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 March 31, 2009

 

Commission file number 1-13805

 

Harris Preferred Capital Corporation

(Exact name of registrant as specified in its charter)

 

 

 

Registrant’s telephone number, including area code:

(312) 461-2121

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

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 þ     No o

 

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

  Yes o     No o

 

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

(Do not check if a smaller reporting company)

 

 

Indicate by check mark whether the registrant is a shell company ( as defined in Rule 12b-2 of the Act).

  Yes o     No þ

 

 

The number of shares of Common Stock, $1.00 par value, outstanding on May 15, 2009 was 1,180. No common equity is held by nonaffiliates.

 

 

HARRIS PREFERRED CAPITAL CORPORATION

 

TABLE OF CONTENTS

 

HARRIS PREFERRED CAPITAL CORPORATION

 

CONSOLIDATED BALANCE SHEETS

 

 

The accompanying notes are an integral part of these financial statements.

HARRIS PREFERRED CAPITAL CORPORATION

 

CONSOLIDATED STATEMENTS OF INCOME

AND COMPREHENSIVE INCOME

 

 

The accompanying notes are an integral part of these financial statements.

HARRIS PREFERRED CAPITAL CORPORATION

 

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

 

 

The accompanying notes are an integral part of these financial statements.

HARRIS PREFERRED CAPITAL CORPORATION

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

The accompanying notes are an integral part of these financial statements.

HARRIS PREFERRED CAPITAL CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

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 2008 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.

 

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.

 

 

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 at March 31, 2009.

 

 

The amortized cost and estimated fair value of securities available-for-sale were as follows:

 

 

 

HARRIS PREFERRED CAPITAL CORPORATION

 

 

 

The Company classifies all securities as available-for-sale. Available-for-sale securities are reported at fair value with unrealized gains and losses included as a separate component of stockholders’ equity. At March 31, 2009, net unrealized gains on available-for-sale securities were $14.5 million compared to $10.6 million of net unrealized gains on December 31, 2008.

 

 

The Company uses a fair value hierarchy to categorize the inputs used in valuation techniques to measure fair value. The extent of the use of quoted market prices (Level 1), internal models using observable market information as inputs (Level 2) and internal models without observable market information (Level 3) in the valuation of available-for-sale securities at March 31, 2009, December 31, 2008 and March 31, 2008 are presented in the following table:

 

 

 

 

HARRIS PREFERRED CAPITAL CORPORATION

 

 

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, as amended, 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 2008 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

 

First Quarter 2009 Compared with First Quarter 2008

 

The Company’s net income for the first quarter of 2009 was $4.9 million, compared to $5.3 million from the first quarter 2008. Earnings decreased primarily because of the initial recognition of Illinois state income taxes during the current quarter.

 

Interest income on securities purchased under agreement to resell for the first quarter of 2009 was $9 thousand, on an average balance of $34 million, with an annualized yield of 0.11%. During the same period in 2008, the interest income on securities purchased under agreement to resell was $634 thousand, on an average balance of $69 million, with an annualized yield of 3.69%. The decrease in income was attributable to lower yields in the short-term money market. The Federal Fund rates at March 31, 2009 was 0.18% compared to the Federal Fund rates at March 31, 2008 of 2.61%. First quarter 2009 interest income on the Notes receivable (Notes) totaled $64 thousand and yielded 6.4% on $4 million of average principal outstanding for the quarter compared to $82 thousand and a 6.4% yield on $5.1 million average principal outstanding for first quarter 2008. The decrease in income was attributable to a reduction in the Notes balance because of customer payoffs in the Securing Mortgage Loans. At March 31, 2009 and 2008, there were no Securing Mortgage Loans on nonaccrual status. Interest income on securities available-for-sale for the current quarter was $5.4 million resulting in a yield of 4.52% on an average balance of $476 million, compared to $4.7 million with a yield of 4.5% on an average balance of $413 million for the same period a year ago. Virtually all income in the current quarter was attributable to the mortgage-backed security portfolio.

 

There were no Company borrowings during first quarter 2009 or 2008.

 

First quarter 2009 operating expenses totaled $179 thousand, an increase of $38 thousand or 27% from the first quarter of 2008. General and administrative expenses totaled $120 thousand, an increase of $22 thousand over the same period in 2008, primarily due to increases in insurance costs and regulatory filings and processing costs, and director fees. Advisory fees for the first quarter 2009 were $56 thousand compared to $39 thousand a year earlier, primarily due to increase in production costs.

