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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION  Washington, DC 20549
 FORM 10-Q (Mark One) þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934
 For the quarterly period endedMarch 31, 2005 o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934 For the transition period from  to. Commission File Number:0-6835 IRWIN FINANCIAL CORPORATION 
 (Exact Name of Corporation as Specified in its Charter)
 Indiana
    
    35-1286807(State or Other Jurisdiction of Incorporation or Organization)
    
    (I.R.S. Employer Identification No.)500 Washington Street Columbus, Indiana
    
    47201(Address of Principal Executive Offices)
    
    (Zip Code)(812) 376-1909
    
    www.irwinfinancial.com(Corporations Telephone Number, Including Area Code)
    
    (Web Site)
 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. þYes
    
    o No
 Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of
the Exchange Act þYes
    
    o No
 As of April 25, 2005, there were outstanding 28,536,435 common shares, no par value, of the
Registrant.




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FORM 10-Q
TABLE OF CONTENTS PAGENO.PART I
    
    FINANCIAL INFORMATIONItem 1
    
    Financial Statements
    
    
    3Item 2
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    18Item 3
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    55Item 4
    
    Controls and Procedures
    
    
    55PART II
    
    OTHER INFORMATIONItem 1
    
    Legal Proceedings
    
    
    56Item 6
    
    Exhibits
    
    
    58Signatures
    
    
    61Restated Articles of IncorporationAmendment No.1 to Amendment and Restatement of Shareholder AgreementAmendment No.1 to Deferred Compensation Agreement302 Certification of Chief Executive Officer302 Certification of Chief Financial Officer906 Certification of Chief Executive Officer906 Certification of Chief Financial Officer
  2




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PART I. FINANCIAL INFORMATION. 
 Item 1. Financial Statements. IRWIN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (Unaudited) March 31,
    
    December 31,2005
    
    2004(Dollars in thousands)Assets:Cash and cash equivalents
    
    $
    153,737
    
    
    $
    97,101Interest-bearing deposits with financial institutions
    
    
    80,209
    
    
    
    58,936Residual interests
    
    
    51,582
    
    
    
    56,101Investment securities- held-to-maturity (Fair value: $4,818
at March 31, 2005 and $4,952 at December 31, 2004)
    
    
    4,810
    
    
    
    4,942Investment securities- available-for-sale
    
    
    103,081
    
    
    
    103,280Loans held for sale
    
    
    1,053,871
    
    
    
    890,711Loans and leases, net of unearned income - Note 2
    
    
    3,487,697
    
    
    
    3,450,440Less: Allowance for loan and lease losses - Note 3
    
    
    (45,428
    )
    
    
    (44,443
    )3,442,269
    
    
    
    3,405,997Servicing assets - Note 4
    
    
    387,287
    
    
    
    367,032Accounts receivable
    
    
    125,641
    
    
    
    122,131Accrued interest receivable
    
    
    15,261
    
    
    
    15,428Premises and equipment
    
    
    29,460
    
    
    
    30,240Other assets
    
    
    118,273
    
    
    
    87,442Total assets
    
    $
    5,565,481
    
    
    $
    5,239,341Liabilities and Shareholders Equity:DepositsNoninterest-bearing
    
    $
    1,076,818
    
    
    $
    975,925Interest-bearing
    
    
    1,848,340
    
    
    
    1,774,727Certificates of deposit over $100,000
    
    
    845,257
    
    
    
    644,6113,770,415
    
    
    
    3,395,263Short-term borrowings - Note 5
    
    
    224,700
    
    
    
    237,277Collateralized debt - Note 6
    
    
    515,578
    
    
    
    547,477Other long-term debt
    
    
    270,169
    
    
    
    270,172Other liabilities
    
    
    280,770
    
    
    
    286,508Total liabilities
    
    
    5,061,632
    
    
    
    4,736,697Commitments and contingencies - Note 10Shareholders equityPreferred stock, no par value - authorized 4,000,000 shares; none issued
    
    
    
    
    
    
    Common stock, no par value - authorized 40,000,000 shares;
issued 29,612,080 shares as of March 31, 2005 and December 31, 2004,
including 1,093,032 and 1,159,684, shares in treasury as of
March 31, 2005 and December 31, 2004, respectively
    
    
    112,000
    
    
    
    112,000Additional paid-in capital
    
    
    
    
    
    
    383Deferred compensation
    
    
    (679
    )
    
    
    (660
    )Accumulated other comprehensive income, net of deferred income tax benefit
of $326 at March 31, 2005 and $129 as of December 31, 2004
    
    
    2,036
    
    
    
    2,454Retained earnings
    
    
    414,034
    
    
    
    413,486527,391
    
    
    
    527,663Less treasury stock, at cost
    
    
    (23,542
    )
    
    
    (25,019
    )Total shareholders equity
    
    
    503,849
    
    
    
    502,644Total liabilities and shareholders equity
    
    $
    5,565,481
    
    
    $
    5,239,341
 The accompanying notes are an integral part of the consolidated financial statements. 3




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IRWIN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (Unaudited) For the Three Months Ended March 31,2005
    
    
    2004(Dollars in thousands, except per share)Interest income:Loans and leases
    
    $
    65,491
    
    
    $
    61,246Loans held for sale
    
    
    18,571
    
    
    
    14,072Residual interests
    
    
    2,340
    
    
    
    3,258Investment securities
    
    
    1,715
    
    
    
    1,209Federal funds sold
    
    
    49
    
    
    
    18Total interest income
    
    
    88,166
    
    
    
    79,803Interest expense:Deposits
    
    
    14,674
    
    
    
    9,489Short-term borrowings
    
    
    3,108
    
    
    
    1,623Collateralized debt
    
    
    4,315
    
    
    
    3,805Other long-term debt
    
    
    5,856
    
    
    
    5,683Total interest expense
    
    
    27,953
    
    
    
    20,600Net interest income
    
    
    60,213
    
    
    
    59,203Provision for loan and lease losses - Note 3
    
    
    3,291
    
    
    
    8,146Net interest income after provision for loan and lease losses
    
    
    56,922
    
    
    
    51,057Other income:Loan servicing fees
    
    
    34,619
    
    
    
    32,577Amortization of servicing assets - Note 4
    
    
    (27,319
    )
    
    
    (31,687
    )Recovery (impairment) of servicing assets - Note 4
    
    
    32,400
    
    
    
    (47,383
    )Net loan administration income (loss)
    
    
    39,700
    
    
    
    (46,493
    )Gain from sales of loans
    
    
    34,525
    
    
    
    52,769Gain on sale of mortgage servicing assets
    
    
    1,185
    
    
    
    6,489Trading gains
    
    
    1,380
    
    
    
    4,673Derivative (losses) gains, net
    
    
    (36,778
    )
    
    
    58,915Other
    
    
    6,208
    
    
    
    6,10146,220
    
    
    
    82,454Other expense:Salaries
    
    
    50,017
    
    
    
    49,834Pension and other employee benefits
    
    
    12,045
    
    
    
    11,747Office expense
    
    
    3,820
    
    
    
    4,737Premises and equipment
    
    
    10,299
    
    
    
    10,455Marketing and development
    
    
    2,815
    
    
    
    3,634Professional fees
    
    
    4,612
    
    
    
    3,844Other
    
    
    14,491
    
    
    
    16,18598,099
    
    
    
    100,436Income before income taxes
    
    
    5,043
    
    
    
    33,075Provision for income taxes
    
    
    1,418
    
    
    
    12,734Net income
    
    $
    3,625
    
    
    $
    20,341Earnings per share: - Note 8Basic
    
    $
    0.13
    
    
    $
    0.72Diluted
    
    $
    0.13
    
    
    $
    0.67Dividends per share
    
    $
    0.10
    
    
    $
    0.08
 The accompanying notes are an integral part of the consolidated financial statements. 4




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IRWIN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY (Unaudited)
For the Three Months Ended March 31, 2005, and 2004 AccumulatedOther
    
    
    
    
    
    
    AdditionalRetained
    
    
    Comprehensive
    
    
    Deferred
    
    
    Paid in
    
    
    Common
    
    
    TreasuryTotal
    
    
    Earnings
    
    
    Income
    
    
    Compensation
    
    
    Capital
    
    
    Stock
    
    
    Stock(Dollars in thousands)Balance at January 1, 2005
    
    $
    502,644
    
    
    $
    413,486
    
    
    $
    2,454
    
    
    $
    (660
    )
    
    $
    383
    
    
    $
    112,000
    
    
    $
    (25,019
    )Net income
    
    
    3,625
    
    
    
    3,625Unrealized loss on investment
securities net of $198 tax benefit
    
    
    (297
    )
    
    
    
    
    
    
    (297
    )Foreign currency adjustment
    
    
    (121
    )
    
    
    
    
    
    
    (121
    )Total comprehensive income
    
    
    3,207Deferred Compensation
    
    
    (19
    )
    
    
    
    
    
    
    
    
    
    
    (19
    )Cash dividends
    
    
    (2,851
    )
    
    
    (2,851
    )Tax benefit on stock option exercises
    
    
    499
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    499Treasury stock:Purchase of 37,139 shares
    
    
    (908
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (908
    )Sales of 103,791 shares
    
    
    1,277
    
    
    
    (226
    )
    
    
    
    
    
    
    
    
    
    
    (882
    )
    
    
    
    
    
    
    2,385Balance at March 31, 2005
    
    $
    503,849
    
    
    $
    414,034
    
    
    $
    2,036
    
    
    $
    (679
    )
    
    $
    
    
    
    $
    112,000
    
    
    $
    (23,542
    )Balance at January 1, 2004
    
    $
    432,260
    
    
    $
    352,647
    
    
    $
    182
    
    
    $
    (504
    )
    
    $
    1,264
    
    
    $
    112,000
    
    
    $
    (33,329
    )Net income
    
    
    20,341
    
    
    
    20,341Unrealized gain on investment
securities net of $43 tax liability
    
    
    64
    
    
    
    
    
    
    
    64Unrealized gain on interest rate cap
net of $56 tax benefit
    
    
    (81
    )
    
    
    
    
    
    
    (81
    )Foreign currency adjustment
    
    
    (75
    )
    
    
    
    
    
    
    (75
    )Total comprehensive income
    
    
    20,249Deferred Compensation
    
    
    (36
    )
    
    
    
    
    
    
    
    
    
    
    (36
    )Cash dividends
    
    
    (2,260
    )
    
    
    (2,260
    )Tax benefit on stock option exercises
    
    
    661
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    661Treasury stock:Purchase of 9,907 shares
    
    
    (333
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (333
    )Sales of 131,627 shares
    
    
    2,644
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,330
    )
    
    
    
    
    
    
    3,974Balance at March 31, 2004
    
    $
    453,185
    
    
    $
    370,728
    
    
    $
    90
    
    
    $
    (540
    )
    
    $
    595
    
    
    $
    112,000
    
    
    $
    (29,688
    )
 The accompanying notes are an integral part of the consolidated financial statements. 5




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IRWIN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) For the Three Months Ended March 31,2005
    
    
    2004(Dollars in thousands)Net income
    
    $
    3,625
    
    
    $
    20,341Adjustments to reconcile net income to cash provided (used)
by operating activities:Depreciation, amortization, and accretion, net
    
    
    3,109
    
    
    
    1,582Amortization and (recovery) impairment of servicing assets
    
    
    (5,081
    )
    
    
    79,070Provision for loan and lease losses
    
    
    3,291
    
    
    
    8,146Gain on sale of mortgage servicing assets
    
    
    (1,185
    )
    
    
    (6,489
    )Gain from sales of loans held for sale
    
    
    (34,525
    )
    
    
    (52,769
    )Originations and purchases of loans held for sale
    
    
    (3,287,612
    )
    
    
    (3,304,377
    )Proceeds from sales and repayments of loans held for sale
    
    
    3,134,320
    
    
    
    3,163,639Proceeds from sale of mortgage servicing assets
    
    
    10,171
    
    
    
    15,606Net decrease in residuals
    
    
    4,519
    
    
    
    1,720Net increase in accounts receivable
    
    
    (3,510
    )
    
    
    (3,774
    )Other, net
    
    
    (37,899
    )
    
    
    (36,902
    )Net cash used by operating activities
    
    
    (210,777
    )
    
    
    (114,207
    )Lending and investing activities:Proceeds from maturities/calls of investment securities:Held-to-maturity
    
    
    1,293
    
    
    
    20,279Available-for-sale
    
    
    
    
    
    
    1,074Purchase of investment securities:Held-to-maturity
    
    
    
    
    
    
    (30,897
    )Available-for-sale
    
    
    (1,480
    )
    
    
    (639
    )Net (increase) decrease in interest-bearing deposits
    
    
    (21,273
    )
    
    
    14,558Net increase in loans, excluding sales
    
    
    (57,467
    )
    
    
    (83,437
    )Proceeds from sale of loans
    
    
    18,400
    
    
    
    13,886Other, net
    
    
    (1,234
    )
    
    
    (308
    )Net cash used by lending and investing activities
    
    
    (61,761
    )
    
    
    (65,484
    )Financing activities:Net increase in deposits
    
    
    375,152
    
    
    
    409,345Net decrease in short-term borrowings
    
    
    (12,577
    )
    
    
    (132,742
    )Repayments of long-term debt
    
    
    (3
    )
    
    
    (3
    )Proceeds from issuance of collateralized borrowings
    
    
    35,448
    
    
    
    112,000Repayments of collateralized borrowings
    
    
    (67,347
    )
    
    
    (174,703
    )Purchase of treasury stock for employee benefit plans
    
    
    (908
    )
    
    
    (333
    )Proceeds from sale of stock for employee benefit plans
    
    
    1,776
    
    
    
    3,305Dividends paid
    
    
    (2,851
    )
    
    
    (2,260
    )Net cash provided by financing activities
    
    
    328,690
    
    
    
    214,609Effect of exchange rate changes on cash
    
    
    484
    
    
    
    (24
    )Net increase in cash and cash equivalents
    
    
    56,636
    
    
    
    34,894Cash and cash equivalents at beginning of period
    
    
    97,101
    
    
    
    140,810Cash and cash equivalents at end of period
    
    $
    153,737
    
    
    $
    175,704Supplemental disclosures of cash flow information:Cash flow during the period:Interest paid
    
    $
    26,436
    
    
    $
    20,916Income taxes
    
    $
    2,456
    
    
    $
    (21,026
    )Noncash transactions:Liability for loans held for sale eligible for repurchase
    
    $
    1,766
    
    
    $
    78,004
 The accompanying notes are an integral part of the consolidated financial statements. 6




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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1 - Summary of Significant Accounting Policies Consolidation:Irwin Financial Corporation and its subsidiaries (the Corporation) provide
financial services throughout the United States and Canada. We are engaged in the mortgage banking,
commercial banking, home equity lending, and commercial finance lines of business. Our direct and
indirect subsidiaries include Irwin Mortgage Corporation, Irwin Union Bank and Trust Company, Irwin
Union Bank, F.S.B., Irwin Home Equity Corporation, and Irwin Commercial Finance Corporation.
Intercompany balances and transactions have been eliminated in consolidation. In the opinion of
management, the financial statements reflect all material adjustments necessary for a fair
presentation. The Corporation does not meet the criteria as primary beneficiary for our
wholly-owned trusts holding our company-obligated mandatorily redeemable preferred securities
established by Financial Accounting Standards Board (FASB) Interpretation No. 46 (FIN 46),
Consolidation of Variable Interest Entities. As a result, these trusts are not consolidated. Use of Estimates:The preparation of financial statements in conformity with generally
accepted accounting principles requires us to make estimates and assumptions that affect the
reported amounts of assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results could differ from
those estimates. Cash and Cash Equivalents Defined:For purposes of the statement of cash flows, we consider
cash and due from banks and federal funds sold to be cash equivalents. Residual Interests:Residual interests are stated at fair value. Unrealized gains and losses
are included in earnings. To obtain fair value of residual interests, quoted market prices are used
if available. However, quotes are generally not available for residual interests, so we generally
estimate fair value based on the present value of expected cash flows using estimates of the key
assumptions - prepayment speeds, credit losses, forward yield curves, and discount rates
commensurate with the risks involved - that management believes market participants would use to
value similar assets. Adjustments to carrying values are recorded as trading gains or losses. Allowance for Loan and Lease Losses:The allowance for loan and lease losses is an estimate
based on managements judgment applying the principles of
Statement of Financial Accounting Standard (SFAS) 5, Accounting for Contingencies,
SFAS 114, Accounting by Creditors for Impairment of a Loan, and SFAS 118, Accounting by
Creditors for Impairment of a Loan - Income Recognition and Disclosures. The allowance is
maintained at a level we believe is adequate to absorb probable losses inherent in the loan and
lease portfolio. We perform an assessment of the adequacy of the allowance on a quarterly basis. Within the allowance, there are specific and expected loss components. The specific loss
component is assessed for loans we believe to be impaired in accordance with SFAS 114. We have
defined impairment as nonaccrual loans. For loans determined to be impaired, we measure the level
of impairment by comparing the loans carrying value to fair value using one of the following fair
value measurement techniques: present value of expected future cash flows, observable market price,
or fair value of the associated collateral. An allowance is established when the fair value implies
a value that is lower than the carrying value of that loan. In addition to establishing allowance
levels for specifically identified higher risk graded loans, management determines an allowance for
all other loans in the portfolio for which historical experience indicates that certain losses
exist. These loans are segregated by major product type, and in some instances, by aging, with an
estimated loss ratio applied against each product type and aging category. The loss ratio is
generally based upon historic loss experience for each loan type as adjusted for certain
environmental factors management believes to be relevant. Servicing Assets:When we securitize or sell loans, we generally retain the right to service
the underlying loans sold. A portion of the cost basis of loans sold is allocated to this servicing
asset based on its fair value relative to the loans sold and the servicing asset combined. We use
the market prices under comparable servicing sale contracts, when available, or alternatively use
valuation models that calculate the present value of future cash flows to determine the fair value
of the servicing assets. In using this valuation method, we incorporate assumptions that we believe
market participants would use in estimating future net servicing income, which include estimates of
the cost of servicing per loan, the discount rate, float value, an inflation rate, ancillary income
per loan, prepayment speeds, and default rates. Servicing assets are amortized over the estimated
lives of the related loans in proportion to estimated net servicing income. In determining servicing value impairment, the servicing portfolio is stratified into its
predominant risk characteristics, principally by interest rate and product type. Each stratum is
valued using market prices under comparable servicing sale contracts 7




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when available, or alternatively, using the same model as was used originally to determine the
fair value at origination using current market assumptions. The calculated value is then compared
with the book value of each stratum to determine the required reserve for impairment. The
impairment reserve fluctuates as interest rates change and, therefore, no reasonable estimate can
be made as to future increases or declines in impaired reserve levels. We also compare actual cash
collections to projected cash collections and adjust our models as appropriate. In addition, we
periodically have independent valuations performed on the portfolio. Other than temporary
impairment is recorded to reflect our view that the originally recorded value of certain servicing
rights and subsequent impairment associated with those rights is unlikely to be recovered in market
value. There is no related direct impact on net income as this other than temporary impairment
affects only balance sheet accounts. However, a write-down will result in a reduction of
amortization expense and potentially reduced recovery of impairment in future periods. Incentive Servicing Fees:For whole loan sales of certain home equity loans, we have the
right to an incentive servicing fee (ISF) that will provide cash payments to us if a
pre-established return for the certificate holders and certain structure-specific loan credit and
servicing performance metrics are met. These ISF contracts are treated as derivatives under SFAS
133, Accounting for Derivative Instruments and Hedging Activities, and classified in other
assets. When we first received cash from an ISF agreement in the first quarter of 2004, our
accounting policy reflected the lack of history for these cash flows and among other factors,
required projections of expected cash flows to occur within one year before recognizing any value.
In the first quarter of 2005 we concluded our actual servicing experience and the performance of
the loan pools subject to these ISFs has now demonstrated a level of predictability that has
allowed us to modify our accounting policy to eliminate the one year to cash flow requirement and,
as appropriate under SFAS 133, recognize derivative value for cash flows expected over time,
including ones not anticipated to occur within one year. Our policy requires discounting these
derivatives at rates between 20% and 40%, depending on a variety of factors, including volatility of
anticipated cash flow, credit quality, loan-to-value ratio, and anticipated prepayment speeds.
ISFs are carried at fair value with the changes to fair value recognized in derivative
gains/losses. Stock-Based Employee Compensation:We have three stock-based employee compensation plans. We
use the intrinsic value method to account for our plans under the recognition and measurement
principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related
interpretations. No stock-based employee compensation cost is reflected in net income for any of
the periods presented, as all options granted under these plans had an exercise price equal to the
market value of the underlying common stock on the date of grant. The following table illustrates
the effect on net income and earnings per share if we had applied the fair value recognition
provisions of SFAS 123, Accounting for Stock-Based
Compensation, to stock-based employee compensation: For the Three Months Ended March 31,2005
    
    2004(Dollars in thousands)Net income as reported
    
    $
    3,625
    
    
    $
    20,341Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects
    
    
    (531
    )
    
    
    (632
    )Pro forma net income
    
    $
    3,094
    
    
    $
    19,709Basic earnings per shareAs reported
    
    $
    0.13
    
    
    $
    0.72Pro forma
    
    $
    0.11
    
    
    $
    0.70Diluted earnings per shareAs reported
    
    $
    0.13
    
    
    $
    0.67Pro forma
    
    $
    0.11
    
    
    $
    0.65
 Income Taxes:A consolidated tax return is filed for all eligible entities. In
accordance with SFAS 109, deferred income taxes are computed using the liability method, which
establishes a deferred tax asset or liability based on temporary differences between the tax basis
of an asset or liability and the basis recorded in the financial statements. Recent Accounting Developments:In December 2004 the FASB issued a revised Statement 123
(SFAS 123R), Accounting for Stock-Based Compensation requiring public entities to measure the
cost of employee services received in exchange for an award of equity instruments based on grant
date fair value. The cost will be recognized over the period during which an employee is required
to provide service in exchange for the award - usually the vesting period. The effective date for
this statement has been established by the Securities and Exchange
Commission (SEC) to be as of the first
annual period that begins after June 15, 2005. We are evaluating the 8




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impact of this new pronouncement and expect it to be comparable to the pro forma effects of
applying the original SFAS 123 as detailed above. Reclassifications:Certain amounts in the 2004 consolidated financial statements have been
reclassified to conform to the 2005 presentation. These changes had no impact on previously
reported net income or shareholders equity. Note 2 - Loans and Leases Loans and leases are summarized as follows: March 31,
    
    
    December 31,2005
    
    
    2004(Dollars in thousands)Commercial, financial and agricultural
    
    $
    1,782,178
    
    
    $
    1,697,651Real estate-construction
    
    
    254,274
    
    
    
    287,496Real estate-mortgage
    
    
    769,481
    
    
    
    808,875Consumer
    
    
    37,693
    
    
    
    31,166Commercial financingFranchise financing
    
    
    337,198
    
    
    
    330,496Domestic leasing
    
    
    183,458
    
    
    
    174,035Canadian leasing
    
    
    270,068
    
    
    
    265,780Unearned incomeFranchise financing
    
    
    (87,022
    )
    
    
    (86,638
    )Domestic leasing
    
    
    (25,407
    )
    
    
    (23,924
    )Canadian leasing
    
    
    (34,224
    )
    
    
    (34,497
    )Total
    
    $
    3,487,697
    
    
    $
    3,450,440
 Note 3 - Allowance for Loan and Lease Losses Changes in the allowance for loan and lease losses are summarized below: March 31,
    
    
    December 31,2005
    
    
    2004(Dollars in thousands)Balance at beginning of year
    
    $
    44,443
    
    
    $
    64,285Provision for loan and lease losses
    
    
    3,291
    
    
    
    14,195Charge-offs
    
    
    (4,033
    )
    
    
    (28,180
    )Recoveries
    
    
    1,918
    
    
    
    5,335Reduction due to sale of loans and leases and other
    
    
    (240
    )
    
    
    (627
    )Reduction due to reclassification of loans
    
    
    (12
    )
    
