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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-------------------------
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2001
COMMISSION FILE NUMBER 1-13805
HARRIS PREFERRED CAPITAL CORPORATION
(Exact name of registrant as specified in its charter)
MARYLAND #36-4183096
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) No.)
111 WEST MONROE STREET, 60603
CHICAGO, ILLINOIS (Zip Code)
(Address of principal executive
offices)
Registrant's telephone number, including area code: (312) 461-2121
-------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
The number of shares of Common Stock, $1.00 par value, outstanding on May 11,
2001 was 1,000.
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2
HARRIS PREFERRED CAPITAL CORPORATION
TABLE OF CONTENTS
Part
I.... FINANCIAL INFORMATION
Item 1. Financial Statements:
Balance Sheets.............................................. 2
Statements of Operations and Other Comprehensive Income..... 3
Statements of Changes in Stockholders' Equity............... 4
Statements of Cash Flows.................................... 5
Notes to Financial Statements............................... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 6
Part II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K............................ 19
Signatures ............................................................ 19
1
3
HARRIS PREFERRED CAPITAL CORPORATION
BALANCE SHEETS
(UNAUDITED)
MARCH 31, 2001 DECEMBER 31, 2000 MARCH 31, 2000
-------------- ----------------- --------------
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
Cash on deposit with Harris Trust and Savings
Bank............................................ $ 1,063 $ 819 $ 410
Securities purchased from Harris Trust and Savings
Bank under agreement to resell.................. 14,002 3,000 6,501
Notes receivable from Harris Trust and Savings
Bank............................................ 91,611 102,960 129,577
Securities available-for-sale:
Mortgage-backed................................. 342,163 352,965 309,516
U.S. Treasury................................... 39,903 24,850 24,896
Securing mortgage collections due from Harris
Trust and Savings Bank.......................... 4,042 2,786 3,102
Other assets...................................... 2,810 2,559 2,516
-------- -------- --------
Total assets............................... $495,594 $489,939 $476,518
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accrued expenses.................................. $ 84 $ 115 $ 66
-------- -------- --------
Commitments and contingencies..................... -- -- --
STOCKHOLDERS' EQUITY
7 3/8% Noncumulative Exchangeable Preferred Stock,
Series A ($1 par value); liquidation value of
$250,000; 20,000,000 shares authorized,
10,000,000 shares issued and outstanding........ 250,000 250,000 250,000
Common stock ($1 par value); 1,000 shares
authorized, issued and outstanding.............. 1 1 1
Additional paid-in capital........................ 240,733 240,733 240,733
Earnings in excess of distributions............... 5,833 536 3,520
Accumulated other comprehensive
income -- unrealized losses on
available-for-sale securities................... (1,057) (1,446) (17,802)
-------- -------- --------
Total stockholders' equity................. 495,510 489,824 476,452
-------- -------- --------
Total liabilities and stockholders'
equity.................................. $495,594 $489,939 $476,518
======== ======== ========
The accompanying notes are an integral part of these financial statements.
2
4
HARRIS PREFERRED CAPITAL CORPORATION
STATEMENTS OF OPERATIONS
AND OTHER COMPREHENSIVE INCOME
(UNAUDITED)
QUARTER ENDED
MARCH 31
--------------------------
2001 2000
---- ----
(IN THOUSANDS, EXCEPT PER
SHARE DATA)
INTEREST INCOME:
Securities purchased from Harris Trust and Savings Bank
under agreement to resell.............................. $ 543 $ 313
Notes receivable from Harris Trust and Savings Bank....... 1,584 2,150
Securities available-for-sale:
Mortgage-backed........................................ 5,569 5,462
U.S. Treasury.......................................... 167 4
--------- ---------
Total interest income................................ 7,863 7,929
NON-INTEREST INCOME:
Gain on sale of securities................................ 2,203 --
--------- ---------
OPERATING EXPENSES:
Loan servicing fees paid to Harris Trust and Savings
Bank................................................... 75 103
Advisory fees paid to Harris Trust and Savings Bank....... 12 15
General and administrative................................ 73 31
--------- ---------
Total operating expenses............................. 160 149
--------- ---------
Net income.................................................. 9,906 7,780
Preferred dividends......................................... 4,609 4,609
--------- ---------
NET INCOME AVAILABLE TO COMMON STOCKHOLDER.................. $ 5,297 $ 3,171
========= =========
Basic and diluted earnings per common share................. $5,297.00 $3,171.00
========= =========
Net income.................................................. $ 9,906 $ 7,780
Other comprehensive income -- unrealized gains/(losses) on
available-for-sale securities............................. 389 (610)
--------- ---------
Comprehensive income........................................ $ 10,295 $ 7,170
========= =========
The accompanying notes are an integral part of these financial statements.
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5
HARRIS PREFERRED CAPITAL CORPORATION
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(UNAUDITED)
QUARTER ENDED MARCH 31
-------------------------
2001 2000
---- ----
(IN THOUSANDS, EXCEPT PER
SHARE DATA)
Balance at January 1........................................ $489,824 $473,891
Net income................................................ 9,906 7,780
Other comprehensive income/(loss)......................... 389 (610)
Dividends (preferred stock $0.4609 per share)............. (4,609) (4,609)
-------- --------
Balance at March 31......................................... $495,510 $476,452
======== ========
The accompanying notes are an integral part of these financial statements.
