan servicing portfolio represents
substantial economic value which is not recorded on the balance
sheet. Management estimated this value to be approximately $53.0
million or $2.42 per share at March 31, 1999. The 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 years and eventually
be reduced to zero as the underlying loans pay off.
Credit Risk
The assumption of credit risk is a key source of earnings
for the community banking and home equity lending businesses. In
addition, the mortgage banking business assumes credit risk
despite the fact that most mortgages are typically secured.
The community banking and home equity lending businesses
manage credit risk through the use of lending policies and credit
analysis and approval procedures. Loans over a certain size are
reviewed prior to approval by a loan committee.
An allowance for loan losses is established as an estimate
of the probable credit losses on the loans held by the
Corporation. It is based on management's judgement combined with
a quantitative process of evaluation and analysis. A specific
allowance is determined by evaluating those loans which are
either substandard or have the potential to become substandard.
In general, commercial loans and mortgage loans are evaluated
individually to determine the appropriate allowance. Consumer
loans, including home equity loans, are evaluated as a group. A
specific allowance is set at a level which management considers
sufficient to cover probable losses on these specific loans. A
general allowance is determined by analyzing historical loss
experience by loan type and then adjusting these loss factors for
current conditions not reflected in prior experience.
Loans 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 previously
charged off.
At March 31, 1999, the allowance for loan losses as a
percentage of total loans was 1.79%, compared to 1.78% at
December 31, 1998. For the three months ended March 31, 1999,
the provision for loan losses totaled $1.2 million, 26.7% lower
than the amount recorded in the first quarter of 1998. This
decrease corresponds with a reduction of net charge-offs which
totaled $438.6 thousand as compared to $525.0 thousand in 1998.
Nonperforming assets (loans 90 days past due, nonaccrual,
and owned real estate) were $16.0 million or 0.98% of total
assets as of March 31, 1999, up from $15.4 million or 0.79% at
December 31, 1998 and $9.5 million or 0.64% at December 31, 1997.
Although most mortgage loans are either government-insured
or conform to the underwriting guidelines of the government-
sponsored agencies that support the secondary mortgage market,
the mortgage bank has credit risk on those loans that do not
receive government insurance or that must be repurchased from
agencies due to lack of conformity to underwriting guidelines.
In recent years, the government-sponsored agencies which provide
credit enhancement on the loans underwritten by the mortgage bank
have become more stringent in their adherence to their right to
seek recourse from the originator of loans. In addition, during
periods of high origination volume such as in recent quarters,
due to delays in gathering documentation required for submission
to the insuring agencies, the mortgage bank experiences an
increase in the number of new loans which do not qualify for
insurance prior to the borrower's first 30-day delinquency. As
such, the mortgage bank has had an increase in the number of
loans it has repurchased from or been unable to submit to the
agencies and other investors. This has resulted in an increase
in the nonperforming loans and other real estate owned at the
mortgage bank. The mortgage bank seeks to cure the underwriting
defect in these loans and resell them to the agencies or sell
them to alternative investors.
Nonperforming Assets March 31, December 31, December 31,
(In Thousands) 1999 1998 1997
Accruing loans past
due
90 days or more:
Real Estate $0 $291 $534
Commercial 234 252 382
Consumer 101 89 86
Subtotal $335 632 1,002
Nonaccrual loans:
Real Estate 10,945 9,570 5,333
Commercial 1,128 1,052 777
Leasing 64 426 506
Consumer 202 174 63
Subtotal 12,339 11,222 6,679
Total nonperforming $12,674 $11,854 7,681
loans
Other real estate 3,308 3,506 1,828
owned
Total nonperforming
assets $15,982 $15,360 $9,509
Nonperforming assets
to 0.98% 0.79% 0.64%
total assets
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, sales of investment securities, or short-term
borrowings. Seasonal fluctuations in deposit levels and loan
demand require differing levels of liquidity at various times
during the year. Liquidity measures are formally reviewed by
management monthly, and they continue to show adequate liquidity
in all areas of the organization.
Interest Rate Risk
Interest rate risk refers to the potential for changes in
market rates of interest to cause changes in net interest income
and in the market value of assets and liabilities.
The Asset-Liability Management Committee of the community
bank monitors the repricing structure of both assets and
liabilities over various time horizons. Exposure to changes in
interest rates is evaluated by modeling the repricing
characteristics of the community bank's portfolio under multiple
rate scenarios. Rate sensitivity at the community bank can
typically be managed by controlling the maturity of loans,
securities, and deposits. The community bank may also use
financial futures or interest rate swaps from time to time.
