--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
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, 2006
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 ON
TITLE OF EACH CLASS 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 a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act. (Check one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X]
Indicate by check mark whether the registrant is a shell company ( 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 14, 2006 was 1,000. No common equity is held by nonaffiliates.
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
HARRIS PREFERRED CAPITAL CORPORATION
TABLE OF CONTENTS
Part I FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets................................. 2
Consolidated Statements of Income and Comprehensive 3
Income......................................................
Consolidated Statements of Changes in Stockholders' 4
Equity......................................................
Consolidated Statements of Cash Flows....................... 5
Notes to Consolidated Financial Statements.................. 6
Item 2. Management's Discussion and Analysis of Financial Condition 6
and Results of Operations...................................
Item 3. Quantitative and Qualitative Disclosures about Market 18
Risk........................................................
Item 4. Controls and Procedures..................................... 18
Part II OTHER INFORMATION
Item 6. Exhibits.................................................... 18
Signatures................................................................... 19
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HARRIS PREFERRED CAPITAL CORPORATION
CONSOLIDATED BALANCE SHEETS
JUNE 30, DECEMBER 31, JUNE 30,
2006 2005 2005
----------- ------------ -----------
(UNAUDITED) (AUDITED) (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
Cash on deposit with Harris N.A........................... $ 1,192 $ 700 $ 438
Securities purchased from Harris N.A. under agreement to
resell.................................................. 16,069 20,500 13,000
Notes receivable from Harris N.A.......................... 7,219 8,684 10,504
Securities available-for-sale:
Mortgage-backed...................................... 343,947 373,584 431,355
U.S. Treasury........................................ 104,888 74,946 29,981
Other assets.............................................. 1,420 1,461 1,664
-------- -------- --------
TOTAL ASSETS....................................... $474,735 $479,875 $486,942
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accrued expenses.......................................... $ 95 $ 129 $ 93
-------- -------- --------
Commitments and contingencies............................. -- -- --
STOCKHOLDERS' EQUITY
7 3/8% Noncumulative Exchangeable Preferred Stock, Series
A ($1 par value); liquidation value of $250,000,000 and
20,000,000 shares authorized, 10,000,000 shares issued
and outstanding......................................... 250,000 250,000 250,000
Common stock ($1 par value); 1,000 shares authorized,
issued and outstanding.................................. 1 1 1
Additional paid-in capital................................ 240,733 240,733 240,733
Earnings in excess of (less than) distributions........... 956 (2) (379)
Accumulated other comprehensive loss -- net unrealized
losses on available-for-sale securities................. (17,050) (10,986) (3,506)
-------- -------- --------
TOTAL STOCKHOLDERS' EQUITY......................... 474,640 479,746 486,849
-------- -------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY......... $474,735 $479,875 $486,942
======== ======== ========
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,
----------------- -----------------
2006 2005 2006 2005
------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
INTEREST INCOME:
Securities purchased from Harris N.A. under agreement
to resell......................................... $ 1,256 $ 251 $ 2,270 $ 451
Notes receivable from Harris N.A..................... 119 171 249 355
Securities available-for-sale:
Mortgage-backed................................... 3,796 4,423 7,691 8,795
U.S. Treasury..................................... 105 17 203 36
------- ------- ------- -------
Total interest income........................... 5,276 4,862 10,413 9,637
OPERATING EXPENSES:
Loan servicing fees paid to Harris N.A............... 6 8 12 16
Advisory fees........................................ 30 41 61 65
General and administrative........................... 78 33 164 135
------- ------- ------- -------
Total operating expenses........................ 114 82 237 216
------- ------- ------- -------
Net income............................................. 5,162 4,780 10,176 9,421