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HARRIS PREFERRED CAPITAL CORPORATION
STATEMENTS OF CASH FLOWS
(UNAUDITED)
QUARTER ENDED MARCH 31
----------------------
2001 2000
---- ----
(IN THOUSANDS)
OPERATING ACTIVITIES:
Net Income................................................ $ 9,906 $ 7,780
Adjustments to reconcile net income to net cash provided
by operating activities:
Gain on sale of securities............................. (2,203) --
Net (increase) decrease in other assets................ (251) 71
Net decrease in accrued expenses....................... (31) (31)
Other, net............................................. 10,571 5,126
--------- --------
Net cash provided in operating activities............ 17,992 12,946
--------- --------
INVESTING ACTIVITIES:
Net (increase) decrease in securities purchased from
Harris Trust and Savings Bank under agreement to
resell................................................. (11,002) 8,499
Repayments of notes receivable from Harris Trust and
Savings Bank........................................... 11,349 7,172
(Increase) decrease in securing mortgage collections due
from Harris Trust and Savings Bank..................... (1,256) 23
Purchases of securities available-for-sale................ (138,975) (24,883)
Proceeds from maturities and sales of securities
available-for-sale..................................... 126,745 --
--------- --------
Net cash used by investing activities................ (13,139) (9,189)
--------- --------
FINANCING ACTIVITIES:
Cash dividends paid on preferred stock.................... (4,609) (4,609)
--------- --------
Net cash used by financing activities................ (4,609) (4,609)
--------- --------
Net increase (decrease) in cash on deposit with Harris
Trust and Savings Bank................................. 244 (852)
Cash on deposit with Harris Trust and Savings Bank at
beginning of period.................................... 819 1,262
--------- --------
Cash on deposit with Harris Trust and Savings Bank at end
of period.............................................. $ 1,063 $ 410
========= ========
The accompanying notes are an integral part of these financial statements.
5
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HARRIS PREFERRED CAPITAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
Harris Preferred Capital Corporation (the "Company") is a Maryland
corporation whose principal business objective is to acquire, hold, finance and
manage qualifying real estate investment trust ("REIT") assets (the "Mortgage
Assets"), consisting of a limited recourse note or notes (the "Notes") issued by
Harris Trust and Savings Bank (the "Bank") secured by real estate mortgage
assets (the "Securing Mortgage Loans") and other obligations secured by real
property, as well as certain other qualifying REIT assets. The Company holds its
assets through a Maryland real estate investment trust subsidiary, Harris
Preferred Capital Trust. Harris Capital Holdings, Inc., a wholly-owned
subsidiary of the Bank, owns 100% of the Company's common stock.
The accompanying financial statements have been prepared by management from
the books and records of the Company, without audit by independent certified
public accountants. These statements reflect all adjustments and disclosures
which are, in the opinion of management, necessary for a fair statement of the
results for the interim periods presented and should be read in conjunction with
the notes to financial statements included in the Company's 2000 Form 10-K.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to the rules and regulations of the
Securities and Exchange Commission.
2. COMMITMENTS AND CONTINGENCIES
Legal proceedings in which the Company is a defendant may arise in the
normal course of business. There is no pending litigation against the Company.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING INFORMATION
The statements contained in this Report on Form 10-Q that are not purely
historical are 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, including statements regarding the Company's expectation, intentions,
beliefs or strategies regarding the future. Forward-looking statements include
the Company's statements regarding tax treatment as a real estate investment
trust, liquidity, provision for loan losses, capital resources and investment
activities. In addition, in those and other portions of this document, the words
"anticipate," "believe," "estimate," "expect," "intend" and other similar
expressions, as they relate to the Company or the Company's management, are
intended to identify forward-looking statements. Such statements reflect the
current views of the Company with respect to future events and are subject to
certain risks, uncertainties and assumptions. It is important to note that the
Company's actual results could differ materially from those described herein as
anticipated, believed, estimated or expected. Among the factors that could cause
the results to differ materially are the risks discussed in the "Risk Factors"
section included in the Company's Registration Statement on Form S-11 (File No.
333-40257), with respect to the Preferred Shares declared effective by the
Securities and Exchange Commission on February 5, 1998. The Company assumes no
obligation to update any such forward-looking statement.
RESULTS OF OPERATIONS
QUARTER ENDED MARCH 31, 2001 COMPARED TO QUARTER ENDED MARCH 31, 2000
The Company's net income for the first quarter of 2001 was $9.9 million.
This represented a $2.1 million or 26.9% increase from 2000 earnings of $7.8
million.
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HARRIS PREFERRED CAPITAL CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
First quarter 2001 interest income on the Notes totaled $1.6 million and
yielded 6.4% on $98.7 million of average principal outstanding for the quarter
compared to $2.2 million and a 6.4% yield on $135 million average principal
outstanding for first quarter 2000. The decrease in income was attributable to a
reduction in the Notes balance because of customer payoffs in the Securing
Mortgage Loans. The average outstanding balance of the Securing Mortgage Loans
for first quarter 2001 and 2000 was $122 million and $167 million, respectively.
Interest income on securities available-for-sale for the current quarter was
$5.7 million resulting in a yield of 6.6% on an average balance of $348 million,
compared to $5.5 million with a yield of 7.1% on an average balance of $309
million for the same period a year ago. The increase in interest income is
primarily attributable to an increase in the investment securities portfolio
partially offset by a reduction in yield. As securities mature or are sold,
proceeds are invested in lower yielding securities as market interest rates have
been declining in recent months. Gains from investment securities sales
increased $2.2 million from the same period in 2000. There were no Company
borrowings during the quarter.