Formal policies approved by the community bank's Board of
Directors ensure that exposure to changes in net interest
revenues is maintained within acceptable levels.
The mortgage banking business assumes a form of interest
rate sensitivity by entering into commitments to extend loans to
borrowers at a fixed price for a limited period of time. Loans
are also held temporarily until a pool is formed. The mortgage
bank buys commitments to deliver loans at a fixed price to manage
risk. The policy at the home equity lending business is to match-
fund all loan assets. The mortgage bank and the home equity
business are also exposed to interest rate risk through their
ownership of servicing assets and other retained interests
resulting from securitization. The companies manage their risk
using a variety of techniques including: maintaining a strong
production operation which offsets the interest rate risk,
selective sales of servicing rights, and the use of financial
hedges. In some cases, the Corporation uses internal hedges to
allow for risk characteristics of one line of business to offset
those of another line.
The following table shows in summary form the Corporation's
interest rate sensitivity based on expected interest rate
repricing intervals for the balance sheet as of March 31, 1999 (a
"gap" analysis). Fixed rate assets and liabilities are analyzed
based on their expected maturities which reflect estimated
prepayment characteristics, rather than their maximum contractual
maturities. For example, the majority of 30-year adjustable rate
residential mortgages held in the portfolio of Irwin Union Bank
are included in the "3 months to 1 year" category since that is
the time frame over which the assets will reprice. Some items,
such as certain deposit accounts, especially those associated
with the escrows on the mortgage servicing assets, are non-
interest bearing, but will vary in balance due to interest rate
changes. Since the Corporation relies on such accounts in its
operations and would need to replace them with "at market"
liabilities should the non-interest bearing ones be unavailable,
they are included in the gap table an in simulations based on
their expected maturities over interest rate cycles.
As the table shows, the consolidated one-year gap at March
31, 1999, was a positive $170.3 million. This compares to a
positive gap of $135.0 million at December 31, 1998.
Within 4-12 1-5 Over 5 Total
3 Months Years Years
Months
(In Thousands)
Assets:
Interest-bearing
deposits with $17,284 $836 $198 $0 $18,318
banks
Federal Funds 12,000 0 0 0 12,000
Sold
Trading assets 30,986 3,501 6,212 2,073 42,772
Taxable
investment 19,159 9,765 6,412 5,880 41,216
securities
Tax-exempt
investment
securities 500 0 217 4,490 5,207
Loans held for 489,463 32,802 67,729 26,308 616,302
sale
Loans, net of
unearned
income 343,559 18,373 99,511 109,430 570,873
Total interest-
earning assets 912,951 65,277 180,279 148,181 1,306,688
Liabilities:
Non-interest
bearing deposits 11,740 29,469 91,921 268,347 401,477
Money Market
checking 17,093 0 51,278 29,106 97,477
Money Market 1,456 0 5,094 0 6,550
savings
Regular savings 21,007 1,609 8,580 6,630 37,826
Time deposits 239,485 88,911 77,356 388 406,140
Short-term
borrowings 361,509 35,657 2,057 0 399,223
Long-term debt 0 0 2,719 0 2,719
Total interest-
bearing 652,290 155,646 239,005 304,471 1,351,412
liabilities
Trust preferred
securities 0 0 0 50,000 50,000
Interest
sensitivity gap 260,661 (90,369) (58,726) (206,290) (94,724)
Cumulative
interest $260,661 $170,292 $111,566 $(94,724) $(94,724)
sensitivity gap
Since the gap was positive at March 31, 1999, it means that
the Corporation's net interest income was positioned to benefit
from rising rates, or to be harmed by declining rates. While
traditional interest rate risk focuses on the changes in net
interest income due to interest rate changes, the Corporation
engages in other activities which are also affected by interest
rate changes. Principal among these activities are mortgage loan
origination and servicing. Through the use of simulations using
regression modeling, option-adjusted valuation techniques for
estimating expected customer behavior, and Monte-Carlo based cash
flow simulation, the Corporation attempts to analyze and mitigate
total interest rate risk, that associated with both net interest
income and non-interest income. For example, if interest rates
decline, management expects an increase in mortgage loan
origination income and a decline in the value of mortgage
servicing assets. Management attempts to monitor this exposure
to traditional interest rate risk as well as interest rate
influences on production and servicing value in a comprehensive
manner.
The following table shows management's estimate of the
present value of interest-sensitive assets and liabilities, as
well as off-balance sheet financial contracts as of March 31,
1999, at then current interest rates as well as simulated rates
1.0% and 2.0% above and below those interest rates. It does not
take into account the book values of the Corporation's non-
interest sensitivity assets and liabilities, such as cash,
accounts receivable, and fixed assets, the value of which is not
directly determined by interest rates.
