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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003
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
------------------------
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 12, 2003 was 1,000.
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--------------------------------------------------------------------------------
HARRIS PREFERRED CAPITAL CORPORATION
TABLE OF CONTENTS
Part I FINANCIAL INFORMATION
Item 1. Financial Statements:
Balance Sheets.............................................. 2
Statements of Operations and Comprehensive Income........... 3
Statements of Changes in Stockholders' Equity............... 4
Statements of Cash Flows.................................... 5
Notes to Financial Statements............................... 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations............... 6
Item 4. Controls and Procedures..................................... 19
Part II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K............................ 19
(a) Exhibits
31.1 Certification of Pamela C. Piarowski 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
Signatures............................................................... 19
HARRIS PREFERRED CAPITAL CORPORATION
BALANCE SHEETS
(UNAUDITED)
JUNE 30, DECEMBER 31, JUNE 30,
2003 2002 2002
-------- ------------ --------
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
Cash on deposit with Harris Trust and Savings Bank.......... $ 312 $ 728 $ 314
Securities purchased from Harris Trust and Savings Bank
under agreement to resell................................. 17,500 20,000 15,000
Notes receivable from Harris Trust and Savings Bank......... 22,933 31,078 41,375
Securities available-for-sale:
Mortgage-backed........................................... 343,900 365,383 198,125
U.S. Treasury............................................. 114,995 79,976 174,947
Securing mortgage collections due from Harris Trust and
Savings Bank.............................................. 1,534 2,930 2,243
Broker receivable -- due from securities sales.............. -- -- 63,624
Other assets................................................ 1,832 1,947 1,229
-------- -------- --------
TOTAL ASSETS......................................... $503,006 $502,042 $496,857
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accrued expenses............................................ $ 82 $ 96 $ 44
-------- -------- --------
Commitments and contingencies............................... -- -- --
STOCKHOLDERS' EQUITY
7 3/8% Noncumulative Exchangeable Preferred Stock, Series A
($1 par value); liquidation value of $250,000; 20,000,000
shares authorized, 10,000,000 shares issued and
outstanding............................................... 250,000 250,000 250,000
Common stock ($1 par value); 1,000 shares authorized, issued
and outstanding........................................... 1 1 1
Additional paid-in capital.................................. 240,733 240,733 240,733
Earnings in excess of distributions......................... 3,938 850 4,266
Accumulated other comprehensive income -- unrealized gains
on available-for-sale securities.......................... 8,252 10,362 1,813
-------- -------- --------
TOTAL STOCKHOLDERS' EQUITY........................... 502,924 501,946 496,813
-------- -------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY........... $503,006 $502,042 $496,857
======== ======== ========
The accompanying notes are an integral part of these financial statements.
2
HARRIS PREFERRED CAPITAL CORPORATION
STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
(UNAUDITED)
QUARTER ENDED JUNE 30 SIX MONTHS ENDED JUNE 30
--------------------- ------------------------
2003 2002 2003 2002
---- ---- ---- ----
(IN THOUSANDS, EXCEPT PER SHARE DATA)
INTEREST INCOME:
Securities purchased from Harris Trust and
Savings Bank under agreement to resell.... $ 296 $ 638 $ 543 $ 959
Notes receivable from Harris Trust and
Savings Bank.............................. 413 740 885 1,585
Securities available-for-sale:
Mortgage-backed........................... 4,050 3,235 8,576 7,917
U.S. Treasury............................. 20 73 68 170
------ --------- --------- ---------
Total interest income................... 4,779 4,686 10,072 10,631
NON-INTEREST INCOME:
Gain on sale of securities................... -- 2,695 2,463 2,695
------ --------- --------- ---------
OPERATING EXPENSES:
Loan servicing fees paid to Harris Trust and
Savings Bank.............................. 19 34 41 75
Advisory fees paid to Harris Trust and
Savings Bank.............................. 10 19 20 27
General and administrative................... 70 48 168 125
------ --------- --------- ---------
Total operating expenses................ 99 101 229 227
------ --------- --------- ---------
Net income..................................... 4,680 7,280 12,306 13,099
Preferred dividends............................ 4,609 4,609 9,218 9,218
------ --------- --------- ---------
NET INCOME AVAILABLE TO COMMON STOCKHOLDER..... $ 71 $ 2,671 $ 3,088 $ 3,881
====== ========= ========= =========
Basic and diluted earnings per common share.... $71.00 $2,671.00 $3,088.00 $3,881.00
====== ========= ========= =========
Net income..................................... $4,680 $ 7,280 $ 12,306 $ 13,099
Other comprehensive income (loss) -- unrealized
gains (losses)on available-for-sale
securities................................... 123 6,208 (2,110) 3,690
------ --------- --------- ---------
Comprehensive income........................... $4,803 $ 13,488 $ 10,196 $ 16,789
====== ========= ========= =========
The accompanying notes are an integral part of these financial statements.