First quarter 2001 operating expenses totaled $160 thousand, an increase of
$11 thousand or 7% from the first quarter of 2000. Loan servicing expenses
totaled $75 thousand, a decrease of $28 thousand or 27% from a year ago. This
decrease is attributable to the reduction in the principal balance of the Notes,
thereby reducing servicing fees payable to the Bank. Advisory fees for the first
quarter 2001 were $12 thousand compared to $15 thousand a year earlier. General
and administrative expenses totaled $73 thousand, an increase of $42 thousand
over first quarter 2000, primarily due to the timing of rating agency fees and
insurance costs paid in the current quarter.
At March 31, 2001 and 2000, there were no Securing Mortgage Loans on
nonaccrual status.
The Company does not currently maintain an allowance for loan losses due to
the over-collateralization of the Notes represented by the Securing Mortgage
Loans.
On March 30, 2001, the Company paid a cash dividend of $0.46094 per share
on outstanding preferred shares to the stockholders of record on March 15, 2001,
as declared on March 2, 2001. On March 30, 2000, the Company paid a cash
dividend of $0.46094 per share on outstanding preferred shares to the
stockholders of record on March 15, 2000, as declared on March 6, 2000.
LIQUIDITY RISK MANAGEMENT
The objective of liquidity management is to ensure the availability of
sufficient cash flows to meet all of the Company's financial commitments. In
managing liquidity, the Company takes into account various legal limitations
placed on a REIT.
The Company's principal liquidity needs are to maintain the current
portfolio size through the acquisition of additional Notes or other qualifying
assets and to pay dividends to its stockholders after satisfying obligations to
creditors. The acquisition of additional Notes or other qualifying assets is
funded with the proceeds obtained from repayment of principal balances by
individual mortgages or maturities of securities held for sale on a reinvested
basis. The payment of dividends on the preferred shares will be made from
legally available funds, principally arising from operating activities of the
Company. The Company's cash flows from operating activities principally consist
of the collection of interest on the Notes and mortgage-backed securities. The
Company does not have and does not anticipate having any material capital
expenditures.
In order to remain qualified as a REIT, the Company must distribute
annually at least 90% (95% for years prior to January 1, 2001) of its adjusted
REIT taxable income, as provided for under the Internal Revenue Code, to its
common and preferred stockholders. The Company currently expects to distribute
dividends annually equal to 90% or more of its adjusted REIT taxable income.
The Company anticipates that cash and cash equivalents on hand and the cash
flow from the Notes and mortgage-backed securities will provide adequate
liquidity for its operating, investing and financing needs.
7
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HARRIS PREFERRED CAPITAL CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
As presented in the accompanying Statements of Cash Flows, the primary
sources of funds in addition to $7.8 million provided from operations during the
three months ended March 31, 2001 were $11 million provided by principal
payments on the Notes and $137 million from the maturities and sales of
securities available-for-sale. In the prior period ended March 31, 2000, the
primary sources of funds other than from operations of $7.8 million were $7
million provided by principal payments on the Notes and $5 million from the
maturities of securities available-for-sale. The primary use of funds for the
three months ended March 31, 2001 was $139 million in purchases of securities
available-for-sale. For the prior year's quarter ended March 31, 2000 the
primary uses of funds were $25 million in purchases of securities
available-for-sale, and $5 million in preferred stock dividends.
MARKET RISK MANAGEMENT
The Company's market risk is composed primarily of interest rate risk.
There have been no material changes in market risk or the manner in which the
Company manages market risk since December 31, 2000.
ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities." The Statement is effective for
all fiscal quarters of fiscal years beginning after June 15, 2000. The Company
adopted this Statement at January 1, 2001. The adoption did not have an effect
on the Company because the Company has not invested in derivatives or
participated in hedging activities.
In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities, a
replacement of SFAS No. 125." The Statement revises the standards pertaining to
accounting for securitizations and other transfers of financial assets and
collateral and requires certain disclosures. It carries over most of the
provisions of SFAS No. 125 without change. The Statement is effective for
transfers and servicing of financial assets and extinguishments of liabilities
occurring after March 31, 2001. The Statement is effective for recognition and
reclassification of collateral and for disclosures relating to securitization
transactions and collateral for fiscal years ending after December 15, 2000. The
Company does not expect the implementation of this Statement to have a material
effect on the Company's financial position or results of operations.
OTHER MATTERS
As of March 31, 2001, the Company believes that it is in full compliance
with the REIT tax rules, and expects to qualify as a REIT under the provisions
of the Code. The Company expects to meet all REIT requirements regarding the
ownership of its stock and anticipates meeting the annual distribution
requirements.
FINANCIAL STATEMENTS OF HARRIS TRUST AND SAVINGS BANK
The following unaudited financial information for the Bank is included
because the Company's preferred shares are automatically exchangeable for a new
series of preferred stock of the Bank upon the occurrence of certain events.