As noted above, the analysis is based on discounted cash
flows over the remaining estimated lives of the financial
instruments. The total measurement of the Corporation's exposure
to interest rate risk as presented in the following table may not
be representative of the actual values which might result from a
higher or lower rate environment. Such environments would likely
result in different lending and borrowing strategies by the
Corporation, designed in part to further mitigate the effect on
the value of, and the net earnings generated from the
Corporation's net assets from any change in interest rates.
The figures suggest, based on balance sheet and off balance
sheet financial assets, that the present value of the
Corporation's interest-sensitive assets and liabilities would
decline in a falling rate environment and increase in a rising
rate environment. The magnitude and direction of the present
value rate sensitivity is largely unchanged from fourth quarter
1998, with the exception of the impact of rising rates on
mortgage servicing assets. The Corporation's book value of
servicing assets was capped below estimated market value as of
March 31, 1999, due to the accounting principle which requires
servicing assets to be carried at the lower of their cost or
market value. The following table shows these assets uncapped
(i.e. at estimated market value rather than book value.) This,
in turn, limited the degree to which estimated market values
would increase in rising rate environments.
As previously noted, this present value sensitivity
analysis does not account for potential earnings the Corporation
would recognize due to strategic initiatives it would undertake
if the interest rate scenarios model occurred, nor does it
reflect activities not traditionally measured as financial assets
or liabilities. Principal among these activities for the
Corporation would be the change in mortgage loan production and
the earnings stream the Corporation derives therefrom.
PRESENT
VALUE
($000)
AT MARCH
31, 1999
-2% -1% CURRENT +1% +2%
Interest Sensitive
Assets
Interest-bearing $17,058 $17,052 $17,048 $17,044 $17,039
deposits with banks
Federal Funds Sold 5,070 5,070 5,070 5,070 5,070
Taxable investment 93,827 93,301 93,475 94,143 95,033
securities
Tax - exempt 5,596 5,394 5,202 5,019 4,845
investment securities
Mortgages held for 628,269 625,645 633,479 619,306 615,493
sale
Mortgage Servicing 71,045 111,133 163,431 188,144 203,203
Rights
Loans, net of 641,003 629,361 617,869 606,421 595,082
unearned discount
Total Interest 1,461,868 1,486,956 1,535,574 1,535,147 1,535,765
Sensitive Assets
Interest Sensitive
Liabilities
Non-Interest Bearing 393,064 393,008 392,957 392,991 392,863
Deposits
Money Market Checking 117,877 117,779 117,683 117,588 117,492
Money Market Savings 6,715 6,710 6,704 6,699 6,693
Regular Savings 111,860 111,769 111,677 111,587 111,496
Time Deposits 317,897 315,579 313,315 311,110 308,967
Short term borrowings 374,689 374,530 374,371 374,212 374,055
Long Term Debt 66,134 61,185 57,372 54,434 52,135
Total Interest 1,388,236 1,380,560 1,374,079 1,368,621 1,363,701
Sensitive Liabilities
Interest Sensitive 9,830 5,505 1,410 971 1,439
Off Balance Sheet
Items
Net Sensitivity as of $83,462 $111,901 $162,905 $167,497 $173,503
March 31, 1999
Potential Change ($79,443) ($51,004) $4,592 $10,598
Net Sensitivity as of $50,666 $78,781 $103,290 $126,155 $140,238
December 31, 1998
Potential Change ($52,624) ($24,509) $22,865 $36,948
Derivative Financial Instruments
The Corporation hedges its interest rate risk on mortgage
loans held for sale using mandatory commitments to sell the loans
at a future date. The economic value of mortgage servicing
assets are hedged using options on treasury futures. At March
31, 1999, these options had a fair value of $0.8 million and a
net notional amount (which does not represent the amount at risk)
of $1.5 billion, consisting of $750.0 million of long positions
and $750.0 million of short positions. Interest-only strips are
hedged using interest rate caps which had a fair value of $0.6
million at March 31, 1999, and a notional amount of $61.4
million. Options on treasury futures and interest rate caps are
classified as trading assets on the balance sheet and carried at
their market values. Adjustments to market values are recorded
as net trading gains or losses on the income statement. In the
first quarter of 1999, the Corporation recorded $10.0 million of
trading losses related to these derivative products. No gains or
losses were reported in the first quarter of 1998.
Capital Adequacy
The Corporation is subject to various regulatory capital
requirements administered by federal banking agencies.