Preferred dividends.................................... 4,609 4,609 9,218 9,218
------- ------- ------- -------
NET INCOME AVAILABLE TO COMMON STOCKHOLDER............. $ 553 $ 171 $ 958 $ 203
======= ======= ======= =======
Basic and diluted earnings per common share............ $553.00 $171.00 $958.00 $203.00
======= ======= ======= =======
Net income............................................. $ 5,162 $ 4,780 $10,176 $ 9,421
Other comprehensive (loss) income -- net unrealized
(losses)/gains on available-for-sale securities...... (2,774) 4,200 (6,064) (2,242)
------- ------- ------- -------
Comprehensive income................................... $ 2,388 $ 8,980 $ 4,112 $ 7,179
======= ======= ======= =======
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,
-----------------------
2006 2005
---------- ----------
(IN THOUSANDS,
EXCEPT PER SHARE DATA)
Balance at January 1........................................ $479,746 $488,888
Net income................................................ 10,176 9,421
Other comprehensive loss.................................. (6,064) (2,242)
Dividends (preferred stock $0.4609 per share)............. (9,218) (9,218)
-------- --------
Balance at June 30.......................................... $474,640 $486,849
======== ========
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,
---------------------
2006 2005
--------- ---------
(IN THOUSANDS)
OPERATING ACTIVITIES:
Net Income................................................ $ 10,176 $ 9,421
Adjustments to reconcile net income to net cash provided
by operating activities:
Decrease (increase) in other assets.................... 41 (64)
Net decrease in accrued expenses....................... (34) (41)
--------- ---------
Net cash provided by operating activities............ 10,183 9,316
--------- ---------
INVESTING ACTIVITIES:
Decrease (increase) in securities purchased from Harris
N.A. under agreement to resell......................... 4,431 (2,500)
Repayments of notes receivable from Harris N.A............ 1,465 1,625
Decrease in securing mortgage collections due from Harris
N.A.................................................... -- 78
Purchases of securities available-for-sale................ (205,174) (113,187)
Proceeds from maturities and paydowns of securities
available-for-sale..................................... 198,805 113,917
--------- ---------
Net cash used by investing activities................ (473) (67)
--------- ---------
FINANCING ACTIVITIES:
Cash dividends paid on preferred stock.................... (9,218) (9,218)
--------- ---------
Net Cash used in financing activities................ (9,218) (9,218)
--------- ---------
Net increase in cash on deposit with Harris N.A........... 492 31
Cash on deposit with Harris N.A. at beginning of period... 700 407
--------- ---------
Cash on deposit with Harris N.A. at end of period......... $ 1,192 $ 438
========= =========
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 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 2005 Form 10-K. Certain reclassifications were made to
conform prior years' financial statements to the current year's presentation.
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 Item 1A. "Risk
Factors" in the Company's 2005 Form 10-K and 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 2006 COMPARED WITH SECOND QUARTER 2005
The Company's net income for the second quarter of 2006 was $5.2 million,
an 8% increase from the second quarter 2005 net income of $4.8 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 of 2006 was $1.3 million, on an average balance of $87.8 million,
with an average rate of 5.7%. During the same period in 2005, the interest
income on securities purchased under agreement to resell was $251 thousand on an
average balance of $32.4 million, with an average rate of 3.1%. Second quarter
2006 interest income on the Notes totaled $119 thousand and yielded 6.4% on $7.4
million of average principal outstanding for the quarter compared to $171
thousand and a 6.4% yield on $10.7 million average principal outstanding for
second quarter 2005. The decrease in income was attributable to a reduction in
the Note balance because of principal paydowns by customers on the Securing
Mortgage Loans. Interest income on securities available-for-sale for the current
quarter was $3.9 million resulting in a yield of 4.4% on an average balance of
$359 million, compared to $4.4 million with a yield of 4.1% on an average
balance of $433 million for the same period a year ago. The decrease in the
interest income is primarily attributable to the decrease in the investment
portfolio of mortgage-backed securities.
There were no Company borrowings during second quarter 2006 or 2005.