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10
HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CONDITION
(UNAUDITED)
MARCH 31 DECEMBER 31 MARCH 31
2001 2000 2000
-------- ----------- --------
(IN THOUSANDS EXCEPT SHARE DATA)
ASSETS
Cash and demand balances due from banks............. $ 1,081,252 $ 1,292,694 $ 1,204,405
Money market assets:
Interest-bearing deposits at banks.................. 174,005 141,348 251,413
Federal funds sold and securities purchased under
agreement to resell.............................. 394,925 491,075 228,400
Trading account assets................................ 39,910 65,211 24,118
Securities available-for-sale......................... 6,593,537 6,500,164 6,423,333
Loans................................................. 10,689,492 10,768,712 10,661,073
Allowance for possible loan losses.................... (115,761) (118,951) (114,583)
----------- ----------- -----------
Net loans........................................... 10,573,731 10,649,761 10,546,490
Premises and equipment................................ 284,303 284,142 279,410
Customers' liability on acceptances................... 36,334 34,100 50,213
Bank-owned insurance investments...................... 916,601 906,103 871,857
Assets held for sale.................................. 125,908 242,271 --
Goodwill and other valuation intangibles.............. 217,314 221,326 230,929
Other assets.......................................... 515,706 461,420 625,621
----------- ----------- -----------
TOTAL ASSETS................................... $20,953,526 $21,289,615 $20,736,189
=========== =========== ===========
LIABILITIES
Deposits in domestic offices -- noninterest bearing... $ 2,376,021 $ 3,067,296 $ 3,138,066
-- interest-bearing..... 7,090,977 7,065,300 6,644,802
Deposits in foreign offices -- noninterest
bearing................. 36,853 34,780 35,549
-- interest-bearing..... 2,375,965 2,326,001 1,976,374
----------- ----------- -----------
Total deposits................................. 11,879,816 12,493,377 11,794,791
Federal funds purchased and securities sold under
agreement to repurchase............................. 5,191,832 4,608,879 4,510,048
Other short-term borrowings........................... 884,041 1,489,730 1,539,403
Senior notes.......................................... 608,500 389,500 853,000
Acceptances outstanding............................... 36,334 34,100 50,219
Accrued interest, taxes and other expenses............ 257,354 213,794 160,221
Other liabilities..................................... 74,554 60,812 50,461
Minority interest-preferred stock of subsidiary....... 250,000 250,000 250,000
Long-term notes....................................... 225,000 225,000 225,000
----------- ----------- -----------
TOTAL LIABILITIES.............................. 19,407,431 19,765,192 19,433,143
----------- ----------- -----------
STOCKHOLDER'S EQUITY
Common stock ($10 par value); authorized 10,000,000
shares; issued and outstanding 10,000,000 shares.... 100,000 100,000 100,000
Surplus............................................... 616,340 613,365 611,254
Retained earnings..................................... 820,786 821,719 730,378
Accumulated other comprehensive income (loss)......... 8,969 (10,661) (138,586)
----------- ----------- -----------
TOTAL STOCKHOLDER'S EQUITY..................... 1,546,095 1,524,423 1,303,046
----------- ----------- -----------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY..... $20,953,526 $21,289,615 $20,736,189
=========== =========== ===========
The accompanying notes to the financial statements are an integral part of these
statements.
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HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
QUARTER ENDED
MARCH 31
--------------------
2001 2000
---- ----
(IN THOUSANDS EXCEPT
SHARE DATA)
INTEREST INCOME
Loans, including fees....................................... $217,646 $205,972
Money market assets:
Deposits at banks......................................... 841 571
Federal funds sold and securities purchased under
agreement to resell..................................... 4,380 3,190
Trading account............................................. 749 665
Securities available-for-sale:
U.S. Treasury and Federal agency.......................... 98,173 98,081
State and municipal....................................... 66 338
Other..................................................... 433 356
-------- --------
Total interest income..................................... 322,288 309,173
-------- --------
INTEREST EXPENSE
Deposits.................................................... 111,573 97,643
Short-term borrowings....................................... 81,552 81,749
Senior notes................................................ 8,430 16,087
Minority interest-dividends on preferred stock of
subsidiary................................................ 4,609 4,609
Long-term notes............................................. 3,959 3,756
-------- --------
Total interest expense.................................... 210,123 203,844
-------- --------
NET INTEREST INCOME......................................... 112,165 105,329
Provision for loan losses................................... 14,458 5,145
-------- --------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES......... 97,707 100,184
-------- --------
NONINTEREST INCOME
Trust and investment management fees........................ 22,390 29,814
Money market and bond trading............................... 5,661 265
Foreign exchange............................................ 1,675 1,800
Merchant and charge card fees............................... 42 5,329
Service fees and charges.................................... 22,128 24,661
Securities gains............................................ 12,963 --
Gain on sale of corporate trust businesses.................. -- 47,193
Bank-owned insurance investments............................ 11,599 9,859
Foreign fees................................................ 5,089 4,981
Other....................................................... 13,806 8,059
-------- --------
Total noninterest income.................................. 95,353 131,961
-------- --------
NONINTEREST EXPENSES
Salaries and other compensation............................. 68,131 70,683
Pension, profit sharing and other employee benefits......... 13,612 13,688
Net occupancy............................................... 8,656 10,671
Equipment................................................... 12,561 13,370
Marketing................................................... 6,627 5,229
Communication and delivery.................................. 4,668 4,546
Expert services............................................. 4,962 5,423
Contract programming........................................ 6,698 3,488
Other....................................................... (1,902) 507
-------- --------
124,013 127,605
Goodwill and other valuation intangibles.................... 5,773 5,686
-------- --------
Total noninterest expenses................................ 129,786 133,291
-------- --------
Income before income taxes.................................. 63,274 98,854
Applicable income taxes..................................... 16,207 31,751
-------- --------
NET INCOME................................................ $ 47,067 $ 67,103
======== ========
EARNINGS PER COMMON SHARE (based on 10,000,000 average
shares outstanding)
Net Income.................................................. $ 4.71 $ 6.71
======== ========
The accompanying notes to the financial statements are an integral part of these
statements.