    
    (10,808
    )Foreign currency adjustment
    
    
    61
    
    
    
    243Balance at end of period
    
    $
    45,428
    
    
    $
    44,443
 9




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Note 4 - Servicing Assets Included on the consolidated balance sheet at March 31, 2005 and December 31, 2004 are $387
million and $367 million, respectively, of capitalized servicing assets. These amounts relate to
the principal balances of mortgage loans serviced by us for investors. Changes in our capitalized
servicing assets, net of valuation allowance, are shown below: March 31,
    
    
    December 31,2005
    
    
    2004(Dollars in thousands)Balance at beginning of year
    
    $
    367,032
    
    
    $
    380,123Additions
    
    
    24,160
    
    
    
    142,689Amortization
    
    
    (27,319
    )
    
    
    (117,143
    )(Impairment), recovery of impairment
    
    
    32,400
    
    
    
    (2,474
    )Reduction for servicing sales
    
    
    (8,986
    )
    
    
    (36,163
    )Balance at end of period
    
    $
    387,287
    
    
    $
    367,032
 We have established a valuation allowance to record servicing assets at their fair market value. Changes in
the allowance are summarized below:
 March 31,
    
    
    December 31,2005
    
    
    2004Balance at beginning of year
    
    $
    54,134
    
    
    $
    76,869Impairment, (recovery of impairment)
    
    
    (32,400
    )
    
    
    2,474Reclass for sales of servicing
    
    
    
    
    
    
    (18,210
    )Other than temporary impairment (1)
    
    
    
    
    
    
    (6,999
    )Balance at end of period
    
    $
    21,734
    
    
    $
    54,134
   (1)
 Note 5 - Short-Term Borrowings Short-term borrowings are summarized as follows: March 31,
    
    
    December 31,2005
    
    
    2004(Dollars in thousands)Federal Home Loan Bank borrowings
    
    $
    21,822
    
    
    $
    71,826Drafts payable related to mortgage loan closings
    
    
    91,333
    
    
    
    53,254Lines of credit and other
    
    
    2,345

    
    
    
    2,197Federal funds
    
    
    109,200
    
    
    
    110,000Total
    
    $
    224,700
    
    
    $
    237,277Weighted average interest rate
    
    
    2.09
    %
    
    
    1.64
    %
 Federal Home Loan Bank borrowings are collateralized by loans and loans held for
sale. Drafts payable related to mortgage loan closings are related to mortgage closings that have
not been presented to the banks for payment. When presented for payment, these borrowings will be
funded internally or by borrowing from the lines of credit. We also have lines of credit available to fund loan originations and operations with variable
rates ranging from 3.2% to 4.0% at March 31, 2005. 10




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Note 6 - Collateralized Debt We pledge or sell loans structured as secured financings at our home equity and
commercial finance lines of business. Sale treatment is precluded on these transactions because we
fail the true-sale requirements of SFAS 140 as we maintain effective control over the loans and
leases securitized. This type of structure results in cash being received, debt being recorded,
and the establishment of an allowance for credit losses. The notes associated with these
transactions are collateralized by $0.5 billion in home equity loans, home equity lines of credit,
and leases. The principal and interest on these debt securities are paid using the cash flows from
the underlying loans and leases. Accordingly, the timing of the principal payments on these debt
securities is dependent on the payments received on the underlying collateral. The interest rates
on the bonds are at a floating rate. Collateralized debt is summarized as follows: WeightedAverageInterest Rate atMarch 31,
    
    
    March 31,
    
    
    December 31,Maturity
    
    
    2005
    
    
    2005
    
    
    2004(Dollars in thousands)Commercial finance line of businessDomestic asset backed note
    
    
    7/2010
    
    
    
    4.50
    
    
    $
    24,653
    
    
    $
    29,050Canadian asset backed notes
    
    
    5/2005-4/2010
    
    
    
    3.60
    
    
    
    183,974
    
    
    
    165,802Home equity line of business2004-1 asset backed notes:Combined variable rate senior note
    
    
    12/2024-12/2034
    
    
    
    3.00
    
    
    
    282,176
    
    
    
    327,850Combined variable rate subordinate note
    
    
    12/2034
    
    
    
    3.85
    
    
    
    24,775
    
    
    
    24,775Total
    
    
    
    
    
    
    
    
    
    $
    515,578
    
    
    $
    547,477
 For the Canadian asset backed notes, we are subject to compliance with certain
financial covenants set forth in this facility including, but not limited to consolidated tangible
net worth, return on average assets, nonperforming loans, loan loss
reserve, Tier 1 leverage ratio,
and risk-based capital ratio. Due to our low level of net income in the first quarter, we
requested and obtained a waiver with respect to the return on average assets ratio covenant. As a
result of this waiver, we are in compliance with all applicable covenants as of March 31, 2005. Note 7 - Employee Retirement Plans Components of net periodic cost of pension benefit: For the Three Months Ended March 31,2005
    
    
    2004(Dollars in thousands)Service cost
    
    $
    681
    
    
    $
    494Interest cost
    
    
    416
    
    
    
    455Expected return on plan assets
    
    
    (446
    )
    
    
    (405
    )Amortization of transition obligation
    
    
    
    
    
    
    3Amortization of prior service cost
    
    
    9
    
    
    
    10Amortization of actuarial loss
    
    
    164
    
    
    
    175Net periodic benefit cost
    
    $
    824
    
    
    $
    732
 As of March 31, 2005, we have not made any contributions to our pension plan in the
current year and currently do not expect to contribute to this plan in 2005 . 11




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Note 8 - Earnings Per Share Earnings
Per Share calculations are summarized as follows: Basic
    
    
    
    
    
    
    Effect of
    
    
    DilutedEarnings
    
    
    Effect of
    
    
    Convertible
    
    
    EarningsPer Share
    
    
    Stock Options
    
    
    Shares
    
    
    Per Share(Dollars in thousands, except per share amounts)Period ended March 31, 2005Net income available to common shareholders
    
    $
    3,625
    
    
    $
    
    
    
    $
    
    
    
    $
    3,625Shares
    
    
    28,462
    
    
    
    329
    
    
    
    
    
    
    
    28,791Per-share amount
    
    $
    0.13
    
    
    $
    
    
    
    $
    
    
    
    $
    0.13Period ended March 31, 2004Net income available to common shareholders
    
    $
    20,341
    
    
    $
    
    
    
    $
    678
    
    
    $
    21,019Shares
    
    
    28,191
    
    
    
    492
    
    
    
    2,607
    
    
    
    31,290Per-share amount
    
    $
    0.72
    
    
    $
    (0.01
    )
    
    $
    (0.04
    )
    
    $
    0.67
 At March 31, 2005 and 2004, 943,792 and 4,000 shares, respectively, related to stock
options, were not included in the dilutive earnings per share calculation because they had exercise
prices below the stock price as of the respective dates. Also at March 31, 2005, 2,607,040 shares and $678,136 of interest related to convertible
securities were not included in the dilutive earnings per share calculation because they had an
antidilutive effect on earnings per share. Note 9 - Industry Segment Information We have four principal segments that provide a broad range of financial services. The
mortgage banking line of business originates, sells, and services residential first mortgage loans.
The commercial banking line of business provides commercial banking services. The home equity
lending line of business originates, purchases, sells and services home equity loans. The
commercial finance line of business originates leases and loans against commercial equipment and
real estate. Our other segment primarily includes the parent company, our private equity
portfolio, and eliminations. 12




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##### Table of Contents



The accounting policies of each segment are the same as those described in the Summary of
Significant Accounting Policies. Below is a summary of each segments revenues, net income, and
assets for three months ended March 31, 2005, and 2004: Mortgage
    
    
    Commercial
    
    
    Home Equity
    
    
    CommercialBanking
    
    
    Banking
    
    
    Lending
    
    
    Finance
    
    
    Other
    
    
    Consolidated(Dollars in thousands)For the Three Months Ended March 31, 2005Net interest income
    
    $
    9,806
    
    
    $
    24,392
    
    
    $
    25,010
    
    
    $
    5,937
    
    
    $
    (8,223
    )
    
    $
    56,922Intersegment interest
    
    
    (1,894
    )
    
    
    (832
    )
    
    
    (4,949
    )
    
    
    (435
    )
    
    
    8,110
    
    
    
    Other revenue
    
    
    17,838
    
    
    
    4,315
    
    
    
    22,704
    
    
    
    1,908
    
    
    
    (545
    )
    
    
    46,220Intersegment revenues
    
    
    24
    
    
    
    66
    
    
    
    
    
    
    
    
    
    
    
    (90
    )
    
    
    Total net revenues
    
    
    25,774
    
    
    
    27,941
    
    
    
    42,765
    
    
    
    7,410
    
    
    
    (748
    )
    
    
    103,142Other expense
    
    
    40,568
    
    
    
    18,326
    
    
    
    30,494
    
    
    
    5,993
    
    
    
    2,718
    
    
    
    98,099Intersegment expenses
    
    
    841
    
    
    
    429
    
    
    

    727
    
    
    
    193
    
    
    
    (2,190
    )
    
    
    Income (loss) before taxes
    
    
    (15,635
    )
    
    
    9,186
    
    
    
    11,544
    
    
    
    1,224
    
    
    
    (1,276
    )
    
    
    5,043Income taxes
    
    
    (6,018
    )
    
    
    3,717
    
    
    
    4,624
    
    
    
    528
    
    
    
    (1,433
    )
    
    
    1,418Net income (loss)
    
    $
    (9,617
    )
    
    $
    5,469
    
    
    $
    6,920
    
    
    $
    696
    
    
    $
    157
    
    
    $
    3,625Assets at March 31, 2005
    
    $
    1,368,894
    
    
    $
    2,894,662
    
    
    $
    1,069,178
    
    
    $
    657,679
    
    
    $
    (424,932
    )
    
    $
    5,565,481For the Three Months Ended March 31, 2004Net interest income
    
    $
    9,193
    
    
    $
    18,556
    
    
    $
    21,177
    
    
    $
    5,601
    
    
    $
    (3,470
    )
    
    $
    51,057Intersegment interest
    
    
    (424
    )
    
    
    790
    
    
    
    (2,380
    )
    
    
    
    
    
    
    2,014
    
    
    
    Other revenue
    
    
    59,867
    
    
    
    4,646
    
    
    
    18,279
    
    
    
    448
    
    
    
    (786
    )
    
    
    82,454Intersegment revenues
    
    
    
    
    
    
    130
    
    
    
    (624
    )
    
    
    
    
    
    
    494
    
    
    
    Total net revenues
    
    
    68,636
    
    
    
    24,122
    
    
    
    36,452
    
    
    
    6,049
    
    
    
    (1,748
    )
    
    
    133,511Other expense
    
    
    51,603
    
    
    
    14,634
    
    
    
    24,662
    
    
    
    4,025
    
    
    
    5,512
    
    
    
    100,436Intersegment expenses
    
    
    866
    
    
    
    449
    
    
    
    724
    
    
    
    173
    
    
    
    (2,212
    )
    
    
    Income (loss) before taxes
    
    
    16,167
    
    
    
    9,039
    
    
    
    11,066
    
    
    
    1,851
    
    
    
    (5,048
    )
    
    
    33,075Income taxes
    
    
    6,435
    
    
    
    3,622
    
    
    
    4,433
    
    
    
    2,144
    
    
    
    (3,900

    )
    
    
    12,734Net income (loss)
    
    $
    9,732
    
    
    $
    5,417
    
    
    $
    6,633
    
    
    $
    (293
    )
    
    $
    (1,148
    )
    
    $
    20,341Assets at March 31, 2004
    
    $
    1,330,505
    
    
    $
    2,311,816
    
    
    $
    1,107,988
    
    
    $
    487,769
    
    
    $
    (91,908
    )
    
    $
    5,146,170
 Note 10  Commitments and Contingencies Culpepper v. Inland Mortgage Corporation Our indirect subsidiary, Irwin Mortgage Corporation (formerly Inland Mortgage Corporation), is
a defendant in a class action lawsuit in the United States District Court for the Northern District
of Alabama, filed in April 1996, alleging that Irwin Mortgage violated the federal Real Estate
Settlement Procedures Act (RESPA) relating to Irwin Mortgages payment of broker fees to mortgage
brokers. In June 2001, the Court of Appeals for the 11th Circuit upheld the district courts
certification of a plaintiff class and the case was remanded for further proceedings in the federal
district court. In November 2001, by order of the district court, the parties filed supplemental briefs
analyzing the impact of an October 18, 2001 policy statement issued by the Department of Housing
and Urban Development (HUD) that explicitly disagreed with the judicial interpretation of RESPA by
the Court of Appeals for the 11th Circuit in its ruling upholding class certification in this case.
In response to a motion from Irwin Mortgage, in March 2002, the district court granted Irwin
Mortgages motion to stay proceedings in this case until the 11th Circuit decided the three other
RESPA cases originally argued before it with this case. The 11th Circuit subsequently decided all of the RESPA cases pending in that court. In one of
those cases, the 11th Circuit concluded that the trial court had abused its discretion in
certifying a class action under RESPA. Further, in that decision, the 11th Circuit expressly
recognized it was, in effect, overruling its previous decision upholding class certification in our
case. In March 2003, Irwin Mortgage filed a motion to decertify the class and the plaintiffs filed
a renewed motion for summary judgment. On October 2, 2003 the case was reassigned to another U.S.
district court judge. In response to an order from the court, the parties met and submitted a joint
status report at the end of October 2003. On June 14, 2004, at the courts request, the parties
engaged in
mediation, which was unsuccessful. The court then reassigned this case to a new judge.
Pursuant to the courts order on March 17, 13




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##### Table of Contents



2005, Irwin Mortgage filed a motion for summary judgment
and updated its motion to decertify the class; the plaintiffs updated their motion for summary
judgment. If the class is not decertified and the district court finds that Irwin Mortgage violated
RESPA, Irwin Mortgage could be liable for damages equal to three times the amount of that portion
of payments made to the mortgage brokers that is ruled unlawful. Based on notices sent by the
plaintiffs to date to potential class members and additional notices that might be sent in this
case, we believe the class is not likely to exceed 32,000 borrowers who meet the class
specifications. Irwin Mortgage intends to defend this lawsuit vigorously and believes it has numerous defenses
to the alleged violations. Irwin Mortgage further believes that the 11th Circuits RESPA rulings in
the cases argued before it with this one provide grounds for reversal of the class certification in
this case. We have no assurance, however, that Irwin Mortgage will be successful in defeating class
certification or will ultimately prevail on the merits. We expect that an adverse outcome
in this case could result in substantial monetary damages that could be material to our financial
position. We have not established any reserves for this case and are unable at this stage of the
litigation to form a reasonable estimate of potential loss that we could suffer. United States ex rel. Paranich v. Sorgnard et al. In January 2001, we and Irwin Leasing Corporation (formerly Affiliated Capital Corp.), our
indirect subsidiary, and Irwin Equipment Finance Corporation, our direct subsidiary (together, the
Irwin companies), were served as defendants in an action filed in the United States District Court
for the Middle District of Pennsylvania. The suit alleges that a manufacturer/importer of certain
medical devices made misrepresentations to health care professionals and to government officials to
improperly obtain Medicare reimbursement for treatments using the devices, and that the Irwin
companies, through Affiliated Capitals financing activities, aided in making the alleged
misrepresentations. On August 10, 2001, the court dismissed Irwin Financial and Irwin Equipment
Finance as defendants in the suit. The Irwin companies prevailed on a motion for summary judgment
in the district court on October 8, 2003, and the plaintiff appealed. The Court of Appeals for the
3rd Circuit heard oral argument on plaintiffs appeal on September 27, 2004. On January 28, 2005,
the court of appeals affirmed the district courts dismissal of plaintiffs action. The period
during which the plaintiff can petition to the United States Supreme Court for writ of certiorari
expires on April 28, 2005. Stamper v. A Home of Your Own Our indirect subsidiary, Irwin Mortgage Corporation, is a defendant in a case filed in August
1998 in the Baltimore, Maryland, City Circuit Court. On January 25, 2002, a jury in this case
awarded the plaintiffs damages of $1.434 million jointly and severally against defendants,
including Irwin Mortgage. The nine plaintiff borrowers alleged that a home rehabilitation company
defrauded the plaintiffs by selling them defective homes at inflated prices and that Irwin
Mortgage, which provided the plaintiff borrowers mortgage loans on the home purchases, participated
in the fraud. Irwin Mortgage filed an appeal with the Maryland Court of Special Appeals and oral
argument was held on January 7, 2003. On February 27, 2004, the Court of Special Appeals ruled
against Irwin Mortgage and remanded the case to the trial court for a partial retrial on whether
the plaintiffs are entitled to punitive damages. Irwin Mortgage petitioned the Maryland Court of
Appeals for a writ of certiorari on April 12, 2004. The Court of Appeals granted Irwin Mortgages
petition and heard oral argument on November 4, 2004. On February 4, 2005, the Court of Appeals
affirmed in part and reversed in part the judgment of the Court of Special Appeals, remanding the
case as follows: to modify the judgment for all plaintiffs by striking the award of $145,000 per
plaintiff for non-economic damages; for further proceedings concerning one plaintiff as to
non-economic damages; and for a new trial as to punitive damages. We have reserved for this case
based upon SFAS 5 guidance. Silke v. Irwin Mortgage Corporation In April 2003, our indirect subsidiary, Irwin Mortgage Corporation, was named as a defendant
in a class action lawsuit filed in the Marion County, Indiana, Superior Court. The complaint
alleges that Irwin Mortgage charged a document preparation fee in violation of Indiana law for
services performed by clerical personnel in completing legal documents related to mortgage loans.
Irwin Mortgage filed an answer on June 11, 2003 and a motion for summary judgment on October 27,
2003. On June 18, 2004, the court certified a plaintiff class consisting of Indiana borrowers who
were allegedly charged the fee by Irwin Mortgage any time after April 17, 1997. This date was later
clarified by stipulation of the parties to be April 14, 1997. In November 2004, the court heard
arguments on Irwin Mortgages motion for summary judgment and plaintiffs motion seeking to send
out class notice. We are unable at this time to form a reasonable estimate of the amount of
potential loss, if any, that Irwin Mortgage could suffer. We have not established any reserves for
this case. 14




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##### Table of Contents



Cohens v. Inland Mortgage Corporation In October 2003, our indirect subsidiary, Irwin Mortgage Corporation (formerly Inland Mortgage
Corporation), was named as a defendant, along with others, in an action filed in the Supreme Court
of New York, County of Kings. The plaintiffs, a mother and two children, allege they were injured
from lead contamination while living in premises allegedly owned by the defendants. The suit seeks
approximately $41 million in damages and alleges negligence, breach of implied warranty of
habitability and fitness for intended use, loss of services and the cost of medical treatment.
Because the case is in the early stages of litigation, we are unable at this time to form a
reasonable estimate of the amount of potential loss, if any, that Irwin Mortgage could suffer. The
parties agreed to delay the filing of an answer in this case until April 29, 2005. We are
attempting to obtain a voluntary dismissal based on our belief that there is insufficient nexus
between the cause of the alleged injuries and Irwin Mortgage. We have not established any reserves
for this case. Litigation in Connection with Loans Purchased from Community Bank of Northern Virginia Our subsidiary, Irwin Union Bank and Trust Company, is a defendant in several actions in
connection with loans Irwin Union Bank purchased from Community Bank of Northern Virginia
(Community). Hobson v. Irwin Union Bank and Trust Companywas filed on July 30, 2004 in the United States
District Court for the Northern District of Alabama. As amended on August 30, 2004, the Hobson
complaint, seeks certification of both a plaintiffs and a defendants class, the plaintiffs class
to consist of all persons who obtained loans from Community and whose loans were purchased by Irwin
Union Bank. Hobsonalleges that defendants violated the Truth-in-Lending Act (TILA), the Home
Ownership and Equity Protection Act (HOEPA), the Real Estate Settlement Procedures Act (RESPA) and
the Racketeer Influenced and Corrupt Organizations Act (RICO). On October 12, 2004, Irwin filed a
motion to dismiss the Hobsonclaims as untimely filed and substantively defective. On March 4,
2005, the court held a hearing on Irwins motion to dismiss. Kossler v. Community Bank of Northern Virginiawas originally filed in July 2002 in the United
States District Court for the Western District of Pennsylvania. Irwin Union Bank and Trust was
added as a defendant in December 2004. The Kosslercomplaint seeks certification of a plaintiffs
class and seeks to void the mortgage loans as illegal contracts. Plaintiffs also seek recovery
against Irwin for alleged RESPA violations and for conversion. The plaintiffs in Hobsonand Kosslerclaim that Community was allegedly engaged in a lending
arrangement involving the use of its charter by certain third parties who charged high fees that
were not representative of the services rendered and not properly disclosed as to the amount or
recipient of the fees. The loans in question are allegedly high cost/high interest loans under
Section 32 of HOEPA. Plaintiffs also allege illegal kickbacks and fee splitting. In Hobson,the
plaintiffs allege that Irwin was aware of Communitys alleged arrangement when Irwin purchased the
loans and that Irwin participated in a RICO enterprise and conspiracy related to the loans. Because
Irwin bought the loans from Community, the Hobsonplaintiffs are alleging that Irwin has assignee
liability under HOEPA. If the Hobsonand Kosslerplaintiffs are successful in establishing a class and prevailing at
trial, possible RESPA remedies could include treble damages for each service for which there was an
unearned fee, kickback or overvalued service. Other possible damages in Hobsoncould include TILA
remedies, such as rescission, actual damages, statutory damages not to exceed the lesser of
$500,000 or 1% of the net worth of the creditor, and attorneys fees and costs; possible HOEPA
remedies could include the refunding of all closing costs, finance charges and fees paid by the
borrower; RICO remedies could include treble plaintiffs actually proved damages. In addition, the
Hobsonplaintiffs are seeking unspecified punitive damages. Under TILA, HOEPA, RESPA and RICO,
statutory remedies include recovery of attorneys fees and costs. Other possible damages in Kossler
could include the refunding of all origination fees paid by the plaintiffs. Irwin Union Bank and Trust Company is also a defendant, along with Community, in two
individual actions (Chatfield v. Irwin Union Bank and Trust Company, et al. and Ransom v. Irwin
Union Bank and Trust Company, et al.)filed on June 9, 2004 in the Circuit Court of Frederick
County, Maryland, involving mortgage loans Irwin Union Bank purchased from Community. On July 16,
2004, both of these lawsuits were removed to the United States District Court for the District of
Maryland. The complaints allege that the plaintiffs did not receive disclosures required under
HOEPA and TILA. The lawsuits also allege violations of Maryland law because the plaintiffs were
allegedly charged or contracted for a prepayment penalty fee. Irwin believes the plaintiffs
received the required disclosures and that Community, a Virginia-chartered bank, was permitted to
charge prepayment fees to Maryland borrowers. Under the loan purchase agreements between Irwin and
Community, Irwin has the right to demand repurchase of the
mortgage loans and to seek indemnification from Community for the claims in these lawsuits. On
September 17, 2004, Irwin made a demand for indemnification and a defense to Hobson, Chatfield and
Ransom.Community denied this request as premature. 15




