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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 SEPTEMBER 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
November 12, 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........................................................ 19
Item 4. Controls and Procedures..................................... 19
Part II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K............................ 19
Signatures..... ............................................................ 20
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HARRIS PREFERRED CAPITAL CORPORATION
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30 DECEMBER 31 SEPTEMBER 30
2004 2003 2003
------------ ----------- ------------
(UNAUDITED) (AUDITED) (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
Cash on deposit with Harris Trust and Savings Bank...... $ 30,228 $ 926 $ 141
Securities purchased from Harris Trust and Savings Bank
under agreement to resell............................. 16,000 11,500 13,000
Notes receivable from Harris Trust and Savings Bank..... 12,958 16,547 18,753
Securities available-for-sale:
Mortgage-backed.................................... 429,915 233,857 289,566
U.S. Treasury...................................... 29,993 229,995 175,000
Securing mortgage collections due from Harris Trust and
Savings Bank.......................................... 121 414 1,135
Other assets............................................ 1,653 1,079 1,143
-------- -------- --------
TOTAL ASSETS..................................... $520,868 $494,318 $498,738
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Broker payable -- due to securities purchase............ $ 29,991 $ -- $ --
Accrued expenses........................................ 42 84 20
-------- -------- --------
TOTAL LIABILITIES..................................... 30,033 84 20
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 (less than) in excess of distributions......... (971) 1,230 3,261
Accumulated other comprehensive income -- net unrealized
gains on available-for-sale securities................ 1,072 2,270 4,723
-------- -------- --------
TOTAL STOCKHOLDERS' EQUITY....................... 490,835 494,234 498,718
-------- -------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY....... $520,868 $494,318 $498,738
======== ======== ========
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 NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 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....... $ 152 $ 307 $ 935 $ 850
Notes receivable from Harris Trust and Savings
Bank......................................... 214 341 708 1,226
Securities available-for-sale:
Mortgage-backed.............................. 4,438 3,178 10,367 11,754
U.S. Treasury................................ 1 30 27 99
------- -------- ---------- ---------
Total interest income...................... 4,805 3,856 12,037 13,929
NON-INTEREST INCOME:
Gain on sale of securities...................... 464 687 862 3,149
------- -------- ---------- ---------
OPERATING EXPENSES:
Loan servicing fees paid to Harris Trust and
Savings Bank................................. 10 16 34 57
Advisory fees paid to Harris Trust and Savings
Bank......................................... 29 10 86 30
General and administrative...................... 55 54 248 222
------- -------- ---------- ---------
Total operating expenses................... 94 80 368 309
------- -------- ---------- ---------
Net income........................................ 5,175 4,463 12,531 16,769
Preferred dividends............................... 4,609 4,609 13,828 13,828
------- -------- ---------- ---------
NET INCOME (DEFICIT) AVAILABLE TO COMMON
STOCKHOLDER..................................... $ 566 $ (146) $ (1,297) $ 2,941
======= ======== ========== =========
Basic and diluted earnings (losses) per common
share........................................... $566.00 $(146.00) $(1,297.00) $2,941.00
======= ======== ========== =========
Net income........................................ $ 5,175 $ 4,463 $ 12,531 $ 16,769
Other comprehensive income (loss) -- net
unrealized gains/ (losses) on available-for-sale
securities...................................... 8,139 (3,529) (1,198) (5,639)
------- -------- ---------- ---------
Comprehensive income.............................. $13,314 $ 934 $ 11,333 $ 11,130
======= ======== ========== =========
The accompanying notes are an integral part of these financial statements.
3
HARRIS PREFERRED CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30
-----------------------
2004 2003
---------- ----------
(IN THOUSANDS,
EXCEPT PER SHARE DATA)
Balance at January 1........................................ $494,234 $501,946
Net income................................................ 12,531 16,769
Other comprehensive loss.................................. (1,198) (5,639)
Dividends -- common stock................................. (904) (530)
Dividends (preferred stock $0.4109 per share per
quarter)............................................... (13,828) (13,828)
-------- --------
Balance at September 30..................................... $490,835 $498,718
======== ========
The accompanying notes are an integral part of these financial statements.