 

On March 30, 2009, the Company paid a cash dividend of $0.46094 per share on outstanding Preferred Shares to the stockholders of record on March 15, 2009 as declared on March 4, 2009. On March 30, 2008, the Company paid a cash dividend of $0.46094 per share on outstanding Preferred Shares to the stockholders of record on March 15, 2008 as declared on March 5, 2008.

 

HARRIS PREFERRED CAPITAL CORPORATION

 

The Company classifies all securities as available-for-sale. The Company has no intent to sell specific securities, and the Company has the ability to hold all securities to maturity. Available-for-sale securities are reported at fair value with unrealized gains and losses included as a separate component of stockholders’ equity. At March 31, 2009, net unrealized gains on available-for-sale securities were $14.5 million compared to $3.4 million of unrealized gains on March 31, 2008.

 

In making a determination of temporary vs. other-than-temporary impairment of an investment, a major consideration of management is whether the Company will be able to collect all amounts due according to the contractual terms of the investment. Such a determination involves estimation of the outcome of future events as well as knowledge and experience about past and current events. Factors considered include the following: whether the fair value is significantly below cost and the decline is attributable to specific adverse conditions in an industry or geographic area; the period of time the decline in fair value has existed; if an outside rating agency has downgraded the investment; if dividends have been reduced or eliminated; if scheduled interest payments have not been made and finally, whether the financial condition of the issuer has deteriorated. In addition, it may be necessary for the Company to demonstrate its ability and intent to hold a debt security to maturity.

 

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. In additional, the Company believes that the $80 million capital contribution from the Company’s parent in March 2009 should provide additional opportunity to invest in earning assets.

 

As presented in the accompanying Consolidated Statements of Cash Flows, the primary sources of funds in addition to $55.3 million provided from operations during the three months ended March 31, 2009, were $48.1 million from the maturities of securities available-for-sale and the $80 million from the issuance of the common stock. In the prior period ended March 31, 2008, the primary sources of funds other than $4.9 million from operations were $121.2 million from the maturities of securities available-for-sale. The primary uses of funds for the three months ended March 31, 2009 were $128.6 million for purchases of securities available-for-sale and $4.6 million in preferred stock dividends paid. Net cash provided by financing activities were $75.4 million compared to $7.6 million used in the prior period ended March 31, 2008. The primary reason was the issuance of stock and capital contribution from the Company’s parent totaling $80 million. For the prior year’s quarter ended March 31, 2008, the primary uses of funds were $121.3 million for purchases of securities available-for-sale and $4.6 million in preferred stock dividends and $3.0 million in common stock dividends paid.

 

HARRIS PREFERRED CAPITAL CORPORATION

 

Market Risk Management

 

The Company’s market risk is composed primarily of interest rate risk. There have been no material changes in market risk or the manner in which the Company manages market risk since December 31, 2008.

 

Accounting Pronouncements

 

In April 2009, the Financial Accounting Standards Board (“FASB”) issued three related Staff Positions (“FSP”) to provide additional application guidance and disclosure requirements regarding fair value measurements and impairments of securities. FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly,” provides guidance on determining fair value when there is no active market and requires additional disaggregated disclosures. FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments,” relate to fair value disclosures under FAS 107 for financial instruments that are not currently reflected on the balance sheet at fair value and require disclosures on a quarterly basis rather than the current annual basis. FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments,” relate to the evaluation of other-than-temporary impairment (“OTTI”) for debt securities classified as available-for-sale or held-to-maturity, the identification of credit and noncredit components of impairment, the recognition of impairment in earnings or OCI and require significant expanded disclosures on a quarterly basis. The three Staff Positions are effective for periods ending after June 15, 2009. The Company is in the process of assessing the impact of adopting the Staff Positions on its financial position and results of operations.

 

The Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 160, “Noncontrolling Interests in Consolidated Financial Statements — An Amendment of ARB 51,” as of January 1, 2009. The Statement requires those entities that have an outstanding noncontrolling (minority) interest in a subsidiary to report that noncontrolling interest as equity in the consolidated financial statements. The adoption of the Statement did not have a material effect on the Company’s financial position or results of operations.