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##### Table of Contents



On December 22, 2004, Irwin filed a motion with the Judicial Panel On Multidistrict Litigation
requesting a transfer of Hobson, Chatfieldand Ransomto the Western District of Pennsylvania for
coordinated or consolidated proceedings with the Kossleraction. On March 31, 2005, the Judicial
Panel On Multidistrict Litigation held a hearing on Irwins motion. At this early stage, we are unable to form a reasonable estimate of the amount of potential
loss, if any, that Irwin could suffer. We have established a reserve for the Community litigation
based upon SFAS 5 and the advice of legal counsel. Litigation Related to NorVergence, Inc. Irwin Business Finance, our indirect subsidiary, is involved on a national basis in equipment
leasing finance and maintains a diverse portfolio of leases, including leases in the
telecommunications field. A portion of Irwins telecommunications portfolio involves leases of
equipment acquired from NorVergence, Inc., a New Jersey-based telecommunications company. After
assigning leases to Irwin and other lenders, NorVergence became a debtor in a Chapter 7 bankruptcy,
which is currently pending in the United States Bankruptcy Court in New Jersey. The sudden failure
of NorVergence left many of its customers without telecommunications service. These customers
became very angry when commitments made to them by NorVergence went unfulfilled. Complaints by former NorVergence customers have led to investigations by the attorneys general
of several states. Irwin Business Finance has been named as a defendant in several lawsuits
connected with NorVergence. Exquisite Caterers, LLC et al. v. Popular Leasing et al.is a lawsuit
filed in the Superior Court of New Jersey, Monmouth County, and was amended to include Irwin
Business Finance and others on September 1, 2004. The Exquisite Caterersplaintiffs seek
certification of a class of persons who leased network computer equipment from NorVergence, whose
leases were assigned to defendants. The complaint alleges that NorVergence misrepresented the
services and equipment provided, that the lessees were defrauded and the lease agreements should
not be enforced. The action alleges violations of, among other things, the New Jersey Consumer
Fraud Act; the New Jersey Truth-in-Consumer Contract, Warranty, and Notice Act; the FTC Holder
Rule; the FTC Act; and breach of contract and implied warranties. The plaintiffs seek compensatory,
statutory and punitive damages, and injunctive relief, including rescission of the leases and
cessation of collections. Irwin Business Finance was also named as a defendant, along with other lenders, in Delanco
Board of Education et al. v. IFC Credit Corporation,a lawsuit filed in the Superior Court of New
Jersey, Essex County, Chancery Division, in October 2004 in connection with leases assigned to the
lenders by NorVergence. (IFC Credit Corporation is not affiliated with Irwin Financial Corporation
or Irwin Business Finance.) The suit involved more than one thousand plaintiffs and alleged fraud,
misrepresentation and violations of the New Jersey Consumer Fraud law based on alleged conduct
similar to that in Exquisite Caterers,with the addition of a count under the New Jersey RICO
statute. Plaintiffs also alleged unjust enrichment and conversion and sought rescission of the
leases plus punitive and other damages. After failing in an attempt to obtain a temporary
injunction, the plaintiffs agreed to withdraw the complaint filed in the Superior Court and have
now commenced actions in the NorVergence bankruptcy proceeding, seeking similar relief. Irwin Business Finance was also named as a defendant, along with other lenders, in Sterling
Asset & Equity Corp. et al. v. Preferred Capital, Inc. et al., an action filed in the United States
District Court for the Southern District of Florida in October 2004, which was voluntarily
dismissed in January 2005. The plaintiffs then filed a similar complaint in the Circuit Court of
the 11th Judicial Circuit, Miami-Dade County, Florida on January 14, 2005 seeking class
certification on behalf of Florida persons or entities who leased equipment from NorVergence and
whose agreement was assigned to one of the named lenders. The plaintiffs allege that NorVergence
engaged in false, misleading and deceptive sales and billing practices. The complaint alleges
violations of the Florida Deceptive and Unfair Trade Practices Act, the FTC Holder Rule, and breach
of contract and warranties. Plaintiffs seek, among other relief, compensatory and punitive damages,
injunctive and/or declaratory relief prohibiting enforcement of the leases, rescission, return of
payments, interest, attorneys fees and costs. In connection with investigations by various state attorneys general, Irwin Business Finance
and other lenders were asked to produce information about their relationships with NorVergence and
to refrain from enforcing NorVergence leases. Irwin Business Finance is pursuing discussions with
all states in which it has customers who executed agreements with NorVergence and has discontinued
collection activities while discussions are in progress. Although negotiations are ongoing in the
following states, Irwin believes it has reached agreements in principle with: the Attorney General
of California for recovery of 15% of outstanding balances on California leases as of July 15, 2004;
the Attorney General of Florida, entitling Irwin to lease payments through January 31, 2005; and
the Attorney General of New Jersey for recovery on a staggered scale based on the contract price,
with full
forgiveness for gross a contract price of $17,999 or less, to 75% forgiveness for a gross
contract price of $30,000 or more. Irwin also is participating in negotiations with a multi-state
group of attorneys general, which appears to be progressing towards an 16




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##### Table of Contents



agreement that would require
NorVergence lessees in their states to pay all amounts due through July 30, 2004, with the lenders,
including Irwin, entitled to 15% of the then-outstanding balance. Prosecution of the suit filed on October 21, 2004, by the Attorney General of Florida against
twelve lenders, including Irwin Business Finance, in the Circuit Court of the Second Judicial
Circuit, Leon County, Florida (State of Florida v. Commerce Commercial Leasing, LLC et al.),has
been stayed by agreement of the parties while they discuss resolution of the concerns expressed by
the Florida Attorney General. The complaint alleges that the agreements assigned by NorVergence to
the lenders are unconscionable under the Florida Deceptive and Unfair Trade Practices Act. The suit
seeks to prohibit collection activities by the lenders and asks for repayment of revenues,
rescission of the agreements, restitution, recovery of actual damages, and civil money penalties. The individual lawsuit filed against Irwin Business Finance in September 2004 in the Superior
Court of Massachusetts has been put on hold pending discussions with the multi-state group of
attorneys general, of which the Attorney General of Massachusetts is a participant. On April 5, 2005, Irwin Business Finance received an informal request for information and
documents from the Federal Trade Commission. Irwin is in the process of responding to this
request. We are unable to form a reasonable estimate of potential loss, if any, that Irwin Business
Finance could suffer as a result of ongoing litigation. Agreements with the various state attorneys
general, if reached, would tend to decrease damages awarded, if any, in NorVergence-related class
actions and other lawsuits, because lessees who accept such agreements would normally cease to be
among potential class action plaintiffs. We have not established reserves in connection with
NorVergence-related litigation. We and our subsidiaries are from time to time engaged in various matters of litigation,
including the matters described above, other assertions of improper or fraudulent loan practices or
lending violations, and other matters, and we have a number of unresolved claims pending. In
addition, as part of the ordinary course of business, we and our subsidiaries are parties to
litigation involving claims to the ownership of funds in particular accounts, the collection of
delinquent accounts, challenges to security interests in collateral, and foreclosure interests,
that are incidental to our regular business activities. While the ultimate liability with respect
to these other litigation matters and claims cannot be determined at this time, we believe that
damages, if any, and other amounts relating to pending matters are not likely to be material to our
consolidated financial position or results of operations, except as described above. Reserves are
established for these various matters of litigation, when appropriate under SFAS 5, based in part
upon the advice of legal counsel. 17




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##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations. About Forward-looking Statements You should read the following discussion in conjunction with our consolidated financial
statements, footnotes, and tables. This discussion and other sections of this report contain
forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934. We intend such forward-looking statements to be
covered by the safe harbor provisions for forward-looking statements contained in the Private
Securities Litigation Reform Act of 1995 and are including this statement for purposes of invoking
these safe harbor provisions. Forward-looking statements are based on managements expectations, estimates, projections, and
assumptions. These statements involve inherent risks and uncertainties that are difficult to
predict and are not guarantees of future performance. In addition, our past results of operations
do not necessarily indicate our future results. Words that convey our beliefs, expectations,
assumptions, estimates, forecasts, outlook and projections or similar language, or that indicate
events we believe could, would, should, may or will occur (or might not occur) or are likely (or
unlikely) to occur, and similar expressions, are intended to identify forward-looking statements.
These may include, among other things, statements and assumptions about:  
    our projected revenues, earnings or earnings per share, as well as managements
short-term and long-term performance goals;
    projected trends or potential changes in our asset quality, loan delinquencies,
asset valuations, capital ratios or financial performance measures;
    our plans and strategies, including the expected results or impact of implementing such plans and strategies;
    potential litigation developments and the anticipated impact of potential outcomes of pending legal matters;
    the anticipated effects on results of operations or financial condition from recent developments or events; and
    any other projections or expressions that are not historical facts. Actual future results may differ materially from what is projected due to a variety of
factors, including, but not limited to:  
    potential changes in and volatility of interest rates, which may affect consumer
demand for our products and the management and success of our interest rate risk
management strategies;
    staffing fluctuations in response to product demand;
    the relative profitability of our lending operations;
    the valuation and management of our residual, servicing and derivative portfolios,
including short-term swings in valuation of such portfolios due to quarter-end secondary
market interest rates, which are inherently volatile;
    borrowers refinancing opportunities, which may affect the prepayment assumptions
used in our valuation estimates and which may affect loan demand;
    unanticipated deterioration in the credit quality of our assets;
    unanticipated deterioration in the carrying value of our other assets, including securities;
    difficulties in delivering products to the secondary market as planned;
    difficulties in expanding our businesses or raising capital and other funding sources as needed;
    competition from other financial service providers for experienced managers as well as for customers;
    changes in the value of companies in which we invest;
    changes in variable compensation plans related to the performance and valuation of
lines of business where we tie compensation systems to line-of-business performance;
    legislative or regulatory changes, including changes in tax laws, changes in the
interpretation of regulatory capital rules, disclosure or consumer lending rules, or
rules affecting corporate governance, and the availability of resources to address these
rules;
    changes in applicable accounting policies or principles or their application to our business; and
    governmental changes in monetary or fiscal policies. We undertake no obligation to update publicly any of these statements in light of future
events, except as required in subsequent reports we file with the Securities and Exchange
Commission (SEC). 18




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##### Table of Contents



Strategy Our strategy is to maintain a diverse and balanced revenue stream by focusing on niches in
financial services where we believe we can optimize the productivity of our capital and where our
experience and expertise can provide a competitive advantage. Our operational objectives are
premised on simultaneously achieving three goals: creditworthiness, profitability and growth. We
believe we must continually balance these goals in order to deliver long-term value to all of our
stakeholders. We have developed a four-part strategy to meet these goals:  
    Identify underserved niches.We focus on product or market niches in financial services
that we believe are underservedand where we believe customers are willing to pay a premium
for value-added services. We dont believe it is necessary to be the largest or leading
market share company in any of our product lines, but we do believe it is important that we
are viewed as a preferred provider in niche segments of those product offerings.
    Hire exceptional management with niche expertise.We enter niches only when we have
attracted senior managerswho have proven track records in the niche for which they are
responsible. Each of our four lines of business has a separate management team that operates
as an independent business unit responsible for performance goals specific to that
particular line of business. Our structure allows the senior managers of each line of
business to focus their efforts on understanding their customers and meeting the needs of
the markets they serve. This structure also promotes accountability among managers of each
enterprise. The senior managers at each of our lines of business and at the parent company
have significant industry experience. We attempt to create a mix of short-term and long-term
incentives (including, in some instances, minority interests in the line of business) that
provide these managers with the incentive to achieve creditworthy, profitable growthover
the long term.
    Diversify capital and earnings risk.We diversifyour revenuesand allocate our capital
across complementary lines of business as a key part of our risk management. Our lines of
business are cyclical, but when combined in an appropriate mix, we believe they provide
sources of diversification and opportunities for growth in a variety of economic conditions.
For example, both the origination and servicing of residential mortgage loans are very
cyclical businesses, which normally respond in opposite ways to changes in interest rates
and show generally opposite effects in certain economic environments. We believe our
participation in these markets has been profitable over time due to our dedication to
participating in both segments of the mortgage banking business, rather than one or the
other.
    Reinvest in new opportunities.We reinveston an ongoing basis in the development of new
and existing opportunities. As a result of our attention to long-term value creation, we
believe it is important at times to dampen short-term earnings growth by investing for
future return. We are biased toward seeking new growth through organic expansion of existing
lines of business. At times we will initiate a new line through a start-up, with highly
qualified managers we select to focus on a single line of business. Over the past ten years,
we have made only a few acquisitions. Those have typically not been in competitive bidding
situations. We believe our historical growth and profitability is the result of our endeavors to pursue
complementary consumer and commercial lending niches through our bank holding company structure,
our experienced management, our diverse product and geographic markets, and our willingness and
ability to align the compensation structure of each of our lines of business with the interests of
our stakeholders. Through various economic environments and cycles, we have had a relatively stable
revenue and earnings stream on a consolidated basis generated primarily through internal growth
rather than acquisitions. Critical Accounting Policies Accounting estimates are an integral part of our financial statements and are based upon our
current judgments. Certain accounting estimates are particularly sensitive because of their
significance to the financial statements and because of the possibility that future events
affecting them may differ from our current judgments or that our use of different assumptions could
result in materially different estimates. Our Annual Report of Form 10-K provides a description of
the critical accounting policies we apply to material financial statement items, all of which
require the use of accounting estimates and/or judgment. In addition, below is our policy for
incentive servicing fees. We have added this policy to our list of critical accounting policies
due to the nature of the policy (requires accounting estimates and/or judgment) and the financial
statement impact. 19




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##### Table of Contents



Incentive Servicing Fees For whole loan sales of certain home equity loans, we have the right to an incentive servicing
fee (ISF) that will provide cash payments to us if a pre-established return for the certificate
holders and certain structure-specific loan credit and servicing performance metrics are met. These
ISF contracts are treated as derivatives under SFAS 133, Accounting for Derivative Instruments and
Hedging Activities, and classified in other assets. When we first received an ISF agreement in
the first quarter of 2004, we adopted an accounting policy that reflected the lack of history for
these cash flows and among other factors, required projections of expected cash flows to occur
within one year before recognizing any value. In the first quarter we concluded our actual
servicing experience and the performance of the loan pools subject to these ISFs has now
demonstrated a level of predictability that has allowed us to modify our accounting policy to
eliminate the one year to cash flow requirement and, as appropriate under SFAS 133, recognize
derivative value for cash flows expected over time, including ones not anticipated to occur within
one year. Our policy requires discounting these derivatives at rates
between 20% and 40%, depending
on a variety of factors, including volatility of anticipated cash flows, credit quality,
loan-to-value ratio, and anticipated prepayment speeds, among other factors. ISFs are carried at
fair value with the changes to fair value recognized in derivative gains/losses. Consolidated Overview For the three months ended March 31,2005
    
    
    2004Net income (millions)
    
    $
    3.6
    
    
    $
    20.3Basic earnings per share
    
    
    0.13
    
    
    
    0.72Diluted earnings per share
    
    
    0.13
    
    
    
    0.67Return on average equity
    
    
    2.9
    %
    
    
    18.4
    %Return on average assets
    
    
    0.3
    
    
    
    1.7
 Consolidated Income Statement Analysis Net Income We recorded net income of $3.6 million for the three months ended March 31, 2005, down 82%
from net income of $20.3 million for the three months ended March 31, 2004. Net income per share
(diluted) was $0.13 for the quarter ended March 31, 2005, down 81% from $0.67 per share for the
first quarter of 2004. Return on equity was 2.9% for the three months ended March 31, 2005 and
18.4% for the same period in 2004. Net Interest Income Net interest income for the three months ended March 31, 2005 totaled $60 million, up 2% from
the first quarter 2004 net interest income of $59 million. Net interest margin for the three
months ended March 31, 2005 was 5.17% compared to 5.59% for the same period in 2004. The decline
in consolidated net interest margin related primarily to two segments due to product mix changes
and pricing pressures. 20




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##### Table of Contents



The following table shows our daily average consolidated balance sheet, interest rates and
interest differential at the dates indicated: For the Three Months Ended March 31,2005
    
    
    2004Annualized
    
    
    
    
    
    
    
    
    
    
    AnnualizedAverage
    
    
    
    
    
    
    Yield/
    
    
    Average
    
    
    
    
    
    
    Yield/Balance
    
    
    Interest
    
    
    Rate
    
    
    Balance
    
    
    Interest
    
    
    Rate(Dollars in thousands)AssetsInterest-earning assets:Interest-bearing deposits with
financial institutions
    
    $
    64,886
    
    
    $
    278
    
    
    
    1.74
    %
    
    $
    75,276
    
    
    $
    137
    
    
    
    0.73
    %Federal funds sold
    
    
    8,143
    
    
    
    49
    
    
    
    2.44
    %
    
    
    8,526
    
    
    
    18
    
    
    
    0.85
    %Residual interests
    
    
    53,201
    
    
    
    2,340
    
    
    
    17.84
    %
    
    
    70,716
    
    
    
    3,258
    
    
    
    18.53
    %Investment
securities (1)
    
    
    108,054
    
    
    
    1,437
    
    
    
    5.39
    %
    
    
    77,952
    
    
    
    1,072
    
    
    
    5.53
    %Loans held for sale
    
    
    1,013,964
    
    
    
    18,571
    
    
    
    7.43
    %
    
    
    803,267
    
    
    
    14,072
    
    
    
    7.05
    %Loans and leases, net of unearned
income(2)
    
    
    3,474,331
    
    
    
    65,491
    
    
    
    7.64
    %
    
    
    3,225,210
    
    
    
    61,246
    
    
    
    7.64
    %Total interest earning assets
    
    
    4,722,579
    
    
    $
    88,166
    
    
    
    7.57
    %
    
    
    4,260,947
    
    
    $
    79,803
    
    
    
    7.53
    %Noninterest-earning assets:Cash and due from banks
    
    
    102,426
    
    
    
    
    
    
    
    
    
    
    
    105,906Premises and equipment, net
    
    
    30,003
    
    
    
    
    
    
    
    
    
    
    
    31,595Other assets
    
    
    607,189
    
    
    
    
    
    
    
    
    
    
    
    553,180Less allowance for loan and lease
losses
    
    
    (44,955
    )
    
    
    
    
    
    
    
    
    
    
    (64,447
    )Total assets
    
    $
    5,417,242
    
    
    
    
    
    
    
    
    
    
    $
    4,887,181Liabilities and Shareholders EquityInterest-bearing liabilities:Money market checking
    
    $
    469,674
    
    
    $
    2,120
    
    
    
    1.83
    %
    
    $
    224,708
    
    
    $
    423
    
    
    
    0.76
    %Money market savings
    
    
    1,113,345
    
    
    
    5,499
    
    
    
    2.00
    %
    
    
    977,262
    
    
    
    2,954
    
    
    
    1.22
    %Regular savings
    
    
    61,728
    
    
    
    210
    
    
    
    1.38
    %
    
    
    59,368
    
    
    
    235
    
    
    
    1.59
    %Time deposits
    
    
    923,920
    
    
    
    6,845
    
    
    
    3.00
    %
    
    
    911,719
    
    
    
    5,877
    
    
    
    2.59
    %Short-term borrowings
    
    
    290,668
    
    
    
    3,108
    
    
    
    4.34
    %
    
    
    273,488
    
    
    
    1,623
    
    
    
    2.39
    %Collateralized debt
    
    
    520,738
    
    
    
    4,315
    
    
    
    3.36
    %
    
    
    563,049
    
    
    
    3,805
    
    
    
    2.72
    %Other long-term debt
    
    
    270,171
    
    
    
    5,856
    
    
    
    8.79
    %
    
    
    270,183
    
    
    
    5,683
    
    
    
    8.46
    %Total interest-bearing liabilities
    
    $
    3,650,244
    
    
    $
    27,953
    
    
    
    3.11
    %
    
    $
    3,279,777
    
    
    $
    20,600
    
    
    
    2.53
    %Noninterest-bearing liabilities:Demand deposits
    
    
    966,653
    
    
    
    
    
    
    
    
    
    
    
    866,721Other liabilities
    
    
    294,440
    
    
    
    
    
    
    
    
    
    
    
    296,774Shareholders equity
    
    
    505,905
    
    
    
    
    
    
    
    
    
    
    
    443,909Total liabilities and shareholders
equity
    
    $
    5,417,242
    
    
    
    
    
    
    
    
    
    
    $
    4,887,181Net interest income
    
    
    
    
    
    $
    60,213
    
    
    
    
    
    
    
    
    
    
    $
    59,203Net interest income to average
interest earning assets
    
    
    
    
    
    
    
    
    
    
    5.17
    %
    
    
    
    
    
    
    
    
    
    
    5.59
    %
   (1)
 (2)
 Provision for Loan and Lease Losses The consolidated provision for loan and lease losses for the three months ended March 31, 2005
was $3 million, compared to $8 million for the same period in 2004. More information on this
subject is contained in the section on credit risk. 21




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##### Table of Contents



Noninterest Income Noninterest income during the first quarter of 2005 totaled $46 million, compared to $82
million for the first three months of 2004. The decrease in 2005 versus 2004 related primarily to
the mortgage banking line of business. Contributing to the decrease were $15 million of losses on
derivative instruments used to hedge our servicing assets in excess of the reversal of servicing
asset impairment, lower gains from servicing sales, and lower gains from sales of loans. Details
related to these fluctuations are discussed later in the mortgage banking section of this
document. Noninterest Expense Noninterest expenses for the three months ended March 31, 2005 totaled $98 million, compared
to $100 million for the same period in 2004. Income Tax Provision Income tax provision for the three month ended March 31, 2005 totaled $1.4 million, compared
to $12.7 million during the same period in 2004. Our effective tax rate declined to 28% during the
first quarter of 2005 as a result of the release of $0.8 million in tax reserves to align our tax
liability to a level commensurate with our currently identified tax exposures. Consolidated Balance Sheet Analysis Total assets at March 31, 2005 were $5.6 billion, up 6% from December 31, 2004. Average
assets for the first quarter of 2005 were $5.4 billion, up 3% from the average assets for the year
2004. The growth in the balance sheet primarily reflects increases at the commercial banking line
of business. Investment Securities The following table shows the composition of our investment securities at the dates indicated: March 31,
    
    
    December 31,2005
    
    
    2004(Dollars in thousands)U.S. Treasury and government obligations
    
    $
    160
    
    
    $
    3,556Obligations of states and political subdivisions
    
    
    5,799
    
    
    
    3,746Mortgage-backed securities
    
    
    33,600
    
    
    
    31,556Other
    
    
    68,332
    
    
    
    69,364Total
    
    $
    107,891
    
    
    $
    108,222
 Loans Held For Sale Loans held for sale totaled $1.1 billion at March 31, 2005, an increase from a balance of $0.9
billion at December 31, 2004. The increase occurred primarily at our mortgage and home equity
banking lines of business where mortgage loans held for sale increased by $0.1 billion at each
company from December 31, 2004. Loans and Leases Our commercial loans and leases are originated throughout the United States and Canada. At
March 31, 2005, 93% of our loan and lease portfolio was associated with our U.S. operations. We
also extend credit to consumers throughout the United States 22




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##### Table of Contents



through mortgages, installment loans and revolving credit arrangements. Loans by major category
for the periods presented were as follows: March 31,
    
    
    December 31,2005
    
    
    2004(Dollars in thousands)Commercial, financial and agricultural
    
    $
    1,782,178
    
    
    $
    1,697,651Real estate-construction
    
    
    254,274
    
    
    
    287,496Real estate-mortgage
    
    
    769,481
    
    
    
    808,875Consumer
    
    
    37,693
    
    
    
    31,166Commercial financingFranchise financing
    
    
    337,198
    
    
    
    330,496Domestic leasing
    
    
    183,458
    
    
    
    174,035Canadian leasing
    
    
    270,068
    
    
    
    265,780Unearned incomeFranchise financing
    
    
    (87,022
    )
    
    
    (86,638
    )Domestic leasing
    
    
    (25,407
    )
    
    
    (23,924
    )Canadian leasing
    
    
    (34,224
    )
    
    
    (34,497
    )Total
    
    $
    3,487,697
    
    
    $
    3,450,440
 Allowance for Loan and Lease Losses Changes in the allowance for loan and lease losses are summarized below: March 31,
    
    
    December 31,2005
    
    
    2004(Dollars in thousands)Balance at beginning of year
    
    $
    44,443
    
    
    $
    64,285Provision for loan and lease losses
    
    
    3,291
    
    
    
    14,195Charge-offs
    
    
    (4,033
    )
    
    
    (28,180
    )Recoveries
    
    
    1,918
    
    
    
    5,335Reduction due to sale of loans and leases and other
    
    
    (240
    )
    
    
    (627
    )Reduction due to reclassification of loans
    
    
    (12
    )
    
    
    (10,808
    )Foreign currency adjustment
    
    
    61
    
    
    