4
HARRIS PREFERRED CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30
---------------------
2004 2003
--------- ---------
(IN THOUSANDS)
OPERATING ACTIVITIES:
Net Income................................................ $ 12,531 $ 16,769
Adjustments to reconcile net income to net cash provided
by operating activities:
Gain on sale of securities............................. (862) (3,149)
(Increase) decrease in other assets.................... (574) 804
Net decrease in accrued expenses....................... (42) (76)
--------- ---------
Net cash provided by operating activities.............. 11,053 14,348
--------- ---------
INVESTING ACTIVITIES:
(Decrease) increase in securities purchased from Harris
Trust and Savings Bank under agreement to resell....... (4,500) 7,000
Repayments of notes receivable from Harris Trust and
Savings Bank........................................... 3,589 12,325
Net decrease in securing mortgage collections due from
Harris Trust and Savings Bank.......................... 293 1,795
Purchases of securities available-for-sale................ (573,977) (535,416)
Proceeds from maturities and sales of securities
available-for-sale..................................... 607,576 513,719
--------- ---------
Net cash provided by (used) in investing activities.... 32,981 (577)
--------- ---------
FINANCING ACTIVITIES:
Cash dividends paid on preferred stock.................... (13,828) (13,828)
Cash dividends paid on common stock....................... (904) (530)
--------- ---------
Net cash used by financing activities.................. (14,732) (14,358)
--------- ---------
Increase (decrease) in cash on deposit with Harris Trust
and Savings Bank....................................... 29,302 (587)
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.............................................. $ 30,228 $ 141
========= =========
NON CASH TRANSACTION
Unsettled security purchase............................ $ 29,991 $ --
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 outstanding 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, 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
THIRD QUARTER 2004 COMPARED WITH THIRD QUARTER 2003
The Company's net income for the third quarter of 2004 was $5.2 million.
This represented a $700 thousand or 16% increase from third quarter 2003
earnings of $4.5 million. Earnings increased primarily because of higher yields
on earning assets.
6
HARRIS PREFERRED CAPITAL CORPORATION
Third quarter 2004 interest income on the Notes totaled $214 thousand and
yielded 6.4% on $13.5 million of average principal outstanding for the quarter
compared to $341 thousand and a 6.4% yield on $21 million average principal
outstanding for third 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 third quarter 2004 and 2003 was $17 million and $26 million,
respectively. Interest income on securities available-for-sale for the current
quarter was $4.4 million resulting in a yield of 4.3% on an average balance of
$415 million, compared to $3.2 million with a yield of 4.1% on an average
balance of $316 million for the same period a year ago. The increase in interest
income is primarily attributable to the increase in the mortgage-backed
investment portfolio.
There were no Company borrowings during third quarter 2004 or 2003.
Third quarter 2004 operating expenses totaled $94 thousand, an increase of
$14 thousand or 18% from the third quarter of 2003. Loan servicing expenses
totaled $10 thousand, a decrease of $6 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 third quarter
2004 were $29 thousand compared to $10 thousand a year earlier, due to increased
costs for processing, recordkeeping and administration. General and
administrative expenses totaled $55 thousand, an increase of $1 thousand over
the same period in 2003.
At September 30, 2004 and 2003, there were no Securing Mortgage Loans on
nonaccrual status.
NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED WITH SEPTEMBER 30, 2003
The Company's net income for the nine months ended September 30, 2004 was
$12.5 million. This represented a $4.2 million decrease or 25% from 2003
earnings. Earnings declined primarily because of a substantial decrease in gains
from security sales compared to last year and lower interest income on earning
assets. The Company had a $1.3 million loss after dividends on its preferred
stock. The Company anticipates that it has sufficient liquidity and earnings
capacity to continue preferred dividend payments on an uninterrupted basis. For
the current 2004 quarter, net income exceeded preferred dividends by $566
thousand.
Interest income on securities purchased under agreement to resell for the
nine months ended September 30, 2004 was $935 thousand, an increase of $85
thousand from the same period in 2003. Interest income on the Notes for the nine
months ended September 30, 2004 totaled $708 thousand and yielded 6.4% on $15
million of average principal outstanding compared to $1.2 million of income
yielding 6.4% on $26 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 $18 million for
the nine months ended September 30, 2004 and $31 million for the same period in
2003. There were no Company borrowings during either period. Interest income on
securities available-for-sale for the nine months ended September 30, 2004 was
$10.4 million resulting in a yield of 4.3% on an average balance of $323
million, compared to $11.9 million of interest income resulting in a yield of
4.6% on an average balance of $346 million a year ago. The decrease in interest
income from available-for-sale securities is primarily attributable to the
decrease in the mortgage-backed investment portfolio and an increase in the U.S.
