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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 JUNE 30, 2005
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
of incorporation or organization) Identification No.)
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 this 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, 2005 was 1,000. No common equity is held by nonaffiliates.
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HARRIS PREFERRED CAPITAL CORPORATION
TABLE OF CONTENTS
Part I
FINANCIAL INFORMATION
Item 1.
Financial Statements:
2
Consolidated Balance Sheets.................................
3
Consolidated Statements of Income and Comprehensive
Income......................................................
4
Consolidated Statements of Changes in Stockholders'
Equity......................................................
5
Consolidated Statements of Cash Flows.......................
6
Notes to Consolidated Financial Statements..................
Item 2. 6
Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................
Item 3. 19
Quantitative and Qualitative Disclosures about Market
Risk........................................................
Item 4. 19
Controls and Procedures.....................................
Part II
OTHER INFORMATION
Item 6. 19
Exhibits....................................................
Signatures................................................................... 20
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HARRIS PREFERRED CAPITAL CORPORATION
CONSOLIDATED BALANCE SHEETS
JUNE 30, DECEMBER 31, JUNE 30,
2005 2004 2004
----------- ------------ -----------
(UNAUDITED) (AUDITED) (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
Cash on deposit with Harris N.A. ......................... $ 438 $ 407 $ 6,081
Securities purchased from Harris N.A. under agreement to
resell.................................................. 13,000 10,500 16,000
Notes receivable from Harris N.A. ........................ 10,504 12,129 14,013
Securities available-for-sale:
Mortgage-backed...................................... 431,355 419,315 405,248
U.S. Treasury........................................ 29,988 44,993 39,800
Securing mortgage collections due from Harris N.A. ....... -- 78 281
Other assets.............................................. 1,657 1,600 1,643
-------- -------- --------
TOTAL ASSETS....................................... $486,942 $489,022 $483,066
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accrued expenses.......................................... $ 93 $ 134 $ 33
-------- -------- --------
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
Distributions in excess of earnings....................... (379) (582) (634)
Accumulated other comprehensive loss -- net unrealized
losses on available-for-sale securities................. (3,506) (1,264) (7,067)
-------- -------- --------
TOTAL STOCKHOLDERS' EQUITY......................... 486,849 488,888 483,033
-------- -------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY......... $486,942 $489,022 $483,066
======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
2
HARRIS PREFERRED CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
(UNAUDITED)
QUARTER ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
------------------ --------------------
2005 2004 2005 2004
------- -------- ------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
INTEREST INCOME:
Securities purchased from Harris N.A. under
agreement to resell............................ $ 251 $ 312 $ 451 $ 783
Notes receivable from Harris N.A. ................ 171 234 355 492
Securities available-for-sale:
Mortgage-backed................................ 4,601 3,299 9,167 5,929
U.S. Treasury.................................. 17 2 36 26
------- -------- ------- ----------
Total interest income........................ 5,040 3,847 10,009 7,230
NON-INTEREST INCOME:
(Loss) gain on sale of securities................. (178) -- (372) 398
------- -------- ------- ----------
OPERATING EXPENSES:
Loan servicing fees paid to Harris N.A. .......... 8 12 16 24
Advisory fees paid to Harris N.A. ................ 41 28 65 57
General and administrative........................ 33 97 135 193
------- -------- ------- ----------
Total operating expenses..................... 82 137 216 274
------- -------- ------- ----------
Net income.......................................... 4,780 3,710 9,421 7,354
Preferred dividends................................. 4,609 4,609 9,218 9,218
------- -------- ------- ----------
NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDER... $ 171 $ (899) $ 203 $ (1,864)
======= ======== ======= ==========
Basic and diluted earnings (loss) per common
share............................................. $171.00 $(899.00) $203.00 $(1,864.00)
======= ======== ======= ==========
Net income.......................................... $ 4,780 $ 3,710 $ 9,421 $ 7,354
Other comprehensive income (loss) -- net unrealized
gains/(losses) on available-for-sale securities... 4,200 (10,143) (2,242) (9,337)
------- -------- ------- ----------
Comprehensive income (loss)......................... $ 8,980 $ (6,433) $ 7,179 $ (1,983)
======= ======== ======= ==========
The accompanying notes are an integral part of these consolidated financial
statements.