    243Balance at end of period
    
    $
    45,428
    
    
    $
    44,443
 The 2004 roll forward of allowance for loan and lease losses above includes the effect of
the transfer and sale of portfolio loans at our home equity lending line of business. We
transferred $355 million in loans to loans held for sale when the decisions were made to sell these
loans from the portfolio. These loans had an associated allowance of $21 million. The loans were
transferred with an allowance of $11 million to reduce their carrying value to fair market value.
After the transfers, the remaining $10 million of excess allowance was reversed through the
provision for loan and lease losses. Deposits Total deposits for the first quarter of 2005 averaged $3.5 billion compared to deposits for
the year 2004 that averaged $3.4 billion. Demand deposits for the first quarter of 2005 averaged
$967 million, a 4% decrease over the average balance for the year 2004. A significant portion of
demand deposits is related to deposits at Irwin Union Bank and Trust Company, which are associated
with escrow accounts held on loans in the servicing portfolio at the mortgage banking line of
business. During the first quarter of 2005, these escrow accounts decreased from $746 million at
December 31, 2004 to $681 million at March 31, 2005. Irwin Union Bank and Trust utilizes institutional broker-sourced deposits as funding from time
to time to supplement deposits solicited through branches and other wholesale funding sources. At
March 31, 2005, institutional broker-sourced deposits totaled $260 million compared to a balance of
$279 million at December 31, 2004. 23




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##### Table of Contents



Short-Term Borrowings Short-term borrowings during the first quarter of 2005 averaged $291 million compared to an
average of $308 million for the year 2004. Short-term borrowings declined to $225 million at March
31, 2005 compared to $237 million at December 31, 2004. The decrease in short-term borrowings at
the end of the first quarter relative to year-end reflects an increase in mortgage escrow deposits
(an alternative funding source for our mortgage warehouse) to $746 million, compared to $681
million at year-end. Federal Home Loan Bank borrowings averaged $153 million for the quarter ended March 31, 2005,
with an average rate of 2.48%. The balance at March 31, 2005 was $22 million at an interest rate of
2.99%. The maximum outstanding during any month end during 2005 was $372 million. Collateralized and Other Long-Term Debt Collateralized debt totaled $516 million at March 31, 2005, compared to $547 million at
December 31, 2004. The decreased debt relates to paydowns on the secured borrowings during the
first quarter at our home equity lending line of business. The bulk of these borrowings have
resulted from securitization structures that result in loans remaining as assets and debt
borrowings being recorded on the balance sheet. The securitization debt represents match-term
funding for these loans and leases. Other long-term debt totaled $270 million at March 31, 2005, unchanged from December 31, 2004. We had obligations represented by subordinated debentures at March 31, 2005 totaling $240 million
with our wholly-owned trusts that were created for the purpose of issuing trust preferred
securities. The subordinated debentures were the sole assets of the trusts at March 31, 2005. In
accordance with FASB Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities
(revised December 2003), we deconsolidated the wholly-owned trusts that issued the trust preferred
securities. As a result, these securities are not consolidated on our balance sheet. Instead, the
subordinated debentures held by the trusts are disclosed on the balance sheet as other long-term
debt. We are evaluating the potential benefits of calling the trust preferred securities issued by
IFC Capital Trust II, which become callable (under certain conditions) at par in September 2005. Capital Shareholders equity averaged $506 million during the first quarter of 2005, up 7% compared to
the average for the year 2004. Shareholders equity balance of $504 million at March 31, 2005
represented $17.67 per common share, unchanged from December 31, 2004. We paid $2.9 million in
dividends in the first quarter of 2005, reflecting an increase of $0.02 per share compared to a
year ago. The following table sets forth our capital and regulatory capital ratios at the dates
indicated: March 31,
    
    
    December 31,2005
    
    
    2004(Dollars in thousands)Tier 1 capital
    
    $
    657,468
    
    
    $
    641,079Tier 2 capital
    
    
    142,000
    
    
    
    141,866Total risk-based capital
    
    $
    799,468
    
    
    $
    782,945Risk-weighted assets
    
    $
    5,321,695
    
    
    $
    4,930,684Risk-based ratios:Tier 1 capital
    
    
    12.4
    %
    
    
    13.0
    %Total capital
    
    
    15.0
    
    
    
    15.9Tier 1 leverage ratio
    
    
    12.0
    
    
    
    11.6Ending shareholders equity to assets
    
    
    9.1
    
    
    
    9.6Average shareholders equity to assets
    
    
    9.3
    
    
    
    9.0
 At March 31, 2005, our total risk-adjusted capital ratio was 15.0% exceeding our internal
minimum target of 11.0%. At December 31, 2004, our total risk-adjusted capital ratio was 15.9%.
Our ending equity to assets ratio at March 31, 2005 was 9.1% compared to 9.6% at December 31, 2004.
Our Tier 1 capital totaled $657 million as of March 31, 2005, or 12.4% of risk-weighted assets. 24




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##### Table of Contents



Cash Flow Analysis Our cash and cash equivalents increased $57 million during the first quarter of 2005 compared
to an increase of $35 million during the same period in 2004. Cash flows from operating activities
resulted in a use of $211 million in cash and cash equivalents in the first quarter of 2005
compared to the first quarter of 2004 when our operations used $114 million in cash and cash
equivalents. Changes in loans held for sale impact cash flows from operations. In a period in
which loan production exceeds sales such as we had in the first quarter of 2005, operating cash
flows will decrease reflecting our investment in cash generating assets. In the first quarter of
2005, our loans held for sale increased $163 million, thus increasing the cash used by operating
activities. Earnings Outlook We do not provide quantitative earnings guidance, as we do not believe it to be in the best
interest of our long-term stakeholders. However, as discussed before, our strategy is to seek
opportunities for credit-worthy, profitable growth by serving niche markets and balancing the
impact of changes in interest rates and economic conditions on our mortgage banking production with
investments in mortgage servicing and in our credit retained portfolios. These investments will
typically respond in an opposite and complementary manner. We expect a substantial proportion of
2005 earnings to come from net interest income derived from our credit portfolios in commercial
banking, home equity lending and commercial finance lines of business. We expect segment growth and
earnings to be more proportionate to our balance sheet exposures, rather than the disproportionate
contribution provided by the mortgage segment during 2002 and 2003. Currently, market conditions
for our mortgage banking segment are very difficult. Origination margins are significantly below
our long-term expectations and we are not seeing meaningful increases in interest rates which would
normally drive an increase in the value of our servicing portfolio as we would typically expect
when mortgage origination revenues are declining Our results in the first quarter were well below our long-term expectations. Our current
expectation is that earnings in the remaining quarters of 2005 will return to amounts more
consistent with our long-term record. However, given results in the first quarter, we expect net
income for the full year of 2005 to be below those recorded in 2004. These estimates are
based on various factors and current assumptions management believes are reasonable, including
current industry forecasts of a variety of economic and competitive factors. However, projections
are inherently uncertain, and our actual earnings may differ significantly from this estimate due
to uncertainties and risks related to our business such as fluctuations in interest rates and other
factors mentioned above in the About Forward-Looking Statements section. Over periods of normal
economic cycles we strive to meet or exceed our long-term targets of double-digit growth in
earnings per share and a return on equity above our cost of capital. A meaningful amount of our earnings comes from activities and mark-to-market accounting
requirements tied directly or indirectly to capital market activities and include estimates of
future cash flows. As such, earnings are more difficult for us to predict over short periods of
time. For example, the valuation of our residual interests and incentive servicing fees are
affected by a variety of factors including current and future credit quality, prepayment speeds,
and discounts rates and our mortgage servicing portfolio is impacted most directly by movements in
the bond market. The impact of short-term movements in interest rates on the valuation of our
mortgage servicing rights is mitigated by a combination of financial derivatives and changes in
income from production of new mortgages likely to be driven by those same movements in interest
rates. However, the correlation within short periods of time (such as a single quarter) between
interest rate movements that impact the reported value of our mortgage servicing rights at quarter
end and the production effects of those interest rate movements  which may not be reflected until
subsequent quarters  can be low. In addition, accounting principles generally accepted in the U.S.
(GAAP) impose a lower-of-cost-or-market (LOCOM) valuation cap on the value of our servicing asset,
while we know of no financial derivatives available in the secondary market with similarly
asymmetric value change characteristics. This anomaly in accounting for mortgage servicing assets
makes it difficult at times to construct economic hedges with the desired GAAP accounting outcome,
although the economic balance may still exist. At the end of the first quarter, we had approximately $200 thousand of mortgage servicing
rights at risk to each one basis point change in interest rates. This amount changes as interest
rates and prepayment expectations change. For example, our exposure increases to approximately
$1.5 million as interest rates decline by approximately 35 basis points from then current mortgage
rates
at the end of the first quarter and declines toward zero as rates increase from that same
quarter-end rate. We typically counteract this risk with the use of derivatives with a similar
basis point value over a limited range of interest rates. It is not possible to construct a hedge
with similar basis point value over a wide range of interest rates. Therefore, if interest rates
move enough to warrant it, we will reposition our hedges to create a new range of rates with
similar basis point value to the MSRs. Repositioning hedges can be costly. Over time, this
derivative hedge has performed well in mitigating loss in value when interest rates have declined
and has been structured in such a manner so that we can recapture some of the increase in value of
servicing rights as rates rise, without losing an equal amount on our derivatives. Over the past
six months, however, basis risk in our servicing asset and the 25




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##### Table of Contents



structuring of our derivative
position has caused our hedging position to be less effective than it has been historically. In
the first quarter we incurred derivative losses in excess of the reversal of our servicing asset
impairment allowance. Although derivative losses in the first quarter were less than the
mark-to-market increase in value of the servicing portfolio, our ability to recognize that
mark-to-market increase is limited under GAAP to the lower of cost or market on the servicing
asset. Finally, as just noted, we are subject to basis risk in the management of our servicing
portfolio. While basis risk exhibits stability over longer periods of time, over shorter periods
there can be separation in the relative spreads of interest rates or indices used to value mortgage
servicing rights and the financial derivatives we use to hedge the change in value in mortgage
servicing rights. At times this basis risk benefits us and at other times it does not. It is
generally not possible to eliminate this basis risk. It is possible, therefore, that our balanced
revenue strategy may be successful as measured over several quarters or years, but may have
market-based variances if measured over short periods such as quarters. Earnings by Line of Business Irwin Financial Corporation is composed of four principal lines of business:  
    Mortgage Banking
    Commercial Banking
    Home Equity Lending
    Commercial Finance The following table summarizes our net income (loss) by line of business for the periods
indicated: Three Months Ended March 31,2005
    
    
    2004(Dollars in thousands)Net income (loss):Mortgage Banking
    
    $
    (9,617
    )
    
    $
    9,732Commercial Banking
    
    
    5,469
    
    
    
    5,417Home Equity Lending
    
    
    6,920
    
    
    
    6,633Commercial Finance
    
    
    696
    
    
    
    (293
    )Other (including consolidating entries)
    
    
    157
    
    
    
    (1,148
    )$
    3,625
    
    
    $
    20,341
 26




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##### Table of Contents



Mortgage Banking The following table shows selected financial information for our mortgage banking line of
business: Three Months Ended March 31,2005
    
    
    2004(Dollars in thousands)Selected Income Statement Data:Net interest income
    
    $
    7,723
    
    
    $
    8,662Recovery of loan loss
    
    
    189
    
    
    
    107Noninterest income
    
    
    17,862
    
    
    
    59,867Total net revenue
    
    
    25,774
    
    
    
    68,636Operating expense
    
    
    (41,409
    )
    
    
    (52,469
    )(Loss) income before taxes
    
    
    (15,635
    )
    
    
    16,167Income taxes
    
    
    6,018
    
    
    
    (6,435
    )Net (loss) income
    
    $
    (9,617
    )
    
    $
    9,732Selected Operating Data:Mortgage loan originations
    
    $
    2,812,411
    
    
    $
    2,930,716Servicing sold as a % of originations
    
    
    108.7
    %
    
    
    50.6
    %
 March 31,
    
    
    December 31,2005
    
    
    2004(Dollars in thousands)Selected Balance Sheet Data at End of Period:Total assets
    
    $
    1,368,894
    
    
    $
    1,238,136Mortgage loans held for sale
    
    
    727,310
    
    
    
    662,832Mortgage servicing assets

    
    
    336,555
    
    
    
    319,225Deposits
    
    
    745,901
    
    
    
    680,812Short-term borrowing
    
    
    165,962
    
    
    
    133,150Shareholders equity
    
    
    136,222
    
    
    
    123,265Selected Operating Data:Servicing portfolio:Balance at end of period
    
    
    24,458,656
    
    
    
    26,196,627Weighted average coupon rate
    
    
    5.72
    %
    
    
    5.75
    %Weighted average servicing fee
    
    
    0.36
    
    
    
    0.35
 Overview In our mortgage banking line of business, we originate, purchase, sell and service
conventional and government agency-backed residential mortgage loans throughout the United States.
We also engage in the business of mortgage reinsurance. Because most of our mortgage originations
either are insured by an agency of the federal government, such as the Federal Housing
Administration (FHA) or the Veterans Administration (VA), or, in the case of conventional
mortgages, meet requirements for sale to Federal National Mortgage Association (FNMA), the Federal
Home Loan Mortgage Corporation (FHLMC) or the Federal Home Loan Bank (FHLB), we are able to remove
substantially all of the credit risk associated with these loans from our balance sheet. While we
securitize and sell mortgage loans to institutional and private investors, we may choose to retain
the servicing rights. Loan origination demand and servicing values react in opposite directions to
changes in interest rates, as explained below. We believe this balance between mortgage loan
originations and mortgage loan servicing values assists in managing the risk from interest rate
changes, which has helped stabilize our revenue stream over the long term. Our channels for originating loans consist primarily of retail, wholesale, and correspondent
lending. The retail channel originates loans through retail branches and identifies potential
borrowers mainly through relationships maintained with housing intermediaries, such as realtors,
homebuilders and brokers. Our wholesale and correspondent divisions purchase loans from third
party sources. The wholesale division purchases primarily from mortgage loan brokers and issues
loan proceeds directly to the borrower. The correspondent lending division purchases closed
mortgage loans primarily from small mortgage banks and retail
banks. We fund our mortgage loan originations using internal funding sources and through credit
facilities provided by third parties. Generally within a 30-day period after funding, we sell our
mortgage loan originations into the secondary mortgage market by either direct loan sales or by
securitization. Our secondary market sources include government-sponsored mortgage entities,
nationally-sponsored mortgage conduits, and institutional and private investors. 27




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We believe there is a balance between mortgage loan originations and mortgage loan servicing
that assists in managing the risk from interest rate changes and the impact of rate changes on each
part of the business. In rising interest rate environments, originations typically decline, while
the unrealized value of our mortgage servicing portfolio generally increases as prepayment
expectations decline. In declining interest rate environments, servicing values typically decrease
as prepayment expectations increase, while the economic value of our mortgage production franchise
generally increases due to the potential for greater mortgage loan originations. However, the
offsetting impact of changes in production income and servicing values may not always be recognized
in the same quarter under generally accepted accounting principles. This timing difference is due
to the application of lower-of-cost-or-market treatment under generally accepted accounting
principles to the mortgage servicing asset with no accounting equivalent for the production
franchise. As a result, we sometimes experience greater volatility in short-term results than is
apparent in longer-term measurements such as annual income. Our strategy of balancing exposure to mortgage originations and mortgage servicing is
challenged in a period of flat or mildly declining interest rates (particularly in a period after
significant refinance activity has subsided) and when interest rates are modestly below the
aggregate LOCOM cap on the valuation of our servicing portfolio. These conditions have existed
since the summer of 2004. As such, our mortgage segment results are likely to continue to be
depressed until these conditions change. We sell servicing rights periodically for many reasons, including income recognition, cash
flow, capital management and servicing portfolio management. Servicing rights sales occur at the
time the underlying loans are sold to an investor (in flow sales) or in pools from our seasoned
servicing portfolio (in bulk sales). In the first quarter, we chose to sell the servicing asset
associated with a relatively higher percentage of our current originations. We made this decision
due to a desire to lower our interest rate risk from the servicing portfolio as well as to mitigate
the growth of servicing assets as a percentage of our consolidated balance sheet. This differs from
our actions over the past several years of adding to the portfolio as rates reached historic lows. While a substantial portion of mortgage banking revenues are derived from loan origination
activities, we have taken steps over the past year, more rapidly in the past six months, to reduce
the number of branches in our system that are not achieving our desired return targets and no
longer fit into our growth strategy. This, by definition, lowers our revenues and in many cases,
lowers the contribution to fixed or semi-fixed costs, but we believe it is the appropriate action
over the long-term as a response to rising interest rates. We have continued these office-closing
activities in the first quarter of 2005, principally in our retail channel that has historically
had the lowest margins in rising interest rate environments. In addition, during the first quarter, we entered into two separate agreements to divest a
portion of our traditional retail, and all of our net branch and credit union lending operations.
The affected operations represent less than 20 percent of our total 2004 originations. Going
forward, we will concentrate on the growth of our most profitable channels in wholesale,
correspondent, and consumer direct lending while sharpening our focus in traditional retail lending
to serve low- to moderate-income homebuyers and emerging market customers. In total, we agreed to
sell 40 of our retail and retail/net branches, mostly in coastal states, and our entire credit
union lending operation. Exit costs associated with these sales totaled approximately $1 million
during the first quarter. We anticipate modest additional costs will be incurred in the second
quarter as these transactions are finalized. We anticipate that we will recognize some incremental
revenue over the next three years as part of an earn-out based remuneration for these branches. Originations The following table shows the composition of our originations by loan categories for the
periods indicated: Three Months Ended March 31,2005
    
    
    2004(Dollars in thousands)Total originations
    
    $
    2,812,411
    
    
    $
    2,930,716Percent retail loans
    
    
    16
    %
    
    
    23
    %Percent wholesale loans
    
    
    36
    
    
    
    43Percent correspondent
    
    
    37
    
    
    
    25Percent brokered (1)
    
    
    11
    
    
    
    9Percent refinances
    
    
    54
    
    
    
    61
   (1) Brokered loans are loans we originate for which we receive loan origination
fees, but which are funded, closed and owned by unrelated third parties. 28




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##### Table of Contents



Net Income Net loss from mortgage banking for the three months ended March 31, 2005 was $9.6 million,
compared to net income of $9.7 million for the same period in 2004. This change from a profit to a
loss in 2005 reflects a significant decline in loan origination revenues and income from secondary
market sales of loans as well as mortgage servicing hedge losses in excess of servicing impairment
recovery of $15 million. During the same period in 2004, derivative gains exceeded servicing
impairment by $10 million. We currently anticipate that the mortgage segment will return to
profitability in the second quarter. Net Revenue Mortgage banking net revenue for the quarter ended March 31, 2005 totaled $26 million compared
to $69 million for the same period in 2004. The following table sets forth certain information
regarding net revenue for the periods indicated: Three Months Ended March 31,2005
    
    
    2004(Dollars in thousands)Selected Income Statement Data:Net interest income
    
    $
    7,723
    
    
    $
    8,662Recovery of loan losses
    
    
    189
    
    
    
    107Gain on sales of loans
    
    
    24,973
    
    
    
    42,782Servicing fees
    
    
    25,625
    
    
    
    25,899Amortization expense
    
    
    (21,210
    )
    
    
    (27,310
    )Recovery (impairment) of servicing assets
    
    
    32,489
    
    
    
    (48,184
    )Gain (loss) on derivatives
    
    
    (47,384
    )
    
    
    58,352Gain on sales of servicing assets
    
    
    1,185
    
    
    
    6,489Other income
    
    
    2,184
    
    
    
    1,839Total net revenue
    
    $
    25,774
    
    
    $
    68,636
 Net interest income is generated from the interest earned on mortgage loans before they
are sold to investors, less the interest expense incurred on borrowings to fund the loans. Net
interest income for the first quarter in 2005 totaled $8 million compared to $9 million for the
first quarter in 2004. The decrease in net interest income in 2005 is a result of decreased
margins on sales in the secondary markets as well as decreased production resulting in a lower
average balance of mortgage loans held for sale on our balance sheet during the quarter. Gain on sale of loans includes net revenues from three principal sources:  
    the valuation of newly-created mortgage servicing rights;
    net loan origination fees which are recognized when loans are pooled and sold into the secondary mortgage market; and,
    changes in fair value of forward contracts and interest rate lock commitments. Gain on sale of loans for the three months ended March 31, 2005 totaled $25 million, compared
to $43 million for the same period in 2004, a decrease of 42%. This decrease is attributable to
reduced secondary market margins as a result of lower industry production and reduced pricing power
on the part of originators. Servicing fee income is recognized by collecting fees, which normally range between 25 and 44
basis points annually on the principal amount of the underlying mortgages. Servicing fee income
totaled $26 million for the first quarter of 2005, a decrease of 1% from first quarter of 2004,
primarily reflecting the decline in the servicing portfolio. Amortization expense relates to mortgage servicing rights and is based on the proportion of
current net servicing cash flows to the total expected for the estimated lives of the underlying
loans. Amortization expense totaled $21 million for the three months
ended March 31, 2005, compared to $27 million during the first three months of 2004. The
decrease in amortization expense relates primarily to the decrease in the servicing portfolio and
reduced prepayment speeds. Impairment expense is recorded when the book value of the mortgage servicing rights exceeds
the fair value on a strata by strata basis. We determined fair value at March 31, 2005, through
the use of internal models, valuation comparisons to actual servicing sale proceeds, and
independent valuations. Impairment recovery totaled $32 million during the first quarter of 2005,
compared to expense of $48 million during the same period of 2004. The fluctuations in impairment
expense/recovery are attributable to 29




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##### Table of Contents



changes in actual or expected prepayment speeds due to
interest rate changes. At March 31, 2005, the mortgage line of business held $6 billion notional
amount of interest rate swaptions to manage the risk associated with our servicing assets.
Notional amounts do not represent the amount at risk. The current risk management activities of
the mortgage bank related to servicing assets do not satisfy the criteria for hedge accounting
under SFAS 133. As a result, these derivatives are accounted for as other assets and other
liabilities, and changes in fair value are adjusted through earnings as derivative gains
(losses), while the underlying servicing asset is accounted for on a strata-by-strata basis at the
lower of cost or market. The impairment recovery in the first quarter of 2005 was more than offset
by derivative losses of $47 million. Derivative gains of $58 million were recorded during the
first quarter of 2004. As a result, mortgage servicing hedge costs exceeded servicing impairment
recovery by $15 million during the first quarter of 2005. During the same period in 2004,
derivative gains exceeded servicing impairment by $10 million. The majority of the hedge losses occurred as interest rates rose rapidly toward the end of the
quarter. This increase in rates resulted in hedge losses which exceeded our servicing asset
impairment reversal which is capped under GAAP at the lower-of-cost-or-market (LOCOM). Absent this
LOCOM cap, by the end of the quarter the market value of our first mortgage servicing asset had
increased in value by approximately $26 million more than the LOCOM-capped carrying value. In
addition to the LOCOM-cap impact, during the first quarter of 2005 we continued to experience
compression between the rate underlying our servicing asset and the interest rate swap curve
underlying derivatives we use to hedge the fluctuation in value of our servicing rights. The
compression between these rates has rendered our servicing hedge significantly less effective than
we would want. As of December 31, 2004, the spread between these two rates was 0.74%. As of March
31, 2005, this spread between the mortgage and swap rates had compressed to 0.56%. At the beginning
of the second quarter, management re-structured its hedge profile to lengthen the duration of the
derivatives, reflecting the relatively better performance over recent periods of longer-term swaps
against mortgages. Our mortgage banking business maintains the flexibility either to sell servicing for current
cash flow or to retain servicing for future cash flow through the retention of ongoing servicing
fees. Total servicing sales represented 109% of loan originations during the first quarter of
2005, compared to 51% during the first quarter of 2004. The decision to sell or retain servicing
is based on current market conditions for servicing assets, loan origination levels and production
expenses, servicing portfolio management considerations, consolidated capital constraints and the
general level of risk tolerance of the mortgage banking line of business and the Corporation. We
sold $1.3 billion of bulk servicing during the first quarter of 2005, generating a $1.2 million
pre-tax gain. We sold $1.1 billion of bulk servicing during the first quarter of 2004, generating
a $6.5 million pre-tax gain. Over the past few years, we have built our servicing portfolio in
anticipation of rising interest rates that would result in lower mortgage loan production. We sold
servicing this quarter to manage the size and composition of our investment in mortgage servicing
assets. To reduce our risk of future servicing asset impairment, we intend to make additional
servicing sales later in the year. Operating Expenses The following table sets forth operating expenses for our mortgage banking line of business
for the periods indicated: Three Months Ended March 31,2005
    