Treasury portfolio. Yields on mortgage-backed securities generally exceed that
of U.S. Treasuries. Recently, additional mortgage-backed securities were
purchased bringing the September 30, 2004 balance to $430 million compared to
$234 million at December 31, 2003. The U.S. Treasury portfolio has substantially
declined at September 30, 2004 to $30 million. Gains from investment securities
sales for the nine months ended September 30, 2004 were $862 thousand compared
to $3.1 million a year ago.
Operating expenses for the nine months ended September 30, 2004 totaled
$368 thousand, an increase of $59 thousand from a year ago. Loan servicing
expenses for the nine months ended September 30, 2004 totaled $34 thousand, a
decrease of $23 thousand or 40% 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 nine months ended September
30, 2004 were $86 thousand compared to $30 thousand a year ago; primarily
attributable to increased costs for processing, recordkeeping and
administration. General and administrative
7
HARRIS PREFERRED CAPITAL CORPORATION
expenses totaled $248 thousand, an increase of $26 thousand or 12% over the same
period in 2003 as a result of additional insurance, compliance, printing and
processing costs.
On September 30, 2004, the Company paid a cash dividend of $0.46094 per
share on outstanding preferred shares to the stockholders of record on September
15, 2004, as declared on September 2, 2004. On September 13, 2004, the Company
paid a cash dividend of $904 thousand on the outstanding common shares to the
stockholder of record on September 6, 2004, as declared on September 2, 2004.
This latter dividend completed the 2003 REIT tax compliance requirements. On
September 30, 2003, the Company paid a cash dividend of $0.46094 per share on
outstanding preferred shares to the stockholders of record on September 15,
2003, as declared on September 3, 2003. On September 12, 2003, the Company paid
a cash dividend of $530 thousand on the outstanding common shares to the
stockholder of record on September 3, 2003, as declared on September 3, 2003.
This latter dividend completed the 2002 REIT tax compliance requirements. On a
year-to-date basis, the Company declared and paid $13.8 million of dividends to
holders of preferred shares for each of the nine-month periods ended September
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 of securities. The payment of dividends on the Preferred
Shares is made from legally available funds, arising from operating activities
of the Company. 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 $11.1 million provided from operations
during the nine months ended September 30, 2004 were $3.6 million provided by
principal repayments on the Notes and $607.6 million from the maturities and
sales of securities available-for-sale. In the prior period ended September 30,
2003, the primary sources of funds other than $14.3 million from operations were
$12.3 million provided by principal repayments on the Notes and $513.7 million
from the maturities and sales of securities available-for-sale. The primary uses
of funds for the nine months ended September 30, 2004 were $574.0 million for
purchases of securities available-for-sale and $13.8 million in preferred stock
dividends paid. For the nine-months ended September 30, 2003, the primary uses
of funds were $535.4 million for purchases of securities available-for-sale and
$13.8 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.
8
HARRIS PREFERRED CAPITAL CORPORATION
OTHER MATTERS
As of September 30, 2004, the Company believes that it is in full
compliance with the REIT tax rules, and expects to qualify as a non-taxable 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.