3
HARRIS PREFERRED CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(UNAUDITED)
SIX MONTHS ENDED
JUNE 30
-----------------------
2005 2004
---------- ----------
(IN THOUSANDS,
EXCEPT PER SHARE DATA)
Balance at January 1........................................ $488,888 $494,234
Net income................................................ 9,421 7,354
Other comprehensive loss.................................. (2,242) (9,337)
Dividends (preferred stock $0.4609 per share)............. (9,218) (9,218)
-------- --------
Balance at June 30.......................................... $486,849 $483,033
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
4
HARRIS PREFERRED CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30
-------------------------
2005 2004
----------- -----------
(IN THOUSANDS)
OPERATING ACTIVITIES:
Net Income................................................ $ 9,421 $ 7,354
Adjustments to reconcile net income to net cash provided
by operating activities:
Loss (gain) on sale of securities......................... 372 (398)
Net increase in other assets.............................. (57) (564)
Net decrease in accrued expenses.......................... (41) (51)
--------- ---------
Net cash provided by operating activities.............. 9,695 6,341
--------- ---------
INVESTING ACTIVITIES:
Net increase in securities purchased from Harris N.A.
under agreement to resell.............................. (2,500) (4,500)
Repayments of notes receivable from Harris N.A. .......... 1,625 2,534
Decrease in securing mortgage collections due from Harris
N.A. .................................................. 78 133
Purchases of securities available-for-sale................ (113,565) (516,889)
Proceeds from sales of securities available-for-sale...... -- 10,989
Proceeds from maturities of securities
available-for-sale..................................... 113,916 515,765
--------- ---------
Net cash (used) provided by investing activities....... (446) 8,032
--------- ---------
FINANCING ACTIVITIES:
Cash dividends paid on preferred stock.................... (9,218) (9,218)
--------- ---------
Net increase in cash on deposit with Harris N.A. ......... 31 5,155
Cash on deposit with Harris N.A. at beginning of period... 407 926
--------- ---------
Cash on deposit with Harris N.A. at end of period......... $ 438 $ 6,081
========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
5
HARRIS PREFERRED CAPITAL CORPORATION
NOTES TO CONSOLIDATED 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 N.A. (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., owns 100% of the
Company's common stock. The Bank owns all common stock outstanding issued by
Harris Capital Holdings, Inc.
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 presentation 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 2004 Form 10-K. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States of
America, have been condensed or omitted pursuant to the rules and regulations of
the Securities and Exchange Commission.
2. COMMITMENTS AND CONTINGENCIES
Legal proceedings in which the Company is a defendant may arise in the
normal course of business. There is no pending litigation against the Company.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING INFORMATION
The statements contained in this Report on Form 10-Q that are not purely
historical are forward-looking statements within the meaning of Section 27A of
the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934, including statements regarding the Company's expectation, intentions,
beliefs or strategies regarding the future. Forward-looking statements include
the Company's statements regarding tax treatment as a real estate investment
trust, liquidity, provision for loan losses, capital resources and investment
activities. In addition, in those and other portions of this document, the words
"anticipate," "believe," "estimate," "expect," "intend" and other similar
expressions, as they relate to the Company or the Company's management, are
intended to identify forward-looking statements. Such statements reflect the
current views of the Company with respect to future events and are subject to
certain risks, uncertainties and assumptions. It is important to note that the
Company's actual results could differ materially from those described herein as
anticipated, believed, estimated or expected. Among the factors that could cause
the results to differ materially are the risks discussed in the "Risk Factors"
section included in the Company's Registration Statement on Form S-11 (File No.
333-40257), with respect to the Preferred Shares declared effective by the
Securities and Exchange Commission on February 5, 1998. The Company assumes no
obligation to update any such forward-looking statement.
RESULTS OF OPERATIONS
SECOND QUARTER 2005 COMPARED WITH SECOND QUARTER 2004
The Company's net income for the second quarter of 2005 was $4.8 million.
This represented a $1.1 million or 29% increase from second quarter 2004
earnings of $3.7 million. Earnings increased primarily because of increased
interest income on earning assets.
6
HARRIS PREFERRED CAPITAL CORPORATION
Interest income on securities purchased under agreement to resell for the
second quarter 2005 was $251 thousand, a decrease of $61 thousand from the same
period in 2004, because the average outstandings declined by $63 million,
partially offset by an increase in market rates over the same period. Second
quarter 2005 interest income on the Notes totaled $171 thousand and yielded 6.4%
on $10.7 million of average principal outstanding for the quarter compared to
$234 thousand and a 6.4% yield on $14.7 million average principal outstanding
for second quarter 2004. The decrease in income was attributable to a reduction
in the Note balance because of principal paydowns by customers in the Securing
Mortgage Loans. The average outstanding balance of the Securing Mortgage Loans
for second quarter 2005 and 2004 was $13 million and $18 million, respectively.