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HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
QUARTER ENDED
MARCH 31
--------------------
2001 2000
---- ----
(IN THOUSANDS)
Net income.................................................. $47,067 $67,103
Other comprehensive income:
Cash flow hedges:
Cumulative effect of accounting change................. (7,976) --
Net unrealized gain on derivative instruments, net of
tax expense of $1,189................................. 2,024 --
Unrealized gains (losses) on available-for-sale
securities:
Unrealized holding gains (losses) arising during the
period, net of tax expense (benefit) of $22,016 in
2001 and ($589) in 2000............................... 33,502 (893)
Less reclassification adjustment for realized gains
included in income statement, net of tax expense of
$5,043 in 2001 and $0 in 2000......................... (7,920) --
------- -------
Other comprehensive income (loss)......................... 19,630 (893)
------- -------
Comprehensive income........................................ $66,697 $66,210
======= =======
The accompanying notes to the financial statements are an integral part of these
statements.
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13
HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY
(UNAUDITED)
2001 2000
---- ----
(IN THOUSANDS)
BALANCE AT JANUARY 1........................................ $1,524,423 $1,251,094
Net income................................................ 47,067 67,103
Contributions to capital.................................. 2,975 742
Dividends -- common stock................................. (48,000) (15,000)
Other comprehensive income (loss)......................... 19,630 (893)
---------- ----------
BALANCE AT MARCH 31......................................... $1,546,095 $1,303,046
========== ==========
The accompanying notes to the financial statements are an integral part of these
statements.
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HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
QUARTER ENDED MARCH 31
--------------------------
2001 2000
---- ----
(IN THOUSANDS)
OPERATING ACTIVITIES
Net income.................................................. $ 47,067 $ 67,103
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses................................. 14,458 5,145
Depreciation and amortization, including intangibles...... 16,845 17,460
Deferred tax expense (benefit)............................ 1,668 (91)
Gain on sales of securities............................... (12,963) --
Gain on sale of corporate trust businesses................ -- (47,193)
Trading account net sales................................. 25,301 42,878
Net decrease in interest receivable....................... 42,093 11,582
Net decrease in interest payable.......................... (12,328) (26,153)
Net decrease in assets held for sale...................... 116,363 45,224
Other, net................................................ (13,825) (8,810)
----------- -----------
Net cash provided by operating activities.............. 224,679 107,145
----------- -----------
INVESTING ACTIVITIES:
Net increase in interest-bearing deposits at banks........ (32,657) (11,581)
Net decrease in Federal funds sold and securities
purchased under agreement to resell.................... 96,150 69,600
Proceeds from sales of securities available-for-sale...... 696,111 0
Proceeds from maturities of securities
available-for-sale..................................... 2,060,377 726,589
Purchases of securities available-for-sale................ (2,794,344) (886,414)
Net decrease (increase) in loans.......................... 61,572 (646,760)
Purchases of premises and equipment....................... (11,233) (8,702)
Net increase in bank-owned insurance investments.......... (10,498) (99,278)
Other, net................................................ (36,302) (189,821)
----------- -----------
Net cash provided (used) by investing activities....... 29,176 (1,046,367)
----------- -----------
FINANCING ACTIVITIES:
Net (decrease) increase in deposits....................... (613,561) 665,104
Net increase (decrease) in Federal funds purchased and
securities sold under agreement to repurchase.......... 582,953 (229,530)
Net (decrease) increase in short-term borrowings.......... (605,689) 858,306
Proceeds from issuance of senior notes.................... 838,500 75,000
Repayment of senior notes................................. (619,500) (722,000)
Net cash proceeds from the sale of the corporate trust
businesses............................................. -- 88,704
Cash dividends paid on common stock....................... (48,000) (15,000)
----------- -----------
Net cash (used) provided by financing activities....... (465,297) 720,584
----------- -----------
NET DECREASE IN CASH AND DEMAND BALANCES DUE FROM
BANKS................................................. (211,442) (218,638)
CASH AND DEMAND BALANCES DUE FROM BANKS AT JANUARY 1... 1,292,694 1,423,043
----------- -----------
CASH AND DEMAND BALANCES DUE FROM BANKS AT MARCH 31.... $ 1,081,252 $ 1,204,405
=========== ===========
The accompanying notes to the financial statements are an integral part of these
statements.
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15
HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES
NOTES TO THE FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
Harris Trust and Savings Bank (the "Bank") is a wholly-owned subsidiary of
Harris Bankcorp, Inc. ("Bankcorp"), a wholly-owned subsidiary of Bankmont
Financial Corp. (a wholly-owned subsidiary of Bank of Montreal). The
consolidated financial statements of the Bank include the accounts of the Bank
and its wholly-owned subsidiaries. Significant intercompany accounts and
transactions have been eliminated. Certain reclassifications were made to
conform prior year's financial statements to the current year's presentation.
The consolidated financial statements have been prepared by management from
the books and records of the Bank, without audit by independent certified public
accountants. However, these statements reflect all adjustments and disclosures
which are, in the opinion of management, necessary for a fair presentation of
the results for the interim periods presented.
Because the results of operations are so closely related to and responsive
to changes in economic conditions, the results for any interim period are not
necessarily indicative of the results that can be expected for the entire year.