Second quarter 2006 operating expenses totaled $114 thousand, an increase
of $32 thousand or 39% from the second quarter of 2005. Loan servicing expenses
totaled $6 thousand, a decrease of $2 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 2006 were $30 thousand compared to $41 thousand a year earlier. General
and administrative expenses totaled $78 thousand, an increase of $45 thousand
over the same period in 2005 primarily as a result of credits for printing and
processing costs received in 2005 for prior periods.
At June 30, 2006 and 2005, there were no Securing Mortgage Loans on
nonaccrual status.
The company classifies all securities as available-for-sale, even if the
Company has no current plans to divest. Available-for-sale securities are
reported at fair value with unrealized gains and losses included as a separate
component of stockholders' equity. At June 30, 2006, net unrealized losses on
available-for-sale securities were $17.1 million compared to $3.5 million of
unrealized losses on June 30, 2005 and $11.0 million of unrealized losses at
December 31, 2005. The unrealized loss positions at June 30, 2006 and 2005 and
December 31, 2005 were attributed to changes in interest rates and not to
lowered credit quality of individual securities; therefore management believes
these unrealized losses are temporary.
SIX MONTHS ENDED JUNE 30, 2006 COMPARED WITH JUNE 30, 2005
The Company's net income for the six months ended June 30, 2005 was $10.2
million. This represented a $755 thousand increase or 8% from 2005 earnings.
Earnings increased primarily because of an increase in balances of securities
purchased under agreement to resell.
Interest income on securities purchased under agreement to resell for the
six months ended June 30, 2006 was $2.3 million, on an average balance of $82.6
million, with an average rate of 5.5%. During the same period in 2005, the
interest income on securities purchased under agreement to resell was $451
thousand on an average balance of $32.4 million, with an average rate of 2.8%.
Interest income on the Notes for the six months ended June 30,2006 totaled $249
thousand, yielding 6.4% on $7.8 million of average principal outstanding
compared to $355 thousand of income yielding 6.4% on $11 million of average
principal outstanding for the same period in 2005. 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 $10 million for the six months ended June 30, 2006 and $14
million for the same period in 2005. There were no Company borrowings during
either period. Interest income on securities available-for-sale for the six
months ended June 30, 2006 was $7.9 million resulting in a yield of 4.3% on an
average balance of $365 million, compared to $8.8 million resulting in a yield
of 4.1% on an average balance of $435 million a year ago. The decrease in
interest income from available-for-sale securities is primarily attributable to
the decrease in the portfolio of mortgage-backed securities.
7
HARRIS PREFERRED CAPITAL CORPORATION
Operating expense for the six months ended June 30, 2006 totaled $237
thousand, an increase of $21 thousand from a year ago. Loan servicing expenses
for the six months ended June 30, 2006 totaled $12 thousand, a decrease of $4
thousand or 25% from 2005. 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, 2006 were $61 thousand
compared to $65 thousand a year ago. General and administrative expenses totaled
$164 thousand, an increase of $29 thousand or 21% over the same period in 2005
as a result of increased costs for regulatory filings and prior year credits for
printing and processing costs received in 2005.
On June 30, 2006, the Company paid a cash dividend of $0.46094 per share on
outstanding Preferred Shares to the stockholders of record on June 15, 2006 as
declared on May 31, 2006. 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.
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 and U.S Treasury 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 $10.2 million provided from operations
during the six months ended June 30, 2006 were $1.5 million provided by
principal repayments on the Notes and $198.8 million from the maturities of
securities available-for-sale. In the prior period ended June 30, 2005, the
primary sources of funds other than $9.3 million from operations were $1.6
million provided by principal repayments on the Notes and $113.9 million from
the maturities of securities available-for-sale. The primary uses of funds for
the six months ended June 30, 2006 were $205.2 million for purchases of
securities available-for-sale and $9.2 million in preferred stock dividends
paid. For the prior year's period ended June 30, 2005, the primary uses of funds
were $113.2 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, 2005.