Quantitative measures established by regulation to ensure capital
adequacy require the Corporation to maintain minimum amounts and
ratios (set forth in the table below) of total and Tier I capital
(as defined in the regulations) to risk-weighted assets (as
defined), and of Tier I capital to average assets (as defined).
Equity and risk-based capital ratios for the Corporation are as
follows:
Ratio
Required to
be
Considered March 31, December December
Well- 1999 31, 1998 31, 1997
Capitalized
Equity to n/a 9.42% 7.46% 8.55%
Assets
Risk-Based 10.0% 12.42% 12.25% 14.85%
Capital
Tier I Capital 6.0% 12.70% 11.63% 13.56%
Tier I Leverage 5.0% 11.97% 10.51% 12.06%
Year 2000 Readiness
The Corporation is actively addressing its exposure to the Year
2000 issue and has four teams focusing on the issue (one at each
of its three principal operating entities and at the parent
company). The Corporation has developed a seven-stage project
plan to achieve Year 2000 readiness by June 30, 1999, that
includes: (i) an awareness campaign throughout the Corporation
to raise the level of importance and attention beyond that of a
typical "information technology" issue; (ii) assessment of the
Corporation's Year 2000 problem, including contract review, a
technical audit and an estimation of remediation costs; (iii)
remediation of non-compliant systems through repairs, upgrades or
replacements of computer programs and chips; (iv) testing of the
Corporation's systems for Year 2000 compliance; (v) development
of contingency plans to continue processes in the event of Year
2000 readiness failure by the Corporation or parties on whom it
is dependent; (vi) implementation of the remediated systems; and
(vii) auditing after January 1, 2000, of the completed processes
for post-year 2000 compliance. The Corporation has engaged a
leading technology-consulting firm to increase its level of
confidence that the methods and standards it employs to address
the Year 2000 issue are appropriate and comprehensive. The
entire project is overseen by a Year 2000 Steering Committee
which includes the Corporation's Chairman, President, and those
in charge of Information Technology (IT) at each entity.
Scope
The Corporation has developed a technology strategy that
primarily uses systems developed by third parties and has very
few internally developed applications. Consequently, the
Corporation's principal focus is on assuring Year 2000 compliance
from its commercial application vendors and other third-party
service providers. In those instances where the Corporation
believes a vendor may not be compliant in a timely manner, the
Corporation is taking additional steps to address its needs with
alternative systems, including replacement of existing vendor's
systems. The project plan has addressed computer hardware and
software as well as environmental systems used in the
Corporation's work places to address readiness of both direct and
indirect process support systems (i.e., IT and non-IT systems).
An initial step in the implementation of the Year 2000
methodology involved the identification of all possible
technologies that utilize date logic. To ensure completeness,
the Corporation provided education and awareness to affected
stakeholders. Once this step was completed, the Corporation
engaged in a comprehensive inventory to identify technologies
that utilize date logic by both business process and critical
need.
Progress
The Corporation is currently in varying stages of the testing,
implementation, and contingency planning steps of its project and
is generally on target to meet the milestones necessary to
achieve Year 2000 readiness by June 30, 1999. However, as noted
in the graphs below which illustrate current project progress
against the work plan for each of the Corporation's principal
entities, there have been some delays in the testing phase of the
project. In general, this is the result of delays brought upon
by reliance on third parties who are late in their delivery of
remediated programs and/or test documentation. The Corporation
is paying close attention to this issue as it is approaching the
point where it would not have time to change vendors if these
issues are not resolved. When certain elements of the project
plan are unexpectedly delayed, the Corporation has accelerated
progress on other areas of the project.
Costs
The Year 2000 project has required a reallocation of business
resources from other areas of the Corporation. However, to date,
the consolidated cost of the project has not been material to the
overall financial results of operations, liquidity, or capital,
nor does the Corporation believe it will be material throughout
the duration of the project. Additionally, the Corporation does
not believe that the reallocation of resources necessary to
address the Year 2000 issue has resulted in a material adverse
change in the Corporation's ability to address other information
technology projects critical to the Corporation's growth. The
Corporation has incurred and expensed approximately $1.9 million
pre-tax on the Year 2000 project since its inception. These
costs have been funded through operating cash flows. The total
cost of the project over the period 1997 to 2000 is anticipated
to be in the range of $3.4 million pre-tax, excluding incentive
stock-based compensation valued at approximately $311 thousand at
the time of grant. The Corporation cannot guarantee that the
current estimate of $3.4 million will be adequate to complete the
project. If the costs increase significantly beyond the current
estimate, it could have a material adverse affect on the
Corporation's financial results. The graph below illustrates the
amounts
expensed on the project to date (excluding the cost of options
which are not
expensed under GAAP) and on a pro forma basis through 1999 and
contains forward-looking estimates.