Interest income on securities available-for-sale, including mortgage-backed and
U.S. Treasury securities, for the current quarter was $4.6 million resulting in
a yield of 4.3% on an average balance of $433 million, compared to $3.3 million
with a yield of 4.3% on an average balance of $310 million for the same period a
year ago. The increase in interest income is primarily attributable to the
increase in the investment portfolio of mortgage-backed securities.
There were no Company borrowings during second quarter 2005 or 2004.
Second quarter 2005 operating expenses totaled $82 thousand, a decrease of
$55 thousand or 40% from the second quarter of 2004. Loan servicing expenses
totaled $8 thousand, a decrease of $4 thousand from a year ago. This decrease is
attributable to the reduction in the principal balance of the Notes, thereby
reducing servicing fees payable to the Bank. Advisory fees for the second
quarter 2005 were $41 thousand compared to $28 thousand a year earlier. The
increase is partially due to increased internal processing costs. General and
administrative expenses totaled $33 thousand, a decrease of $64 thousand over
the same period in 2004 as a result of lower legal, processing, recordkeeping
and administration costs.
At June 30, 2005 and 2004, there were no Securing Mortgage Loans on
nonaccrual status.
SIX MONTHS ENDED JUNE 30, 2005 COMPARED WITH JUNE 30, 2004
The Company's net income for the six months ended June 30, 2005 was $9.4
million. This represented a $2.1 million increase or 28% from 2004 earnings.
Earnings increased primarily because of the increase in the investment portfolio
of mortgage-backed securities which improved the overall yield on earning
assets.
Interest income on securities purchased under agreement to resell for the
six months ended June 30, 2005 was $451 thousand, a decrease of $332 thousand
from the same period in 2004, because the average outstandings declined by $100
million partially offset by an increase in the market rate over the same period.
Interest income on the Notes for the six months ended June 30, 2005 totaled $355
thousand and yielded 6.4% on $11 million of average principal outstanding
compared to $492 thousand of income yielding 6.4% on $15 million of average
principal outstanding for the same period in 2004. 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 $14 million for the six months ended June 30, 2005 and $19
million for the same period in 2004. There were no Company borrowings during
either period. Interest income on securities available-for-sale for the six
months ended June 30, 2005 was $9.2 million resulting in a yield of 4.2% on an
average balance of $435 million, compared to $6.0 million resulting in a yield
of 4.3% on an average balance of $277 million a year ago. The increase in
interest income from available-for-sale securities is primarily attributable to
the increase in the portfolio of mortgage-backed securities.
Operating expenses for the six months ended June 30, 2005 totaled $216
thousand, a decrease of $58 thousand from a year ago. Loan servicing expenses
for the six months ended June 30, 2005 totaled $16 thousand, a decrease of $8
thousand or 33% from 2004. 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, 2005 were $65 thousand
compared to $57 thousand a year ago; primarily attributable to increased
internal costs for processing, recordkeeping and administration. General and
administrative expenses totaled $135 thousand, a decrease of $58 thousand or 30%
over the same period in 2004 as a result of reduced costs for insurance,
compliance, printing and processing costs.
7
HARRIS PREFERRED CAPITAL CORPORATION
On June 30, 2005, the Company paid a cash dividend of $0.46094 per share on
outstanding preferred shares to the stockholders of record on June 15, 2005, as
declared on June 2, 2005. On June 30, 2004, the Company paid a cash dividend of
$0.46094 per share on outstanding preferred shares to the stockholders of record
on June 15, 2004, as declared on June 1, 2004. On 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, 2005 and 2004.
At June 30, 2005, net unrealized losses on available-for-sale securities
were $3.5 million compared to $7.1 million of unrealized losses at June 30, 2004
and $1.3 million of unrealized losses at December 31, 2004. The unrealized loss
positions at June 30, 2005 and 2004 and December 31, 2004 were attributed to
changes in interest rates and not to lowered credit quality of individual
securities and therefore management believes these losses are temporary.
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 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 $9.7 million provided from operations
during the six months ended June 30, 2005 were $1.6 million provided by
principal repayments on the Notes and $113.9 million from the maturities of
securities available-for-sale. In the prior period ended June 30, 2004, the
primary sources of funds other than $6.3 million from operations were $2.5
million provided by principal repayments on the Notes and $526.8 million from
the maturities and sales of securities available-for-sale. The primary uses of
funds for the six months ended June 30, 2005 were $113.6 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, 2004, the primary uses of
funds were $516.9 million for purchases of securities available-for-sale and
$9.2 million in preferred stock dividends paid.
MARKET RISK MANAGEMENT
The Company's market risk is composed primarily of interest rate risk.
