UNITED STATES
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 JUNE 30, 2004
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 (I.R.S. Employer Identification No.)
of incorporation or organization)
111 WEST MONROE STREET, CHICAGO, ILLINOIS 60603
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(312) 461-2121
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
------------------- ------------------------
7 3/8% Noncumulative Exchangeable Preferred
Stock, Series A, par value $1.00 per share New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None
------------------------
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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act)
Yes [ ] No [X]
The number of shares of Common Stock, $1.00 par value, outstanding on
August 13, 2004 was 1,000.
HARRIS PREFERRED CAPITAL CORPORATION
TABLE OF CONTENTS
Part I FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets................................. 2
Consolidated Statements of Operations and Comprehensive
Income...................................................... 3
Consolidated Statements of Changes in Stockholders'
Equity...................................................... 4
Consolidated 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
Item 3. Quantitative and Qualitative Disclosures about Market
Risk........................................................ 18
Item 4. Controls and Procedures..................................... 18
Part II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K............................ 18
Signatures..................................................................... 19
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HARRIS PREFERRED CAPITAL CORPORATION
CONSOLIDATED BALANCE SHEETS
JUNE 30 DECEMBER 31 JUNE 30
2004 2003 2003
----------- ------------ -----------
(UNAUDITED) (AUDITED) (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
Cash on deposit with Harris Trust and Savings Bank........ $ 6,081 $ 926 $ 312
Securities purchased from Harris Trust and Savings Bank
under agreement to resell............................... 16,000 11,500 17,500
Notes receivable from Harris Trust and Savings Bank....... 14,013 16,547 22,933
Securities available-for-sale:
Mortgage-backed......................................... 405,248 233,857 343,900
U.S. Treasury........................................... 39,800 229,995 114,995
Securing mortgage collections due from Harris Trust and
Savings Bank............................................ 281 414 1,534
Other assets.............................................. 1,643 1,079 1,832
-------- -------- --------
TOTAL ASSETS......................................... $483,066 $494,318 $503,006
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accrued expenses.......................................... $ 33 $ 84 $ 82
-------- -------- --------
Commitments and contingencies............................. -- -- --
STOCKHOLDERS' EQUITY
7 3/8% Noncumulative Exchangeable Preferred Stock, Series
A ($1 par value); liquidation value of $250,000,000 and
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 (less than) of distributions........... (634) 1,230 3,938
Accumulated other comprehensive income -- net unrealized
gains/ (losses) on available-for-sale securities........ (7,067) 2,270 8,252
-------- -------- --------
TOTAL STOCKHOLDERS' EQUITY........................... 483,033 494,234 502,924
-------- -------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY........... $483,066 $494,318 $503,006
======== ======== ========
The accompanying notes are an integral part of these financial statements.
2
HARRIS PREFERRED CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
(UNAUDITED)
QUARTER ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
----------------- ----------------------
2004 2003 2004 2003
-------- ------ ---------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
INTEREST INCOME:
Securities purchased from Harris Trust and
Savings Bank under agreement to resell........ $ 312 $ 296 $ 783 $ 543
Notes receivable from Harris Trust and Savings
Bank.......................................... 234 413 492 885
Securities available-for-sale:
Mortgage-backed............................... 3,299 4,050 5,929 8,576
U.S. Treasury................................. 2 20 26 68
-------- ------ ---------- ---------
Total interest income....................... 3,847 4,779 7,230 10,072
NON-INTEREST INCOME:
Gain on sale of securities....................... -- -- 398 2,463
-------- ------ ---------- ---------
OPERATING EXPENSES:
Loan servicing fees paid to Harris Trust and
Savings Bank.................................. 12 19 24 41
Advisory fees paid to Harris Trust and Savings
Bank.......................................... 28 10 57 20
General and administrative....................... 97 70 193 168
-------- ------ ---------- ---------
Total operating expenses.................... 137 99 274 229
-------- ------ ---------- ---------
Net income......................................... 3,710 4,680 7,354 12,306
Preferred dividends................................ 4,609 4,609 9,218 9,218
-------- ------ ---------- ---------
NET (DEFICIT) INCOME AVAILABLE TO COMMON
STOCKHOLDER...................................... $ (899) $ 71 $ (1,864) 3,088
======== ====== ========== =========
Basic and diluted (losses) earnings per common
share............................................ $(899.00) $71.00 $(1,864.00) $3,088.00
======== ====== ========== =========
Net income......................................... $ 3,710 $4,680 $ 7,354 $ 12,306
Other comprehensive (loss) income -- net unrealized
gains/(losses) on available-for-sale
securities....................................... (10,143) 123 (9,337) (2,110)
-------- ------ ---------- ---------
Comprehensive (loss) income........................ $ (6,433) $4,803 $ (1,983) $ 10,196
======== ====== ========== =========
The accompanying notes are an integral part of these financial statements.