Year 2000 Project-Irwin Financial Consolidated
As of March 31, 1999
Pre-tax Costs in $000
1997--Actual $119
1998--Actual 1317
1999--YTD 511
1999 * 1,934
* Estimate as of March 31, 1999.
Risks
Financial services require exact calculations and prompt
delivery. If the Corporation's products are not accurate and
timely, it increases its exposure to risks such as client service
failure, regulatory compliance problems and disruption of third
party operations when it interacts with others. The Corporation
expects to implement the necessary changes to ensure that its
internal operations are Year 2000 compliant prior to December 31,
1999. To achieve this goal, the Corporation is reliant upon its
information system vendors to provide Year 2000 compliant systems
sufficiently before December 31, 1999, to allow ample time to
test the systems. The Corporation cannot guarantee that all of
its key suppliers will achieve Year 2000 compliance in a timely
manner. The failure of the Corporation's vendors to successfully
address the Year 2000 issue in a timely manner could have a
material adverse effect on the Corporation's ability to
successfully address its Year 2000 issue. Certain of the
Corporation's vendors are late in delivering test documentation.
In addition, if the Year 2000 issue adversely affects the
Corporation's customers, this in turn could have a material
adverse effect on the Corporation's ability to collect and
service outstanding loans. Finally, even if the Corporation's
internal operations and customers are Year 2000 compliant, the
Corporation's operations can be materially adversely affected if
agencies and third parties with which the Corporation interacts
fail to address the Year 2000 issue successfully.
Contingency Plans
The Corporation has not completed its assessment of the
probability or cost of potential Year 2000 system failures, nor
has it completed step five of its project plan, contingency
planning. Therefore, it is difficult at this time to accurately
estimate the cost to the Corporation of Year 2000 failures by
third parties or the Corporation itself. Any of the failures
mentioned above could have a material adverse effect on the
financial condition and results of operations of the Corporation.
Additional detail on the Year 2000 project at the Corporation's
parent company and each of its principal subsidiaries is shown
below.
Irwin Financial Corporation (parent company)
The operations of the parent company largely are intended to
further the Corporation's strategic development, allocation of
capital, planning for entering or exiting lines of business,
certain support services for its operating companies, and
external relations. There are few direct, ongoing revenue-
producing interactions with end customers of the Corporation.
Nonetheless, the services of the parent company are of sufficient
size and importance to the overall condition of the Corporation
that a separate project team is in place to assure Year 2000
readiness of its systems and operating environment.
Scope
As with the Corporation's overall project plan, the parent
company's plan included an assessment of computer hardware and
software as well as environmental systems. The principal risk of
failure to be Year 2000 compliant at the parent company lies in
the failure or delay in providing its services to its
constituents in a timely manner. In most cases, this will lead
to increases in expenses, rather than in ultimate failure to
deliver the service.
Like the other units of the Corporation, the parent company has
developed a technology strategy that primarily uses systems
developed by third parties and has very few internally developed
applications. Consequently, the parent company's principal focus
is on assuring Year 2000 compliance from its commercial
application vendors and other third-party service providers.
Progress
The progress of this team in meeting the seven-stage requirements
of its project plan to achieve Year 2000 readiness by June 30,
1999, is shown below.
Year 2000 Project-Irwin Financial (parent only)
As of March 31, 1999
Percent Completed
Target Actual Projected
Completion * Completion Actual
Completion
Date
Post-2000 Audit 0 0 During 2000
and 2001
Implementation 50 50 2Q99
Contingency 25 25 On-going
Planning
Testing 100 95 2Q99
Remediation 100 100 Done
Assessment 100 100 Done
Awareness 100 100 Done
* Target is original plan to achieve Year 2000 Readiness by June
30, 1999.
Costs
The parent company has expended approximately $157 thousand pre-
tax since inception of the Year 2000 project. The graph below
indicates the amounts expensed on the project to date and on a
pro forma basis through 1999.
Year 2000 Project-Irwin Financial (parent only)
As of March 31, 1999
Pre-tax Costs in $000
1997-Actual $33
1998-Actual 103
1999-YTD 22
1999 * 115
* Estimate as of March 31, 1999.
Risks
The consequence of failure to achieve Year 2000 compliance at the
parent company is likely to be increased labor expense as certain
automated procedures are performed with additional human
intervention. If such failures caused the parent company to miss
deadlines for required filings, the company could face fines or
penalties for late reporting of regulatory items. The company
does not believe these risks pose a material monetary risk.
Contingency Plans
A contingency planning team has been identified and business
processes have been assigned to members of that team.