 

Tax Matters

 

As of March 31, 2009, the Company believes that it is in full compliance with the REIT federal tax rules, and expects to qualify as a REIT under the provisions of the Internal Revenue Code. The Company expects to meet all REIT requirements regarding the ownership of its stock and anticipates meeting the annual distribution requirements. Beginning January 1, 2009, Illinois requires a “captive” REIT to increase its state taxable income by the amount of dividends paid. Under this law, a captive REIT includes a REIT of which 50% of the voting power or value of the beneficial interest or shares is owned by a single person. Management believes that the Company would be classified as a “captive” REIT under Illinois law, in light of the fact that (1) all of the Company’s outstanding common shares are held by Harris Capital Holdings, Inc. a wholly owned subsidiary of Harris N.A. and (2) the Company’s Common Stock represents more than 50% of the voting power of the Company’s equity securities and (3) the Common Stock is not listed for trading on an exchange. Management believes that the future state tax expense to be incurred by the Company beginning January 1, 2009 should not have a material adverse effect upon the Company’s ability to declare and pay future dividends on the preferred shares. The current Illinois statutory tax rate is 7.3%. This belief is based upon the ownership interest of the Company, whereby any tax expense incurred is expected to primarily reduce the net earnings available to the holder of the Common Stock. For the first quarter of 2009, $385,000 Illinois income tax was recorded.

 

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.

HARRIS N.A. AND SUBSIDIARIES

 

 

 

The accompanying notes to consolidated financial statements are an integral part of these statements.

 

HARRIS N.A. AND SUBSIDIARIES

 

 

 

The accompanying notes to consolidated financial statements are an integral part of these statements.

HARRIS N.A. AND SUBSIDIARIES

 

 

 

The accompanying notes to consolidated financial statements are an integral part of these statements.

HARRIS N.A. AND SUBSIDIARIES

 

 

 

The accompanying notes to consolidated financial statements are an integral part of these statements.

HARRIS N.A. AND SUBSIDIARIES

 

 

 

The accompanying notes to consolidated financial statements are an integral part of these statements.

HARRIS N.A. AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

Harris N.A. (the “Bank”) is a wholly-owned subsidiary of Harris Bankcorp, Inc. (“Bankcorp”), a wholly-owned subsidiary of Harris Financial Corp. (“HFC”), 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 inter-company 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 29, 2008 Bankcorp completed the acquisition of Merchants and Manufacturers Bancorporation, Inc. (“Merchants and Manufacturers”), for a purchase price of $136.7 million. Of this amount, $111.5 million was recorded as goodwill and $11.0 million was recorded as a core deposit premium intangible with an expected life of ten years. Bankcorp recorded additional goodwill of $3.4 million for related acquisition costs. Goodwill and other intangibles related to this acquisition are not deductible for tax purposes. The results of Merchants and Manufacturers’ operations have been included in Bankcorp’s consolidated financial statements since March 1, 2008. The acquisition of Merchants and Manufacturers provides Bankcorp with the opportunity to expand banking services in the Wisconsin market.

 

On February 29, 2008 BMO completed the acquisition of Ozaukee Bank (“Ozaukee”), for a purchase price of $183.3 million consisting of 3,283,190 BMO common shares with a market value of $55.84 per share. BMO immediately contributed Ozaukee to HFC in exchange for HFC common shares. HFC immediately contributed Ozaukee to Bankcorp in exchange for Bankcorp common shares. Of the purchase price amount, $127.7 million was recorded as goodwill and $11.7 million was recorded as a core deposit premium intangible with an expected life of ten years. Bankcorp recorded additional goodwill of $1.8 million for related acquisition costs. Goodwill and other intangibles related to this acquisition are not deductible for tax purposes. The results of Ozaukee’s operations have been included in Bankcorp’s consolidated financial statements since March 1, 2008. The acquisition of Ozaukee provides Bankcorp with the opportunity to expand banking services in the Wisconsin market.

 

On September 6, 2008, Bankcorp merged Merchants and Manufacturers with and into the Bank and merged Ozaukee with and into the Bank. Each transaction was recorded at its respective carrying value on that date. The interim financial statements for the three month period ended March 31, 2008 of the Bank include the results of the merged entities since March 1, 2008.