    
    2004(Dollars in thousands)Salaries and employee benefits
    
    $
    17,181
    
    
    $
    19,740Incentive and commission pay
    
    
    6,687
    
    
    
    9,788Other expenses
    
    
    17,541
    
    
    
    22,941Total operating expenses
    
    $
    41,409
    
    
    $
    52,469Number of employees at period end (1)
    
    
    1,222
    
    
    
    2,022
   (1) On a full time equivalent basis Operating expenses for the three months ended March 31, 2005 totaled $41 million, a
21% decrease over the same period in 2004. Salaries and employee benefits including incentive and
commission pay declined 19% during the first quarter of 2005 compared to the same period in 2004.
These fluctuations reflect efforts in place to reduce the size of our mortgage operation since the
refinance boom of 2001-2003 to align our costs with the reduced margins we are experiencing. 30




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##### Table of Contents



Mortgage Servicing The following table shows information about our managed mortgage servicing portfolio,
including mortgage loans held for sale, for the periods indicated: March 31,
    
    
    December 31,2005
    
    
    2004(Portfolio in billions)Beginning servicing portfolio
    
    $
    26.2
    
    
    $
    29.6Mortgage loan closings(1)
    
    
    2.5
    
    
    
    11.7Bulk sales(1)
    
    
    (1.3
    )
    
    
    (4.0
    )Flow sales(1)
    
    
    (1.5
    )
    
    
    (4.3
    )Run-off(2)
    
    
    (1.4
    )
    
    
    (6.8
    )Ending servicing portfolio
    
    $
    24.5
    
    
    $
    26.2Number of loans (end of period)
    
    
    203,342
    
    
    
    205,463Average loan size
    
    $
    120,283
    
    
    $
    127,500Weighted average coupon
    
    
    5.72
    %
    
    
    5.75
    %Percent Government National Mortgage Association
(GNMA) and state housing programs
    
    
    32
    
    
    
    30Percent conventional and other
    
    
    68
    
    
    
    70Delinquency ratio
    
    
    3.5
    
    
    
    4.6Mortgage servicing assets to related servicing portfolio(3)
    
    
    1.36
    
    
    
    1.20
   (1)
 (2)
 (3)
 We record originated mortgage servicing assets at allocated cost basis when the
loans are sold and record purchased servicing assets at fair value. Thereafter, servicing rights
are accounted for at the lower of their cost or fair value. We record a valuation allowance for
any impairment on a disaggregated basis. We determine fair value on a monthly basis based on a
discounted cash flow analysis. These cash flows are projected over the life of the servicing using
prepayment, default, discount rate and cost to service assumptions that we believe market
participants would use to value similar assets. We then assess these modeled assumptions for
reasonableness through independent third-party valuations, periodic servicing asset sales and
through the use of industry surveys. At March 31, 2005, we estimated the fair value of these assets
to be $362 million in the aggregate, or $26 million greater than the carrying value on the balance
sheet, the difference between carrying value and market value being the result of a cap under
generally accepted accounting principles at the lower of cost or market for these assets. At
December 31, 2004, we estimated the fair value of these assets to be $321 million in the aggregate,
or $2 million greater than the carrying value on the balance sheet. 31




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##### Table of Contents



Commercial Banking The following table shows selected financial information for our commercial banking line of
business: Three Months Ended March 31,2005
    
    
    2004(Dollars in thousands)Selected Income Statement Data:Interest income
    
    $
    38,048
    
    
    $
    28,385Interest expense
    
    
    (13,488
    )
    
    
    (7,839
    )Net interest income
    
    
    24,560
    
    
    
    20,546Provision for loan and lease losses
    
    
    (1,000
    )
    
    
    (1,200
    )Other income
    
    
    4,381
    
    
    
    4,776Total net revenue
    
    
    27,941
    
    
    
    24,122Operating expense
    
    
    (18,755
    )
    
    
    (15,083
    )Income before taxes
    
    
    9,186
    
    
    
    9,039Income taxes
    
    
    (3,717
    )
    
    
    (3,622
    )Net income
    
    $
    5,469
    
    
    $
    5,417
 March 31,
    
    
    December 31,2005
    
    
    2004(Dollars in thousands)Selected Balance Sheet Data at End of Period:Assets
    
    $
    2,894,662
    
    
    $
    2,622,877Securities and short-term investments (1)
    
    
    493,251
    
    
    
    327,664Loans and leases
    
    
    2,279,907
    
    
    
    2,223,474Allowance for loan and lease losses
    
    
    (22,819
    )
    
    
    (22,230
    )Deposits
    
    
    2,684,457
    
    
    
    2,390,839Shareholders equity
    
    
    132,471
    
    
    
    143,580Daily Averages:Assets
    
    $
    2,756,210
    
    
    $
    2,476,835Loans and leases
    
    
    2,246,704
    
    
    
    2,094,190Allowance for loan and lease losses
    
    
    (22,574
    )
    
    
    (22,304
    )Deposits
    
    
    2,259,114
    
    
    
    2,258,538Shareholders equity
    
    
    139,047
    
    
    
    147,759Shareholders equity to assets
    
    
    5.04
    %
    
    
    5.97
    %
   (1) Includes $338 million and $293 million of inter-company investments at March 31,
2005 and December 31, 2004, respectively, that are eliminated in consolidation and are the result
of excess liquidity at the commercial banking line of business related to deposit growth in excess
of its asset deployment needs. The funds have been redeployed in earning assets at our other lines
of business. Overview Our commercial banking line of business focuses on providing credit, cash management and
personal banking products to small businesses and business owners. We offer commercial banking
services through our banking subsidiaries, Irwin Union Bank and Trust, an Indiana state-chartered
commercial bank, and Irwin Union Bank, F.S.B., a federal savings bank. Net Income Commercial banking net income totaled $5.4 million during the first quarter of 2005,
relatively unchanged compared to the same period in 2004. 32




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##### Table of Contents



Net Interest Income The following table shows information about net interest income for our commercial banking
line of business: Three Months Ended March 31,2005
    
    
    2004(Dollars in thousands)Net interest income
    
    $
    24,560
    
    
    $
    20,546Average interest earning assets
    
    
    2,658,100
    
    
    
    2,178,870Net interest margin
    
    
    3.75
    %
    
    
    3.79
    %
 Net interest income was $25 million for the first quarter of 2005, an increase of 20% over
first quarter of 2004. The 2005 improvement in net interest income resulted primarily from an
increase in our commercial banking loan portfolio as a result of growth and expansion efforts. Net
interest margin is computed by dividing net interest income by average interest earning assets.
Net interest margin for the three months ended March 31, 2005 was 3.75%, compared to 3.79% for the
same period in 2004. The reduction in 2004 margin is due to deposit growth exceeding loan growth
and consequently greater than planned excess liquidity invested in lower yielding assets. Provision for Loan and Lease Losses Provision for loan and lease losses declined to $1.0 million during the first quarter of 2005,
compared to a provision of $1.2 million during the same period in 2004. The declining provision
relates to a combination of improving economic conditions, slower loan growth and improved overall
loan quality. See further discussion in the Credit Quality section later in the document. Noninterest Income The following table shows the components of noninterest income for our commercial banking line
of business: Three Months Ended March 31,2005
    
    
    2004(Dollars in thousands)Trust fees
    
    $
    533
    
    
    $
    518Service charges on deposit accounts
    
    
    996
    
    
    
    1,459Insurance commissions, fees and premiums
    
    
    533
    
    
    
    665Gain from sales of loans
    
    
    808
    
    
    
    862Loan servicing fees
    
    
    354
    
    
    
    328Amortization of servicing assets
    
    
    (318
    )
    
    
    (401
    )Recovery (impairment) of servicing assets
    
    
    214
    
    
    
    (139
    )Brokerage fees
    
    
    301
    
    
    
    430Other
    
    
    960
    
    
    
    1,054Total noninterest income
    
    $
    4,381
    
    
    $
    4,776
 Noninterest income during the first quarter of 2005 decreased 8% over 2004. This
decrease was due primarily to lower service charges on deposit accounts. The lower charges resulted
from higher earnings credits on commercial customer accounts due to increasing interest rates.
Offsetting lower service charges was an impairment recovery of $0.2 million in the first quarter of
2005 compared to impairment expense of $0.1 million during the same period in 2004. The commercial
banking line of business has a first mortgage servicing portfolio totaling $455 million,
principally a result of mortgage loan production in its south-central Indiana markets. Servicing
rights are carried on the balance sheet at the lower of cost or market, estimated at March 31, 2005
to be $4 million. 33




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##### Table of Contents



Operating Expenses The following table shows the components of operating expenses for our commercial banking line
of business: Three Months Ended March 31,2005
    
    
    2004(Dollars in thousands)Salaries and employee benefits
    
    $
    11,947
    
    
    $
    9,322Other expenses
    
    
    6,808
    
    
    
    5,761Total operating expenses
    
    $
    18,755
    
    
    $
    15,083Efficiency ratio
    
    
    64.8
    %
    
    
    59.6
    %Number of employees at period end(1)
    
    
    547
    
    
    
    480
   (1) On a full time equivalent basis. Operating expenses for the three months ended March 31, 2005 totaled $19 million, an
increase of 24% over the same period in 2004. The increase in operating expenses is primarily due
to higher personnel costs related to recent office expansions in Sacramento and Southern
California. Balance Sheet Total assets for the quarter ended March 31, 2005 were $2.8 billion compared to $2.5 billion
for the year ended December 31, 2004. Average earning assets for the quarter ended March 31, 2005
averaged $2.7 billion compared to $2.4 billion for the year 2004. The most significant component
of the increase in 2005 was inter-company investments that are eliminated in consolidation and are
the result of excess liquidity at the commercial banking line of business related to deposit growth
in excess of its asset deployment needs. The funds have been redeployed in earning assets at our
other lines of business. Average core deposits for the first quarter of 2005 totaled $2.2 billion,
an increase of 1% over average core deposits in the fourth quarter 2004. Credit Quality The allowance for loan losses to total loans was unchanged from December 31, 2004.
Nonperforming assets to total assets decreased in 2005 over 2004. The decline in nonperforming
loans relate primarily to one commercial customer whose loan was transferred to other real estate
owned. Nonperforming loans are not significantly concentrated in any industry category. The
following table shows information about our nonperforming assets in this line of business and our
allowance for loan losses: March 31,
    
    
    December 31,2005
    
    
    2004(Dollars in thousands)Nonperforming loans
    
    $
    15,456
    
    
    $
    21,247Other real estate owned
    
    
    4,946
    
    
    
    1,533Total nonperforming assets
    
    $
    20,402
    
    
    $
    22,780Nonperforming assets to total assets
    
    
    0.70
    %
    
    
    0.87
    %Allowance for loan losses
    
    $
    22,819
    
    
    $
    22,230Allowance for loan losses to total loans
    
    
    1.00
    %
    
    
    1.00
    %
 March 31,2005
    
    
    2004For the Period Ended:Provision for loan losses
    
    $
    1,000
    
    
    $
    1,200Net charge-offs
    
    
    412
    
    
    
    1,170Net charge-offs to average loans
    
    
    0.07
    %
    
    
    0.24
    %
 34




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##### Table of Contents



Home Equity Lending The following table shows selected financial information for the home equity lending line of
business: Three Months Ended March 31,2005
    
    
    2004(Dollars in thousands)Selected Income Statement Data:Net interest income
    
    $
    20,432
    
    
    $
    24,696Provision for loan and lease losses
    
    
    (371
    )
    
    
    (5,899
    )Noninterest income
    
    
    22,704
    
    
    
    17,655Total net revenues
    
    
    42,765
    
    
    
    36,452Operating expenses
    
    
    (31,221
    )
    
    
    (25,386
    )Income before taxes
    
    
    11,544
    
    
    
    11,066Income taxes
    
    
    (4,624
    )
    
    
    (4,433
    )Net income
    
    $
    6,920
    
    
    $
    6,633Selected Operating Data:Loan volume:Lines of credit
    
    $
    92,326
    
    
    $
    94,825Loans
    
    
    337,288
    
    
    
    212,052Gain on sale of loans to loans sold
    
    
    2.57
    %
    
    
    4.29
    %
 March 31,
    
    
    December 31,2005
    
    
    2004(Dollars in thousands)Selected Balance Sheet Data:Total assets
    
    $
    1,069,178
    
    
    $
    996,500Home equity loans and lines of credit(1)
    
    
    553,310
    
    
    
    590,175Allowance for loan losses
    
    
    (11,364
    )
    
    
    (11,330
    )Home equity loans held for sale
    
    
    325,719
    
    
    
    227,740Residual interests
    
    
    45,900
    
    
    
    51,542Mortgage servicing assets
    
    
    46,765
    
    
    
    44,000Short-term borrowings
    
    
    514,942
    
    
    
    359,902Collateralized debt
    
    
    306,951
    
    
    
    352,625Shareholders equity
    
    
    135,342
    
    
    
    138,372Selected Operating Data:Total managed portfolio balance
    
    
    1,159,076
    
    
    
    1,147,137Delinquency ratio(2)
    
    
    3.7
    %
    
    
    4.8
    %Total managed portfolio balance
Including credit risk sold
    
    
    2,948,104
    
    
    
    2,807,367Weighted average coupon rate:Lines of credit
    
    
    9.54
    %
    
    
    9.18
    %Loans
    
    
    10.92
    
    
    
    11.87Net home equity annualized charge-offs to average
managed portfolio
    
    
    0.87
    
    
    
    1.85
   (1)
 (2)
 Overview Our home equity lending line of business originates, purchases, sells and services a variety
of home equity lines of credit and fixed-rate home equity loan products nationwide. We market our
home equity products (generally using second mortgage liens)
through a combination of direct mail, brokers, the Internet, and correspondent channels. We target
creditworthy homeowners who are active credit users. Customers are underwritten using proprietary
models based on several criteria, including the customers previous use of credit. We offer home equity loans with combined loan-to-value (CLTV) ratios of up to 125% of their
collateral value. Home equity loans are priced taking into account, among other factors, the
credit history of our customer, the disposable income of the borrower, and the relative
loan-to-value (LTV) ratio of the loan at origination. For example, all else being equal, those
loans with loan-to-value ratios greater than 100% (high LTV or HLTVs) are priced with higher
coupons than home equity loans with loan-to- 35




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##### Table of Contents



value ratios less than 100% to compensate for increased
expected losses through default. For the quarter ended March 31, 2005, HLTV home equity loans
constituted 41% of our loan originations and 46% of our managed portfolio in this line of business.
In an effort to manage portfolio concentration risk and to comply with existing banking
regulations, we have policies in place governing the size of our investment in loans secured by
real estate where the LTV is greater than 90%. For most of our home equity product offerings, we offer customers the choice to accept an
early repayment fee in exchange for a lower interest rate. A typical early repayment option
provides for a fee equal to up to six months interest that is payable if the borrower chooses to
repay the loan during the first three to five years of its term. Approximately 77%, or $0.9
billion, of our home equity managed portfolio at March 31, 2005 was originated with early repayment
provisions, reflecting such customer choice. Generally we either sell loans through whole loan sales or we fund these loans on balance
sheet through warehouse lines or secured, term financings. In addition to loan sales, from time to
time we have sold loans and will continue to consider the sale of certain assets such as residual
assets and mortgage servicing rights. We balance our loan portfolio growth objectives with cash
flow and profit targets, as well as a desire to manage our capital accounts. In addition, regulated
banks are prohibited from holding more than their total regulatory capital in certain mortgage
exposures where the underlying loan to value exceeds 90%. This limitation also factors into our
sale decisions. Our long-term expectation for whole loan sales are in the 75% range. We generally
retain the servicing rights for the loans we sell. The following table provides a breakdown of our home equity lending managed portfolio by
product type, outstanding principal balance and weighted average coupon as of March 31, 2005 : WeightedAverageAmount
    
    
    % of Total
    
    
    Coupon(Dollars in thousands)Home equity loans < = 100% CLTV
    
    $
    236,547
    
    
    
    20.41
    %
    
    
    8.58
    %Home equity lines of credit < = 100% CLTV
    
    
    347,519
    
    
    
    29.98
    
    
    
    8.09Total <= 100% CLTV
    
    
    584,066
    
    
    
    50.39
    
    
    
    8.29Home equity loans > 100% CLTV
    
    
    345,636
    
    
    
    29.82
    
    
    
    13.04Home equity lines of credit > 100% CLTV
    
    
    170,347
    
    
    
    14.70
    
    
    
    12.08Total > 100% CLTV
    
    
    515,983
    
    
    
    44.52
    
    
    
    12.72First mortgages
    
    
    43,017
    
    
    
    3.71
    
    
    
    6.80Other (including discontinued products)
    
    
    16,010
    
    
    
    1.38
    
    
    
    13.79Total managed portfolio(1)
    
    $
    1,159,076
    
    
    
    100.00
    %
    
    
    10.28
    %
   (1) We define our Managed Portfolio as the portfolio of loans ($1.2 billion) that
we service and on which we carry credit risk. At March 31, 2005, we also serviced another $1.8
billion of loans for which the credit risk is held by others. 36




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##### Table of Contents



Loan Volume The following table shows the composition of our loan volume by categories for the periods
indicated: Three Months Ended March 31,Product
    
    2005
    
    
    2004(Funding amount in thousands)First mortgage loansFunding Amount
    
    $
    31,726
    
    
    $
    18,719Weighted Average Disposable Income
    
    
    4,576
    
    
    
    4,654Weighted Average FICO score
    
    
    689
    
    
    
    692Weighted Average Coupon
    
    
    6.51
    %
    
    
    7.11
    %Home equity loans up to 100% CLTVFunding Amount
    
    $
    140,663
    
    
    $
    48,507Weighted Average Disposable Income
    
    
    5,478
    
    
    
    5,030Weighted Average FICO score
    
    
    724
    
    
    
    690Weighted Average Coupon
    
    
    7.08
    %
    
    
    8.79
    %Home equity loans up to 125% CLTVFunding Amount
    
    $
    164,900
    
    
    $
    144,826Weighted Average Disposable Income
    
    
    4,215
    
    
    
    4,203Weighted Average FICO score
    
    
    689
    
    
    
    680Weighted Average Coupon
    
    
    11.78
    %
    
    
    11.50
    %Home equity lines of credit up to 100% CLTVFunding Amount
    
    $
    79,618
    
    
    $
    71,737Weighted Average Disposable Income
    
    
    6,052
    
    
    
    5,942Weighted Average FICO score
    
    
    691
    
    
    
    683Weighted Average Coupon
    
    
    7.41
    %
    
    
    6.76
    %Home equity lines of credit up to 125% CLTVFunding Amount
    
    $
    12,708
    
    
    $
    23,088Weighted Average Disposable Income
    
    
    4,590
    
    
    
    4,500Weighted Average FICO score
    
    
    697
    
    
    
    696Weighted Average Coupon
    
    
    11.44
    %
    
    
    10.21
    %All ProductsFunding Amount
    
    $
    429,614
    
    
    $
    306,877Weighted Average Disposable Income
    
    
    5,086
    
    
    
    4,789Weighted Average FICO score
    
    
    701
    
    
    
    684Weighted Average Coupon
    
    
    9.03
    %
    
    
    9.60
    %
 Net Income Our home equity lending business recorded net income of $6.9 million during the three months
ended March 31, 2005, compared to net income for the same period in 2004 of $6.6 million. Net Revenue Net revenue for the three months ended March 31, 2005 totaled $43 million, compared to net
revenue for the three months ended March 31, 2004 of $36 million. The increase in revenues is
primarily a result of gains on incentive servicing fee agreements classified as derivatives that
resulted from credit performance exceeding expectations and reduced provision for loan losses.
These increases were offset by lower trading gains resulting from marking our residual interests to
fair value. 37




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##### Table of Contents



During the first quarter of 2005, our home equity lending business produced $430 million of
home equity loans, compared to $307 million during the same period in 2004. Our home equity
lending business had $879 million of net loans and loans held for sale at March 31, 2005, compared
to $818 million at December 31, 2004. Included in the loan balance at March 31, 2005 were $317
million of collateralized loans as part of secured financings. The following table sets forth certain information regarding net revenue for the periods
indicated: Three Months Ended March 31,2005
    
    
    2004(Dollars in thousands)Net interest income
    
    $
    20,432
    
    
    $
    24,696Provision for loan losses
    
    
    (371
    )
    
    
    (5,899
    )Gain on sales of loans
    
    
    8,268
    
    
    
    8,689Loan servicing fees
    
    
    8,511
    
    
    
    6,101Amortization of servicing assets
    
    
    (5,789
    )
    
    
    (3,977
    )Recovery (impairment) of servicing assets
    
    
    (303
    )
    
    
    940Trading gains
    
    
    480
    
    
    
    4,641Derivative gains
    
    
    11,080
    
    
    
    1,204Other income
    
    
    457
    
    
    
    57Total net revenue
    
    $
    42,765
    
    
    $
    36,452
 Net interest income decreased to $20 million for the three months ended March 31, 2005,
compared to $25 million for the same period in 2004. This line of business earns interest income
on loans held on the balance sheet and the accretion of the discount applied to its residual
interests. Accretion totaled $2 million during the first three months of 2005 versus $3 million for
the same period in 2004. The reduced accretion relates to the 33% reduction in our residual
interests at March 31, 2005 compared to the same period a year earlier. The decrease in the
non-accretion net interest income from $21 million in the first quarter of 2004 to $18 million in
the first quarter of 2005 is a result of the reduction of our on-balance sheet loan portfolio which
decreased from $936 million at March 31, 2004 to $879 million at March 31, 2005, reflecting
portfolio sales and runoff. Provision for loan losses decreased to $0.4 million during the quarter ended March 31, 2005
compared to $5.9 million during the same period in 2004. The decreased provision relates to
improvements in the credit quality of the loan portfolio and a significant increase in net
recoveries in the current period. We completed whole loan sales during the first quarter of 2005 of $322 million resulting in a
gain on sale of loans of $8 million, compared to $9 million in gain on sale of loans during the
same period in 2004. The decrease in gains in 2005 relates to lower margin on those sales. The
gain on sales of loans relative to the principal balance of loans sold decreased during the first
quarter of 2005 compared to the same period in 2004 due to product mix and related loan yields. We do not record a residual interest as a result of these whole loan sales as we do not retain
a credit loss interest after the sale. These are cash sales for which we receive a premium,
generally record a servicing asset, and recognize any points and fees at the time of sale. For
certain sales, we have the right to an incentive servicing fee (ISF) that will provide cash
payments to us if a pre-established return for the certificate holders and certain
structure-specific loan credit and servicing performance metrics are met.
These ISF fee contracts are treated as derivatives under SFAS 133 Accounting for Derivative
Instruments and Hedging Activities, and classified in other assets. When we first received cash
from an ISF agreement in the first quarter of 2004, our accounting policy reflected the lack of
history for these cash flows and among other factors, required projections of expected cash flows
to occur within one year before recognizing any value. In the first quarter we concluded our
actual servicing experience and the performance of the loan pools subject to these ISFs has now
demonstrated a level of predictability that has allowed us to modify our accounting policy to
eliminate the one year to cash flow requirement and, as appropriate under SFAS 133, recognize
derivative value for cash flows expected over time, including ones not anticipated to occur within
one year. Our policy requires discounting these derivatives at rates
between 20% and 40%, depending
on a variety of factors, including volatility of anticipated cash flow, credit quality,
loan-to-value ratio, and anticipated prepayment speeds. At March 31, 2005, we were receiving
incentive fees for two transactions that had met these performance metrics. Included in derivative
gains was $10.5 million related to these ISFs. The ISF valuation is based upon actual and
projected performance of the underlying pools of loans and represents the projected value of future
cash flow, present valued at discount rates ranging from 30%-40%. 38