Contingency plans for all of the highest priority systems are
expected to be complete by June 30, 1999. All contingency plans
are expected to be substantially complete by August 31. As part
of the planning process estimates will be made as to the exact
manner in which the company would address likely worst case
scenarios, including the financial or operational impact of such
scenarios.
Irwin Mortgage Corporation
Irwin Mortgage Corporation (IMC) is principally engaged in the
business of originating, selling, and servicing mortgage loans.
Its net income is dependent on information technology and support
systems which allow the efficient production and servicing of
loans.
Scope
IMC has had teams addressing Year 2000 readiness since August of
1997 and it has adopted the same seven phase plan to achieve
readiness used by the Corporation as discussed above. IMC
participates with the Corporation's Steering Committee and has
specific internal personnel whose time is dedicated solely to the
Year 2000 project. In addition, IMC has partnered with the local
office of a national IT consulting firm that has assisted with
staff augmentation and technical expertise in the areas of code
renovation and testing applications. IMC has kept abreast of
Year 2000 issues by participating in local Year 2000 user groups
and national Year 2000 seminars.
IMC is dependent on third parties in three principal areas.
1. IMC has developed a technology strategy that primarily uses
systems developed by third parties and has very few internally
developed applications.
2. IMC depends on several key business partners to successfully
conduct operations (e.g., Government Sponsored Enterprises [GNMA,
FNMA, and FHLMC], private investors, title companies, mortgage
brokers).
3. IMC needs a properly operating infrastructure (i.e. power,
communications, transportation) in order to effectively conduct
business.
Consequently, IMC is focusing its Year 2000 readiness efforts on
working with each of these groups.
As with the Corporation's overall project plan, IMC's plan
includes computer hardware, software, and environmental systems.
IMC owns none of the properties in which it conducts business, so
the principal focus of the environmental systems review has been
to work with the management companies of the facilities it
leases. Additionally, the company has worked with various user
groups to address the Year 2000 issue with public service
providers on which it depends.
Progress
At present, IMC is generally on schedule with its existing plan
to achieve Year 2000 readiness by June 30, 1999. The first three
phases of the plan (awareness, assessment, and remediation) have
been completed. The company is now well into the testing and
implementation phases of the initiative. Testing has involved
internal application validation in the IMC Y2K test laboratory as
well as participation in the Mortgage Bankers Association Year
2000 Inter-Industry Test. IMC has participated in the mandatory
test transactions set forth by FNMA, FHLMC, and GNMA. The
implementation phase of this initiative has been substantially
completed with the implementation into production of the Y2K-
ready version of IMC's loan servicing system.
Year 2000 Project-Irwin Mortgage
As of March 31, 1999
Percent Completed
Target Actual Projected
Completion* Completion Actual
Completion Date
Post-2000 Audit 0 0 During 2000 and
2001
Implementation 80 90 2Q99
Contingency 30 65 On-going
Planning
Testing 100 75 2Q99
Remediation 100 100 Done
Assessment 100 100 Done
Awareness 100 100 Done
* Target is original plan to achieve Year 2000 readiness by June
30, 1999.
Costs
IMC has expended approximately $1.46 million pre-tax since
inception on the Year 2000 project. The graph below indicates
the amounts expensed in the project to date and on a pro forma
basis through 1999.
Year 2000 Project-Irwin Mortgage
As of March 31, 1999
Pre-tax Costs in $000
1997--Actual $40
1998--Actual 1,046
1999--YTD 382
1999 * 1,441
* Estimate as of March 31, 1999.
Risks
Failure to be Year 2000 compliant could cause the malfunctioning
of the loan origination or servicing systems.
If there is a failure within the loan origination system that
prevented IMC from closing mortgage loans, the company could be
adversely affected through delayed or failed loan closings. This
would reduce current revenues and/or would increase the cost to
originate loans as more processes are performed with alternative,
less efficient processes. The company intends to develop
contingency plans which should allow a certain amount of
production to continue, thus mitigating the loss of revenues.
Another risk to the company could involve a failure of one or
more components in the loan servicing system. The loan servicing
system is a high-volume, transactional system that makes logic
decisions based on dates (both current and future). For example,
if the payment posting module of the system fails, the company
may be unable to remit payments and information to IMC's
investors. The cost associated with this problem includes fines
(for late reporting) that could range from a few hundred dollars
to cease and desist orders that could cost IMC all revenue
related to an individual investor's servicing portfolio.