There have been no material changes in market risk or the manner in which the
Company manages market risk since December 31, 2004.
8
HARRIS PREFERRED CAPITAL CORPORATION
OTHER MATTERS
As of June 30, 2005, 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 N.A.
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.
On May 27, 2005, Harris Bankcorp, Inc., the Bank's parent company,
consolidated twenty-six of its separate bank subsidiaries in Illinois (including
Harris Trust and Savings Bank, the parent company of Harris Capital Holdings,
Inc. at that date) into one national bank, Harris N.A. Each outstanding share of
the Company's Series A Preferred Stock became automatically exchangeable for one
newly issued preferred share of Harris N.A. under the same exchange conditions
previously in existence for preferred shares of Harris Trust and Savings Bank,
except that the primary regulator for purposes of the exchange conditions will
be the Office of the Comptroller of the Currency, not the Board of Governors of
the Federal Reserve Bank. References herein to the "Bank" for those times prior
to the charter consolidation are intended to refer to Harris Trust and Savings
Bank.
Financial statements are presented for the Bank using the historical cost
basis for all combining entities, similar to pooling-of-interests accounting.
Results for prior periods have been restated assuming the combination had taken
place before the earliest period presented.
9
HARRIS N.A. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CONDITION
JUNE 30 DECEMBER 31 JUNE 30
2005 2004 2004
----------- ----------- -----------
(UNAUDITED)
(IN THOUSANDS EXCEPT SHARE DATA)
ASSETS
Cash and demand balances due from banks..................... $ 910,664 $ 947,580 $ 1,177,624
Money market assets:
Interest-bearing deposits at banks...................... 667,715 662,366 410,117
Federal funds sold...................................... 180,666 94,950 466,843
Securities available-for-sale (including $3.07 billion,
$4.27 billion, and $2.78 billion of securities pledged as
collateral for repurchase agreements at June 30, 2005,
December 31, 2004 and June 30, 2004, respectively)........ 7,459,925 7,154,743 6,896,661
Trading account assets...................................... 127,493 90,130 94,878
Loans....................................................... 21,567,937 20,218,993 19,146,078
Allowance for loan losses................................... (308,942) (316,575) (329,937)
----------- ----------- -----------
Net loans............................................... 21,258,995 19,902,418 18,816,141
Premises and equipment...................................... 407,880 455,211 442,916
Bank-owned insurance........................................ 1,092,776 1,072,660 1,053,436
Loans held for sale......................................... 51,237 43,423 122,432
Goodwill and other intangible assets........................ 298,615 306,760 315,280
Other assets................................................ 622,688 594,085 635,913
----------- ----------- -----------
TOTAL ASSETS.......................................... $33,078,654 $31,324,326 $30,432,241
=========== =========== ===========
LIABILITIES
Deposits in domestic offices -- noninterest-bearing......... $ 5,251,930 $5,372,605 $ 5,254,300
-- interest-bearing............... 16,402,911 15,646,690 15,747,746
Deposits in foreign offices -- interest-bearing............. 1,207,928 1,677,428 1,016,051
----------- ----------- -----------
Total deposits........................................ 22,862,769 22,696,723 22,018,097
Federal funds purchased and securities sold under agreement
to repurchase............................................. 4,207,670 4,613,046 4,330,817
Short-term borrowings....................................... 1,622,430 120,795 447,897
Short-term senior notes..................................... 400,000 200,000 100,000
Accrued interest, taxes and other expenses.................. 214,655 227,539 216,327
Other liabilities........................................... 281,500 289,131 218,289
Minority interest-preferred stock of subsidiary............. 250,000 250,000 250,000
Preferred stock issued to Harris Bankcorp, Inc. ............ -- 5,000 5,000
Long-term notes -- senior................................... 250,000 -- --
Long-term notes -- subordinated............................. 292,750 292,750 292,750
----------- ----------- -----------
TOTAL LIABILITIES..................................... 30,381,774 28,694,984 27,879,177
----------- ----------- -----------
STOCKHOLDER'S EQUITY
Common stock ($10 par value); 40,000,000 shares authorized,
13,487,257 shares issued and outstanding.................. 134,873 134,873 134,873
Surplus..................................................... 1,062,631 1,061,314 1,056,771
Retained earnings........................................... 1,536,991 1,477,163 1,413,392
Accumulated other comprehensive loss........................ (37,615) (44,008) (51,972)
----------- ----------- -----------
TOTAL STOCKHOLDER'S EQUITY............................ 2,696,880 2,629,342 2,553,064
----------- ----------- -----------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY............ $33,078,654 $31,324,326 $30,432,241
=========== =========== ===========
The accompanying notes to consolidated financial statements are an integral part
of these statements.