8
HARRIS PREFERRED CAPITAL CORPORATION
OTHER MATTERS
As of June 30, 2006, 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.
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America,
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
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.
9
HARRIS N.A. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CONDITION
(UNAUDITED)
JUNE 30, DECEMBER 31, JUNE 30,
2006 2005 2005
----------- ------------ -----------
(UNAUDITED) (AUDITED) (UNAUDITED)
(IN THOUSANDS EXCEPT SHARE DATA)
ASSETS
Cash and demand balances due from banks............... $ 988,329 $ 1,321,202 $ 925,768
Money market assets:
Interest-bearing deposits at banks.................. 1,201,761 1,007,411 667,915
Federal funds sold.................................. 595,010 303,130 180,666
Securities available-for-sale (including $4.20
billion, $3.79 billion, and $4.40 billion of
securities pledged as collateral for repurchase
agreements at June 30, 2006, December 31, 2005 and
June 30, 2005, respectively)........................ 7,138,656 6,513,873 7,648,285
Trading account assets................................ 256,747 181,121 127,493
Loans held for sale................................... 34,044 32,364 51,237
Loans................................................. 25,014,563 23,783,547 22,351,489
Allowance for loan losses............................. (319,438) (324,080) (314,798)
----------- ----------- -----------
Net loans........................................... 24,695,125 23,459,467 22,036,691
Premises and equipment................................ 449,453 436,609 429,730
Bank-owned insurance.................................. 1,136,601 1,115,172 1,092,776
Goodwill and other intangible assets.................. 343,560 353,439 318,626
Other assets.......................................... 709,841 805,575 697,462
----------- ----------- -----------
TOTAL ASSETS..................................... $37,549,127 $35,529,363 $34,176,649
=========== =========== ===========
LIABILITIES
Deposits in domestic offices -- noninterest-bearing... $ 6,522,870 $ 6,278,823 $ 5,536,027
-- interest-bearing..... 18,401,581 17,471,141 17,055,148
Deposits in foreign offices -- interest-bearing...... 1,531,854 1,270,741 1,207,928
----------- ----------- -----------
Total deposits................................... 26,456,305 25,020,705 23,799,103
Federal funds purchased and securities sold under
agreement to repurchase............................. 3,365,226 3,413,640 3,923,999
Short-term borrowings................................. 1,898,805 2,041,715 1,897,701
Short-term senior notes............................... 500,000 800,000 400,000
Accrued interest, taxes and other expenses............ 279,991 253,141 218,410
Other liabilities..................................... 374,656 261,065 296,447
Long-term notes -- senior............................. 996,500 250,000 250,000
Long-term notes -- subordinated....................... 292,750 292,750 292,750
Minority interest -- preferred stock of subsidiary.... 250,000 250,000 250,000
----------- ----------- -----------
TOTAL LIABILITIES................................ 34,414,233 32,583,016 31,328,410
----------- ----------- -----------
STOCKHOLDER'S EQUITY
Common stock ($10 par value); authorized 40,000,000
shares; issued and outstanding 13,905,513,
13,618,513 and 13,557,257 shares at June 30, 2006,
December 31, 2005 and June 30, 2005, respectively... 139,055 136,185 135,573
Surplus............................................... 1,358,808 1,204,450 1,155,158
Retained earnings..................................... 1,716,724 1,675,571 1,595,965
Accumulated other comprehensive loss.................. (79,693) (69,859) (38,457)
----------- ----------- -----------
TOTAL STOCKHOLDER'S EQUITY....................... 3,134,894 2,946,347 2,848,239
----------- ----------- -----------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY....... $37,549,127 $35,529,363 $34,176,649
=========== =========== ===========
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)
QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
2006 2005 2006 2005
-------- -------- -------- --------
(IN THOUSANDS)
INTEREST INCOME
Loans................................................... $380,346 $297,340 $739,850 $573,669
Money market assets:
Deposits at banks..................................... 3,361 2,363 6,637 4,569