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
SEPTEMBER 30 DECEMBER 31 SEPTEMBER 30
2004 2003 2003
------------ ----------- ------------
(UNAUDITED) (AUDITED) (UNAUDITED)
(IN THOUSANDS EXCEPT SHARE DATA)
ASSETS
Cash and demand balances due from banks..................... $ 730,716 $ 823,615 $ 931,360
Money market assets:
Interest-bearing deposits at banks...................... 508,984 424,459 394,428
Federal funds sold...................................... 501,900 409,425 724,345
Securities available-for-sale (including $3.41 billion,
$4.07 billion, and $4.17 billion of securities pledged as
collateral for repurchase agreements at September 30,
2004, December 31, 2003 and September 30, 2003,
respectively)............................................. 5,782,203 6,624,280 6,673,499
Trading account assets...................................... 71,325 59,467 26,066
Loans....................................................... 10,884,158 9,573,452 9,397,975
Allowance for possible loan losses.......................... (204,211) (234,798) (226,940)
----------- ----------- -----------
Net loans............................................... 10,679,947 9,338,654 9,171,035
Premises and equipment...................................... 309,815 302,975 303,066
Customers' liability on acceptances......................... 6,156 44,234 32,632
Bank-owned insurance........................................ 1,062,728 1,035,239 1,024,783
Loans held for sale......................................... 46,437 168,904 176,162
Goodwill and other valuation intangibles.................... 158,192 165,978 168,574
Other assets................................................ 560,391 522,260 544,962
----------- ----------- -----------
TOTAL ASSETS.......................................... $20,418,794 $19,919,490 $20,170,912
=========== =========== ===========
LIABILITIES
Deposits in domestic offices -- noninterest-bearing......... $ 4,398,381 $4,231,540 $ 4,316,409
-- interest-bearing............... 7,999,115 7,844,596 7,492,481
Deposits in foreign offices -- noninterest-bearing.......... -- 49,016 23,729
-- interest-bearing................. 1,304,948 616,889 1,063,120
----------- ----------- -----------
Total deposits........................................ 13,702,444 12,742,041 12,895,739
Federal funds purchased and securities sold under agreement
to repurchase............................................. 3,549,343 4,643,406 4,713,078
Short-term borrowings....................................... 80,118 10,841 1,926
Short-term senior notes..................................... 400,000 -- --
Acceptances outstanding..................................... 6,156 44,234 32,632
Accrued interest, taxes and other expenses.................. 179,301 171,422 140,820
Other liabilities........................................... 415,096 230,917 312,079
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..................................... 18,787,458 18,322,861 18,576,274
----------- ----------- -----------
STOCKHOLDER'S EQUITY
Common stock ($10 par value); 10,000,000 shares authorized,
issued and outstanding.................................... 100,000 100,000 100,000
Surplus..................................................... 646,561 634,944 633,355
Retained earnings........................................... 931,253 860,674 836,481
Accumulated other comprehensive (loss) income............... (46,478) 1,011 24,802
----------- ----------- -----------
TOTAL STOCKHOLDER'S EQUITY............................ 1,631,336 1,596,629 1,594,638
----------- ----------- -----------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY............ $20,418,794 $19,919,490 $20,170,912
=========== =========== ===========
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 NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
------------------- -------------------
2004 2003 2004 2003
-------- -------- -------- --------
(IN THOUSANDS EXCEPT SHARE DATA)
INTEREST INCOME
Loans, including fees....................................... $135,377 $114,101 $387,207 $353,340
Money market assets:
Deposits at banks......................................... 1,663 583 3,421 2,339
Federal funds sold and securities purchased under
agreement to resell..................................... 2,284 891 5,646 2,586
Trading account............................................. 632 443 1,626 1,300
Securities available-for-sale:
U.S. Treasury and Federal agency.......................... 22,797 40,732 84,754 126,207
State and municipal....................................... 221 27 805 39
Other..................................................... 3,261 347 6,453 1,816
-------- -------- -------- --------
Total interest income..................................... 166,235 157,124 489,912 487,627
-------- -------- -------- --------
INTEREST EXPENSE
Deposits.................................................... 39,140 31,138 109,287 89,984
Short-term borrowings....................................... 12,589 10,746 32,614 40,300
Senior notes................................................ 1,202 971 2,601 3,569
Minority interest-dividends on preferred stock of
subsidiary................................................ 4,609 4,609 13,828 13,828
Long-term notes............................................. 827 2,585 5,337 7,872