3
HARRIS PREFERRED CAPITAL CORPORATION
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(UNAUDITED)
SIX MONTHS
ENDED JUNE 30
-----------------------
2003 2002
---- ----
(IN THOUSANDS,
EXCEPT PER SHARE DATA)
BALANCE AT JANUARY 1........................................ $501,946 $489,242
Net income................................................ 12,306 13,099
Other comprehensive (loss) income......................... (2,110) 3,690
Dividends (preferred stock $0.4609 per share)............. (9,218) (9,218)
-------- --------
BALANCE AT JUNE 30.......................................... $502,924 $496,813
======== ========
The accompanying notes are an integral part of these financial statements.
4
HARRIS PREFERRED CAPITAL CORPORATION
STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30
------------------------
2003 2002
---- ----
(IN THOUSANDS)
OPERATING ACTIVITIES:
Net income................................................ $ 12,306 $ 13,099
Adjustments to reconcile net income to net cash provided
by operating activities:
Gain on sale of securities............................. (2,463) (2,695)
Net decrease in other assets........................... 115 716
Net decrease in accrued expenses....................... (14) (56)
--------- ---------
Net cash provided by operating activities............ 9,944 11,064
--------- ---------
INVESTING ACTIVITIES:
Net decrease in securities purchased from Harris Trust and
Savings Bank under agreement to resell................. 2,500 6,000
Repayments of notes receivable from Harris Trust and
Savings Bank........................................... 8,145 14,587
Decrease in securing mortgage collections due from Harris
Trust and Savings Bank................................. 1,396 3,110
Purchases of securities available-for-sale................ (340,490) (371,585)
Proceeds from maturities and sales of securities
available-for-sale..................................... 327,307 345,850
--------- ---------
Net cash used in investing activities................ (1,142) (2,038)
--------- ---------
FINANCING ACTIVITIES:
Cash dividends paid on preferred stock.................... (9,218) (9,218)
--------- ---------
Net decrease in cash on deposit with Harris Trust and
Savings Bank........................................... (416) (192)
Cash on deposit with Harris Trust and Savings Bank at
beginning of period.................................... 728 506
--------- ---------
Cash on deposit with Harris Trust and Savings Bank at end
of period.............................................. $ 312 $ 314
========= =========
NON-CASH TRANSACTION
Unsettled security sale................................... $ -- $ 63,624
========= =========
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. The Company holds its
assets through a Maryland real estate investment trust subsidiary, Harris
Preferred Capital Trust. Harris Capital Holdings, Inc., a wholly-owned
subsidiary of the Bank, owns 100% of the Company's common stock.
The accompanying financial statements have been prepared by management from
the books and records of the Company, without audit by independent certified
public accountants. These statements reflect all adjustments and disclosures
which are, in the opinion of management, necessary for a fair statement of the
results for the interim periods presented and should be read in conjunction with
the notes to financial statements included in the Company's 2002 Form 10-K.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to the rules and regulations of the
Securities and Exchange Commission.
2. COMMITMENTS AND CONTINGENCIES
Legal proceedings in which the Company is a defendant may arise in the
normal course of business. There is no pending litigation against the Company.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING INFORMATION
The statements contained in this Report on Form 10-Q that are not purely
historical are forward-looking statements within the meaning of Section 27A of
the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934, including statements regarding the Company's expectation, intentions,
beliefs or strategies regarding the future. Forward-looking statements include
the Company's statements regarding tax treatment as a real estate investment
trust, liquidity, provision for loan losses, capital resources and investment
activities. In addition, in those and other portions of this document, the words
"anticipate," "believe," "estimate," "expect," "intend" and other similar
expressions, as they relate to the Company or the Company's management, are
intended to identify forward-looking statements. Such statements reflect the
current views of the Company with respect to future events and are subject to
certain risks, uncertainties and assumptions. It is important to note that the
Company's actual results could differ materially from those described herein as
anticipated, believed, estimated or expected. Among the factors that could cause
the results to differ materially are the risks discussed in the "Risk Factors"
section included in the Company's Registration Statement on Form S-11 (File No.