 

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.

 

 

Harris N.A. and certain of its subsidiaries are party to legal proceedings in the ordinary course of their businesses. While there is inherent difficulty in predicting the outcome of these proceedings, management does not expect the outcome of any of these proceedings, individually or in the aggregate, to have a material adverse effect on the Bank’s consolidated financial position or results of operations.

 

 

In the Consolidated Statements of Cash Flows, cash and cash equivalents include cash and demand balances due from banks, interest-bearing deposits at banks and federal funds sold and securities purchased under agreement to resell. Cash interest payments for the three months ended March 31 totaled $145.1 million and $281.4 million in

 

HARRIS N.A. AND SUBSIDIARIES

 

2009 and 2008, respectively. Cash income tax payments over the same periods totaled $294 thousand and $26.8 million, respectively.

 

 

Harris N.A. was a member of Visa U.S.A. Inc. (Visa U.S.A.) and in 2007 received shares of restricted stock in Visa, Inc. (Visa) as a result of its participation in the global restructuring of Visa U.S.A., Visa Canada Association, and Visa International Service Association in preparation for an initial public offering by Visa. Harris N.A. and other Visa U.S.A. member banks were obligated to share in potential losses resulting from certain indemnified litigation involving Visa that has been settled.

 

A member bank such as Harris N.A. was also required to recognize the contingent obligation to indemnify Visa under Visa’s bylaws (as those bylaws were modified at the time of the Visa restructuring on October 3, 2007), for potential losses arising from the other indemnified litigation that has not yet settled at its estimated fair value in accordance with FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” Harris N.A. is not a direct party to this litigation and does not have access to any specific, non-public information concerning the matters that are the subject of the indemnification obligations. While the estimation of any potential losses was highly judgmental, as of December 31, 2007, Harris N.A. recorded a liability and corresponding charge of $34 million (pretax) for the remaining litigation.

 

The initial public offering (IPO) occurred on March 25, 2008 followed by a mandatory partial redemption of Harris’ restricted stock in Visa that took place in two parts: exchange for cash and funding of the covered litigation escrow account. During the first quarter of 2008, Harris N.A. received $37.8 million in cash in conjunction with the mandatory partial redemption which was recognized as an equity security gain in the Consolidated Statement of Income since there was no basis in the stock. In addition, Visa funded the U.S. litigation escrow account with IPO proceeds. Harris’ share of the U.S. litigation escrow account funding was $17 million which was recognized as a reversal to the litigation reserve and as a decrease to other non-interest expense.

 

On October 27, 2008, Visa announced the settlement of the litigation involving Discover Financial Services. As a result, the Bank recorded an additional reserve for this matter of $7.0 million (pretax) during the third quarter as an increase to non-interest expense.

 

In December 2008 Harris N.A. recorded a decrease to non-interest expense of $6.3 million as a reduction in the Visa litigation reserve to reflect Visa’s use of a portion of the Bank’s restricted Visa stock to fund the escrow account available to settle certain litigation matters. Visa’s funding of amounts required beyond the current escrow, if any, will be obtained via additional mandatory redemptions of restricted shares. As of March 31, 2009 and December 31, 2008 the recorded reserve relating to the Visa litigation matter included in the Consolidated Statement of Condition was $17.8 million.

 

 

In April 2009, the Financial Accounting Standards Board (“FASB”) issued three related Staff Positions (“FSP”) to provide additional application guidance and disclosure requirements regarding fair value measurements and impairments of securities. FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly,” provides guidance on determining fair value when there is no active market and requires additional disaggregated disclosures. FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments,” relate to fair value disclosures under FAS 107 for financial instruments that are not currently reflected on the balance sheet at fair value and require disclosures on a quarterly basis rather than the current annual basis. FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments,” relate to the evaluation of other-than-temporary impairment (“OTTI”) for debt securities classified as available-for-sale or held-to-maturity, the identification of credit and noncredit components of impairment, the recognition of impairment in earnings or OCI and require significant expanded disclosures on a quarterly basis. The three Staff Positions are

 

HARRIS N.A. AND SUBSIDIARIES

 

effective for periods ending after June 15, 2009. The Bank is in the process of assessing the impact of adopting the Staff Positions on its financial position and results of operations.