Contingency Plans
The company is making progress toward completing its contingency
planning efforts. Its approach is to review the most important
business processes that were identified in the assessment phase
and work with the key personnel to develop alternative plans in
case the Year 2000 readiness efforts fail. IMC has identified 13
business functions that require contingency planning work and has
developed plans for 9 of them. Once a plan is developed the teams
work with internal audit in order to validate the contingency
plan.
Irwin Union Bank
Irwin Union Bank & Trust (the Bank) is engaged in providing
consumer and commercial banking, trust, insurance and brokerage
services. The Year 2000 technology compliance issue poses a
significant challenge to the organization as technology has been
integrated with all major business processes. The methodology is
based on the Corporation's seven-stage implementation plan. The
Bank is scheduled to complete all Year 2000 technology testing by
the end of June 1999.
Scope
Recognizing the impact of non-compliance, the Bank began a
formalized compliance program in 1997. The Bank has adopted the
same seven-phase plan to achieve readiness used by the
Corporation as discussed above. The Bank participates with the
Corporation's Steering Committee. The Bank's plan includes
computer hardware, software, and environmental systems.
The Bank's applications are primarily commercial off-the-shelf
applications, including its core banking technologies, facility
controls and desktop applications. In addition, the Bank
utilizes third party providers for retail brokerage and
trust/employee benefits account processing. Finally, the Bank
has two internally developed technologies, those for certificate
of deposit servicing and insurance originations that required
remediation due to non-compliance.
Progress
The Bank involved over 25 staff members to participate in Year
2000 technology discussions, vendor appraisals and compliance
testing. A multi-level testing strategy has been deployed within
the Bank. Depending on the level of vendor and third party
testing, the Bank has determined whether additional testing is
warranted. For those applications that were certified by either
a third party or vendor, the Bank has requested and reviewed the
test results and scripts. An exception to this policy of
reviewing the testing procedures of others was deemed necessary
for those applications that were critical to the Bank's continued
operation. These "Hot List" technologies were, or are currently
in process of being tested by the Bank staff using either proxy
testing, vendor scripts, or actual date scenario testing with
internally developed scripts.
The testing procedures for third party providers are more
challenging for the Bank to assess Year 2000 compliance. The
Bank has two critical technologies that are provided through a
service bureau environment: retail brokerage, trust and employee
benefits account processing. The vendors of these services are
both industry-leading providers who have committed significant
resources to ensure Year 2000 compliance. The providers have
documented their efforts to the Bank through ongoing disclosure
of testing plans and results. Both the retail brokerage and
trust service providers have provided testing results indicating
full compliance. The review of the employee benefits vendor
testing is currently in progress and is expected to be completed
by May, 1999. In addition, the Bank must install an updated
version of its loan origination software. Once implementation is
complete, the application's compliance will be confirmed through
internal testing.
The Bank's progress against each stage of its plan is shown
below.
Year 2000 Project-Irwin Union Bank
As of March 31, 1999
Percent Completed
Target Actual Projected
Completion* Completion Actual
Completion Date
Post-2000 Audit 0 0 During 2000 and
2001
Implementation 90 90 2Q99
Contingency 95 95 On-going
Planning
Testing 100 95 2Q99
Remediation 100 100 Done
Assessment 100 100 Done
Awareness 100 100 Done
* Target is original plan to achieve Year 2000 readiness by June
30, 1999.
Costs
The focus on commercial off-the-shelf applications has allowed
the Bank to avoid major programming costs that are required with
proprietary systems. However, the impact of testing existing
systems has added significant time requirements to the Bank's IT
department. In 1998, the Bank added a fifth IT professional to
allow the department to support its 350 users while conducting
Year 2000 activities. In addition, the Bank has incurred expense
in the replacement and repair of specific non-compliant systems.
To date, expenditures for the Year 2000 effort have totaled $229
thousand. The graph below illustrates the estimated total cost
of the project for the Bank.
Year 2000 Project-Irwin Union Bank
As of March 31, 1999
Pre-tax Costs in $000
1997--Actual $46
1998--Actual 98
1999--YTD 77
1999 * 165
* Estimate as of March 31, 1999.
Risks
The impact of specific technologies utilized by the Bank not
being Year 2000 compliant could be significant, although the risk
has not yet been quantified by the Bank. The inability to
process, reconcile and report customer account information could
create concern for the safety and security of the customer funds.
However, customer funds which are eligible for FDIC insurance
will continue to be insured against loss regardless of any Year
2000 disruption.
Contingency Planning
The Bank's contingency planning approach identifies core
processes, and corresponding critical activities, to develop
alternative approaches to accomplishing the desired outputs. The
bank has formed teams comprising of the departmental managers and
members of the IT department to evaluate the impact of technology
non-compliance for each critical process. Each team is then
responsible for preparing a contingency plan that provides
alternative operating procedures in the case of technology non-
compliance. The IT manager of the Bank is responsible for
collecting the contingency plans and ensuring completeness. At
present, the Bank is about ninety percent complete with its
contingency planning process.