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##### Table of Contents



Loan servicing fees totaled $9 million during the first quarter of 2005 compared to $6 million
during the same period in 2004. The servicing portfolio underlying the mortgage servicing asset at
our home equity lending line of business totaled $2.4 billion and $1.7 billion at March 31, 2005

and 2004, respectively. The increase in loan servicing fees in 2005 relates to the increased size
of our servicing portfolio as well as increased early repayment fees that totaled $4 million during
the quarter ended March 31, 2005 compared to $2 million during the same period in 2004 on the
portfolio underlying the mortgage servicing asset. Amortization and impairment of servicing assets includes amortization expenses and valuation
adjustments relating to the carrying value of servicing assets. Our home equity lending business
determines fair value of its servicing asset using discounted cash flows and assumptions as to
estimated future servicing income and cost that we believe market participants would use to value
similar assets. In addition, we periodically assess these modeled assumptions for reasonableness
through independent third-party valuations. At March 31, 2005, net servicing assets totaled $47
million, compared to a balance of $44 million at December 31, 2004. Servicing asset amortization
and impairment expense totaled $6 million during the first quarter of 2005, compared to $3 million
for the three months ended March 31, 2004. Trading gains represent unrealized gains as a result of adjustments to the carrying values of
our residual interests. Trading gains totaled $0.5 million in the first quarter of 2005 compared
to gains of $4.6 million for the same period in 2004. Residual interests had a balance of $46
million at March 31, 2005 and $52 million at December 31, 2004. The $46 million valuation at March
31, 2005 reflects $51 million of anticipated undiscounted cash flows of which $43 million
represents existing securitization overcollateralization and reserve funds, and the remaining $8
million represents expected future net spread and prepayment penalties. Included in the valuation
are assumptions for estimated prepayments, expected losses, and discount rates that we believe
market participants would use to value similar assets. To the extent our expectations of future
loss rates, prepayment speeds and other factors change as we gather additional data over time,
these residual valuations may be subject to additional adjustments in the future. These
adjustments could have a material effect on our earnings. Our forward loss assumptions are
reevaluated monthly and, as such, our residual asset valuations will be adjusted monthly to reflect
changes in actual and expected loss rates in our portfolio. Operating Expenses The following table shows operating expenses for our home equity lending line of business for
the periods indicated: Three Months Ended March 31,2005
    
    
    2004(Dollars in thousands)Salaries and employee benefits
    
    $
    21,069
    
    
    $
    16,126Other
    
    
    10,152
    
    
    
    9,260Total operating expenses
    
    $
    31,221
    
    
    $
    25,386Number of employees at period end (1)
    
    
    651
    
    
    
    607
   (1) On a full time equivalent basis . Operating expenses were $31 million for the three months ended March 31, 2005, compared to $25
million for the same period in 2004. Operating expenses include compensation expense related to
long term compensation plans at the home equity lending line
of business totaling $4 million and $3 million during the first quarter of 2005 and 2004,
respectively. During the first quarter of 2005, we completed our repurchase of the minority
ownership interests in this line of business and as such, the segment is now a wholly-owned
subsidiary of the Corporation and its subsidiary Bank. Operating expenses also increased as a
result of an increase in number of employees, increased production and a migration to more variable
incentive compensation plans. Home Equity Servicing Our home equity lending business continues to service a majority of the loans it has
securitized and sold. We earn a servicing fee of approximately 50 to 100 basis points of the
outstanding principal balance of the loans securitized. Generally accepted accounting principles
require us to book a servicing asset under both the SFAS 140 and the secured financing
structures. The total servicing portfolio was $2.9 billion at March 31, 2005 compared to $2.8
billion at December 31, 2004. For whole loans sold with servicing retained totaling $1.5 billion
and $1.4 billion at March 31, 2005 and December 31, 2004, respectively, we capitalize servicing
fees including rights to future early repayment fees. The servicing asset at March 31, 2005 was $47
million up from $44 million at December 31, 2004 reflecting additional secondary market sales and
financings, net of amortization and run-off. 39




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##### Table of Contents



Our
managed portfolio, representing that portion of the servicing portfolio on which we have
retained credit risk, is separated into two categories: $0.9 billion of loans originated, generally
since 2002, and held on balance sheet either as loans held for investment or loans held for sale,
and $0.3 billion of loans and lines of credit securitized for which we retained a residual
interest. Generally, these loans categorized as owned residual were originated prior to 2002 and
treated as sold under SFAS 140 and have a reserve methodology that reflects life of account loss
expectations; whereas our policy for on-balance sheet loans requires that we hold at a minimum,
sufficient reserves for potential losses inherent in the portfolio at the balance sheet date. Such
losses for on-balance sheet loans manifest themselves over a period which management believes
approximates twelve months. In both cases, we retain credit and interest rate risk. In addition, where applicable, we have the opportunity to earn additional future servicing
incentive fees. Included below in the category Credit Risk Sold, Potential Incentive Servicing Fee
Retained Portfolio are $0.9 billion of loans at March 31, 2005 and $1.0 billion at December 31,
2004 for which we have the opportunity to earn an incentive servicing fee. In addition, we have
sold $0.6 billion of loans since late 2004 on which we anticipate we will receive incentive
servicing agreements during 2005. While the credit performance of these loans we have sold effect
the valuation of the incentive servicing fee, we do not have direct credit risk in these pools. March 31,
    
    
    December 31,2005
    
    
    2004(Dollars in thousands)Managed PortfolioTotal Loans
    
    $
    1,159,076
    
    
    $
    1,147,13730 days past due
    
    
    3.69
    %
    
    
    4.76
    %90 days past due
    
    
    1.44
    
    
    
    1.60Annualized QTD Net Chargeoff Rate
    
    
    0.87
    
    
    
    1.85Unsold LoansTotal Loans (1)
    
    $
    872,847
    
    
    $
    814,59530 days past due
    
    
    1.82
    %
    
    
    1.93
    %90 days past due
    
    
    0.75
    
    
    
    0.78Annualized QTD Net Chargeoff Rate
    
    
    0.15
    
    
    
    0.79Loan Loss Reserve
    
    $
    11,364
    
    
    $
    11,330Owned ResidualTotal Loans
    
    $
    286,229
    
    
    $
    332,54230 days past due
    
    
    9.38
    %
    
    
    11.71
    %90 days past due
    
    
    3.53
    
    
    
    3.61Annualized QTD Net Chargeoff Rate
    
    
    2.98
    
    
    
    4.48Residual Undiscounted Losses
    
    $
    7,260
    
    
    $
    11,323Credit Risk Sold, Potential
Incentive Servicing Fee Retained
PortfolioTotal Loans
    
    $
    919,830
    
    
    $
    1,023,58530 days past due
    
    
    2.87
    %
    
    
    3.11
    %90 days past due
    
    
    1.17
    
    
    
    1.10
   (1) Excludes deferred fees and costs. The managed portfolio amounts listed above include those loans we service with credit
risk retained. Delinquency rates and losses on our managed portfolio result from a variety of
factors, including loan seasoning, portfolio mix, our servicing practices, and general economic
conditions. 40




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##### Table of Contents



Commercial Finance The following table shows selected financial information for our commercial finance line of
business for the periods indicated: Three Months Ended March 31,2005
    
    
    2004(Dollars in thousands)Selected Income Statement Data:Net interest income
    
    $
    7,612
    
    
    $
    6,754Provision for loan and lease losses
    
    
    (2,110
    )
    
    
    (1,153
    )Noninterest income
    
    
    1,908
    
    
    
    448Total net revenue
    
    
    7,410
    
    
    
    6,049Operating expense
    
    
    (6,186
    )
    
    
    (4,198
    )Income before taxes
    
    
    1,224
    
    
    
    1,851Income taxes
    
    
    (528
    )
    
    
    (2,144
    )Net income (loss)
    
    $
    696
    
    
    $
    (293
    )Selected Operating Data:Net charge-offs
    
    $
    1,368
    
    
    $
    1,294Net interest margin
    
    
    4.85
    %
    
    
    5.74
    %Total funding of loans and leases
    
    $
    83,362
    
    
    $
    71,652Loans sold
    
    
    12,403
    
    
    
    7,694
 March 31,
    
    
    December 31,2005
    
    
    2004(Dollars in thousands)Selected Balance Sheet Data at End of Period:Total assets
    
    $
    657,679
    
    
    $
    636,177Loans and leases
    
    
    644,020
    
    
    
    625,140Allowance for loan and lease losses
    
    
    (10,186
    )
    
    
    (9,624
    )Shareholders equity
    
    
    55,415
    
    
    
    54,935
 Overview We established this line of business in 1999. In this segment, we provide small ticket, full
payout lease financing on a variety of small business equipment in the United States and Canada as
well as equipment and leasehold improvement financing for franchisees (mainly in the quick service
restaurant sector) in the United States. We provide cost-competitive, service-oriented financing alternatives to small businesses
generally and to franchisees. We utilize direct and indirect sales forces to distribute our
products. In the small ticket lease channel our sales efforts focus on providing lease solutions
for vendors and manufacturers. The majority of our leases are full payout (no residual),
small-ticket assets secured by commercial equipment. We finance a variety of commercial, light
industrial and office equipment types and try to limit the concentrations in our loan and lease
portfolios. Within the franchise channel, the majority of our contracts are full payout loans with
higher transaction sizes than in our small-ticket channel. The franchise channel may also finance
real estate for select franchise systems. Net Income During the three months ended March 31, 2005, the commercial finance line of business had net
income of $0.7 million, compared to a loss of $0.3 million in the same period in the prior year.
The 2005 improvement in earnings is attributable primarily to a lower effective tax rate. Net
income last year was negatively affected by a one-time income tax charge of $1.7 million during the
first quarter reflecting the cumulative impact of tax liabilities acquired, but not recorded on the
books of the company at the time of our purchase of our Canadian operations from a now bankrupt
seller. 41




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##### Table of Contents



Net Interest Income The following table shows information about net interest income for our commercial finance
line of business: Three Months Ended March 31,2005
    
    
    2004(Dollars in thousands)Net interest income
    
    $
    7,612
    
    
    $
    6,754Average interest earning assets
    
    
    635,996
    
    
    
    472,883Net interest margin
    
    
    4.85
    %
    
    
    5.74
    %
 Net interest income was $8 million for the quarter ended March 31, 2005, an increase of
13% over 2004. The improvement in net interest income resulted primarily from an increase in our
commercial finance portfolio. The total loan and lease portfolio has increased to $644 million at
March 31, 2005, an increase of 3% over year-end 2004 and an increase of 34% over March 31, 2004.
This line of business originated $83 million in loans and leases during the first quarter of 2005,
compared to $72 million during the same period of 2004. Net interest margin is computed by dividing net interest income by average interest earning
assets. Net interest margin for the first quarter of 2005 was 4.85%, compared to 5.74% in 2004 for
the same period. The decrease in 2005 margin is due primarily to changes in product mix and changes
in yields. Provision for Loan and Lease Losses The provision for loan and lease losses increased to $2.1 million during the first three
months in 2005 compared to $1.2 million for the same period in 2004. The increased provisioning
levels relate primarily to year-over-year growth in the commercial finance portfolio. Noninterest Income The following table shows the components of noninterest income for our commercial finance line
of business: Three Months Ended March 31,2005
    
    
    2004(Dollars in thousands)Gain from sales of loans
    
    
    679
    
    
    
    387Derivative losses, net
    
    
    (146
    )
    
    
    (946
    )Other
    
    
    1,375
    
    
    
    1,007Total noninterest income
    
    $
    1,908
    
    
    $
    448
 Noninterest income during the three months ended March 31, 2005 increased $1.5 million
over the same period in 2004. Included in noninterest income were gains from sales of leases and
whole loans that totaled $0.7 million in the first quarter of 2005 compared to $0.4 million during
the same period in 2004. Also included in noninterest income during first quarter 2005 and 2004 was
$0.1 million and $0.9 million of interest rate derivative losses in our Canadian operation related
to asset-liability mismatches in our funding of that operation. Operating Expenses The following table shows the components of operating expenses for our commercial finance line
of business: Three Months Ended March 31,2005
    
    
    2004(Dollars in thousands)Salaries and employee benefits
    
    $
    3,948
    
    
    $
    3,362Other
    
    
    2,238
    
    
    
    836Total operating expenses
    
    $
    6,186
    
    
    $
    4,198Number of employees at period end (1)
    
    
    172
    
    
    
    137
   (1)
    
    On a full time equivalent basis. 42




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##### Table of Contents



Operating expenses during the first quarter in 2005 totaled $6.2 million, an increase of
47% over the same period in 2004. The increased operating expenses relate to the continued growth
in this business since its inception in 1999, including variable compensation costs related to
higher production levels, infrastructure and staffing development, and incentive compensation costs
related to the achievement of profitability. The increase in other operating expenses is primarily
attributable to the resolution of a contract dispute and related legal fees involving our franchise
channel during the first quarter of 2005. Credit Quality The commercial finance line of business had nonperforming loans and leases at March 31, 2005
of $4.1 million compared to $3.9 million as of December 31, 2004. Net charge-offs recorded by this
line of business totaled $1.4 million for the first quarter of 2005 compared to $1.3 million for
the first quarter of 2004. Our allowance for loan and lease losses at March 31, 2005 totaled $10.2
million, representing 1.58% of loans and leases, compared to a balance at December 31, 2004 of $9.6
million, representing 1.54% of loans and leases. The following table shows information about our nonperforming loans and leases in this line of
business and our allowance for loan and lease losses: March 31,
    
    
    December 31,2005
    
    
    2004(Dollars in thousands)Nonperforming loans
    
    $
    4,058
    
    
    $
    3,936Allowance for loan losses
    
    
    10,186
    
    
    
    9,624Allowance for loan losses to total loans
    
    
    1.58
    %
    
    
    1.54
    %
 March 31,For the Period Ended:
    
    2005
    
    
    2004(Dollars in thousands)Provision for loan losses
    
    $
    2,110
    
    
    $
    1,153Net charge-offs
    
    
    1,368
    
    
    
    1,294Annualized net charge-offs to average loans
    
    
    0.88
    %
    
    
    1.11
    %
 The following table provides certain information about the loan and lease portfolio
of our commercial finance line of business at the dates shown: March 31,
    
    
    December 31,2005
    
    
    2004(Dollars in thousands)Domestic franchise loans
    
    $
    250,176
    
    
    $
    243,859Weighted average yield
    
    
    8.63
    %
    
    
    8.11
    %Delinquency ratio
    
    
    0.77
    
    
    
    0.35Domestic leases
    
    $
    158,000
    
    
    $
    149,999Weighted average yield
    
    
    8.50
    %
    
    
    8.95
    %Delinquency ratio
    
    
    0.88
    
    
    
    1.09Canadian leases (1)
    
    $
    235,844
    
    
    $
    231,282Weighted average yield
    
    
    9.09
    %
    
    
    9.77
    %Delinquency ratio
    
    
    1.58
    
    
    
    0.82
   (1)
    
    In U.S. dollars . 43




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##### Table of Contents



Parent and Other Results at the parent company and other businesses totaled net income of $0.2 million for the
three months ended March 31, 2005, compared to a loss of $1.2 million during the same period in
2004. Results at the parent company include operating expenses in excess of management fees charged
to the lines of business and interest income earned on intracompany loans. Also included in parent
and other expense were compensation charges related to key employee retention initiatives at the
home equity lending line of business totaling negative $0.5 million for the quarter ended March 31,
2005. We recognized $1.2 million in expense with respect to this initiative during the first
quarter of 2004. Also included in parent company operating results are allocations to our
subsidiaries of interest expense related to our interest-bearing capital obligations. During the
quarter ended March 31, 2005, we allocated $4.4 million of these expenses to our subsidiaries,
compared to $3.3 million during the first quarter of 2004. During the first quarter of 2005, we released $0.8 million in tax reserves at the parent
company to align our tax liability to a level commensurate with our currently identified tax
exposures. Each subsidiary pays taxes to us at the statutory rate. Subsidiaries also pay fees to us to
cover direct and indirect services. In addition, certain services are provided from one subsidiary
to another. Intercompany income and expenses are calculated on an arms-length, external market
basis and are eliminated in consolidation. Risk Management We are engaged in businesses that involve the assumption of financial risks including:  
    Credit risk
    Liquidity risk
    Interest rate risk
    Operational risk Each line of business that assumes financial risk uses a formal process to manage this risk.
In all cases, the objectives are to ensure that risk is contained within prudent levels and that we
are adequately compensated for the level of risk assumed. Our Chairman, Executive Vice President, Senior Vice Presidents (including the Chief Financial
Officer), and Chief Risk Officer meet on a regularly-scheduled basis (or more frequently as
appropriate) as an Enterprise-wide Risk Management Committee (ERMC), reporting to the Board of
Directors Audit and Risk Management Committee. Each of our principal risks is managed at the line of business level, with oversight and, when
appropriate, standardization provided by the ERMC and its subcommittees. The ERMC and its
subcommittees oversee all aspects of our financial, credit, and operational risks. The ERMC
provides senior-level review and enhancement of line manager risk processes and oversight of our
risk reporting, surveillance and model parameter changes. Credit Risk The assumption of credit risk is a key source of earnings for the home equity lending,
commercial banking and commercial finance lines of business. The mortgage banking line of business
assumes limited credit risk as its mortgages typically are insured and are sold within a short
period of time after origination. The credit risk in the loan portfolios of the home equity lending, commercial finance and
commercial banking lines of business has the most potential for a significant effect on our
consolidated financial performance. These lines of business each have a Chief Credit Officer with
expertise specific to the product line and manage credit risk through various combinations of the
use of lending policies, credit analysis and approval procedures, periodic loan reviews, servicing
activities, and/or personal contact with borrowers. Commercial loans over a certain size, depending
on the loan type and structure, are reviewed by a loan committee prior to approval. We perform
independent loan review across the Corporation through a function that reports directly to the
Audit and Risk Management Committee. 44




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##### Table of Contents



The allowance for loan and lease losses is an estimate based on our judgment applying the
principles of SFAS 5, Accounting for Contingencies, SFAS 114, Accounting by Creditors for
Impairment of a Loan, and SFAS 118, Accounting by Creditors for Impairment of a Loan  Income
Recognition and Disclosures. The allowance is maintained at a level we believe is adequate to
absorb probable losses inherent in the loan and lease portfolio. We perform an assessment of the
adequacy of the allowance at the segment level no less frequently than on a quarterly basis and
through review by a subcommittee of the ERMC. Within the allowance, there are specific and expected loss components. The specific loss
component is based on a regular analysis of all loans over a fixed-dollar amount where the internal
credit rating (for commercial loans) or loan delinquency status (for consumer loans) is at or below
a predetermined classification. From this analysis we determine the loans that we believe to be
impaired in accordance with SFAS 114. Management has defined impaired as nonaccrual loans. For
loans determined to be impaired, we measure the level of impairment by comparing the loans
carrying value to fair value using one of the following fair value measurement techniques: present
value of expected future cash flows, observable market price, or fair value of the associated
collateral. An allowance is established when the fair value of the loan implies a value that is
lower than its carrying value. In addition to establishing allowance levels for specifically
identified higher risk graded or high delinquency loans, management determines an allowance for all
other loans in the portfolio for which historical or projected experience indicates that certain
losses will occur. These loans are segregated by major product type, and in some instances, by
aging, with an estimated loss ratio or migration pattern applied against each product type and
aging category. For portfolios that are too new to have adequate historical experience on which to
base a loss estimate, we use estimates derived from industry experience and managements judgment.
The loss ratio or migration patterns are generally based upon historic loss experience or historic
rate migration behaviors, respectively, for each loan type adjusted for certain environmental
factors management believes to be relevant. Net charge-offs for the three months ended March 31, 2005 were $2 million, or 0.2% of average
loans, compared to $8 million, or 1.0% of average loans during the same period in 2004. The
decrease in charge-offs and allowance is a result of improvements in credit quality associated with
tighter underwriting guidelines in our home equity business and an improving economy. At March 31,
2005, the allowance for loan and lease losses was 1.3% of outstanding loans and leases, unchanged
from year end 2004. Total nonperforming loans and leases at March 31, 2005, were $28 million compared to $34
million at December 31, 2004. Nonperforming loans and leases as a percent of total loans and
leases at March 31, 2005 were 0.8%, compared to 1.0% at December 31, 2004. Other real estate we
owned totaled $13 million at March 31, 2005, up from $9 million at December 31, 2004. Total
nonperforming assets at March 31, 2005 were $41 million, or 0.8% of total assets compared to
nonperforming assets at December 31, 2004, of $45 million, or 0.9% of total assets. The 2005
decrease in nonperforming loans and leases occurred primarily at the commercial banking line of
business where nonperforming loans decreased to $15 million at March 31, 2005, compared to $21
million at the end of 2004. The majority of this decrease was due to a single nonperforming
relationship at the commercial banking line of business that was moved to other real estate owned. 45




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##### Table of Contents



The following table shows information about our nonperforming assets at the dates shown: March 31,
    
    
    December 31,2005
    
    
    2004(Dollars in thousands)Accruing loans past due 90 days or more:Commercial, financial and
agricultural loans
    
    $
    181
    
    
    $
    Real estate mortgages
    
    
    
    
    
    
    219Consumer loans
    
    
    223
    
    
    
    426Commercial financingFranchise financing
    
    
    27
    
    
    
    Domestic leasing
    
    
    
    
    
    
    Foreign leasing
    
    
    150
    
    
    
    12581
    
    
    
    657Nonaccrual loans and leases:Commercial, financial and
agricultural loans
    
    
    14,151
    
    
    
    20,394Real estate mortgages
    
    
    8,376
    
    
    
    8,590Consumer loans
    
    
    902
    
    
    
    128Commercial financingFranchise financing
    
    
    1,128
    
    
    
    1,193Domestic leasing
    
    
    1,081
    
    
    
    1,029Foreign leasing
    
    
    1,671
    
    
    
    1,70227,309
    
    
    
    33,036Total nonperforming
loans and leases
    
    
    27,890
    
    
    
    33,693Nonperforming loans held for sale not guaranteed
    
    
    741
    
    
    
    2,066Other real estate owned
    
    
    12,846
    
    
    
    9,427Total nonperforming assets
    
    $
    41,477
    
    
    $
    45,186Nonperforming loans and leases to total
loans and leases
    
    
    0.8
    %
    
    
    1.0
    %Nonperforming assets to total
assets
    
    
    0.8
    %
    
    
    0.9
    %
 For the periods presented, the balances of any restructured loans are reflected in the
table above either in the amounts shown for accruing loans past due 90 days or more or in the
amounts shown for nonaccrual loans and leases. Loans that are past due 90 days or more are placed on nonaccrual status unless, in
managements opinion, there is sufficient collateral value to offset both principal and interest.
The $41 million in nonperforming assets at March 31, 2005 were held at our lines of business as
follows (dollars in millions): March 31,2005
    