10
HARRIS N.A. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
SIX MONTHS ENDED
QUARTER ENDED JUNE 30 JUNE 30
--------------------- -------------------
2005 2004 2005 2004
--------- --------- -------- --------
(IN THOUSANDS)
INTEREST INCOME
Loans................................................... $286,959 $231,425 $553,682 $453,890
Money market assets:
Deposits at banks..................................... 2,362 882 4,567 1,759
Federal funds sold and securities purchased under
agreement to resell................................. 1,622 1,295 3,167 1,909
Trading accounts........................................ 1,449 622 2,577 994
Securities available-for-sale:
U.S. Treasury and federal agency...................... 39,921 34,425 72,354 74,615
State and municipal................................... 4,783 4,862 9,267 9,719
Other................................................. 4,587 2,664 8,609 3,484
-------- -------- -------- --------
Total interest income................................. 341,683 276,175 654,223 546,370
-------- -------- -------- --------
INTEREST EXPENSE
Deposits................................................ 101,781 57,864 189,069 115,594
Short-term borrowings................................... 36,361 10,388 63,763 20,695
Senior notes............................................ 4,147 1,273 5,887 1,399
Minority interest-dividends on preferred stock of
subsidiary............................................ 4,609 4,609 9,218 9,218
Long-term notes......................................... 2,390 2,326 4,581 5,279
-------- -------- -------- --------
Total interest expense................................ 149,288 76,460 272,518 152,185
-------- -------- -------- --------
NET INTEREST INCOME..................................... 192,395 199,715 381,705 394,185
Provision for loan losses............................... 1,292 3,760 3,441 27,035
-------- -------- -------- --------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES..... 191,103 195,955 378,264 367,150
-------- -------- -------- --------
NONINTEREST INCOME
Trust and investment management fees.................... 23,667 23,246 47,093 46,324
Money market and bond trading........................... 2,542 3,574 5,132 5,687
Foreign exchange........................................ 1,425 1,435 2,640 3,160
Service charges and fees................................ 32,842 33,480 62,327 65,684
Net securities gains (losses)........................... 157 14,113 (80) 25,424
Bank-owned insurance.................................... 9,880 10,116 20,126 20,504
Gains from loan restructuring........................... -- -- -- 7,131
Letter of credit fees................................... 4,958 5,820 10,488 12,033
Other................................................... 29,121 29,983 59,098 62,692
-------- -------- -------- --------
Total noninterest income.............................. 104,592 121,767 206,824 248,639
-------- -------- -------- --------
NONINTEREST EXPENSES
Salaries and other compensation......................... 90,484 91,219 179,870 182,829
Pension, profit sharing and other employee benefits..... 27,116 27,091 53,567 53,576
Net occupancy........................................... 18,131 15,230 34,791 31,329
Equipment............................................... 13,199 14,325 26,681 28,258
Marketing............................................... 10,258 9,243 18,796 18,052
Communication and delivery.............................. 4,537 5,599 10,551 11,636
Expert services......................................... 5,770 6,424 11,973 12,250
Contract programming.................................... 6,613 5,268 14,081 13,558
Other................................................... 31,978 29,851 66,042 59,559
-------- -------- -------- --------
208,086 204,250 416,352 411,047
Amortization of intangibles............................. 4,068 4,124 8,146 8,289
-------- -------- -------- --------
Total noninterest expenses............................ 212,154 208,374 424,498 419,336
-------- -------- -------- --------
Income before income taxes.............................. 83,541 109,348 160,590 196,453
Applicable income taxes................................. 25,453 36,106 49,700 63,617
-------- -------- -------- --------
NET INCOME............................................ $ 58,088 $ 73,242 $110,890 $132,836
======== ======== ======== ========
The accompanying notes to consolidated financial statements are an integral part
of these statements.