3
HARRIS PREFERRED CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(UNAUDITED)
SIX MONTHS ENDED
JUNE 30
-----------------------
2004 2003
---------- ----------
(IN THOUSANDS,
EXCEPT PER SHARE DATA)
Balance at January 1........................................ $494,234 $501,946
Net income................................................ 7,354 12,306
Other comprehensive loss.................................. (9,337) (2,110)
Dividends (preferred stock $0.4109 per share per
quarter)............................................... (9,218) (9,218)
-------- --------
Balance at June 30.......................................... $483,033 $502,924
======== ========
The accompanying notes are an integral part of these financial statements.
4
HARRIS PREFERRED CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIX MONTHS ENDED
JUNE 30
---------------------
2004 2003
--------- ---------
(IN THOUSANDS)
OPERATING ACTIVITIES:
Net Income................................................ $ 7,354 $ 12,306
Adjustments to reconcile net income to net cash provided
by operating activities:
Gain on sale of securities............................. (398) (2,463)
(Increase) decrease in other assets.................... (564) 115
Net decrease in accrued expenses....................... (51) (14)
--------- ---------
Net cash provided by operating activities............ 6,341 9,944
--------- ---------
INVESTING ACTIVITIES:
(Decrease) increase in securities purchased from Harris
Trust and Savings Bank under agreement to resell....... (4,500) 2,500
Repayments of notes receivable from Harris Trust and
Savings Bank........................................... 2,534 8,145
Net decrease in securing mortgage collections due from
Harris Trust and Savings Bank.......................... 133 1,396
Purchases of securities available-for-sale................ (516,889) (340,490)
Proceeds from maturities and sales of securities
available-for-sale..................................... 526,754 327,307
--------- ---------
Net cash provided (used) in investing activities..... 8,032 (1,142)
--------- ---------
FINANCING ACTIVITIES:
Cash dividends paid on preferred stock.................... (9,218) (9,218)
--------- ---------
Increase (decrease) in cash on deposit with Harris Trust
and Savings Bank....................................... 5,155 (416)
Cash on deposit with Harris Trust and Savings Bank at
beginning of period.................................... 926 728
--------- ---------
Cash on deposit with Harris Trust and Savings Bank at end
of period.............................................. $ 6,081 $ 312
========= =========
The accompanying notes are an integral part of these financial statements.
5
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, primarily U.S.
treasury securities and securities collateralized with real estate mortgages.
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 consolidated financial statements have been prepared by
management from the books and records of the Company. 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 2003 Form 10-K. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with accounting principles generally accepted in the United States of America,
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
SECOND QUARTER 2004 COMPARED WITH SECOND QUARTER 2003
The Company's net income for the second quarter of 2004 was $3.7 million.
This represented a $1 million or 21% decrease from second quarter 2003 earnings
of $4.7 million. Earnings declined primarily because of reduced interest income
on earning assets.
6
HARRIS PREFERRED CAPITAL CORPORATION
Second quarter 2004 interest income on the Notes totaled $234 thousand and
yielded 6.4% on $14.7 million of average principal outstanding for the quarter
compared to $413 thousand and a 6.4% yield on $25.8 million average principal
outstanding for second quarter 2003. The decrease in income was attributable to
a reduction in the Notes balance because of principal paydowns by customers on
the Securing Mortgage Loans. The average outstanding balance of the Securing
Mortgage Loans for second quarter 2004 and 2003 was $18 million and $32 million,
respectively. Interest income on securities available-for-sale for the current
quarter was $3.3 million resulting in a yield of 4.3% on an average balance of
$310 million, compared to $4.1 million with a yield of 4.6% on an average
balance of $354 million for the same period a year ago. The decrease in interest
income is primarily attributable to the reduction in the investment portfolio
and lower interest rate of mortgage-backed securities. During the current
quarter, additional securities were purchased, bringing the June 30, 2004
balance to $435 million with an average yield at that date of approximately
4.40%.