-------- -------- -------- --------
Total interest expense.................................... 58,367 50,049 163,667 155,553
-------- -------- -------- --------
NET INTEREST INCOME......................................... 107,868 107,075 326,245 332,074
Provision for loan losses (reduction in allowance).......... (25,000) 28,732 (7,676) 76,632
-------- -------- -------- --------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES......... 132,868 78,343 333,921 255,442
-------- -------- -------- --------
NONINTEREST INCOME
Trust and investment management fees........................ 22,323 21,729 68,583 62,071
Money market and bond trading............................... 4,382 957 10,069 7,717
Foreign exchange............................................ 1,440 1,350 4,600 3,576
Service fees and charges.................................... 25,317 27,576 76,448 84,482
Securities gains............................................ 420 1,224 26,028 9,543
Bank-owned insurance investments............................ 9,919 11,659 30,423 33,228
Gains from loan restructuring............................... -- -- 7,131 --
Letter of credit fees....................................... 5,725 6,528 17,607 18,966
Other....................................................... 32,184 56,319 118,245 155,141
-------- -------- -------- --------
Total noninterest income.................................. 101,710 127,342 359,134 374,724
-------- -------- -------- --------
NONINTEREST EXPENSES
Salaries and other compensation............................. 77,575 88,764 225,831 241,826
Pension, profit sharing and other employee benefits......... 20,590 21,199 62,687 58,261
Net occupancy............................................... 10,670 11,279 33,955 31,847
Equipment................................................... 13,127 13,948 39,779 41,140
Marketing................................................... 10,018 8,196 26,987 22,929
Communication and delivery.................................. 5,653 6,262 16,458 17,287
Expert services............................................. 6,748 6,961 18,494 20,356
Contract programming........................................ 9,454 8,761 23,012 21,527
Other....................................................... 23,403 13,150 67,351 51,963
-------- -------- -------- --------
177,238 178,520 514,554 507,136
Amortization of valuation intangibles....................... 2,596 4,682 7,787 13,197
-------- -------- -------- --------
Total noninterest expenses................................ 179,834 183,202 522,341 520,333
-------- -------- -------- --------
Income before income taxes.................................. 54,745 22,483 170,714 109,833
Applicable income taxes..................................... 17,288 2,853 52,174 26,263
-------- -------- -------- --------
NET INCOME................................................ $ 37,457 $ 19,630 $118,540 $ 83,570
======== ======== ======== ========
EARNINGS PER COMMON SHARE (based on 10,000,000 average
shares outstanding)
Net Income.................................................. $ 3.75 $ 1.96 $ 11.85 $ 8.36
======== ======== ======== ========
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 NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
------------------ -------------------
2004 2003 2004 2003
------- -------- -------- --------
(IN THOUSANDS)
Net income.......................................... $37,457 $ 19,630 $118,540 $ 83,570
Other comprehensive income (loss):
Minimum pension liability adjustment net of tax
expense for the quarter of zero in 2004 and
zero in 2003 and net of tax (benefit) for the
year-to-date period of ($1,750) in 2004 and
zero in 2003................................... -- -- (3,411) --
Unrealized gains (losses) on available-for-sale
securities:
Unrealized holding gains (losses) arising
during the period, net of tax expense
(benefit) for the quarter of $10,399 in 2004
and ($19,976) in 2003 and net of tax
(benefit) for the year-to-date period of
($16,772) in 2004 and ($11,831) in 2003...... 13,358 (29,722) (28,844) (17,132)
Less reclassification adjustment for realized
gains included in income statement, net of
tax expense for the quarter of $164 in 2004
and $476 in 2003 and net of tax expense for
the year-to-date period of $10,126 in 2004
and $3,712 in 2003........................... (256) (749) (15,902) (5,831)
------- -------- -------- --------
Other comprehensive income (loss)................. 13,102 (30,471) (48,157) (22,963)
------- -------- -------- --------
Comprehensive income (loss)......................... $50,559 $(10,841) $ 70,383 $ 60,607
======= ======== ======== ========
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................................................ 118,540 83,570
Contributions to capital.................................. 7,016 6,715
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.............................. (86) (338)
Dividends -- common stock................................. (53,000) (50,000)
Other comprehensive loss.................................. (48,157) (22,963)
---------- ----------
Balance at September 30..................................... $1,631,336 $1,594,638
========== ==========
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)
NINE MONTHS ENDED
SEPTEMBER 30