 

 

The Bank adopted FAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115, as of January 1, 2008. The Statement permits entities to choose to measure certain eligible items at fair value at specified election dates. In 2008, the Bank elected the fair value option for certain financial liabilities. The carrying value of those liabilities was $156.2 million at March 31, 2009 and $77.7 million at December 31, 2008.

 

 

The Bank adopted Emerging Issues Task Force (“EITF”) Issue No. 06-04, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements,” in the first quarter of 2008. It requires recognition of a liability and related compensation costs for endorsement split-dollar life insurance arrangements that provide employee benefits in postretirement periods. The Bank acquired endorsement split-dollar life insurance arrangements for certain employees through various bank acquisitions. Upon adoption of the EITF, the Bank recognized a $0.5 million increase in the liability for deferred compensation; recorded a $0.3 million decrease in retained earnings and a $0.2 million increase in deferred taxes.

 

 

Auction-rate securities (ARS) are typically short-term notes issued in the United States to fund long-term, fixed rate debt instruments (corporate or municipal bonds primarily issued by municipalities, student loan authorities and other sponsors). The interest rate on ARS is regularly reset every 7 to 35 days through auctions managed by financial institutions. A disruption in the market for ARS occurred in the early part of 2008. Certain customer-managed portfolios held these securities, which were no longer liquid.

 

In 2008, the Bank offered to purchase specific holdings of ARS from certain client accounts at par value plus accrued interest. The gross par value of ARS holdings purchased was $93.1 million plus accrued interest. A discounted cash flow valuation methodology was applied to estimate the fair value of the securities. The methodology included management assumptions about future cash flows, discount rates, market liquidity and credit spreads. The difference between the estimated fair values and the par values paid by the Bank resulted in a pre-tax charge of $21.8 million for the year ended December 31, 2008 in addition to the legal costs of $185 thousand. The purchases of these securities were substantially completed by December 31, 2008 and the ARS purchased are classified as available-for-sale. As of March 31, 2009 the fair value of the ARS held by the Bank was $61.3 million and the amortized cost was $68.5 million.

 

 

The Bank adopted Statement of Financial Accounting Standards (“SFAS”) No. 160, “Noncontrolling Interests in Consolidated Financial Statements — An Amendment of ARB 51,” as of January 1, 2009. The Statement requires those entities that have an outstanding noncontrolling (minority) interest in a subsidiary to report that noncontrolling interest as equity in the consolidated financial statements. Upon adoption, $250 million of noncontrolling interest was reclassified from liabilities to the Bank’s stockholder’s equity.

HARRIS N.A. AND SUBSIDIARIES

 

FINANCIAL REVIEW

 

First Quarter 2009 Compared with First Quarter 2008

 

Summary

 

The Bank’s first quarter 2009 net income was $3.5 million, a decrease of $72.6 million or 95.4 percent from the first quarter of 2008, primarily the result of a higher provision for credit losses.

 

Net interest income was $220.9 million, down $5.8 million or 2.6 percent from a year ago, largely due to a higher level of non-accrual loans. The decline in the net interest margin to 1.91 percent from 2.53 percent in the first quarter of 2008 also reflects an increase in low return Federal Reserve Bank interest-bearing deposits. Average earning assets increased to $47.2 billion in 2009 from $37.6 billion in 2008, due to an increase of $11.2 billion in Federal Reserve Bank interest-bearing deposits. In turn, these balances are the result of a substantial increase in nonretail demand deposits.

 

Provision for loan losses of $93.1 million was up $69.9 million over last year primarily attributable to higher net charge-offs on commercial and consumer credits and increased levels of estimated loss in both the commercial and consumer credit portfolios. Net loan charge-offs during the quarter were $58.3 million compared to $17.2 million in the same period last year. The provision for loan losses is based on past loss experience, management’s evaluation of the loan portfolio under current economic conditions and management’s estimate of losses inherent in the portfolio.

 

Non-interest income was $130.9 million, a decrease of $18.6 million or 12.5 percent. This was primarily attributable to a $37.8 million decrease in equity securities gains largely due to participation in the Visa initial public offering in the first quarter of 2008. This impact was partially offset by a $17.6 million increase in net securities gains during the current quarter.