Irwin Home Equity
The primary products of Irwin Home Equity (IHE) are second
mortgage and line of credit loans secured by real estate. Since
IHE relies on third party processors and off-the-shelf software,
its efforts are mainly directed to the testing of these
applications. Principal remediation efforts, therefore, have
been the responsibility of its vendors.
Scope
The company's Year 2000 project plan was developed within the
guidelines set forth by the Corporation to achieve Year 2000
readiness by June 30, 1999.
When compiling the plan, all functions of the organization were
considered, including computer software, hardware, data
communications, environmental facilities, third party vendors,
and other companies with whom data is exchanged. IHE's team to
manage the Year 2000 effort consists of individuals representing
Senior Management, Information Systems, Networks, Loan
Origination, Loan Servicing, Accounting, and Finance. In
addition, Telecommunications, Building, and Office Services are
involved in various phases of the project. A full time project
manager oversees the effort and IHE participates on the
Corporation's Steering Committee.
Progress
The company identified its mission critical applications and is
proceeding on schedule with testing of those modules first.
Applications were considered mission critical if they have an
impact on customers or could have a negative impact on the
continued operation of the company.
The company has completed the installation of the remediated
versions of software for all of its mission critical
applications. Conversion to a new Loan Servicing System was
completed in late March. Since this application is housed at the
vendor's service bureau, the company will rely on proxy test
results to validate Year 2000 readiness. The vendor for this
application is an industry leading provider who has committed
significant resources to Year 2000 compliance.
The progress of the IHE Year 2000 team in meeting the
requirements of its project plan to achieve Year 2000 readiness
by June 30, 1999, is shown below.
Year 2000 Project-Irwin Home Equity
As of March 1, 1999
Percent Completed
Target Actual Projected
Completion* Completion Actual
Completion Date
Post-2000 Audit 0 0 During 2000 and
2001
Implementation 100 100 Done
Contingency 25 20 On-going
Planning
Testing 100 90 2Q99
Remediation 100 100 Done
Assessment 100 100 Done
Awareness 100 100 Done
* Target is original plan to achieve Year 2000 readiness by June
30, 1999.
Costs
Few direct Year 2000 costs have been expended to date, since all
software and hardware upgrades were planned as part of our normal
business plan. Year 2000 costs have largely been limited to
internal staff time. Costs directly associated with the Year
2000 remediation have thus far totaled $102 thousand. Those
costs and anticipated future costs for the project are displayed
below.
Year 2000 Project-Irwin Home Equity
As of March 31, 1999
Pre-tax Costs in $000
1997--Actual
1998--Actual $72
1999--YTD 30.2
1999 * 213
* Estimate as of March 31, 1999.
Risks
As a result of IHE's dependence on third party providers, there
is no assurance that all vendors will achieve Year 2000
compliance in a timely manner. For instance, should the loan
origination system be unavailable due to software problems or
environmental outages, this would slow the closing and funding
process. The loan servicing system could be unavailable,
requiring manual payment or billing methods to be implemented,
thereby incurring increased expenses. The company anticipates
that any Year 2000 failure would lead principally to increased
expenses rather than failure to perform the origination,
servicing, and support functions of the company.
Contingency Plans
IHE is in the early stages of its contingency planning phase for
Year 2000. It has determined that the most likely worst case
scenario would be environmental in nature (lack of power,
telephone, data center communications). As contingency planning
progresses, the company will complete a detailed plan addressing
the potential impact a Year 2000 compliance failure by it or its
service providers could have on the company.
PART II
Item 6
(a) Exhibits to Form 10-Q
Number Assigned Sequential Numbering
In Regulation S-K System Page Number
Item 601 Description of Exhibit
(2) No Exhibit
(3) No Exhibit
(4) No Exhibit
(10) No Exhibit
(11) Computation of earnings per
share is included in the
footnotes to the financial
statements
(15) No Exhibit
(18) No Exhibit
(19) No Exhibit
(22) No Exhibit
(23) No Exhibit
(24) No Exhibit
(99) No Exhibit
(b) Reports on Form 8-K
None
SIGNATURES
Pursuant to the requirements 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
By: /s/ Thomas D. Washburn
________________________
Thomas D. Washburn
Chief Financial Officer
By: /s/ Marie S. Ameis
_________________________
Marie S. Ameis
Corporate Controller
(Chief Accounting Officer)
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