2. LEGAL PROCEEDINGS
The Bank and certain of its subsidiaries are defendants in various legal
proceedings arising in the normal course of business. In the opinion of
management, based on the advice of legal counsel, the ultimate resolution of
these matters will not have a material adverse effect on the Bank's consolidated
financial position.
3. CASH FLOWS
For purposes of the Bank's Consolidated Statements of Cash Flows, cash and
cash equivalents is defined to include cash and demand balances due from banks.
Cash interest payments (net of amounts capitalized) for the three months ended
March 31 totaled $222.5 million and $230.0 million in 2001 and 2000,
respectively. Cash income tax payments over the same periods totaled $16.1
million and $6.1 million, respectively.
4. ACCOUNTING CHANGES
In September 2000, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,
a replacement of SFAS No. 125." The Statement revises the standards for
accounting for securitizations and other transfers of financial assets and
collateral and requires certain disclosures. It carries over most of the
provisions of SFAS No. 125 without change. The Statement is effective for
transfers and servicing of financial assets and extinguishments of liabilities
occurring after March 31, 2001. The Statement is effective for recognition and
reclassification of collateral and for disclosures relating to securitization
transactions and collateral for fiscal years ending after December 15, 2000. The
Bank does not expect the implementation of this Statement to have a material
effect on the Bank's financial position or results of operations.
5. DERIVATIVES
The Bank adopted SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities", as amended by SFAS No. 138, "Accounting for Certain
Derivative Instruments and Certain Hedging Activities", on January 1, 2001. The
transition adjustment arising from the adoption of the Statement on January 1,
2001 was not material to the consolidated financial statements of the Bank.
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16
HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
ACCOUNTING FOR DERIVATIVES AND HEDGING ACTIVITIES
All derivative instruments are recognized at fair value in the Consolidated
Statement of Condition. All derivative instruments are designated either as
hedges or as held for trading or non-hedging purposes.
Derivative instruments that are used in the management of the Bank's risk
strategy may qualify for hedge accounting if the derivatives are designated as
hedges and applicable hedge criteria are met. On the date that the Bank enters
into a derivative contract, it designates the derivative as a hedge of the fair
value of a recognized asset or liability or an unrecognized firm commitment, a
hedge of a forecasted transaction or the variability of cash flows that are to
be received or paid in connection with a recognized asset or liability, a
foreign currency fair value or cash flow hedge, or a hedge of a net investment
in a foreign operation. Changes in the fair value of a derivative that is highly
effective (as defined) and qualifies as a fair value hedge, along with changes
in the fair value of the underlying hedged item, are recorded in current period
earnings. Changes in the fair value of a derivative that is highly effective (as
defined) and qualifies as a cash flow hedge, to the extent that the hedge is
effective, are recorded in other comprehensive income only until earnings are
recognized from the underlying hedged item. Net gains or losses resulting from
hedge ineffectiveness are recorded in current period earnings. Changes in the
fair value of a derivative that is highly effective (as defined) and qualifies
as a foreign currency hedge are recorded in either current period earnings or
other comprehensive income depending on whether the hedging relationship meets
the criteria for a fair value or cash flow hedge. For a derivative used as a
hedge of a net investment in a foreign operation, changes in the derivative's
fair value, to the extent that the hedge is effective, are recorded in the
cumulative translation adjustment account within other comprehensive income.
The Bank formally documents all hedging relationships at inception of hedge
transactions. The process includes documenting the risk management objective and
strategy for undertaking the hedge transaction and identifying the specific
derivative instrument and the specific underlying asset, liability, firm
commitment or forecasted transaction. The Bank formally assesses, both at
inception and on an ongoing quarterly basis, whether the derivative hedging
instruments have been highly effective in offsetting changes in the fair value
or cash flows of the hedged items and whether the derivatives are expected to
remain highly effective in future periods.
Hedge accounting is discontinued prospectively when the Bank determines
that the hedge is no longer highly effective, the derivative instrument expires
or is sold, terminated or exercised, it is no longer probable that the
forecasted transaction will occur, the hedged firm commitment no longer meets
the definition of a firm commitment, or the designation of the derivative as a
hedging instrument is no longer appropriate.
When hedge accounting is discontinued because a fair value hedge is no
longer highly effective, the derivative instrument will continue to be recorded
on the balance sheet at fair value but the underlying hedged item will no longer
be adjusted for changes in fair value. When hedge accounting is discontinued
because the hedged item no longer meets the definition of a firm commitment, the
derivative instrument will continue to be recorded on the balance sheet at fair
value and any asset or liability that was recorded to recognize the firm
commitment will be removed from the balance sheet and recognized as a gain or
loss in current period earnings. When hedge accounting in discontinued because
it is no longer probable that the forecasted transaction will occur, the gain or
loss on the derivative that was in accumulated other comprehensive income will
be recognized immediately in earnings. When hedge accounting is discontinued and
the derivative remains outstanding, the derivative may be redesignated as a
hedging instrument as long as the applicable hedge criteria are met under the
terms of the new contract.
Derivative instruments that are used as part of the Bank's dealer and
trading activities are marked to market and the resulting unrealized gains and
losses are recognized in noninterest income in the period of change. Realized
and unrealized gains and losses on interest rate contracts and foreign exchange
contracts are recorded in trading account income and foreign exchange income,
respectively.