 

First quarter 2009 non-interest expenses were $262.0 million, an increase of $20.3 million or 8.4 percent. During first quarter 2008, the Bank reversed $17.0 million of prior expense in conjunction with the Visa litigation escrow account funding (Note 4). In addition, in 2009 there was a $10.0 million increase in operating and integration costs associated with the Wisconsin acquisitions (Note 1). Excluding these items, expenses declined $6.6 million largely due to a $12.8 million reduction in compensation-related costs along with a $5.2 million decline in inter-company service charges. This was somewhat offset by a $13.8 million rise in FDIC insurance. Income tax expense decreased $42.1 million from the first quarter of 2008, reflecting lower pre-tax income.

 

Nonperforming loans at March 31, 2009 totaled $579 million or 2.31 percent of total loans, compared to $427 million or 1.64 percent a year earlier. At March 31, 2009, the allowance for loan losses was $607.6 million, equal to 2.42 percent of loans outstanding compared to $373.2 million or 1.43 percent of loans outstanding at the end of the first quarter 2008. Coverage of nonperforming loans by the allowance for loan losses increased from 87 percent at March 31, 2008 to 105 percent at March 31, 2009.

 

At March 31, 2009 consolidated stockholder’s equity of the Bank amounted to $3.9 billion, unchanged from December 31, 2008. Return on equity was 0.37 percent in the current quarter, compared to 7.79 percent in last year’s first quarter. Return on assets was 0.03 percent compared to 0.74 percent a year ago. The Bank did not declare any dividends on common stock in the first quarter of 2009 compared to $8.0 million declared in the first quarter of 2008.

 

At March 31, 2009, Tier 1 capital of the Bank amounted to $3.6 billion, unchanged from one year earlier. The Bank’s March 31, 2009 Tier 1 and total risk-based capital ratios were 10.95 percent and 13.09 percent compared to respective ratios of 10.72 percent and 12.69 percent at March 31, 2008. The regulatory leverage capital ratio was 7.05 percent for the first quarter of 2009 compared to 8.95 percent a year ago, the decrease primarily attributable to the aforementioned increase in Federal Reserve Bank deposits. The Bank’s capital ratios exceed the prescribed regulatory minimum for well-capitalized banks.

 

 

See “Liquidity Risk Management” and “Market Risk Management” under Management’s Discussion and Analysis of Financial Condition and Results of Operations on page 8.

 

The following table stratifies the Company’s available-for-sale securities by maturity date (dollars in thousands):

 

 

 

 

At March 31, 2009, December 31, 2008 and March 31, 2008, the Company’s investments held in mortgage-backed securities are secured by adjustable and fixed interest rate residential mortgage loans. The yield to maturity on each security depends on, among other things, the price at which each such security is purchased, the rate and timing of principal payments (including prepayment rates as well as default rates, which in turn would impact the value and yield to maturity of the Company’s mortgage-backed securities. These investments are guaranteed by the Federal National Mortgage Association, (“FNMA”) or “Freddie Mac,” and none of the underlying loan collateral is represented by sub-prime mortgages.

 

 

 

Harris Preferred Capital Corporation’s management, with the participation of the Chief Executive Officer and Chief Financial Officer, has evaluated the Company’s disclosure controls and procedures as of March 31, 2009. Based on this evaluation, management has concluded that the disclosure controls and procedures are effective to provide reasonable assurance that the information required to be disclosed by the Company in the reports filed under the Securities Exchange Act of 1934, as amended is (i) recorded, processed, summarized and reported within the time period specified in the Securities and Exchange Commission’s rules and forms, and (ii) accumulated and communicated to management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

 

 

There were no changes in our internal control over financial reporting that occurred during the quarter ended March 31, 2009 that has materially affected, or is reasonably likely to materially affect, internal control over financial reporting.

 

Items 1, 1A, 3, 4 and 5 are being omitted from this Report because such items are not applicable to the reporting period.

 

 

Please refer to the Company’s Current Report filed on Form 8-K dated March 4, 2009

 

 

3.1  Articles of Incorporation, as amended, of Harris Preferred Capital Corporation*

 

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

 

 

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, there unto duly authorized on the 15th day of May 2009.

 

Paul R. Skubic
Chairman of the Board and President

 

Pamela C. Piarowski
Chief Financial Officer