-------------------------
2004 2003
----------- -----------
(IN THOUSANDS)
OPERATING ACTIVITIES:
Net Income................................................ $ 118,540 $ 83,570
Adjustments to reconcile net income to net cash provided
by operating activities:
Provision for loan losses (reduction in allowance)..... (7,676) 76,632
Depreciation and amortization, including intangibles... 51,134 50,123
Deferred tax expense (benefit)......................... 4,544 (2,940)
Gain on sales of securities............................ (26,028) (9,543)
Increase in bank-owned insurance....................... (29,628) (32,598)
Trading account net cash sales......................... 127,835 43,801
Net decrease (increase) in interest receivable......... 5,097 (757)
Net (decrease) increase in interest payable............ (5,938) 3,462
Net decrease (increase) in loans held for sale......... 122,467 (26,851)
Other, net............................................. 45,369 40,079
----------- -----------
Net cash provided by operating activities.............. 405,716 224,978
----------- -----------
INVESTING ACTIVITIES:
Net (increase) decrease in interest-bearing deposits at
banks.................................................. (84,525) 22,778
Net increase in Federal funds sold and securities
purchased under agreement to resell.................... (86,353) (486,395)
Proceeds from sales of securities available-for-sale...... 2,340,842 827,198
Proceeds from maturities of securities
available-for-sale..................................... 2,801,244 3,756,918
Purchases of securities available-for-sale................ (4,332,117) (5,526,178)
Net increase (decrease) in loans.......................... (1,222,905) 136,148
Purchases of premises and equipment....................... (44,244) (41,578)
Other, net................................................ 2,139 (744)
----------- -----------
Net cash used by investing activities.................. (625,919) (1,311,853)
----------- -----------
FINANCING ACTIVITIES:
Cash received in contribution of parent's banking
assets................................................. 3,379 --
Net increase in deposits.................................. 840,787 1,857,455
Net decrease in Federal funds purchased and securities
sold under agreement to repurchase..................... (1,103,063) (347,706)
Net increase (decrease) in other short-term borrowings.... 69,277 (298,768)
Proceeds from issuance of senior notes.................... 1,780,000 2,425,000
Repayment of senior notes................................. (1,380,000) (2,625,000)
Proceeds from issuance of long-term notes................. 200,000 --
Repayment of long-term notes.............................. (225,000) --
Cash dividends paid on common stock....................... (53,000) (50,000)
Cash portion of dividend of non-bank subsidiary........... (5,076) --
----------- -----------
Net cash provided by financing activities.............. 127,304 960,981
----------- -----------
NET DECREASE IN CASH AND DEMAND BALANCES DUE FROM
BANKS................................................. (92,899) (125,894)
CASH AND DEMAND BALANCES DUE FROM BANKS AT JANUARY 1... 823,615 1,057,254
----------- -----------
CASH AND DEMAND BALANCES DUE FROM BANKS AT SEPTEMBER
30.................................................... $ 730,716 $ 931,360
=========== ===========
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 nine months ended September 30 totaled $169.6
million and $152.1 million in 2004 and 2003, respectively. Cash income tax
payments over the same periods totaled $41.1 million and $7.7 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 September 30, 2004 was
$89.3 million. No impairment was recorded during the quarter ended September 30,
2004.
Other than goodwill, the Bank did not have any intangible assets not
subject to amortization as of September 30, 2004.
15
HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
As of September 30, 2004, the gross carrying amount and accumulated
amortization of the Bank's amortizable intangible assets are included in the
following table.
GROSS NET
CARRYING ACCUMULATED CARRYING
AMOUNT AMORTIZATION VALUE
-------- ------------ --------
(IN THOUSANDS)
Branch network.............................................. $145,000 $(79,750) $65,250
Other....................................................... 5,724 (2,106) 3,618
-------- -------- -------
Total finite life intangibles............................. $150,724 $(81,856) $68,868
======== ======== =======
Total amortization expense for the Bank's intangible assets was $2.6
million for the quarter ended September 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
THIRD QUARTER 2004 COMPARED WITH THIRD QUARTER 2003
SUMMARY
The Bank had third quarter 2004 net income of $37.5 million, an increase of
$17.8 million or 91 percent from third quarter 2003.
Cash ROE was 10.66 percent in the current quarter and 6.26 percent in the
third quarter 2003. Excluding the impact of unrealized gains and losses in the
securities portfolio recorded directly to equity, cash ROE was 10.52 percent in
the current quarter, compared to 6.46 percent a year ago.
Third quarter net interest income on a fully taxable equivalent basis was
$109.4 million, down $0.3 million from $109.7 million in 2003's third quarter.