11
HARRIS N.A. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
QUARTER ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
----------------- -------------------
2005 2004 2005 2004
------- ------- -------- --------
(IN THOUSANDS)
Net income........................................... $58,088 $73,242 $110,890 $132,836
Other comprehensive income (loss):
Cash flow hedges:
Net unrealized gain (loss) on derivative
instruments, net of tax expense (benefit) for
the quarter of $4,793 in 2005 and ($461) in
2004 and net of tax (benefit) year-to-date
period of ($540) in 2005 and ($541) in 2004... 8,161 (784) (919) (921)
Minimum pension liability adjustment net of tax
expense for the quarter of zero in 2005 and
$2,368 in 2004 and net of tax expense for the
year-to-date period of zero in 2005 and $2,290
in 2004......................................... -- (2,368) -- (2,490)
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 $4,924 in 2005 and ($36,169) in
2004 and net of tax expense (benefit) for the
year-to-date period of $3,889 in 2005 and
($34,472) in 2004............................. 9,158 (55,566) 7,263 (53,498)
Less reclassification adjustment for realized
(gains) losses included in income statement,
net of tax expense for the quarter of $61 in
2005 and $5,489 in 2004 and net of tax
(benefit) expense for the year-to-date period
of ($31) in 2005 and $9,976 in 2004........... (96) (8,624) 49 (15,448)
------- ------- -------- --------
Other comprehensive income (loss).................. 17,223 (67,342) 6,393 (72,357)
------- ------- -------- --------
Comprehensive income................................. $75,311 $ 5,900 $117,283 $ 60,479
======= ======= ======== ========
The accompanying notes to consolidated financial statements are an integral part
of these statements.
12
HARRIS N.A. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY
(UNAUDITED)
2005 2004
---------- ----------
(IN THOUSANDS)
BALANCE AT JANUARY 1........................................ $2,629,342 $2,521,778
Net income................................................ 110,890 132,836
Contributions to capital.................................. 1,317 7,512
Contribution of parent's banking assets................... -- 36,938
Dividend of non-bank subsidiary........................... -- (5,357)
Adjustment of prior quarters' preferred dividends......... -- 767
Dividends -- preferred stock.............................. (62) (53)
Dividends -- common stock................................. (51,000) (69,000)
Other comprehensive income (loss)......................... 6,393 (72,357)
---------- ----------
BALANCE AT JUNE 30.......................................... $2,696,880 $2,553,064
========== ==========
The accompanying notes to consolidated financial statements are an integral part
of these statements.
13
HARRIS N.A. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30
-------------------------
2005 2004
----------- -----------
(IN THOUSANDS)
OPERATING ACTIVITIES:
Net Income................................................ $ 110,890 $ 132,836
Adjustments to reconcile net income to net cash provided
by operating activities:
Provision for loan losses.............................. 3,441 27,035
Depreciation and amortization, including intangibles... 35,601 38,983
Deferred tax (benefit) expense......................... (34,347) (4,535)
Net loss (gain) on sales of securities................. 80 (25,424)
Increase in bank-owned insurance....................... (20,116) (19,950)
Trading account net cash purchases..................... (17,954) (43,980)
Net increase (decrease) in interest receivable......... (8,118) 11,282
Net increase (decrease) in interest payable............ 15,811 (5,361)
Net (increase) decrease in loans held for sale......... (7,814) 46,472
Other, net............................................. 10,269 31,366
----------- -----------
Net cash provided by operating activities.............. 87,743 188,724
----------- -----------
INVESTING ACTIVITIES:
Net increase (decrease) in interest-bearing deposits at
banks.................................................. (5,349) 14,448
Net increase in Federal funds sold and securities
purchased under agreement to resell.................... (85,716) (381,971)
Proceeds from sales of securities available-for-sale...... 86,564 2,418,548
Proceeds from maturities of securities
available-for-sale..................................... 2,465,697 3,332,459
Purchases of securities available-for-sale................ (2,875,727) (4,424,980)
Net increase in loans..................................... (1,372,648) (1,168,920)
Purchases of premises and equipment....................... (33,048) (38,862)
Other, net................................................ 107,859 1,753
----------- -----------
Net cash used by investing activities.................. (1,712,368) (247,525)
----------- -----------
FINANCING ACTIVITIES:
Cash received in contribution of parent's banking
assets................................................. -- 3,380
Net increase in deposits.................................. 97,349 332,441
Net decrease in Federal funds purchased and securities
sold under agreement to repurchase..................... (405,376) (319,869)
Net increase in other short-term borrowings............... 1,501,736 310,895
Proceeds from issuance of senior notes.................... 1,400,000 1,130,000
Repayment of senior notes................................. (950,000) (1,030,000)
Proceeds from issuance of long-term notes................. -- 206,250
Repayment of long-term notes.............................. -- (225,000)
Cash dividends paid on common stock....................... (51,000) (69,000)
Cash portion of dividend of non-bank subsidiary........... -- (5,076)
Retirement of preferred stock............................. (5,000) --
----------- -----------
Net cash provided by financing activities.............. 1,587,709 334,021
----------- -----------
NET (DECREASE) INCREASE IN CASH AND DEMAND BALANCES DUE
FROM BANKS............................................ (36,916) 275,220
CASH AND DEMAND BALANCES DUE FROM BANKS AT JANUARY 1... 947,580 902,404
----------- -----------
CASH AND DEMAND BALANCES DUE FROM BANKS AT JUNE 30..... $ 910,664 $ 1,177,624
=========== ===========
The accompanying notes to consolidated financial statements are an integral part
of these statements.