There were no Company borrowings during second quarter 2004 or 2003.
Second quarter 2004 operating expenses totaled $137 thousand, an increase
of $38 thousand or 38% from the second quarter of 2003. Loan servicing expenses
totaled $12 thousand, a decrease of $7 thousand 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 second
quarter 2004 were $28 thousand compared to $10 thousand a year earlier, due to
increased costs for processing, recordkeeping and administration. General and
administrative expenses totaled $97 thousand, an increase of $27 thousand over
the same period in 2003 as a result of additional costs for insurance,
compliance, printing and processing.
At June 30, 2004 and 2003, there were no Securing Mortgage Loans on
nonaccrual status.
SIX MONTHS ENDED JUNE 30, 2004 COMPARED WITH JUNE 30, 2003
The Company's net income for the six months ended June 30, 2004 was $7.3
million. This represented a $5 million decrease or 40% from 2003 earnings.
Earnings declined primarily because of reduced interest income on earning assets
and a substantial decrease in gains from security sales.
Interest income on securities purchased under agreement to resell for the
six months ended June 30, 2004 was $783 thousand, an increase of $240 thousand
from the same period in 2003. Interest income on the Notes for the six months
ended June 30, 2004 totaled $492 thousand and yielded 6.4% on $15 million of
average principal outstanding compared to $885 thousand of income yielding 6.4%
on $28 million of average principal outstanding for the same period in 2003. The
decrease in income was attributable to a reduction in the Note balance because
of customer payoffs on the Securing Mortgage Loans. The average outstanding
balance of the Securing Mortgage Loans was $19 million for the six months ended
June 20, 2004 and $34 million for the same period in 2003. There were no Company
borrowings during either period. Interest income on securities
available-for-sale for the six months ended June 30, 2004 was $6.0 million
resulting in a yield of 4.3% on an average balance of $277 million, compared to
$8.6 million resulting in a yield of 4.8% on an average balance of $361 million
a year ago. The decrease in interest income from available-for-sale securities
is primarily attributable to the decrease in the investment portfolio and the
reduction in yield for the greater part of the current period. Gains from
investment securities sales for the six months ended June 30, 2004 were $398
thousand compared to $2.5 million a year ago.
Operating expenses for the six months ended June 30, 2004 totaled $274
thousand, an increase of $45 thousand from a year ago. Loan servicing expenses
for the six months ended June 30, 2004 totaled $24 thousand, a decrease of $17
thousand or 41% from 2003. This decrease is attributable to the reduction in the
principal balance of the Notes because servicing costs vary directly with these
balances. Advisory fees for the six months ended June 30, 2004 were $57 thousand
compared to $20 thousand a year ago; primarily attributable to increased costs
for processing, recordkeeping and administration. General and administrative
expenses totaled $193 thousand, an increase of $25 thousand or 15% over the same
period in 2003 as a result of additional insurance, compliance, printing and
processing costs.
7
HARRIS PREFERRED CAPITAL CORPORATION
On June 30, 2004, the Company paid a cash dividend of $0.46094 per share on
outstanding preferred shares to the stockholders of record on June 15, 2004, as
declared on June 1, 2004. On June 30, 2003, the Company paid a cash dividend of
$0.46094 per share on outstanding preferred shares to the stockholders of record
on June 15, 2003, as declared on June 3, 2003. On a year-to-date basis, the
Company declared and paid $9.2 million of dividends to holders of preferred
shares for each of the six-month periods ended June 30, 2004 and 2003.
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 asset management requirements are to maintain the
current earning asset portfolio size through the acquisition of additional Notes
or other qualifying assets in order 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 as a result of
repayment of principal balances of individual Securing Mortgage Loans or
maturities or sales or securities. The payment of dividends on the Preferred
Shares is made from legally available funds, arising from operating activities
of the Company and sales or maturities of portfolio securities. The Company's
cash flows from operating activities principally consist of the collection of
interest on the mortgage-backed securities and other earning assets. 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% of its adjusted REIT ordinary 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 ordinary 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 including the
capacity to continue preferred dividend payments on an uninterrupted basis.