Federal funds sold.................................... 7,078 1,622 10,060 3,167
Trading accounts........................................ 2,335 1,448 3,999 2,577
Securities available for sale:
U.S. Treasury and federal agency...................... 60,359 41,227 111,804 75,006
State and municipal................................... 5,724 4,889 11,004 9,486
Other................................................. 5,668 4,592 10,728 8,618
-------- -------- -------- --------
Total interest income................................. 464,871 353,481 894,082 677,092
-------- -------- -------- --------
INTEREST EXPENSE
Deposits................................................ 168,407 105,049 318,189 195,233
Short-term borrowings................................... 73,655 36,248 129,545 63,578
Short-term senior notes................................. 3,983 4,146 11,754 5,887
Long-term notes -- senior............................... 5,073 -- 8,543 --
Long-term notes -- subordinated......................... 3,904 2,390 7,450 4,580
Minority interest -- dividends on preferred stock of
subsidiary............................................ 4,610 4,610 9,219 9,219
-------- -------- -------- --------
Total interest expense................................ 259,632 152,443 484,700 278,497
-------- -------- -------- --------
NET INTEREST INCOME..................................... 205,239 201,038 409,382 398,595
Provision for loan losses............................... 5,661 2,118 11,307 5,092
-------- -------- -------- --------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES..... 199,578 198,920 398,075 393,503
-------- -------- -------- --------
NONINTEREST INCOME
Trust and investment management fees.................... 22,366 23,711 37,690 47,181
Money market and bond trading........................... 4,177 2,542 5,728 5,132
Foreign exchange........................................ 1,200 1,425 2,400 2,640
Service charges and fees................................ 33,878 33,533 66,308 63,678
Net securities gains (losses)........................... 2,455 157 2,352 (80)
Bank-owned insurance.................................... 10,856 9,880 21,440 20,126
Letter of credit fees................................... 4,601 5,003 9,538 10,571
Syndication fees........................................ 4,168 3,436 5,865 6,128
Other................................................... 17,675 26,080 34,014 53,753
-------- -------- -------- --------
Total noninterest income.............................. 101,376 105,767 185,335 209,129
-------- -------- -------- --------
NONINTEREST EXPENSES
Salaries and other compensation......................... 85,176 92,482 169,706 184,261
Pension, profit sharing and other employee benefits..... 26,583 27,623 56,916 54,604
Net occupancy........................................... 19,050 18,591 37,709 35,579
Equipment............................................... 16,004 13,554 31,199 27,383
Marketing............................................... 9,236 10,327 19,694 18,913
Communication and delivery.............................. 6,005 4,785 12,019 10,975
Expert services......................................... 7,782 5,770 17,255 11,973
Contract programming.................................... 6,484 6,613 14,074 14,081
Intercompany services................................... 13,891 6,180 28,868 16,993
Other................................................... 28,668 26,760 53,481 50,883
-------- -------- -------- --------
218,879 212,685 440,921 425,645
Amortization of intangibles............................. 5,018 4,883 10,042 9,936
-------- -------- -------- --------
Total noninterest expenses............................ 223,897 217,568 450,963 435,581
-------- -------- -------- --------
Income before income taxes.............................. 77,057 87,119 132,447 167,051
Applicable income taxes................................. 25,284 26,786 39,294 52,076
-------- -------- -------- --------
NET INCOME.............................................. $ 51,773 $ 60,333 $ 93,153 $114,975
======== ======== ======== ========
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
----------------- ------------------
2006 2005 2006 2005
------- ------- ------- --------
(IN THOUSANDS)
Net income............................................ $51,773 $60,333 $93,153 $114,975
Other comprehensive (loss) income:
Cash flow hedges:
Net unrealized gain (loss) on derivative
instruments, net of tax expense for the quarter
of $45 in 2006 and $5,779 in 2005 and net of
tax (benefit) expense year-to-date period of
($658) in 2006 and $350 in 2005................ 76 9,839 (1,122) 595
Less reclassification adjustment for realized
loss (gain) included in income statement, net
of tax (benefit) expense for the quarter of
($1,202) in 2006 and $986 in 2005 and net of
tax (benefit) expense year-to-date period of
($2,274) in 2006 and $889 in 2005.............. 2,048 (1,678) 3,872 (1,514)
Unrealized (loss) gain on available-for-sale
securities:
Unrealized holding (loss) gain arising during the
period, net of tax (benefit) expense for the
quarter of ($2,910) in 2006 and $4,574 in 2005
and net of tax (benefit) expense for the
year-to-date period of ($5,837) in 2006 and
$3,580 in 2005................................. (5,696) 10,169 (11,149) 6,844
Less reclassification adjustment for realized
(gain) loss included in income statement, net
of tax expense for the quarter of $957 in 2006
and $61 in 2005 and net of tax expense
(benefit) for the year-to-date period of $917
in 2006 and ($31) in 2005...................... (1,498) (95) (1,435) 50
------- ------- ------- --------
Other comprehensive (loss) income................... (5,070) 18,235 (9,834) 5,975
------- ------- ------- --------
Comprehensive income.................................. $46,703 $78,568 $83,319 $120,950
======= ======= ======= ========
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)
2006 2005
---------- ----------
(IN THOUSANDS)
BALANCE AT JANUARY 1........................................ $2,946,347 $2,774,752
Net income................................................ 93,153 114,975
Contributions to capital surplus.......................... 148,001 --
Issuance of common stock.................................. 2,870 --
Stock option exercise..................................... 6,357 3,599
Dividends -- preferred stock.............................. -- (62)
Dividends -- common stock................................. (51,000) (51,000)
Other comprehensive (loss) income......................... (9,834) 5,975
---------- ----------
BALANCE AT JUNE 30.......................................... $3,134,894 $2,848,239
========== ==========
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
-------------------------
2006 2005
----------- -----------
(IN THOUSANDS)
OPERATING ACTIVITIES:
Net Income.................................................. $ 93,153 $ 114,975
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses................................. 11,307 5,092
Depreciation and amortization, including intangibles...... 38,256 38,110
Deferred tax benefit (expense)............................ 36,152 (34,347)
Net (gain) loss on sales of securities.................... (2,352) 80
Increase in bank-owned insurance.......................... (21,429) (20,116)
Trading account net cash purchases........................ (53,285) (17,954)
Net increase in interest receivable....................... (11,472) (8,838)
Net increase (decrease) in interest payable............... 8,015 (15,418)
Origination of loans held for sale........................ (122,344) (202,946)
Proceeds from sale of loans held for sale................. 121,555 195,652
Net gain on loans held for sale........................... (891) (520)
Other, net................................................ 113,708 40,389
----------- -----------
Net cash provided by operating activities.............. 210,373 94,159
----------- -----------
INVESTING ACTIVITIES:
Net increase in interest-bearing deposits at banks........ (225,347) (5,349)
Net increase in Federal funds sold........................ (291,880) (85,716)
Proceeds from sales of securities available-for-sale...... 257 86,564
Proceeds from maturities of securities
available-for-sale..................................... 3,547,479 2,477,218
Purchases of securities available-for-sale................ (4,188,162) (2,875,727)
Net increase in loans..................................... (1,261,476) (1,426,623)
Net (purchases) sales of premises and equipment........... (41,058) 74,656
----------- -----------
Net cash used by investing activities.................. (2,460,187) (1,754,977)
----------- -----------
FINANCING ACTIVITIES:
Net increase in deposits.................................. 1,563,765 114,448