14
HARRIS N.A. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
Harris N.A. (the "Bank") is a wholly-owned subsidiary of Harris Bankcorp,
Inc. ("Bankcorp"), a wholly-owned subsidiary of Harris 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.
On May 27, 2005 Bankcorp consolidated 26 of its individually chartered bank
subsidiaries (including Harris Trust and Savings Bank) into one national bank,
Harris N.A. The combination was recorded at historical carrying value and prior
year financial statements have been restated. Harris N.A. is subject to
regulation by the Office of the Comptroller of the Currency.
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 $256.7 million
and $157.4 million in 2005 and 2004, respectively. Cash income tax payments over
the same periods totaled $40.2 million and $27.6 million, respectively.
4. GOODWILL AND OTHER INTANGIBLE ASSETS
The Bank records goodwill and other intangible assets in connection with
the acquisition of assets from unrelated parties or the acquisition of new
subsidiaries. Goodwill and other intangible assets that have indefinite useful
lives are not subject to amortization while intangible assets with finite lives
are amortized. Goodwill is periodically assessed for impairment, at least
annually. Intangible assets with finite lives are amortized on either an
accelerated or straight-line basis depending on the character of the acquired
asset. Intangible assets 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 was $214 million at both June 30,
2005 and 2004, respectively. No impairment was recorded during the quarter ended
June 30, 2005.
Besides goodwill, the Bank did not have any intangible assets not subject
to amortization as of June 30, 2005 and 2004.
15
HARRIS N.A. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
As of June 30, 2005, the gross carrying amount and accumulated amortization
of the Bank's amortizable intangible assets are included in the following table.
JUNE 30,
-------------------
JUNE 30, 2005 2005 2004
----------------------- -------- --------
GROSS NET 2004 NET
CARRYING ACCUMULATED CARRYING CARRYING
AMOUNT AMORTIZATION VALUE VALUE
-------- ------------ -------- --------
(IN THOUSANDS)
Branch network.................................... $145,000 $ (87,000) $58,000 $ 67,667
Core deposits..................................... 53,161 (26,172) 26,989 33,662
-------- --------- ------- --------
Total finite life intangibles................... $198,161 $(113,172) $84,989 $101,329
======== ========= ======= ========
Total amortization expense for the Bank's intangible assets was $4.1
million for each of the quarters ended June 30, 2005 and June 30, 2004.
Estimated intangible asset amortization expense (assuming the current level
of intangible assets) for the years ending December 31, 2005, 2006, 2007, 2008
and 2009 is $16.3 million, $16.3 million, $16.2 million, $16.2 million and $13.3
million, respectively.
5. SALE OF BUILDING
On March 1, 2005, the Bank sold to a third party the land and building
located at 111 W. Monroe Street in Chicago. Upon sale, the Bank entered into a
leaseback agreement for approximately 50 percent of the building space with an
average lease term of 16 years. The leaseback agreement meets the criteria to be
recorded as an operating lease. The sale resulted in a gain of $55.8 million,
all of which was deferred and will be amortized over the term of the leaseback.
16
HARRIS N.A. AND SUBSIDIARIES
FINANCIAL REVIEW
SECOND QUARTER 2005 COMPARED WITH SECOND QUARTER 2004
SUMMARY
The Bank had second quarter 2005 net income of $58.1 million, a decrease of
$15.2 million or 21 percent from second quarter 2004.
Second quarter net interest income on a fully taxable equivalent basis was
$197.8 million, down $6.8 million or 3 percent from $204.6 million in 2004's
second quarter. Average earning assets increased 7 percent to $29.66 billion
from $27.69 billion in 2004, due in part to an increase of $2.1 billion in
average loans. Net interest margin decreased to 2.67 percent in the current
quarter from 2.97 percent in the year-ago quarter, reflecting the impact of
higher rates on deposits and the issuance of higher-cost incremental wholesale
supporting funds. This was somewhat offset by higher yields in the loan
portfolio and solid loan growth, particularly retail loans.
The second quarter 2005 provision for loan losses of $1.3 million was down
from $3.8 million in the second quarter of 2004. Net charge-offs decreased to
$2.2 million from $11.2 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 will result in potentially lower loan
losses.