    Mortgage banking
    
    $
    6
    
    Commercial banking
    
    
    20
    
    Home equity ending
    
    
    11
    
    Commercial finance
    
    
    4
 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. 46




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##### Table of Contents



Liquidity Risk Liquidity is the availability of funds to meet the daily requirements of our business. For
financial institutions, demand for funds results principally from extensions of credit and
withdrawal of deposits. Liquidity is provided through deposits and short-term and long-term
borrowings, by asset maturities or sales, and through equity capital. The objectives of liquidity management are to ensure that funds will be available to meet
current and future demands and that funds are available at a reasonable cost. We manage liquidity
via daily interaction with the lines of business and periodic liquidity planning sessions. Since
loans are less marketable than securities, the ratio of total loans to total deposits is a
traditional measure of liquidity for banks and bank holding companies. At March 31, 2005, the
ratio of loans and loans held for sale to total deposits was 120%. We are comfortable with this
relatively high level due to our position in first mortgage loans held for sale ($0.7 billion) and
second mortgage loans and leases financed through matched-term secured financing ($0.5 billion).
The mortgage loans carry an interest rate at or near current market rates and are generally sold
within a short period after origination. Excluding these two items, our loans to deposit ratio at
March 31, 2005 was 88%. The mortgage banking line of business sells virtually all of its mortgage loan originations
within 30 days of funding, taking them off our balance sheet. Therefore, the on-balance sheet
funding of first mortgage loans is for the brief period of time from origination to
sale/securitization. In the first quarter of 2005, the home equity lending line of business
produced $0.4 billion and home equity loan sales totaled $0.3 billion, thus requiring increases in
funding facilities for this line of business of $0.1 billion. Beginning in 2002, home equity loan securitizations were retained on-balance sheet, moving
away from gain-on-sale treatment. As a result, both the securitized assets and the funding from the
securitization are now reflected on the balance sheet. From a liquidity perspective, these
securitizations provide matched funding for the life of the loans making up the securitizations
unless we choose to utilize a clean-up call provision to terminate the securitization funding
early. A clean-up call typically is optional at our discretion. It can typically be made once
outstanding loan balances in the securitization fall below 10% of the original loan balance in the
securitization. Bond principal payments are dependent upon principal collections on the underlying
loans. Prepayment speeds can affect the timing and amount of loan principal payments. Deposits consist of three primary types: non-maturity transaction account deposits,
certificates of deposit (CDs), and escrow account deposits. Core deposits exclude jumbo CDs,
brokered CDs, public funds and mortgage escrow deposits, although the escrow deposits exhibit
core-like maturity characteristics. Core deposits totaled $2.4 billion at March 31, 2005 compared
to $2.2 billion at December 31, 2004. Non-maturity transaction account deposits are generated by our commercial banking line of
business and include deposits placed into checking, savings, money market and other types of
deposit accounts by our customers. These types of deposits have no contractual maturity date and
may be withdrawn at any time. While these balances fluctuate daily, a large percentage typically
remains for much longer. At March 31, 2005, these deposit types totaled $2.0 billion, an increase
of $0.1 billion from December 31, 2004. We monitor overall deposit balances daily with particular
attention given to larger accounts that have the potential for larger daily fluctuations and which
are at greater risk to be withdrawn should there be an industry-wide or bank-specific event that
might cause uninsured depositors to be concerned about the safety of their deposits. On a monthly
basis we model the expected impact on liquidity from moderate and severe liquidity stress scenarios
as one of our tools to ensure that our liquidity is sufficient. CDs differ from non-contractual maturity accounts in that they do have contractual maturity
dates. We issue CDs both directly to customers and through brokers. As of March 31, 2005, CDs
issued directly to customers totaled $0.7 billion, up $0.2 billion from December 31, 2004. Brokered

CDs are typically considered to have higher liquidity (renewal) risk than CDs issued directly to
customers, since brokered CDs are often done in large blocks and since a direct relationship does
not exist with the depositor. In recognition of this, we manage the size and maturity structure of
brokered CDs closely. For example, the maturities of brokered CDs are laddered to mitigate
liquidity risk. CDs issued through brokers totaled $0.3 billion at March 31, 2005, and had an
average remaining life of 15 months, as compared to $0.3 billion outstanding with a 14 month
average remaining life at December 31, 2004. Escrow account deposits are related to the servicing of our originated first mortgage loans.
When a first mortgage borrower makes a monthly mortgage payment, consisting of interest and
principal due on the loan and often a real estate tax and insurance portion, we hold the payment on
a non-interest earning basis, except where otherwise required by law, until the payment is remitted
to the current owner of the loan or the proper tax authority and insurance carrier. Escrow deposits
may also include proceeds from the payoff of loans in our servicing portfolio prior to the
transmission of those proceeds to investors. At March 31, 2005, these escrow balances totaled $0.7
billion, which was up $0.1 billion from December 31, 2004. 47




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##### Table of Contents



Short-term borrowings consist of borrowings from several sources. Our largest borrowing source
is the Federal Home Loan Bank of Indianapolis (FHLBI). We utilize their collateralized borrowing
programs to help fund qualifying first mortgage, home equity and commercial real estate loans. As
of March 31, 2005, FHLBI borrowings outstanding totaled $22 million, a $50 million decrease from
December 31, 2004. We had sufficient collateral pledged to FHLBI at March 31, 2005 to borrow an
additional $0.7 billion, if needed. In addition to borrowings from the FHLBI, we use other lines of credit as needed. At March 31,
2005, the amount of short-term borrowings outstanding on our major credit lines and the total
amount of the borrowing lines were as follows:  
    Warehouse lines of credit to fund first mortgages and home equity loans: none outstanding
on a $300 million borrowing facility, of which $150 million is committed
    Warehouse borrowing facilities to fund first mortgage loans: none outstanding on a $100
million committed borrowing facility
    Lines of credit with correspondent banks, including fed funds lines: $109 million
outstanding out of $215 million available but not committed
    Line of credit with a correspondent bank collateralized by mortgage servicing rights:
none outstanding out of $50 million committed borrowing facility
    Warehouse lines of credit and conduits to fund Canadian sourced small ticket leases: $184
million outstanding on $281 million of borrowing facilities In addition to short-term borrowings from the aforementioned credit lines, sale facilities are
used to effect sale of Government Sponsored Enterprise (GSE) conforming first mortgage loans before
scheduled GSE settlement dates. The first two of these sale facilities listed below have specific
dollar limits as noted. The size of the third facility is limited only by the amount of
mortgage-backed securities we can package for purchase by the facility provider. At March 31, 2005,
the amount unsettled by the GSE on these facilities and the total facility amount were as follows:  
    Committed warehouse sale facility: $75 million unsettled on a $600 million facility
    Uncommitted warehouse sale facility: $37 million unsettled on a $150 million facility
    Investor warehouse sale facility: $121 million unsettled Interest Rate Risk Because all of our assets are not perfectly match-funded with like-term liabilities, our
earnings are affected by interest rate changes. Interest rate risk is measured by the sensitivity
of both net interest income and fair market value of net interest sensitive assets to changes in
interest rates. An asset/liability management committee (ALMC) at each of our lines of business that has
interest rate risk monitors the repricing structure of assets, liabilities and off-balance sheet
items and uses a financial simulation model to measure the potential change in market value of all
interest-sensitive assets and liabilities and also the potential change in earnings resulting from
changes in interest rates. Our corporate-level ALMC oversees the interest rate risk profile of all
of our lines of business as a whole and is represented at each of the line of business ALMCs. We
incorporate many factors into the financial model, including prepayment speeds, deposit rate
forecasts for non-maturity transaction accounts, caps and floors that exist on some variable rate
instruments, fee income and a comprehensive mark-to-market valuation process. We reevaluate risk
measures and assumptions regularly and enhance modeling tools as needed. Our commercial banking, home equity lending, and commercial finance lines of business assume
interest rate risk in the form of repricing structure mismatches between their loans and leases and
funding sources. We manage this risk by adjusting the duration of their interest sensitive
liabilities and through the use of hedging via financial derivatives. Our mortgage banking line of business assumes interest rate risk by entering into commitments
to extend loans to borrowers at a fixed rate for a limited period of time. We hold closed loans
only temporarily until a pool is formed and sold in a securitization or 48




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under a flow sale arrangement. To mitigate the risk that interest rates will rise between loan
origination and sale, the mortgage bank buys commitments to deliver loans at a fixed price.
Interest rate risk also exists for the mortgage pipeline period, which is the period starting when
a rate lock commitment is made and ending at the time a loan originates or the rate lock expires.
To mitigate this risk, the mortgage bank also buys commitments to deliver loans at a fixed rate for
a portion of our pipeline. Our mortgage, commercial banking and home equity lines of business all assume interest rate
risk by holding mortgage servicing rights (MSRs). These assets are recorded at lower of cost or
fair market value. Among other items, a key determinant to the value of MSRs is the prevailing
level of interest rates. We purchase derivative securities to mitigate the expected volatility in
the value of these assets. Our mortgage, commercial banking and home equity lending lines of business also are exposed to
the risk that interest rates will decline, possibly increasing prepayment speeds on loans and
decreasing the value of servicing assets and residual interests. Some offsets to these exposures
exist in the form of strong production operations, selective sales of servicing rights,
match-funded asset-backed securities sales and the use of financial instruments to manage the
economic performance of the assets. Since there are accounting timing differences between the
recognition of gains or losses on financial derivatives and the realization of economic gains or
losses on certain offsetting exposures (e.g., strong production operations), our decisions on the
degree to which we manage risk with derivative instruments to insulate against short-term price
volatility depends on a variety of factors, including:  
    the type of risk we are trying to mitigate;
    offsetting factors elsewhere in the Corporation;
    the level of current capital above our target minimums;
    time remaining in the quarter (i.e., days until quarter end);
    current level of derivative gain or loss relative to accounting and economic basis;
    basis risk: the degree to which the interest rates underlying our derivative instruments
might not move parallel to the interest rate driving our asset valuation;
    convexity: the degree to which asset values, or risk management derivative instrument
values, do not change in a linear fashion as interest rates change; and
    volatility: the level of volatility in market interest rates and the related impact on
our asset values and derivatives instrument values. When considering hedging strategies for first mortgage MSRs, we attempt to optimize the
following mix of competing goals:  1.
    provide adequate hedge coverage for falling rates;2.
    minimize premium costs to establish hedge positions;3.
    provide a moderate amount of net impairment recapture if interest rates rise;4.
    when near or above the MSR LOCOM cap, maintain an acceptable range over which interest
rates may rise without causing hedge losses to significantly exceed accounting gains Pursuit of the last goal may result in the economic value of MSRs increasing without
offsetting hedge losses. In order to capture this economic value in earnings, MSR sales must
occur. Our typical strategy is to establish a corridor of interest rates within which we are
initially hedged. This hedge position is dynamically adjusted throughout the quarter. As interest
rates move, we adjust our corridor accordingly. Significant fluctuations in interest rates or in
the spread between our hedging instruments and mortgage rates can cause the need to reposition our
hedges multiple times. This repositioning may, at times, result in variability in inter-quarter
results that are not reflective of underlying trends for the Corporation. 49




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##### Table of Contents



The following tables reflect our estimate of the present value of interest sensitive assets,
liabilities, and off-balance sheet items at March 31, 2005. In addition to showing the estimated
fair market value at current rates, they also provide estimates of the fair market values of
interest sensitive items based upon a hypothetical instantaneous move both up and down 100 and 200
basis points in the entire yield curve. The first table is an economic analysis showing the present value impact of changes in
interest rates, assuming a comprehensive mark-to-market environment. The second table is an
accounting analysis showing the same net present value impact, adjusted for expected GAAP
treatment. Neither analysis takes into account the book values of the noninterest sensitive assets
and liabilities (such as cash, accounts receivable, and fixed assets), the values of which are not
directly determined by interest rates. The analyses are based on discounted cash flows over the remaining estimated lives of the
financial instruments. The interest rate sensitivities apply only to transactions booked as of
March 31, 2005, although certain accounts are normalized whereby the three- or six-month average
balance is included rather than the quarter-end balance in order to avoid having the analysis
skewed by a significant increase or decrease to an account balance at quarter-end. The tables that follow should be used with caution.  
    The net asset value sensitivities do not necessarily represent the changes in the lines
of business net asset value that would actually occur under the given interest rate
scenarios, as sensitivities do not reflect changes in value of the companies as a going
concern or management actions that might be taken in the future under asset/liability
management as interest rates change.
    Specifically, the volume of derivative contracts entered into to manage the risk of MSRs
fluctuates from quarter to quarter and within a given quarter, depending upon market
conditions, the size of our MSR portfolio and various additional factors. We monitor
derivative positions frequently and reposition them as needed. Therefore, our derivative
positions, shown in the table below as of March 31, 2005, may or may not be representative
of our risk position during the succeeding quarter. Additionally, it is unlikely that the
volume and strike prices of derivative positions would remain constant over large
fluctuations in interest rates, although the tables below assume they do. MSR risk
management derivative contracts appear under the category Interest Sensitive Financial
Derivatives in the tables below.
    The tables below show modeled changes in interest rates for individual asset classes.
Asset classes in our portfolio have interest rate sensitivity tied to different underlying
indices or instruments. While the rate sensitivity of individual asset classes presented
below is our best estimate of changes in value due to interest rate changes, the total
potential change figures are subject to basis risk between value changes of individual
assets and liabilities which has not been included in the model.
    Few of the asset classes shown react to interest rate changes in a linear fashion. That
is, the point estimates we have made at Current and +/2% and +/1% are good estimates
at those amounts of rate change, but it may not be accurate to interpolate linearly between
those points. This is most evident in products that contain optionality in payment timing or
pricing such as mortgage servicing or nonmaturity transaction deposits.
    Finally, the tables show theoretical outcomes for dramatic changes in interest rates
which do not consider potential rebalancing or repositioning of hedges. 50




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##### Table of Contents



Economic Value Change Method Present Value at March 31, 2005Change in Interest Rates of:-2%
    
    
    -1%
    
    
    Current
    
    
    +1%
    
    
    +2%(In Thousands)Interest Sensitive AssetsLoans and other assets
    
    $
    3,858,892
    
    
    $
    3,823,572
    
    
    $
    3,787,124
    
    
    $
    3,751,702
    
    
    $
    3,717,408Loans held for sale
    
    
    1,072,121
    
    
    
    1,065,718
    
    
    
    1,056,879
    
    
    
    1,046,290
    
    
    
    1,035,142Mortgage servicing rights
    
    
    193,923
    
    
    
    262,501
    
    
    
    416,562
    
    
    
    529,366
    
    
    
    582,794Residual interests
    
    
    55,250
    
    
    
    53,381
    
    
    
    51,582
    
    
    
    49,045
    
    
    
    45,393Interest sensitive financial derivatives
    
    
    21,285
    
    
    
    23,366
    
    
    
    4,816
    
    
    
    (87,742
    )
    
    
    (220,323
    )Total interest sensitive assets
    
    
    5,201,471
    
    
    
    5,228,538
    
    
    
    5,316,963
    
    
    
    5,288,661
    
    
    
    5,160,414Interest Sensitive LiabilitiesDeposits
    
    
    (3,709,934
    )
    
    
    (3,689,539
    )
    
    
    (3,670,970
    )
    
    
    (3,652,809
    )
    
    
    (3,636,430
    )Short-term borrowings (1)
    
    
    (514,031
    )
    
    
    (513,696
    )
    
    
    (513,366
    )
    
    
    (513,038
    )
    
    
    (512,713
    )Long-term debt
    
    
    (598,543
    )
    
    
    (591,312
    )
    
    
    (582,375
    )
    
    
    (572,497
    )
    
    
    (560,031
    )Total interest sensitive liabilities
    
    $
    (4,822,508
    )
    
    $
    (4,794,547
    )
    
    $
    (4,766,711
    )
    
    $
    (4,738,344
    )
    
    $
    (4,709,174
    )Net market value as of March 31, 2005
    
    $
    378,963
    
    
    $
    433,991
    
    
    $
    550,252
    
    
    $
    550,317
    
    
    $
    451,240Change from current
    
    $
    (171,289
    )
    
    $
    (116,261
    )
    
    $
    
    
    
    $
    65
    
    
    $
    (99,012
    )Net market value as of December 31, 2004
    
    $
    464,835
    
    
    $
    495,091
    
    
    $
    574,825
    
    
    $
    581,006
    
    
    $
    474,480Potential change
    
    $
    (109,990
    )
    
    $
    (79,734
    )
    
    $
    
    
    
    $
    6,181
    
    
    $
    (100,345
    )
   (1)
    
    Includes certain debt which is categorized as collateralized borrowings in other sections of this document GAAP-Based Value Change Method Present Value at March 31, 2005Change in Interest Rates of:-2%
    
    
    -1%
    
    
    Current
    
    
    +1%
    
    
    +2%(In Thousands)Interest Sensitive AssetsLoans and other assets (1)
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Loans held for sale
    
    
    1,053,871
    
    
    
    1,053,872
    
    
    
    1,053,871
    
    
    
    1,043,283
    
    
    
    1,032,135Mortgage servicing rights
    
    
    190,948
    
    
    
    258,585
    
    
    
    387,287
    
    
    
    396,559
    
    
    
    402,350Residual interests
    
    
    55,250
    
    
    
    53,381
    
    
    
    51,582
    
    
    
    49,045
    
    
    
    45,393Interest sensitive financial derivatives
    
    
    21,285
    
    
    
    23,366
    
    
    
    4,816
    
    
    
    (87,742
    )
    
    
    (220,323
    )Total interest sensitive assets
    
    
    1,321,354
    
    
    
    1,389,204
    
    
    
    1,497,556
    
    
    
    1,401,145
    
    
    
    1,259,555Interest Sensitive LiabilitiesDeposits (1)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Short-term borrowings (1)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Long-term debt (1)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total interest sensitive liabilities (1)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net market value as of March 31, 2005
    
    $
    1,321,354
    
    
    $
    1,389,204
    
    
    $
    1,497,556
    
    
    $
    1,401,145
    
    
    $
    1,259,555Potential change
    
    $
    (176,202
    )
    
    $
    (108,352
    )
    
    $
    
    
    
    $
    (96,411
    )
    
    $
    (238,001
    )Net market value as of December 31, 2004
    
    $
    1,177,394
    
    
    $
    1,218,843
    
    
    $
    1,314,396
    
    
    $
    1,221,554
    
    
    $
    1,060,818Potential change
    
    $
    (137,002
    )
    
    $
    (95,553
    )
    
    $
    
    
    
    $
    (92,842
    )
    
    $
    (253,578
    )
   (1)
    
    Value does not change in GAAP presentation 51




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Operational Risk Operational risk is the risk of loss resulting from inadequate or failed internal processes,
people and systems or from external events. Irwin Financial, like other financial services
organizations, is exposed to a variety of operational risks. These risks include regulatory,
reputational and legal risks, as well as the potential for processing errors, internal or external
fraud, failure of computer systems, and external events that are beyond the control of the
Corporation, such as natural disasters. Our Board of Directors has ultimate responsibility for approving the level of operational risk
assumed by us. The Board guides management by approving our business strategy and significant
policies. Our management and Board have also established and continue to improve a control
environment that encourages a high degree of awareness and proactivity in alerting senior
management and the Board to potential control issues on a timely basis. The Board has directed that primary responsibility for the management of operational risk
rests with the managers of our business units, who are responsible for establishing and maintaining
internal control procedures that are appropriate for their operations. In 2002, we started
implementing a multi-year program to provide a more integrated firm-wide approach for the
identification, measurement, monitoring and mitigation of operational risk. The enterprise-wide
operational risk oversight function reports to the Chief Risk Officer, who in turn reports to the
Audit and Risk Management Committee of our Board of Directors and chairs our Enterprise-Wide Risk
Management Committee. We have an enterprise-wide compliance oversight function. The compliance
oversight function reports to our Chief Risk Officer. We have developed risk and control summaries
(risk summaries) for our key business processes. Line of business and corporate-level managers use
the risk summaries to assist in identifying operational and other risks for the purpose of
monitoring and strengthening internal and disclosure controls. Our Chief Executive Officer, Chief
Financial Officer and Board of Directors, as well as the Boards of our subsidiaries, use the risk
summaries to assist in overseeing and assessing the adequacy of our internal and disclosure
controls, including the adequacy of our controls over financial reporting as required by section
404 of the Sarbanes Oxley Act and FDICIA. The financial services business is highly regulated. Failure to comply with these regulations
could result in substantial monetary or other damages that could be material to our financial
position. Statutes and regulations may change in the future. We cannot predict what effect these
changes, if made, will have on our operations. It should be noted that the supervision, regulation
and examination of banks, thrifts and mortgage companies by regulatory agencies are intended
primarily for the protection of depositors and other customers rather than shareholders of these
institutions. We are registered as a bank holding company with the Board of Governors of the Federal Reserve
System under the Bank Holding Company Act of 1956, as amended, and the related regulations. We are
subject to regulation, supervision and examination by the Federal Reserve, and as part of this
process we must file reports and additional information with the Federal Reserve. The regulation,
supervision and examinations occur at the local, state and federal levels and involve, but are not
limited to minimum capital requirements, consumer protection, community reinvestment, and deposit
insurance. Off-Balance Sheet Instruments In the normal course of our business as a provider of financial services, we are party to
certain financial instruments with off-balance sheet risk to meet the financial needs of our
customers. These financial instruments include loan commitments and standby letters of credit.
Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess
of the amounts recognized on the consolidated balance sheet. We follow the same credit policies in
making commitments and contractual obligations as we do for our on-balance sheet instruments. Our exposure to credit loss, in the form of nonperformance by the counterparty on commitments
to extend credit and standby letters of credit, is represented by the contractual amount of those
instruments. Collateral pledged for standby letters of credit and commitments varies but may
include accounts receivable; inventory; property, plant, and equipment; and residential real
estate. Total outstanding commitments to extend credit at March 31, 2005 and December 31, 2004,
respectively, were $695 million and $720 million. We had $19 million and $25 million in irrevocable
standby letters of credit outstanding at March 31, 2005 and December 31, 2004, respectively. Derivative Financial Instruments Financial derivatives are used as part of the overall asset/liability risk management process.
We use certain derivative instruments that do not qualify for hedge accounting treatment under SFAS
133. These derivatives are classified as Other assets and Other liabilities and marked to
market on the income statement. While we do not seek GAAP hedge accounting treatment for 52




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the assets that these instruments are hedging, the economic purpose of these instruments is to manage the risk
inherent in existing exposures to either interest rate risk or foreign currency risk. We entered into an interest rate swap that has a notional amount (which does not represent the
amount at risk) of $25 million as of March 31, 2005. Under the terms of the swap agreement, we
receive a fixed rate of interest and pay a floating rate of interest based upon one-month LIBOR. We
recognized a loss of $28 thousand included in derivative gains (losses) during the quarter ended
March 31, 2005 related to this swap. By receiving a fixed rate of interest and paying a floating
rate on the swap, we are converting the economics of a $25 million fixed rate-funding source into
a floating rate funding source. Additionally, we enter into interest rate swaps that meet the
criteria for the application of SFAS 133 hedge treatment accounting. These swaps have a notional
amount (which does not represent the amount of risk) of $70 million to hedge a fixed rate
certificate of deposit. We recognized losses of $8 thousand in interest expense related to these
swaps. Under the terms of the swap agreement, we receive a fixed rate of interest and pay a
floating rate of interest based upon three-month LIBOR. We enter into forward contracts to protect against interest rate fluctuations from the date of
mortgage loan commitment until the loans are sold. A portion of the transactions hedging the closed
mortgage loans qualifies for hedge accounting treatment under SFAS 133. The notional amount of our
forward contracts (which does not represent the amount at risk) totaled $1.1 billion at March 31,
2005. The closed mortgage loans hedged by forward contracts qualify for hedge accounting treatment
under SFAS 133. The basis of the hedged closed loans is adjusted for change in value associated
with the risk being hedged. We value closed loan contracts at period end based upon the current
secondary market value of securities with similar characteristics. The unrealized gain on our
forward contracts at March 31, 2005 was $5 million and the hedge ineffectiveness during the first
quarter of 2005 resulted in a loss of $1 million. The effect of these hedging activities was
recorded through earnings as a component of Gain from sale of loans. We enter into commitments to originate mortgage loans whereby the interest rate on the loan is
determined prior to funding (rate lock commitments). Rate lock commitments on loans intended to be
sold are considered to be derivatives. We record changes in the fair value of these commitments
based upon the current secondary market value of securities with similar characteristics. For first
quarter of 2005, a net decrease in fair value of these derivatives totaling $4 million was recorded
in Gain from sale of loans. At March 31, 2005, we had a notional amount of rate lock commitments
outstanding totaling $0.8 billion with a fair value of $0.2 million. Notional amounts do not
represent the amount of risk. Our commercial finance line of business delivered fixed rate leases into conduits that fund
them with floating rate commercial paper, which creates an interest rate risk mismatch.  
    In two instances, this funding mismatch is lessened by a combination of amortizing
interest rate caps and Eurodollar futures contracts. The interest rate caps have a strike
price of 5% and provide protection against a large increase in short-term interest rates. As
of March 31, 2005, the notional value and first quarter 2005 gain on the interest rate caps
were $21 million and $2 thousand, respectively. As of March 31, 2005, the total notional
amount and year-to-date gain on the Eurodollar futures were $70 million and $0.1 million,
respectively.
    We deliver fixed rate leases into a second commercial paper conduit. Although the leases
and funding were in Canadian dollars (CAD), the interest rate mismatch is similar in nature
to that described above. To lessen the repricing mismatch between fixed rate CAD-denominated
leases and floating rate CAD commercial paper, a series of four amortizing CAD interest rate
swaps have been executed, although Irwin is only a counterparty on three of the swaps. The
fourth swap is between the commercial paper conduit and an outside party, but affects the
conduit funding cost that is charged to Irwin. For two of the three swaps on Irwins books,
we pay a fixed rate of interest and receive a floating rate. For the third swap, we pay a
floating rate of interest and receive a fixed rate. The U.S. dollar-equivalents of the
CAD-based notional and year-to-date losses on these swaps at March 31, 2005 were $185
million and $0.3 million, respectively. Certain of our home equity fixed rate residual interests are funded with floating rate
liabilities. Starting in the first quarter of 2004, we began entering into Eurodollar futures
contracts to manage such mismatches. The original positions taken are typically rebalanced
quarterly. The current notional value outstanding is $375 million (which does not represent the
amount at risk). As of March 31, 2005, the fair value and year-to-date gain recorded on these
contracts were $0.8 million and $0.6 million, respectively. In connection with certain of our whole loan servicing retained second mortgage sales we have
the opportunity to earn an additional incentive servicing fee (ISF) in the future. The whole loan
sales have been to firms (the buyers) who securitize the loans and contract with us to service the
loans. We recognize a mortgage servicing asset or liability for these contracts. As a part of the
buyers securitizations, the buyers issue an Incentive Servicing Agreement to us as Master
Servicer. Once a pre-established return 53