333-40257), with respect to the Preferred Shares declared effective by the
Securities and Exchange Commission on February 5, 1998. The Company assumes no
obligation to update any such forward-looking statement.
6
HARRIS PREFERRED CAPITAL CORPORATION
RESULTS OF OPERATIONS
SECOND QUARTER 2003 COMPARED WITH SECOND QUARTER 2002
The Company's net income for the second quarter of 2003 was $4.7 million.
This represented a $2.6 million or 36% decrease from second quarter 2002
earnings of $7.3 million. Earnings decreased primarily because of a $2.7 million
gain on sale of securities in second quarter 2002 compared to no gains in the
second quarter of 2003.
Second quarter 2003 interest income on the Notes totaled $413 thousand and
yielded 6.4% on $25.8 million of average principal outstanding for the quarter
compared to $740 thousand and a 6.4% yield on $46.3 million average principal
outstanding for second quarter 2002. The decrease in income was attributable to
a reduction in the Notes balance because of principal paydowns by customers in
the underlying Securing Mortgage Loans. The average outstanding balance of the
Securing Mortgage Loans for second quarter 2003 and 2002 was $32 million and $57
million, respectively. Interest income on securities available-for-sale for the
current quarter was $4.1 million resulting in a yield of 4.6% on an average
balance of $354 million, compared to $3.3 million with a yield of 5.4% on an
average balance of $245 million for the same period a year ago. The increase in
interest income from available for sale securities is primarily attributable to
the increase in the investment portfolio and partially offset by the reduction
in yield As securities mature or are sold, proceeds have been invested in lower
yielding securities because market interest rates have generally been declining.
There were no Company borrowings during second quarter 2003 or 2002.
Second quarter 2003 operating expenses totaled $99 thousand, a decrease of
$2 thousand or 2% from the second quarter of 2002. Loan servicing expenses
totaled $19 thousand, a decrease of $15 thousand or 44% 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 2003 were $10 thousand compared to $19 thousand a year earlier
partially due to increased securities processing costs in the second quarter of
2002. General and administrative expenses totaled $70 thousand, an increase of
$22 thousand or 46% over the same period in 2002, as a result of additional
corporate governance costs.
At June 30, 2003 and 2002, there were no Securing Mortgage Loans on
nonaccrual status.
The Company does not currently maintain an allowance for loan losses due to
the over-collateralization of the Notes represented by the Securing Mortgage
Loans.
SIX MONTHS ENDED JUNE 30, 2003 COMPARED WITH JUNE 30, 2002
The Company's net income for the six months ended June 30, 2003 was $12.3
million. This represented a $793 thousand or 6% decrease from 2002 earnings of
$13.1 million. Earnings declined primarily because of reduced interest income on
earning assets. As assets mature or are sold, proceeds have been invested in
lower yielding securities because market interest rates have been declining in
the past twelve months.
Interest income on securities purchased under agreement to resell for the
six months ended June 30, 2003 was $543 thousand, a decrease of $416 thousand
from the same period in 2002. Interest income on the Notes for the six months
ended June 30, 2003 totaled $885 thousand and yielded 6.4% on $28 million of
average principal outstanding compared to $1.6 million of income yielding 6.4%
on $50 million of average principal outstanding for the same period in 2002. The
decrease in income was attributable to a reduction in the Note balance because
of customer payoffs on the Securing Mortgage Loans. There were no Company
borrowings during either period. Interest income on securities
available-for-sale for the six months ended June 30, 2003 was $8.6 million
resulting in a yield of 4.8% on an average balance of $361 million, compared to
$8.1 million of income with a yield of 5.6% on an average balance of $290
million a year ago. The increase in interest income from available for sale
securities is primarily attributable to the increase in the investment portfolio
and partially offset by the reduction in yield. As securities mature or are
sold, proceeds have been invested in lower yielding securities as a result of
market interest rates declining in recent months. Gains from investment
7
HARRIS PREFERRED CAPITAL CORPORATION
securities sales for the six months ended June 30, 2003 were $2.5 million
compared to $2.7 million a year ago. The average outstanding balance of the
Securing Mortgage Loans was $34 million for the six months ended June 30, 2003
and $61 million for the same period in 2002. There were no Company borrowings
during either period.