Average earning assets increased 4 percent to $17.45 billion from $16.79 billion
in 2003. Average loans increased by $1.08 billion while average securities
available for sale decreased $775 million. Net interest margin decreased to 2.50
percent in the current quarter from 2.60 percent in the year-ago quarter,
reflecting the impact of declining yields in the securities portfolio and higher
rates on interest-bearing liabilities. This was somewhat offset by a greater
retail loan base with yields generally higher than other earning asset
portfolios and increased levels of noninterest-bearing funds in the mix of
supporting funds.
In the third quarter 2004 the Bank recorded a reduction in the allowance
for loan losses (negative provision) of $25.0 million, a decrease of $53.7
million from the third quarter of 2003. Net charge-offs decreased to $4.9
million from $17.6 million in the prior year. The decrease in provision resulted
from a reduction in net charge-offs and management's assessment that declining
non-performing loan levels are consistent with lower loan losses.
Third quarter noninterest income of $101.7 million decreased $25.6 million
from the same quarter last year. Income from service charges decreased $13.8
million, syndication income decreased $5.7 million and income from mortgage
sales decreased $7.3 million.
Third quarter 2004 noninterest expenses of $179.8 million decreased $3.4
million from the year ago quarter. A decrease in salary expense was partially
offset by increased contract services expense in the quarter.
Nonperforming assets at September 30, 2004 were $135 million or 1.24
percent of total loans, down from $146 million or 1.37 percent at June 30, 2004,
and $182 million or 1.94 percent a year ago. At September 30, 2004, the
allowance for possible loan losses was $204 million, equal to 1.88 percent of
loans outstanding, compared to $227 million or 2.41 percent at the end of third
quarter 2003. The ratio of the allowance for possible loan losses to
nonperforming assets remained unchanged at 124 percent from September 30, 2003
to September 30, 2004.
At September 30, 2004, Tier 1 capital of the Bank amounted to $1.74
billion, up from $1.62 billion one year earlier. The regulatory leverage capital
ratio was 8.71 percent for the third quarter of 2004 compared to 8.42 percent in
the same quarter of 2003. The Bank's capital ratio exceeds the prescribed
regulatory minimum for banks. The Bank's September 30, 2004 Tier 1 and total
risk-based capital ratios were 9.57 percent and 11.80 percent compared to
respective ratios of 10.09 percent and 12.28 percent at September 30, 2003.
NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED WITH SEPTEMBER 30, 2003
SUMMARY
The Bank had net income for the nine months ended September 30, 2004 of
$118.5 million, an increase of $35.0 million or 42 percent from the same period
a year ago.
Excluding the impact of unrealized gains and losses in the securities
portfolio, cash ROE was 11.37 percent, up from 9.07 percent last year.
17
Net interest income on a fully taxable equivalent basis was $332.3 million,
down $8.4 million or 2 percent from $340.7 million in 2003's year-to-date
period. Average earning assets increased 7 percent to $17.58 billion from $16.51
billion in 2003. Most of the increase was attributable to average loans, up $650
million from last year. Net interest margin decreased to 2.52 percent from 2.76
percent in 2003, reflecting the impact of declining yields in the securities
portfolio somewhat offset by increased levels of noninterest-bearing funds in
the mix of supporting funds.
The year-to-date 2004 reduction in the allowance for loan losses of $7.7
million was down $84.3 million from the $76.6 million provision for loan losses
in 2003. Net charge-offs were $24.1 million, a decrease of $32.6 million from
last year, resulting from lower commercial loan write-offs.
Noninterest income of $359.1 million decreased $15.6 million from the same
period last year. Net gains from securities sales increased $16.5 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, syndication fees and income from service
charges.
Noninterest expenses of $522.3 million increased $2.0 million from the year
ago period. Income tax expense increased $25.9 million, reflecting higher pretax
income from year ago results.
18
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 September 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 September 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
19
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 12th day of November 2004.
/s/ PAUL R. SKUBIC
--------------------------------------
Paul R. Skubic
Chairman of the Board and President
/s/ JANINE MULHALL
--------------------------------------
Janine Mulhall
Chief Financial Officer
20
EXHIBIT INDEX
EXHIBIT DESCRIPTION
- ------- -----------
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
21