As presented in the accompanying Consolidated Statements of Cash Flows, the
primary sources of funds in addition to $6.34 million provided from operations
during the six months ended June 30, 2004 were $2.5 million provided by
principal repayments on the Notes and $526.8 million from the maturities and
sales of securities available-for-sale. In the prior period ended June 30, 2003,
the primary sources of funds other than $9.9 million from operations were $8.1
million provided by principal repayments on the Notes and $327.3 million from
the maturities and sales of securities available-for-sale. The primary uses of
funds for the six months ended June 30, 2004 were $516.9 million for purchases
of securities available-for-sale and $9.2 million in preferred stock dividends
paid. For the six-months ended June 30, 2003, the primary uses of funds were
$340.5 million for purchases of securities available-for-sale and $9.2 million
in preferred stock dividends paid.
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, 2003.
OTHER MATTERS
As of June 30, 2004, 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 Internal Revenue Code. The Company expects to meet all REIT requirements
regarding the ownership of its stock and anticipates meeting the annual
distribution requirements.
8
HARRIS PREFERRED CAPITAL CORPORATION
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.
9
HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CONDITION
JUNE 30 DECEMBER 31 JUNE 30
2004 2003 2003
----------- ----------- -----------
(UNAUDITED) (AUDITED) (UNAUDITED)
(IN THOUSANDS EXCEPT SHARE DATA)
ASSETS
Cash and demand balances due from banks............... $ 1,118,125 $ 823,615 $ 1,096,975
Money market assets:
Interest-bearing deposits at banks.................. 410,111 424,459 355,839
Federal funds sold.................................. 768,168 409,425 679,238
Securities available-for-sale (including $2.87
billion, $4.07 billion, and $5.20 billion of
securities pledged as collateral for repurchase
agreements at June 30, 2004, December 31, 2003 and
June 30, 2003, respectively)........................ 5,367,110 6,624,280 6,816,419
Trading account assets................................ 94,879 59,467 52,948
Loans................................................. 10,648,356 9,573,452 9,802,195
Allowance for possible loan losses.................... (234,059) (234,798) (215,833)
----------- ----------- -----------
Net loans........................................... 10,414,297 9,338,654 9,586,362
Premises and equipment................................ 305,755 302,975 301,098
Customers' liability on acceptances................... 7,934 44,234 25,326
Bank-owned insurance.................................. 1,053,436 1,035,239 1,014,876
Loans held for sale................................... 122,432 168,904 239,818
Goodwill and other valuation intangibles.............. 160,787 165,978 169,321
Other assets.......................................... 471,866 522,260 553,698
----------- ----------- -----------
TOTAL ASSETS................................... $20,294,900 $19,919,490 $20,891,918
=========== =========== ===========
LIABILITIES
Deposits in domestic offices -- noninterest-bearing... $ 3,982,996 $ 4,231,540 $ 4,128,062
-- interest-bearing...... 8,031,987 7,844,596 6,570,548
Deposits in foreign offices -- noninterest-bearing... -- 49,016 27,194
-- interest-bearing...... 1,016,051 616,889 1,002,636
----------- ----------- -----------
Total deposits................................. 13,031,034 12,742,041 11,728,440
Federal funds purchased and securities sold under
agreement to repurchase............................. 4,431,378 4,643,406 5,505,440
Short-term borrowings................................. 300,397 10,841 301,562
Short-term senior notes............................... 100,000 -- 600,000
Acceptances outstanding............................... 7,934 44,234 25,326
Accrued interest, taxes and other expenses............ 171,035 171,422 147,286
Other liabilities..................................... 203,337 230,917 485,361
Minority interest -- preferred stock of subsidiary.... 250,000 250,000 250,000
Preferred stock issued to Harris Bankcorp, Inc........ 5,000 5,000 5,000
Long-term notes -- subordinated....................... 200,000 225,000 225,000
----------- ----------- -----------
TOTAL LIABILITIES.............................. 18,700,115 18,322,861 19,273,415
----------- ----------- -----------
STOCKHOLDER'S EQUITY
Common stock ($10 par value); 10,000,000 shares
authorized, issued and outstanding.................. 100,000 100,000 100,000
Surplus............................................... 644,535 634,944 631,274
Retained earnings..................................... 909,830 860,674 831,957
Accumulated other comprehensive (loss) income......... (59,580) 1,011 55,272
----------- ----------- -----------
TOTAL STOCKHOLDER'S EQUITY..................... 1,594,785 1,596,629 1,618,503
----------- ----------- -----------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY..... $20,294,900 $19,919,490 $20,891,918
=========== =========== ===========
The accompanying notes to the financial statements are an integral part of these
statements.