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for the certificate holders has been met, the ISF provides potential cash payments to us in the event certain structure-specific loan credit and servicing
performance metrics are met. We have characterized these contracts as derivative instruments.
Included in Derivative gains or losses for the first quarter ended March 31, 2005 was a $10.5
million gain related to these incentive servicing fees. The ISF valuation is based upon actual and
projected value of future cash flow, present valued at discount rates ranging from 30-40%. In
total, we have $0.9 billion in loans for which we hold such derivative contracts. Our accounting
policy is to recognize a derivative asset on a mark-to-market basis at such time that the credit
and prepayment performance models we use for valuing like pools of loans indicate with adequate
predictability that we are more likely than not to receive cash payments on the derivatives. We use
assumptions to value the ISFs that we believe market participants would use to value similar
assets. We manage the interest rate risk associated with our mortgage servicing rights at our mortgage
banking and commercial banking lines of business through the use of swaptions and Eurodollar
futures contracts. Both the options and futures contracts were marked-to-market and included in
Other assets with changes in value recorded in the consolidated income statements as Derivative
gains or losses. At March 31, 2005, we held open swaption positions with a notional value (which
does not represent the amount at risk) totaling $6 billion. In the first quarter of 2005 we
recorded losses on swaptions, including premiums paid, totaling $49 million. We held no Eurodollar
futures contracts at March 31, 2005, but we recorded gains of $1 million on contracts held during
the quarter. The size and mix of these positions change during the year, so period-end positions
may not be indicative of our net risk exposure throughout the year. We are subject to basis risk in the management of our servicing portfolio. In recent quarters,
the basis risk is moving in a manner opposite to historic patterns, negatively affecting management
of these assets. As discussed in more detail in the section of this report on Interest Rate Risk,
at March 31, 2005, we had approximately $0.2 million of mortgage servicing rights at risk to each
one basis point change in interest rates. This amount increases to approximately $1.5 million as
interest rates decline by approximately 35 basis points from current rates at the end of the
quarter and declines toward zero as rates increase. We typically counter-act this risk with the
use of derivatives with a similar basis point value over a limited range of interest rates. It is
not possible to construct a hedge with similar basis point value over a wide range of interest
rates. Therefore, if interest rates move enough to warrant it, we will reposition our hedges to
create a new range of rates with similar basis point value to the MSRs. Repositioning hedges can
be costly. Over time, this hedge has performed well in mitigating loss in value when interest
rates have declined and has been structured in such a manner so that we can recapture some of the
increase in value of servicing rights as rates rise, without losing an equal amount on our
derivatives. Over the past six months, however, basis risk in our servicing asset and derivative
position has caused our hedging position to be less effective than it has been historically as
recent declines in mortgage rates have not been matched with equal declines in swap rates. Finally, while basis risk exhibits stability over longer periods of time, over shorter periods
there can be separation in the relative spreads of interest rates and indices used to value
mortgage servicing rights and the financial derivatives we use to hedge the change in value in
mortgage servicing rights. At times this basis risk benefits us and at other times it does not. It
is generally not possible to eliminate this basis risk. It is possible, therefore, that our
balanced revenue strategy may be successful as measured over several quarters or years, but may
have market-based variances if measured over short periods such as quarters. 54




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The following table illustrates the changes in net impairment and hedge gains/losses by quarter for
the mortgage lending line of business:

Ending
    
    
    Change inGNMA
    
    
    GNMA
    
    
    
    
    
    
    Derivative
    
    
    NetRate
    
    
    Rate (in bps)
    
    
    Impairment
    
    
    Gain/(Loss)
    
    
    Impairment2002
    
    
    
    
    
    
    
    
    
    
    
    
    
    (Dollars in millions)Q1 02
    
    
    
    
    
    
    6.66
    %
    
    
    21
    
    
    $
    10.7
    
    
    $
    (8.1
    )
    
    $
    2.6Q2 02
    
    
    
    
    
    
    6.08
    %
    
    
    (58
    )
    
    
    (48.0
    )
    
    
    45.4
    
    
    
    (2.6
    )Q3 02
    
    
    
    
    
    
    5.15
    %
    
    
    (93
    )
    
    
    (86.8
    )
    
    
    81.2
    
    
    
    (5.6
    )Q4 02
    
    
    
    
    
    
    5.02
    %
    
    
    (13
    )
    
    
    (19.4
    )
    
    
    7.1
    
    
    
    (12.3
    )Total 2002
    
    
    
    
    
    
    (143
    )
    
    
    
    
    
    
    
    
    
    $
    (17.9
    )Q1 03
    
    
    
    
    
    
    4.97
    %
    
    
    (5
    )
    
    $
    (2.0
    )
    
    $
    0.3
    
    
    $
    (1.7
    )Q2 03
    
    
    
    
    
    
    4.51
    %
    
    
    (46
    )
    
    
    (40.7
    )
    
    
    28.9
    
    
    
    (11.8
    )Q3 03
    
    
    
    
    
    
    4.99
    %
    
    
    48
    
    
    
    41.8
    
    
    
    (27.6
    )
    
    
    14.2Q4 03
    
    
    
    
    
    
    5.24
    %
    
    
    25
    
    
    
    46.2
    
    
    
    (22.9
    )
    
    
    23.3Total 2003
    
    
    
    
    
    
    22
    
    
    
    
    
    
    
    
    
    
    $
    24.0Q1 04
    
    
    
    
    
    
    4.90
    %
    
    
    (34
    )
    
    $
    (48.2
    )
    
    $
    58.4
    
    
    $
    10.2Q2 04
    
    
    
    
    
    
    5.54
    %
    
    
    64
    
    
    
    71.3
    
    
    
    (57.8
    )
    
    
    13.5Q3 04
    
    
    
    
    
    
    5.16
    %
    
    
    (38
    )
    
    
    (17.7
    )
    
    
    22.5
    
    
    
    4.8Q4 04
    
    
    
    
    
    
    5.05
    %
    
    
    (11
    )
    
    
    (9.7
    )
    
    
    (4.2
    )
    
    
    (13.9
    )Total 2004
    
    
    
    
    
    
    (19
    )
    
    
    
    
    
    
    
    
    
    $
    14.7Q1 05
    
    
    
    
    
    
    5.33
    %
    
    
    28
    
    
    $
    32.5
    
    
    $
    (47.4
    )
    
    $
    (14.9
    )
 We own foreign currency forward contracts to protect the U.S. dollar value of intercompany
loans made to Onset Capital Corporation that are denominated in Canadian dollars. We had a notional
amount of $36 million in forward contracts outstanding as of March 31, 2005. Year to date, we
recognized losses on these contracts of $0.1 million. These contracts are marked-to-market with
gains and losses included in Derivative gains or losses on the consolidated income statements.
The foreign currency transaction gain on the intercompany loans was $0.1 million for the quarter
ended March 31, 2005. 
 Item 3. Quantitative and Qualitative Disclosures about Market Risk. The quantitative and qualitative disclosures about market risk are reported in the Interest
Rate Risk section of Item 2, Managements Discussion and Analysis of Financial Condition and
Results of Operations found on pages 48 through 51. 
 Item 4. Controls and Procedures. In the ordinary course of internal process and control review by management, internal and
external audit, we will periodically identify processes and controls that need improvement. When
these are identified, we have procedures in place to bring the matter to the attention of the
appropriate management and Board committees and to put into place project plans to address the
improvement opportunity. As of March 31, 2005, we performed an evaluation under the supervision and with the
participation of our management, including the Chief Executive Officer and the Chief Financial
Officer, of the effectiveness of the design and operation of our disclosure controls and procedures
(as defined in Exchange Act Rules 13a-15(e)). Based on that evaluation, our management, including
the CEO and CFO, concluded that our disclosure controls and procedures were effective as of March
31, 2005, to provide that material information relating to the Corporation would be made known to
them by others within the Corporation in a timely manner sufficient for filing or furnishing
reports to the SEC. Based on an evaluation by management of our internal control over financial reporting,
performed with the participation of our Chief Executive Officer and Chief Financial Officer, there
have been no changes during the first quarter of 2005 in our internal control over financial
reporting that have materially affected or are reasonably likely to materially affect the
Corporations internal control over financial reporting. 55




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PART II. Other Information. 
 Item 1. Legal Proceedings. Since the time we filed our Report onForm 10-Kfor the year ended December 31, 2004, we
experienced developments as noted in the litigation described below. For a full description of the
litigation, see Note 10, Commitments and Contingencies, in the Notes to Consolidated Financial
Statements, Part I, Item 1, of this Report. Culpepper v. Inland Mortgage Corporation(class action lawsuit filed in April 1996 in the
United States District Court for the Northern District of Alabama,
alleging that Irwin Mortgage, our indirect subsidiary, violated the federal Real Estate Settlement Procedures Act relating to Irwin Mortgages payment of
broker fees to mortgage brokers). Developments: Pursuant to the courts order on March 17, 2005, Irwin Mortgage filed a motion
for summary judgment and updated its motion to decertify the class; the plaintiffs updated their
motion for summary judgment. Cohens v. Inland Mortgage Corporation(lawsuit filed in October 2003 in the Supreme Court of
New York, County of Kings for alleged injuries from lead contamination while living in premises
allegedly owned by defendants). Developments: The parties agreed to delay the filing of an answer in this case until April
29, 2005. Litigation in Connection with Loans Purchased from Community Bank of Northern Virginia
(Community)(lawsuits alleging various violations under the Truth-in-Lending Act, the Home
Ownership and Equity Protection Act, the Real Estate Settlement Procedures Act, the Racketeer
Influenced and Corrupt Organizations Act, other state law violations, and/or conversion in
connection with loans Irwin Union Bank and Trust Company, our
subsidiary, purchased from Community). Developments: On March 4, 2005, the court held a hearing on Irwins motion to dismiss in
Hobson v. Irwin Union Bank and Trust Company(action seeking class certification filed in July 2004
in the United States District Court for the Northern District of Alabama). On March 31, 2005, the
Judicial Panel On Multidistrict Litigation held a hearing on Irwins request to transfer Hobsonand
two individual lawsuits (Chatfield v. Irwin Union Bank and Trust Companyand Ransom v. Irwin Union
Bank and Trust Company)to the Western District of Pennsylvania for coordination or consolidation
with Kossler v. Community Bank of Northern Virginia,an action seeking class certification originally
filed in July 2002 in the United States District Court for the Western District of Pennsylvania and
amended to add Irwin Union Bank and Trust as a defendant in December 2004. Litigation Related to NorVergence, Inc.(complaints, lawsuits and investigations in various
jurisdictions in connection with the failure of NorVergence, Inc., a telecommunications company
that assigned its leases to Irwin Business Finance and other lenders; the actions against the
lenders, including Irwin Business Finance, seek to void the lease contracts and stop collection
efforts). Developments: Irwin Business Finance is pursuing discussions with all states in which it has
customers who executed agreements with NorVergence and has discontinued collection activities while
discussions are in progress. Although negotiations are ongoing in the following states, Irwin
believes it has reached agreements in principle with: the Attorney General of California for
recovery of 15% of outstanding balances on California leases as of July 15, 2004; the Attorney
General of Florida, entitling Irwin to lease payments through January 31, 2005; and the Attorney
General of New Jersey for recovery on a staggered scale based on the contract price, with full
forgiveness for gross a contract price of $17,999 or less, to 75% forgiveness for a gross contract
price of $30,000 or more. Irwin also is participating in negotiations with a multi-state group of
attorneys general, which appears to be progressing towards an agreement that would require
NorVergence lessees in their states to pay all amounts due through July 30, 2004, with the lenders,
including Irwin, entitled to 15% of the then-outstanding balance. The individual lawsuit filed against Irwin Business Finance in the Superior Court of
Massachusetts has been put on hold pending discussions with the multi-state group of attorneys
general, of which the Attorney General of Massachusetts is a participant. On April 5, 2005, Irwin Business Finance received an informal request for information and
documents from the Federal Trade Commission. Irwin is in the process of responding to this
request. 56




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##### Table of Contents



We and our subsidiaries are from time to time engaged in various matters of litigation,
including the matters described above, other assertions of improper or fraudulent loan practices or
lending violations, and other matters, and we have a number of unresolved claims pending. In
addition, as part of the ordinary course of business, we and our subsidiaries are parties to
litigation involving claims to the ownership of funds in particular accounts, the collection of
delinquent accounts, challenges to security interests in collateral, and foreclosure interests, that is incidental to our regular business
activities. While the ultimate liability with respect to these other litigation matters and claims
cannot be determined at this time, we believe that damages, if any, and other amounts relating to
pending matters are not likely to be material to our consolidated financial position or results of
operations, except as described above. Reserves are established for these various matters of
litigation, when appropriate under SFAS 5, based in part upon the advice of legal counsel. 57




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##### Table of Contents



Item 6. Exhibits. ExhibitNumber
    
    Description of Exhibit3.1
    
    Restated Articles of Incorporation of Irwin Financial Corporation, as amended April 7, 2005.3.2
    
    Code of By-laws of Irwin Financial Corporation, as amended, dated April 30, 2004.
(Incorporated by reference to Exhibit 3.3 to Form 10-Q Report for the quarter ended June
30, 2004, File No. 001-16691.)4.1
    
    Specimen Common Stock Certificate (Incorporated by reference to Exhibit 4(a) to Form 10-K
report for year ended December 31, 1994, File No. 0-06835.).4.2
    
    Certain instruments defining the rights of the holders of long-term debt of Irwin Financial
Corporation and certain of its subsidiaries, none of which authorize a total amount of
indebtedness in excess of 10% of the total assets of the Corporation and its subsidiaries
on a consolidated basis, have not been filed as Exhibits. The Corporation hereby agrees to
furnish a copy of any of these agreements to the Commission upon request.4.3
    
    Rights Agreement, dated as of March 1, 2001, between Irwin Financial Corporation and Irwin
Union Bank and Trust. (Incorporated by reference to Exhibit 4.1 to Form 8-A filed March 2,
2001, File No. 000-06835.)4.4
    
    Appointment of Successor Rights Agent dated as of May 11, 2001 between Irwin Financial
Corporation and National City Bank. (Incorporated by reference to Exhibit 4.5 to Form S-8
filed on September 7, 2001, File No. 333-69156.)10.1
    
    *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. 000-06835.)10.2
    
    *Irwin Financial Corporation 1997 Stock Option Plan. (Incorporated by reference to Exhibit
10 to Form 10-Q Report for period ended June 30, 1994, File No. 000-06835.)10.3
    
    *Amendment to Irwin Financial Corporation 1997 Stock Option Plan. (Incorporated by
reference to Exhibit 10(i) to Form 10-Q Report for period ended June 30, 1997, File No.
000-06835.)10.4
    
    *Irwin Financial Corporation Amended and Restated 2001 Stock Plan. (Incorporated by
reference to Exhibit 1 to the Corporations proxy statement for its 2004 Annual Meeting,
filed with the Commission on March 18, 2004, File No. 001-16691.10.5
    
    *Irwin Financial Corporation 1999 Outside Director Restricted Stock Compensation Plan.
(Incorporated by reference to Exhibit 2 to the Corporations proxy statement for its 2004
Annual Meeting, filed with the Commission on March 18, 2004, File No. 001-16691.)10.6
    
    *Employee Stock Purchase Plan III. (Incorporated by reference to Exhibit 10(a) to Form 10-Q
Report for period ended June 30, 1999, File No. 000-06835.)10.7
    
    *Long-Term Management Performance Plan. (Incorporated by reference to Exhibit 10(a) to Form
10-K Report for year ended December 31, 1986, File No. 000-06835.)10.8
    
    *Long-Term Incentive Plan-Summary of Terms. (Incorporated by reference to Exhibit 10(a) to
Form 10-K Report for year ended December 31, 1986, File No. 000-06835.)10.9
    
    *Inland Mortgage Corporation Long-Term Incentive Plan. (Incorporated by reference to
Exhibit 10(j) to Form 10-K Report for year ended December 31, 1995, File No. 000-06835.)10.10
    
    *Amended and Restated Management Bonus Plan. (Incorporated by reference to Exhibit 10(a) to
Form 10-K Report for year ended December 31, 1986, File No. 000-06835.)10.11
    
    *Limited Liability Company Agreement of Irwin Ventures LLC. (Incorporated by reference to
Exhibit 10(a) to Form 10-Q/A Report for period ended March 31, 2001, File No. 000-06835.)10.12
    
    *Limited Liability Company Agreement of Irwin Ventures Co-Investment Fund LLC, effective as
of April 20, 2001. (Incorporated by reference to Exhibit 10.17 to Form S-1/A filed February
14, 2002, File No. 333-69586.)10.13
    
    *Promissory Note dated January 30, 2002 from Elena Delgado to Irwin Financial Corporation.
(Incorporated by reference to Exhibit 10.19 to Form S-1/A filed February 14, 2002, File No.
333-69586.)
 58




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ExhibitNumber
    
    Description of Exhibit10.14
    
    *Consumer Pledge Agreement dated January 30, 2002 between Elena Delgado and Irwin Financial
Corporation. (Incorporated by reference to Exhibit 10.20 to Form S-1/A filed February 14,
2002, File No. 333-69586.)10.15
    
    *Redemption and Loan Repayment Agreement dated December 22, 2004 between Irwin Financial
Corporation, Irwin Home Equity Corporation and Elena Delgado. (Incorporated by reference
to Exhibit 10.15 of Form 10-K Report for year ended December 31, 2004, File No. 001-16691.)10.16
    
    *Irwin Home Equity Corporation Amendment and Restatement of Shareholder Agreement dated
December 22, 2004 between Irwin Home Equity Corporation, Irwin Financial Corporation and
Elena Delgado. (Incorporated by reference to Exhibit 10.16 of Form 10-K Report for year
ended December 31, 2004, File No. 001-16691.)10.17
    
    *Deferred Compensation Agreement dated December 22, 2004 between Irwin Home Equity
Corporation, Irwin Financial Corporation and Elena Delgado. (Incorporated by reference to
Exhibit 10.17 of Form 10-K Report for year ended December 31, 2004, File No. 001-16691.)10.18
    
    *Tax Gross-up Agreement dated December 22, 2004 between Irwin Financial Corporation and
Elena Delgado as Shareholder. (Incorporated by reference to Exhibit 10.18 of Form 10-K
Report for year ended December 31, 2004, File No. 001-16691.)10.19
    
    *Amendment No. 1 to Irwin Home Equity Corporation Amendment and Restatement of Shareholder
Agreement dated April 7, 2005 between Irwin Home Equity Corporation, Irwin Financial
Corporation and Elena Delgado.10.20
    
    *Amendment No. 1 to the Deferred Compensation Agreement dated April 7, 2005 between Irwin
Home Equity Corporation, Irwin Financial Corporation and Elena Delgado.10.21
    
    *Irwin Financial Corporation Amended and Restated Short Term Incentive Plan effective
January 1, 2002. (Incorporated by reference to Exhibit 3 to the Corporations proxy
statement for its 2004 Annual Meeting, filed with the Commission on March 18, 2004, File
No. 001-16691.)10.22
    
    *Irwin Commercial Finance Amended and Restated Short Term Incentive Plan (Incorporated by
reference to Exhibit 4 of the Corporations proxy statement for its 2004 Annual Meeting,
filed with the Commission on March 18, 2004, File No. 001-16691.)10.23
    
    *Irwin Home Equity Amended and Restated Short Term Incentive Plan (Incorporated by
reference to Exhibit 5 to the Corporations proxy statement for its 2004 Annual Meeting,
filed with the Commission on March 18, 2004, File No. 001-16691.)10.24
    
    *Irwin Mortgage Corporation Amended and Restated Short Term Incentive Plan effective
January 1, 2002. (Incorporated by reference to Exhibit 6 of the Corporations proxy
statement for its 2004 Annual Meeting, filed with the Commission on March 18, 2004, File
No. 001-16691.)10.25
    
    *Irwin Union Bank and Trust Company Amended and Restated Short Term Incentive Plan
effective January 1, 2002. (Incorporated by reference to Exhibit 7 to the Corporations
proxy statement for its 2004 Annual Meeting, filed with the Commission on March 18, 2004,
File No. 001-16691.)10.26
    
    *Irwin Capital Holdings Short Term Incentive Plan effective January 1, 2002. (Incorporated
by reference to Exhibit 10.25 to Form 10-Q Report for period ended March 31, 2002, File No.
000-06835.)10.27
    
    *Onset Capital Corporation Employment Agreement. (Incorporated by reference to Exhibit
10.26 to Form 10-Q Report for period ended June 30, 2002, File No. 000-06835.)10.28
    
    *Irwin Financial Corporation Restated Supplemental Executive Retirement Plan for Named
Executives. (Incorporated by reference to Exhibit 10.27 to Form 10-Q Report for period
ended June 30, 2002, File No. 000-06835.)10.29
    
    *Irwin Financial Corporation Supplemental Executive Retirement Plan for Named Executives.
(Incorporated by reference to Exhibit 10.28 to Form 10-Q Report for period ended June 30,
2002, File No. 000-06835.)10.30
    
    *Onset Capital Corporation Shareholders Agreement (Incorporated by reference to Exhibit
10.29 to Form 10-K Report for period ended December 31, 2003, File No. 000-06835.)
 59




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ExhibitNumber
    
    Description of Exhibit11.1
    
    Computation of Earnings Per Share is included in the footnotes to the financial statements.31.1
    
    Certification pursuant to 18 U.S.C. Section 302 of the Sarbanes-Oxley Act of 2002 by the
Chief Executive Officer.31.2
    
    Certification pursuant to 18 U.S.C. Section 302 of the Sarbanes-Oxley Act of 2002 by the
Chief Financial Officer.32.1
    
    Certification of the Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act of
2002.32.2
    
    Certification of the Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of
2002.
   *
    
    Indicates management contract or compensatory plan or arrangement. 60




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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 CORPORATIONDATE: April 29, 2005
    
    BY:
    
    /s/ Gregory F. EhlingerGREGORY F. EHLINGERCHIEF FINANCIAL OFFICERBY:
    
    /s/ Jody A. LittrellJODY A. LITTRELLCORPORATE CONTROLLER(Chief Accounting Officer)
 61