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17
HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The Bank has an interest rate risk management strategy that incorporates
the use of derivative instruments to minimize significant unplanned fluctuations
in earnings that may be caused by interest rate volatility. The Bank manages
interest rate sensitivity by modifying the repricing or maturity characteristics
of certain fixed rate assets so that net interest margin is not adversely
affected, on a material basis, by movements in interest rates. As a result of
interest rate fluctuations, fixed rate assets will appreciate or depreciate in
market value. The effect of the unrealized appreciation or depreciation will
generally be offset by the gains or losses on the derivative instruments.
The Bank has a foreign currency risk management strategy that incorporates
the use of derivative instruments to minimize significant unplanned fluctuations
in earnings that may be caused by foreign currency exchange rate fluctuations.
Certain senior notes are denominated in foreign currency, creating exposure to
changes in exchange rates. The Bank uses cross currency interest rate swaps and
foreign currency forward exchange contracts to hedge this risk.
The Bank uses various interest rate and foreign exchange derivative
contracts as part of its dealer and trading activities. As dealer, the Bank
serves customers seeking to manage interest rate risk by entering into contracts
as a counterparty to their (customer) transactions. In its trading activities,
the Bank uses interest rate contracts to profit from expected future market
movements. The Bank is also a dealer in foreign exchange contracts.
Interest rate derivative contracts may create exposure to both credit and
market risk. Replacement risk, the primary component of credit risk, is the risk
of loss should a counterparty default following unfavorable market movements and
is measured as the Bank's cost of replacing contracts at current market rates.
The Bank manages credit risk by establishing credit limits for customers and
products through an independent corporate-wide credit review process and
continually monitoring exposure against those limits to ensure they are not
exceeded. Credit risk is, in many cases, further mitigated by the existence of
netting agreements, which provide for netting of contractual receivables and
payables in the event of default or bankruptcy. Netting agreements apply to
situations where the Bank is engaged in more than one outstanding derivative
transaction with the same counterparty and also has a legally enforceable master
netting agreement with that counterparty. Market risk is the potential for loss
arising from potential adverse changes in underlying market factors, including
interest and foreign exchange rates. The Bank manages market risk through the
imposition of integrated value-at-risk limits and an active, independent
monitoring process. Value-at-risk methodology is used for measuring the market
risk of the Bank's trading positions. This statistical methodology uses recent
market volatility to estimate the maximum daily trading loss that the Bank would
expect to incur, on average, 99 percent of the time. The model also measures the
effect of correlation among the various trading instruments to determine how
much risk is eliminated by offsetting positions.
Foreign exchange derivative contracts may create exposure to market and
credit risk, including replacement risk and settlement risk. Credit risk is
managed by establishing limits for customers through an independent
corporate-wide credit approval process and continually monitoring exposure
against those limits. In addition, both settlement and replacement risk are
reduced through netting by novation, agreements with counterparties to offset
certain related obligations. Market risk is managed through establishing
exposure limits by currency and monitoring actual exposure against those limits,
entering into offsetting positions, and closely monitoring price behavior.
FAIR VALUE HEDGES
The Bank uses interest rate swaps to alter the character of revenue earned
on certain long-term, fixed rate loans. Interest rate swaps convert the fixed
rate loans into variable rate loans. Interest rate swap contracts
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18
HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
generally involve the exchange of fixed and variable rate interest payments
between two parties, based on a common notional amount and maturity date.
For fair value hedges, as of March 31, 2001 the Bank recorded the fair
value of derivative instrument liabilities of $5.4 million in other liabilities.
A net loss of $0.2 million was recorded for the quarter ended March 31, 2001
representing the ineffective portion of all of the Bank's fair value hedges.
Gains or losses resulting from hedge ineffectiveness are recorded in noninterest
income.
CASH FLOW HEDGES
The Bank uses a total return swap to reduce the variability associated with
the cash flows from an equity security. A total return swap converts the cash
flows received on an available-for-sale equity security from variable to fixed.
Changes in the fair value of the swap are recorded in other comprehensive
income. The unrealized holding gain (loss) on the available-for-sale equity
security is also recorded in other comprehensive income. For cash flow hedges,
as of March 31, 2001 the Bank recorded the fair value of derivative instrument
liabilities of $9.4 million in other liabilities. No hedge ineffectiveness was
recorded to earnings for the quarter ended March 31, 2001. The unrealized gain
(loss) in accumulated other comprehensive income related to the total return
swap will be reclassified to earnings if and when the unrealized holding gain
(loss) on the available-for-sale equity security affects earnings. The amount
expected to be reclassified into earnings over the next twelve months is
expected to be immaterial. The Bank is hedging its exposure to the variability
of future cash flows over a maximum term of nineteen months.
DEALER AND TRADING ACTIVITIES
Trading activities include derivative transactions that are entered into
for risk management purposes and do not otherwise qualify for hedge accounting.
Foreign exchange contracts are used to stabilize any currency exchange rate
fluctuation for certain senior notes. The derivative instruments, primarily
cross currency interest rate swaps, do not qualify for hedge accounting.
The Bank has qualifying mortgage loan commitments that are intended to be
sold in the secondary market. The commitments are derivatives, but since they
are not firm commitments they do not qualify for hedge accounting. The Bank
enters into forward sales of mortgage-backed securities to minimize its exposure
to interest rate volatility.
The Bank utilizes various derivative instruments to meet its customers'
financing and risk management needs and produce fee income and trading profits.