Operating expenses for the six months ended June 30, 2003 totaled $229
thousand, an increase of $2 thousand from a year ago. Loan servicing expenses
for the six months ended June 30, 2003 totaled $41 thousand, a decrease of $34
thousand or 45% from 2002. 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, 2003 were $20 thousand
compared to $27 thousand a year ago; primarily attributable to increased
securities processing costs in 2002. General and administrative expenses totaled
$168 thousand, an increase of $43 thousand or 34% over the same period in 2002,
as a result of additional corporate governance costs.
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 June 28, 2002, the Company paid a cash dividend of
$0.46094 per share on outstanding preferred shares to the stockholders of record
on June 15, 2002, as declared on June 4, 2002. 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, 2003 and 2002.
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 Notes, 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.
As presented in the accompanying Statements of Cash Flows, the primary
sources of funds in addition to $9.9 million provided from operations during the
six months ended June 30, 2003 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. In the prior period ended June 30, 2002, the
primary sources of funds other than $11.1 million from operations were $14.6
million provided by principal repayments on the Notes and $345.9 million from
the maturities and sales of securities available-for-sale. The primary uses of
funds for the six months ended June 30, 2003 were $340.5 million for purchases
of securities available-for-sale and $9.2 million in preferred stock dividends
paid. For the prior year's quarter ended June 30, 2002, the primary uses of
funds were $371.6 million for purchases of securities available-for-sale and
$9.2 million in preferred stock dividends paid.
8
HARRIS PREFERRED CAPITAL CORPORATION
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, 2002.
OTHER MATTERS
As of June 30, 2003, the Company believes that it is in full compliance
with the REIT tax rules, and expects to qualify as a REIT under the provisions
of the Code. The Company expects to meet all REIT requirements regarding the
ownership of its stock and anticipates meeting the annual distribution
requirements.
FINANCIAL STATEMENTS OF HARRIS TRUST AND SAVINGS BANK
The following unaudited financial information for the Bank is included
because the Company's preferred shares are automatically exchangeable for a new
series of preferred stock of the Bank upon the occurrence of certain events.
9
HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CONDITION
(UNAUDITED)
JUNE 30 DECEMBER 31 JUNE 30
2003 2002 2002
------- ----------- -------
(IN THOUSANDS EXCEPT SHARE DATA)
ASSETS
Cash and demand balances due from banks.......................... $ 1,096,975 $ 1,057,254 $ 918,094
Money market assets:
Interest-bearing deposits at banks............................. 355,839 417,206 405,582
Federal funds sold and securities purchased under agreement to
resell...................................................... 679,238 237,950 524,650
Trading account assets........................................... 52,948 42,423 35,211
Securities available-for-sale (including $5.20 billion, $4.39
billion, and $2.67 billion of securities pledged as collateral
for repurchase agreements at June 30, 2003, December 31, 2002,
and June 30, 2002 respectively)................................ 6,816,419 5,781,360 4,902,417
Loans............................................................ 9,802,195 9,607,887 9,482,692
Allowance for possible loan losses............................... (215,833) (206,999) (218,656)
----------- ----------- -----------
Net loans...................................................... 9,586,362 9,400,888 9,264,036
Premises and equipment........................................... 301,098 298,414 287,620
Customers' liability on acceptances.............................. 25,326 16,168 16,924
Bank-owned insurance investments................................. 1,014,876 994,185 973,982
Loans held for sale.............................................. 239,818 149,311 61,245
Goodwill and other valuation intangibles......................... 181,375 187,317 202,527
Other assets..................................................... 541,644 444,542 590,931
----------- ----------- -----------
TOTAL ASSETS.............................................. $20,891,918 $19,027,018 $18,183,219
=========== =========== ===========
LIABILITIES
Deposits in domestic offices -- noninterest-bearing.............. $ 4,128,062 $ 3,414,159 $ 3,002,014
-- interest-bearing................. 6,570,548 6,408,171 6,963,096
Deposits in foreign offices -- noninterest-bearing.............. 27,194 31,383 30,480
-- interest-bearing................. 1,002,636 1,184,571 1,074,501
----------- ----------- -----------
Total deposits............................................ 11,728,440 11,038,284 11,070,091
Federal funds purchased and securities sold under agreement to
repurchase..................................................... 5,505,440 5,060,784 3,325,080
Short-term borrowings............................................ 301,562 300,694 557,198
Short-term senior notes.......................................... 600,000 200,000 650,000
Acceptances outstanding.......................................... 25,326 16,168 16,924