Net decrease in Federal funds purchased and securities
sold under agreement to repurchase..................... (48,414) (567,697)
Net (decrease) increase in other short-term borrowings.... (142,910) 1,683,556
Proceeds from issuance of short-term senior notes......... 1,345,000 1,400,000
Repayment of short-term senior notes...................... (1,645,000) (950,000)
Proceeds from issuance of long-term senior notes.......... 746,500 --
Proceeds from issuance of common stock.................... 150,000 --
Cash dividends paid on common stock....................... (52,000) (51,000)
Retirement of preferred stock............................. -- (5,000)
----------- -----------
Net cash provided by financing activities.............. 1,916,941 1,624,307
----------- -----------
NET DECREASE IN CASH AND DEMAND BALANCES DUE FROM
BANKS................................................. (332,873) (36,511)
CASH AND DEMAND BALANCES DUE FROM BANKS AT JANUARY 1... 1,321,202 962,279
----------- -----------
CASH AND DEMAND BALANCES DUE FROM BANKS AT JUNE 30..... $ 988,329 $ 925,768
=========== ===========
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 U.S. 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 February 17, 2006 Bankcorp merged one of its bank subsidiaries, New
Lenox State Bank, with and into Harris N.A. This transaction was recorded at its
carrying value and prior year financial statements have been restated.
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 $476.7 million
and $263.1 million in 2006 and 2005, respectively. Cash income tax payments over
the same periods totaled $65.8 million and $40.2 million, respectively.
15
HARRIS N.A. AND SUBSIDIARIES
FINANCIAL REVIEW
SECOND QUARTER 2006 COMPARED WITH SECOND QUARTER 2005
SUMMARY
The Bank had second quarter 2006 net income of $51.8 million, a decrease of
$8.6 million or 14 percent from second quarter 2005. Return on equity was 6.90
percent in the current quarter, compared to 8.62 percent from last year's second
quarter. Return on assets was 0.56 percent compared to 0.71 percent a year ago.
Second quarter net interest income on a fully taxable equivalent basis was
$212.7 million, up $6.2 million or 3 percent from $206.5 million in 2005's
second quarter. Average earning assets increased 10 percent to $33.57 billion
from $30.61 billion in 2005, due primarily to an increase of $2.6 billion in
average loans. Net interest margin decreased to 2.54 percent in the current
quarter from 2.70 percent in the year-ago quarter, primarily reflecting a flat
yield curve that depressed spreads on earnings assets and the impact of greater
reliance on higher-cost wholesale funding sources. This was somewhat offset by
strong loan growth, particularly in the retail loan portfolio, which are
generally higher yielding earnings assets.
The second quarter 2006 provision for loan losses was $5.7 million compared
to $2.1 million in the second quarter of 2005. Net charge-offs increased to $8.2
million from $2.3 million in the prior year. The credit profile of the loan
portfolio is expected to remain solid with moderate increases in default and
loss experiences in late 2006. The increase in the provision in the second
quarter of 2006 reflected charge-off activity and management's assessment of
non-performing loans.
Noninterest income was $101.4 million, a decrease of $4.4 million or 4
percent from the same quarter last year. This was primarily attributable to a
$5.9 million decline in intercompany service income, a $2.5 million decrease in
referral fees and a $1.3 million decrease in trust and investment management
fees. The decreases were partially offset by a $2.3 million increase in net
securities gains, a $1.6 million increase in money market and bond trading
income and $1.0 million higher in bank-owned insurance income.
Second quarter 2006 noninterest expenses of $223.9 million increased $6.3
million or 3 percent from the year ago quarter. The increase was primarily
attributable to intercompany service costs rising by $7.7 million and a $2.5
million increase in equipment expenditures. The increases were partially offset
by reduced salaries and other compensation expenses. Income tax expense
decreased $1.5 million, reflecting lower pretax income from prior year's
results. The effective tax rate was higher in this year's quarter as a result of
current second quarter settlements for prior years' tax returns.