Interest rate contracts include futures, forward rate agreements, option
contracts, guarantees (caps, floors and collars) and swaps. Foreign exchange
contracts include spot, futures, forwards, option contracts and swaps.
As of March 31, 2001 the Bank recorded the fair value of trading derivative
instrument assets of $216.0 million in other assets and trading derivative
instrument liabilities of $217.8 million in other liabilities. These amounts
reflect the netting of certain derivative instrument assets and liabilities when
the conditions in FIN No. 39, "Offsetting of Amounts Related to Certain
Contracts," have been met.
6. CORPORATE TRUST SALE
In March 2000, Bankcorp sold its corporate trust business. In separate and
unrelated transactions, the indenture trust business was sold to a subsidiary of
The Bank of New York Company, Inc., and the shareholder services business to
Computershare Limited. The combined sales resulted in a pre-tax gain to Bankcorp
of $50.2 million in first quarter 2000. The Bank recognized $47.2 million of
that gain. Additional revenue of approximately $2.0 million was recognized in
first quarter.
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19
HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES
FINANCIAL REVIEW
FIRST QUARTER 2001 COMPARED WITH FIRST QUARTER 2000
SUMMARY
The Bank had first quarter 2001 net income of $47.1 million, a decrease of
$20.0 million or 30 percent from first quarter 2000. First quarter 2000 earnings
included a pretax gain of $47.2 million resulting from the sale of the corporate
trust business. Excluding this gain, earnings in the first quarter increased
from $39.2 million last year to $47.1 million, an increase of 20 percent.
Cash ROE was 15.67 percent in the current quarter. Excluding the gain on
the sale of the corporate trust business, cash ROE was 17.10 percent in first
quarter 2000. Excluding unrealized gains and losses on the securities portfolio
recorded directly to equity and the corporate trust gain, cash ROE rose 96 basis
points from last year's first quarter. These favorable operating results were
attributable to continued strong earnings growth in the core businesses and a
more favorable interest rate environment that contributed to increased earnings
from treasury and trading activities. This was partially offset by an increased
loan loss provision with a slowing economy.
First quarter net interest income on a fully taxable equivalent basis was
$117.1 million, up $6.6 million or 6 percent from $110.5 million in 2000's first
quarter. Average earning assets rose 3 percent to $17.92 billion from $17.42
billion in 2000, primarily attributable to an increase of $383 million in
average loans and $101 million in money market assets, somewhat offset by a
decline in investment securities of $69 million. Consumer loans and residential
mortgages were the most significant contributors to the growth in loans. Net
interest margin increased to 2.69 percent from 2.55 percent in the same quarter
last year.
The first quarter 2001 provision for loan losses of $14.5 million was up
$9.3 million from $5.1 million in the first quarter of 2000. Net charge-offs
were $17.6 million compared to $4.3 million in the prior year's quarter. Most of
the increase resulted from higher commercial loan write offs.
First quarter 2001 noninterest income of $95.4 million decreased $36.6
million from the same quarter last year. Excluding the $47.2 million gain on the
sale of the corporate trust business in 2000, noninterest income increased 13
percent. Further, last year's results also included operating revenue for both
the corporate trust business and the merchant card business which was also sold
in 2000. Excluding both the gain on trust sale and operating revenue from these
businesses, noninterest revenue increased 32 percent. Most of the increase
resulted from additional net gains from securities sales of $13.0 million and
higher bond trading profits of $5.7 million.
First quarter 2001 noninterest expenses of $129.8 million decreased $3.5
million or 3 percent from the year-ago quarter. Excluding the operating expenses
for the corporate trust and merchant card businesses sold in 2000, noninterest
expenses increased five percent.
Nonperforming assets at March 31, 2001 were $109 million or 1.02 percent of
total loans, compared to $101 million or 0.94 percent at December 31, 2000, and
$34 million or 0.32 percent a year ago. At March 31, 2001, the allowance for
possible loan losses was $116 million, equal to 1.08 percent of loans
outstanding, compared to $115 million or 1.07 percent at the end of first
quarter 2000. As a result, the ratio of the allowance for possible loan losses
to nonperforming assets was 300 percent at March 31, 2000 compared to 106
percent at March 31, 2001.
At March 31, 2001, Tier 1 capital of the Bank amounted to $1.58 billion, up
from $1.46 billion one year earlier. The regulatory leverage capital ratio was
7.65 percent for the first quarter of 2001 compared to 7.24 percent in the same
quarter of 2000. The Bank's capital ratio exceeds the prescribed regulatory
minimum for banks. The Bank's March 31, 2001 Tier 1 and total risk-based capital
ratios were 9.31 percent and 11.23 percent compared to respective ratios of 8.66
percent and 10.61 percent at March 31, 2000.
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PART II. OTHER INFORMATION
ITEMS 1, 2, 3, 4 AND 5 ARE BEING OMITTED FROM THIS REPORT BECAUSE SUCH ITEMS ARE
NOT APPLICABLE TO THE REPORTING PERIOD.
ITEM 6. (A) REPORTS ON FORM 8-K: NONE
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Harris Preferred Capital Corporation has duly caused this
Report to be signed on its behalf by the undersigned, thereunto duly authorized
on the 11th day of May, 2001.
/s/ PAUL R. SKUBIC
--------------------------------------
Paul R. Skubic
Chairman of the Board and President
/s/ PIERRE O. GREFFE
--------------------------------------
Pierre O. Greffe
Chief Financial Officer
19