Accrued interest, taxes and other expenses....................... 147,286 153,148 150,295
Other liabilities................................................ 485,361 200,286 391,080
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.................................. 225,000 225,000 225,000
----------- ----------- -----------
TOTAL LIABILITIES......................................... 19,273,415 17,449,364 16,640,668
----------- ----------- -----------
STOCKHOLDER'S EQUITY
Common stock ($10 par value); authorized 10,000,000 shares;
issued and outstanding 10,000,000 shares....................... 100,000 100,000 100,000
Surplus.......................................................... 631,274 626,640 623,764
Retained earnings................................................ 831,957 803,249 790,865
Accumulated other comprehensive income........................... 55,272 47,765 27,922
----------- ----------- -----------
TOTAL STOCKHOLDER'S EQUITY................................ 1,618,503 1,577,654 1,542,551
----------- ----------- -----------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY................ $20,891,918 $19,027,018 $18,183,219
=========== =========== ===========
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
JUNE 30 ENDED JUNE 30
-------------------- --------------------
2003 2002 2003 2002
---- ---- ---- ----
(IN THOUSANDS EXCEPT SHARE DATA)
INTEREST INCOME
Loans, including fees....................................... $121,747 $129,210 $239,239 $260,230
Money market assets:
Deposits at banks......................................... 763 375 1,756 556
Federal funds sold and securities purchased under
agreement to resell..................................... 1,000 2,989 1,695 4,807
Trading account............................................. 404 402 857 911
Securities available-for-sale:
U.S. Treasury and Federal agency.......................... 42,966 47,289 85,475 105,611
State and municipal....................................... 7 5 12 18
Other..................................................... 348 553 1,469 1,101
-------- -------- -------- --------
Total interest income................................. 167,235 180,823 330,503 373,234
-------- -------- -------- --------
INTEREST EXPENSE
Deposits.................................................... 28,527 43,031 58,846 85,892
Short-term borrowings....................................... 15,334 14,112 29,554 31,760
Senior notes................................................ 1,703 3,944 2,598 10,022
Minority interest-dividends on preferred stock of
subsidiary................................................ 4,610 4,609 9,219 9,219
Long-term notes............................................. 2,610 2,840 5,287 5,691
-------- -------- -------- --------
Total interest expense................................ 52,784 68,536 105,504 142,584
-------- -------- -------- --------
NET INTEREST INCOME......................................... 114,451 112,287 224,999 230,650
Provision for loan losses................................... 30,282 21,761 47,900 50,318
-------- -------- -------- --------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES......... 84,169 90,526 177,099 180,332
-------- -------- -------- --------
NONINTEREST INCOME
Trust and investment management fees........................ 20,604 22,773 40,342 42,364
Money market and bond trading............................... 3,635 2,443 6,760 4,127
Foreign exchange............................................ 1,250 536 2,226 3,684
Service fees and charges.................................... 29,182 30,908 56,906 60,990
Securities gains............................................ 5,856 23,337 8,319 38,711
Bank-owned insurance investments............................ 10,773 12,468 21,569 25,283
Foreign fees................................................ 6,220 5,828 12,438 11,853
Other....................................................... 48,554 34,330 98,822 75,337
-------- -------- -------- --------
Total noninterest income.............................. 126,074 132,623 247,382 262,349
-------- -------- -------- --------
NONINTEREST EXPENSES
Salaries and other compensation............................. 74,294 74,387 153,062 151,152
Pension, profit sharing and other employee benefits......... 18,939 15,438 37,062 30,585
Net occupancy............................................... 10,760 10,240 20,568 19,583
Equipment................................................... 14,123 11,867 27,192 25,580
Marketing................................................... 7,518 7,344 14,733 14,682
Communication and delivery.................................. 5,427 5,606 11,025 11,173
Expert services............................................. 7,181 6,978 13,395 13,248
Contract programming........................................ 6,423 6,507 12,766 13,531
Other....................................................... 19,900 12,184 38,813 26,782
-------- -------- -------- --------
164,565 150,551 328,616 306,316
Goodwill and other valuation intangibles.................... 4,365 3,961 8,515 7,784
-------- -------- -------- --------
Total noninterest expenses............................ 168,930 154,512 337,131 314,100
-------- -------- -------- --------
Income before income taxes.................................. 41,313 68,637 87,350 128,581
Applicable income taxes..................................... 10,795 20,967 23,410 37,412
-------- -------- -------- --------