10
HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
QUARTER ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
------------------- -------------------
2004 2003 2004 2003
-------- -------- -------- --------
(IN THOUSANDS EXCEPT SHARE DATA)
INTEREST INCOME
Loans, including fees....................................... $130,660 $121,747 $251,830 $239,239
Money market assets:
Deposits at banks......................................... 881 763 1,758 1,756
Federal funds sold and securities purchased under
agreement to resell..................................... 1,915 1,000 3,362 1,695
Trading account............................................. 622 404 994 857
Securities available-for-sale:
U.S. Treasury and Federal agency.......................... 28,521 42,966 61,957 85,475
State and municipal....................................... 305 7 584 12
Other..................................................... 2,505 348 3,192 1,469
-------- -------- -------- --------
Total interest income................................. 165,409 167,235 323,677 330,503
-------- -------- -------- --------
INTEREST EXPENSE
Deposits.................................................... 35,272 28,527 70,147 58,846
Short-term borrowings....................................... 10,097 15,334 20,025 29,554
Senior notes................................................ 1,273 1,703 1,399 2,598
Minority interest-dividends on preferred stock of
subsidiary................................................ 4,610 4,610 9,219 9,219
Long-term notes............................................. 1,932 2,610 4,510 5,287
-------- -------- -------- --------
Total interest expense................................ 53,184 52,784 105,300 105,504
-------- -------- -------- --------
NET INTEREST INCOME......................................... 112,225 114,451 218,377 224,999
Provision for loan losses................................... 0 30,282 17,325 47,900
-------- -------- -------- --------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES......... 112,225 84,169 201,052 177,099
-------- -------- -------- --------
NONINTEREST INCOME
Trust and investment management fees........................ 23,208 20,604 46,260 40,342
Money market and bond trading............................... 3,574 3,635 5,687 6,760
Foreign exchange............................................ 1,435 1,250 3,160 2,226
Service fees and charges.................................... 26,028 29,182 51,131 56,906
Securities gains............................................ 14,113 5,856 25,608 8,319
Bank-owned insurance investments............................ 10,116 10,773 20,504 21,569
Gains from loan restructuring............................... -- -- 7,131 --
Foreign fees................................................ 5,732 6,220 11,882 12,438
Other....................................................... 40,828 48,554 86,061 98,822
-------- -------- -------- --------
Total noninterest income.............................. 125,034 126,074 257,424 247,382
-------- -------- -------- --------
NONINTEREST EXPENSES
Salaries and other compensation............................. 73,957 74,294 148,256 153,062
Pension, profit sharing and other employee benefits......... 21,403 18,939 42,097 37,062
Net occupancy............................................... 11,357 10,760 23,285 20,568
Equipment................................................... 13,527 14,123 26,652 27,192
Marketing................................................... 8,677 7,518 16,969 14,733
Communication and delivery.................................. 5,190 5,427 10,805 11,025
Expert services............................................. 6,144 7,181 11,746 13,395
Contract programming........................................ 5,267 6,423 13,558 12,766
Other....................................................... 22,305 19,900 43,948 38,813
-------- -------- -------- --------
167,827 164,565 337,316 328,616
Amortization of valuation intangibles....................... 2,596 4,365 5,191 8,515
-------- -------- -------- --------
Total noninterest expenses............................ 170,423 168,930 342,507 337,131
-------- -------- -------- --------
Income before income taxes.................................. 66,836 41,313 115,969 87,350
Applicable income taxes..................................... 20,828 10,795 34,886 23,410
-------- -------- -------- --------
NET INCOME............................................ $ 46,008 $ 30,518 $ 81,083 $ 63,940
======== ======== ======== ========
EARNINGS PER COMMON SHARE (based on 10,000,000 average
shares outstanding)
Net Income.................................................. $ 4.60 $ 3.05 $ 8.11 $ 6.39
======== ======== ======== ========
The accompanying notes to the financial statements are an integral part of these
statements.