Nonperforming assets at June 30, 2006 were $125 million or 0.50 percent of
total loans, down from $169 million or 0.69 percent at March 31, 2006, and $146
million or 0.65 percent a year ago. At June 30, 2006, the allowance for loan
losses was $319 million, equal to 1.28 percent of loans outstanding, compared to
$315 million or 1.41 percent of loans outstanding at the end of second quarter
2005. As a result, the ratio of the allowance for loan losses to nonperforming
assets increased from 215 percent at June 30, 2005 to 255 percent at June 30,
2006.
At June 30, 2006, Tier 1 capital of the Bank amounted to $3.12 billion, up
from $2.83 billion one year earlier. The regulatory leverage capital ratio was
8.48 percent for the second quarter of 2006 compared to 8.43 percent in the same
quarter of 2005. The Bank's capital ratio exceeds the prescribed regulatory
minimum for banks. The Bank's June 30, 2006 Tier 1 and total risk-based capital
ratios were 9.84 percent and 11.77 percent compared to respective ratios of 9.92
percent and 12.05 percent at June 30, 2005.
SIX MONTHS ENDED JUNE 30, 2006 COMPARED WITH JUNE 30, 2005
SUMMARY
The Bank had net income for the six months ended June 30, 2006 of $93.2
million, a decrease of $21.8 million or 19 percent from the same period a year
ago. Return on equity was 6.31 percent in the current
16
HARRIS N.A. AND SUBSIDIARIES
year, compared to 8.28 percent from last year. Return on assets was 0.52 percent
compared to 0.70 percent a year ago.
Net interest income on a fully taxable equivalent basis was $423.1 million,
up $14.4 million or 4 percent from $408.7 million in 2005's year-to-date period.
Average earning assets increased 10 percent to $32.98 billion from $30.07
billion in 2005. Loan growth of 4.77% fueled the increase in earnings assets.
Net interest margin decreased to 2.58 percent from 2.73 percent in 2005,
reflecting the impact of higher rates on deposits and the issuance of
higher-cost wholesale supporting funds. This was somewhat offset by higher
yields in the loan portfolio and strong retail loan growth.
The year-to-date 2006 provision for loan losses was $11.3 million compared
to $5.1 million in 2005, an increase of $6.2 million. Net charge-offs were $15.9
million, an increase of $4.7 million from last year, resulting primarily from
higher retail loan write-offs. The increase in provision resulted from increased
net charge-offs and management's assessment of non-performing loans.
Noninterest income of $185.3 million decreased $23.8 million or 11 percent
from the same period last year. This was primarily attributable to a $9.5
million decline in trust and investment management fees a $9.3 million decrease
in intercompany service income, a $3.2 million prior year gain on a loan sale
and lower indirect loan and referral fees. The decreases were partially offset
by a $2.6 million increase in service charges and fees and a $2.4 million
increase in net securities gains.
Noninterest expenses of $451.0 million increased $15.4 million or 4 percent
from the year-ago period. The increase was attributable to intercompany service
costs rising by $11.9 million and a $5.3 increase in expert service fees, as
well as increases in most expense categories. These increases were primarily
offset by reduced salaries and other compensation expenses. Income tax expense
decreased $12.8 million, reflecting lower pretax income from year ago results.
17
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, 2006, Paul R. Skubic, the Chairman of the Board, Chief
Executive Officer and President of the Company, and Pamela C. Piarowski, 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 decisions 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, 2006 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, 1A, 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 PAMELA C. PIAROWSKI PURSUANT TO RULE 13A-14(A)
31.2 CERTIFICATION OF PAUL R. SKUBIC PURSUANT TO RULE 13A-14(A)
32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
18
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 14th day of August
2006.
/s/ PAUL R. SKUBIC
--------------------------------------
Paul R. Skubic
Chairman of the Board and President
/s/ PAMELA C. PIAROWSKI
--------------------------------------
Pamela C. Piarowski
Chief Financial Officer
19