NET INCOME............................................ $ 30,518 $ 47,670 $ 63,940 $ 91,169
======== ======== ======== ========
EARNINGS PER COMMON SHARE (based on 10,000,000 average
shares outstanding)
Net Income.................................................. $ 3.05 $ 4.77 $ 6.39 $ 9.12
======== ======== ======== ========
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)
SIX MONTHS ENDED
QUARTER ENDED JUNE 30 JUNE 30
--------------------- -------------------
2003 2002 2003 2002
---- ---- ---- ----
(IN THOUSANDS)
NET INCOME............................................ $30,518 $ 47,670 $63,940 $ 91,169
OTHER COMPREHENSIVE INCOME:
Unrealized gains on available-for-sale securities:
Unrealized holding gains arising during the
period, net of tax expense for the quarter of
$13,598 in 2003 and $28,978 in 2002 and net of
tax expense for the year-to-date period of
$8,145 in 2003 and $20,218 in 2002............. 20,806 44,428 12,590 31,475
Less reclassification adjustment for realized
gains included in income statement, net of tax
expense for the quarter of $2,278 in 2003 and
$9,078 in 2002 and net of tax expense for the
year-to-date period of $3,236 in 2003 and
$15,058 in 2002................................ (3,578) (14,259) (5,083) (23,653)
------- -------- ------- --------
Other comprehensive income.......................... 17,228 30,169 7,507 7,822
------- -------- ------- --------
COMPREHENSIVE INCOME.................................. $47,746 $ 77,839 $71,447 $ 98,991
======= ======== ======= ========
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)
2003 2002
---- ----
(IN THOUSANDS)
BALANCE AT JANUARY 1........................................ $1,577,654 $1,560,677
Net income................................................ 63,940 91,169
Contributions to capital.................................. 4,635 3,178
Dividends -- preferred stock.............................. (233) (295)
Dividends -- common stock................................. (35,000) (120,000)
Other comprehensive income................................ 7,507 7,822
---------- ----------
BALANCE AT JUNE 30.......................................... $1,618,503 $1,542,551
========== ==========
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
--------------------------
2003 2002
---- ----
(IN THOUSANDS)
OPERATING ACTIVITIES:
Net income.................................................. $ 63,940 $ 91,169
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses................................. 47,899 50,318
Depreciation and amortization, including intangibles...... 32,727 28,794
Deferred tax expense...................................... 1,128 4,271
Gain on sales of securities............................... (8,319) (38,711)
Increase in bank-owned insurance.......................... (21,756) (23,525)
Trading account net (purchases) sales..................... (2,883) 55,351
Net (increase) decrease in interest receivable............ (992) 18,253
Net increase (decrease) in interest payable............... 3,642 (5,549)
Net (increase) decrease in loans held for sale............ (90,507) 60,343
Other, net................................................ 29,357 (41,128)
----------- -----------
Net cash provided by operating activities.............. 54,236 199,586
----------- -----------
INVESTING ACTIVITIES:
Net decrease (increase) in interest-bearing deposits at
banks.................................................. 61,367 (209,860)
Net (increase) decrease in Federal funds sold and
securities purchased under agreement to resell......... (441,288) 55,100
Proceeds from sales of securities available-for-sale...... 214,760 2,071,179
Proceeds from maturities of securities
available-for-sale..................................... 2,409,116 4,421,885
Purchases of securities available-for-sale................ (3,489,126) (5,521,560)
Net (increase) decrease in loans.......................... (244,193) 415,442
Purchases of premises and equipment....................... (26,896) (21,081)
Other, net................................................ 1,065 --
----------- -----------
Net cash (used) provided by investing activities....... (1,515,195) 1,211,105
----------- -----------
FINANCING ACTIVITIES:
Net increase (decrease) in deposits....................... 690,156 (120,770)
Net increase (decrease) in Federal funds purchased and
securities sold under agreement to repurchase.......... 444,656 (1,098,271)
Net increase (decrease) in short-term borrowings.......... 868 (147,501)
Proceeds from issuance of senior notes.................... 1,625,000 400,000
Repayment of senior notes................................. (1,225,000) (610,000)
Cash dividends paid on common stock....................... (35,000) (120,000)
----------- -----------
Net cash provided (used) by financing activities....... 1,500,680 (1,696,542)
----------- -----------
NET INCREASE (DECREASE) IN CASH AND DEMAND BALANCES DUE
FROM BANKS............................................ 39,721 (285,851)
CASH AND DEMAND BALANCES DUE FROM BANKS AT JANUARY 1... 1,057,254 1,203,945
----------- -----------
CASH AND DEMAND BALANCES DUE FROM BANKS AT JUNE 30..... $ 1,096,975 $ 918,094
=========== ===========
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 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 $101.9 million
and $148.1 million in 2003 and 2002, respectively. Cash income tax payments over
the same periods totaled $0.6 million and $24.4 million, respectively.