11
HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
QUARTER ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
------------------ ------------------
2004 2003 2004 2003
-------- ------- -------- -------
(IN THOUSANDS)
NET INCOME........................................... $ 46,008 $30,518 $ 81,083 $63,940
OTHER COMPREHENSIVE INCOME:
Minimum pension liability adjustment net of tax
benefit for the quarter of $1,591 in 2004 and
zero in 2003 and net of tax benefit for the
year-to-date period of $1,749 in 2004 and zero
in 2003......................................... (3,152) -- (3,411) --
Unrealized (losses) gains on available-for-sale
securities:
Unrealized holding (losses) gains arising during
the period, net of tax (benefit) expense for the
quarter of ($29,589) in 2004 and $13,598 in 2003
and net of tax (benefit) expense for the
year-to-date period of ($27,171) in 2004 and
$8,145 in 2003.................................. (45,798) 20,806 (42,202) 12,590
Less reclassification adjustment for realized
gains included in income statement, net of tax
expense for the quarter of $5,574 in 2004 and
$2,278 in 2003 and net of tax expense for the
year-to-date period of $9,962 in 2004 and $3,236
in 2003......................................... (8,539) (3,578) (15,646) (5,083)
-------- ------- -------- -------
Other comprehensive (loss) income.................. (57,489) 17,228 (61,259) 7,507
-------- ------- -------- -------
COMPREHENSIVE (LOSS) INCOME.......................... $(11,481) $47,746 $ 19,824 $71,447
======== ======= ======== =======
The accompanying notes to the financial statements are an integral part of these
statements.
12
HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY
(UNAUDITED)
2004 2003
---------- ----------
(IN THOUSANDS)
BALANCE AT JANUARY 1........................................ $1,596,629 $1,577,654
Net income................................................ 81,083 63,940
Contributions to capital.................................. 4,991 4,635
Contribution of parent's banking assets................... 14,984 --
Dividend of non-bank subsidiary........................... (5,357) --
Adjustment of prior quarters' preferred dividends......... 767 --
Dividends -- preferred stock.............................. (53) (233)
Dividends -- common stock................................. (37,000) (35,000)
Other comprehensive (loss) income......................... (61,259) 7,507
---------- ----------
BALANCE AT JUNE 30.......................................... $1,594,785 $1,618,503
========== ==========
The accompanying notes to the financial statements are an integral part of these
statements.
13
HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIX MONTHS ENDED
JUNE 30
-------------------------
2004 2003
----------- -----------
(IN THOUSANDS)
OPERATING ACTIVITIES:
Net Income.................................................. $ 81,083 $ 63,940
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses................................. 17,325 47,899
Depreciation and amortization, including intangibles...... 33,590 32,727
Deferred tax expense...................................... 775 1,128
Gain on sales of securities............................... (25,608) (8,319)
Increase in bank-owned insurance.......................... (19,950) (21,756)
Trading account net cash purchases........................ (43,981) (2,883)
Net decrease (increase) in interest receivable............ 8,051 (992)
Net (decrease) increase in interest payable............... (3,839) 3,642
Net decrease (increase) in loans held for sale............ 46,472 (90,507)
Other, net................................................ 22,066 29,357
----------- -----------
Net cash provided by operating activities.............. 115,984 54,236
----------- -----------
INVESTING ACTIVITIES:
Net decrease in interest-bearing deposits at banks........ 14,348 61,367
Net increase in Federal funds sold and securities
purchased under agreement to resell.................... (352,621) (441,288)
Proceeds from sales of securities available-for-sale...... 2,316,660 214,760
Proceeds from maturities of securities
available-for-sale..................................... 2,418,932 2,409,116
Purchases of securities available-for-sale................ (3,526,448) (3,489,126)
Net increase in loans..................................... (978,272) (244,193)
Purchases of premises and equipment....................... (27,471) (26,896)
Other, net................................................ 1,753 1,065
----------- -----------
Net cash used by investing activities.................. (133,119) (1,515,195)
----------- -----------
FINANCING ACTIVITIES:
Cash received in contribution of parent's banking
assets................................................. 3,379 --
Net increase in deposits.................................. 206,814 690,156
Net (decrease) increase in Federal funds purchased and
securities sold under agreement to repurchase.......... (221,028) 444,656
Net increase in other short-term borrowings............... 289,556 868
Proceeds from issuance of senior notes.................... 1,130,000 1,625,000
Repayment of senior notes................................. (1,030,000) (1,225,000)
Proceeds from issuance of long-term notes................. 200,000 --
Repayment of long-term notes.............................. (225,000) --
Cash dividends paid on common stock....................... (37,000) (35,000)
Cash portion of dividend of non-bank subsidiary........... (5,076) --
----------- -----------
Net cash provided by financing activities.............. 311,645 1,500,680
----------- -----------
NET INCREASE IN CASH AND DEMAND BALANCES DUE FROM
BANKS................................................. 294,510 39,721
CASH AND DEMAND BALANCES DUE FROM BANKS AT JANUARY 1... 823,615 1,057,254
----------- -----------
CASH AND DEMAND BALANCES DUE FROM BANKS AT JUNE 30..... $ 1,118,125 $ 1,096,975
=========== ===========
The accompanying notes to the financial statements are an integral part of these
statements.