Second quarter noninterest income of $104.6 million decreased $17.1 million
or 14 percent from the same quarter last year. This was largely attributable to
a reduction in gains from sales of investment securities amounting to $14.0
million. Money market and bond trading income decreased by $1.0 million and
letter of credit fees declined $0.9 million.
Second quarter 2005 noninterest expenses of $212.2 million increased $3.9
million from the year ago quarter. The increase reflects higher occupancy costs
of $2.9 million related to the sale of a building in 2005 and higher expenses
for outsourced administrative and technology activities of $2.3 million,
partially offset by lower equipment expense of $1.1 million. Income tax expense
decreased $10.7 million, reflecting lower pretax income from year ago results.
Nonperforming assets at June 30, 2005 were $146 million or 0.68 percent of
total loans, down from $151 million or 0.72 percent at March 31, 2005, and $166
million or 0.75 percent a year ago. At June 30, 2005, the allowance for possible
loan losses was $309 million, equal to 1.43 percent of loans outstanding,
compared to $330 million or 1.72 percent of loans outstanding at the end of
second quarter 2004. As a result, the ratio of the allowance for possible loan
losses to nonperforming assets increased from 198 percent at June 30, 2004 to
211 percent at June 30, 2005.
At June 30, 2005, Tier 1 capital of the Bank amounted to $2.66 billion, up
from $2.53 billion one year earlier. The regulatory leverage capital ratio was
8.15 percent for the second quarter of 2005 compared to 8.31 percent in the same
quarter of 2004. The Bank's capital ratio exceeds the prescribed regulatory
minimum for banks. The Bank's June 30, 2005 Tier 1 and total risk-based capital
ratios were 9.46 percent and 11.61 percent compared to respective ratios of 9.89
percent and 12.28 percent at June 30, 2004.
SIX MONTHS ENDED JUNE 30, 2005 COMPARED WITH JUNE 30, 2004
SUMMARY
The Bank had net income for the six months ended June 30, 2005 of $110.9
million, a decrease of $21.9 million or 17 percent from the same period a year
ago.
Net interest income on a fully taxable equivalent basis was $391.7 million,
down $12.6 million or 3 percent from $404.3 million in 2004's year-to-date
period. Average earning assets increased 7 percent to $29.13 billion from $27.26
billion in 2004. Net interest margin decreased to 2.70 percent from 2.99 percent
in 2004, reflecting the impact of higher rates on deposits and the issuance of
higher-cost incremental wholesale supporting funds. This was somewhat offset by
higher yields in the loan portfolio and strong retail loan growth.
17
HARRIS N.A. AND SUBSIDIARIES
The year-to-date 2005 provision for loan losses of $3.4 million was down
$23.6 million from $27.0 million in 2004. Net charge-offs were $11.1 million, a
decrease of $11.0 million from last year, resulting from lower commercial loan
write-offs. The decrease in provision resulted from a reduction in net
charge-offs and management's assessment that declining non-performing loan
levels will result in potentially lower loan losses.
Noninterest income of $206.8 million decreased $41.8 million or 17 percent
from the same period last year. This was largely due to a reduction in gains
from sales of securities amounting to $25.5 million, a $7.1 million gain
realized in 2004 by the Bank on the sale of assets received in an earlier
troubled debt restructuring and a $7.7 million gain realized in 2004 by the Bank
on the termination of a swap. Additionally, service fees and charges decreased
by $3.4 million, mortgage origination fees decreased $2.7 million and mutual
fund fees decreased $2.1 million. This was somewhat offset by higher ATM and
debit card fees, commissions and syndication fees.
Noninterest expenses of $424.5 million increased $5.2 million or 1 percent
from the year-ago period. The increase reflects higher expenses for outsourced
administrative and technology activities of $8.9 million and higher occupancy
costs of $3.5 million related to the sale of a building in 2005. This was
partially offset by lower employment costs, including benefits, of $3.0 million
and lower equipment expense of $1.6 million. Income tax expense decreased $13.9
million, reflecting lower 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 and Results of
Operations on page 6.
ITEM 4. CONTROLS AND PROCEDURES
As of June 30, 2005, 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 recorded, processed, summarized
and made known to them in a timely fashion, as appropriate to allow timely
discussion regarding disclosures. There was no change in the Company's internal
control over financial reporting identified in connection with such evaluations
that occurred during the quarter ended June 30, 2005 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. 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
19
SIGNATURES
Pursuant to the requirements 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
2005.
/s/ PAUL R. SKUBIC
--------------------------------------
Paul R. Skubic
Chief Executive Officer
/s/ JANINE MULHALL
--------------------------------------
Janine Mulhall
Chief Financial Officer
20