4. GOODWILL AND OTHER INTANGIBLE ASSETS
The Bank adopted Statement of Financial Accounting Standards ("SFAS") No.
142, "Goodwill and Other Intangible Assets," on January 1, 2002. Under this
standard, 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.
Upon adoption of SFAS No. 142, the Bank had no goodwill.
The Bank adopted SFAS No. 147, "Acquisitions of Certain Financial
Institutions--an amendment of FASB Statements No. 72 and 144 and FASB
Interpretation No. 9," on October 1, 2002. Under this standard, most
acquisitions of financial institutions are removed from the scope of SFAS No. 72
and Interpretation No. 9 and are accounted for in accordance with SFAS No. 141,
"Business Combinations," and SFAS No. 142. As such, unidentifiable intangible
assets recognized and amortized in accordance with SFAS No. 72, "Accounting for
Certain Acquisitions of Banking or Thrift Institutions," represent goodwill that
will be accounted for under SFAS No. 142. At adoption date, the Bank had an
unidentifiable intangible asset that, in accordance with SFAS No. 72, was
excluded from the scope of SFAS No. 142 and continued to be amortized through
third quarter 2002. Upon adoption of the Statement, the unidentifiable
intangible asset was reclassified to goodwill and no longer amortized starting
in fourth quarter 2002. Under the transitional requirements of the Statement,
the first three quarters of 2002 were restated to reflect the reversal of
previously amortized goodwill in those quarters. The earnings impact for each of
these three quarters was $2.35 million pretax ($1.4 million after tax).
15
HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
The Bank's goodwill was subject to the annual impairment test in the fourth
quarter of 2002. The fair value of the reporting unit was estimated using a
valuation technique based on multiples of book value. The test did not identify
potential impairment and no impairment loss was recognized in 2002.
The carrying value of the Bank's goodwill as of June 30, 2003 was $89.3
million.
As of June 30, 2003, the gross carrying amount and accumulated amortization
of the Bank's amortizable intangible assets were $208.3 million and $116.2
million, respectively.
Total amortization expense for the Bank's intangible assets was $4.4
million for the quarter ended June 30, 2003.
Estimated intangible asset amortization expense for the years ending
December 31, 2004, 2005, 2006, 2007 and 2008 is $17.2 million, $17.4 million,
$17.7 million, $17.9 million and $18.1 million, respectively.
16
HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES
FINANCIAL REVIEW
SECOND QUARTER 2003 COMPARED WITH SECOND QUARTER 2002
SUMMARY
The Bank had second quarter 2003 net income of $30.5 million, a decrease of
$17.2 million or 36 percent from second quarter 2002.
Cash ROE was 9.36 in the current quarter and 14.87 in the second quarter
2002. Excluding the impact of unrealized gains and losses in the securities
portfolio recorded directly to equity, cash ROE was 9.87 percent in the current
quarter, compared to 15.02 percent a year ago.
Second quarter net interest income on a fully taxable equivalent basis was
$117.4 million, up $2.8 million or 2 percent from $114.6 million in 2002's
second quarter. Average earning assets increased 11 percent to $16.86 billion
from $15.18 billion in 2002, primarily due to an increase of $1.64 billion in
average securities available for sale. Net interest margin decreased to 2.79
percent in the current quarter from 3.03 percent in the year-ago quarter,
reflecting the impact of declining spreads, particularly in the securities
portfolio.