14
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 Harris
Financial Corp. (formerly known as 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 for the six months ended June 30 totaled $109.1 million
and $101.9 million in 2004 and 2003, respectively. Cash income tax payments over
the same periods totaled $27.6 million and $0.6 million, respectively.
4. GOODWILL AND OTHER INTANGIBLE ASSETS
The Bank records goodwill and other intangible assets in connection with
the acquisition of assets from unrelated parties or the acquisition of new
subsidiaries. Goodwill and other intangible assets that have indefinite useful
lives are not subject to amortization while intangible assets with finite lives
are amortized. Goodwill is periodically assessed for impairment, at least
annually. Intangible assets with finite lives are amortized on either an
accelerated or straight-line basis depending on the character of the acquired
asset. Intangible assets with finite lives are reviewed for impairment when
events or future assessments of profitability indicate that the carrying value
may not be recoverable.
The carrying value of the Bank's goodwill as of June 30, 2004 was $89.3
million. No impairment was recorded during the quarter ended June 30, 2004.
Other than goodwill, the Bank did not have any intangible assets not
subject to amortization as of June 30, 2004.
15
HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
As of June 30, 2004, the gross carrying amount and accumulated amortization
of the Bank's amortizable intangible assets are included in the following table.
GROSS CARRYING ACCUMULATED NET CARRYING
AMOUNT AMORTIZATION VALUE
-------------- ------------ ------------
(IN THOUSANDS)
Branch network......................................... $145,000 $(77,333) $67,667
Other.................................................. 5,724 (1,927) 3,797
-------- -------- -------
Total finite life intangibles........................ $150,724 $(79,260) $71,464
======== ======== =======
Total amortization expense for the Bank's intangible assets was $2.6
million for the quarter ended June 30, 2004.
Estimated intangible asset amortization expense for the years ending
December 31, 2004, 2005, 2006, 2007 and 2008 is $10.4 million per year.
16
HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES
FINANCIAL REVIEW
SECOND QUARTER 2004 COMPARED WITH SECOND QUARTER 2003
SUMMARY
The Bank had second quarter 2004 net income of $46.0 million, an increase
of $15.5 million or 51 percent from second quarter 2003.
Cash ROE was 13.21 percent in the current quarter and 8.97 percent in the
second quarter 2003. Excluding the impact of unrealized gains and losses in the
securities portfolio recorded directly to equity, cash ROE was 13.21 percent in
the current quarter, compared to 9.46 percent a year ago.
Second quarter net interest income on a fully taxable equivalent basis was
$114.3 million, down $3.1 million or 3 percent from $117.4 million in 2003's
second quarter. Average earning assets increased 7 percent to $18.01 billion
from $16.86 billion in 2003, due in part to an increase of $563 million in
average loans. Net interest margin decreased to 2.55 percent in the current
quarter from 2.79 percent in the year-ago quarter, reflecting the impact of
declining yields in the securities portfolio and volume increases in higher-cost
supporting funds, somewhat offset by greater levels of noninterest-bearing
funds.
There was no provision for loan losses in the current quarter, a decrease
of $30.3 million from the second quarter of 2003. This decrease in provisions
was a result of the reduction in net charge-offs during the first half of 2004
as well as management's assessment that declining non-performing loan levels
will result in potentially lower loan losses. Net charge-offs decreased to $10.0
million from $22.7 million in the prior year.
Second quarter noninterest income of $125.0 million decreased $1.0 million
from the same quarter last year. Net gains from securities sales increased $8.3
million. This was offset by declines in mortgage sale income and service fees
and charges.
Second quarter 2004 noninterest expenses of $170.4 million increased $1.5
million from the year ago quarter.
Nonperforming assets at June 30, 2004 were $146 million or 1.37 percent of
total loans, down from $159 million or 1.56 percent at March 31, 2004, and $202
million or 2.06 percent a year ago. At June 30, 2004, the allowance for possible
loan losses was $234 million, equal to 2.20 percent of loans outstanding,
compared to $216 million or 2.20 percent at the end of second quarter 2003. As a
result, the ratio of the allowance for possible loan losses to nonperforming
assets increased from 107 percent at June 30, 2003 to 161 percent at June 30,
2004.
At June 30, 2004, Tier 1 capital of the Bank amounted to $1.72 billion, up
from $1.61 billion one year earlier. The regulatory leverage capital ratio was
8.34 percent for the second quarter of 2004 compared to 8.35 percent in the same
quarter of 2003. The Bank's capital ratio exceeds the prescribed regulatory
minimum for banks. The Bank's June 30, 2004 Tier 1 and total risk-based capital
ratios were 9.68 percent and 12.06 percent compared to respective ratios of 9.65
percent and 11.80 percent at June 30, 2003.
SIX MONTHS ENDED JUNE 30, 2004 COMPARED WITH JUNE 30, 2003
SUMMARY
The Bank had net income for the six months ended June 30, 2003 of $81.1
million, an increase of $17.1 million or 27 percent from the same period a year
ago.
Excluding the impact of unrealized gains and losses in the securities
portfolio, cash ROE was 11.81 percent, up from 10.04 percent last year.
Net interest income on a fully taxable equivalent basis was $222.9 million,
down $8.1 million or 4 percent from $231.0 million in 2003's year-to-date
period. Average earning assets increased 8 percent to $17.65 billion from $16.36
billion in 2003. Average securities available for sale showed the largest
increase, up $465 million
17
from last year. Net interest margin decreased to 2.54 percent from 2.84 percent
in 2003, reflecting the impact of declining yields in the securities portfolio.
The year-to-date 2004 provision for loan losses of $17.3 million was down
$30.6 million from $47.9 million in 2003. Net charge-offs were $19.3 million, a
decrease of $19.8 million from last year, resulting from lower commercial loan
write-offs.
Noninterest income of $257.4 million increased $10.0 million from the same
period last year. Net gains from securities sales increased $17.3 million
compared to a year ago. Trust revenue increased and the Bank realized a $7.1
million gain on the sale of assets received in an earlier troubled debt
restructuring and a gain on the termination of a swap. These were offset by
decreases in mortgage sale income and service fees and charges.
Noninterest expenses of $342.5 million increased $5.4 million or 2 percent
from the year ago period. Income tax expense increased $11.5 million, reflecting
higher pretax income from year ago results.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Liquidity Risk Management" and "Market Risk Management" under
Management's Discussion and Analysis of Financial Condition on page 8 and
Results of Operations on page 6.
ITEM 4. CONTROLS AND PROCEDURES
As of June 30, 2004, Paul R. Skubic, the Chairman of the Board, Chief
Executive Officer and President of the Company, and Janine Mulhall, the Chief
Financial Officer of the Company, evaluated the effectiveness of the disclosure
controls and procedures of the Company and concluded that these disclosure
controls and procedures are effective to ensure that material information
required to be included in this Report has been made known to them in a timely
fashion. There was no change in the Company's internal control over financial
reporting identified in connection with such evaluations that occurred during
the quarter ended June 30, 2004 that has materially affected or is reasonably
likely to materially affect, the Company's internal control over financial
reporting.
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) EXHIBITS
31.1 CERTIFICATION OF JANINE MULHALL PURSUANT TO SECTION 302 OF THE
SARBANES-OXLEY ACT OF 2002
31.2 CERTIFICATION OF PAUL R. SKUBIC PURSUANT TO SECTION 302 OF THE
SARBANES-OXLEY ACT OF 2002
32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
(b) REPORTS ON FORM 8-K:
NONE
18
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 13th day of August 2004.
/s/ PAUL R. SKUBIC
--------------------------------------
Paul R. Skubic
Chairman of the Board and President
/s/ JANINE MULHALL
--------------------------------------
Janine Mulhall
Chief Financial Officer
19