The second quarter provision for loan losses of $30.3 million was up $8.5
million from $21.8 million in the second quarter of 2002. Net charge-offs
decreased slightly to $22.7 million from $22.8 million in the prior year.
Second quarter noninterest income of $93.7 million decreased $14.9 million
from the same quarter last year. The decrease was primarily due to a $17.5
million decrease in net gains from sales of investment securities.
Second quarter 2003 noninterest expenses of $136.6 million increased $6.0
million or 5 percent from the year ago quarter.
Nonperforming assets at June 30, 2003 were $202 million or 2.06 percent of
total loans, up from $175 million or 1.79 percent at March 31, 2003, and $181
million or 1.91 percent a year ago. At June 30, 2003, the allowance for possible
loan losses was $216 million, equal to 2.20 percent of loans outstanding,
compared to $219 million or 2.31 percent at the end of second quarter 2002. As a
result, the ratio of the allowance for possible loan losses to nonperforming
assets decreased from 121 percent at June 30, 2002 to 107 percent at June 30,
2003.
At June 30, 2003, Tier 1 capital of the Bank amounted to $1.61 billion,
down from $1.58 billion one year earlier. The regulatory leverage capital ratio
was 8.35 percent for the second quarter of 2003 compared to 8.99 percent in the
same quarter of 2002. The Bank's capital ratio exceeds the prescribed regulatory
minimum for banks. The Bank's June 30, 2003 Tier 1 and total risk-based capital
ratios were 9.65 percent and 11.80 percent compared to respective ratios of
10.12 percent and 12.55 percent at June 30, 2002.
SIX MONTHS ENDED JUNE 30, 2003 COMPARED WITH JUNE 30, 2002
SUMMARY
The Bank had net income for the six months ended June 30, 2003 of $63.9
million, a decrease of $27.2 million or 30 percent from the same period a year
ago.
Excluding the impact of unrealized gains and losses in the securities
portfolio, cash ROE was 10.44 percent, down from 14.30 percent last year.
Net interest income on a fully taxable equivalent basis was $231.0 million,
down $4.5 million or 2 percent from $235.5 million in 2002's year-to-date
period. Average earning assets increased 5 percent to $16.36 billion from $15.57
billion in 2002, primarily attributable to a $963 million increase in average
securities available for sale. Net interest margin decreased to 2.84 percent
from 3.04 percent in 2002, reflecting the impact of declining spreads,
particularly in the securities portfolio.
17
HARRIS TRUST AND SAVINGS BANK AND SUBSIDIARIES
FINANCIAL REVIEW -- (CONTINUED)
The year-to-date 2003 provision for loan losses of $47.9 million was down
$2.4 million from $50.3 million in 2002. Net charge-offs were $39.1 million, a
decrease of $19.9 million from last year, resulting from lower commercial loan
write-offs.
Noninterest income of $180.9 million decreased $30.0 million from the same
period last year. This decrease is attributable to lower net gains from
securities sales of $30.4 million.
Noninterest expenses of $270.7 million increased $8.0 million or 3 percent
from the year ago period. Income tax expense decreased $14.0 million, reflecting
lower pretax income.
18
ITEM 4. CONTROLS AND PROCEDURES
We are responsible for establishing and maintaining a set of disclosure
controls and procedures ("DCP") that are designed to ensure that information
required to be disclosed by us in the reports filed by us under the Exchange Act
is recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms. In addition, we are responsible for
establishing and maintaining adequate internal control over our financial
reporting ("IC") that is designed to provide reasonable assurances that our
records are maintained in reasonable detail to accurately and fairly reflect
transactions, our transactions are properly authorized, our assets are
safeguarded against unauthorized or improper acquisition, use or disposition,
and our transactions are properly recorded and reported to permit the
preparation of our financial statements in conformity with generally accepted
accounting principles.
There were no changes in our IC during our second quarter of 2003 that
materially affected or are reasonably likely to materially affect our IC,
including any corrective actions with regard to significant deficiencies and
material weaknesses.
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 PAMELA C. PIAROWSKI 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
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 August 2003.
/s/ PAUL R. SKUBIC
--------------------------------------
Paul R. Skubic
Chairman of the Board and President
/s/ PAMELA C. PIAROWSKI
--------------------------------------
Pamela C. Piarowski
Chief Financial Officer
19